Midterm Notes - Tax

Why is income subject to Tax?

It is the best measure of a taxpayer's ability to pay tax.
It is an excellent object of taxation in the allocation of government costs.

(those who earn more will pay more tax)

GROSS INCOME - any inflow of wealth to the taxpayer that net worth from whatever source, legal or illegal.

(inflow of wealth should increase the net worth, not just a mere return of what he have invested)

-It includes income from employment, trade, business or exercise of profession, income from properties, and other regular or casual transactions.

(all sources of income regardless of the source will be subjected to taxes)

ELEMENTS OF GROSS INCOME

It is a RETURN ON CAPITAL that increases net worth.

(return on capital is any wealth that increases or the profit earned more than the capital. It is a TAXABLE INCOME)

It is a REALIZED BENEFIT.

(it is something that you already owned, you can use it in any way or you can enjoy the benefit from that income therefore TAXABLE, however, unrealized gain are not taxable because it is just a mere paper income)

It is NOT EXEMPTED by law, contract, or treaty.

(if there is a specific law that exempts such income from any taxes, then that is not taxable)

GROSS INCOME (SEC 32A)

All income derived from whatever source including, but not limited to the following:

Compensation for services
Interests
Rents
Royalties
Dividends
Annuities
Prizes and winnings
Pension
Partners distributive share
Gross income derived from trade or the exercise of a profession
Gains from property

INCOME TAX MODEL:

Gross income

Less: Allowable deductions

Net Taxable Income

Apply: Tax rate

Income Tax Due

Less: Tax credit, if any

Income Tax Still Due or Payable

GROSS INCOME:

Exempt - excluded in the computation, not subject to any taxes.
Final Tax - withheld tax that cannot be taxed again, not part of the income tax model.
Basic Tax - may be subjected to creditable withholding taxes.

Final withholding taxes - it is already the tax and cannot be taxed again because it will violate the principle.
Creditable withholding taxes - it is an advance tax payment, so not yet the tax

(Income subject to BASIC TAXES may be subjected to CREDITABLE withholding taxes. But ALL subject to FINAL TAX is subject to FINAL withholding taxes.)

GENERAL RULE/GOLDEN RULE:

Resident Citizen - global

Other citizens - within

NRANETB - 25% final tax
Domestic Corp. - global

Foreign Corp. - within

NRFC - 25% final tax under CREATE LAW
Passive income except rent - final tax (PI means you receive an income without doing anything)
All income without the Phil. - RC & DC (subject to BASIC tax)

COMPENSATION INCOME - all remuneration for services performed by an employee for his employer whether paid in cash or in kind. Or an income arising out of an employer-employee relationship.

CLASSIFICATION OF COMPENSATION INCOME

Regular Compensation - fixed remuneration such as basic salary, and fixed allowances for representation.
Supplemental Compensation - performance based remuneration, such as overtime pay.
13th month pay and other benefits:

Christmas bonus
Cash gifts
14th and 15th
Other fringe benefits
Additional compensation allow.

REGULAR COMPENSATION INCOME

Salary - general earnings paid on a regular interval.
Wage - paid on an hourly or daily basis.

(mandatory GSIS, SSS, Philhealth, Pag-ibig contributions and union dues are considered as tax exempt contributions, PS: MANDATORY ONLY)

FIXED OR VARIABLE ALLOWANCES

Generally subject to income tax, except:

For ordinary and necessary traveling
Required to account or liquidate for the foregoing expenses
Any excess advances are returned to the employer.

SUPPLEMENTAL COMPENSATION

Fees - professional services
Commissions - quotas are reach
Tips and gratuities - other income of the employee
Overtime pay - work beyond required working hours
Hazard pay - amount paid to those employee who were assigned to great danger
Night differential - between 10pm to 6am
Holiday pay - special day

OTHER FORMS OF COMPENSATION

Property as payment of compensation - fair market value of the property at the time of payment.
Service as payment of compensation - fair market value of the service at the time the service was rendered.
Debt cancellation - income when the creditor wave or cancel in consideration.

Recognize as donation when creditor simply cancels without consideration

Payment of dividends - canceled by BOD without any consideration.
Issuance of shares of stocks as payment of compensation - at the fair market value at the time it is issued.
Issuance of notes as payment of compensation - fair value of note

Interest bearing - face amount

Non interest bearing - discounted to its Present Value

13TH MONTH PAY & OTHR BENEFITS

13th month pay - equivalent to the mandatory one month basic salary.
Other benefits:

Christmas bonus
Productivity incentive bonus
Loyalty awards
Gifts in cash or in kind

(total all the amount including the 13th month, and 90K only is deducted and the rest of income is taxable)

DE MINIMIS BENEFITS - benefits that are minimal or relatively small value thus not taxable.

Monetized unused VACATION LEAVE credits of private employees not exceeding 10 DAYS during the year. (any excess of 90k will be subjected to tax)
Monetized value of VACATION AND SICK LEAVE credits paid to government officials and employees. (unlike private employees, it is exempted from tax regardless of the number of days)
Medical cash allowance to DEPENDENTS of employees not exceeding 1500 per semester or 250 per month.
Rice subsidy of not more than 2k per month or 1 sack of rice per month (50kg)
Uniforms given to employees by the employer not exceeding 6k per annum.
Actual medical assistance given not exceeding 10k per annum such as medical allowance to cover medical and healthcare needs, annual medical or executive check up, maternity assistance and routine consultations.
Laundry allowance not exceeding 300 per month.
Employee achievement awards (must be in a form of tangible personal property other than cash /gift certificate not exceeding 10k)
GIFTS given during christmas and major anniversary celebrations not exceeding 5k per employee per annum. (in excess of 5k will be subject to 90k limit)
Daily meal allowance for overtime work and night/graveyard shift not exceeding 25% of the basic minimum wage.
Benefits received by an employee by virtue of a collective bargaining agreement and productivity incentive schemes provided that the total annual monetary value received from the two items when combined, do not exceed 10k per employee per taxable year. (if more than 10k, the entire amount shall be included in other benefits which will be subjected to 90k limit)

The foregoing list of de minimis benefits are ALL INCLUSIVE, which means, all other benefits which are not included in the enumeration above SHALL NOT be considered de minimis benefits.

MINIMUM WAGE INCOME EARNERS (RS 9504) - refer to a worker in a private sector paid the statutory minimum wage or to an employee in the public sector with compensation income of not more than statutory minimum wage.

Statutory minimum wage - refers to rate fixed by the regional tripartite wage and productivity board as defined by the DOLE (exempt from income tax)

Following are also exempted from tax:

Holiday pay
Overtime pay
Night shift differential
Hazard pay

Rules Governing about Exemptions:

MWE receiving other income - their income from business shall be subjected to tax.
MWE receiving other benefits - shall be subjected to tax if it exceeds the 90k limit.

Separation Pay - refers to the amount due to the employee who has been terminated from services for causes authorized by law. Generally, it is taxable exempt if:

Due to job threatening sickness, death, or other physical disability
Beyond the control of the employee

GENERAL RULE:

Involuntary - tax exempt
Voluntary - part of taxable income

Retirement Pay - amount received by officials and employees of private firms in accordance with a reasonable private benefit plan maintained by the employer. Generally, it is taxable exempt if:

REQUISITE OF EXEMPTION:

Employer maintains a reasonable private plan and is registered to BIR.
Has been in the service of the same employer for at least 10yrs.
At least 50yrs old at the time of retirement.
First time availment of retirement benefit exemption.

BUSINESS AND PROFESSIONAL INCOME

Business income - engagement in commercial activity.
Professional income - exercise of one’s profession.

CLASSIFICATION OF BUSINESS INCOME

Farming - engage in agriculture, farm operation, or production of farm animals.

Cash basis
Accrual basis
Crop year basis

Construction - business engaged in the construction of roads, bridges, buildings, and other permanent structures.

Completed contract - will only recognize income when it is fully completed.
Percentage of Completion - recognize income based on the progress of the work completed.

Interest Income - earning derived from depositing or lending money, goods, or credits. And is subject to income tax.

Bank - final tax
Non-bank - basic tax

(Interest income or yield from local currency bank deposits or deposit substitute are subject to final tax)

Rents - leasing properties of any kind. It is a passive income but subject to regular income tax. It includes:

Obligations of the lessor
Advance rentals - unrestricted & restricted
Improvements made by the lessee

HOW TO RECOGNIZE INCOME FROM LEASEHOLD IMPROVEMENT?

Outright Method - outright means recognize one time, or may report income at the time it is completed at the fair market value of the property at the date of completion.
Spread-out Method - will recognize income every year, or may spread out the life of the lease at the book value of the property.

Annual Income = BV, end of lease term

Remaining term of the lease

Termination of Lease Contract Before Expiration of the Lease Term

	Outright	Spread-out
Income	FMV@completion	Annual Income
Termination of contract	Additional income = 0	FMV@termination less income recognize
Loss of property B4 end of lease term	FMV@completion less depreciation	Loss = Income recognize

Royalties - payment or portion of proceeds paid to the owner of a right, such as an oil right or a patent for the use of it, or a portion of the proceeds from the work of an author or composer. Generally, subject to FINAL TAX. While active royalties are subject to Basic Tax.

Dividends - any distribution made by a corporation to its shareholders, out of its earnings or profits and payable to shareholders, whether in money or in property.

Domestic - Final Tax
Foreign - basic tax

Foreign Corporation receive dividend from domestic can be exempted if:

Dividends are reinvested in the business operations within the next taxable year.
Shall only be used for working capital, working expense, etc.
Holds at least 20% and it is uninterrupted.

DC - within

NRFC - without

RFC - within

Without

(by predominance test)

GI - Phils 3yrs = 50% or less - without

GI - World 3yrs 51% to 85% - partly within, party w/out (%Xdividend=within)

86% or more = within

Annuities - refers to the installment amount paid for life insurance coverage returned by an insurance company. The basic concept of income will be applied.

Prizes - without effort

	Individuals	NRANETB	Corporations	NRFC
10kmore	20%	25%	basic	30%
10kless	basic	25%	basic	20%
foreign	basic	NT	basic	NT

Exempt prizes:

Prizes received without effort to join a contest.
Prizes from sports competitions that are sanctioned by the National Sport Organization.

Winnings - with effort

Lotto/PCSO - exempted if less than 10k
If more than, subject to 20% final tax

PARTNERS DISTRIBUTIVE PROFIT FOR GPP’S NET INCOME - the partner’s share in the distributive profit of a professional partnership represents his gross income.

OTHER SOURCES OF INCOME:

Recovery of Bad debts written off - should be included in gross taxable income in the year of recovery.
Tax refund - tax paid and later on refunded, taxable but not all tax refund.

Deductible expense - taxable

Non deductible - not taxable

Damages recovery - compensation for loss of profit or life.

Profit - taxable

Life - non taxable

Life insurance - proceeds paid to heirs upon death of the insured are excluded from gross income (except if there is an agreement about interest)
Gifts - free, subject to donor’s tax
Bequests - personal property transferred by will, estate tax
Devises - real property transferred by will, estate tax. It is the inheritance at the time of death.

Fringe Benefits - is still part of gross income. It is a form of compensation, particularly a bonus or other benefits given by an employer to his employee.

Sec 33 (B), any good, service or other benefit provided or granted in cash or in kind by an employer to an individual employee in addition to the basic salary, but not limited to the following:
Housing
Expense account
Vehicle
Household personnel, such as maid, driver, and others
Interest on loan at less than market rate
Membership fees, dues and other expenses
Expenses for foreign travel
Holiday and vacation expenses
Educational assistance to the employee or his dependents
Life or health insurance and other non-life insurance premiums or similar accounts

PROPER TAX TREATMENT FOR FRINGE BENEFITS

Depends primarily on the classification on the employee receiving fringe benefits:

Ran-and File - not holding a managerial or supervisory position.
Supervisory - are those employees who, in the interest of the employer, effectively recommend such managerial actions if the exercise of such authority is not merely routinary or clerical in nature but requires the use of independent judgment.
Managerial - include those who are vested with powers or prerogatives to lay down and execute management policies and/or hire, transfer, suspend, lay-off, recall, discharge, assign, or discipline employees.

Rank and file - included as part of gross taxable income subject to basic tax.

Supervisory and Managerial - not part of gross taxable income but subject to fringe benefit tax or final tax.

NON-TAXABLE FRINGE BENEFITS

Fringe benefits authorized and exempt from tax under special laws
Contributions of the employer for the benefit of the employee to retirement, insurance, and hospitalization benefit plans.
Benefits given to rank and file employees, whether granted under a collective bargaining agreement or not.
De minimis benefits
Fringe benefits granted to the employee, that is required by the nature of, or necessary to, the trade, business or profession of the employer. (The Benefit should be the employer)
Fringe benefit given to the employee for the convenience or advantage of the employer.

FRINGE BENEFIT TAX

The fringe benefit tax is a FINAL TAX ON THE EMPLOYEE’S INCOME TO BE WITHHELD BY THE EMPLOYER.
The withholding and remittance of fringe benefit tax shall be made on a quarterly basis.

TAX BASE AND RATES

Sec 33 (A) - Final tax shall be imposed on the GROSSED-UP MONETARY VALUE OF FRINGE BENEFITS granted to the employee by the employer, whether the latter is an individual or a corporation.
GROSSED-UP MONETARY VALUE (GUMV) = Monetary value or actual value divided by Grossed-up monetary rate.
the whole amount of income realized by the employee which includes the net amount of money or net monetary value of property that has been received.
FBT = GUMV x FBTR

BASIC PROCEDURES IN COMPUTING FBT

Classify properly the taxpayer.
Determine the correct actual value of the fringe benefit.
Compute the correct monetary value of the fringe benefit.
Compute the GUMV by dividing the monetary value by its GUMR
Multiply the GUMV by the fringe benefits tax rate.

MONETARY VALUE - GENERAL RULE

Cash - face value
MV = cash given or paid
Except for rent, MV = ½ of cash paid
FBE = GUMV (cash given or paid + FBT)
In kind - transfer of ownership
MV = PURCHASE PRICE OR FAIR MARKET VALUE OF THE PROPERTY or BOOK VALUE, whichever is higher
FMV = Zonal or Market value, whichever is higher
FBE = Book Value + FBT
Use - usufructuary rights or the right to use of property
MV = 50% of depreciation
FBE = FBT
Useful life - 5 years if personal property, 20 years if real property

OTHER BENEFITS

Purchase of car in installment
MV = purchase price / 5
50% if use and 100% if given
Interest is not included in the MV
Purchase of real property in installment
MV = Purchase price / 20
50% if use and 100% if given
Interest is not included in the MV
Forgone interest on loans granted
MV = principal x (12%-r) x t
12% is the standard interest rate
Foreign Travel
no documentary evidence = 100% of the cost
With documentary evidence:
Business class or economy ticket = exempt
First class ticket = 30% FB
Lodging expense = exempt
Food, beverages, and local transportation = $300/day is exempt and if there is an excess, it is taxable.
Educational assistance
EMPLOYEE
if related to business or with obligation to remain in the employ of the employer = exempt, otherwise = taxable
DEPENDENTS
provided under competitive scheme = non taxable
Use of aircraft, helicopter, or yacht
aircraft or helicopter = not subject
Yacht = MV is AC/20