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Chapter 9 - Regular Income Tay: Inclusion in Gross Income CHAPTER 9 REGULAR INCOME TAX: INCLUSION IN GROSS INCOME Chapter Overview and Objectives pected to demonstrate: 1. Mastery of the NIRC list of items of gross income subject to regular tax and their measurement rujes 2. Knowledge of the boundg gains tax and those subject 3. Knowledge of the link be regular income tax 4. Comprehension of the effect of acco reportable amount of gross income Knowledge of the treatment of creditable withholding tax Understanding the treatment of income from pass-through entities Mastery of the rules on recoveries of past deductions Appreciation of the es sence and purposes of transfer pricing regulation ITEMS OF GROSS INCOME The term items of gross income or inclusions in gross income is a broad category Pertaining to all items of income subject to taxation, namely: L. Gross income subject to final tax ‘ 2. Gross income subject to capital gains tax 3. Gross income subject to regular tax ry between income subject to final tax or capital toregular income tax . tween items of exempt income and income subject to unting methods and situs rules on the ®© N o Items of gross income subject to final tax and items of gross income subject to ‘@pital gains tax are respectively discussed in Chapter 5 and Chapter 6. This Chapter focuses on the items of gross income subject to regularl tax. ITEMS oF GROSS INCOME SUBJECT TO REGULAR TI_&X . Toss income includes, but is not limited to, the follgwmg items: Compensation for services in whatever form paid . _ r0ss income from the conduct of trade, business, or exercise of a profession ains derived from dealings in properties Interegt Rentg Royaltieg o v A WL 287
Chapter 9 - Regular Income Tax: Inclusion in Gross Income 7. Dividends 8. Annuities 9. Prizes and winnings 10. Pensions 11. Partner’s distributive share from the net income of general professional partnership Compensation for services in whatever form paid Under current tax rules, the term “compensation income” technically pertains to the types of employee benefits that are subject to regular tax. The fringe benefits of managerial or supervisory employees are not considered compensation income and are subject to final tax. To minimize the complexity of this section, compensation income is separately discussed in Chapter 10. Gross income from the conduct of trade, business or exercise of a profession This includes income from any trade or business, legal or illegal, and whether registered or unregistered. Gross income from business or profession is determined as follows: Sales/Revenues/Receipts/Fees P xxxxxx Less: Cost of sales or services XXX XXX Gross income from operations P xXxxxxx The following business income shall not be included in gross income subject to regular income tax: 1. Business income exempt from income tax such as: a. Gross income from a Barangay Micro-Business Enterprise (BMBE) under RA 9178 b. Gross income from enterprises enjoying tax holiday incentives under the CREATE law which have not yet graduated to their income tax holiday incentives 2. Business income subject to special tax such as: a. Philippine Economic Zone Authority (PEZA)-registered enterprises subject to 5% gross income tax b. Tourism Infrastructure and Enterprise Zone Authority (TIEZA)-registered enterprises subject to 5% gross income tax C. Income of self-employed and or individuals (SE/P) who opted to be taxed under the 8% income tax 3. Business income subject to final tax when not subjected to final tax by the payor a. Subcontractors o : . . f petroleum service contractors subject to 8% final tax - Business income of foreign currency deposit units (FCDUs) and expanded FCDUs (eFCDUs) from Philippine residents subject to 10% final tax Taxpayers with multi Ple type of business i - iect to regular tax under the column “Regul o o chal repart their gross income subje ar” in the computation of tax per regime in the Annual 288
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Income Tax Return. Gross income subject to special rate and those . o _ exempts are pre respectively under the columns “Total Special” and “Total Exempt. p presented Gains from Dealings in properties The gains. or los.ses in dealing in ordinary assets are subject to regular income tax. Dealings in capital assets other than domestic stocks and real properties are also subject to regular income tax. Ordinary gains are included as items of gross income. Ordinary losses are items of deductions against gross income. The net capital gain from other capital assets after deducting capital losses is also included as an item of gross income. A net capital loss is not an item of deduction against gross income. To avoid complicating this section, the tax rules on measurement and recognition of gains from dealings in properties are discussed in detail in Chapter 12. Interest income This particularly refers to interest income other than passive interest income subject to final tax. A taxable interest income must have been actually paid out of an agreement to pay interest. It cannot be imputed. (CIR vs. Filinvest Development Corporation, GR 163653 and 167689) Examples of interest income subject to regular income tax: 1. Interest income from lending activities to individuals and corporations by banks, finance companies, and other lenders A 2. Interest income from corporate bonds and promissory notes 3. Interestincome from bank deposits abroad Exempt interest income The following are exempt from regular income taxation: 1. Interest income earned by landowners in disposing their lands to their tenants pursuant to the Comprehensive Agrarian Reform Law 2. Imputed interest income Imputed interest income (the opportunity cost of money) does not constitute an actual income; hence, it is exempt from income tax. The power of the Commissioner to allocate income and deduction does not include the power to impute “theoretical interest.” (Ibid) Mlustration Sapphire Bank has the following income in 2021: Interest income from loans P 3,000,000 Interest income from deposits with other banks 400,000 Interest income from notes rediscounting 100,000 50,000 Interest income from Treasury notes 289
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Only the interest income from loans and notes rediscounting are items of gross incom, subject to regular income tax. The interest on deposits and treasury notes are itemg of gross income subject to final income tax. Rents . ol o Rent income arises from leasing properties of any kind. It is a passive income by is not subject to final tax under the NIRC; hence, it is subject to regular income tay. Special considerations on rent - 1. Obligations of the lessor that are assumed by the lessee are additional renta] income to the lessor. 2. Advance rentals are | a. Item of gross income upon receipt if: i. Unrestricted or AT Lk il. Restricted to be applied in future years or upon the termination of the lease dy'ay Bl A b | b. Notan item of gross income if: i. Itconstitutesaloan | ii. 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 discussed in Chapter 4. | o ‘ R Illustration Under the Escalante Corporation’s standard lease contract, leases shall run for a non- preterminable 12-month period for a monthly rental of P25,000. The lessee shall pay three months rental in advance plus one month security deposit. The rent for the last two months of the lease shall be taken from the advance while the security deposit will be returned if there are no damages sustained by the property during the lease term. | - ' B | | | The entire P75,000 rental payments for the current month and tbe“ ddvdnc_éd rental for the Ia'st two months is an item of income subject to regular tax. The P25,000 security deposit is not an income. o Royalties Royalties earned from sources within the Philippines are generally sfibieét to final Income tax except when they are active by nature. Active royalty income a0 lt‘;))}('altles earned from sources outside the Philippines are subject to regular incom® 290
Chapter 9 - Regular Income Tax: Inclusion in Gross Income [lustration 1 Robotic-Technology Designed is a distributor of a computer program and earns royalties from its licensed users. Computer programs are specifically tailored to each client and regular continuing maintenance services are provided. During the year, client-users remitted a total of P500,000 royalty payments. The entire P500,000 is subject to regular income tax since the royalty is an active income to Robotic-Technology Designed. | Illustration 2 Mang Donald has the following royalties: Royalties from mining properties in the Philippines P 550,000 Royalties from books published in the Philippines 200,000 Royalties from books published abroad 300,000 Royalties from franchise exercised abroad 400,000 The royalties from mining properties and from books in the Philippines are subject to final tax. The royalties from sources abroad aggregating P700,000 are items of gross income subject to regular income tax. Remember that the final withholding tax does not apply to foreign income. Dividends 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 discussed in Chapter 5. Foreign sourced dividends are generally subject to regular tax subject to the pre-dominance tests discussed in Chapter 3. Cash, property, and script dividends from foreign corporations are generally items of gross income subject to regular income tax. Stock dividend ‘= , It should be recalled that stock dividends are exempt from income tax, but when the declaration confers to the recipient a different interest or right after the stock dividend declaration or when stocks dividends are subsequently redeemed such that it amounts to payment of cash dividend, the fair market value of the stock dividends received is taxable. Liquidating dividends Liquidating dividend is not income. The liquidating dividends are considered an amount in exchange for the investment of the investor and are subject to the rules of dealings in properties in Chapter 12. 291
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Comprehensive summary of rules on dividends Source of dividends Domestic Foreigr.: Recipient taxpayer corporation corporation Individual - Citizens and residents 10% final tax Regular tax - NRA-ETB 20% final tax Regular tax . - NRA-NETB 25% final tax 25% final tax |Corporations - Domestic corporation Exempt Regular tax2 - RFC Exempt Regular tax - NRFC 15% final taxt 25% final tax Note: 1. Subject to the tax sparing rule, otherwise, 25%. 2. Subject to conditional exemption lllustration - Foreign-sourced dividends received by individual taxpayers Mr. Lubao received P100,000 cash dividends from a foreign corporation which derived 60% of its income from the Philippines in the previous 3 years. Scenario 1: Gross income ratio in thé preceding 3 years is 60%: Analysis of income treatment: Dividend is 60% earned within and 40% without. _ Remarks - Resident citizen P100,000 RC is taxable within and without - _Resident alien P 60,000 RA is taxable within only Scenario 2: Gross income ratio in the preceding 3 years is 45%: Analysis of income treatment: Dividend is 100% earned without, Recii 7 Subject to RIT ‘ R E - __Resident citizen P100,000 RC is taxable within and without - __Resident alien None RA is taxable within only . Exemption of foreign-sourced dividends receiv Under the CREATE law, inter- corporations from foreign corpora may be exempted from regular inc ed by domestic corporation corporate dividends received by domestic tions are generally subject to regular tax. They Ome tax under the following conditions: 292
Chapter 9 - Regular Income Tax: Inclusion in Gross Income io in the predominance test i 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. less than 50%, the foreign-sourced 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 entire 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: Capital expenditures Dividend payments © a0 o Infrastructure projects Working capital requirements Investment in domestic subsidiaries Foreign-sourced dividends that are not utilized in the following taxable year shall be declared as taxable income subject to surcharges, interest and penalties. If the ratio in the predominance test 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. Illustration - corporate taxpayers 4 Assume that the following data relates to an inter-corporate foreign-sourced dividend received in 2023: Ratio of predominance test 60% Foreign-sourced dividends received . | P 100,000 Investment holding period 2 years Ownership in the foreign corporation 20% | Dividends utilized 100% Analysis of income treatment: Dividend is 60% earned within and 40% without. Recipient taxpayer Subject to RIT Remarks - Domestic corporation None Exempt since GI ratio is > 50% - _Resident foreign corp. P 60,000 RFC is taxable within only. Note that the conditional exemption applies to recipient domestic corporations only to the exclusion of resident foreign corporations. 293
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Xllslztr::ttil?; fhe following data relates to a foreign-sourced dividends: Ratio of predominance test 40% Foreign-sourced dividends received P 100,000 Investment holding period 2 years Ownership in the foreign corporation 20% Dividends utilized 100% - Analysis of income treatment: Dividend is 100% earned without., Recipient taxpayer Subject to RIT - .&m_a__c;g_ - Domestic corporation None Exempt since conditions are met. - _Resident foreign corp. ‘None None is earned within. Scenario 1 Assume the same information in Illustration 2 except the investment holding period is below 2 years or the ownership interest is below 20%: The income subject to regular tax shall be as follows: - Domestic corporation P 100,000 DC is taxable within and without; - _Resident foreign corp. None None is earned within, Scenario 2 Assume the same information in [Nlustration 2 except there is a P40,000 unutilized dividends at the end of 2024. : A domestic corporate recipient shall report the P40,000 as taxable income in 2024. The corporate tax on P40,000 shall be Imposed with 25% surcharge plus interest, This rule does not apply to resident foreign corporation and individyq] taxpayers., IMustration 3 A domestic corporation received the following income distribution from the following Investments which was all acquired 3 years ago: Income distribution source Amount received Dividends from foreign subsidiary P 400,000 Dividends from foreign associate 200,000 Dividends from 109 foreign investee 300,000 Dividends from 309, domestic investee 100,000 Share from Philippine joint venture 120,000 Shar.e from foreign Partnership 150,000 Profit remittance from foreign branch 250:000 294
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Assuming all the income distributions were utilized domestically, the followin hall be the inclusions in gross income subject to regular tax: v Dividends from 10% foreign investee P 300,000 Share from Philippine joint venture 120,000 Profit share from foreign partnership __ 150,000 Total inclusion in gross income P_ 570,000 Subsidiary corporations are more than 50% owned while associates are at least 20% owned by the investing company. Since all requisites are fulfilled, dividends from these NRFCs are exempt from regular tax. The dividend from' domestic investees Is exempt under final income tax. : , The foreign branch profit remittance is not subject to tax since the branch income gre already taxed as part of the regular income of the combined domestic home office and the foreign branch. The profit share from foreign partnership is not exempt since the CREATE exemption is limited to “dividends”. . Annuities The excess of annuity payments received by the recipient over premium paid is taxable income in the year of receipt. - | ~ Illustration ' Andrew purchased an annuity contract for P100,000 which shall pay him P10,000 annually until he dies. The receipt of the first 10 annual annuity payments is a return of capital. Any further receipt from year 11 onwards is an item of gross income subject to regular income tax. Prizes and winnings | | Prizes and winnings that are exempted from final tax are not items of gross income subject to regular income tax. Exempt prizes and winnings: 1. Prizes received without effort to join a contest | g 2. Prizes in athletic competitions sanctioned by their respective national sports association 3. Winnings from PCSO games, not exceeding P10,000 in amount _Summary rules of prizes and winnings: Individual taxpayers ' Earned from sources Prizes: Within Abroad - __P10,000 and below Regular tax Regular tax | - More than P10,000 Final tax Regular tax 295
R e e e A e s e S Chapter 9 - Regular Income Tax: Inclusion in Gross Income Earned from sources Winnings: Within Abroad - PCSO winnings, exceeding P10,000 Final tax N/A - PCSO winnings, not exceeding P10,000 Exempt N/A - Winnings from other sources Final tax Regular tax Summary rules of prizes and winnings: Corporate taxpayers Earned from sources Prizes: Within Abroad - Prizes (regardless of amount) Regular tax Regular tax - PCSO winnings, exceeding P10,000 Final tax N/A - PCSO winnings, not exceeding P10,000 Exempt N/A - Winnings from other sources Regular tax Regular tax Illustration - The City of Baguio held its Panagbenga flower festival. During the festivities, Mr. Sebastien, the proprietor of Mr. Not So Fit Gym, won the P500,000 second prize in the flower float competition. John Hay Corporation won the P600,000 first prize. The City of Baguio shall withhold 20% final tax on the Winhings of Mr. Sebastien. The prize of John Hay Corporation shall not be subjected to a 20% final tax. John Hay shall include the prize in its gross income subject to regular income tax. Pensions These pertain to pensions and retirement benefits that fail to meet the exclusion criteria and hence subject to regular tax. Taxable partnership and taxable joint venture or co-ownership 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: If partner, venturer or Mgw co-owner is a/an: Philippines Abroad - _Individual 20% final tax Regulz;t_ax - _Corporation Regular tax Regular tax The share. in the net income of non-taxable entities such as general professiOrlal partner§h1p, €Xempt joint ventures or exempt coownership shall be subject t0 regular income tax to the recipient partner, venturer or co-owner. 296
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Partner’s distributable share in the net income of a general professional partnership A general professional partnership (GPP) is not subject to income tax (i.e., final tax, capital gains tax or regular income tax). The partners are the ones subject to regular tax on their share in the net income of the GPP. For this purpose, the net income of the GPP shall include items of income which are exempted from final tax or capital gains tax to the general professional partnership. Illustration: Distributive share from a general professional partnership Set and Siegfried practice their profession in a general professional partnership and share profits 60:40. Their firm reported the following: Gross receipts P 2,000,000 Less: Professional expenses 1,200,000 Net income from operations P 800,000 Add: Interest from bank deposits 20,000 Distributive net income P__ 820,000 The share of the partners in the net income of the partnership shall be computed as: Total distribution to Set (60% x P820,000) P 492,000 Total distribution to Siegfried (40% x P820,000) 328,000 Distributive net income P__ 820,000 The partners shall include their respective shares in their gross income subject to regular income tax. GENERAL CRITERIA FOR ITEMS OF GROSS INCOME Items of gross income subject to regular income tax are not limited to the list mentioned in the NIRC. Under the NIRC, the regular income tax has a catch-all provision for all income derived from whatever sources that are: L. not subject to final tax, capital gains tax, and special tax regime, and 2. notexcluded or exempted by law, treaty, or contract from taxation. OTHER SOURCES OF GROSS INCOME SUBJECT TO REGULAR INCOME TAX L. Income distributions from taxable estates or trusts Share from the net income of other pass-through entities: a. Exempt joint venture Exempt co-ownership Farming income Ret_:overy of past deductions Reimbursement of expenses Cancellation of indebtedness for g consideration 2. o v W 297 -
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Income Distribution from taxable estates or trusts "y, : 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 such income must not have been subjected to final tax or capital gains tax. llh'ls“trat\i'ori: Estates Roman is one of several helrs to ;tfl'hle_:"fiusines‘s estate of his father which is under judicial settlement. The "adminis_tfrf?'to;r" distribu_te‘d the following income for the support of Roman: o Domestic dividends g, P 22,500" Business income T SIAAR STy 70,000 Roman shall include in his gross income subject to regular income tax the P70,000 distribution from business income. The estate shall present the same amount as a deduction against its gross income. The P22,500 dividend shall not be reported by Roman since this was already subjected to final tax at source. e - Illustration; Trusts . - .- | & o Horace received the following income distributions in his capacity as beneficiary to an irrevocable trust designated by his grandmother: ‘ Net capital gains on sale of domestic stocks P 9,500 Rental income e e | 12,000 Horace shall report only the P12,000 rental income in his gross income subject to rEguIdr ~ income tax. The net gain on the sale of stocks is subject to capital gains tax to the trust. Share from the net income of exempt joint ventures and co-ownerships The same tax treatment on recognition of share in the net income of a general professional partnership applies to the share from the net income of exempt joint ventures and co-ownerships.. - | : | Farmingincome =~ Farming operations can be classified as: 1. Raise and sell operation O | The proceeds on the sales of livestock or farm products is included in gross income subject to regular income tax. Animal raising expenses are presented as items of deductions against gross income. 2. Purchase and sell operation , '}‘he gross profit from the sale (sales less cost of purchase) is included in gross income. ., Taxpayers may follow accrual or cash basis in accounting for inventories of livestock or farm products. The crop year basis discussed in Chapter 4 may be used for recognizing income for long-term crops. "0 298
Chapter 9 - Regular Income Tax: Inclusion in Gross Income It should be recalled that the proceeds of crop or livestock insurance constitute a taxable item of gross income because they are recovery of lost profits. RECOVERIES OF PAST DEDUCTIONS 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, they should be analyzed whether or not they resulted in tax benefit to the taxpayer. Examples of recoveries of past deductions: Recovery of previously claimed bad debt expense Refund of local tax expense Refund of foreign tax previously claimed as deduction - Recommissioning of abandoned petroleum,service contracts or mlnlng tenements Release of reserve funds of insurance companies . : - Interest expense which were subsequently condoned by the lender uR 2 N at e Past deductions that created tax benefit to the taxpayer must be reverted back to gross income in the year of recovery S0 that the government W1ll recover the tax lost from the deduction. Tax benefit There are two ways a taxpayer may benefit from a deduction: a. Directly, through reduction of taxable income in the year deduction is made b. Indirectly, through reduction of future taxable income through carry-over of net operatlng loss Note: ' 1. Under our tax laws, the excess of deductions over gross mcome in a taxable year is carried over as a deduction against the net income of the next three years of operation. This is called net operating loss carry-over or NOLCO. Because of this, almost all prior year deductions have tax benefit; hence, their recovery is taxable. 2. NOLCO will be discussed in Chapter 13-B. It is partlally discussed here because of its relevant to the topic at hand. Illustration 1: With Net income in the year of de’dii"c't"ion" o A taxpayer incurred P60,000 bad debt expenSe in 2023 out of which P35,000 was recovered in 2025: 09023 NEN . 0g4 2025 Net income before bad debt expense P 100,000 P 80,000 P 120,000 (Bad debt expense)/Recoveries (__60,000) . ‘ 35,000 Net income after bad debt expense P_40,000 ;1'___8_&94& P 272 The entire P60,000 deduction in 2023 is a tax benefit to the taxpayer Hence, the P35,000 recovery from this deduction is a tax benefit which must be reverted back to gross income in 2025, The taxable net income in'2025 shall be P155, 000." 299
Chapter 9 - Regular Income Tax: Inclusion in Gross Income 4 fore recovery tion 2: With operating loss & NOLCO carry-over be : Xl;it;:yer incurred a P90,000 bad debt expense in 2023 out of which P60,000 was recovered in 2025. L , 2023 2024 2025 Net income before bad debt éxpense P 70,000 P 100,000 P 120,000 (Bad debt expense)/Recoveries (__90,000) oy s Q0,0QQ Net income after bad debt expense (P__20,000) P 100,000 7N Less: NOLCO application L——»(__ 20,000) ~ ',‘..xhr 3 ¥ ‘;’ w,‘: ‘ ';:' | 1'N}et income % The entife,P90,,000 -déd‘uctio’n» IS a tax benefit. The taxpayer benefited by the P70,000 reduction in 2023 taxable income plus the P20,000 carry-over of NOLCO. The P60,000 recovery from the deduction in 2025 is a tax benefit subject to tax. The reportable net income in 2025 shall be P180,000. .- llustration 3: With expired NOLCO before recovery Suppose a taxpayer deducted a ,P',:SOO' interest expense in 2017 but failed to pay the same due to financial difficulty. The lender condoned the interest in 2021. i 2017 2018 2019 2020 2021 Income before interest P 100 (P 130) P 80 (P 160) (P 70) Less: Interest expense ( 500) ___ - - 500 Net income (NOLCO) - (P_400) (P_130) P 80 (P_160) P__ 777 NOLCO application =~ ‘“————1(p 80) ‘P 7 s 7S Netindome” ! VP g The interest exb’eh‘se saved the 2017 P100 pre-tax income and the 2019 P80 net income from taxation. Note that NOLCO can be deducted only against net income in the next three years. The P320 remaining NOLCO expired in 2020 without tax benefit, The P500 interest deduction oth"benefited ’lth"e'tc'zxpayer P180. Hence, only P180 of the P500 recovery in 2021 shall be reverted back to the 2021 gross income. lustration 4: With Operéting loss in th e year of recovery | A taxpayer incurred a P90,000 bad debt expense in 2023 out of which P45,000 was recovered in 2024. ‘ ‘ ‘ 2023 2024 Net income/(loss) before bad debts/recovery P 70,000 (P 15,000) (Bad debt expense)/ Recovery ( 90.000) 45,000 Netincome after bad debtexpense ' (p 20000y p___ ™ h has not expired before the beginning of the taxable year in ace shall be treated as tax benefit. Thus, the entire P90,000 is 'r. Hence, the P45,000 recovered out of it is a tax benefit which ross income in 2024, | 300
Chapter 9 - Regular Income Tax: Inclusion in Gross Income The 2024 net income shall be computed as follows: Net loss before recovery (P 15,000) Add: Recovery 45,000 Net income P 30,000 Less: NOLCO application - 2024 | - 20.000 Taxable net income P 10000 Illustration 5: Without benefit of NOLCO carry-over | A corporate taxpayer had a change in 80% of its shareholders in 2023. Thus, any net operating loss incurred before 2022 is not allowed to be carried over by law. A P90,000 bad debt write-off was made in 2022 out of which P60,000 was recovered in 2024. STREING RIS R T M_ _2_0__2_3_ 2024 'y Net income before bad debt expense P 70,000 P 100,000 P 120,000 (Bad debt expense) /Recoveries (—90000) _____- __ 60,000 Net income after bad debt expense (R_20.000) P 100,000 7272 The tax benefit of the P90,000 bad debt expense to the corporation in this case shall be determined using the As-If Approach. L T Re-compute the net income in the year of deduction ;by 'adjusting"-"the, Edecl_uction as if the subsequent deduction recovery is known. The computed netincome is compared to what was previously reported to determine the income that is saved from taxation. Assuming the future recovery is known, the 2022 net income should have been: Net income before bad debt expense o £ bttt DLT ” | P 70000 Less: Bad debt expense if recovery is known (P 90,000 - P60,000) __ 30,000 Net income if recovery known RUTER T R - B__40,000 The tax benefit is the income that escaped taxation in 2022 computed as: Net income if subsequent recovery is known | P 40,000 Less: Net income as reported in 2022 (recovery is unknown) 0 Tax benefit of the bad debt expense ... B _40000 P40,000 out of the P60,000 recovery in 2024 constitutes tax benefits which must be Included in the 2024 gross income. The 2024 net income shall be P160,000. lllt{strafion 6: Taxpayer is exempt in the year of deduction S eane 1l L i Kalinga Corporation is an exempt BMBE taxpayer in 2023 but became a taxable ;%g\fla}' income taxpayer in 2024. It deducted P120,000 bad debt expense in 2023. In 24, it recovered P40,000 out of the bad debts. 301
Chapter 9 - Regular Income Tax: Inclusion in Gross Income __2023 - 2024 Net income before bad debt expense P 70,000 P 100,000 (Bad debt expense)/Recovery (__120,000) 40,000 Net income after bad debt expense (R_50,000) P 222 Deductions have no tax benefit to a taxpayer who is exempt from tax. Future recoveries from deductions made in the year of exemption are non-taxable. The P40,000 recovery is not income. The 2024 net income shall be P100,000. Refund of non-deductible expenses Expenses or payments which are non-deductible against gross income in the computation of taxable net income will never create tax benefit to the taxpayer. As such, their recovery should not be included in gross income. Hence, the refund of the following non-deductible items is not taxable: »1. Philippine income tax 2. Estate or donor’s tax : 3. Income tax paid or incurred to a foreign country if the taxpayer claimed a credit for such tax in the year it was paid or incurred. 4. Stock transaction tax in disposing stocks through the Philippine Stock Exchange:. io o ool e i ATESIREY S NNES S 7T I, | 5. Special assessment £ 3t REIMBURSEMENTS OF EXPENSES Expenses of the taxpayer that are reimbursed or paid by the customer or client constitute additional income to the taxpayer. Examples: O B AT 1. When the lessee pays the ownership costs of the lessor such as real property tax and insurance on the property, the payment constitutes income to the lessor. 2. When a client reimburses the out-of-pocket expenses of a professional practitioner, the reimbursements.are income to the practitioner. CANCELLATION OF INDEBTEDNESS The cancellation of indebtedness may amount to gratuity or payment of income. The cancellation of debt: s a. In consideration of service or goods - treated as income b. Asanactof gratuity - treated as gift; not as income C. As capital transaction such as forfeiting the right to receive dividends in exchange of the debt - treated as dividend income [ / 4 -7 302
Chapter 9 - Regular Income Tax: Inclusion in Gross Income SPECIAL CONSIDERATIONS IN REPORTING OF GROSS INCOME Accounting methods ' Situs rules Effect of value added tax Creditable withholding tax | RN ‘Power of the CIR to redistribute income and expenses GIh wR ACCOUNTING METHOD I RURACEMETUR AR IR S SVES 1L . The accounting method adopted by the taxpayer has a direct effect on the reportable amount of gross income subject to regular income'tax.* S e For instance, cash-basis taxpayers will report their gross receipts or collection as gross income while accrual basis taxpaye,ps,v,\(illireport.,thei.r;I:e-.V,enue;CODSiSting of collected and uncollected income as gross income. ‘ It must be recalled also that regardless of the accounting methods of the taxpayer, advanced income must be included in gross income in the period received. SITUS RULES | MUV PR iatl ER) o, S The situs of taxation also affects the extent of income included as items of gross income of the taxpayer. It must be recalled that all taxpayers are taxable only on Philippine income except resident citizens and domestic corporations:which are taxable on global income. trimrpenagss L iveds For taxpayers taxable only on Philippine in}:?%‘?':.~9913"‘.*~th%i§' giter;?%, of gross income subject to regular tax from sources W1th1nthe Philippines 'al‘fg‘_in':cl;qudfii,n gross income. | wt aile o Srane) s o ble on global income, their items of gross income subject to For taxpayers taxa Ay urces within and without the Philippines are included in gross regular tax from so income. Integrative Illustration 1 s o2 K] Lending, a finance corporation, lends to various clients: pine residents - . ; P.400,000 .- - - dentclients 500,000 he Philippines 20,000 ©1:,10,000 0 - Interest income from loans to Philip Interest income from loans to non-resi Interest income from bank depositsin t Interest income from bank deposits abroad Required: AN i Yo Determine the total amount of gross income subject to final tax and the reportable amount of gross income subject to regular income tax assuming the taxpayer is a: 1. Non-resident foreign corporation by 2e Leadhalt - 0D WAL BhAamY 2. Resident foreign corporation 3. Domestic corporation 303
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Solution: - : | An analysis of the situs of the above income 1s shown below: Within = _Without Loan interest income P 400,00(; P 5(1)8,888 Bank interest income 20,00 b Total P 420,000 P 510,000 The following are the amounts subject to final tax and the amounts to be reported in gross income subject to regular income tax: Subject to Final tax Regular tax 1. Non-resident foreign corporation P 420,000 P 0 2. Resident foreign corporation 20,000 400,000 3. Domestic corporation 20,000 910,000 Note: 1. Non-resident foreign corporations are subject to final income tax on gross income within. Philippine residents shall withhold 25% final tax on their gross income. 2. The interest income from banks in the Philippines is an item of gross income subject to 20% final tax. The gross income subject to regular income tax of resident foreign corporations includes only those earned from sources within. ' ‘ Income from sources abroad, passive or active, are subject to regular income tax for taxpayers subject to tax on global income. The gross income of domestic corporations includes items of gross income subject to regular tax from sources within and outside the Philippines. Thus, P400K + P500K + P10K. ' Integrative Illustration 2 A certain taxpayer had the following details of income during the year: Service fees from Philippine clients P 400,000 Service fees from foreign clients | 500,000 Gain on sale of domestic stocks directly to a buyer 150,000 Dividends from domestic corporations 5,000 Interest income on bank deposits abroad 30,000 Required: Determine the amount of capital gains tax assuming 1. anindividua] a. Non-resident alie gross income subject to regular income tax, final tax and that the taxpayer is: N not engaged in trade or business (NRA-NETB) Non-resident alien engaged in trade or business (NRA-ETB), a resident alien (RA) ora non-resident citizen (NRQO) C. Resident citizep (RC) a corporation a. Non-resident for b. Resident forei C. Domestic cor eign corporation 8N corporation poration 304
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Solution: An analysis of the situs of the foregoing income is as follows: Within Without Service fees ' P 400,000 P 500,000 Gain on sale of domestic stocks 150,000 Domestic dividends 5,000 Interest income from foreign bank - 30,000 Total P 555,000 P 530.000 The following are the amounts to be included in gross income subject to final income tax (FIT), capital gains tax (CGT), and regular income tax (RIT): Taxpayers FIT CGT RIT Individuals 1. NRA-NETB P 405,000 P 150,000 P - 2. NRA-ETB, RA, or NRC 5,000 150,000 400,000 3. RC 5,000 150,000 930,000 Corporations 4. NRFC P 405,000 P 150,000 P - 5. RFC - 150,000 400,000 6. DC - 150,000 930,000 Note: 1. NRFCs and NRA-NETBs are subject to final tax on Philippine income. 2. The 15% capital gains tax is the most universal rule in taxation that applies to all taxpayers regardless of classification. 3. Inter-corporate dividends are exempt from final tax, except when the recipient is a non- resident foreign corporation. EFFECTS OF VALUE ADDED TAX ON REPORTABLE GROSS INCOME Remember that business taxpayers are required to either register as: 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 Every VAT taxpayer is mandatorily required to 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, 305
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Illustration 1: VAT taxpayers A VAT-registered taxpayer charged P78,400 to a client for rental. The VAT-taxpayer shall split the billing as follows: Rental income (P78,400/112%) P 70,000 Plus: Output VAT (P78,400 x 12/112) 8.400 Invoice price P___ 78,400 Only the rental income is subject to income tax. The output VAT shall be recorded as a liability. The collection of the rental is recorded in accounting as follows: Cash P78,400 Rent income 70,000 Output VAT 8,400 Illustration 2: Non-VAT taxpayers A non-VAT taxpayer charged P78,400 to a client for rental. Non-VAT taquyers are not subject to VAT. The entire amount they charge for their sales of goods or services is gross income subject to income tax. ' CREDITABLE WITHHOLDING TAX i | . : Creditable withholding taxes (CWT) deducted by income payors a-gainst 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. Illustration : Guimaras Inc., a non-VAT and MSME domestic corporation, reported the following: Rent income, net of 5% or P25,000 CWT P 475,000 Professional fees, net of 10% or P40,000 CWT 360,000 In.terest income, net of 20% final tax 40,000 Dividends from a domestic corporation 10,000 Business expenses 500,000 Required: Determine the total reportable gross income and the income tax due and still due under the regular income tax, The total reportable gross income shall be: ll}:nft income [P475K/95% or (P475K + P25K)] P 500,000 ofessional fees [P360K/90% or (P360K + P40K)] —400,000 Total gross income £.900,000 306 P et — . e d
Chapter 9 - Regular Income Tax: Inclusion in Gross Income Note: The interest income and the dividend income are subject to final tax. They should not be included in the item of gross income subject to regular income tax. The income tax due and still due shall be determined as: Total gross income P 900,000 Less: Allowable deductions (business expenses) __500,000 Taxable net income P 400,000 Multiply: Corporate tax rate 25% Income tax due P 100,000 Less: Creditable withholding tax e - Rent P 25,000 - Professional fees 40,000 ___65.000 Income tax still due P__35,000 Note: 1. The CWTs are actually advances to the annual income tax due of corporations and individuals and are deductible (i.e. creditable) thereto. Same procedures are applied with individuals except that their income tax dues are determined by progressive tax rates. 2. The final taxes should not be credited against the annual income tax due. Creditable withholding tax and VAT | VAT taxpayers shall revert back to gross income amounts of withholding tax but excludes therefrom the amount of VAT charged to customers or clients. | Illustration 1 , A 1 | . A VAT taxpayer collected a total of P55,000 cash for services rendered, net of P1,000 withheld tax by the client evidenced by a BIR Form 2307. The VAT taxpayer shall compute his service income subject to regular tax as follows: Cash received P 55,000 Plus: Withholding tax (BIR Form 2307) Y Bl 1,000 Invoice price (inclusive of VAT) P 56,000 Less: Output VAT (P56,000 x 12/112) ____ 6,000 Service fees (Gross income) P_50.000 Mustration 2 A VAT taxpayer collected P85,600 rental from a lessee who withheld 5% creditable withholding tax. A The VAT taxpayer shall compute his rent income subject to regular tax as follows: Cash received (inclusive of 12% but net of 5% CWT) P 85,600 gividg by: (100% + 12% - 5%) P_80 ggog €ntincome (Gross income)
Chapter 9 - Regular Income Tax: Inclusion in Gross Income The VAT and withholding tax are as follows: Rent income P 80,000 Plus: Output VAT (P80,000 x 12%) 9,600 Less: Withholding tax (P80,000 x 5%) 4,000 Cash payments to the lessor ‘ P__85,600 POWER OF THE CIR TO REDISTRIBUTE INCOME AND DEDUCTIONS In the case of two or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly 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 determined that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization, trade or business. (Sec. 50, NIRC) The Problem of Unfair Pricing between Associated Enterprises There is a risk that the pricing of the transfer of goods and 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. Examples: 1. A domestic corporation which is subject to 25% corporate tax in the Philippines has a subsidiary that operates in a tax haven country where no income tax is imposed. The domestic corporation transfers goods to its foreign subsidiary at a transfer pricing based on production cost so that no gross income will be recognized in the Philippines while the entire gross income will be recognized abroad where no tax is imposed. : 2. A foreign corporation subject to 10% corporate tax in its home country has a branch in the Philippines which is subject to the 25% corporate income tax herein. The foreign corporation transfers goods at a pricing method that will allow very minimal profit for the Philippine branch to minimize exposure to higher income tax. The transfer pricing guideline ';'gglsl(: ;numer.ated. Scenarios are just a few of the problems in taxation brought Y unfair pricing practices. To limit these unfair practices and to properly 308
chapter 9 - Regular Income Tax: Inclusion in Gross Income 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. What are associated enterprises? Under RR2-2013, two or more enterprises are associated if one participates directly or indirectly in the management, control, or capital of the other; or if the same persons participate directly or indirectly in the management, control, or capital of the enterprises. Associated enterprises are also called “related parties.” Examples of associated enterprises: 1. Parent corporation and its subsidiary corporation 2. Sister companies or businesses owned by the same parent corporation 3. All corporations controlled under the same holding company 4. Businesses owned by the same person The arm’s length principle Under RR2-2013, transfer pricing between associated enterprises shall be made under comparable conditions and circumstances as those entered into between independent parties where market forces drive the terms and conditions of the transaction rather than being controlled solely by reason of special relationship between the associated enterprises. In other words, 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. The arm’s length principle shall be applied to: 1. Cross-border transactions between associated enterprises 2. Domestic transactions between associated enterprises When operations are conducted cross-border, the taxpayer may enter into an “advanced pricing agreement” with the BIR where a pricing rate is pre-agreed to apply for a period of time. Although this is not a mandatory requirement, this may serve as a safety net for the taxpayer to avoid the risk of transfer pricing examination and adjustment and the inconvenience it may possibly cause. Transfer pricing methods 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 of the following method considering the Circumstance of the taxpayer: 309
Chapter 10 - Compensation Income CHAPTER 10 COMPENSATION INCOME Chapter Overview and Objectives This chapter discusses the employee benefits considered as compensation income. It discusses the types of employees, and exempt and taxable benefits. It also delineates the gap between the compensation income subject to regular income tax and the fringe benefits subject to fringe benefit tax. After this chapter, readers are expected to demonstrate: Understanding of the concept of an employer-employee relationship 2. Knowledge of the classifications of employees and the tax treatment of their compensation income and fringe benefits 3. Mastery of the list of employee benefits exempted under the NIRC and special laws and the de minimis list 4. Knowledge of the condition for exemption of employee benefits under treaty or international agreements 5. Understanding of the concept of “employer convenience” rule and the “necessity of the employer” rule ‘ 6. Understanding of the conditions of exemption of a minimum wage earner 7. Knowledge of the classification rules for items of gross taxable compensation income 8. Mastery of the composition of “13t month pay and other benefits” for rank and file employees and managerial or supervisory employees 9. Comprehension of the fringe benefits subject to regular tax and fringe benefits subject to fringe benefits tax - == ———— EMPLOYER-EMPLOYEE RELATIONSHIP Employer - refers to any person for whom an individual performs any service of whatever nature as employee of such person. An employer is the person who has control over the payment of the employee rémuneration. However, if such person is a non-resident not engaged in trade or business in the Philippines, the employer is deemed the person paying Fémuneration in their behalf. lz;llployee - refers to any individual who is a recipient of wages and includes officer, employee or ele cted official of the Government of the Philippines or any Dolitigal subdivisions, agency or instrumentality thereof. The term also includes an officer of 3 corporation. 331
Chapter 10 - Compensation Income Elements of employer and employee relationship under case law: 1. 4 3. 4. Selection and engagement of employees - There is a screening process for employees to hire. Payment of wages - The employer usually fixes and controls the payment of wages. Power of dismissal - Employer has power to retrench or terminate employees when incurring heavy losses or other reasonable basis. Power of control - The employer has power to control the employee on the means and methods by which the work is accomplished. An arrangement which do not manifest all the elements is not an employer- employee relationship but an independent contract for the provision of services. The following are not considered employees: 1. r A 3. Consultants Directors without management function Talents and artists on TV shows or radio broadcasts (Sonza vs. ABS-CBN Broadcasting Corporation, G.R. No. 138051) The income or fees of these individuals are not compensation income but are business or professional income. TYPES OF EMPLOYEES AS TO FUNCTION 1. Managerial employees — Those who are given powers or prerogatives to lay down and execute managerial policies and/or to hire, transfer, suspend, lay- off, recall, discharge, assign or discipline employees. Supervisory employees - Those who 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. Rank and file employees - Those who hold neither managerial nor supervisory functions. TYPES OF EMPLOYEES AS TO TAXABILITY 1 Minimum wage earners - Employees who are recipients of minimum wage. They are exempt from income tax on their compensation. 2. Regular employees - Employees who are subject to the regular progressive income tax. Minimum Wage Earner A minimum wage earner refers to a worker in the private sector who is paid the minimum wage or to an employee in the public sector with compensatlon income 332
Chapter 10 - Compensation Income of not more than the statutory minimum wage (i.e., those with salary grade 1 to 3) in the non-agricultural sector where he or she is assigned. The statutory minimum wage refers to rate fixed by the Regional Tripartite Wage and Productivity Board of the Department of Labor and Employment or p5,000/month or P60,000/year, whichever is higher. THE TAX MODEL ON COMPENSATION INCOME Gross compensation income . P xxx,xxX Less: Non-taxable compensation XXX, XXX Taxable compensation income B D 6.0.8.0.9.4 GROSS COMPENSATION INCOME Gross compensation income generally includes all remuneratlons received under an employer-employee relationship. NON-TAXABLE COMPENSATION A. Mandatory deductions These includes employees’ mandatory contribution to GSIS, SSS, PhilHealth, HDMF, and union dues B. Exempt benefits 1. Benefits excluded and/or exempted under the NIRC and special laws 2. Benefits exempt under treaty or international agreements 3. Benefits necessary to the trade, business, or conduct of profession of the employer 4. Benefits for the convenience or advantage of the employer EXEMPT BENEFITS UNDER THE NIRC, AS AMENDED, AND SPECIAL LAWS 1. Remunerations received as incidents of employment a. Exempt retirement benefits under RA 7641 1nclud1ng exempt retirement gratuities to government officials and employees b. Exempt termination benefits c. Benefits from the United States Veterans Administration d. Social security, retirement gratuities, pensions, and similar benefits from foreign government agencies and other institutions, private or public e. Benefits from SSS, under the SSS Act of 1954, as amended Benefits from GSIS under the GSIS Act of 1937, as amended COVID-19 benefits to health workers under RA 11494 (BAYANIHAN 2) a. Special Risk Allowance b. Actual Hazard Duty Pay ¢. Compensation paid to private and public health workers who have contracted COVID-19 in the line of duty 333 o ™
Chapter 10 - Compensation Income 2. 3. 4. De minimis benefits 13th month pay and other benefits not exceeding P90,000 Certain benefits of minimum wage earners De minimis benefits | | De minimis benefits are facilities or privileges such as entertainment, medical services, or courtesy discounts on purchases that are of relatively small value and are furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his employees. De minimis benefits are petty fringe benefits exempt from income tax. | As originally conceived, other petty fringe benefits which fall within the purview of de minimis even if not part of the de minimis list are normally treated as de minimis and are also exempt from income tax. However, the term “de minimis benefits” was restricted under RR5-2011 and RR11-2018 to mean only the following: | 10. Monetized unused yacation leave credits of private employees not exceeding 10 days during the year ' Monetized unused vacation and sick leave credits paid to government officials and employees Medical cash allowance to dependents of employees not exceeding P1,.500 per employee per semester, or P250 per month Rice subsidy not exceeding P2,000 or 1 sack of 50-kg rice per month amounting to not more than P2,000 Uniform and clothing allowance not exceeding P6,000 per annum (RR11- 2018) 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 award, e.g. for length of service or safety achievement, which must be in the form of tangible property other than cash or gift certificates, with an annual monetary value not exceeding P10,000 received by the employee under an established written plan which does not discriminate in favor of highly paid employees. Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum (ie, Christmas gift and anniversary gifts) Daily meal allowance for overtime work and night or graveyard shift not exceeding 25% of the basic minimum wa : s overtime meal) ge on a per region basis (i.e. 334
(R« w0 L rigm p c Cwmmeriaw1pd gc md o i w4 TR Chapter 10 - Compensation Income 11. 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. Note that only CBA benefits and productivity incentives amounting to P10,000 or less is de minimis. If the amount exceeds P10,000, the entire amount is a taxable “other benefits.” Taxable de minimis benefits 1. Excess de minimis over their regulatory limits 2. Other benefits of relatively small value that are not included in the list of de minimis benefits Treatment of taxable de minimis benefits a. For rank and file employees - taxable de minimis is treated as other compensation income under the category “13t month pay and other benefits” b. For managerial and supervisory employees -the taxable de minimis is treated as fringe benefit subject to final fringe benefit tax DETERMINATION OF EXCESS DE MINIMIS BENEFITS Illustration 1: De minimis limits Alexanderia, a private employee who is paid a P600 daily rate, receives the following benefits during the year 2023: Monetized unused vacation leave credits 9 days Monetized unused sick leave credits 9 days Medical assistance I P 7,000 Rice subsidy (P2,500 per month) 30,000 Clothing allowance 9,000 Laundry allowance 6,000 Required: Determine the taxable amount of de-minimis benefits. Solution: Actual Limit __Excess Monetized unused VL P 5400 P 6,000 P 0 Monetized unused SL 5,400 0 5,400 M‘edical assistance 7,000 10,000 0 Rice subsidy 30,000 24,000 6,000 Clothing allowance 9,000 6,000 3,000 Laundry allowance 6,000 3,600 ____ 2,400 Taxable de minimis as “other benefits” P_16,800 335
Chapter 10 - Compensation Income Note: Private employees . il 1. The actual value of the monetized unused VL was computed as P600 x 9 while the limit was 2 'Il)‘flgol):)-l&y rule applies only to vacation leaves. Monetization of sick leaves of private employees is taxable. (BIR Ruling No. 22 7-2013, June 20, 2013). 3. The rice subsidy and laundry allowance were likewise annualized by multiplying their monthly limit by 12. The de minimis benefits within the limits are exempt from income tax, IMlustration 2 Hazelyn, a government rank and file employee, received the following benefits: Monetized unused vacation leave credits (10 days) P 6,000 Monetized unused sick leave credits (15 days) 9,000 Uniform allowance 5,000 Laundry allowance 4,800 Required: Determine the amount to be included in other benefits. Solution: Actual Limit __Excess Monetized unused VL P 6,000 exempt P 0 Monetized unused SL 9,000 exempt : 0 Uniform allowance 5,000 6,000 0 Laundry allowance 4,800 3,600 1,200 Taxable de minimis as “other benefits” P 1,200 Note: It is clear under RR5-2011 that the vacation leave and sick leave of government employees are not subject to the 10-day limit rule. Illustration 3 Professor Estoque was one of the Hall of Fame awardees of Youbee University. He was granted P25,000 cash as loyalty award for his 30 years of service. He was also given P10,000 Christmas gift and an additional P10,000 gift during the institution’s Founding Day Anniversary. Besides, he was also given free lunch meals with a total value of P15,000 during the same year. Required: Compute the total taxable de-minimis benefits as other benefits. Solution: Actual Limit Excess Loyalty or service award P 25,000 P 0 P 25,000 Christmas and anniversary gift 20,000 5,000 15,000 Meals ’ 15,000 0 15,000 Total taxable de minimis as “other benefits” P 55,000 Note: 1. The limit on loyalty or service awards applies only if it is given in kind. 336
S Chapter 10 - Compensation Income Only meals for overtime or graveyard shifts are considered de minimis. Other meal benefits . are no longer considered de minimis. Note that in all three illustrations, if the employee is a managerial or supervisory employee, the entire excess de minimis shall be considered as other fringe benefits subject to fringe benefits tax. Note to readers: Many follow the practice of treating excess de-minimis benefits as part of 13% month pay and other benefits regardless of whether the employee is a managerial, supervisory or rank and file. This treatment is based on the erroneous use of the phrase “income tax as well as withholding tax on compensation income” in section 2 of RR5-2011. This inadvertence was subsequently clarified and corrected by then Commissioner Henares as “fringe benefits tax” under RMC20-2011, It must be clarified therefore that the excess de-minimis benefits of managerial or supervisory employees is subject to final fringe benefits tax and is not part of 13t month pay and other benefits. Commutation of accumulated leave credits The terminal leave pay or the commutation of unused leave credits due to involuntary separation from employment of the employee is now treated as de minimis benefits subject to the 10-day leave credit limit and is no longer exempt as part of exempt termination benefits. 13th month pay and other benefits not in excess of P 90,000 The composition of the “13th month pay and other benefits” will be discussed later under taxable benefits. BENEFITS EXEMPT UNDER TREATY OR INTERNATIONAL AGREEMENTS Employee benefits of non-Filipino nationals and/or non-permanent residents of the ?hllippines from foreign governments, embassies or diplomatic missions, and international organizations in the Philippines are exempt from income tax. Exemption from withholding tax does not mean income tax exemption Foreign government embassies, diplomatic missions and international organizations are immune from income tax including the obligation to withhold income tax by virtue of international comity as embodied in several international agreements to which the Philippines is a signatory. ::“Z‘Z;\;er, this exemption from the obligation to withhold tax does not mean ‘mematkt)axlexemptlon of their Filipino employees. In fact, most of the sialh nal agreements to which the Philippines is a signatory limit exemption Y to non-Filipino nationals and/or non-residents of the Philippines. 337
Chapter 10 - Compensation Income Filipino employees of foreign governments, international missions, and organizations are taxable as a rule except only to employees of the following organizations: United Nations (UN) Specialized Agencies of the United Nations Australian Agency for International Development (AUSAID) Food and Agriculture Organization (FAO) World Health Organization (WHO) United Nations Development Programme (UNDP) International Organization for Migration (I0M) International Seabed Authority (ISA) 0% N @y Ui o D3R These organizations have exemption provisions that extend even to their Filipino employees. Other aid agencies or international organizations may have tax free provisions in their articles of agreement for Filipino employees. Confirmation of Tax Exemptions ' \ The exemption of Filipino employees is not automatic. Filipinos claiming exemptions under the terms of international agreements or under provisions of special laws granting privileges to international organizations shall file an application for confirmation of tax exemption with the BIR’s International Tax Affairs Division (ITAD). The confirmation shall serve as proof of exemption. Without the confirmation certificate, the employee is taxable. | Employees of Philippine embassies or consulate offices It should be recalled that employees working in Philippine embassies or Philippine consulate offices are not considered non-resident citizens and are therefore subject to Philippine income tax. i Summary of rules Foreign embassy, Philippine embassy v missions, or organization | or consulate office In the Philippines ‘ - ‘ - _ Filipino citizens Taxable* : N/A - Aliens Exempt : N/A Abroad ' | - Filipino citizens Exempt Taxable - Aliens Exempt . - Exempt * . . . ; Taxpayer must prove if there is an exemption grant under contract or special law. BENEFITS REQUIRED BY THE NATURE OF, OR NECESSARY TO, THE TRADE, BUSINESS OR CONDUCT OF PROFESSION OF THE EMPLOYER 338
Chapter 10 - Compensation Income Benefits or allowances furnished by the employer to the employees to enable them to appropriately and effectively execute their duties as required by their employment are exempt from income tax. This is referred to as “necessity of the employer rule.” Examples: 1. Necessary traveling, transportation, representation, or entertainment expenses that are subject to an accounting or liquidation in accordance with specific requirements of substantiation of expense. 2. Allowances which essentially constitute reimbursement to government personnel for expenses they incurred in the performance of their official duties, such as: a. Representation and Transportation Allowance (RATA) of public officers and employees under the General Appropriation Act | Personnel Economic Relief Allowance (PERA) (RR10-2008) 3. Reasonable amounts of reimbursements or advances to employees for travelling and representation which are pre-computed on a daily basis and which are paid to any employee while on assignment or duty. These amounts given to the employee are not income but are expenses of the trade, business or profession of the employer that are incurred or paid through the employee. These are not employee benefits since they are mere advances or replenishments of what are supposed to be direct cash outflows from the employer; hence, these are not considered as compensation income. BENEFITS FOR THE CONVENIENCE OR ADVANTAGE OF THE EMPLOYER Benefits or allowances which are intended for the furtherance of the interest of the employer’s business or to ensure its smooth operations are likewise exempt from income tax. This is referred to as the “convenience of the employer rule.” Examples: 1. Work-related mobile phone allowance and transportation allowance particularly to employees of call centers which are operated on a 24-hour basis where employees are required to be available always for assignment and consultation (BIR Ruling DA-233-07) 2. Outstation allowance for employees who will be out from office site at least 8 hours to visit lotto franchise holders for repairs and/or inspection of equipment leased by the employer (BIR Ruling No. 013-02) ' 3. Grant of housing privilege to employees working at distant or remote facilities even if the dwelling is distanced from the facility in compliance to labor safety standards (BIR Ruling No. 055-99) 4. Car incentives to employed on-call medical doctors S. SCho_la.rShiP grants to employees under contract to remain in service for a specified period upon completion of the study 339
Chapter 10 - Compensation Income 6. Housing privilege of military officials of the AFP located inside or near the military camps These types of employer spending are regarded as business expenses and are not considered as employee reward because they are not intended for the free personal consumption or disposal of the employees but as implements of the employer’s business to ensure the employer’s convenience. However, if the expense is unreasonably excessive making it depart from the nature of a reasonable business expense such as when it is deliberately granted to include a benefit for the employee, the portion of the expense representing provision or privilege to the employee is considered a taxable fringe benefit. These types of expense are regarded as “hybrid expenses” because they are partially business expense and partially employee benefits. COMPOSITION OF TAXABLE COMPENSATION INCOME 1. Regular compensation - This pertains to the fixed remunerations received by the employee every payroll period. 2. Supplemental compensation - This pertains to other performance-based pays to employees with or without regard to the payroll period. An adjunct category to the supplemental compensation, 13th month pay and other benefit, is necessary to contain incentive pays and all other taxable employee benefits not classifiable as regular or supplemental compensation. 13th month pay and other benefits not exceeding P90,000 is an exclusion from gross income. The excess above P90,000 is added to supplemental compensation. Illustration An employee received P400,000 regular compensation, P120,000 supplemental compensation, and P100,000 13th month pay and other benefits. The taxable compensation income shall be computed as follows: Regular compensation P 400,000 Supplemental compensation [P120,000 + (P100 000 P90,00)] 130,000 Taxable compensation income P 530,000 REGULAR COMPENSATION INCOME The regular compensation includes fiXed remunerations due to be received by an employee every period such as: 1. Basic salary 2. Fixed allowances such as cost-of-living allowance, fixed housing allowance representation, transportation, and other allowances paid to an employee€ every payroll period | . 340
Chapter 10 - Compensation Income Fixed allowances Allowances which are fixed in amounts and regularl ' . y received as part of th i monthly, bi-weekly, weekly or daily salaries or wages are gart of :egiis; compensatiOI;l. This applies even if a portion of the allowances are actually used in the employer’s business. Exception rule on the taxability of allowances: a. Ordinary and necessary allowances for travelling, representation or entertainrpent expense of employees incurred in the pursuit of the employer’ trade, business or profession. b. The expense is subject to accounting or liquidation. c. Any excess advances are returned to the employer. Hence, variable and liquidated allowances are not subject to tax. However, amounts of allowances that are retained by the employee for himself shall be considered compensation. | Paid vacation and sick leave allowances | - The paid absences of an employee applied against his vacation or sick leave credits which are normally received as part of the regular salary is part of the regular compensation. Non-compensation items 1. Fees - . . . Retainer fees of consultants, talents, and directors who have no management function in the business are professional income, not compensation income of the recipient. 2. Commissions to non-employees such as independent sales agents are business income to the sales agent. | 3. Tips and gratuities Tips and gratuities paid directly to an employee by customers of the employer which are not accounted for by the employee to the employer are not considered as compensation income, but are to be reported as “other income in the income tax return of the employee. Valuation of compensation paid in kind Compensation in kind is taxable at the fair value of t received in shares, the fair value of the shares at the is used. he consideration received. If date services were provided Ilustration 1 The following pertains to an employee in 2024: ' P 400,000 Gross salaries 36,000 Cost-of-living allowance 341
Chapter 10 - Compensation Income Fixed monthly transportation allowance (P2Kx 12) 24,000 Deduction for withholding tax on compensation 10,000 Deduction for employee share in SSS, PHIC, and HDMF 32,000 The taxable compensation income shall be computed as follows: Gross salaries P 400,000 Cost-of-living allowance 36,000 Fixed monthly transportation allowance 24,000 Regular compensation income P 460,000 Less: Non-taxable compensation Mandatory deduction 2,00 Taxable compensation income P 428,000 Illustration 2 An employee who was terminated in 2024 due to business closure of the employer received the following: Unpaid 2024 salaries P 200,000 Unpaid 2023 salaries | 20,000 Reimbursement for transportation expenses 10,000 Termination pay 100,000 The taxable compensation income shall be computed as follows: Gross compensation income (P200K + P20K + P100K) P 320,000 Less: Non-taxable compensation Non-taxable benefits 100,000 Taxable compensation income P 220,000 Note: 1. Reimbursement for transportation expense is not an income to the employee. 2. The termination pay is included in gross compensation income, but is also deducted as non- taxable compensation because the reason of termination is beyond the employee’s control. SUPPLEMENTARY COMPENSATION Supplementary or additional compensation includes performance-based remunerations to an employee in addition to the regular compensation with or without regard to the payroll period. The following are the additional compensation under current tax rules: Overtime pay ' Hazard pay Night shift differential pay Holiday pay Commissions Fees, including director’s fees (if director is an employee) Emoluments and honoraria NO D W 342
chapter 10 - Compensation Income Taxable retirement and separation pay 9: value of living quarters or meals 10. Gains on exercise of stock options 11. Profit sharing and taxable bonuses overtime, holiday, hazard, and night differential pay These constitute additional compensation, except when derived by a minimum wage earner. Commissions, emoluments and honoraria Commissions are incentives intended to stimulate sales. These may be given as a profit sharing or performance bonus. Emoluments pertain to any pay in general while honoraria are additional payments for attending to special tasks or assignments. Living quarters or meals If an employee receives free living quarters or meals in addition to salary for services rendered, the value to the employee of such living quarters or meals is included in compensation income. However, when the same was furnished to an employee for the convenience of the employer or out of necessity of the employer’s business, the value thereof is not compensation income, but a business expense. Stock option plans To motivate employees, employers give stock options to employees allowing them to earn additional rewards on the appreciation of the stock price of the company. The option will have value when the value of the stock of the employer exceeds the exercise price fixed at the grant date. | Types of options | | 1. Equity-settled options - entitles employees to purchase shares of stocks of the employer at a pre-determined exercise price fixed on the grant date 2. Cash-settled options - entitles the employee to receive in cash the excess of the fair value of stocks over the exercise price without actually delivering stocks Upon the exercise of the option, the excess of the book value or fair value of the stocks, whichever is higher, less the exercise price set at grant date is treated as follows: a. Additional compensation income - if the employee is a rank and file b. Fringe benefits - if the employee is a managerial or a supervisory employee This rule is applied regardless of the type of the option. (RMC 79-2014) Mustration - equity-settled option Mr. Anthony, a rank and file employee, received a stock option from his employer, ggg Inc, entitling him to buy 10,000 of ABC’s share at a strike price of P100. In April h 1, Mr. Anthony exercised the option when ABC shares was selling P150/share. The ABé'es had a book value of P145/share in the latest published financial statements of » Inc. After two years, he sold the shares for P180/share. 343
Chapter 10 - Compensation Income Fair value of stocks (P150 x 10,000 shares) P 1,500,000 Less: Exercise price of option (P100x10,000) __1.000.000 Compensation income (discount) P__ 500,000 Note: 1. The P150/share fair value is used since it is higher than the P145/share book value. 2. For listed shares, the fair value of the stock is based on the simple average of high and low on the exercise date. For non-listed shares, the book value per share is simply used in the absence of an over-the-counter (OTC) market price available. The compensation income shall be reported by Anthony in his 2021 income tax return. If Mr. Anthony is a supervisory or managerial employee, the P500,000 shall not be treated as a compensation but as a fringe benefit subject to a gross-up fringe benefits tax. i Treatment of the subsequent sale of the shares If the employer corporation is a: | 1. Domestic corporation, and the sale of the stocks is made: a. through the PSE, the sale is subject to the stock transaction tax of 60% of 1% of the gross selling price. The tax would be computed as: Selling price (P180 x 10,000) P 1,800,000 Multiply by: stock transaction tax rate 60% x 1% Stock transaction tax P 10,800 The tax will be withheld by the broker who effected the sale. The gain from the sale of the stocks would not be subject to income tax. b. directly to buyer, the net gain on the sale is subject to the 15% capital gains tax. The tax shall be computed as follows: Selling price (P180 x 10,000) P 1,800,000 Less: Tax basis of shares sold _1,500,000 Capital gains P 300,000 Capital gains P 300,000 Multiply by: CGT tax rate 15% Capital gains tax P___ 45000 2. Foreign corporation, the net gain on the sale is a capital gain subject to the rules of regular income tax. The gain subject to regular tax shall be computed as follows: Selling price (P180 x 10,000) P 1,800,000 Less: Tax basis of shares sold 1,500,000 Capital gains P 300,000 Multiply by: Holding period rate (>1 year) 50% Capital gain subject to regular tax P__150,000 The rules on dealings in other capital assets will be discussed in Chapter 12. 344 Ve adl - » DY - § P
Chapter 10 - Compensation Income [llustration - cash-settled option Mr. Anthony, a supervisor, received a cash-settled sto ' ' ABC, Inc., entitling him to receive the increase in the con(;ll{)a(‘:gf’lsocr:llgfgrionmg S?asregmppfl.lgogyzr, exercise date over the strike price of P100/share covering 10,000 ABC shares 0?1 March 23, 2023, Mr. Anthony exercised the option. ABC shares traded P156/si1are high, p146/share low and closed P150/share at the Philippine Stock Exchange. The volume weighted average traded price was P148/share. ABC shares had a book value of P153/share in the latest published financial statements. Based on the ABC, Inc.’s option plan, Mr. Anthony shall receive cash instead of stocks amounting to: ' Fair value of stocks (P150 x 10,000 shares) P 1,500,000 Less: Exercise price of option (P100 x 10,000) 1.000.000 Cash (Fringe benefit subject to final tax) P__ 500,000 What if the option is an equity-settled option? If the option would have been an equity-settled option, Mr. Anthony shall receive the following number of ABC shares pursuant to the terms option plan: Fair value of stocks (P150 x 10,000 shares) P 1,500,000 Less: Exercise price of option (P100 x 10,000) 1,000,000 Increase in value of stocks covered by the option P 500,000 Divide by: Exercise day closing price 150 Number of shares 333333 Under the regulations, the fair value of listed stocks is the simple average of high and low, computed as (P156 + P146)/2 = P151/share. Pursuant to RMC 79-2014, the fringe benefits would be valued based on the P153/share higher book value as follows: ' Number of shares 3,333.33 Multiply by: _ 153 Stocks (Fringe benefit subject to final tax) P__510,000 The subsequent sale of the stocks would be subject to the stock transaction tax. There would be no income tax on the realized gain. Profit sharing or taxable bonus : Profit sharing is a reward for churning the business to post a profit. It is a compensation for controlling all the factors that influence profit such as .marketmg and sales, productivity, and administrative factors. It is a reward which can be enjoyed by individual employees such as salesmen, division heads, key officers, or by all employees collectively. 345
Chapter 10 - Compensation Income Bonuses are supplemental or additional compensation. However, if they are linkeq solely to productivity under the productivity incentive plan of the employer pursuant to RA 6971, they should be considered as de minimis benefits. Productivity incentive bonus A productivity incentive is linked to improvements in productivity usually in terms of cost savings through waste reduction, efficient labor utilization, or increase in volume of production. Under the revision of RA 10653, productivity incentive is now a de minimis benefit. Productivity incentive distinguished from profit sharing bonus Productivity incentive is anchored on improvements in the factors of production and is usually enjoyed collectively by employees due to the inherent difficulty of | tracing productivity to individual performance. It is based upon cost savings; hence, it is payable even if the business poses a loss. Profit sharing is payable only | when the business post a profit. | 13TH MONTH PAY AND OTHER BENEFITS “13th Month Pay and Other Benefits” includes: 1. 13th month pay 2. Other benefits | a. Christmas bonus of private employees b. Cash gifts other than Christmas or anniversary gifts of private employees (RR2-98, as amended by RR5-2011) ' ¢. Additional compensation allowance (ACA) of government personnel (RR8-2000) | | d. 14* month pay, 15t month pay, etc. e. Other fringe benefits of rank and file employees 13th month pay a. The 13th month pay of government employees consists of a Christmas bonus equivalent to one-month salary plus a P5,000 cash gift. (RA 8441) b. The 13th month pay of private employees is equivalent to one-month salary. - Christmas bonus and Christmas gift The Christmas bonus of government employees is their 13th month pay. In private companigs, the term “Christmas bonus” may pertain to the 13th month pay, a Seéparate incentive pay, or to a profit sharing. Christmas bonus of private employees which is a non-performance-based | irlllcer}tive pay is part of other benefits. Christmas bonus in the nature of profit Sharing should be treated as additional compensation income, not as “other 346
Chapter 10 - Compensation Income benefits.” The nature of the Christmas bonus of private employees shall determine its tax classification. The Christmas gift of government employees is specifically designated as part of “13th month pay and other benefit” under Sec. 32(B)(7)(e)(i) of the NIRC. RRS- 2011 includes Christmas gift in the list of de minimis benefits but this should be interpreted to apply only to Christmas gifts of private employees. Hence, Government Private employees employees Christmas bonus 13th month pay 13th month pay and other benefits | and other benefits Christmas gift 13th month pay De minimis and other benefits Bonus vs. Gift Bonus is performance-based and is non-discretiona ry to the employer while a gift is a gratuity and is discretionary upon the employer. Other fringe benefits Other fringe benefits include all other taxable fringe benefits not specifically included in compensation income as regular, supplementary or 13th month pay, and other benefits under current tax rules such as: 1. Employee personal expenses shouldered by the employer 2. Taxable de minimis benefits such as: a. Excess de minimis b. Benefits not included in the de minimis list Employee personal expenses Employee personal expenses, even if receipted in the name of the employer, such as, but not limited to, rental of residence, grocery, association or club membership dues, travel or vacation expense or tuition fees, when assumed or paid by the employer, constitute fringe benefits to the employee. Taxable de minimis benefits All other benefits of relatively small value which are not included in the list of de minimis benefits shall not be considered as de minimis but as ordinary fringe benefits, Corollary to this rule, excess de minimis benefits should be considered as taxable ordinary fringe benefits. Tax Treatment of Other Fringe Benefits - fOf rank and file employees - treated as compensation income as part of other benefits” under “13* month pay and other benefits" b. For Managerial or supervisory employee - treated as fringe benefit subject to fringe benefit tax 347
Chapter 10 - Compensation Income It must be emphasized that the “other fringe benefits” of managerial or supervisory employees are excluded from their “13th month pay and other benefits.” Hlustration 1 ) N : The employer pays for the tuition fee of the employee in addition to his regular compensation. The tuition fee paid is a fringe benefit which will be treated as follows: 1. As a compensation income as part of “other benefits” under “13th month pay and other benefits” if the employee is a rank and file employee 2. As a fringe benefit subject to fringe benefit tax if the employee is a managerial or supervisory employee 3. As an exempt fringe benefit, regardless of the type of employee, if the same was given by the employer for his convenience or business necessity such as when the employee is required to study to acquire expertise for the future use of the employer’s business | Illustration 2 An employee receives a monthly rice allowance of P3,000 a month which is P1,000 in excess of the P2,000 a month de minimis limit for rice allowance. The P1,000 monthly excess constitutes a taxable de minimis benefit taxable as compensation as part of “other benefits” for a rank and file employee. It is a fringe benefit subject to final fringe benefit tax for a managerial or supervisory employee. TAX TREATMENT OF 13TH MONTH PAY AND OTHER BENEFITS ‘ RR2-98 provides that 13th month pay and other benefits are exempt from withholding on compensation provided they do not exceed P90,000. It follows, therefore, that the excess above P90,000 is subject to the withholding tax on compensation. ' RR3-98, the revenue regulation implementing the fringe benefit tax, also provides that it does not cover benefits forming part of compensation income subject to the withholding tax on compensation. | Hence, the excess of “13th month pay and other benefits” over P90,000 should be treated as compensation income subject to regular income tax. Illustration 1 A government rank and file employee received the following benefits aside from the basic pay in 2023: Bk Christmas bonus P 70,000 Cash gift , 5,000 Additional compensation allowance 36,000 Person.nel Economic Relief Allowance (P2,000/month) 24,000 quet1zed value of vacation leave and sick leave (18 days) 9,000 Uniform and clothing allowance 7,000 348
Chapter 10 - Compensation Income Required: Determine the taxable “13th month pay and other benefits.” Solution: Christmas bonus (13th month pay of gov't employees) P 70,000 Cash gift 5,000 Additional compensation allowance 36,000 Excess uniform and clothing allowance (P7,000 - P6,000) 1,000 Total 13th month pay and other benefits P 112,000 Less: Exclusion T hreshold 90,000 Taxable 13th month pay and other benefits P_22,000 Note on government employees: 1. Personnel Economic Relief Allowance is not subject to income tax and withholding tax (Under RR8-2000, as affirmed by RR10-2008). ‘ - 2. The P5,000 Christmas gift of government employees is designated by the NIRC to be part of «13th month pay and other benefits”; hence, itis nota de minimis benefit. 3. Under RR5-2011, the monetization of vacation leave and sick leave credits of government officials is an exempt de minimis benefit without regard to the number of days. ustration 2 A private rank and file employee working in a remote tower station of Snail Internet Company received the following benefit during 2023: 13th month pay P 72,000 Performance bonus . 15,000 Christmas gift 30,000 Danger exposure allowance (hazard pay) | 6,000 Housing privilege 38,000 Uniform and clothing allowance - 8,000 Laundry allowance e | 6,000 The housing privilege pertains to the annual value of the emplbyees’ living quarters furnished by the employer to employees for staying on-site. | Required: Compute the excess 13th month pay and other benefits. Solution: De Other _minimis __Limit _Benefits Christmas gift ‘ P 30,000 P 5,000 P 25,000 Uniform and clothing allowance 8,000 6,000 2,000 Laundry allowance ‘ 6,000 3,600 2,400 Excess de minimis benefits (other fringe benefits) P 29,400 13th month pay ' 72,000 Total 13th month pay and other benefits P 101,400 Less: Exclusion threshold 90,000 Taxable 13th month pay and other benefits P 11,400 Note: Private employees 1. : " " . g;rformance bonus is a supplemental or additional compensation. L e laundry allowance limit is computed as P300 x 12 = P3,600. 349
Chapter 10 - Compensation Income 3. Christmas giftis a de minimis benefit for private employees under RR5-2011. 4' The housing privilege is exempt under the convenience of the employer rule. 5. The “13th month pay and other benefits” of rank and file employees includes “other fringe benefits.” Illustration 3 _ A managerial employee received the following benefits in 2023: 13th month pay P 95,000 Rental expense on condominium unit 18,000 Salary of personal body guard 12,000 Profit sharing 12,000 Rice allowance 32,400 Clothing allowance 7,000 Night shift differential pay 11,000 Required: Determine the taxable “13th month pay and other benefits,” additional compensation, and the fringe benefit subject to fringe benefit tax. Solution: ~ De Other _minimis __Limit _Benefits Rice allowance P 32,400 P 24,000 P 8,400 Clothing allowance 7,000 6,000 1,000 Excess de minimis P 9,400 Other fringe benefits: | Rent of residence paid by employer 18,000 Salary of personal body guard 12.000 Total fringe benefit subject to fringe benefit tax P_39.400 Profit sharing P 12,000 Night shift differential pay _ — 11,000 Total supplemental compensation P_23.000 Total 13t month pay and other benefits P 95,000 Less: Exclusion threshold 90.000 Taxable 13th month pay and other benefits P__ 5,000 INTEGRATIVE ILLUSTRATIONS: COMPENSATION INCOME Integrative Illustration 1 A government rank and file em ployee had the following summary of his compensation and benefits in 2023: . Gross compensation income P 1,044,000 Less: Employee payroll deductions Employee contribution to GSIS, PHIC; HDMF P 80,000 Employee deduction for withholding tax — 64,000 ___ 144,000 Net regular payrol] P 900,000 350
Chapter 10 - Compensation Income Net regular payroll P 900,000 Representation and Transportation Allowance 18,000 personnel Economic Relief Allowance 24,000 Christmas bonus §7.000 Uniform allowance 12,000 Christmas gift 5.000 Honoraria 15000 Total compensation P_1.061,000 The taxable compensation income shall be computed as follows: De Non- Other Taxable _minimis _ Taxable _Benefits _ Benefits Regular and supplementary compensation: Mandatory deductions P 80,000 Regular compensation (P1,044,000 - P80,000) P 964,000 Supplemental compensation Honoraria 15,000 RATA 18,000 PERA 24,000 Total P 0P 979,000 13th month pay and other benefits: Christmas bonus P 87,000 Christmas gift 5,000 Excess De minimis: : Uniform allowance P 12,000 P 6.000 6,000 Total P 12,000 P 48,000 P 98,000 Exclusion threshold (up to P90,000) 90,000 €«=-90,000 Total P 138,000 P 8,000 Total non-taxable compensation P 218,000 Taxable excess 13th month pay and other benefits - 8,000» 8.000 Taxable compensation income P 987,000 Note: 1. The taxable regular compensation income is computed as (P1,044,000 - P80,000). . 2. The excess of the P90,000 threshold over the actual 13t month pay and other benefits is non-deductible to other items of compensation income. (; RR3-2015) Presentation in the Income Tax Return of the employee: Gross compensation income (i.e,, P1,061,000 + P144,000) P 1,205,000 Less: Non-taxable compensation income Mandatory deductions P 80,000 Exempt benefits 138,000 218.000 Taxable compensation income p__ 987,000 351
Chapter 10 - Compensation Income Integrative Illustration 2 A private employee derived the following remunerations and benefits in 2023: Basic compensation, net of P32,000 SSS, PHIC, PhilHealth, HDMF, union dues, and P35,000 withholding tax P 533,000 Overtime pay 21,000 Vacation expenses of the employee paid by employer 24,000 Cost-of-living allowance (COLA) | 12,000 Pre-computed daily transportation allowance 16,000 Rice subsidy (12 cavans worth P2,600 each) 31,200 13th month pay 50,000 Monetized unused leave credit (10 VL and 8 SL) 18,000 Uniform allowance 9,000 Total compensation income P 714,200 The non-taxable compensation income and the gross taxable compensation income shall be computed as follows: For a rank and file employee: De Non- Other Taxable minimis __Taxable _Benefits Benefits Regular and supplementary compensation: Mandatory deductions P 32,00 Regular compensation (P600,000 - P32,000) P 568,000 Supplementary compensation Overtime pay | ’ 21,000 COLA | 12,000 Daily transportation allowance P 16,000 Total P 0P 601,000 13th month pay and other benefits: 13th month pay P 50,000 Other benefits: Vacation expense paid by employer 24,000 Excess de minimis benefits: Rice subsidy P 31,200 24,000 7,200 Monetized VL 10,000 10,000 - Monetized SL 8,000 - 8,000 Uniform allowance 9.000 6,000 ___ 3,000 Total P 58200 P 56,000 P 92,200 P 601,000 Exclusion threshold 90,000 <*-90,000 Total P 146,000 P 2,200 Total non-taxable compensation P 178,000 Taxable 13th month pay and other benefits - 2200—» 2,200 Taxable compensation income P__603.200 352
Chapter 10 - Compensation Income Note: i : 1. The P568,000 basic compensation may also be computed as P533,000+P35,000. Note that the withholding tax is not an exclusion from gross income. 2. The limit of the monetized unused VL is computed as P18,000 x 10/18 = P10,000. The SL pay is computed as P18,000 x 8/18 = P8,000. 3. The vacation expense shouldered by the employer is a fringe benefit forming part of compensation income of a rank and file employee under “other benefits.” Presentation in the Income Tax Return of the employee: Gross compensation income* P 781,200 Less: Non-taxable compensation income Mandatory deductions P 32,000 Exempt benefits 146,000 178.000 Taxable compensation income P_ 603,200 *P714,200 net pay + (P32,000 + P35,000) payroll deductions Income Tax Due The income tax due of the employee would be computed as follows: Tax Taxable income P 603,200 ~¥Less: Lower limit of applicable bracket 400,000 P 22,500 1 Excess P 203,200 ! Multiply by: incremental tax rate 20% 40,640 E Income tax due P_63,140 1 E Over ButNotOver BasicTax Plus% Ofexcessover | [ 25000000 40000000 "0 15% 25000000 '--4 400,000.00 800,000.00 ,500 20% 400,000, 800,000.00 2,000,000.00 102,500 25% 800,000.00 Note: Check the complete Individual Income Tax Table in Chapter 7 or in the Appendix. For a managerial or supervisory employee: De Non- Other Taxable _Minimis _ Taxable _Benefits _Benefits Regular and supplementary compensation: Mandatory deductions P 32,000 Regular compensation P 568,000 Supplemental compensation Overtime pay 21,000 COLA 12,000 Daily transportation allowance 16,000 Total P 601,000
Chapter 10 - Compensation Income De Non- Other Taxable _Minimis _ Taxable _Benefits _Benefits 13th month pay a ; 13th month pay P 50,000 Exclusion threshold (up to P90,000) ___ 50,000 % - 50,000 Total P 66,000 P 0 Excess 13th month pay & other benefit 0—» 0 Taxable compensation income P 601,000 Other fringe benefits: Vacation expense paid by employer P 24,000 Excess de minimis benefits ' Rice subsidy P 31,200 24,000 P 7,200 Monetized unused VL 10,000 10,000 - Monetized SL 8,000 0 8,000 Uniform allowance 9.000 6.000 3,000 Total P 58200 P 106.000 P 18,200 Total non-taxable compensation P 138,000 | Excess de minimis benefits _-18,200 18,200 Total fringe benefits subject to final tax P_42,200 The gross compensation income is computed as follows: Total remunerations and benefits P 781,200 Less: Fringe benefit subject to final tax 42,200 Gross compensation income P_739,000 Presentation in the Income Tax Return of the employee: Gross compensation income | P 739,000 Less: Non-taxable compensation income | Mandatory deductions P 32,000 Exempt benefits 106,000 138,000 Taxable compensation income P 601,000 Income Tax Due The income tax due of the employee would be computed as follows: Tax Taxable income P 601,000 r~ ®Less: Lower limit of applicable bracket —400,000 P 22,500 !t Excess | P 201,000 i }Vlultiply by: incremental tax rate 20% 40,200 + Income tax due P_ 62,700 : Over But Not Over Basic Tax Plus % Of excess over \ 1..250,000.00 " 400,000.00 0 15% __ 250,000.00 '--4..400,000.00 .800,000,00 22500 20% ___ 400,000.00 | 354
Chapter 10 - Compensation Income The fringe benefits tax on managerial or supervisory employees The fringe benefits of managerial or supervisory employees is subject to a - final tax at the rate of 35%, computed as follows: 4 Ject to a grossed-up Taxable fringe benefits P 42200 Divide by: Gross-up by rate 65% Grossed-up monetary value | P 64923 Multiply by: Tax rate 3504 Fringe benefits tax P 22723 The fringe benefits tax is a final tax which be paid by the employer to the government. It is presumed withheld out of the fringe benefits of the managerial or supervisory employee. The detailed rules on fringe benefit taxation will be discussed in the following chapter. It is merely shown here for you to obtain preliminary understanding. TAXABILITY OF MINIMUM WAGE EARNERS (MWE) | Minimum wage earners are exempt from income tax on the following: 1. Basic minimum wage | 2. Other benefits (HHON) a. Holiday pay b. Hazard pay c. Overtime pay d. Night shift differential pay These shall be presented as exempt benefits under non-taxable compensation income. Since exempt from income tax, the exempt benefits of MWEs shall not be subject to withholding tax. | IMlustration _ Ms. Guevarra, a minimum wage earner employed by CSO Company, derived the following benefits during the year: Basic minimum wage ‘ P 124,000 13% month pay 11,000 Overtime pay | 80,000 Night shift differential pay 30,000 Hazard pay | 15,000 Holiday pay 15,000 Total P 275,000 Less: SSS, PhilHealth, HDMF contributions 5,000 Net total | P_270,000 355
Chapter 10 - Compensation Income The taxable compensation income should be computed as follows: Gross compensation income . P 275,000 Less: Non-taxable compensation income oo Mandatory deductions P ) Exempt benefits 270,000 275,000 Taxable compensation income P 0 Receipt of other taxable income by MWEs . | MWEs are still exempt from income tax on the foregoing exempt bepeflts even if they are earning other taxable items of compensation or other income from concurrent employers, trade, business or practice of a profession. ‘MWESs are subject to tax only to the extent of income other than the aforementioned exempt benefits. (RR11-2018) Hence, additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the allowable amount of P90,000, taxable allowances and other taxable income given by the same employers to MWEs are subject to withholding tax. Despite this, it must be noted that MWEs will actually pay income tax only if their total taxable income exceeds P250,000 for the year. Nustration 1: With other taxable compensation income Mary Dela Fuente, a minimum wage employee, was able to close a sales deal for her employer in 2023. She received the following compensation during the year: | Basic minimum wage, net of P8,000 mandatory deductions P 160,800 13% month pay - 14,000 Holiday pay 4,000 Overtime pay 70,000 Night shift differential pay 15,000 Hazard pay 10,000 Profit sharing bonus 12,000 Commission income 370,000 Total P__ 655,800 The taxable compensation income should be computed as follows: Gross compensation income (ie, P 655800 +P 8 ,000) P 663,800 Less: Non-taxable compensation income | lglandat%ry deductions P 8,000 xempt benefits 273,800 281,800 Taxable compensation income P__ 382,000 356
Chapter 10 - Compensation Income Exempt benefits consist of the following: Basic minimum wage P 160,800 13th month pay 14,000 Holiday pay 4,000 Overtime pay 70,000 Night shift differential pay 15,000 Hazard pay . - 10,000 Total exempt benefits P__ 273,800 Mary’s tax due shall be computed as: __Tax Due _ Taxable compensation income P 382,000 Less: Lower limit of the income bracket where the taxable income qualifies 250,000 P 0 Excess P 132,000 Multiply by: 15% 19,800 Total tax due P 19,800 Illustration 2: With business income Jun, a minimum wage employee, do part-time business after work. He received total minimum wage of P290,000 inclusive of P11,000 13t month pay but net of P5,000 mandatory deductions. He also received a performance bonus of P20,000 and earned P300,000 from his side-line business. Jun’s taxable income shall be computed as follows: Gross compensation income (i.e, P 290K + P 5K + P20K) P 315,000 Less: Non-taxable compensation income | ' Mandatory deductions P 5,000 Exempt benefits 290,000 ____295,000 Taxable compensation income P 20,000 Net income from business 300,000 Taxable income ‘ P 320,000 Rules of change in status as a Minimum Wage Earner during a year 1. When an employee becomes a minimum wage earner during the year, he shall bg subject to income tax only on compensation earned before becoming a minimum wage earner. ' Ilustration 1 {Xnthony had a basic pay of P400/day when the minimum wage was P382/day. He 1; also receiving overtime pay and the year-end 13th month pay. On July 1, 2021, the Regional Wages and Productivity Board increased the minimum wage by P22/day to P404/day. Anthony’s employer increased his salary to the minimum P404/day. 357
Chapter 10 - Compensation Income Anthony shall be taxed on his income from January 1 to June 30 because he is not yet a minimum wage earner. The employer shall regularly deduct the withholding tax on compensation from his salary but shall stop withholding by June 30. Anthony’s compensation starting July 1 including overtime pay and year-end 13th month pay shall be tax exempt. If the exact amount of income taxes had been withheld by the employer for the January 1 to June 30 compensation, Anthony need not file an income tax return. Otherwise, Anthony shall file an adjustment return reflecting his compensation from January 1 to June 30 and shall pay the tax still due or claim for refund in case of excess withholding. This rule may also apply in cases of: a. Transfer to an employer paying salary at the minimum wage b. Transfer of employment to a region with higher minimum wage 2. When an employee ceases to be a minimum wage earner during the year due to increase in salary, only the income for the rest of the year is taxable Illustration 2 Andrea is a minimum wage earner. She was promoted and was given a salary raise above the minimum wage starting August 1, 2021. Andrea shall be exempt from income tax from January 1 to July 31 because she is a minimum wage earner. Effective August 1, 2021, Andrea shall be subject to tax. The employer shall start deducting the withholding tax on compensation from Andrea’s salaries effective the same date. If the employer properly withheld the income tax for the period August 1 to December 31, Andrea need not file an income tax return. Otherwise, she shall file an adjustment return reflecting her compensation for the same period and shall pay the tax still due or claim for refund in case of excess withholding. This rule applies in cases of: a. Transfer to an employer paying salary above the minimum wage b. Transfer of employment to a region with lower statutory minimum wage 3. When an employee ceases to be a minimum wage earner during the year by disqualification (i.e., earning taxable income) Note that if the taxable income of the employee does not exceed P250,000 for the year, there will be no income tax due for the period under the tax table. Treatment of Cost-of-living Allowance of MWEs Under RMC23-2011, COLA which forms part of the new wage rates prescribed to be the statutory minimum wage should be treated as part of the minimum wage and shall not be treated as a separate or other benefit. 358
Chapter 10 - Compensation Income THE The withhol wITHHOLDING TAX ON COMPENSATION ding tax on compensation is a method of collecting the income tax at source upon receipt of the income. It applies to all employed individuals whether citizens OF Reproduced herein is the withholding tax table for compensation: aliens. The employer is constituted as the withholding agent. REVISED WITHHOLDING TAX TABLE | oAy T+ Lz = J &« T s I s ] | Compensztic P 685 and P5,479-P P 21,918 and : P685-P 1,095/ P1,096-P2,191 (| P . : 918 an IRange below 2,192-P 5,478 21,917 above [ 0.00 ps219 || P356.16 P134247 || P6,602.74 . g Tax 0.00 +15% over +20% over P +25% over +30% over +35% over P ithhold P685 1,096 P2,192 PS,479 21,918 = - I | s [« 1 s 1 & | SMpensatic pago8and|| P4,808- P7,692- P 15,385 - p38462- || P153,846and Pznge below P7,691 P15,384 P38,461 P153,845 above s 0.00 P 576.92 P 2,500.0 P 9,423.08 P 46,346.15 | : g Tax 0.00 + 15% over +20% over +25% over +30% over + 35% over iehiokt P4,308 P7,692 P15,385 P38,462 P153,846 ommonty || 1 | 2 |3 || 4 T s e | {Compensatic P 10,417 P 10,417 - P 16,667 - P 33,333- P 383,333- || P333,333and IRange and below P16,666 P33,332 P83,332 P333,332 above ’ o 0.00 P 1,250 P 5,416.67 P 20,416.67 || P 100,416.67 e T 0.00 +15% over +20% over + 25% over + 30% over + 35% over [Vl T P10,417 P16,667 P33,333 P83,333 P333,333 oy || 1 | 2 | 3 T & @ /&l 38092 {Compensatia p20,833 || P20,833- P33,333- P 66,667 - P 166,667 - || P 666,667 and \Range and below h p33,332 P66,666 P166,666 P666,666 above Pr 0.00 P 2,500.00 P 10,833.33 P40,833.33 || P200,833.33 I , e T 0.00 + 15% over +20% over + 25% over +30% over +35% over | Winholding Tax J' P20,833 P33,333 P66,667 P166,667 P666,667 Procedural computation of the withholding tax on compensation 1. Determine the total monetary and non- employee for the payroll period: monthly, Segregate non-taxable benefits, mandatory ¢ compensation. 2. Determine the bracket that applies to th employee for the applicable payroll period. Determine bracket. 3. Add supplemental compensation to the excess of the regu the basic P Subject the total to the incremental tax rate for the bracket. - Total the basic tax and the incremental basic tax. 359 monetary compensation of the semi-monthly, weekly or daily. ontributions and supplemental e regular compensation of the tax for the lar compensation.
Chapter 10 - Compensation Income Illustration 1: Weekly payroll period Olongapo Company pays Employee Marudo weekly. Marudo has a weekly salary of P10,000, before P500 mandatory contributions for SSS, PhilHealth, HDMF and Union dues and P1,000 non-taxable benefits. Marudo’s taxable compensation shall be computed as: Gross compensation P 10,000 Less: Mandatory contributions P 500 Non-taxable benefits 1,000 1,500 Taxable income P 8.500 Marudo’s P8,500 weekly taxable income qualifies under Column 3 under the weekly payroll period. Olongapo Company shall compute the withholding tax on compensation as follows: Tax Regular compensation income P 8,500 Less: Base amount at Column No. 3 - weekly 7692 P 576.92 Excess P 808 Multiply by: Incremental tax rate 20% 161.60 Total withholding tax on compensation P 738.52 The amount of compensation income that will be released to Marudo shall be: Gross compensation P 10,000.00 Less: Mandatory contributions P 500 Non-taxable benefits 1,000 1,500.00 Taxable income P 8,500.00 Less: Withholding tax on compensation 738.52 Net payroll due to Marudo P 776148 Illustration 2 ABC Company employs Mr. Penoy has a semi-monthly salary of P35,000. During the period, he earned a total overtime pay of P12,000. His mandatory contributions for SSS, PhilHealth, HDMF and union dues were P2,400. Penoy’s semi-monthly withholding tax base shall be P 33,800, (P35,000 - P2,400). This qualifies under Column 4 under the semi-monthly payroll period. ABC Company shall compute the withholding tax on compensation as follows: Tax Regular compensation income P 33800 Less: Base amount at Column No. 4 - semi-monthly ___ 33333 P 5416.67 Excess P 467 Add: Supplemental compensation — 12,000 Total P 12,467 Multiply by: Incremental tax rate 2000 3.116.75 Total withholding tax on compensation P_8.53342 360
chapter 10 - Compensation Income The amount of semi-monthly pay that will be released to Penoy shall be: Regular compensation P 35,000.00 Supplemental compensation 12.000.00 Total compensation P 47,000.00 Less: Mandatory deduction P 1,200.00 Non-taxable benefits 0.00 1,200.00 Taxable income P 45,800.00 Less: Withholding tax on compensation 8.533.42 Net payroll due to Penoy P 37.266.58 The procedures discussed herein are also applicable for daily or monthly payroll periods but of course using their respective withholding tax table. Year-end Tax Adjustment It must be noted that the total amount withheld on every payroll date may not exactly match the annual tax due. Due to this, the income of the employee needs to be reckoned at the end of the year and adjustment is made as necessary. Any under-withholding shall be deducted on the final payroll of the employee. An over- withholding shall be refunded to the employee. BENEFITS NOT SUBJECT TO WITHHOLDING TAX ON COMPENSATION UNDER RR2-98, AS AMENDED: 1. Remunerations received as incidents of employment 2. Remuneration paid for agricultural labor and paid entirely in products of the farm where the labor is performed 3. Remuneration for domestic services Note that the minimum wage for domestic workers or “kasambahay” prescribed under Sec. 24, Art. IV of RA 10361 or the Domestic Workers Act or Batas Kasambahay of 2013 ranges from P1,500 to P2,500 a month - too low compared to the tax exempt minimum wage for commercial, industrial, or agricultural workers. 4. Remuneration for casual labor not in the course of an employer’s trade or business - treated as other income i 5. Compensation for services by a citizen or resident of the Philippines for a foreign government or an international organization pnder RMC 31-2013, this is not compensation income subject to withholding, but It is still taxable compensation income; hence, it must be reported by the employee, 6. Damages paig by the employer to employees 7. Proceeds of Jife insurance 2- aémounts received by an insured employee as a return of premium Ompensation for injuries or sickness 361
Chapter 10 - Compensation Income i 10. Income exempt under treaty 11. 13th month pay and other benefits not exceeding a total of P90,000 12. GSIS, SSS, PhilHealth, and other contributions 13. Compensation income including overtime pay, holiday pay, night shift differential pay, and hazard pay of Minimum Wage Earners 14. Compensation income of employees in the public sector if the same does not exceed those of minimum wage earners in the non-agricultural sector These listed benefits are not considered compensation income; hence, they are exempt from the withholding tax on compensation. DEADLINE OF FILING AND REMITTANCE OF THE WITHHOLDING TAX ON COMPENSATION Employers shall file the BIR Form 1601-C (Monthly Remittance Return of Income Taxes Withheld on Compensation) on or before the 10th day of the following month the withholding was made except for taxes withheld for December which shall be filed/paid on or before January 15 of the succeeding year. Employers are also required to file BIR Form 1604-CF (Annual Information Return of Income Taxes Withheld on Compensation and Final Withholding Taxes) on or before January 31 of the following calendar year in which the compensation income payments and passive income payments were made. Employers shall furnish each employee-taxpayer a copy of BIR Form 2316 (Certificate of Compensation Payment or Income Tax Withheld) on or before January 31 of the succeeding year. Penalties for Non-compliance 1250 Employers are subject to the same penalties discussed in Chapter 4 for non- compliance of withholding tax requirements. Treatment of the Withholding Tax on Compensation If the employee has other items of income that are subject to regular income tax such as income from business or profession, income from other employment or casual income, he must file a consolidated income tax return to include such items of income for the entire taxable year. The withholding tax on compensation is credited against the total tax due in the consolidated income tax return. Substituted filing of tax return Under the substituted filing system, the employer files the income tax return of the employee. If the amount of tax is correctly withheld by the employer, the employee no longer needs to file an annual income tax return. 362