Basic Taxation Law: Salient Features of the Present Income Tax System & Income and Requisites; Income Tax, Nature and Functions

Chapter 1 

Salient Features of the Present Income Tax System

I. Individual Income Taxation

• It is a system by which governments impose taxes on the income earned by individuals.

A. Schedular Tax Treatment CI-DTR-DTR

1. It classifies income.
• Income is categorized into different types, such as salaries, business income, interest, dividends, etc.
2. It provides for different tax rules.
• The deductions allowed, exemptions applicable, and filing requirements may vary depending on the income type.
3. It imposes different tax rates.
• Tax rates can vary depending on the income type.
• Example:
• Capital gains might be taxed at a lower rate compared to ordinary income such as wages.

• Schedular Approach 
• It is a system where the income tax treatment varies and made to depend on the kind or category of taxable income of the taxpayer 

B. Net Income Taxation RNRN

• It involves calculating the tax based on the net income, which is the gross income minus allowable deductions and exemptions. 

1. Resident citizen (RC)
• Filipino citizen living in the Philippines.
• taxed on all income earned, whether inside or outside the country
2. Non-resident citizen (NRC)
• Filipino citizen living outside the Philippines.
• taxed on income earned within the country
3. Resident alien (RA)
• Non-Filipino citizen living in the Philippines.
• taxed on all income earned, whether inside or outside the country
4. Non-resident alien engaged in trade or business (NRA-ETB)
• Non-Filipino citizen not living in the Philippines but has business activities here.
• taxed on income derived from sources within the country.

C. Gross Income Taxation

• It applies to certain individuals where taxes are imposed on their gross income without allowing for deductions. 

1. Non-resident alien not engaged in trade or business (NRA-NETB)
•  Non-Filipino citizen not living in the Philippines and has no business activities here.

D. Income Tax Situs RPC

1. Residence
• RA
• RC 
2. Place
• NRA
• NRC
3. Citizenship
• RC 

• Place — applied to
1. Non-resident alien
2. Non-resident foreign corporations
3. Non-resident citizen⭐
• taxed upon sources of income derived from within the  Philippines. 
• Citizenship — applied to
1. Resident citizen ⭐
2. Domestic corporation
• taxed upon sources of income derived from within and without the Philippines.
• Residence — applied to 
1. Resident alien ⭐
2. Resident Foreign Corporation 
•  taxed upon income derived from sources within the Philippines.

II. Corporate Income Taxation

A. Global Tax Treatment UTR-UTR-NCI

1. It generally provides for uniform rules.
2. It generally imposes uniform tax rate.
3. It does not generally classify income.

• Global Approach 
• It is a system where the tax treatment views indifferently the tax base and generally treats in common all categories of taxable income of the taxpayer.

B. Net Income Taxation DR

1. Domestic Corporation (DC)
2. Resident Foreign Corporation (RFC)

C. Gross Income Taxation

1. 1Non-resident Foreign Corporation (NRFC)

D. Income Tax Situs RPC

1. Residence
• RFC
2. Place
• NRFC
3. Citizenship
• DC 

III. Common Features

A. Pay as You File System

1. Individuals
• upon filing of their income tax returns
2. Corporations 
• upon filing of their quarterly corporate income tax returns and final adjustment corporate returns. (QC ITR, FARC)

B. Creditable Withholding Tax System

1. Withholding agent (source)
• withholds the tax and remits the same to the BIR
2. Tax withheld
• creditable against income tax due

C. Final Withholding Tax System

1. Withholding agent (source)
• withholds the tax and remits the same to the BIR
2. Tax withheld
• final settlement of the tax liability on the income covered

D. Operational Rules of the Withholding Tax System

1. Withholding agent
• the payor, agent of the government for the collection of the tax in order to ensure its payments. 
• It is a payee by fiction of law; a mere tax collector. 
• The liability is direct and independent from the taxpayer, because the income tax is still imposed on and due from the latter.
• As agent, it is personally liable for the tax arising from the breach of its legal duty to withhold. 
• Ergo, the agent is not liable for the tax as no wealth flowed into him - he earned no income.
2. Taxpayer
• The person subject to tax imposed by law. 
• He should not answer for the non-performance by the withholding agent of its legal duty.

E. Three-fold purpose of the Withholding Tax System CCC

1. To provide the taxpayer with a convenient way of paying his tax liability;
2. To ensure the collection of tax; and 
3. To improve the government's cash flow.

Chapter 2

Income and Requisites;

Income Tax, Nature and Functions

A. Definitions

• In a broad sense, income means all wealth that flows into the taxpayer other than as a mere return of capital. 
• It includes the forms of income specifically described as gains and profits including gains derived from the sale or other disposition of capital assets. 
• ❌ A mere advance in the value of property of a person or a corporation in no sense constitutes the "income" specified in the law. 
• Such advance constitutes and can be treated merely as an increase in capital.
• Cash Dividends
• taxed as income because they have been realized/received;
• they are actual receipt of profits.
• Stock Dividends
• not taxed as income because they are merely inchoate
• they are mere anticipation of income
• they become income once you sell the shares
• they are the receipt of a representation of the increased value of the assets of a corporation.
• Judicial definitions:
• gain derived:
• from capital, or 
• from labor, or 
• from both capital and labor, 
• including the gain derived from the sale or exchange of capital assets.
• amount of money coming to a person or corporation within a specified time, whether as payment for:
• services,
• interest, or 
• profit from investment. 
• Economist's definition:
• money value of the net accretion to one's economic power between two points of time.
• cannot be determined by reckoning cash receipts; 
• other income determining factors: 
• inventories accounts receivable
• property acquisition, and 
•  accounts payable for expenses incurred.

B. Income, Capital, Revenue, Receipts; Distinctions

• Capital
• Fund 
• Wealth
• Tree (property) 
• Income
• Flow
• Service of wealth
• Fruit (metaphorical language)

• Gross receipt
• It includes receipts which may constitute capital as well as income; therefore, broader in scope. 
• Income connotes a narrower concept limited only to gain derived from labor, capital or property, excluding non-income items such as the capital invested, cost of goods sold or those excluded by law from income taxation. 
• Revenue 
• It refers to all funds or income derived by the government whether from tax or other sources. 
• Revenue = government 
• Income = private persons or corporations.

C. Sources of Income PLS

1. Property (capital) 
2. Labor (service)
3. Sale/Exchange of capital asset and activity

• Source of income is any property, activity or service that produced the income. 
• It may also be in the form of proceeds from sales of transport documents.

• Under the Tax Code, however, income derived from whatever source forms part of the taxpayer's income. This includes the following: TM-III-TB
1. Treasure found or punitive damages representing profits lost;
2. Amount received by mistake 
• If a foreign bank erroneously remitted U.S.$1 million instead of U.S.$1,000 and it appears subsequently that the recipients spent the difference of U.S.$999,000 on various purchases of property both here and abroad of their own material benefit, the said sum constitutes taxable income. 
• It has been held that if a taxpayer receives earnings under a claim of right without restrictions as to its disposition, he has received income even though it may still be claimed that he is not entitled to retain the money and even though he may still be adjudged liable to restore its equivalent. 
• This is an exception to the rule that income received through mistake is not taxable as its receipt is offset by liability to the party making the excessive payment. (
3. Cancellation of the taxpayer's indebtedness;
4. Payment of usurious interest;
5. Illegal gains
• gambling
• theft
• embezzlement
• extortion
• fraud - income to embezzler if forgiven by the owner;
6. Tax refund 
• It must be claimed as deduction from gross income in the preceding year. 
• It means that the tax must be a deductible one
7. Bad debt recovery
• It must be claimed as deduction from gross income in the preceding year. 
• It assumes that the taxpayer has a net income, not a net loss. 
• Recovery of bad debt and tax refund finds a jurisprudential hook in Tax Benefit Rule. 
• It is a rule which limits the recognition of income from the recovery of an expense or loss properly deducted in a prior taxable year to the amount of the deduction that generated a tax savings. 
• Under this rule, if an amount deducted from gross income in a prior taxable year is recovered in a later year, the recovery is income in the last year.

D. Income Tax; Basis, Nature and Functions

1. It is a tax on all yearly profits arising from property, profession, trades or offices or as a tax on a person's income, emoluments, profits and the like. 
2. It is based on income, either gross or net, realized in one taxable year. 
3. Excise tax
• It is not levied upon the person or property but upon the right of a person to receive income or profits.
4. Functions of income tax: LR-RC-ME
1. to provide large amounts of revenues; 
2. to offset regressive sales and consumption taxes 
3. to mitigate the evils arising from the inequalities in the distribution of income and wealth which are considered deterrents to social progress, by a progressive scheme of taxation. 
5.  The basis of the right of the government to tax income emanates from its partnership in the production of Income by providing the protection, resources, Incentive, and proper climate for such production. 
• This is called the Partnership Theory which has spawned the following principles: 
1. Protection theory. 
• It dictates that when the flow of wealth proceeded from, and occurred within, Philippine territory, enjoying the protection accorded by the Philippine government, the same, in consideration of such protection should share the burden of supporting the government. 
2. Theory of favorable business climate. 
• Domestic corporations owe their corporate existence and privilege to do business to the government. 
• They also benefit from the efforts of the government to improve the financial market and to ensure a favorable business climate. 
• It is therefore fair for the government to require them to make a reasonable contribution to the public expenses.

E. Requisite for an Income to be Taxable G-R-E

1. There must be gain or profit, whether in cash or its equivalent.
2. The gain must be realized or received.
3. The gain must not be excluded by law or treaty from taxation.

The gain must be realized or received.

• This implies that not all economic gains constitute taxable income.
• ❌ Mere increase in the value of property is not income (unrealized increase in capital)
• ❌ Increases in the taxpayer's net worth are not taxable increases in net worth if they are not the result of the receipt by it of unreported or unexplained taxable income, but are shown to be merely the result of the correction of errors in its entries in its books relating to its indebtedness to certain creditors, which had been erroneously overstated or listed as outstanding when they had in fact been duly paid. 
• ✅ But if the increase in the net worth of a taxpayer is the result of the receipt by it of unreported or unexplained taxable income, the correction is taxable income.
• ✅ Stock dividends issued by the corporation are considered unrealized gain which cannot be subjected to income tax until that gain has been realized.
• Receipt includes constructive receipt.
• Doctrine of Constructive Receipt of Income 
• Income which is credited to the account of and set apart for a taxpayer and which may be drawn by him at any time is subject to tax for the year during which it was so credited or set apart although not yet then actually received or reduced to his possession. 
• To constitute receipt in such case, the income must be credited to the taxpayer without any substantial limitation or condition upon which payment is to be made. 
• Examples of Constructive Receipt:
1. Matured interest coupons due and demandable (convertible into cash);
2. Share in the profits of a partner in a partnership; 
3. Interest credited on savings bank deposit; 
4. Dividends applied by the corporation against the indebtedness of a stockholder; 
5. Rental payments refused by the lessor when the lessee tendered payment and the latter made a judicial deposit of the rental; 
6. Amount credited to shareholders of a building and loan association when such credit passes without restriction to the shareholder.
• The Doctrine of Constructive Receipt is designed to prevent the taxpayer using the cash basis from deferring or postponing the actual receipt of taxable income. 
• Without the rule, the taxpayer can conveniently select the year in which he will report the income.
• Filipinas Synthetic Corporation v. C A, 316 SCRA 480:
• It is the right to receive income, and not the actual receipt, that determines when to include the amount in gross income.
• CIR v. Isabela Cultural Corporation, 515 SCRA 556:
• For taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income? The accrual of income is per mitted when the all-events test has been met. This test requires: 
1. fixing of a right to income to pay; and 
2. the availability of the reasonable accurate determination of such income.
• Corn Exchange v . US, 37 F2nd 34:
• The all-events test requires that 
1. the right to receive the amount must be valid, unconditional and enforceable, i.e., not contingent upon future time;
2. the amount must be reasonably susceptible of accurate estimate; and 
3. there must be a reasonable expectation that the amount will be paid in due course.

The gain must not be excluded by law or treaty from taxation.

• This means that not all income is required to be included in computing the taxable income.

F. Doctrines in Determination of Taxable Income

•  C-S-C-P-R

1. Claim of Right Doctrine
• If the taxpayer receives earnings under a claim of right and without restriction as to its disposition, such earnings are considered income.
• Illegally acquired income constitutes realized gain. 
2. Severance Test Theory
• Separation from capital of something which is of exchangeable value.
• Income is recognized when there is separation of something which is of exchangeable value.
• The increase in the value of an asset is not income as it has not yet been exchanged or transferred for something else. 
• Once the asset is exchanged, then a severance of the gain from its original value takes place, resulting into taxable income.
3. Control Test 
• Power to procure the payment of income and enjoy the benefit thereof. 
4. Doctrine of Proprietary Interest
• It treats stock options, shares of stock or other assets transferred by an employer to an employee to secure better services as taxable.
5. Realization Test
• Revenue is generally recognized when the earning process is complete or virtually complete and an exchange has taken place.
• Income is recognized when both of the following conditions are met:
• The earning is complete or virtually complete; and
• An exchange has taken place.