TAXATION 1 – INCOME TAXATION ​

2020

Chapter 4   

GROSS INCOME  

GROSS INCOME DEFINED  

Gross  income  means  the  pertinent  items  of  income  referred  to  in  Section  32(A)  of  the  Tax  Code.  It 
includes  all  income  from  whatever  source  (unless  exempt  from  tax  by  law)  including,  but  not  limited 
to, the following items.  
1. Compensation for services in whatever form paid including fees, salaries and wages, 
commissions, and similar items;  
2. Gross income derived from the conduct of trade or business or the exercise of a profession; 
3. Gains from dealings in property;  
4. Interests;  
5. Rents;  
6. Royalties;  
7. Dividends;  
8. Annuities;  
9. Prizes and winnings;  
10. Pensions; and  
11. Partner’s distributive share from the net income of general professional partnership.   

GROSS COMPENSATION INCOME  

Gross  compensation  income  means  any  remuneration  for  rendering  personal  services.  Generally, 
compensation  income  is  obtained  from  an  employer-employee  relationship  between  payor  and 
recipient.  

Classification of Gross Income  

1. Basic salary or wage  
Salary ​refers to earnings received periodically for a regular work other than manual labor, such 
as a monthly salary of an employee.  
Wages​, on the other hand, are earnings received usually according to specified intervals of 
work, as by the hour, day or week. An example is a carpenter’s daily wage.  
2. Honoraria ​are payments given in recognition for services performed for which established 
practice discourages charging a fixed fee. The honorarium of a guest lecturer is an example.  
3.  ​Fixed  or  variable  allowances  ​In  general,  fixed  or  variable  transportation,  representation  and 
other  allowances  that  are  received  by  a  public  officer  or  employee  or  officer  or  employee  of  a 
private  entity,  in  addition  to  the  regular  compensation  fixed  for  his  position  or  office,  is  a 
compensation subject to withholding tax.  
4. Commission ​is usually a percentage of total sales or on certain quota of sales volume attained as 
part of incentive, such a s sales commission.   
5.  Fees  ​are  received  by  an  employee  for  the  services  rendered  to  the  employer  including  a 
director’s  fee  of  the  company,  fees  paid  to the public officials such as clerks of court or sheriffs 
for  services  rendered  in  the  performance  of  their  official  duty  over  and  above  their  regular 
salaries.  
6. Tips and gratuities  
7. Hazard or emergency pay  
8. Retirement pay  
9. Separation pay  
a. Death;   
b. Sickness; 
 Chapter 4 – Gross Income Page 1
TAXATION 1 – INCOME TAXATION ​
2020

c. Disability;  
d. Reorganization/merger of company; and  
e. Company at the brink of bankruptcy.  
10. Pension  
11. Vacation and sick leave  
12. Thirteenth month pay and other benefits  
13. Overtime pay  
14. Profit sharing  
15. Awards for special services  
16. Beneficial payments  
17. Other forms of compensation  

Shares of Stock Received as Compensation  

Compensation paid to an employee of a corporation in its stock is to be treated as if the corporation 
sold the stock at its market value and paid the employee in cash.   

Employee Stock Option  

A stock option is a privilege granted to some key employees of a corporation to avail of the said 
corporation’s share of stock in the future for a certain price.  

Cancellation of Debt  
The cancellation and forgiveness of indebtedness may amount to a payment of income, gift or capital 
transaction, depending upon the circumstances.   

Insurance Premiums as Compensation  

These  are  premiums  paid  by  the  employer  on  life  insurance  coverage  of  the  employee  wherein  the 
beneficiary  is  the  employee’s  family.  These  constitute  taxable  income  on  the  basis  of  the  amount  of 
premium paid.  

Income Tax Paid as Compensation  

For income tax paid by the employer in favor of the employee, the basis of tax is the amount of tax 
paid.  

GROSS INCOME FROM BUSINESS AND PROFESSION   

Business Defined  
Business  ​means  any  commercial  activity  engaged  in  as  a  means  of livelihood or profit of an individual 
or  group  of  individuals.  Examples  are  trading,  merchandising,  manufacturing  and  other  similar 
activities.  

Profession Defined   
For  tax  purposes,  ​profession  ​is  primarily  any  endeavor  or  work  requiring  specialized  training  in  the 
field  of  learning,  art  or  science  engaged  in  as  a  means  of  livelihood  or  profit  of  an individual or group 
of  individuals.  In  general,  a  practice  or  profession  is  a  service  business.  Examples  are  Certified Public 
Accountants, Lawyers, Medical Doctors, and the like.  

Classification of Gross Income from Business  

1. Manufacturing;  
2. Merchandising or Trading;  
3. Servicing;  
4. Farming; and  
 5. Long-term contract.  

The Cost of Sales  

Chapter 4 – Gross Income Page 2

TAXATION 1 – INCOME TAXATION ​
2020

1. Cost of goods manufactured and sold of manufacturing concern;  

2. Cost of goods sold of trading or merchandising concern; and  
3. Cost of service of servicing concern. ​(Sec. 27 [A], NIRC)  

Cost of Goods Manufactured and Sold  

For  manufacturing  business,  all  costs  of  finished goods that are sold (such as raw materials used, direct 
labor  and  manufacturing  overhead,  freight  cost,  insurance  premiums  and  other  costs  incurred  to  bring 
the raw materials to the factory or warehouse) are called ​cost of goods manufactured and sold.  

Cost of Goods Sold of Trading or Merchandising Concern  

Cost  of  goods  sold  of  trading  or  merchandising  business  ​refers  to  the  invoice  cost  of  the  goods  sold, 
plus  import  duties  and  freight-in  transporting  the  goods  to  the  place  where  they  are  actually  sold, 
including insurance while the goods are in transit.  

Cost of Services  
Cost of services are the direct costs and expenses necessarily incurred to provide the services required 
by the customers and clients including:  
a. Salaries;   
b. Benefits of personnel, consultants and specialists directly rendering the service; c. Cost of 
facilities directly utilized in providing the service such as depreciation or rental of equipment used 
and cost of supplies; and  
d. In the case of banks, costs of services shall include interest expense.  

Rental Income  

1.  ​Prepaid  Rental.  ​If  the  advanced  payment  is  a  ​prepaid  received  without  restriction  ​as to its use, 
the  entire  amount  is  taxable  in  the  year  it  is  received  whether  the  lessor  uses  cash  or  accrual 
method of accounting.   
2. ​Security Deposit with Restriction. ​If the advanced payment is a ​security deposit which  restricts 
the  lessor  ​as  to  its  use,  then  such  amount  should  be  excluded  in  the  determination  of  rental 
income.  
3.  ​Security  Deposit  with  an  Acceleration  Clause.  ​If  the  advanced  payment  is  a  loan  deposit,  or 
option  money  for  the  property,  or  a  security  deposit  for  the  faithful  compliance of the lessee of 
the  lease  contract,  such  advance  payment  is  not  an  income  to  the  lessor.  The  income  to  the 
lessor inures which the lessee violates the terms of the contract.  

Income from Leasehold Improvements  

∙ ​Outright Method  
∙ ​Spread-Out Method  

Termination of the Contract of Lease  

Where  there  is  an  immovable  improvement  made  by  the  lessee  on  the  lease  property  and  the 
termination  of  the  contract  of  lease  is  made  before  the expiration of the lease term​, the following rules 
should regulate the circumstances:  

PASSIVE INCOME   
1. Yield from deposit substitutes and trust fund;  
2. Interest income;  
3. Royalty income;  
4. Dividend income; and  
5. Prizes and winnings  
A ​deposit substitute ​is a debt instrument issued by the bank to borrow money from the public other 
than from the client’s deposit. 

Chapter 4 – Gross Income Page 3

TAXATION 1 – INCOME TAXATION ​
2020

A ​trust fund ​is any estate, especially stock, securities or money which is held in trust by a person in 
behalf of another person.  

Interest  income  ​is  an  earning  derived  from  depositing  or  lending  of  money,  goods,  or  credits.  Unless 
exempted  by  law,  interest  income  received  by  the  taxpayer,  whether  or  not  usurious,  is  subject  to 
income tax.  

A ​royalty income ​is a payment or portion of proceeds paid to the owner of a right, such as an oil right 
or a patent for the use of it, or a portion of the proceeds from the work of an author or composer.  

Dividend income ​is a form of earnings derived from the distribution made by a corporation out of its 
earnings or profits and payable to its stockholders, whether in money or in other property.  

Summary of Taxes on Dividends  

∙ ​Tax exempt  
Dividends are tax-exempt if:  
1. Received from a Domestic Corporation by:  
a. Another Domestic Corporation.  
b. Resident Foreign Corporation.  
2. Received from a Cooperative.  
3. Pure stock dividend.  
4. Pure liquidating dividend (return of capital)  
∙ ​Subject to Final Tax  
Dividends are subject to final tax if received from a Domestic Corporation by 
a: 1. Citizen or Resident Alien  
2. Non-resident Alien doing business in the Philippines  
3. Non-resident Alien not doing business in the Philippines   
4. Non-resident Foreign Corporation   
∙ ​Subject to Normal Tax  
Dividends are subject to year-end normal tax of individuals or corporations if such dividends 
are:  
1. Not included as tax-exempt dividends.  
2. Not subject to final tax.  
3. Distributive shares of a partner in professional partnership.  

Forms and Valuations of Dividend Income  

1. Cash dividend;  
2. Property dividend;  
3. Stock dividend;  
4. Scrip dividend;  
5. Indirect dividend; and  
6. Liquidating dividend.  

OTHER SOURCES OF INCOME  

1. Bad debt recovery;  
2. Tax refund or credit;  
3. Annuities; and  
4. Income from whatever source.  

Bad Debt Recovery  

The following are requisites for deductibility of bad debts:  
1. There must be a valid and existing debt.  
2. The debt must be actually ascertained to be worthless and uncollectible during the taxable year. 
3. The debt must be charged off during the taxable year.  
4. The debt must arise from business or trade of the taxpayer. 

Chapter 4 – Gross Income Page 4

TAXATION 1 – INCOME TAXATION ​
2020

COMPUTATION OF GROSS INCOME   

Problem 1 – Gross Compensation Income  

Pamela Lantes has earned the following income in 2019:  

Salary  as  a  professor,  net  of  withholding  tax  of  ₱10,000  ₱290,000  Income 
from  practice  of  profession  as  CPA  200,000  Per  Diem  as  a  board  of  director 
120,000  Thirteenth  month  pay  25,  000  First  Prize  in  essay  writing  contest 
50,000  

What is the amount of gross compensation income?  

a. ₱420,000 b. ₱445,000 c. ₱645,000 d. ₱695,000  

Problem 2 – Taxable Compensation Income  

The following incomes are reported by Cute, a CPA:  

Salary  as  an  accountant  ₱240,000  Overtime  pay  30,000  13​th  ​month  pay  and 
bonuses 15,000 Audit professional fee 60,000 Gains from sale of car 25,000  

The amount of taxable compensation income is:  

a. ₱240,000 b. ₱270,000 c. ₱285,000 d. ₱295,000  

Problem 3 – Retirement Pay  

Sue reported the following retirement:  

First  employment  for  30  years  received  at  the  age  of  50  ₱500,000  Second 
employment  for  10  years  received  at the age of 60 400,000 Third employment 
for 10 years received at the age of 70 300,000  

How much is the non-taxable retirement pay of Sue?  

a. ₱0 b. ₱300,000 c. ₱400,000 d. ₱500,000  

Problem 4 – Cancellation of Debt  

Bingcol  works  as  the  CEO  of  B  Company.  His  compensation  income is ₱50,000 per month . In 
January  31,  2019,  he  borrowed  ₱300,000  from  B  Co.  As  a  result  his  monthly  compensation 
income  is  reduced  by  ₱25,000  as  payment  to  his  borrowing.  If  on  December  31,  2019,  B  Co. 
cancelled  Bingcol’s  indebtedness,  how  much  is  the  latter’s  compensation  income  in  December 
2019?  

a. ₱25,000 c. ₱75,000  
b. ₱50,000 d. ₱100,000 
 Chapter 4 – Gross Income Page 5
TAXATION 1 – INCOME TAXATION ​
2020

Problem 5 – Cost of Goods Sold  

During  the  year,  the  total  purchases  of  goods  for  sale  amounted  to  ₱500,000.  Transportation 
cost  is  ₱5,000  for  goods  purchased  and  ₱10,000  expenses  for  goods  sold. During the year, total 
sales  amounted  to  ₱550,000.  At  the  end  of  the  year  unsold  goods  amounted  to  ₱40,000.  The 
cost of goods sold for the period is:  

a. ₱505,000 b. ₱475,000 c. ₱465,000 d. ₱460,000  

Problem 6 – Gross Service Income  

From the following data compute for the gross profit of a servicing business:  

Professional  fee,  accounting  services  ₱500,000  Salaries  of  accounting  staff 

150,000  Salaries  of  office  assistant  60,000  Accounting  Supplies  10,000 
General Supplies 5,000  

a. ₱340, 000 b. ₱335, 000 c. ₱280, 000 d. ₱275, 000  

Problem 7 – Passive Income  

Which of the following is subject to 10% final tax?  

a. ₱10,000 prizes  
b. ₱20,000 winnings  
c. ₱50,000 cash dividend received by an individual  
d. ₱100,000 property dividend received by a domestic corporation from another domestic 
corporation.  

Problem 8 – Interest Income  

The following are the income of a resident citizen for the period:  

Interest  income  from  an  investment  in  a  10-year  bond  ₱40,000  Interest 
income  from  5  year  time  deposit  in  Philippine  bank  ₱50,000 Interest income 
from expanded foreign currency deposit ₱60,000  

His interest income subject to normal tax is  

a. ₱150,000 c. ₱40, 000  
b. ₱100,000 d. 0  

Problem 9 – Dividend Income  

A  domestic  corporation  received  ₱500,000  cash  dividend  from  a  foreign  corporation  the 
earnings  of  which  are  70%  earned  in  the  Philippines.  The  taxable  dividend  income  of  the 
domestic corporation is  
a. ₱500, 000 c. ₱150, 000  
b. ₱350, 000 d. ₱100, 000 

Chapter 4 – Gross Income Page 6

TAXATION 1 – INCOME TAXATION ​
2020

Problem 10 – Nontaxable Compensation  

A  MWE employee received a total take home pay amounting to ₱280,800 for the year  inclusive 
of  13​th  ​month  pay  of  P22,000.  The  ₱280,800  is  net  of ₱2,200 withholding tax on  compensation 
and  ₱3,000  SSS, Philhealth and Pag-ibig share contribution. In addition, he  earned a ₱20,000 as 
other income subject to normal tax.  

How much is the total amount of his taxable income?  

a. ₱261,000 c. ₱286,000  
b. ₱281,000 d. ₱284, 000  

Problem 11 – Employer’s Benefits  

Mr.  X  was  hired  with  a  condition  (due  to  the  nature  of  his  work)  that  he  will  be  a  stay-in  at 
monthly  salary  of  ₱21,  000  per  month,  he  was  also provided with free lodging valued at ₱2,000 
per month and free meals, valued at ₱3,000 per month.  

The taxable monthly compensation income of the employee is  

a. ₱21,000 c. ₱24,000  
b. ₱23,000 d. ₱26,000  

Problem 12 – Proceeds of Life Insurance  

Twinkle  Co.  insured  Mr.  Rodrigo  Pajama,  its  President  for  ₱500,000.  Mr.  Pajama  died  and 
Twinkle  Co.  received  the  proceeds  of  the  insurance  after  paying  insurance  premium  of 
₱50,000. The reportable taxable income would be:  

a. ₱500,000 c. ₱300,000  
b. ₱450,000 d. ₱0  

Problem 13 – Income from Life Insurance  

Mrs.  Vina  Luchina  was  insured  under  an  endowment  policy  with  value  of  ₱500,000.  Total 
premiums  paid  by  her  during  the  term  of  premium  payments on the policy were ₱490,000 from 
which  there  was  a  return  of  premiums  of  ₱40,000.  At  the  maturity  of  the  policy,  Mrs.  Luchina 
received ₱500,000. The income of Mrs. Luchina under the policy is  

a. ₱500, 000 c. ₱10, 000  

b. ₱50, 000 d. ₱0  

Problem 14 – Taxable and Non-taxable Terminal Pay  

The heir, upon the death of an employee, received the following amounts: 
Terminal pays ₱ 60,000  
Life insurance 500,000  
SSS death benefit 10,000  
Donation of relatives 40,000  

What amount of these receipts is taxable and not taxable with income tax?  

Taxable Nontaxable  
a. ₱610, 000 ₱ 0  
b. ₱500, 000 ₱110, 000  
c. ₱110, 000 ₱500, 000  
d. ₱ 0 ₱610, 000  

Chapter 4 – Gross Income Page 7

TAXATION 1 – INCOME TAXATION ​
2020

Problem 15 – Income from Separation  

During the year, the resident citizen received the following among others: Last 
pay upon resignation from his 1​st ​employment ₱100, 000 Separations pay due 
to closure of his 2​nd ​employer 70, 000 Retirement pay received from SSS as 
member 150, 000  

How much is the reportable income from the above data?  

a. ₱220,000 c. ₱150,000  
b. ₱170,000 d. ₱100,000  

Problem 16 – Non-taxable Receipts  

Eddie Gil received the following cash during a taxable year:  

Actual  damages  for  injuries  suffered  ₱30,000  Separation  pay  due to sickness 

100,000  SSS  Retirement  benefits  500,000  Inheritance  from  his  grandparents 
100,000  

How much amount of cash receipts is subject to income tax?  

a. ₱0 c. ₱130, 000  
b. ₱100, 000 d. ₱230, 000  

Problem 17 – Gifts, Bequests and Devices  

Pandoy received the following fits during the year:  

Christmas  gifts  from  his  employer  ₱  5,000  Gifts  from  relatives  on account of 
his  birthday  100,000  Inheritance  from  his  grandfather  500,000  Donations 
from his friends 30,000  

How much is the gifts subject to income tax?  

a. ₱635,000 c. ₱5,000  
b. ₱ 35,000 d. ₱ 0  

Problem 18 – Non-taxable Interest Income  

A non-resident alien earned the following interest income:  

Interest  income  from  peso  savings  deposit  ₱50,000  Interest  from  expanded 
foreign  currency  deposit  (converted  to  peso)  100,000  Interest  from  yield 
deposit 30,000  
How much of the above income is non-taxable?  
a. ₱30,000 c. ₱ 80, 000  
b. ₱50,000 d. ₱100, 000  

Problem 19 – Cooperative Income  

A CDA registered cooperative reported a total income of ₱500,000 inclusive of ₱10,000 

interests in bank savings deposit. The taxable income of this cooperative would be a. ₱500,000 
c. ₱10,000  
b. ₱490,000 d. ₱ 0  
__________________________________________________________________________________ 

Chapter 4 – Gross Income Page 8