Harpy Jane V.

Manalac

Financial Management 3

Chapter 4

GROSS INCOME

- Means the pertinent items of income referred to in Sec 32 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
11. Partners’ distributive share from the net income of general professional partnership

Gross Compensation Income – means any remuneration for rendering personal services. It is obtained from an employer-
employee relationship between payor and recipient

The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes compensation.
Thus, it may be paid on the basis of piecework, or percentage of profits and may be paid hourly, daily, weekly, monthly or
annually.

There is no determination of compensation until the service is rendered

Exception: the compensation income including overtime pay, holiday pay, night shift differential pay, and hazard pay, earned by
Minimum Wage Earners (MWE) who has no other returnable income are non-taxable and not subject to withholding tax on
wages

When does an employer-employee relationship exist?

Generally, an employer-employee relationship exists when the person for whom services are rendered has the right to control
and direct the individual who performs the services, not only as to the result in accomplishing the work but also as to the details
and means by which that result is accomplished

Remuneration for services constitutes compensation even if the relationship of employer and employee does not exist any longer
at the time when payment is made between the person in whose employ the services had been performed and the individual who
performed them.

Compensation income subject to tax is based on gross income less applicable exemptions. No business and personal expenses are allowed as
deductions from gross compensation income

The rule on compensation income applies only to resident citizens, resident aliens and non-resident citizens and non-resident aliens engaged in
business in the Philippines. It does not apply to non-resident aliens not engaged in business. Neither does it apply to corporations, estate and
trusts because compensation presupposes personal service.

Classification of Gross Compensation 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 are earnings received usually according to specified intervals of work, as by the hour, day or week. E.g.
carpenter’s daily wage
 Backwages are subject to income tax and the withholding tax on wages

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, COLA 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, are compensation subject to withholding tax

Any amount paid specifically, either as advances or reimbursements for travelling, representation and other bona fide
ordinary and necessary expenses incurred or reasonably expected to be incurred by the employee in the performance of
his duties are not compensation subject to withholding tax, if the following conditions are satisfied:

a. It is for ordinary and necessary travelling and representation or entertainment expenses paid or incurred by the
employee in the pursuit of the employee in the pursuit of the employer’s trade business or profession
b. The employee is required to account/liquidate for the foregoing expenses pursuant to substantiation requirements
of Sec. 34 of the tax code

The excess of actual expenses over advance made shall constitute taxable income if such amount is not returned to the employer

Latest Rulings on Allowances:

a. Transportation and cell phone allowances given to call center employees are not taxable compensation
1. Fixed monthly transportation allowance of P1500 for rank-and-file employees and P3000 for supervisory employees
precomputed on a daily basis
2. Mobile phone allowance of P1200 for supervisors, managers, and directors who are expected to be on call 24 hours a
day
b. Transportation and Night Shift Allowances granted to night shift employees and Meal and/or Out-of-Town Allowances
granted to employees assigned to conduct field work are not subject to FBT, income tax and withholding tax.
c. Taxi/transportation allowance of P100 per day given by BPO company servicing global businesses 24 hours a day to
employees who work overtime beyond 10PM or whose work shift starts at 10 PM onwards is exempt from tax
d. Where taxi/transportation allowance is precomputed on a daily basis and is paid to employees while they are on
assignment or duty, it is not subject to substantiation requirement or to income and withholding tax

4. Commission is usually a percentage of total sales or on certain quota of sales volume attained as part of incentive such as
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 service rendered in the performance of their official
duty over and above their regular salaries.

Legal fees paid by a union on behalf of its president constitute compensation

Marriage fees, baptismal offerings, sums paid for conducting masses for the dead and other contributions received by a
clergyman, evangelist, or religious worker for services rendered are considered compensation

6. Tips and gratuities – paid directly to an employee (by a customer of the employer) which are not accounted for by the
employee to the employer are considered taxable income, but not subject to withholding tax
7. Hazard or Emergency pay – an additional payment received due to workers’ exposure to danger or harm while working.
This is normally night differential pay to arrive at gross salary.
Hazard, overtime, night shift differential and holiday pay of a minimum wage earner is non-taxable as long as the MWE
has no other reportable income

8. Retirement pay – it refers to a lump sum payment received by an employee who has served a company for a
considerable period of time and has decided to withdraw from work into privacy.

in general, retirement pay is taxable except in the following instances:

I. SSS or GSIS retirement pays
II. Retirement pay due to old age provided that the following requisites are met:
 a. The retirement program is approved by the BIR Commissioner
b. It must be a reasonable benefit plan. Its implementation must be fair and equitable for the benefit of all
employees (from president to labour)
c. The retiree should have been employed for 10 years in the said company
d. The retiree should have been 50 years old at the time of retirement
e. It should have been availed of for the first time

9. Separation pay – taxable if voluntarily availed of. It shall not be taxable if involuntary. Examples of involuntary separation
are:
a. Death
b. Sickness
c. Disability
d. Reorganization/merger of company
e. Company at the brink of bankruptcy

When a company is at the brink of bankruptcy, the sequence of satisfying the company’s indebtedness should be in this order

a. BIR
b. Employee
c. Creditors

As a rule, any amount received by an official or employee or by his heirs from the employer due to death, sickness or other
physical disability or for any cause beyond the control of the said official or employee(such as retrenchment, redundancy, or
cessation of business) are exempted from tax

The phrase for any cause beyond the control of the said official or employee connotes involuntariness on the part of the official or
employee. The separation from the service of the official or employee must not be asked for or initiated by him.

Amounts received by reason of involuntary separation remain exempt from income tax even if the official or the employee, at the
time of separation, had rendered less than 10 years of service and/or is below 50 years of age.

Any payment made by an employer to an employee on account of dismissal constitutes compensation regardless of whether the
employer is legally bound by contract, statute or otherwise, to make such payment

10. Pension is a stated allowance paid regularly to a person on his retirement or to his dependents on his death, in
consideration of past services, meritorious work, age, loss or injury.
Pension pay is TAXABLE unless the law states otherwise, or unless the BIR approves the pension plan of a private
company.

11. Vacation and Sick Leave

Taxable or Not:

a. If paid or availed of as salary of an employee who is on vacation or on sick leave notwithstanding his absence from work,
it constitutes taxable compensation income
b. Monetized value of unutilized vacation leave credits of 10 days or less which were paid to private employees during the
year are not subject to tax and to the withholding tax
c. Monetized value of vacation and sick leave credits paid to government officials and employees are not subject to income
tax and to the withholding tax
12. Thirteenth month pay and other benefits
As a general rule, thirteenth month pay and other benefits are not taxable if the total amount received is P82000or less.
Any amount exceeding P82000 is taxable.

13. Fringe benefits and de Minimis

FRINGE BENEFITS - as any good, service, or other benefit furnished or granted by an employer, in cash or in kind, in
addition to basic salaries of an individual employee

De Minimis benefits - privileges of relatively small value as given by the employer to his employees. They are not
considered as compensation subject to income tax and consequently to withholding tax.

14. Overtime Pay – refers to premium payment received for working beyond regular hours of work which is included in the
computation of gross salary of employee. Back pay and overtime pay constitute compensation.
 15. Profit sharing – proportionate share in the profits of the business received by the employee in addition to his wages

16. Awards for Special Services – the amount received as an award for special services of employee, or suggestions to
employer resulting in the prevention of theft or robbery. Awards for past services and the like are also compensations

17. Beneficial payments – such as where an employer pays the income tax owned by an employee are additional
compensation income

18. Other forms of Compensation – received due to service rendered are compensation paid in kind. It is to be noted that
compensation can be paid in kind but taxes are generally paid in money. For example, an insurance premium paid by
employer for insurance coverage where the heirs of employee are the beneficiaries is the employee’s income

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

Hence, if compensation is received in the form of shares of stock, the fair market value of the shares of stock at the time the
service is rendered is the basis of tax.

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.

The following rules shall be observed when a company issues a stock option to its employees:

1. Compensation income – if the market price is greater than the option price, the difference is a compensation income at
the date of grant.
2. Capital gain – when the stocks are sold, the excess of the market price at the date of sale over the market price at the
date of grant is a capital gain

Cancellation of Debt

The cancellation and forgiveness of indebtedness may amount to a payment of income, gift, or capital transaction, depending
upon the circumstances. The following rules shall then be observed:

1. If a creditor merely desires to benefit a debtor and without any consideration cancels the debt, the amount of the
cancelled debt is a gift, not an income of debtor.
2. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a
dividend income to debtor
3. If however a debtor performs services for a creditor, who, in consideration thereof cancels the debt, the debtor realizes
income for his services to the extent of the amount of debt cancelled

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 favour of the employee, the basis of tax is the amount of tax paid.

Convenience of the Employer’s Rule

This tax rule provides that allowances in kind furnished to the employee for and as a necessary incident to the performance of his
duties are not taxable. Examples are food and lodging benefit by a household maid, driver, etc.

Living Quarters

The following rules govern the living quarters and meals:

 1. When living quarters are furnished in addition to cash salary, the rental value of such quarters should be reported as
income
2. However, if living quarters or meals are furnished to an employee for the convenience of the employer, the value thereof
need not be included as part of compensation income

Unless provided for the exclusive benefit of the employer, the rental value of living quarters is compensation income to the
employee to the extent of his reasonable needs, and the excess shall be considered as expenses of the corporation.

Meals Subsidized by Employer

The value of any board and lodging furnished by an employer is ordinarily taxable to the employee

The exclusion for meals is allowed only when meals are furnished or subsidized to an employee for the convenience of the
employee and incidental to the requirement of his work or position

Remuneration for Casual Labor

1. Remuneration for casual labor not in the course of an employer’s trade or business is not considered compensation

The term casual labor includes labor which is occasional, incidental or regular. The expression not in the course of the
employer’s trade or business includes labor that does not promote or advance the trade or business of the employer
2. Any remuneration paid for casual labor( that is, labor which is occasional, accidental or irregular, but which is rendered in
the course of the employer’s trade or business) is considered compensation
3. Any remuneration paid for casual labor performed for a corporation is considered as compensation

Gross Income from Business and Profession

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 benefits

Profession – primarily any endeavour 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.

Gross income from Business

1. Manufacturing
2. Merchandising
3. Servicing
4. Farming
5. Long-term contract

In case of manufacturing, merchandising or mining business, Gross income shall mean gross sales less sales returns, discounts and
allowances, and cost of goods sold, plus any income from investment and other incidental or outside operations or sources

In determining gross income, subtractions should not be made for depreciation, depletion, selling expenses or losses or for items
not ordinarily used in computing the cost of goods sold

In the case of taxpayers engaged in the sale of service, gross income is based on gross receipts less returns

The Cost of Sales

Cost of Goods Sold shall include all business expenses directly incurred to produce the merchandise to bring them to their present
location and use. The cost of sale is deducted from the net sales to calculate gross income from business. Cost of Sales of a
business may be classified as follows:

1. Cost of Goods Manufactured and Sold – it shall include 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
2. Cost of goods sold of trading or merchandising concern – refers to the invoice cost of goods sold, plus import duties and
freight incurred in transporting the goods to the place where they are actually sold, including insurance while the goods
are in transit
 3. Cost of Service of Servicing Concern – for minimum corporate income tax purposes, gross income from service business
is gross receipts less returns, allowances, discounts and cost of services. The Cost of Services shall include the direct costs
and expenses necessarily incurred to provide the services required by the customers and clients which include the
following items:
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
d. In the case of banks, costs of services shall include interest expense.

Telegraph and Cable Services of a foreign corporation – shall include income from services within the Philippines only. Specifically,
the income may be derived from the following:

1. Gross revenues derived from messages originating in the Philippines

2. Amount received by the company collected abroad on collect messages originating in the Philippines and deducting from
such amounts paid or accrued for transmission of messages beyond the company’s own circuit

Amounts received by the foreign company in the Philippines with respect to collect messages originating outside the Philippines.

Rental Income – refers to earnings derived from leasing real estate as well as personal property. Aside from the regular amount of
payment for using the property, rental income also includes all other obligations assumed to be paid by the lessee to the third
party in behalf of the lessor

Rental income is generally determined by the gross receipts for the year, (earned and unearned under accrual basis) because the
nature of business involved is service.

1. Prepaid rental – if the advance payment is a prepaid rental 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 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 when the lessee violates the terms of the contract.

Income from Leasehold Improvement – when the lessee erected or built permanent improvements on the leased property which
will become the property of the lessor upon the expiration of the lease, the value of the improvements should be reported as
income of the lessor using either outright method or spread out method.

a. Outright method – the income from leasehold improvement shall be recognized when the improvement is completed at its fair
market value
b. Spread-out method – the estimated book value of the leasehold improvement at the end of the lease is spread over the term
of the lease and is reported as income for each year of the lease an aliquot part thereof

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:

1. If the improvement is destroyed BEFORE the expiration of the lease, the lessor is entitled to deduct as a loss for the
year, when such destruction takes place, the amount previously reported as income less any salvage value, to the extent
that such loss was not compensated for by insurance
2. If for any reason other than a bona fide purchase from the lessee by the lessor, the lease is terminated so that the lessor
comes into possession of the property prior to the final fixed period of the lease contract, the lessor receives additional
income for the year if the value of improvement exceeds the amount of income already reported

No appreciation in value due to causes other than the premature termination of lease shall be included.

Gains from Dealings in Property

This refers to the income derived from the sale, and/or exchange of assets, which results in gain because of the excess of the
amount or value received by the taxpayer over the determined value of the property he has disposed of.

The general rule is that the entire amount of the gain or loss arising there from is a taxable gain or deductible loss.

Passive Income

A final tax is imposed upon gross passive income of citizen and resident aliens

An income is considered passive if the taxpayer merely waits for it to be realized. Examples of passive income are:

1. Yield from deposit substitutes and trust fund

Deposit substitute – is a debt instrument issued by the bank to borrow money from the public other than from the
client’s deposit

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

Both deposit substitute and trust fund yield earnings that are to be treated as interest income

2. Interest income – 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

For individuals, except non-resident aliens not engaged in trade or business in the Philippines, interest income from long-term
deposit or investment shall be exempt from income tax, provided that the following conditions must be met:

a. The deposit or investment must be evidenced by certificates conforming to the Bangko Sentral ng Pilipinas prescribed
form
b. The same must have a maturity period of not less than five years and in denominations of P10,000 or other
denominations as may be approved by BSP issued by banks(not by non-bank financial intermediaries or finance
companies)

However, should the holder of the certificate pre-terminate the deposit or investment before the fifth year, a tax shall be
imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long term
deposit or investment certificate based on the remaining maturity thereof, as follows:

Final tax of 5% ------------------- 4 years to less than 5 years

Final tax of 12% ------------------3 years to less than 4 years
Final tax 20% ---------------------less than 3 years

Classifications of Interest Income

a. Exempt from Income tax – if received from:

1. By members from a duly-registered cooperative
2. BSP prescribed form of investments maturing more than 5 years
3. Expanded foreign currency deposit system by non-resident citizens/aliens
4. A tenant who paid to a landowner on the price of land under a tenant-purchaser agreement as part of CARP
b. Subject Final Withholding tax
Interest income on deposits made in banking institutions is a passive income which is usually subjected to final
withholding tax of 20%
c. Subject to Normal Tax (lending is the Main Course of Business)
These are earnings derived from lending money, goods or credits from one person to another without any withholding
tax made. Since these interest earnings are received in its total amount, they should be subject to normal tax of the
taxpayer

Since the interest income is earned in the normal conduct of business, this shall be included as part of income to be
reported in the Annual Income Tax Return

3. 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.
 a. In general, royalty income includes those which are derived from natural resources or products such as coal, gas, oil,
copper, silver, gold, and other similar products. These kinds of royalty income are subject to 20% final tax
b. Royalties on books, literary works and musical composition are royalty income subject to 10% final tax

4. 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

Such earnings may be exempt from income tax, or subject to either final tax or on the normal year-end tax of individuals or
corporations

Tax Rules on Dividend Income

1. If received by a domestic or resident corporation from a domestic corporation subject to tax, such dividend is tax exempt
(non-taxable inter-corporate principle)
2. Pure stock dividends, dividends received from cooperative, and pure liquidating dividends are tax-exempt
3. Cash or property dividend is subject to final tax if received by an individual or non-resident corporation from a domestic
corporation subject to income tax

a. If received by a resident citizen, non-resident citizen and resident alien, the final tax applicable is 10%
b. If received by a non-resident alien engaged in business in the Philippines, the final tax is 20%
c. If received by a non-resident alien not doing business within, the final tax is 25%
d. If received by a non-resident foreign corporation from a domestic corporation, the final withholding tax is 15%

4. Other dividends excluded from rules 1,2, and 3 are included in the computation of the taxable income and income tax at
the end of the year

Forms and Valuations of Dividend Income

For income tax purposes, the form of dividend income shall determine its applicable treatment. Dividends that are usually
received by a stockholder are as follows:

1. Cash dividend – the most common form of dividend. It is valued and taxable to the extent of amount of money received
by the stockholder
2. Property dividend – a dividend payable in property of an issuing corporation is a property dividend. The property
dividend is usually valued and taxable to the extent of the fair market value of the property received at the time of
declaration
a. Merchandise inventory, supplies, etc.
b. Shares of stock of another corporation
c. Treasury stock of issuing corporation if acquired at cost different from its par value
3. Stock Dividend – pure stock dividends are not subject to tax because they simply involve a transfer of the retained
earnings to the paid-in capital account, except when the following circumstances exists:
a. There is an option that some stockholders could take cash or property dividends instead of stock dividends
b. Some stockholders exercised the option to take cash or property dividends
c. The exercise of option resulted in a change of the stockholder’s proportionate share in the outstanding shares of the
corporation

Redemption of Stock Dividend

If the corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and
cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so
distributed in redemption or cancellation of the stock is considered taxable income to the extent that it represents a distribution
of earnings or profits.

Stock Dividends Different from Shares Previously Acquired

When stock dividends received are of a different class from shares previously acquired, the stock dividends are not income, and
therefore, not taxable. The original cost of the investment is allocated between the original shares and the stock dividends on the
basis of their respective market value at the date of receipt

4. Scrip Dividend – is issued in the form of promissory note and is taxable to the extent of its fair market value. It is taxable
in the year when the warrant was issued.
 5. Indirect Dividends – are those other dividends representing payments or rights received by the taxpayer, which are really
dividends
6. Liquidating Dividend – are return of stockholders investment. It arises from the distribution of assets by a corporation to
its stockholders upon corporate dissolution

As a rule, the excess amount of liquidating dividends over cost of shares surrendered is taxable. Such excess is a gain
realized which is taxable.

Distribution of liquidating dividends is to be treated as a sale of stock. The difference between the cost or other basis of
the stock and the amount received in liquidation of the stock is a capital gain or a capital loss. The gain realized or loss
sustained by the stockholder is a taxable income or deductible loss, as the case may be. Consequently, the capital gain on
liquidating dividend is not subject to final tax.

5. Prizes and winnings

Prize – is a reward for a contest or a competition. It represents remuneration for an effort reflecting one’s superiority, like prize
money of a boxing contest

Winnings – is a reward for an event that depends on chance such as winnings from gambling, lottery or raffle ticket

In general, prizes are subject to final tax of 20% except if the amount of the prize is ten thousand (P10,000) or less which shall be
subjected to normal tax. Winnings are subject to final tax final tax of 20% regardless of amount

Prize and winnings are generally taxable except when the law provides for their exemption

PARTNERS’ DISTRIBUTIVE PROFITS FROM PROFESSIONAL PARTNERSHIP’S NET INCOME

The partner’s share in the distributive profit of a professional partnership represents his gross income

Other Sources of Income – generally incidental earnings or not common source earnings

1. Bad debt recovery

2. Tax refund or credit
3. Damages recovery
4. Annuities
5. Income from whatever source

Tax Benefit Rule – a general principle in taxation which states that if a taxpayer deducted an item on his income tax return and
enjoyed a tax benefit (reduced his income tax) thereby, and in a subsequent year recovers all or part of that item, he will
recognize gross income in the year the deducted item is recovered

Bad Debt Recovery

The following are the requisites for deductibility of bad debts:

1. There must be a valid and existing debt arising from business or trade of the taxpayer
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

For taxation purposes, bad debts are considered the amounts of receivable being ascertained worthless to be written off during
the taxable year

When a written off receivable has been recovered in the succeeding year, the recovered amount must be included in the gross
income during the taxable year of recovery. However, under the doctrine of equitable benefit, the amount recovered is only
taxable to the extent of the tax benefit in the year the account was written off

Tax Refund or Credit

As a rule, refunds from taxes paid are taxable except for the following:

a. Estate or Donor’s tax

b. Philippine income tax
c. Stock transaction tax
d. VAT, claimed as input tax

Tax refund is subject to the tax benefit rule which states that the refund of tax would only be subjected to tax if such tax was
previously deducted from gross income resulting in the reduction of reported taxable income

As a rule, if the tax paid is deductible, refund is taxable. If the tax paid is not deductible, refund is not taxable.

TAX REFUND OR CREDIT shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of
the said deduction

Damages Recovery – an amount received by an injured person as payment for loss income or payment to compensate damage to
property, injury to person, or loss of life.

As a rule, recoveries of damage representing compensation for loss of profit or income are TAXABLE

Recoveries that are to compensate for damages to property, injury to person, or loss of life are not taxable

Annuities – are instalment payments received for life insurance sold by insurance companies. The annuity payments represent a
part that is taxable and not taxable. If the part of annuity payment represents interest, then it is TAXABLE income. If the annuity is
a return of premium, it is NOT TAXABLE.

Under the contract of life annuity, the debtor binds himself to pay an annual pension or income during the life of one or more
determinate persons in consideration of a capital consisting of money or other property, whose ownership is transferred to him at
once with the burden of the income

Income from whatever sources – inclusion of all income not expressly exempted within the class of taxable income under the
laws irrespective of the voluntary or involuntary action of the tax payer in producing the gains and whether derived from legal or
illegal sources

Examples of Income from legal source are:

a. Employee’s salary bonus

b. Commissions/rebate of a medical representative

Examples of Income from illegal sources are:

a. Gambling
b. Kidnapping
c. Extortion
d. Smuggling
e. Embezzlement

Illegal Obtained Income

As a rule, illegal income is taxable. Income obtained through illegal means is included in the wrongdoer’s gross income even
though he is obligated to return it when discovered

The mere fact that a transaction is illegal does not exempt it from income tax laws. Gains from such transactions as gambling,
extortion, swindling and the like are all taxable

Income that is not realized is not taxable, even though its absence is due to an illegal act. Moral turpitude is not a touchstone of
taxability

The courts have sustained the BIR Commissioner’s determination of the illegal gains from such records as bank deposits, or on the
basis of commissions paid out, and even from a formula determination based upon the nationwide experience. The burden is on
the taxpayer to offer independent evidence to contradict such determination

Embezzled funds - are income without consent (express or implied) with an obligation to repay. If the embezzler reaps the fruit of
his crime without restriction as to disposition, he is in receipt of income though it may be claimed he is not entitled to the money
and may be adjudged liable to restore its equivalent. When reported as income, actual repayment of embezzled fund will give rise
to deduction.

Income Received by Error

When income is received under a mistake of fact or law, the income is included in the gross taxable income of the recipient
notwithstanding the fact that the recipient may be required to return the income item to the payor when the error is discovered.