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PROBLEM EXERCISES: INDIVIDUAL INCOME TAXATION

and ON THE TRAIN LAW
Series 2019)
(S

Prepared by: Dr. Jeannie P. Lim

ª The new individual income tax rates are: 20%, 25%, 30, 32% and 35% (until 2022)
by 2023 and onwards: 15%, 20%, 25%, 30% and 35%.

ª “Special Aliens” – are now subject to the normal income tax under the Train Law.

ª ESTATE UNDER JUDICIAL SETTLEMENT and IRREVOCABLE TRUST are no longer

considered artificial single persons for income tax purposes. Hence, these juridical
persons cannot claim personal exemptions of Php 20,000 beginning 2018 under the
Train Law.

ª The Fringe Benefits given to managerial and supervisory employees is now subject to
the new 35% final withholding tax. Under the Tax Code (old) the tax rate applicable
shall depend on the classification of the recipient of the benefits.

ª Compensation income earners whose annual gross salary is Php 250,000 and below
shall be exempt from income tax. His salary shall likewise be exempt from
withholding tax. The exemption shall include his hazard pay, holiday pay, overtime
pay and payments for night differentials.

ª Benefits of Php 90,000 and below received by an employee over and above his basic
salary shall be exempt from income tax under the Train Law.

ª Interest income from foreign currency deposits in banks shall be subject to the 15%
Final Withholding Tax under the Train Law.

ª Lotto and sweepstakes winning of more than Php 10,000 shall be subject to the 20%
final withholding tax.

ª The tax base of the capital gains tax of 6% in the selling of capital asset is NOW the
higher figure between (a) The zonal value and (b) the fair market value as determined
by the Provincial or City Assessor where the property is located. The gross selling
price or consideration agreed upon between buyer and seller is no longer used.

ª Self-employed businessmen (sole proprietor) and professionals (Board and BAR

passers engage in the practice of their profession, i.e., they are not employed but on
their own) – realizing an annual gross sale/gross receipt of more than Php 250,000 to
Php 3.0 million can choose between the 8% FLAT tax or the graduated schedule of tax
rates under the Train Law for income tax purposes.

ª If an individual in business or profession uses the accrual basis of accounting for his
income and deductions, the optional standard deduction (OSD) of 40% shall be based
on his GROSS SALES during the year. Whereas, if he uses the cash basis of accounting
for his income and deductions, the OSD shall be based on his GROSS RECEIPTS during
the taxable year.

ª If the taxpayer is a compensation income earner and at the same time is self-
employed (in business or in the exercise of his profession) the compensation income
shall be subject to the graduated rates of tax under the Train Law and the self-
employment/professional income maybe subject to either the 8% Flat tax or the
graduated tax rates.

A mixed income earner is NOT entitled to the Php 250,000 exemption on self-
employment income because such amount is already incorporated in the first tier of
the graduated income tax rates applicable to compensation income.
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1. X, is an employee who receives a monthly salary of Php 18,500.00. Her 13 th month pay and
other allowances and benefits amounted to Php 105,000 per annum. Her holiday pay and
overtime pay amounted to Php 36,000 last year. Is X exempt from income tax and withholding
tax under the Train Law?

Answer. X’s annual compensation income is Php 222,000.00 (18,500 x 12). Her allowances and other benefits taxable
is Php 25,000 (in excess of Php 90,000 per annum). Since, her total salary for the year is only Php 247,000.00 (222,000 +
25,000) which is below the threshold of Php 250,000. X is exempt from income tax and withholding taxes. Her holiday and
overtime pays are both exempt from income tax and withholding tax as well.

2. X, is a supervisor in a manufacturing concern. His monthly salary is Php 32,500. His living
allowances and other benefits is Php 5,300 per month. In the month of December he receives
his 13th month pay plus Christmas bonus of Php 40,000 from his employer. (a) If X comes to
you seeking advice on how to report his income under the Train Law, what will be you advice
under the given facts? (b) If X works as the manager of an accredited NGO that is exempt
from income tax. Is X taxable on his compensation income?

Answer. (a) Total salary for the year (32,500 x 12) . . . . . . .. . . . . . . . . . . . . . . . .Php 390,000.00
Add: Amount of benefits in excess of Php 90,000
5,300 x 12 = 63,600 + 40,000 – 90,000 . . . . . . . . . . . . . . 13,600.00
Total taxable income for the year ………………………………….. Php 403,600.00
vvvvvvvvvvv
) The first 250,000.00 of his salary is exempt from income tax.

403,600.00 - 250,000 = 153,600 x 20% = Php 30,720.00 less creditable withholding taxes if there be any.

(b) X’s net compensation income of Php 403,600 is still taxable. The determination of whether
or not the same is subject to income tax is the total amount he received from his employer by
way of compensation. X cannot invoke the exemption of his employer because tax exemption
is non-transferable.

3. X’s total gross annual salary from employment is Php 300,000 (25,000 per month) His total
monthly contributions to SSS, philhealth, pag-ibig, union dues and company group
insurance is Php 4,825.00 per month. Is he taxable under the Train Law?

Answer. He is exempt from income tax for the following reasons:

Salary (25,000 x 12) ………………………………………Php 300,000.00
Less: Non-taxable SSS, Philhealth, Pag-ibig
union dues and group insurance
contributions (4,825.00 x 12) ………….. 57,900.00
Php 242,100.00
vvvvvvvvvvv

The above-named contributions mandated by law are exempt from income tax. X’s net compensation income after
the deduction thereof is below the threshold of Php 250,000.00. Hence, X is exempt from income tax.

4. X operates a small laundry shop while also practicing his dental profession. In 2018, his
gross sales amounted to Php 1,100,000 in addition to his receipt from dental practice of Php
1,600,000.00. The cost of sales and operating expenses incurred on the laundry shop were
Php 650,000 and Php 190,000, respectively. The cost of services on the profession was Php
850,000.00. (a) Compute the tax due if X uses the 8% FLAT tax and (b) The graduated rates of
tax.

Answer. (a) Gross receipts from laundry shop …………………………… Php 1,100,000.00
Gross receipt from dental profession ………… 1,600,000.00
Total receipts ……………………………….. 2,700,000.00
Less: (First sum exempted) …………………… 250,000.00
Taxable income ………………… 2,450,000.00
X 8% Tax rate …………………………………… 8%
Income Tax due ………………………………………. Php 196,000
vvvvvvvvvvvv

) X’s choice of 8% FLAT tax will exempt him from the payment of income tax and 3% percentage tax to the BIR.

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) This choice of 8% flat must be made during the first quarter of the year or on the initial quarter return of the
taxable year after the commencement of a new business/practice of profession. Failure to signify this choice
during the said period, the taxpayer shall be considered as having availed of the graduated rates of tax under
the Train Law.

) Such election shall be irrevocable and no amendment shall be allowed for the taxable year.

) X shall not be entitled to avail of the optional standard deduction because he is taxed at gross.

) Financial statements (FS) is not required to be attached in the final income tax return but existing rules and
regulations on bookkeeping and invoicing/receipting shall be applied.

) If during the taxable year the X’s gross sales/receipts exceeds Php 3.0M, his income tax shall be computed
under the graduated income tax rates and he shall be allowed a tax credit for the previous quarter(s) income
tax payments under the 8% flat tax.

(b) Graduated rates of tax under the Train Law:

Gross receipts – laundry shop ……………………………… Php 1,100,000.00

Less cost of sales ………………………. 650,000.00
Gross Income ……………………….. 450,000.00
Less: Expenses:………………… 190,000.00 260,000.00
Gross receipts from profession …………………….. 1,600,000.00
Less: Cost of services ……………………. 850,000.00 750,000.00
Taxable income …………………………… 1,010,000.00
Income Tax due: on Php 800,000.00 = 130,000.00
In excess of 800,000 = 210,000. X 30% = 63,000.00
Php 193,000.00
vvvvvvvvvvv

) Since X has chosen the graduated rates in the computation of his income tax payable, he shall pay the 3%
PERCENTAGE TAX. Hence: Total receipts from laundry shop and profession is Php 2,700,000.00 X 3% =
Php 81,000.00.

) X can avail of the 40% optional standard deductions in claiming his expenses.

5. Who are the taxpayers who are not allowed to avail of the 8% FLAT under the Train Law.
Notwithstanding the fact that they have not exceeded their gross sales/receipts of Php 3.0
million per annum?

Answer. (a) If the business or profession of the taxpayer is VAT Registered,

(b) If the taxpayer is liable to other percentage Tax which is not 3% Non-VAT (example: franchise tax, common
carrier’s tax, amusement tax, stock exchanges, etc.)
(c) The taxpayer is a partner of a General Professional Partnership by virtue of their distributive share from the
GPP which is already net of cost and expenses.

6. What businesses are covered by the “other percentage taxes” under Title V of the NIRC,
which are not qualified to avail of the 8% FLAT tax of the Train Law?

Answer, (a) Businesses subject to franchises tax

(b) Amusement taxes
(c) Tax on insurance companies and agents of foreign insurance companies
(d) Tax on international carriers
(e) Tax on common carriers and keepers of garages
(f) Tax on overseas dispatch and communications
(g) Tax on winnings (Jai-alai and horse races)
(h) Tax on sale, barter, exchanges of shares of stocks listed in the exchanges
(i) Tax on banks, Q-banks and financial intermediaries

7. X operates a business subject to 2% franchise tax. His gross receipts are Php 2,750,000.00
and his non-operating income is Php 120,000.00. Costs and expenses for the year is Php
1,200,000.00. Compute his income tax payable under the Train Law.

Answer. X cannot use the 8% FLAT because his business is covered by the “other percentage taxes”
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Gross receipts…………….. Php 2,750,000.00 If X desires to use the OSD:

Add: non-operating income ….. 120,000.00 Gross receipts ………. Php 2,750,000.00
Total ……………………………….. 2,870,000.00 Add: Non-operating income….. 120,000.00
Less costs/expenses ……….. 1,200,000.00 Total ……………. 2,870,000.00
Taxable income 1,670,000.00 Less: First sum exempted ……… 250,000.00
Less: First sum exempted ………. 250,000.00 Net taxable income …………… 2,620,000.00
1,420,000.00 OSD (40% of 2,750,000.00) …… 1,100,000.00
Train rates: Php 800,000.00 at Php 130,000.00 1,520,000.00
In excess of Php 800K = Php 620,000 X 30% -= 186,000.00 Tax rate under the Train schedule:
Income tax payable ………………….. Php 316,000.00 Php 800,000.00 ……………. Php 130,000.00
vvvvvvvvvvv In excess of 800,000.00
= 720,000.00 X 30% = 216,000.00
Income tax payable: Php 346,000.00
vvvvvvvvvv

8. In 2018, X, a bank cashier, earned an annual compensation income of Php 480,000. Her 13th
month pay and other benefit amounted to Php 89,500.00. In addition, she is a licensed real
estate broker and appraiser, with gross income of Php 2,500,000.00. Her cost of services and
operating expenses were Php 570,000.00 and Php 390,000, respectively. During the same
year, she had a non-operating income of Php 125,000.00.

(a) Compute the income tax due on X if she opted to be taxed at the 8% Flat, and (b) the
graduated rates of tax under the Train Law.

Answer. (a) If X chooses the 8% FLAT, she has to compute separately her income tax due from her compensation
and from business and thereafter to aggregate the two (2) in arriving at the income tax payable under the FLAT
tax.
On her compensation income: On her business income:
Total compensation income ………………… Php 480,000.00 Gross receipts…………… Php 2,500,000.00
Less: Non taxable benefits 89,500.00 Add: other non-operating income 125,000.00
Taxable compensation income 390,500.00 Taxable income 2,625,000.00
On the first Php 250,000 exempt X 8%
In excess of 250,000 = 140,500.00 x 20% = Php 28,100.00 Php 210,000.00

Therefore tax due is Php 238,100.00 (sum of 28,100 and 210,000)

NOTE: The choice of 8% FLAT will exempt X from the payment of the 3% percentage.

(b) Graduated rates of tax: Combine income from compensation and business and subject to the graduated rates.

On business income: On compensation income:

Gross receipts ………………………… … Php 2,500,000.00 Total salary Php 480,000.00
Less: Cost of services ………… 570,000.00 Less: Non taxable benefits 89,500.00
Gross Income ……………………… 1,930,000.00 Taxable compensation income 390,500,00
Less: Operating expenses 390,000.00 vvvvvvvvvvvv
Net income from operation 1,540,000.00
Add: Non-operating income 125,000.00
Taxable business/professional income 1,665,000.00
vvvvvvvvvvvvv

Total taxable income from both is Php 2,055,500.00. Hence on the first 2,000,000.00 is taxed at Php 402,500.00
and in excess thereof is 55,500.00 x 32% = 17,760.00. Hence, TOTAL INCOME TAX PAYABLE is Php 420,260.00

Note: In addition, X has to pay the 3% percentage to the BIR based on her gross receipts.

9. In 2017 X rendered some services in favor of “C”, customer. In payment thereof, X received a
post dated check with a face value of Php 100,000. The PDC with mature in 2019. X took the
PDC to his friend and had it discounted less 15%. On maturity C paid the PDC. (a) How much
income is subject to tax in 2018? (b) Is there income reportable in 2019? How much?

Answer. (a) Face value of the PDC ……… Php 100,000.00 (b) Face value of PDC …………… .Php 100,000.00
Discount (100,000 x 15%) . . . 15,000.00 Less: Amount declared as income
Taxable income in 2017 . . . . . . . . . .85,000.00 in 2018 . . . . . . . . . . . . . . . . . 85,000.00
vvvvvvvv Income taxable in 2019 ….. 15,000.00
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10. X is an amateur chess player and she represented the Philippines in an international
women’s chess tournament in California, USA. She won the championship there and
received the following prizes: (a) US 10,000 cash prize, (b) one (1) year educational
scholarship in University of California; (c) Talent fees of Php US 50,000 from Nike Sports,
Inc.; (d) 60-inch TV from Samsung, Inc. and (e) various gifts from the Filipino communities in
USA. X shipped the prizes (TV, Trophy and various gifts received from friends and from the
Filipino communities) back to the Philippines as she has yet to visit other States and
Universities giving speeches. Are the prizes X received taxable?

Answer. A, B, D and E are exempt from income tax because they were received by X as prizes in connection with the
chess tournament. C is taxable as it is income not related to the sport competition. The shipment of her other prizes and
gifts to the Philippines is subject to VAT and customs duties because these impositions are entirely different from income
tax that X is exempted from. .

11. The BOD of X Corporation decided to transfer its own shares of stocks to 10 of its loyal
employees who started their employment since X’s business inception not only to secure
their loyalty but to reward them as well. Is there any tax implication under the given facts?

Answer. Yes, the transaction is subject to income tax. When the corporation transfers to its employees its own shares of
stocks as remuneration for services rendered, the fair market value of the shares at the time it was given is taxable to the
employees. (Doctrine of Proprietary Interest)

12. Celdric works as a barber in a saloon. Every day he receives tips from his customers. (a) Is
he subject to income tax on the tips he receives from his customers?

Answer. Yes. Celdric is subject to income tax on the tips he receives from his customers because he receives them by
reason of his employment. The income however is not subject to withholding tax because between him and his customers
there is no employer-employee relationship.

13. X works with a manufacturing concern as a field worker who travels regularly to the different
provinces showing sample goods. He books orders from customers and sends them to his
office for delivery. X receives regularly Php 15,000 as his transportation, hotel and food
allowances. Is the Php 15,000 part of his compensation income subject to income tax?

Answer. The general rule is that transportation and other bona fide expenses which are received by employees in the
performance of their duties are compensation income taxable to them. However, under the given facts, If X is required to
account or liquidate the Php 15,000 and to return the excess, if there be any, then the Php 15,000 is not taxable to him. If
there is no requirement to return any amount thereof to his employer, X shall report the Php 15K as part of his salary
earned.

14. X is a bank employee. Among the benefits she enjoys in the bank is a 15-day sick leave and
15-day vacation leave. Last year X was hospitalized and she had fully utilized all her sick
leave allowances. In addition, X had utilized only 5 days of her vacation leave the remaining
10 days was monetized to her at the end of the year. Briefly discuss the taxability of the 15-
day sick leave and 15-day vacation leave of X.

Answer. Both the 15-day sick leave and 15-day vacation leave constitute compensation income of an employee. Thus,
the salary of X on vacation or on sick leave which are paid to her notwithstanding her absence from work constitute
compensation income to her. However, if the value of unutilized vacation leave/sick credits is equivalent to ten (10) days
and below during the year, it shall not be subject to income tax because they are classified as benefits de minimis (of
small value) which is exempt from income tax. This principle is applicable only to employees in the private sector.

NOTE: The RATA (Representation and Transportation Allowance, and PERA (Personnel Economic Relief Allowance of
government employees are not taxable compensation income to them. The ACA (Additional Compensation Allowance)
granted to all officials and employees of the National Government Agencies, SUCs, GOCCs LGUs and GFIs (government
financial institutions) is PART of other benefits which is not subject to income tax if the amount is Php 90,000 and below.

15. Atty. Mondrigo Monte is the Acting Dean of the College of Law of “C” University. He was
advised to pursue a post-graduate degree of Master of Laws as required by the Legal Board
of Education to officially hold the position of deanship. His study was financed by the
university. Is the study grant subject to fringe benefit tax?

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Answer. No, the study grant is not subject to the fringe benefit tax of 35%. The post-graduate degree is a requirement for
the position and it is directly connected with the trade or business of the school. The University is not allowed to appoint a
dean without a post graduate degree.

) If the school is willing to shoulder the tuition fees of the professors pursuing their post-graduate studies on condition
that the subject employees shall remain under the employ of the employer for a period of time, the cost of the
educational benefits is NOT subject to the fringe benefit tax. However, the cost of the tuition fees shall form part of the
compensation income of the professors subject to income tax.

16. The Legal Education Board requires all faculty members of the College of Law to possess
the minimum paper qualification of a completed post-graduate study. X University sent six
(6) of its law professors to the graduate program of Y University free of all expenses (tuition
fees, books etc.) on condition that for every year of study the subject professor will render a
three-year of teaching in the College of Law. Is this benefit taxable to the law professors or is
it considered a gift that is exempt from income tax? Reason.

Answer. When the recipient of benefits are required to render substantial future services as a condition of receiving the
prize or award, the value of the benefit is taxable to the recipient. Hence, the professors on study shall report the cost of
the graduate program as part of this gross income subject to income tax.

17. Many employees/officers of big corporations receive not only the mandated 13 th month basic
salary at the year of the year. X regularly receives year-end bonus of up to 17th month. Are
the benefits of X subject to income tax?

Answer. The 13th month pay equivalent to the mandatory one (1) month basic salary of officials and employees from
work (private and public) including other benefits such as Christmas bonus, productivity incentive bonus, loyalty award,
gifts in cash or in kind and other benefits of similar nature actually received are considered exclusion which are exempt
from income tax during the year, provided that the total amount does not exceed Php 90,000.00. Hence, if all benefits of X
added together has a value of Php 345,000, the Php 255,000 in excess of Php 90,000 shall be taxable.

18. In 2018, X received from the BIR a tax refund for excess withholding taxes. Is the tax refund
taxable to X the year he received it?

Answer. If the tax refunded is a non-deductible tax for income tax purposes the refund is not taxable. Withholding tax is a
non-deductible tax under income taxation. Hence, X need not report the tax refund he received from the BIR for income
tax purposes.

NOTE: Non-deductible taxes under income taxation: Income tax, Estate and Donor’s taxes, Final withholding
taxes, VAT, Special Assessment, Energy tax, Stock Transfer tax and War profit tax.

19. Under an international treaty airlines with landing rights in our country are exempt from
excise tax on aviation fuel. Japan International Airlines has landing rights in our country. It
buys aviation fuel from Shell (Phils) Inc., Shell passes on the excise tax (indirect taxes) on
gasoline to “JAL.” JAL did not notice the excise taxes that were included in the purchase
price. Several months thereafter, JAL discovered the error and filed a claim for tax refund of
the indirect taxes on its purchases of aviation fuel. The BIR denied the claim. Is the denial
valid? Why?

Answer. Yes, the denial is meritorious. If the tax is an indirect tax, the proper party to question or seek a refund of it is the
statutory taxpayer, the person to whom the tax is imposed by law and who paid the same even if he/it shifts the burden
thereof to another. The proper party to claim is Shell and not JAL and if Shell succeeds in its claim it has the obligation to
return that to JAL (Silkair vs. CIR, November 14, 2008)

20. X, a businessman deducted bad debt from his gross income which he was able to ascertain
to be worthless. A year thereafter, his debtor (D) came back to pay the bad debt having won
the lotto. Should X declare the amount he received for income tax purposes or is it exempt
from income tax for reason that it is a mere return of capital? Reason.

Answer. When X recovered the bad debts he had previously claimed as deductions, he was already benefited under the
law. Hence, the recovery thereof after deduction is not considered “mere return of capital” but it shall be considered a
fresh income subject to income tax. It shall be included as part of X’s gross income in the year of recovery because he
cannot be benefited twice at the expense of the government. Hence, bad debts that were deducted but subsequently paid
shall be considered fresh income subject to income tax. (This is referred to as the RECAPTURE RULE or the TAX-
BENEFIT Rule).
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21. (a) X has a vacant lot which he sold to a GOCC. Is the transaction taxable? What taxes, if
any, is payable by X? (b) If a portion of X’s vacant lot was expropriated by the DPWH to give
way to road widening, Is X taxable on the just compensation payable to me? .

Answer. (a) Yes, the transaction is taxable because it is a voluntary sale. Considering that the buyer of his real property
classified as capital asset is a government (national or local or any of its political subdivisions or agencies including
GOCCs), the seller, X, shall have the option of paying the 6% capital Gains Tax or subject his gain, if there be any, to the
normal income tax. The choice belongs to X.

(b) If X’s property is EXPROPRIATED (involuntary sale) by the government for public use, the transaction is still subject
to tax. Upon released of the just compensation to X, DPWH shall withhold the 6% capital gains tax from the proceeds and
remit the same to the BIR. X can not avail of the alternative taxation. e.g., choosing between 6% CGT or the normal
income tax.

22. Today, X is 45 years old and he has worked with “F” factory for the last 18 years. “F” has
recently purchased equipment and machineries. As a result, X together with some of his co-
employees will be retrenched. Should X receive from the company Php 150,000.00 separation
pay and comes to you to inquire whether this money is subject to income tax because his
supervisor told him to declare it for tax purposes having failed to meet the “50-10” years
Rule in income taxation. What will be your most esteemed advised?

Answer. X’s supervisor is wrong. The “50-10” years Rule in income taxation applies to Optional Retirement Benefits and
not to Separation Pay of an employee. Amounts received by reason of involuntary separation remain exempt from income
tax even if X at the time of separation is blow 50 years of age and has rendered less than 10 years of service. In fact,
separation pay can be exemption as many times as there are provided the employee is severed from the service and the
reason thereof is not initiated by him or is beyond his control. Whereas, Optional Retirement Benefit is exempted ONLY
ONCE.

23. “S”, the supervisor of the firm had an urgent meeting with 15 regular employees of the
company who have worked for more than 10 years with the firm. “S” informs the employees
that the company is incurring huge losses in the last three years of their operation and he
was saying that it is inevitable that some of them will be retrenched. He informed the
employees that management will offer Php 50,000.00 for those who will be voluntarily
resigned. According to her, this offer is the better option rather than wait to be retrenched as
that would have the implication of inefficiency on the part of the employee.

a) If X voluntarily tendered his letter of resignation and received the Php 50,000 separation
pay, is the amount taxable?
b) If Y, refused to tender his letter of resignation but the company terminated him and was
paid Php 50,000. Is the amount taxable to Y?
c) Z, refused to accept the offer but he was terminated anyway without having paid any
single centavo. If Z filed a labor case against the firm and subsequently won where he
was awarded with back wages and reinstatement. Is his back wages subject to tax?
Reasons.

Answer. (a) Yes the amount is taxable because X voluntarily resigned from service. The principal reason for cessation
from work is his resignation and not the losses being suffered by the company. Resignation is an act that is within the
control of the employee.

(b) No, the amount Y received is not taxable because the cause of his severance from employment was termination due
to retrenchment – a cause which is not within his control.

(c) Back wages awarded to an illegally dismissed employee is subject to income tax for reason that the money represents
salary actualized. It is also subject to withholding tax.

24. X was terminated from his job due to his undesirable attitude and willful disobedience of the
lawful orders of his employer. After a meeting with the manager. X was given financial
assistance of Php25,000 but has to leave the service. Is the money taxable to X? Why?

Answer. Termination of employment by the employer due to willful disobedience of an employee of the lawful orders of
his employer, inefficiency, undesirable attitude, dishonesty, moral depravity or serious misconduct are deemed cause
which are not beyond the control of the employee. Hence, any financial assistance or money given to subject employee
who will be terminated for the causes herein stated is taxable to him.

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25. X owns a vacant lot and Y desires to lease the real property. A Lease Contract was drawn
and among the stipulations agreed upon are:

(a) Y will construct a 4-storey commercial building at his exclusive expense on the lot and
the building will automatically belong to X at the end of the 20-year contract.

(b)The annual real property tax on the land and building shall be paid by Y during the lifetime
of the lease contract.

(c) Y will extend a loan of Php 300,000 to X, which shall be gradually deducted from Y’s
monthly rental of Php 75,000.00 at Php 20,000 per month beginning on the second year of the
lease contract.

What are the tax implications under the above-agreements between X and Y?

Answer. (a) The monthly rentals of Php 75,000.00 is income to X. In addition, when the lessee makes improvements on
the leased premises and said improvements will belong to the lessor upon the termination of the lease contract, the lessor
(X) may at his option report income using the (1) outright method – report as income the fair market value of the
improvements in the year of completion, or (b) spread-out method – spread over the remaining term of the lease the book
value of such improvements at the termination of the lease contract.

(b) The real property taxes paid by Y on behalf of X shall be considered additional income to the lessor and constitutes
income taxable to X.

(c) The loan extended by Y to X will still form part of the income of X taxable to him.

26. (a) X took a life insurance policy with a term of 15 years. Her total contribution amounted to
Php 200,000.00. She outlived the policy and received from the insurance company her life
insurance proceeds of Php 320,000.00. Is the money X received subject to tax?

Answer. Since X outlived her insurance policy, the money returned to her is taxable but only the Php 120,000.00 being
the excess of her total contribution of Php 200,000.00. The later amount is not taxable being a mere return of her capital.
One important requisite in order that proceeds of life insurance shall be exempt from tax is the death of the insured.

(b) If X is a beneficiary of a Php 1.0 million policy on her father’s life and upon his death, X
elects to receive Php 220,000 every year for five (5) instead of lump sum. Is there any
difference in your answer?

Answer. The Php 200,000 she receives every year is tax exempt but the Php 20,000.00 remaining is taxable being
interest earned from the life insurance proceeds.

(c) X took out a life insurance policy and named his wife and 4 kids as beneficiaries. X paid
only five (5) months premium in the total amount of Php 15,000.00 and suddenly died of a
heart attack. If the heirs received from the insurance company the life insurance proceeds of
Php 500,000.00. Is the amount in excess of X’s contribution taxable to the heirs? Why?

Answer. No. Proceeds of life insurance policies paid to heirs or beneficiaries upon the death of the insured, whether in a
single sum or otherwise, are excluded from gross income. However, if such amounts are held by the insurer under an
agreement to pay interest thereon, the interest payments shall be included in gross income. The reason for its non-
taxability is that such proceeds are considered more as an indemnity rather than as gain or profit.

27. Alfredo inherited from his uncle an apartment located in Baguio City worth Php 12.0M. The
real property has an annual lease income of Php 600,000.00. (a) How much income is taxable
to Alfredo? (b)

Answer. The Php 12.0 million apartment is not subject to income tax but to estate tax because Inheritance is considered
capital. Only the Php 600K lease income of the apartment is subject to income tax.

28. X has a grocery store. In 2018 he realized gross sales of Php 2,350,000.00 and incurred
operating expenses of Php 1,150,000.00. If he comes to you asking what is the use of the
Optional Standard Deduction in income taxation, how will you answer the query?

Answer. Businessmen and professionals are given 2 options on how to deduct their expenses. The (a) Itemized Standard
Deduction (ISD) and the (b) Optional Standard Deduction (OSD). The OSD is in lieu of the ISD. X may elect OSD in an
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amount not exceeding forty per centum (40%) of his gross sales or receipts, as the case may be. Provided: (1) his
intention to use this method is signified in his first quarterly tax return during the taxable year or in his initial quarter return
after the commencement of a new business, and (b) once the election is made, this is irrevocable for the whole taxable
year.
The purpose of the OSD is to facilitate the audit or review of taxpayer’s returns because there is no need on the
part of the BIR to determine which items are deductible and which deductions are allowed under the law.

) The 40% deduction does not require supporting receipts.

) None resident aliens are not allowed to use this method of claiming their expenses.
) Taxpayers who have chosen the 8%FLAT tax under the Train Law are not allowed to deduct their expenses. So
they may not avail of the OSD.
) Corporate taxpayers using this method to deduct their expenses shall use their GROSS INCOME as tax base for
the 40%, whereas, individual taxpayers use their GROSS SALES OR GROSS RECEIPTS as tax base.

29. Income earned by Resident Citizens of the Philippines that are subject to FINAL
WITHHOLDING TAXES and NOT to INCOME TAX:

Answer (a) Interest earned from currency deposits in banks (Pesos account) …………. 20% FWT.
(b) interest earned from foreign currency deposit in banks ……………….. 15% FWT
(c) Royalties …………………………………………………………………………….. 20% FWT
(d) Royalties on books, literary works and musical compositions ……. 10% FWT
(e) Prizes in excess of Php 10,000.00 won within the Philippines ………….. 20% FWT
(f) Lotto and sweepstakes winnings in excess of Php 10,000 ………………. 20%FWT
(g) Cash and property dividends ………………………………………………….. 10% FWT
(h) Capital gains from sale of shares of stocks not listed in the exchanges…… 15% FWT
(i) Capital gains from sale of capital assets of real property located in the Phi ……. 6% FWT
(j) Proceeds of pre-terminate time deposits of more than 5 years:
Four (4) years but less than 5 years ……………………….. 5% FWT
Three (3) years but less than 4 years ……………………. 12% FWT
Less than three (3) years ………………………………… 20% FWT

30. Taxation of partnership and partners:

x Partnership is taxed like a corporation. Unregistered partnership is also taxed like a

corporation.

x Share in the profit of the partnership shall be taxable to the partners only in their
separate and individual capacities.

x Partners shall be taxed on their share whether the profit has been distributed or
otherwise. Under the Doctrine of Constructive Receipt of Income, the partners have
the control and the right to decide as to when and whether or not the profits should be
distributed to them.

ª Kinds of partnerships:

1. Exempt partnership such as General Professional Partnership – These are partnerships formed by
persons for the purpose of exercising their common profession and no part of their income is derived from
engaging in any trade or business. Reason for exemption – The GPP is exempt from corporate income tax
because it is only acting as a “pass through” entity where the income is ultimately taxed to the partners
comprising it. However, it is subject to business taxes.

) It is required to file an income tax return of their income for the purpose of given information to the BIR as
to the share in the gains/profits which each partner is entitled to.

) Income payments, drawings, allowances, advances, sharing, stipends, etc. made periodically or at the end
of the taxable year to partners of a GPP shall be subject to creditable withholding tax of 15% if the gross
income in one year exceeds Php 720K and to 10% CWTax if income is Php 720K and less.

) For purposes of computing the distributive share of the partners, the net income shall be computed in the
same manner as a corporation.

) The GPP may claim the itemized standard deductions (ISD) or the optional standard deduction (OSD) in
the amount not exceeding 40% of its gross income.
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) It the partnership availed of the ISD in computing its net income, the individual partners CANNOT avail of
deductions anymore in computing their respective income tax on their share in the net income of the
partnership because the distributive share from the partnership is already net of costs and expenses.

) If the GPP avails of OSD in computing its net income, the partners can NO LONGER claim further
deductions from their share in the net income for the following reasons: (a) the partner’s distributive share
in the GPP is treated as gross income NOT his gross sales/receipts and the 40% OSD allowed to
individuals is specially mandated to be deducted not from his gross income but from his gross
sales/receipts, and (b) the OSD is in lieu of the ISD in computing taxable income will answer for both the
items of deduction allowed to the general professional partnership and its partners. (RR 2-2010)

) Under the TRAIN Law, a GPP and the partners comprising such partnership may avail of the optional
standard deduction (OSD) of 40% only once, either by the GPP or the partners comprising the
partnership.

) The partners comprising the GPP (a) can no longer claim further deductions from their distributive share in
the net income of the GPP and (b) are NOT allowed to avail of the 8% Income Tax rate option since their
distributive share from the GPP is already net of cost and expenses.

) If the partner has other income derived from trade, business or practice of profession apart and distinct
from the share in the net income of the GPP, the deduction that can be claimed from the other income
would either be itemized deductions or OSD.

) An individual taxpayer who opted to avail of the OSD shall not be required to submit with his tax return
such financial statements otherwise required under the Tax Code.

2. All other taxable partnership – They are taxed like a corporation. The rules on corporate taxation such as the
filing of quarterly income tax returns, the rules on deductibility and non–deductibility of expenses incurred, tax
rates, etc. are applicable to them.

31. Tax on co-ownership:

) Co-ownership is exempt from corporate income tax if the activities of the co-owners are limited to the
preservation of the property and the collection of the income therefrom.

) Upon distribution of the net profits to the co-owners, they shall be taxed separately and individually based on
their distributive share.

32. X and Y are cousins. They bought two (2) parcels of land from Z, another cousin who is
leaving for abroad in 2015. In 2016, X and Y purchased the inherited property of Z consisting
of two (2) agricultural lands. In 2018, X and Y sold all the real properties and realized a gain
of Php 2.0 million and divided the same equally between them. Is an unregistered partnership
formed by X and Y thereby subjecting them to corporate income tax?

Answer. No unregistered partnership was formed between X and Y. The mere sharing of gross returns does not of itself
establish an unregistered partnership. To be such, there must be an unmistakable intention to form a partnership or joint
venture. Under the given facts there is no showing that the joint purchase was for the purpose of earning profits to be
divided between them.

33. W, X, Y and Z inherited from their last parent income generating properties. Every year they
divide the net income therefrom equally. The tax official learned of this arrangement and
subjects the income to corporate income tax of an unregistered partnership because the
business is owned by 2 or more persons. Is the tax official correct? Why?

Answer. Co-heirs who inherited properties which produce income should not automatically be considered as partners of
an unregistered partnership or corporation subject to tax if there is no contribution or investment of additional capital to
increase or expand the inherited properties, merely continuing the dedication of the property to the use to which it had
been put up by the forebears. (Obillos vs. CIR)

34. In the above problem, granting that the co-heirs decided to sell the inherited property and
realized a profit of Php 8.0 million. Is the gain subject to corporate income tax?

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Answer. No. the gains realized is not subject to corporate income tax because the sale does not necessarily established
their intention to form an unregistered partnership.

35. Upon due investigation, the tax official was able to determine that X has under declared his
income by more than 50%. (a) what kind of penalty is imposable against X? (b) May the
government collect deficiency interest and delinquency interest at the same time?

Answer. When a return filed is fraudulent (substantial under declaration of more than 30%) there shall be imposed a
surcharge of 50% and not 25% because the latter is for late payment or late filing of the return, and an interest of 12% per
annum on the basic tax. (b) In no case shall double imposition of interest be allowed. i.e., the deficiency and the
delinquency interest simultaneously imposed. .

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