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REGULAR INCOME TAX: INCLUSION IN GROSS INCOME
accountingbuddyph
Overview
This video explains the various types of income that are subject to regular income tax, as opposed to final taxes or capital gains tax. It details income from compensation, business operations, dealings in properties, interest, rents, royalties, dividends, annuities, prizes, winnings, pensions, and distributive shares from professional partnerships. The discussion emphasizes the conditions under which each income type is taxed regularly, highlighting exclusions and specific rules for different scenarios, such as active vs. passive royalties and the treatment of advance rentals.
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Chapters
- Regular income tax applies to income items not subject to final tax or capital gains tax.
- Key inclusions are compensation, business income, gains from property dealings, interest, rents, royalties, dividends, annuities, prizes, winnings, pensions, and partnership shares.
- This list is not exhaustive; specific rules determine taxability.
Understanding what income is subject to regular income tax is fundamental for accurate tax filing and compliance.
- Compensation for services, regardless of form, is subject to regular income tax, excluding certain fringe benefits taxed separately.
- Gross income from any trade, business, or profession (legal or illegal, registered or unregistered) is subject to regular income tax.
- Business income exempt from regular income tax includes those enjoying tax holidays, subject to special regimes (like PEZA/TIEZA 5% gross income tax), or opted for the 8% income tax.
- Business income subject to final tax (e.g., subcontractors of petroleum service contractors) is excluded from regular income tax.
This section clarifies the tax treatment of earnings from employment and entrepreneurial activities, distinguishing taxable income from exemptions.
The calculation for business income involves sales/revenues minus cost of sales/services to arrive at gross income.
- Gains or losses from dealings in ordinary assets are subject to regular income tax.
- Ordinary assets include inventory and assets used in the business (e.g., supplies, property, plant, and equipment).
- Gains from dealings in capital assets, excluding domestic stocks and real properties (which are subject to capital gains tax), are also subject to regular income tax.
- Capital assets are those not meeting the definition of ordinary assets, including personal non-business assets and certain financial/intangible assets.
This distinction is crucial because gains from ordinary assets are taxed at regular rates, while gains from specific capital assets have different tax treatments.
Selling inventory or equipment used in a business results in ordinary gains or losses taxable under regular income tax.
- Taxable interest income must be actually paid or credited pursuant to an agreement to pay interest; theoretical interest is not taxable.
- Interest income from loans, notes, and bank deposits abroad are generally subject to regular income tax.
- Interest income from bank deposits, deposit substitutes, government securities, money market placements, and trust funds are typically subject to final tax.
- Interest income earned by landowners from land disposals under agrarian reform is exempt.
Understanding the nuances of interest income taxation helps identify which interest earnings are subject to regular tax versus a final withholding tax.
Interest earned from loans extended by a company is subject to regular income tax, while interest from a local bank deposit is subject to final tax.
- Rental income from properties is generally subject to regular income tax.
- Obligations of the lessor assumed by the lessee are treated as additional rental income.
- Advance rentals are taxable upon receipt if unrestricted; they are not taxable if they constitute a loan or a security deposit.
- Leasehold improvements made by the lessee can be recognized as income by the lessor under specific methods.
This section clarifies how rental income, including advance payments and lessee-funded improvements, is recognized and taxed.
A lessee paying three months' rent in advance is recognized as income by the lessor upon receipt, unless it's clearly a loan or security deposit.
- Active royalties and royalties earned outside the Philippines are subject to regular income tax.
- Passive royalties (e.g., from mining properties, published books) and royalties from franchises exercised within the Philippines are subject to final tax.
- Dividends from foreign corporations (cash, property, or stock) are subject to regular income tax for individual recipients.
- Dividends from domestic corporations are generally subject to final tax for individuals and exempt for corporate recipients.
Differentiating between active and passive royalties, and the source of dividends, determines whether they fall under regular income tax or final withholding tax.
Royalties received for licensing software tailored to specific clients (active royalty) are taxed regularly, while royalties from published books in the Philippines (passive) are subject to final tax.
- Annuity payments received after the return of the premium paid are considered taxable income subject to regular income tax.
- Prizes and winnings not subject to final tax are included in gross income for regular income tax.
- Prizes below a certain threshold or those won without effort (e.g., contests not requiring participation) are taxed regularly.
- Pensions and retirement benefits are generally exempt from regular income tax if specific conditions are met.
This covers miscellaneous income types, clarifying the taxability of annuities beyond the recovery of cost, and specific rules for prizes and winnings.
Lottery winnings not exceeding PHP 20,000 are exempt from tax; amounts exceeding this threshold are subject to final tax if won in the Philippines.
- General Professional Partnerships (GPPs) are not taxed directly; their partners are taxed on their distributive share of the net income.
- The net income of a GPP includes items exempt from final tax or capital gains tax.
- A partner's share in the GPP's net income is added to their individual gross income and taxed at regular rates.
- This pass-through taxation principle also applies to certain joint ventures and co-ownerships.
This explains how income earned through a partnership flows through to the individual partners and is taxed at their personal income tax rates.
If a GPP earns PHP 1,000,000 in net income and has PHP 20,000 in interest income from bank deposits, the total PHP 1,020,000 is distributed to partners and taxed accordingly.
Key takeaways
- Income subject to regular income tax encompasses a broad range of earnings, including compensation, business profits, and gains from property, interest, rents, and royalties.
- The distinction between ordinary and capital assets is critical for determining the tax treatment of gains from property dealings.
- Interest income is taxed regularly unless it falls under specific exclusions or is subject to final withholding tax (e.g., from local bank deposits or government securities).
- Rental income, including advance payments, is generally taxed regularly, with specific rules for deposits and lessee improvements.
- Active royalties and royalties sourced from outside the Philippines are taxed regularly, contrasting with passive royalties which are subject to final tax.
- Dividends from foreign corporations are typically subject to regular income tax for individuals, while dividends from domestic corporations are often subject to final tax or exempt.
- Partnerships (GPPs) act as pass-through entities, with income taxed at the partner level, including items that might otherwise be exempt or subject to final tax if earned directly.
- Understanding exemptions and special tax regimes (e.g., tax holidays, 5% GIE) is essential to correctly identify income subject to regular income tax.
Key terms
Regular Income TaxCompensation IncomeGross Income from BusinessOrdinary AssetsCapital AssetsInterest IncomeRental IncomeRoyalties (Active vs. Passive)DividendsAnnuitiesPrizes and WinningsPensionsGeneral Professional Partnership (GPP)Distributive Share
Test your understanding
- What are the primary categories of income subject to regular income tax discussed in the video?
- How does the tax treatment of gains from dealings in ordinary assets differ from those in capital assets?
- Under what conditions is interest income subject to regular income tax versus final tax?
- Explain the tax implications of advance rental payments received by a lessor.
- What criteria determine whether royalties are subject to regular income tax or final tax?
- How are dividends received from domestic versus foreign corporations taxed differently for individual recipients?
- Why are General Professional Partnerships considered pass-through entities for tax purposes?