Theory of Income Taxation

What is taxation?
It is the inherent power by which the sovereign state imposes financial burden upon
persons and property as a means of raising revenues in order to defray the necessary expenses of
the government.
Taxation is the imposition of the financial charges or other levies, upon a taxpayer (an
individual or legal entity) by a state such that failure to pay is punishable by law.
What is income taxation?
It is a government tax imposed on individuals or entities (taxpayers) that varies with the
income or profits (taxable income) of the taxpayer. It is generally computed as the product of tax
rate and taxable income.
Requisites for income to be taxable
1. There must be a gain or profit.
2. The gain must be realized or received.
3. The gain must not be excluded by law or treaty from taxation.
Why is it important?
Its primary purpose is to generate funds to defray expenses incurred by the government in
promoting the general welfare of its citizenry.
It also aims to equitably contribute to the wealth of the nation, protect the new industries,
and protect local producers.
Theory

The existence of the government is a necessity.

The government cannot continue without a means to pay its expenses.

The government has the rights to compel its citizens and property within its limits to
contribute.

Development of the community tax

Cedula was imposed by the Americans on January 1, 1940, when Commonwealth Act No.
465 went to effect, mandating the imposition of a base residence tax of fifty centavos and an
additional tax of one peso based on factors such as income and real estate holdings.
The payment of this tax would merit the issue of a residence certificate. Corporations were
also subject to residence tax.
The four Rs of Taxation

Revenue - the taxes raise money to spend on armies, roads, schools, hospitals, and on
more indirect government functions like market regulation or legal system.

Redistribution - this refers to the transferring wealth from the richer sections of society to
poorer sections.

Repricing - taxes are leveid to address externalities; for example, tobacco is taxed to
discourage smoking, and a carbon tax discourages use of carbon-based fuels.

Representation - rulers tax citizens, and citizens demand accountability from their rulers as
the other part of this bargain.

The Philippine Tax System

Tax law in the Philippines covers national and local taxes. National taxes refer to national internal
revenue taxes imposed and collected by the national government through the Bureau of Internal
Revenue (BIR) and local taxes refer to those imposed and collected by the local government. The
1987 Philippine Constitute sets limitations on the exercise of the power to tax. The rule of
taxation shall be uniform and equitable. The Congress shall evolve a progressive system of
taxation. (Article VI, Section 28, Paragraph 1).
Tax Evasion
Tax evasion happens when there is fraud through pretension and the use of other illegal devices
to lessen ones taxes, there is tax evasion, under-declaration of income, and non-declaration of
income and other items subject to tax, Under-appraisal of goods subject to tariff, and overdeclaration of deductions
The Forms of Taxes Imposed on Persons and Property
A) Personal, capitation or poll taxes
These are taxes of fixed amount upon residents or persons of a certain class without
regard to their property or business.
B) Property taxes
1. Real Property Tax
-An annual tax that may be imposed by a province or city or a municipality on
real property such as land, building, machinery and other improvements affixed or
attached to real property.
2. Estate Tax (Inheritance Tax)
-a tax on the right of transmitting property at the time of death and on the
privilege that a person is given in controlling to a certain extent the disposition of his
property to take effect upon death.
3. Gift or Donors Tax
-a tax on the privilege of transmitting ones property or property rights to
another or others without adequate and full valuable consideration.
4. Capital Gains Tax
-Tax imposed on the sale or exchange of property. Those imposed are
presumed to have been realized be the seller for the sale, exchange or other
disposition of real property located in the Philippines, classified as capital assets.
C) Income taxes
A tax imposed on the income of the taxpayers from whatever sources it is derived.
Tax on all yearly profits arising from property, possessions, trades or offices.
D) Excise or License Taxes
Taxes imposed on the privilege, occupation or business not falling within the
classification of poll taxes or property taxes. These are imposed on alcohol products; on
tobacco products; on petroleum products like lubricating oils, grease, processed gas etc; on
mineral products such as coal and coke and quarry resources; on miscellaneous articles
such as automobiles.
Other Taxes:
1. Documentary Stamp Tax
- A tax imposed upon documents, instruments, loan agreements and papers
and upon acceptance of assignments, sales and transfers of obligation and
etc.
2. Value Added Tax

Is imposed on any person who, in the course of trade or business sells,

barters, exchanges, leases, goods or properties, renders services, or
engages in similar transactions.

Comprehensive Income: The Haig-Simons Definition

In an economic sense, income is usually viewed as a measure of a persons power to purchase

goods and services in a given year. As defined by Henry Simons, income is an indicator of the
exercise of control over the use of societys scarce resources. Income can be spent, thereby
converting purchasing power into consumption, or it can be stored for future use.

All individuals who earn income, regardless of age or the amount of income earned will be
subject to the tax. No separate tax on business income is necessary.
The income of an individual is usually specified per year

Income-in-kind
- is income in the form of goods and services rather than cash payments. This often results from
home production of goods and services. People provide themselves with services rather than
purchasing those goods and services from others in markets.
Who Should Pay Taxes?
1. Individuals
a) Resident Citizen
b) Non-resident Citizen
c) Resident Aliens
d) Non-resident aliens
2. Corporations
a) Domestic Corporations
b) Foreign Corporations
3. Estate under judicial settlement
4. Trusts irrevocable both as to the trust property and as to the income.
Who (or What) are those exempted in paying taxes?
The Constitution expressly grants tax exemption on certain entities/institutions such as:
1.
Charitable institutions, churches, parsonages or convents appurtenant thereto, mosques,
and nonprofit cemeteries and all lands, buildings and improvements actually, directly and
exclusively used for religious, charitable or educational purposes (Article VI, Section 28,
Paragraph 3).
1. Non-stock non-profit educational institutions used actually, directly, and exclusively for
educational purposes. (Article XVI, Section 4 (3)).
Exempted to tax as stated in the Article 283 of Rules and Regulations Implementing
Local Government Code of 1991 (RA 7160):

Local water districts

Cooperative duly registered under RA 6938, otherwise known as the Cooperative Code
of the Philippines

Non-stock and non-profit hospitals and educational institutions

Printer and/or publisher of books or other reading materials prescribed by DECS (now
DepEd) as school texts or references insofar as receipts from the printing and/or
publishing thereof are concerned.

TAXATION OF PERSONAL INCOME

Gross Income refers to All gains, profits, and income, except income subject to final tax, derived
during a taxable year by a taxpayer from whatever source, whether legal or illegal, and in
whatever form (money, property, or services), including (but not limited to) the following items:
1. Compensation for services, in whatever form paid, including but not limited to fees,
salaries, wages, commissions and similar items;
2. Gross income derived from the conduct of trade or business, or the exercise of a profession;
3. Gains derived from dealings in property;
4. Interests;
5. Rents;
6. Royalties;
7. Dividends;
8. Annuities;
9. Prizes and winnings;
10.Pensions; and
11.Partners distributive share from the net income of a general professional partnership.
Taxable Income is the amount or tax base upon which the tax rate prescribed by law is to be
applied. Depending upon the class of taxpayer, it may refer to gross income or net income.
Under the Tax Code, the term means the pertinent items of gross income specified in the Tax
Code less the deductions and/or personal and additional exemptions if any, authorized for such
types of income by the Code or other special laws.

Classification of Individual Taxpayer:

A. Citizens of the Philippines who may be:
1. Resident citizens. those residing in the Philippines;
or
1. Non-resident citizens. those not residing in the Philippines.
B. Aliens or foreigners who are divided into:

1. Resident aliens. those residing in the Philippines;

and
1. Non-resident aliens. those not residing in the Philippines and they are either:
a. Those engaged in trade or business in the Philippines;
b. Those not engaged in trade or business in the Philippines.

Tax Rate Structure

Tax Rate is the percentage at which an individual or corporation is taxed. The tax rate is the tax
imposed by the state based on an individual's taxable income or a corporation's earnings. The
Philippines uses a progressive tax rate system, where the percentage of tax increases as taxable
income.
The progressive scheme of income taxation has been introduced in our tax system as a measure
of raising more revenues to meet adequately the increased needs of the government and at the
same time correcting inequalities in taxation by equitably distributing the tax burden based upon
the principle of ability to pay.
Tax Bracket is a range of income subject to a given marginal tax rate. Tax brackets are set based
on income levels; individuals with lower income are taxed at a lower rate than those with higher
income levels. Tax brackets serve as cutoff for given income tax rates.
Taxable Income (Php)

Tax rate

0 - 10,000

5%

10,000 - 30,000

P500 + 10% of the excess over P10,000

30,000 - 70,000

P2,500 + 15% of the excess over P30,000

70,000 - 140,000

P8,500 + 20% of the excess over P70,000

140,000 - 250,000

P22,500 + 25% of the excess over P140,000

250,000 - 500,000

P50,000 + 30% of the excess over P250,000

Over 500,000

P125,000 + 32% of the excess over P500,000

Minimum wage earners are exempt from the payment of income.

Computation of Tax

If pure compensation income

Gross income (all sources)
Less: premium payments
.
= Net income from all sources
Less: Personal & additional exemptions
= Taxable compensation income
Multiplied by : tax rate
.
= income tax payable
For business and/or professional income
Gross income (all sources)
Less: allowable (itemized) deductions or 40% OSD
= Net income from all sources

Less: Personal & additional exemptions

= Taxable compensation income
Multiplied by : tax rate.
.
= income tax payable

Deductions from Gross Income

Deductions are items or amounts which the law allows to be deducted from the gross income of
a taxpayer in order to arrive at taxable income.
A taxpayer has the right to deduct all authorized allowances for the taxable year. If he does not
within any year deduct certain of his expenses, losses, interest, taxes or other charges, he cannot
deduct them from the income of the next or any succeeding year.
Kinds of Deductions
1. Deductions from compensation income of individual taxpayers - only personal and
additional

exemptions

and,

if

applicable,

premium

payments

on

health

and/or

hospitalization insurance of individual taxpayer. An individual taxpayer is not allowed to

elect an optional standard deduction (OSD) of his income.
2. Deductions from business and/or professional income - may deduct the itemized
deductions or claim the 40% OSD from his gross sales.
3. Deductions from corporate income - may also claim itemized deductions. And if subject
to tax under section 27(A) & 28(A) of tax code they may elect an OSD.
4. Special deductions - additional deductions allowed.
Itemized Deductions (Section 34)
A. Expenses B. Interest

C. Taxes

D. Losses

E. Bad DebtsF. Depreciation

G. Depletion of Oil and Gas Wells and Mines H. Charitable and Other Contributions
I. Research and Developments

J. Pension Trusts

Optional Standard Deduction (OSD)

Exemptions on Gross Income

Personal Exemptions are fixed amounts allowed, in the nature of a deduction from the amount
of gross compensation income and/or net business and/or professional income, as the case may
be, for personal, living or family expenses of an individual taxpayer.
The allowance for personal exemptions is based essentially on the economic and political grounds
that persons whose income is small should be exempted from income taxation. It is consistent
with the principle that the burden of income taxation should be adjusted according to capacity to
pay. For obvious reasons, a married taxpayer with dependents is entitled to a higher exemption
from tax than a single person. Exemption from tax should be weighed in proportion to the number
of dependents of the taxpayer.
A.

Basic Personal Exemption Each individual taxpayer is allowed a basic personal exemption of
P50,000.

B.

Additional Exemption There is allowed an additional exemption of P25,000 for each

dependent not exceeding four (4). The additional exemption for dependents shall be claimed
by only one spouses in case of married individuals.

The following are requisites of a dependent:

1. The child is

Legitimate. one born during marriage; or

Illegitimate. one born outside a valid marriage; or

Legally adopted. one who has been legally adopted through an order of a court;
and

2. The child is

Living with a taxpayer;

Chiefly dependent upon the taxpayer for support;

Not more than 21 years of age (except in the year the child attained the age of 21)

Not married; and

Not gainfully employed or incapable of self-support because of mental or physical

defect even if over 21 years of age.

Exemptions as affected by change of status:

1. If the taxpayer marries during the taxable year, he may claim the personal exemption in full as a
married person for such year.
Ex.: A single individual who marries, say on December 31, is considered a married person in that
year and thus is entitled to a personal exemption. Note: Each individual taxpayer without distinction,
is now entitled to a personal exemption of P50,000.
2. If the taxpayer should have additional dependent during the year, he may claim the additional
exemptions in full for such year.
Ex.: A childless married couple who were blessed with a child during the year say, on December 25,
may claim an additional exemption of P25,000 for the year.
3. If the taxpayer dies during the taxable year, his estate may still claim the personal and additional
exemptions for himself and his dependents, as if he died at the close of such year.
Ex.: The estate of a married taxpayer, with two (2) dependent children, who dies during the year,
say on January 1, is still entitled to claim a total exemption of P100,000.
4. If the spouse or any of the dependents dies during the taxable year, the taxpayer may still claim the
same exemptions as if he died at the close of such year.
Ex.: A married taxpayer whose only dependent child dies during the year, say in May, still get a total
exemption of P75,000. However, in the succeeding year, he gets only a personal exemption of
P50,000.
5. If any of the dependents become 21 years old during the taxable year, the taxpayer may still claim
the same exemption as if such dependent became 21 years old at the close of such year.
Ex.: A married taxpayer whose only dependent child became 21 years old still gets an additional
exemption of P25,000for such child. Next year, however, the child is no longer a dependent for being
over age.