EXCLUSION FROM GROSS INCOME EXCLUSION FROM GROSS INCOME, IN GENERAL Discuss briefly whether or not all income is taxable. (1988)
Not all income are taxable. Some incomes are excluded from gross incomes in the determination determinat ion of taxable income, and others are subject to tax exemptions. Exclusions from gross income distinguished from deductions from gross income. a) Exclusions from gross income refer to a flow of wealth to the taxpayer which are not treated as part of gross income for purposes of computing the taxpayer’s taxable income, due to the following reasons: reasons: 1) 2)
it
is it
exempted is
by
exempted
the fundamental by
statute;
law; and
3) it does not come within the definition of income (Sec. 61, Rev, Regs. No. 2), WHILE deductions are the amounts which the law allows to be subtracted from gross income in order to arrive at net income. b) Exclusions pertain to the computation of gross income, WHILE deductions to thecomputation thecomputati on of
net
income.
c) Exclusions are something received or earned by the taxpayer which do not form part of gross income, WHILE deductions are something spent or paid in earning gross income. An example of exclusion from gross income are life insurance proceeds, and an example of a deduction are ordinary and necessary expenses. Distinguish “Exclusion from Gross Income” from “Deductions from Gross Income”. Give an example of each. a) Exclusions from gross income refer to a flow of wealth to the taxpayer which are not treated as part of gross income for purposes of computing the taxpayer’s taxable income, due to the following reasons: reasons:
1) 2)
it
is it
exempted is
by
exempted
the fundamental by
statute;
law; and
3) it does not come within the definition of income (Sec. 61, Rev, Regs. No. 2), WHILE deductions are the amounts which the law allows to be subtracted from gross income in order to arrive at net income. b) Exclusions pertain to the computation of gross income, WHILE deductions to thecomputation of
net
income.
c) Exclusions are something received or earned by the taxpayer which do not form part of gross income, WHILE deductions are something spent or paid in earning gross income. An example of an exclusion is life insurance proceeds while an example of deduction is depreciation.
LIFE INSURANCE PROCEEDS “X” Corporation took a keymen insurance of the life of its President, Mr. Rodel Cruz. The policy designated Mr. Cruz’s wife as its revocable beneficiary in the event of death of Mr. Cruz. Will the insurance proceeds be treated as income subject to tax by the wife?(1980) No. Proceeds of life insurance policies paid to the beneficiary, in this case the wife, upon the death of the insured are excluded from gross income. [Sec. 32 (B) (1), NIRC of 1997]. The reason is that life insurance proceeds represents indemnity not income. Mr. X received the following income and you were asked to prepare his income tax return. Is he required to include as part of gross income the proceeds from a life insurance policy received from the estate of his deceased parents? Give your reasons. (1988) No. Life insurance proceeds are excluded from gross income. [Sec. 32 (B) {1}, NIRC of 1997], being compensation or indemnity for loss and not income.
RETURNED PREMIUMS
A took out a life insurance policy for P1,000,000.00 naming his wife as beneficiary. Under the terms of the policy, the insurer will pay A the amount of P1,000,000.00 after the 20th year of the policy, and his beneficiaries, should he died before that date. A outlived the policy and received
P1,000,000.00.
The
premiums
paid
on
the
policy
was
P250,000.00. Is the P1,000,000.00 received by A subject to tax? Explain your answer. (1978) No, not all of the P1,000,000.00 is subject to tax. The amount of P250,000.00 is not subject to tax because it is the amount received by A, as a return of the premiums paid by him under a life insurance contract at the maturity of the term mentioned in the contract. [Sec. 32 (B) (2), NIRC of 1997]. The premiums returned are not income but return of capital. They represent earnings which were previously taxed. On the other hand, the amount of P750,000.00 is subject to tax because it represents income being interest or earnings of the premium and not return of capital. (Ibid) Linus purchased a life annuity for P500,000 which will pay him P120,000 a year. The life expectancy of Linus is 12 years. Under Section 32 of NIRC of 1997, which of the following will Linus be able to exclude from his gross income: a.
P940,000
b.
P500,000
c.
P1,440,000
Choose one of the above answers and explain your choice. (1986) P500,000. the said amount represents a return of premiums paid by Linus which is not income but return of capital. They represent earnings which were previously taxed. [Sec (B) (2), NIRC of 1997] Born of a poor family on 14 February 1952, Mario worked his way through college. After working for more than 12 years in X Manufacturing Corporation, Mario decided to retire and avail of the benefits under the very reasonable retirement plan maintained by his employer. On the day of his retirement on 30 April 2002, his endowment insurance policy, for which he was paying an annual premium of P1,520 since 1982 also matured.
He was then paid the face value of his insurance policy in the amount of P50,000. Is his P50,000 insurance proceeds exempt from income taxation? (1991) Not all of the P50,000 would be exempt. Only the amount of P30,400 considered as a return of premiums would be exempt while the balance of P19,600 representing the interest or earnings of the premium would be subject to tax. The amount of P30,4000 represents a return of premiums paid by Marcelo which is not income but return of capital. They represent earnings which were previously taxed. [Sec.32 (B) (2), NIRC of 1997]
GIFTS, BEQUESTS AND DEVISES Explain whether or not the following taxpayer is subject to income tax on her described item received: Mrs. Y, wife of a deceased employee, received financial benefits voluntarily voted upon by the Board of Directors of the employer-company in recognition of her husband’s long and loyal service and primarily to help her meet financial needs. (1988) Mrs. Y is not subject to income tax on the financial benefits she received because there were no services rendered by Mrs. Y. It could not also be considered as income of the deceased employee because the giving was not in payment for services rendered. Since there was no consideration given, it is a gift and not income. Mr. Osorio, a bank executive, while paying golf with Mr. Perez, a manufacturing firm executive, mentioned to the latter that his (Osorio’s) bank had just opened a business relationship with a big foreign importer of goods which Perez’ company manufactures. Perez requested Osorio to introduce him to this foreign importer and put in a good word for him (Perez), which Osorio did. As a result, Perez was able to make a profitable business deal with the foreign importer. In gratitude, Perez, in behalf of his manufacturing firm, sent Osorio an expensive car as a gift. Osorio called Perez and told him that there was
really no obligation on the part of Perez or his company to give such expensive gift. But Perez insisted that Osorio keep the car. The company of Perez deducted the cost of the car as a business expenses. The Commissioner of Internal Revenue included the fair market value of the car as income of Osorio who protested that the car was a gift and therefore excluded from income. Who is correct, the Commissioner or Osorio? Mr. Osorio is correct. Where the taxpayer receives a car from a corporation for furnishing the names of potential customers, the same is a gift excluded from income taxation.(Duberstein v. Commissioner of Internal Revenue) Mr. Rodrigo, an 80-year old retired businessman, fell in love with a 20-year old Tetchie Sonora, a nightclub hospitality girl. Although she refused to marry him, she agreed to bbe his “live in” partner. In gratitude, Mr. Rodrigo transferred to her a condominium unit, where they both live, under a deed of salee for P10 million. Mr. Rodrigo paid the capital gains tax of 6% of P10 million. The Commissioner found that the property was transferred to Tetchie Sonora by Mr. Rodrigo because of the companionship she was providing him. Accordingly, the Commissioner made a determination that Sonora had compensation income of P10 million in the year the condominium was transferred to her and issued a tax deficiency income tax assessment. Tetchie Sonora protests the assessment and claims that the transfer of the condominium unit was a gift and therefore excluded from income. How will you rule on the protest of Tetchie Sonora? Explain. (1995) Protest granted. There was no legally demandable obligation on the part of Sonora to get the condominium unit. This is because there was no consideration she gave to Mr. Rodrigo in exchange for the condominium unit. The giving stemmed from a pure act of liberality on the part of Mr. Rodrigo which is a gift excluded from gross income.
X, a multinational corporation doing business in the Philippines, donated to Mr. Y, its resident manager in the Philippines. Assuming the shares of stock were given to Mr. Y in consideration of his services to the corporation, what is the tax implication? Explain. (1996) The value of the shares shall be taxable as a compensation income because it was paid as a result of employer-employee relationship.
COMPENSATION FOR INJURIES OR SICKNESS Are moral damages awarded a litigant for mental anguish on account of a libelous article written about him taxable as income or not? Why? (1964) Moral damages are taxable as income. Mental anguish is not physical injuries, therefore moral damages awarded due to moral anguish are not excluded from income. Amount received as a compensation for personal injuries plus amounts of any damages received on account of such injuries are excluded from taxable income if the personal injuries are physical in character. Exclusions from taxable income are considered as exemptions from taxation, hence to be interpreted in strictissimi juris against the taxpayer. The words “personal injuries” should be given a restrictive meaning to refer only to physical injuries. This interpretation finds basis in Sec. 32 (B) (4), NIRC of 1997 which refers to “Accident or Health Insurance or under Workmen’s Compensation Acts, both of which refers to “physical injuries or sickness”. This could only mean physical injuries. In a certain civil case, plaintiff was awarded damages by the court in the sum of P20,000 representing profit he failed to realize on account of defendant’s failure to comply with his obligation to said plaintiff. Are those damages taxable against him? (1967) Yes, because damages which are excluded from gross income are only those that paid as a result of injuries or sickness. Furthermore, since this is “unearned income” than he would have paid income taxes on the income if he was not previously deprived of such income. It is only just that upon recovery he should pay income taxes on the same.
An accident solely attributable to the criminal negligence of the driver of B Bus Company resulted in the death of X’s wife, physical injuries to X that prevented him from working for a month, and the total wreck of X’s brand new car which he had bought for P400,000. In the action for damages filed by X against B Bus Company, the court awarded the following; p30,000 for X’s injuries consisting mainly in the loss of his right hand; P25,000 for X’s loss of one month salary; P25,000 fo r the death of his wife and P100,000 moral damages on account of such loss; and P800,000 for the loss of X’s car, the value of which had in the meantime doubles on account of inflation. How would you treat each of the above items of damages for income tax purposes? Explain (1984) The amount of P30,000 for X’s injuries consisting in the loss of his right hand, P25,000 for the death of his wife, and the P100,000 moral damages arising from the death of X’s wife are all excluded from gross income. They represent amounts of damages received by suit as compensation for injuries. Consequently, such amounts are not considered income. [Sec. 32 (B) (4), NIRC of 1997] The P800,000 is partly taxable. The first P400,000 representing the value of the damaged car is not taxable because it is merely compensation or replacement of what X lost. Consequently, there is no income. The increase in value of the car in the amount of P400,000 is taxable income because it was a damage payment arising from the destruction of the car and not from the physical injuries arising from sickness or accident. The P25,000 award representing salary not earned as a result of the accident is taxable because it is merely a replacement of income that is taxable if earned. Exclusions are to be strictly construed as they constitute tax exemptions. The widow and children of a passenger who died in an airplane crash were paid P1,200,000 by the airline. This figure was reached after negoatiation between the heirs of the deceased and the insurer of the airline, the latter having received indubitable evidence that the deceased had a net income of P120,000 at the time of his death, and that 10 productive years would have
insured financial stability to his family. Should the heirs declare this amount in their income tax returns. State your answer. (1970) No, the amount of P1,200,000 should not be declared in the heir’s income tax returns. The amount represents damages received on account of personal injuries (which includes death) by agreement hence to be excluded from gross income. [Sec. 32 (B) (4) NIRC of 1997]. The reason for the exclusion is that the payment is mere compensation for injuries suffered and not income. Furthermore, the amounts were not existing at the time of the death of the decedent. Patroclus was injured in a vehicular accident in 1999. He incurred and paid medical expenses of P10,000 and legal fees of P5,000 during the year. In 2002, he recovered P35,000 as settlement from the insurance company which insured the car owned by the other party involved in the accident. From the above payments and transactions, the amount taxable to Patroclus
in
20002
is:
a.
P20,000
b.
P25,000
c.
P30,000
d.
P35,000
e.
None
of
the
above.
Choose one of the above answers and give reasons for your choice. (1986) None of the above. All of the recovered amounts are not income because they are merely compensation for actual losses suffered. They do not constitute taxable gain as they were not received as payment for services, interest or profit from investment. Mr. Infante was hit by a wayward bus while on his way to work. He survived but had to pay P400,000 for his hospitalization. He was unable to work for six (6) months which meant that he did not receive his usual salary of P10,000 a month or a total of P60,000. He sued the bus company and was able to obtain a final judgment awarding him P400,000 as reimbursement for his hospitalization, p60,000 for the salaries he failed to receive while hospitalized, P200,000 as moral damages for his pain and suffering, and P100,000 as exemplary damages. He was able to collect in full from the judgment.
How much income did he realize when he collected on the judgment? Explain. (1995) P60,000 because this amount is merely a replacement of income which should have been subjected to tax if earned. All of the other receipts are excluded from gross income. They represent amounts of damages received by suit as compensation for injuries. Consequently, such amount are considered as income. [Sec. 32 (B) (4), NIRC of 1997]
RETIREMENT BENEFITS, GRATUITIES, PENSION, ETC RSV was retired by his employer corporation in 1997 and paid P100,000 as a retirement gratuity without any deduction of withholding tax. The corporation subsequently became bankrupt. Can the BIR subject the P100,000 retirement gratuity to income tax? Discuss. No. It is clear that “RSV was retired by his employer xxx.” The only conclusion that could be drawn is that he was separated beyond his control. Thus, the retirement gratuity he received is excluded from gross income and not subject to income tax. Romulus, 48 years of age and a retired employee had among his properties and transactions at the end of the 1998 taxable year: Retirement benefits in the amount of P200,000.00 received by him in 2002 under a qualified retirement plan maintained by his former employer company. Romulus voluntarily retired after 20 years of service. Is the above item subject to the regular tax rates found in the schedule under Section 24 (A) of the NIRC, which states that the tax rates on citizens and residents? Explain your answer. Yes, because it is not among excluded incomes. There is no showing that Romulus retirement was compulsory, hence it could not be said that his separation was beyond his control. The amount of P200,000.00 could not also be considered as tax-exempt retirement because Romulus is only 48 years which is below 50 years. Neither is there a
statement in the facts that he has worked for the same employer for at least ten (10) years or that he has not previously enjoyed tax-free retirement benefits. Explain whether or not the following taxpayer is subject to the income tax on the described item received: Retiree from AG&P receiving retirement benefits from the company retirement plan, qualified by the BIR. (1988) The retirement benefits would be subject to tax because there is no showing that the retiree is a qualified tax-free retiree. The problem does not show that the retiree is above 50 years, that he has served his employer for more than 10 years and that he has not previously
availed
of
tax-free
retirement.
Furthermore, there is no showing that the separation through retirement wass beyond the retiree’s control. “A” worked for “Z” from 1970 to 2002. Beginning 2003 “A’s” employment was terminated as he could no longer perform his duties. “A” was informed by “Z” that he will get a pension of P5,000.00 a month for the rest of his life. “Z” has neither standardized pension plan nor a qualified pension plan. “A’s” pension was paid from “Z’s” operating revenues and “Z” deducted the payments as necessary and ordinary business expense. On the part of “A”, must he treat his pension as income? Reasons. (1989) No, because they are amounts received by “A” from his employer as a consequence of his termination from the service for a cause beyond his control. The pension is excluded from gross income. Born of a poor family on 14 February 1954, Mario worked his way through college. After working for more than 12 years in X Manufacturing Corporation, Mario decided to retire and avail of the benefits under the very reasonable retirement plan maintained by his employer. On the day of his retirement on 30 April 2002 he received P400,000.00 as retirement benefit. Is Mario’s P400,000.00 retirement benefit subject to income tax?
Yes. Mario’s retirement benefits are subject to income tax as he was only 48 years old at the time of his retirement. For retirement to be excluded from gross income, hence not subject to tax, the retiree must be above 50 years. Pedro Reyes, an official of Corporation X, asked for an “earlier retirement because he was emigrating to Australia. He was paid P2,000,000.00 as separation pay in recognition of his valuable services to the corporation. Juan Cruz, another official of the same company, was separated for occupying a redundant position. He was given P500,000.00 as separation pay. Jose Bautista was separated due to his failing eyesight. He was given P500,000.00 as separation pay. All the three (3) were not qualified to retire under the BIR-approved pension
plan
of
the
corporation.
a) Is the separation pay given to Reyes subject to income tax? b)
How
about
the
separation
pay
received
by
Cruz?
c) How about the separation pay received by Bautista? (1994) a) Yes. The voluntary action on the part of Pedro Reyes, is not considered as a cause beyond his control, the separation is not excluded from gross income. It is included for tax purposes. He does not qualify for tax-free retirement because there is no showing that he is 50 years or over, that he has rendered at least 10 years of service with Corporation X, and that he has not previously availed of the tax-free retirement. b) No, because Cruz was separated for a reason beyond his control as a result of redundancy. c) No. The separation pay received by Bautista was due to his failing eyesight, a cause beyond his control. Mr. Jacobo worked for a manufacturing firm. Due to this business reverses the firm offered a voluntary redundancy program in order to reduce overhead expenses. Under the program, an employee who offered to resign would be given separation pay equivalent to his three months’ basic salary for every year of service. Mr. Jacobo accepted the offer and received P400,000.00 as separation pay under the program.
After all the employees who accepted the offer were paid, the firm found its overhead still excessive. Hence, it adopted another redundancy program. Various unprofitable departments were closed. As a result, Mr. Kintanar was separated from the service. He also received P400,000.00 as separation pay. a) Did Mr. Jacobo derive income when he received his separation pay? Explain. b) Did Mr. Kintanar derive income when he received his separation pay? Explain. (1995) a) Yes. Mr. Jacobo voluntarily resigned hence the separation pay he received, not being for a cause beyond his control, is not excluded from gross income. Furthermore, the separation pay is not also considered as tax-free retirement because there is no showing that he is 50 years or over, that he has rendered at least 10 years service with his employer,
and
he
has
not
previously
availed
of
the
tax-free
retirement.
b) No, because Mr. Kintanar was separated for a reason beyond his control which is redundancy. The amount he received is excluded from gross income, hence, not taxable. Mr. Quiroz worked as chief accountant of a hospital for forty-five years. When he retired at 65, he received a retirement pay equivalent to two months salary for every year of service as provided in the hospital’s retirement plan in view of his loyalty and invaluable services for forty-five years; hence, it resolved to pay him a gratuity of P1 million over and above his retirement pay. The Commissioner of the Internal Revenue taxed the P1 million as part of the gross compensation income of Quiroz who protested that it was all excluded from income because (a) it was retirement pay and (b) it was a gift. a) Is Mr. Quiroz correct in claiming that the additional P1 million was retirement
pay
and
therefore
excluded
from
income?
Explain.
b) Is Mr. Quiroz correct in claiming that the additional P1 million was a gift and therefore excluded from income? Explain. (1995)
a) No, because the P1 million was beyond the amount paid from the reasonable retirement
plan.
b) Yes. The P1 million was given on the basis of the pure act of liberality on the part of the hospital. There was no obligation on the part of the hospital to give the amount. X, an employee of ABC Corporation, died. ABC Corporation gave X’s widow an amount equivalent to X’s salary for one year. Is the amount considered taxable income to the widow? Why? (1996) The amount given is not considered taxable income to the widow because it is among the exclusions from gross income. The amount received by the heirs of an employee as a consequence of separation of such employee from the service of the employer because of death is excluded from gross income. The money given to X’s heir, his widow because of X’s death the amount is not income. (Sec. 32 (B) (6) (b), NIRC of 1997) A Co., a Philippine corporation, has two divisions- manufacturing and construction. Due to the economic situation, it had to close its construction division and lay-off the employees in that division. A Co., has a retirement plan approved by the BIR, which requires a minimum of 50 years of age and 10 years of service in the same employer at the time of retirement. There
are
2
groups
of
employees
to
be
laid
off:
(a) Employees who are at least 50 years of age and has 10 years of service at the
time
of
termination
of
employment.
(b) Employees who do not meet either the age or length of service A Co., plans to give the following: For category (A) employees – the benefits under the BIR approved plan plus an ex gratia payment of one month for every year of service. For category (B) employees – one month for every year of service. A Co., seeks your advice as to whether or not it will subject any of these payments to WT. Explain your advice. (1999)
The payments should not be subject to withholding tax (WT). The separation, due to the economic situation, is one which is beyond the employees control, hence excluded from gross income and not subject to income taxation. To start a business of his own, Mr. Mario de Guzman opted for an early retirement from a private company after ten (10) years of service. Pursuant to the company’s qualified and app roved private retirement benefit plan, he was paid his retirement benefit which was subjected to withholding tax. a)
Is
the
employer
correct
in
withholding
the
tax?
Explain.
b) Under what conditions are retirement benefits received by officials and employees of private firms excluded from gross income and exempt from taxation? (2000) a) Yes. Mario is not entitled to a tax-free retirement because he has not complied with the requirements, specifically the absence of showing that he is at least fifty 50) ears of age at the time of retirement and that he has not previously availed of the tax-free retirement. b) Retirement benefits received under Republic Act No. 7614 and those received by officials and employees of private firms, whether, individual or corporate, in accordance with employer’s reasonable private benefit plan approved by the BIR, are excluded from gross income and exempt from income taxation if the retiring official or employee was: 1)
In
2)
Not
service less
of than
same fifty
employer (50)
years
for of
at age
least at
ten
time
(10) of
years.
retirement;
3) Availed of the benefit of exclusion only once. [Sec. 32 (B) (6) (a), NIRC of 1997] The retiring official or employee should not have previously availed of the privilege under the retirement plan of the same or another employer. [1st par., Sec. 2.78 (B) (1), Rev. Regs. 2-98] Maribel Santos, a retired public school teacher, relies on her pension form the GSIS and the interest income from a time deposit of P500,000.00 with ABC Bank. Is Miss Santos liable to pay any tax on her income? (1994)
Her pension is not subject to tax as it is an exclusion from income. The interest from the time deposit is subject to the final tax of 20% as passive income. Mr. Javier is a non-resident senior citizen. He receives a monthly pension from the GSIS, which he deposits with the PNB-Makati Branch. Is he exempt from income tax and therefore not required to file an income tax return? (2000) Yes. Mr. Javier does not have any income which is required to be reported in the income tax return. His pension is not subject to tax as it is an exclusion from income. The interest form the time deposit is subject to the final tax of 20% as passive income, and therefore not required to report in an income tax return.
MISCELLANEOUS ITEMS EXCLUDED FROM GROSS INCOME Evelyn is a graduate student of U.P. In January, 2002, she won the Palanca Award for an outstanding short story she wrote. The award was P25,000.00 in cash. In February, 2002, she was also named most Valuable Player of the Varsity Volleyball Team and she was given a trophy plus P10,000.00. Finally, in March, 2002, she received a Fellowship Award from the University of California to pursue a master’s degree in American Literature. The fellowship is for $10,000.00 plus free board and lodging fro two (2) semesters. Should Evelyn include these awards and fellowship in her gross income? Reasons. (1993) All of the awards and monetary value of her fellowship are excluded from her gross income. The awards were made primarily in recognition of her educational and literary achievements. There is no showing in the problem that Evelyn was selected due to any action on her part to join the contest. And that she is required to render substantial future services as a condition to receiving the prize or award. [Sec. 32 (B) (7) (c), NIRC of 1997] Jose Miranda, a young artist and designer, received a prize of P100,000.00 fro winning in the on-the-spot peace poster contest sponsored by a local
Lions Club. Shall the award be included in the gross income of the recipient for tax purposes? Explain. (2000) Yes. It is apparent from the nature of an on-the-spot poster contest that there was action on the participant’s part to enter the contest. [Sec. 32 (B) (7) (c), NIRC of 1997], hence the prize is not excluded from income taxation. Onyok, an amateur boxer, won in a boxing competition sponsored by the Gold Cup Boxing Council, a sports association duly accredited by the Philippine Boxing Association. Onyok received the amount of P500,000 as his prize which was donated by Ayala Land Corporation. The BIR tries to collect income tax on the amount received by Onyok who refuses to pay. Decide. (1996) The P50,000 prize is subject to tax. The prize was granted to Onyok, an athlete, in a local or international sport tournament, but there is no showing in the problem that the Philippine Boxing Association, is the national sports associations for boxing duly accredited by the Philippine Olympic Committee. (Sec. 32 (B) (7) (d), NIRC of 1997) In June 2002, the Sangguniang Bayan authorized a mid-year bonus of P3,000, a cash gift of P5,000 and transportation and representation allowance
of
a.
the
b.
Is
How
P6,000
for
midyear
each
of
bonus
about
the
municipal
subject the
to cash
employees. any
tax? gift?
c. How about the transportation and representation allowance? Since the total amounts do not exceed P30,000 for the year, then they are excluded from gross income. (Sec. 32 (B) (7) (e), NIRC of 1997)
