Income Taxation Valencia Roxas Tax Chapter 4: Gross Income

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

CHAPTER 4

GROSS INCOME Problem 4 – 1 TRUE OR FALSE 1. True 2. True 3. True 4. False – cost of living allowance is part of a taxable compensation income. 5. True 6. False – Religious officer’s income is subject to income tax. 7. True 8. True 9. False , income of debtor = amount of debt settled 10. False – transportation allowance pre-computed on a daily basis is not subject to tax. 11. False – there is no income because the actual expenses is greater than the advances. 12. True 13. False, the rule on MCIT is being described. 14. True 15. True Problem 4 – 2 TRUE OR FALSE 1. False – tips are taxable because there is no law exempting it from income tax. 2. True 3. False – Not income but a liability in compliance with the trading business rule. 4. False – Under service business, advances from clients are to be reported as income. Include as income because the advanced rental is without restriction. 5. True 6. True 7. False – because estimated bad debts is not allowed to be deducted from gross business income. 8. True 9. False – Not an option to report, but required to report. 10. False – the return of premium from insurance company is not taxable. 11. True 12. False – income should be realized to be taxable. 13. True 14. False – As a rule, income obtained illegally is taxable. 15. False – As a rule, income received by error is reportable income.

Problem 4 – 3 TRUE OR FALSE

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

1.

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

False – This tax-exemption is granted only to public employees and applicable to accumulated monetized vacation and sick leave credits. False – Only 13th month pay is nontaxable within P30,000 ceiling. True False – proceeds of life insurance due to death is nontaxable regardless of who is the beneficiary. False – as a rule board and loading furnished by an employer is taxable, except when it applies to employer’s benefit rule. True False – not taxable income because the dividend received is still stock though different in class. True True True False – The rule of P10,000 and below applies to prizes not winnings. False – Only damages resulting from injuries is nontaxable. True False – this rule applies to winnings. Prizes amounting to P10,000 and below is subject to normal tax. True

Problem 4 – 4 TRUE OR FALSE 1. True 2. True 3. False – Income from profession 4. True 5. True 6. False – Only those employees who can meet the requisites are exempt from income tax even if the retirement plan is BIR approved. 7. True 8. False – Not taxable. 9. False – Overtime pay of MWE is nontaxable. 10. True 11. True 12. False – Interest expense of a bank is treated as part of cost of service. 13. False – Advance collection of rent income is taxable. 14. False – All earnings of a resident Filipino citizen from all sources are taxable in the Philippines. 15. False – Subject to a normal tax of 30% because such interest income is a normal operating income of the bank.

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

Problem 4 – 5 1. D 2. C 3. C 4. A 5. D 6. D 7. A 8. B 9. A 10. B

Problem 4 – 6 1. D 2. B 3. D 4. B 5. A 6. B 7. C 8. A 9. C 10. D

Problem 4 – 8 A Net take home pay Add: Withholding income tax Total Less: 13th month pay Gross reportable compensation

Problem 4 – 7 1. D 2. C 3. B 4. C 5. A 6. B 7. D 8. B 9. D 10. C P180,000 30,000 P210,000 10,000 P200,000

Unused 10-day vacation leave is nontaxable if it is converted into cash (Rev. Regs. No. 102008; BIR Ruling No. 93-34). In the above problem, the 10-day vacation leave was actually availed; hence, taxable. Problem 4 – 9 D Salary (P370,000 + P50,000) Per diem as a board of director Taxable thirteenth month pay (P35,000 – P5,000) Gross taxable compensation income

P420,000 200,000 5,000 P625,000

Problem 4 – 10 B Salary Overtime pay 13th month pay and other bonuses Total compensation income

P150,000 30,000 15,000 P195,000

Problem 4 – 11 B Salary Tips Cost and living allowance Total taxable compensation income

P120,000 360,000 5,000 P485,000

Note: New BIR interpretation provides that the 13th month pay and other benefits amounting to P30,000 and below is not taxable. Since the 13 th month pay is only P10,000, the P20,000 achievement awards being part of de-minimis can be used as other benefits, to complete the P30,000 nontaxable threshold.

Problem 4 – 12

C

Salary (P120,000 + P24,000) Overtime pay

P144,000 36,000

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

Payment of services (P4,000 + P30,000) Present value of non-interest bearing notes (P30,000 x 0.909) Reportable taxable income per ITR

34,000 27,270 P241,270

In general, interest income is subject to final tax; hence not to be reported in the ITR. Non-interest bearing note is to be reported at its discounted value when received. (Sec. 2.78.1, Rev. Reg. No. 2-98) Problem 4 – 13 D (First employment for 30 years received at the age of 50)

P500,000

Aside from the requirement that the plan should be reasonable, the Tax Code requires that the retiring employee should have been in the service of the same employer for at least ten years and is not less than fifty years of age at the time of his retirement. The taxpayer should not also have previously availed of the privilege under a retirement benefit plan for the same or another employer.)

Problem 4 – 14 First employment – resigned

B P300,000

Problem 4 – 15 C Gross compensation income (1,000 x P10) Problem 4 – 16

B

Compensation income (P13 – P12) x 10,000 Capital gain (P15 – P13) x 10,000 Problem 4 – 17

P10,000

Compensation P 10,000

Capital gain P 20,000

C

Compensation income (P25 – P23) x 10,000 Capital gain (P30 – P25) x 10,000

Compensation P 20,000

Capital gain P 50,000

Correction: The option was exercised and sold in year 200C when the market price was P30. Problem 4 – 18 C Regular compensation per month Cancellation of indebtedness (P300,000 – P275,000) Total compensation income – December 200B Problem 4 – 19 B Insurance premium – beneficiary Sico Problem 4 – 20 A Basic compensation (P30,000 x 12) Shares of stock (P100 x 100) Stock option (P120 – P80) x 100 Annual insurance premium (P4,000 x 50%) Gross compensation Problem 4 – 21 B Cleaning of business equipment Repair service of store

P 50,000 25,000 P75,000 P5,000 P360,000 10,000 4,000 2,000 P376,000 P 1,000 3,000

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

Total casual service income

P 4,000

Problem 4 – 22 C Total purchases Transportation cost on purchases Unsold goods Cost of goods sold Problem 4 – 23 Inventory, beginning Purchases Purchase discounts Purchase returns Transportation in Inventory end Cost of sale

C

Problem 4 – 24

C

P500,000 5,000 ( 40,000) P465,000 P 20,000 1,200,000 ( 10,000) ( 40,000) 5,000 ( 50,000) P1,125,000 Year 1

Inventory, beginning Inventory, ending Purchases Freight – in Purchase discount Cost of sales

(P50,000) 850,000 10,000 ( 20,000) P790,000

Problem 4 – 25 B Sales Sales returns Net sales Less: Cost of goods manufactured and sold Purchases – raw materials Freight-in Raw materials, ending inventory Raw materials used Direct labor Factory overhead Total manufacturing cost Work-in-process, ending inventory Finished goods, ending inventory Gross business income Problem 4 – 26 Advance payment Additional collection Office machine Gross service income

Year 2 P 50,000 ( 30,000) 900,000 15,000 ( 25,000) P910,000 P1,275,000 ( 25,000) P1,250,000

P 540,000 20,000 ( 10,000) P 550,000 400,000 200,000 P1,150,000 ( 100,000) ( 50,000)

1,000,000 P 250,000

B

Problem 4 – 27 B Professional fee, accounting services Less: Direct costs of services: Salaries of accounting staff Accounting supplies Gross business income for MCIT purposes*

P 2,000 8,000 3,000 P13,000 P500,000 P150,000 10,000

160,000 P340,000

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

Correction: The requirement should qualify that the gross business income is for MCIT purposes. Problem 4 – 28 B Interest income from clients Trading gain Less: Cost of services: Lending and investments funds salaries Interest expenses paid to depositors Gross income for MCIT purposes Problem 4 – 29

P50,000,000 10,000,000 P3,000,000 2,000,000

5,000,000 P55,000,000

C

Interest income from clients Gain on sale of capital assets Rent income Total Less: Cost of services: Salaries of bank employees assigned in lending and investments of funds Depreciation of computers and teller machines used Direct supplies used Interest expense paid to depositors Gross income for MCIT purposes

P10,000,000 5,000,000 2,000,000 P17,000,000 P3,700,000 600,000 200,000 1,500,000

6,000,000 P11,000,000

Problem 4 – 30 B Service charges: Originating from the Philippines Collection abroad of collect messages originating in the Philippines Gross income for Philippine Income Tax computation

P 150,000 60,000 P 210,000

Problem 4 – 31 B Rent for year: 200A 200B 200C 200B Reportable income

P 80,000 480,000 40,000 P 600,000

Problem 4 – 32

1 .

Letter C Advanced deposit Monthly rental (P20,000 x 10 months)

P 40,000 200,000

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

Annual insurance premium to be paid by the lessee (P6,000 x 10/12) Portion of real estate tax to be paid by the lessee (P3,000 x 10/12) Rent income

5,000 2,500 P247,500

As a general rule, pre-collection of rental is taxable in full to the lessor when received regardless of accounting method used. 2 .

Letter B Monthly rental (P20,000 x 10 months) Annual insurance premium to be paid by the lessee (P6,000 x 10/12) Portion of real estate tax to be paid by the lessee (P3,000 x 10/12) Rent income Commission income (P2,000,000 x 5%) Reportable taxable income

Problem 4 – 33

P200,000 5,000 2,500 P207,500 100,000 P307,500

D

Year 1 Outright method Year 1 Spread-out method Value of investment Less: Accum. depreciation [(P240,500 - P560)/8 yrs] x 4.75 yrs

Outright P240,500

P240,500.00 142,464.3 7 P 98,035.63 4.7 5 P 20,639 9/12 P 15,479

Book value, end of lease Divided by remaining years of contract Annual income from improvement Multiplied by months in a year Year 1 spread-out – rent income on improvement Problem 4 – 34

Spread-out

C Outright P180,000

Outright Spread-out

Spread-out P - 0 -

For spread out method, there is no reportable income from leasehold improvement for year 200B because the said improvement was completed at the end of the year.

Problem 4 – 35

C

Cost of improvement Less: Accumulated depreciation at the end of the lease (P300,000/6) x 4 years and 7 months Book value at the end of the lease Divided by number of years until the termination of lease contract = 4 years and 7 months Annual additional income Multiplied by number of years expired (from March 31, 200B to December 31, 200D)

P300,000 229,167 P 70,833 4.58 P 15,454 2.75

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income Reported additional income from improvement Book value of improvement at the time of pre-termination Cost Less: Accum. depreciation at pre-termination (P300,000/6) x 2.75 years Additional income in 200D from the pre-termination of contract

(P42,500) P300,000 137,500

Problem 4 – 36 A Interest income from an investment in a 10-year bond Interest income from 5-year time deposit in Philippine bank Interest income from expanded foreign currency deposit Total taxable interest income

162,500 P120,000

P 40,000 50,000 60,000 P150,000

Note: Technically speaking, the interest from 5-year time deposit in Philippine bank is taxable because the period involved is not more than 5 years and the deposit is not BSP prescribed form. Problem 4 – 37 D Year 3 interest income of P4,461.20. Problem 4 – 38 D Royalty income as author (P100,000 x 10%) Royalty income from franchising (P200,000 x 20%) Royalty income from gold mine (P500,000 x 20%) Total final tax Problem 4 – 39

P 10,000 40,000 100,000 P150,000

D

Gross royalties: Copyright (P31,500/90%) Patent (P20,000/80%) Income tax – final Copyright (P35,000 x 10%) Patent (P25,000 x 20%) Income after tax

Copyright P 35,000

Patent P 25,000

( 3,500) . P 31,500

( 5,000) P 20,000

Problem 4 – 40

1 .

Letter B Royalties within derived from: Pain reliever invention (P100,000 x 20%) Musical compositions (P200,000 x 10%) Books (P500,000 x 10%) Final tax on royalty income

2 .

P20,000 20,000 50,000 P90,000

Letter D Royalties outside derived from: Pain reliever invention Musical compositions Books Royalty income subject to normal tax

P200,000 100,000 300,000 P600,000

In general, royalties derived from sources within the Philippines are subject to a final tax of 20%, except royalties on books, other literary works and musical compositions

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

which shall be subject to a final tax of 10%. Royalties received by resident citizens from sources outside the Philippines shall be subject to normal tax under Section 24 (A) of the NIRC and by the domestic corporation under Section 27 (A) of the NIRC. Problem 4 – 41

A

P500,000 - Dividends earned by a domestic corporation from a foreign corporation are taxable.

Problem 4 – 42 A The dividend received by a domestic corporation from another domestic corporation is nontaxable. Problem 4 – 43 C First prize in Talentadong Pinoy 2nd place in bicycle race 3rd place in chess tournament Amount subject to normal tax

P10,000 6,000 15,000 P31,000

In general, prizes (reward for a contest) are subject to final tax of 20% except if the amount of the prize is P10,000 or less which will be subject to normal tax. Winnings (reward that depends on chance) are subject to 20% final tax regardless of amount. [Sec. 24 (B)(1), NIRC] Problem 4 – 44 D First prize – raffle draw (P50,000 – P1,000) Gambling winnings Beauty contest winnings Taxable prizes and winnings Problem 4 – 45

P 49,000 300,000 100,000 P449,000

C

Income (loss) Less: NOLCO (P25,000 – P20,000 – P10,000) Bad debts written off Income (loss) before bad debts recovery Bad debts recovery of previous year with tax benefit Taxable income

Year 1 P100,000

Year 2 (P 20,000)

25,000 P 75,000 . P 75,000

10,000 (P 30,000) 25,000 (P 5,000)

Year 3 P 50,000 5,000 5,000 P 40,000 8,000 P 48,000

Note: The tax benefit allowed in year 2 for the bad debts written off is only P5,000; hence, the reportable bad debts recovery in year 3 should also be P5,000. Problem 4 – 46 D Year 1: No bad debt recovery Year 2: Bad debt recovery

None P 600

Problem 4 – 47 D P5,000 local tax recovery. Problem 4 – 48 C Real property tax Local taxes Reportable income from tax refund Problem 4 – 49 Unfair competition Loss earnings

P 10,000 500 P 10,500

B P400,000 100,000

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

Moral damages for breach of contract Exemplary damages for breach of contract Interest on damages Gross income from damage recoveries subject to tax

150,000 50,000 10,000 P710,000

Actual damages are considered taxable income to the extent that such damages constitute a loss of anticipated profits, and are non-taxable to the extent they represent a return of capital or investment. However, moral and exemplary damages awarded as a result of a breach of contract are subject to income tax, and, consequently, withholding tax. (BIR Ruling No. DA489-2005 dated December 6, 2005) Take note that the moral damages and exemplary damages awarded were not on account of injuries or sickness. Problem 4 – 50 C Annuity received Present value (P20,000 x 0.9091) Interest income - Taxable annuity

P 20,000 18,182 P 1,818

Note: The present value factor of P1 for an effective interest rate of 10% is 0.9091. Problem 4 – 51 D Annuity received Present value (P5,880 x 0.8928) Interest income - Taxable annuity

P 5,880 5,250 P 630

Problem 4 – 52 B Excess of withdrawable amount ($10,000 - $1,000) Multiplied by exchange rate per 1 dollar Reportable income received by error

$ 9,000 P 50 P450,000

Problem 4 – 53 C Net increase in net asset Less: Salary in a year (P5,000 x 12) Illegally obtained income - taxable

P108,000 60,000 P 48,000

Correction: The increase in net worth should be P108,000. Note: Income derived from illegal source is taxable even if the taxpayer is a MWE. Problem 4 – 54 Gross income

P 425,000

In case of taxpayers engaged in the sale of service, “gross income” means gross receipts less sales returns, allowances and discounts. [Sec. 27 (A) NIRC] Problem 4 – 55 Salary P300,000 Corporate shares received (1,000 shares x P100) 100,000 Cancellation of debt in lieu of service rendered 50,000 Profit sharing 40,000 Gross taxable compensation income P490,000 Problem 4 – 56 Licensing fee Registration fees of delivery trucks Real estate tax

P 30,000 4,000 5,000

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INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 4: Gross Income

Community tax Foreign income tax previously claimed as deduction Reportable gross income on tax refunds Problem 4 – 57 1. Gross income – trading business (P500,000 – P200,000) Gross income – warehouse (P200,000 – P150,000) Net capital gains (loss) on personal properties Computer – more than 1 year (P10,000 – P20,000) x 50% Car – more than 1 year (P100,000 – P50,000) x 50% Gross income subject to regular tax 2.

3,000 80,000 P122,000 P300,000 50,000 (P5,000) 25,000

Unutilized portion of sale of residential house (P1,000,000 – P800,000) x 6%

Problem 4 – 58 Salary (P25,000 + P302,000) Income tax paid by the employer Note receivable Total compensation Business gross income Allowable expenses Prepaid rent income Bad debts recovered previously written- off (P38,000 x 60%) Taxable income subject to tabular tax

20,000 P370,000 P12,000

P327,000 5,000 20,000 P352,000 P 400,000 ( 250,000)

150,000 50,000 22,800 P574,800