(c) Income from Business

iv. Income from business

In the case of manufacturing, merchandising, or mining business, “gross income” means the total sales, less cost of goods sold, plus any income from investments and from incidental or outside operations or sources. In determining gross income, deductions should not be made for depreciation, depletion, selling expenses or losses, or for items not ordinarily used in computing the cost of goods sold.

In the case of sellers of services, gross income is computed by deducting “cost of services” which pertains to all direct costs and expenses exclusively and directly incurred in relation to the revenue realized by such sellers. These refer to costs which are considered indispensable to the earning of the revenue such that without such costs, no revenue can be generated. (Rev. Regs. 24-08)¹

(d) Rental income

Amount or compensation paid for the use or enjoyment of a thing or a right and implies a fixed sum or property amounting to a fixed sum to be paid at a stated time for the use of property

Lease of personal property

Rental income on the lease of personal property located in the Philippines and paid to a nonresident taxpayer shall be taxed as follows:

Lease of real property

Rental income from real property received by a lessor engaged in trade or business forms part of income taxable under the applicable rules of the NIRC. Philippine-source rental income received by a nonresident lessor not engaged in trade or business is subject to the applicable tax on gross income under NIRC, Secs. 25(B) and 28(B)(1).

Improvements made by lessees are taxable as income on the part of the lessor provided that such buildings or improvements are not subject to the removal by the lessee. The lessor may either:

• Report the improvements as income at the time when such improvements are completed based on their fair market value [outright method]; or
• Spread over the life of the lease the estimated depreciated value of the improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof [spread-out method] (Rev. Regs. 02-40, Sec. 49)³

The US Supreme Court in Helvering v. Bruun, 309 U.S. 461 (1940)⁴ stated that it is not necessary for recognition of taxable gain that the lessor be able to sever the improvement begetting the gain from his original capital.

Any additional amount paid, directly or indirectly, by the lessee in consideration for the lease is considered rental. Therefore, taxes paid by the lessee on leased property are part of rental income of the landlord.

Prepaid or advance rental is taxable income to the lessor in the year received, if so received under a claim-of-right and without restriction as to its use, and regardless of the method of accounting employed. Security deposit applied to the rental of the terminal month or period of contract must be recognized as income at the time it is applied.

Note: If the security deposit merely serves to ensure compliance with the contract (security deposit with acceleration clause), it is not income to the lessor until the lessee violates any provision of the contract.

Tax treatment of:

• Income from Leasehold Improvements

When the lessee erected or built permanent improvements on the leased property, which will become the property of the lessor upon the expiration of the lease, the value of the improvements should be reported as income of the lessor either through the outright method or the spread-out method.

• Advance payment/long-term lease

If the advance payment is a prepaid rental without restriction as to use, the entire amount is taxable in the year it is received.

If the advance payment is a security deposit which restricts the lessor as to its use, such amount shall be taxable only at the time it is applied.

If the advance payment is a loan deposit, or option money for the property or a security deposit to ensure the faithful performance of certain obligations of the lessee, such amount shall not be taxable to the lessor unless the lessee violates the terms of the contract.

INCOME TAX ON INDIVIDUALS

iii. Taxation on business income/income from practice of profession

Income from business

In the case of manufacturing, merchandising, or mining business, “gross income” means the total sales, less cost of goods sold, plus any income from investments and from incidental or outside operations or sources.

In determining gross income, deductions should not be made for depreciation, depletion, selling expenses or losses, or for items not ordinarily used in computing the cost of goods sold.

In the case of sellers of services, gross income is computed by deducting “cost of services” which pertains to all direct costs and expenses exclusively and directly incurred in relation to the revenue realized by such sellers. These refer to costs which are considered indispensable to the earning of the revenue such that without such costs, no revenue can be generated. (Rev. Regs. 24-08)⁵

(b) Optional 8% income tax

Self-employed individuals and/or professionals whose gross sales/gross receipts and other non-operating income does not exceed the VAT threshold of P3,000,000 shall have the option to avail of an eight percent (8%) tax on gross sales or gross receipts and other non-operating income in excess of P250,000 in lieu of the graduated income tax rates and percentage tax.

Mixed Income Earner – an individual earning both compensation income from employment and income from business, practice of profession and/or sources aside from employment shall be subject to the following tax rates:

• Compensation income – graduated rates under Sec. 24(A)(2) of NIRC⁶ as amended; and
• Income from business or practice of profession
• If Total Gross Sales and/or Gross Receipts and Other Non-Operating Income does not exceed VAT threshold (P3,000,000), the individual has the option to be taxed at:
• Graduated rates; OR
• 8% income tax on gross sales or gross receipts and other nonoperating income, without deducting P250,000.
• Exceeds P3,000,000 – graduated rates

Note: Unless the taxpayer signifies the intention to elect the 8% income tax rate in the 1st quarter percentage and/or ITR, or on the initial quarter return of the taxable year after the commencement of a new business/practice of profession, the taxpayer shall be considered as having availed of the graduated rates. Such election, shall be irrevocable and no amendment of option shall be made for the said taxable year.

The option to be taxed at 8% income tax rate is not available to a VAT-registered taxpayer, regardless of the amount of gross sales/receipts, and to a taxpayer who is subject to Other Percentage Tax, except those subject under Sec. 116⁷. Likewise, partners of a General Professional Partnership (GPP) by virtue of their distributive share from GPP which is already net of cost and expenses cannot avail of the 8% income tax rate option.

A taxpayer shall automatically be subject to the graduated rates even if the flat 8% income tax rate option is initially selected, when taxpayer’s gross sales/receipts and other non-operating income exceeded the VAT threshold during the taxable year. (Rev. Regs. 08-18 Sec. 3)⁸

Illustration 1 (Rev. Regs. 08-18)⁹

Ms. EBQ operates a convenience store while she offers bookkeeping services to her client. In 2018, her gross sales amounted to P800,000, in addition to her receipts from bookkeeping services of P300,000. She signified her intention to be taxed at 8% income tax rate in her 1st quarter return.