INCOME TAX

Income means all wealth which flows into the taxpayer, other than return of capital.

Income vs. Capital

Capital constitute the investment which generates income.
Capital is fund while income is the flow.
Capital is wealth while income is the service of wealth.
Capital is the tree while income is the fruit.

Items deemed capital not income:

Anything received as compensation for the loss of life, health, or reputation, is deemed a return
of capital. Hence:
(1) Proceeds of life insurance policies
(2) Compensation received in consideration for the loss of health (injuries or tortuous acts)
(3) Indemnity received such as moral damages received from (a) oral defamation or slander, (b)
alienation of affection, and (c) breach of promise to marry, are deemed return of capital exempt
from income tax.

Recovery of lost capital vs. recovery of lost profits

The recovery of lost capital merely maintains net worth while recovery of lost profits increases
net worth. Hence, the following, as return on capital are taxable when recovered:
(1) Proceeds of crop or livestock insurance
(2) Guarantee payments
(3) Indemnity received from patent infringement suit

Gross Income means all income derived from whatever source, including but not limited to:
(1) Compensation for services in whatever form paid
(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) Interest income
(5) Rents
(6) Royalties
(7) Dividends
(8) Annuities
(9) Prizes and winnings
(10) Pensions
(11) Partner’s distributive share from the net income of a general professional partnership

Proceeds from illegal activities, like embezzlement or swindling, for instance, are income
because embezzler or swindler already has complete dominion over them and use such for his economic
benefit.
When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition,
express or implied, of an obligation to repay and without restriction as to their disposition, he has
received taxable income, even though it may still be claimed that he is not entitled to retain the money,
and even though he may still be adjudged to restore its equivalent (James vs. US, 366 US 213, 1961). To
treat the embezzled funds not as taxable income would perpetuate injustice by relieving embezzlers of
the duty of paying income taxes on the money they enrich themselves with through embezzlement,
while honest people pay their taxes on every conceivable type of income.

Requisites for Income to be Taxable:

(a) There must be gain.

It needs not be in cash. It may occur as a result of exchange of property, payment,
assumption or cancellation of the taxpayer’s indebtedness (except gifts) or other profit realized
from completion of a transaction.

(b) The gain must be received or realized.

Income is recognized in the year it is actually or constructively received in cash or cash
equivalents.
The realization of income need not take the form of actual receipt or property by the
taxpayer as it may occur as where there is a constructive receipt of the income by the taxpayer.
Income may be realized in any form, whether in money, property, services, indirect
economic benefit.

Doctrine of Constructive Receipt. It is not the actual receipt but the right to receive that
determines when to include an amount in the gross income (Filipinas Synthetic Fiber Corp. vs. CA). The
right to receive must be unconditional, valid and enforceable.
It prevents a cash-basis taxpayer from deliberately turning his back on income and thereby
selecting the year in which he reports it. No recognizing the constructive receipt of income as realized
income would open the door to tax avoidance and, possibly, tax evasion.

There is no constructive receipt of income when:

(a) Constructive receipt is subject to substantial limitations
(b) Payor does not have funds necessary to make payment
(c) The amount is not available to the taxpayer/payee

(c) The gain must not be excluded by law from taxation.

Income that are not exempt from tax law by law or treaty are not considered in
determining gross income.