I. Introduction

Income tax in the Philippines is imposed on income earned by individuals, corporations, estates, trusts, and certain other taxable entities. Its computation depends on the taxpayer’s classification, the nature and source of income, the allowable deductions or exemptions, and the applicable tax rate under the National Internal Revenue Code of 1997, as amended, particularly by Republic Act No. 10963, or the TRAIN Law, and later amendments such as the CREATE Act.

In general, Philippine income tax is computed by identifying the taxpayer, classifying the income, determining whether the income is taxable or exempt, deducting allowable deductions when applicable, applying the proper tax rate, and subtracting any creditable withholding taxes or tax credits.

The computation is not uniform for all taxpayers. Compensation earners, self-employed individuals, professionals, mixed-income earners, corporations, nonresident aliens, and passive-income recipients are subject to different rules.

II. Governing Law

The principal law on income taxation in the Philippines is the National Internal Revenue Code of 1997, as amended. Important amendments include:

Republic Act No. 10963, or the TRAIN Law, which revised individual income tax rates beginning 2018 and further adjusted them starting 2023.
Republic Act No. 11534, or the CREATE Act, which reduced corporate income tax rates and introduced changes to incentives and corporate taxation.
Relevant regulations and issuances of the Bureau of Internal Revenue, including revenue regulations, revenue memorandum circulars, and rulings.

III. Basic Concept of Income Tax

Income tax is a tax on income, not on capital. In broad terms, income means all wealth that flows into the taxpayer, other than a mere return of capital, and includes compensation, business profits, professional fees, interest, dividends, rents, royalties, prizes, pensions, and gains from dealings in property.

The usual formula is:

Gross Income less Allowable Deductions equals Taxable Income multiplied by Tax Rate equals Income Tax Due less Tax Credits and Creditable Withholding Taxes equals Tax Payable or Refundable

However, this general formula does not apply to all types of income. Some income is subject to final withholding tax, meaning the tax withheld is already the full and final tax. Other income is subject to capital gains tax, special rates, preferential rates, or exemption.

IV. Classification of Taxpayers

The first step in computing income tax is identifying the taxpayer’s classification.

A. Individual Taxpayers

Individual taxpayers may be:

Resident citizens
Nonresident citizens
Resident aliens
Nonresident aliens engaged in trade or business in the Philippines
Nonresident aliens not engaged in trade or business in the Philippines
Self-employed individuals
Professionals
Mixed-income earners
Minimum wage earners

The classification matters because it determines what income is taxable and what rates apply.

B. Corporate Taxpayers

Corporations may be:

Domestic corporations
Resident foreign corporations
Nonresident foreign corporations
Special corporations, such as proprietary educational institutions, hospitals, regional operating headquarters, and certain entities subject to special tax regimes

Corporate income tax computation depends on whether the corporation is domestic or foreign, and whether the income is from within or outside the Philippines.

V. Taxability Based on Source of Income

Philippine income taxation follows both residence and source principles.

A. Resident Citizens

A resident Filipino citizen is taxable on income from all sources, whether within or outside the Philippines.

Thus, a resident citizen must generally report worldwide income, subject to applicable exclusions, deductions, treaty relief, and foreign tax credits.

B. Nonresident Citizens

A nonresident citizen is taxable only on income derived from sources within the Philippines.

C. Overseas Filipino Workers

Overseas Filipino workers are generally taxable only on income from sources within the Philippines. Income earned abroad from overseas employment is not subject to Philippine income tax.

D. Resident Aliens

A resident alien is taxable only on income from sources within the Philippines.

E. Nonresident Aliens

A nonresident alien engaged in trade or business in the Philippines is generally taxed on Philippine-sourced income at graduated rates for certain income, subject to special rules.

A nonresident alien not engaged in trade or business in the Philippines is generally taxed on gross Philippine-sourced income at a flat rate, commonly 25%, unless a treaty or special rule applies.

F. Domestic Corporations

A domestic corporation is taxable on income from all sources, whether within or outside the Philippines.

G. Foreign Corporations

A resident foreign corporation is taxable only on income from sources within the Philippines.

A nonresident foreign corporation is also taxed only on Philippine-sourced income, generally through final withholding tax on gross income, subject to treaty or special-rate rules.

VI. Gross Income

Gross income includes all income derived from whatever source, unless excluded by law.

Common items of gross income include:

Compensation for services
Salaries, wages, allowances, commissions, and bonuses
Professional fees
Business income
Gains from sale or exchange of property
Interest income
Rents
Royalties
Dividends
Annuities
Prizes and winnings
Pensions
Partner’s distributive share in partnership income
Income from estates or trusts

Gross income is not always equal to cash received. Income may be taxable when actually or constructively received, depending on the taxpayer’s accounting method.

VII. Exclusions from Gross Income

Certain receipts are not taxable income. These are excluded before computing taxable income.

Common exclusions include:

Life insurance proceeds paid to heirs or beneficiaries upon death of the insured.
Amount received as return of premium under life insurance, endowment, or annuity contracts.
Gifts, bequests, and devises, although income from such property may be taxable.
Compensation for injuries or sickness, including damages received on account of personal injuries or sickness.
Income exempt under treaty.
Retirement benefits, if the statutory conditions are met.
Separation pay due to death, sickness, physical disability, or causes beyond the employee’s control.
Social security benefits, GSIS benefits, SSS benefits, and similar statutory benefits.
13th month pay and other benefits, up to the statutory exclusion threshold.
Minimum wage income of qualified minimum wage earners, including certain related benefits.

Exclusions are important because excluded income is not part of taxable income.

VIII. Compensation Income Tax

A. Meaning of Compensation Income

Compensation income refers to income arising from an employer-employee relationship. It includes:

Salaries
Wages
Commissions
Bonuses
Taxable allowances
Taxable fringe benefits or benefits not otherwise exempt
Fees received by employees
Other forms of remuneration for services

B. General Formula for Compensation Earners

For a purely compensation-income earner, the computation is generally:

Gross Compensation Income less Non-taxable Compensation and Exclusions equals Taxable Compensation Income apply Graduated Income Tax Rates equals Income Tax Due less Tax Withheld by Employer equals Tax Payable or Refundable

C. Non-taxable Compensation Items

The following may be excluded, subject to conditions and limits:

Mandatory SSS, GSIS, PhilHealth, and Pag-IBIG employee contributions
13th month pay and other benefits up to the statutory ceiling
De minimis benefits within BIR limits
Minimum wage income of qualified minimum wage earners
Qualified retirement benefits
Qualified separation pay
Non-taxable fringe or convenience benefits

D. Graduated Individual Income Tax Rates

Beginning taxable year 2023, individual taxpayers subject to graduated rates are generally taxed as follows:

Taxable Income	Income Tax
Not over ₱250,000	0%
Over ₱250,000 but not over ₱400,000	15% of excess over ₱250,000
Over ₱400,000 but not over ₱800,000	₱22,500 + 20% of excess over ₱400,000
Over ₱800,000 but not over ₱2,000,000	₱102,500 + 25% of excess over ₱800,000
Over ₱2,000,000 but not over ₱8,000,000	₱402,500 + 30% of excess over ₱2,000,000
Over ₱8,000,000	₱2,202,500 + 35% of excess over ₱8,000,000

These rates apply to individuals subject to graduated rates, including compensation earners and certain self-employed individuals.

E. Example: Compensation Earner

Assume an employee earns:

Annual salary: ₱900,000
Mandatory contributions: ₱50,000
13th month pay and other benefits: ₱90,000
Tax withheld by employer: ₱120,000

Assuming the full ₱90,000 benefits are exempt:

Gross salary: ₱900,000 Less mandatory contributions: ₱50,000 Less exempt 13th month pay and other benefits: ₱90,000 Taxable compensation income: ₱760,000

Tax on ₱760,000:

₱22,500 + 20% of excess over ₱400,000 Excess: ₱760,000 - ₱400,000 = ₱360,000 20% of ₱360,000 = ₱72,000 Tax due: ₱22,500 + ₱72,000 = ₱94,500

Less tax withheld: ₱120,000 Result: ₱25,500 refundable or creditable, subject to filing and substantiation rules.

IX. Minimum Wage Earners

A minimum wage earner is exempt from income tax on statutory minimum wage income. The exemption also generally covers:

Holiday pay
Overtime pay
Night shift differential pay
Hazard pay

The exemption applies only to qualified minimum wage earners. If the employee receives additional taxable income, commissions, allowances, or benefits beyond what the law exempts, taxability must be reviewed.

X. Self-Employed Individuals and Professionals

Self-employed individuals and professionals earn income from business, trade, or practice of profession. Examples include sole proprietors, consultants, doctors, lawyers, accountants, architects, freelancers, online contractors, and other independent service providers.

They may generally compute income tax using either:

Graduated income tax rates with deductions, or
8% income tax rate on gross sales or receipts and other non-operating income, subject to statutory conditions.

A. Graduated Rates Method

Under this method:

Gross Sales or Gross Receipts less Cost of Sales or Cost of Services, if applicable equals Gross Income less Allowable Deductions equals Taxable Income apply Graduated Rates equals Income Tax Due less Tax Credits and Creditable Withholding Taxes equals Tax Payable

This method allows deductions, either itemized or optional standard deduction.

B. 8% Income Tax Option

Certain self-employed individuals and professionals may elect the 8% income tax option in lieu of graduated income tax rates and percentage tax, subject to limitations.

The general formula is:

8% × (Gross Sales or Gross Receipts and Other Non-operating Income less ₱250,000)

The ₱250,000 reduction applies when the individual is purely self-employed or purely professional and has no compensation income.

The 8% option is generally available only when gross sales or receipts do not exceed the VAT threshold and the taxpayer is not VAT-registered. Taxpayers subject to other percentage taxes, VAT, or special tax regimes may not qualify.

C. Example: Professional Using 8% Option

A freelance consultant earns gross receipts of ₱1,200,000 during the year and validly elects the 8% option.

Gross receipts: ₱1,200,000 Less ₱250,000: ₱950,000 8% tax: ₱76,000

If creditable withholding taxes of ₱40,000 were withheld by clients:

Income tax due: ₱76,000 Less CWT: ₱40,000 Tax payable: ₱36,000

D. Example: Professional Using Graduated Rates

Assume:

Gross receipts: ₱1,200,000
Allowable deductions: ₱400,000
Creditable withholding tax: ₱40,000

Taxable income:

₱1,200,000 - ₱400,000 = ₱800,000

Tax on ₱800,000:

₱22,500 + 20% of excess over ₱400,000 Excess: ₱400,000 20% = ₱80,000 Tax due: ₱102,500

Less CWT: ₱40,000 Tax payable: ₱62,500

In this example, the 8% option produces a lower tax, but that is not always the case. The better method depends on gross receipts, deductions, VAT status, and withholding credits.

XI. Mixed-Income Earners

A mixed-income earner earns both compensation income and business or professional income.

For mixed-income earners, compensation income is taxed using graduated rates. Business or professional income may be taxed under the graduated method or, if qualified and elected, the 8% option.

However, the ₱250,000 reduction is already considered in the compensation income tax table. Therefore, when a mixed-income earner elects the 8% option for business or professional income, the 8% rate generally applies to the entire gross sales or receipts from business or profession without deducting another ₱250,000.

Example: Mixed-Income Earner

Assume:

Taxable compensation income: ₱600,000
Professional gross receipts: ₱500,000
8% option validly elected
Tax withheld from compensation: ₱60,000
CWT from professional clients: ₱20,000

Tax on compensation income:

₱22,500 + 20% of excess over ₱400,000 Excess: ₱200,000 20% = ₱40,000 Tax on compensation: ₱62,500

Tax on professional income under 8%:

8% × ₱500,000 = ₱40,000

Total income tax due:

₱62,500 + ₱40,000 = ₱102,500

Less tax withheld:

₱60,000 + ₱20,000 = ₱80,000

Tax payable:

₱22,500

XII. Allowable Deductions

For taxpayers using the graduated rates method or regular corporate income tax method, allowable deductions reduce gross income to taxable income.

A. Ordinary and Necessary Business Expenses

The law allows deductions for ordinary and necessary expenses paid or incurred in carrying on a trade, business, or profession.

Examples include:

Salaries and wages
Rent
Utilities
Supplies
Repairs and maintenance
Professional fees
Advertising
Transportation and travel
Communication expenses
Insurance
Office expenses
Bank charges
Certain taxes and licenses

To be deductible, an expense must generally be:

Ordinary and necessary
Paid or incurred during the taxable year
Connected with the trade, business, or profession
Substantiated by proper documents
Not contrary to law, public policy, or specific deduction rules
Subject to withholding tax compliance where applicable

B. Cost of Sales or Cost of Services

For sellers of goods, cost of sales may include inventory cost, freight, direct labor, and production costs.

For service providers, cost of services may include direct costs attributable to services rendered, depending on the taxpayer’s accounting and industry.

C. Interest Expense

Interest paid or incurred on indebtedness connected with business may be deductible, subject to limitations.

D. Taxes

Certain taxes connected with business may be deductible, except income tax, estate and donor’s taxes, special assessments, and taxes not allowed by law.

E. Losses

Business losses may be deductible if actually sustained, properly substantiated, and not compensated by insurance or otherwise.

F. Bad Debts

Bad debts may be deductible if:

There is a valid and subsisting debt.
The debt is connected with business or profession.
The debt becomes worthless during the taxable year.
The debt is actually charged off.
The taxpayer can prove worthlessness.

G. Depreciation

Depreciation is allowed for property used in trade or business or held for income production. It allocates the cost of property over its useful life.

H. Charitable Contributions

Donations may be deductible if made to qualified entities and subject to statutory limits, unless fully deductible under special rules.

I. Research and Development

Research and development expenses may be deductible or deferred depending on the applicable tax rules.

J. Pension Trust Contributions

Contributions to qualified pension trusts may be deductible subject to conditions.

XIII. Optional Standard Deduction

In lieu of itemized deductions, certain taxpayers may elect the Optional Standard Deduction, or OSD.

A. Individuals

For individuals earning business or professional income, the OSD is generally 40% of gross sales or gross receipts.

B. Corporations

For corporations, the OSD is generally 40% of gross income.

C. Effect of OSD Election

Once elected for the taxable year, the taxpayer may no longer claim itemized deductions for that year. The taxpayer must still maintain records of gross sales, receipts, and income.

D. Example: Individual Using OSD

Gross receipts: ₱1,000,000 OSD: 40% of ₱1,000,000 = ₱400,000 Taxable income: ₱600,000

Tax:

₱22,500 + 20% of excess over ₱400,000 Excess: ₱200,000 20% = ₱40,000 Tax due: ₱62,500

XIV. Personal and Additional Exemptions

Under the current income tax regime after the TRAIN Law, the old personal and additional exemptions for individual taxpayers were effectively removed and replaced by the first ₱250,000 bracket taxed at 0%.

Thus, individual taxpayers subject to graduated rates do not separately deduct personal exemptions or additional exemptions for dependents.

XV. Passive Income

Some income is not included in the ordinary graduated-rate computation because it is subject to final tax.

A. Interest from Philippine Bank Deposits

Interest from bank deposits and deposit substitutes is generally subject to final withholding tax.

For individuals, interest from Philippine currency bank deposits is generally subject to 20% final tax.

B. Royalties

Royalties are generally subject to final withholding tax. The applicable rate depends on the taxpayer and the type of royalty.

C. Prizes and Winnings

Prizes and winnings are generally subject to final tax, subject to exclusions for certain small prizes or specific statutory treatment.

Philippine Charity Sweepstakes and Lotto winnings above the statutory exemption threshold are generally subject to final tax.

D. Dividends

Cash or property dividends received by resident citizens and resident aliens from domestic corporations are generally subject to final tax.

Dividends received by domestic corporations from domestic corporations are generally not subject to tax as intercorporate dividends, subject to applicable rules.

E. Effect of Final Tax

Income subject to final tax is generally no longer included in the annual income tax return as part of taxable income. The withholding agent withholds and remits the final tax.

XVI. Capital Gains Tax

Certain gains from property transactions are subject to special capital gains tax rules rather than ordinary income tax.

A. Sale of Domestic Shares Not Traded Through the Stock Exchange

Net capital gains from sale, barter, exchange, or other disposition of shares of stock in a domestic corporation not traded through the local stock exchange are generally subject to capital gains tax.

The rate is generally 15% of net capital gains.

B. Sale of Real Property Classified as Capital Asset

For individuals and domestic corporations, sale of real property located in the Philippines classified as a capital asset is generally subject to 6% capital gains tax based on the higher of:

Gross selling price;
Fair market value as determined by the Commissioner; or
Fair market value as shown in the schedule of values of the provincial or city assessor.

This tax applies even if the seller incurred an actual loss, because the tax base is not net gain but the higher value provided by law.

C. Principal Residence Exemption

An individual may be exempt from capital gains tax on the sale of a principal residence if the proceeds are fully utilized to acquire or construct a new principal residence within the prescribed period and all statutory requirements are met.

XVII. Fringe Benefits Tax

Fringe benefits granted to managerial or supervisory employees are generally subject to fringe benefits tax. The employer is liable for the tax.

The tax is imposed on the grossed-up monetary value of the fringe benefit.

Common fringe benefits include:

Housing
Expense accounts
Vehicles
Household personnel
Interest on loans below market rate
Club memberships
Foreign travel
Holiday and vacation expenses
Educational assistance
Insurance benefits

Fringe benefits given to rank-and-file employees are generally treated under compensation income rules, subject to exclusions for de minimis benefits and other exempt benefits.

XVIII. De Minimis Benefits

De minimis benefits are small-value benefits given by employers to employees for convenience, morale, or welfare. If within BIR-prescribed limits, they are not taxable compensation.

Examples may include monetized unused vacation leave credits within limits, medical cash allowance, rice subsidy, uniform allowance, laundry allowance, employee achievement awards, gifts during Christmas and major anniversary celebrations, daily meal allowance for overtime work, and similar benefits within regulatory ceilings.

Amounts exceeding the de minimis limits may form part of “other benefits” and may be taxable if the statutory ceiling for exempt 13th month pay and other benefits is exceeded.

XIX. Corporate Income Tax

A. Domestic Corporations

A domestic corporation is taxable on worldwide income.

The regular corporate income tax rate under current law is generally:

25% of taxable income for most domestic corporations; or
20% for domestic corporations with net taxable income not exceeding ₱5,000,000 and total assets not exceeding ₱100,000,000, excluding land on which the business entity’s office, plant, and equipment are situated.

B. Resident Foreign Corporations

Resident foreign corporations are generally taxed only on Philippine-sourced income at the regular corporate income tax rate applicable under law.

C. Nonresident Foreign Corporations

Nonresident foreign corporations are generally subject to final withholding tax on gross income from Philippine sources, subject to domestic law rates and tax treaty relief.

D. Corporate Tax Formula

For corporations subject to regular corporate income tax:

Gross Sales or Receipts less Sales Returns, Allowances, and Discounts less Cost of Sales or Cost of Services equals Gross Income less Allowable Deductions equals Taxable Income multiplied by Corporate Tax Rate equals Regular Corporate Income Tax less Tax Credits equals Tax Payable

E. Example: Domestic Corporation

Assume:

Gross sales: ₱20,000,000
Cost of sales: ₱12,000,000
Operating expenses: ₱5,000,000
Creditable withholding taxes: ₱300,000
Applicable tax rate: 25%

Gross income:

₱20,000,000 - ₱12,000,000 = ₱8,000,000

Taxable income:

₱8,000,000 - ₱5,000,000 = ₱3,000,000

Income tax:

25% × ₱3,000,000 = ₱750,000

Less CWT:

₱750,000 - ₱300,000 = ₱450,000 tax payable

XX. Minimum Corporate Income Tax

A corporation may be subject to Minimum Corporate Income Tax, or MCIT.

MCIT generally applies beginning on the fourth taxable year immediately following the year in which the corporation commenced business operations.

The MCIT is generally computed as a percentage of gross income. Under the regular rule, the rate is 2% of gross income, although temporary statutory reductions have applied during certain periods.

The corporation pays whichever is higher:

Regular corporate income tax; or
Minimum corporate income tax.

Example

Gross income: ₱10,000,000 Taxable income after deductions: ₱100,000 Regular corporate income tax at 25%: ₱25,000 MCIT at 2% of gross income: ₱200,000

Tax payable before credits: ₱200,000

The excess MCIT over regular tax may generally be carried forward and credited against regular corporate income tax for the prescribed period.

XXI. Improperly Accumulated Earnings Tax

The improperly accumulated earnings tax was historically imposed on corporations that allowed earnings and profits to accumulate instead of distributing them to shareholders for the purpose of avoiding shareholder-level tax.

Under current law after the CREATE Act, the improperly accumulated earnings tax has been repealed. However, accumulated earnings may still have legal and tax relevance in corporate planning, dividend declarations, and anti-avoidance analysis.

XXII. Partnerships, Joint Ventures, and Co-ownerships

A. General Professional Partnerships

A general professional partnership is not itself subject to income tax as a corporation. The partners are taxed on their distributive share in the partnership income, whether actually distributed or not.

B. Business Partnerships

Business partnerships are generally treated as corporations for income tax purposes and are subject to corporate income tax.

C. Joint Ventures

Certain joint ventures may be taxable as corporations, while others, such as qualified construction joint ventures or energy service contract arrangements under specific rules, may be exempt from corporate income tax at the joint venture level.

D. Co-ownerships

A mere co-ownership formed to preserve property and collect income may not necessarily be treated as a taxable partnership. However, if the co-owners contribute property or money to carry on business for profit, the arrangement may be treated as a partnership taxable as a corporation.

XXIII. Estates and Trusts

Estates and trusts may be subject to income tax. The computation depends on whether income is accumulated, distributed, or currently distributable to beneficiaries.

The taxable income of an estate or trust is generally computed in the same manner as that of an individual, with special rules on deductions and distributions.

Beneficiaries may be taxed on income distributed or distributable to them, depending on the nature of the estate or trust and applicable provisions.

XXIV. Withholding Tax System

Income tax computation in the Philippines is closely linked to withholding taxes.

A. Final Withholding Tax

Final withholding tax is the full and final tax on the income. The recipient generally no longer includes the income in taxable income.

Examples include certain interest income, royalties, dividends, prizes, winnings, and payments to nonresident foreign corporations.

B. Creditable Withholding Tax

Creditable withholding tax is an advance payment of income tax. It is credited against the income tax due in the quarterly or annual return.

Examples include withholding on professional fees, rentals, contractor payments, and certain income payments.

C. Withholding on Compensation

Employers withhold tax from employee compensation. The employee’s annual tax due is compared against the amount withheld.

For qualified substituted filing, certain employees no longer need to file an annual income tax return if the employer correctly withholds the tax and all legal conditions are met.

XXV. Substituted Filing

Substituted filing applies to qualified employees receiving purely compensation income from one employer during the taxable year, where the employer has correctly withheld the tax due.

Under substituted filing, the employer’s annual information return and the employee’s certificate of compensation payment and tax withheld serve as the equivalent of the employee’s income tax return.

Substituted filing generally does not apply to:

Mixed-income earners
Employees with multiple employers during the year
Self-employed individuals
Professionals
Taxpayers with other income subject to regular tax
Taxpayers whose tax was not correctly withheld

XXVI. Quarterly and Annual Filing

A. Individuals Engaged in Business or Practice of Profession

Self-employed individuals, professionals, and mixed-income earners generally file quarterly income tax returns and an annual income tax return.

Quarterly income tax payments are credited against the annual income tax due.

B. Corporations

Corporations generally file quarterly corporate income tax returns and an annual income tax return.

Corporate quarterly tax is computed cumulatively, and prior quarterly payments are credited against the tax due for later quarters and the annual return.

C. Calendar Year and Fiscal Year

Individuals generally use the calendar year.

Corporations may use either a calendar year or an approved fiscal year.

XXVII. Accounting Methods

Income tax computation may depend on the accounting method used.

A. Cash Method

Under the cash method, income is generally reported when received, and expenses are deducted when paid.

This method is common for individuals and professionals.

B. Accrual Method

Under the accrual method, income is reported when earned, and expenses are deducted when incurred, regardless of actual receipt or payment.

This method is common for corporations and businesses maintaining inventories.

C. Hybrid or Special Methods

Some taxpayers may use other methods if allowed by law and regulations, provided the method clearly reflects income.

XXVIII. Taxable Period

Income tax is computed for a taxable year.

For individuals, the taxable year is generally the calendar year ending December 31.

For corporations, the taxable year may be:

Calendar year; or
Fiscal year ending on the last day of any month other than December.

The taxable period matters because income and deductions must be matched to the correct year.

XXIX. Situs of Income

Determining whether income is from sources within or outside the Philippines is essential, especially for nonresident citizens, aliens, and foreign corporations.

Common source rules include:

Interest is generally sourced based on the residence of the debtor.
Dividends are sourced based on the corporation paying the dividend, subject to special rules.
Services are sourced where the services are performed.
Rentals and royalties are sourced where the property or right is used.
Sale of real property is sourced where the real property is located.
Sale of personal property may depend on the type of property, place of sale, residence of seller, and special statutory rules.

XXX. Tax Treaties

The Philippines has tax treaties with various countries. Tax treaties may reduce or exempt tax on certain income, such as:

Dividends
Interest
Royalties
Business profits
Capital gains
Independent personal services
Dependent personal services
Pensions
Income of teachers, researchers, or students

Treaty relief is not automatic in practice. The taxpayer must comply with applicable BIR requirements, such as securing or maintaining proof of residency, beneficial ownership, and entitlement to treaty benefits.

XXXI. Foreign Tax Credits

Resident citizens and domestic corporations taxable on worldwide income may claim foreign tax credits for income taxes paid to foreign countries, subject to limitations.

The purpose is to mitigate double taxation.

The allowable foreign tax credit is generally limited so that the Philippine tax attributable to foreign income is not exceeded.

XXXII. Special Rules for Nonresident Aliens

A. Nonresident Alien Engaged in Trade or Business

A nonresident alien is generally considered engaged in trade or business in the Philippines if present in the Philippines for an aggregate period of more than 180 days during the calendar year.

Such taxpayer may be subject to graduated rates on taxable income from Philippine sources, subject to applicable rules.

B. Nonresident Alien Not Engaged in Trade or Business

A nonresident alien not engaged in trade or business is generally taxed on gross Philippine-sourced income at a flat final tax rate, commonly 25%, unless a treaty or special law provides otherwise.

XXXIII. Special Rules for Employees of Special Entities

Certain aliens employed by regional or area headquarters, regional operating headquarters, offshore banking units, petroleum service contractors, or other special entities were historically subject to preferential tax treatment. Some special regimes have been modified or repealed by later legislation.

Any computation involving special employees must be checked against the current statute, applicable grandfathering rules, and relevant BIR issuances.

XXXIV. Taxation of Dividends

A. Dividends Received by Individuals

Dividends received by resident citizens and resident aliens from domestic corporations are generally subject to final tax.

B. Dividends Received by Domestic Corporations

Dividends received by a domestic corporation from another domestic corporation are generally not subject to income tax.

C. Dividends Paid to Nonresident Foreign Corporations

Dividends paid to a nonresident foreign corporation are generally subject to final withholding tax, subject to possible reduced rates under tax treaties or domestic tax-sparing rules.

XXXV. Sale of Property

Income tax treatment depends on the classification of the property and the taxpayer.

A. Ordinary Assets

Ordinary assets are generally assets used in business, held for sale to customers, inventory, or property subject to depreciation.

Gains from the sale of ordinary assets are generally subject to ordinary income tax.

B. Capital Assets

Capital assets are assets other than ordinary assets.

Capital gains may be subject to special capital gains tax, especially for real property in the Philippines and shares of domestic corporations not traded through the stock exchange.

C. Real Property

For real property, the tax treatment depends on whether the property is a capital asset or ordinary asset.

If capital asset, the sale is generally subject to 6% capital gains tax.

If ordinary asset, the gain is generally subject to ordinary income tax and may also be subject to VAT or percentage tax, depending on the taxpayer and transaction.

XXXVI. Net Operating Loss Carry-Over

A net operating loss may be carried over as a deduction from gross income for the next three consecutive taxable years immediately following the year of loss, subject to statutory conditions.

The benefit may be denied or limited if there is substantial change in ownership, failure to substantiate the loss, or noncompliance with applicable rules.

Special extensions or rules may apply under extraordinary legislation, but the general rule is a three-year carry-over period.

XXXVII. Tax Credits

Tax credits reduce tax due, unlike deductions, which reduce taxable income.

Common tax credits include:

Creditable withholding taxes
Prior year excess credits
Quarterly income tax payments
Foreign tax credits, where applicable
Minimum corporate income tax carry-forward
Other credits allowed by law

The taxpayer must substantiate tax credits with certificates, returns, and records.

XXXVIII. Common Computation Errors

Common mistakes in income tax computation include:

Treating final-tax income as part of regular taxable income.
Failing to deduct non-taxable benefits from compensation income.
Claiming both itemized deductions and OSD for the same taxable year.
Claiming the ₱250,000 reduction twice for mixed-income earners.
Using the 8% option despite being VAT-registered or otherwise disqualified.
Failing to include constructive receipts.
Deducting expenses without proper invoices or receipts.
Failing to withhold tax on deductible payments.
Misclassifying ordinary assets as capital assets.
Treating gross receipts as taxable income without considering deductions where allowed.
Forgetting to credit quarterly payments and CWT.
Applying corporate rates to individual income or vice versa.
Applying tax treaty rates without proof of entitlement.
Ignoring related-party and transfer-pricing rules.
Using outdated tax brackets.

XXXIX. Step-by-Step Computation for Individuals

Step 1: Determine taxpayer classification

Identify whether the taxpayer is a resident citizen, nonresident citizen, resident alien, nonresident alien, compensation earner, self-employed individual, professional, mixed-income earner, or minimum wage earner.

Step 2: Determine taxable income sources

Identify whether income is from within or outside the Philippines and whether the taxpayer is taxable on worldwide income or Philippine-sourced income only.

Step 3: Classify income

Separate income into:

Compensation income
Business income
Professional income
Passive income
Capital gains
Exempt income

Step 4: Remove exclusions and exempt income

Exclude non-taxable items, such as qualified 13th month pay and benefits, de minimis benefits, exempt retirement benefits, and statutory exclusions.

Step 5: Determine applicable tax method

For business or professional income, determine whether the taxpayer will use:

Graduated rates with itemized deductions;
Graduated rates with OSD; or
The 8% gross receipts tax option, if qualified.

Step 6: Compute taxable income

For compensation income, compute taxable compensation.

For business or professional income, compute net taxable income or the 8% tax base.

Step 7: Apply tax rate

Apply the graduated tax table, 8% rate, final tax, or capital gains tax, as applicable.

Step 8: Deduct tax credits

Deduct withholding taxes, quarterly payments, prior year credits, and other allowable tax credits.

Step 9: Determine tax payable or overpayment

If tax due exceeds credits, the difference is payable.

If credits exceed tax due, the excess may be refunded, carried over, or otherwise treated according to law and the taxpayer’s election.

XL. Step-by-Step Computation for Corporations

Step 1: Determine corporate classification

Identify whether the corporation is domestic, resident foreign, nonresident foreign, or subject to a special tax regime.

Step 2: Determine taxable income sources

Domestic corporations are taxable on worldwide income. Foreign corporations are generally taxable only on Philippine-sourced income.

Step 3: Compute gross income

Gross sales or receipts are reduced by returns, allowances, discounts, and cost of sales or services.

Step 4: Deduct allowable deductions

Deduct ordinary and necessary expenses, depreciation, losses, taxes, bad debts, interest, charitable contributions, and other deductions allowed by law.

Step 5: Compute taxable income

Gross income less allowable deductions equals taxable income.

Step 6: Apply regular corporate income tax

Apply the proper corporate rate, generally 25% or 20% for qualified domestic corporations.

Step 7: Compare with MCIT

If applicable, compare regular corporate income tax with MCIT and pay the higher amount.

Step 8: Deduct tax credits

Deduct creditable withholding taxes, quarterly payments, excess prior year credits, and other allowable credits.

Step 9: Determine tax payable or overpayment

The result is the final amount payable or creditable/refundable, subject to statutory rules.

XLI. Illustrative Comprehensive Example: Individual

Assume a resident citizen has the following annual income:

Compensation income: ₱1,000,000
Mandatory contributions: ₱60,000
13th month pay and other benefits: ₱90,000
Professional gross receipts: ₱700,000
Creditable withholding tax from employer: ₱120,000
Creditable withholding tax from clients: ₱35,000
The taxpayer elects 8% for professional income and is qualified.

A. Compensation Income

Gross compensation: ₱1,000,000 Less mandatory contributions: ₱60,000 Less exempt 13th month pay and benefits: ₱90,000 Taxable compensation income: ₱850,000

Tax on ₱850,000:

₱102,500 + 25% of excess over ₱800,000 Excess: ₱50,000 25% = ₱12,500 Tax on compensation: ₱115,000

B. Professional Income

Because the taxpayer is a mixed-income earner, the ₱250,000 reduction is not again deducted.

Professional receipts: ₱700,000 8% tax: ₱56,000

C. Total Income Tax

Tax on compensation: ₱115,000 Tax on professional income: ₱56,000 Total income tax due: ₱171,000

Less withholding taxes:

Employer withholding: ₱120,000 Client CWT: ₱35,000 Total credits: ₱155,000

Tax payable: ₱16,000

XLII. Illustrative Comprehensive Example: Corporation

Assume a domestic corporation has the following:

Gross sales: ₱50,000,000
Sales returns and discounts: ₱2,000,000
Cost of sales: ₱30,000,000
Operating expenses: ₱10,000,000
Interest expense: ₱1,000,000
Taxes and licenses: ₱500,000
Depreciation: ₱1,500,000
Creditable withholding taxes: ₱1,000,000
Applicable tax rate: 25%

A. Net Sales

Gross sales: ₱50,000,000 Less returns and discounts: ₱2,000,000 Net sales: ₱48,000,000

B. Gross Income

Net sales: ₱48,000,000 Less cost of sales: ₱30,000,000 Gross income: ₱18,000,000

C. Taxable Income

Gross income: ₱18,000,000 Less operating expenses: ₱10,000,000 Less interest expense: ₱1,000,000 Less taxes and licenses: ₱500,000 Less depreciation: ₱1,500,000 Taxable income: ₱5,000,000

D. Regular Corporate Income Tax

25% × ₱5,000,000 = ₱1,250,000

E. Less Tax Credits

Tax due: ₱1,250,000 Less CWT: ₱1,000,000 Tax payable: ₱250,000

The corporation must still check whether MCIT applies and whether it is higher than the regular corporate income tax.

XLIII. Income Tax Returns

Common income tax returns include:

BIR Form 1700 — Annual Income Tax Return for individuals earning purely compensation income.
BIR Form 1701 — Annual Income Tax Return for self-employed individuals, estates, and trusts.
BIR Form 1701A — Annual Income Tax Return for individuals earning income purely from business or profession under certain methods.
BIR Form 1701Q — Quarterly Income Tax Return for individuals.
BIR Form 1702 series — Corporate annual income tax returns.
BIR Form 1702Q — Quarterly corporate income tax return.
BIR Form 1601-C — Monthly remittance return of income taxes withheld on compensation.
BIR Form 1601-EQ — Quarterly remittance return of creditable income taxes withheld.
BIR Form 1604-C and 1604-E series — Annual information returns for withholding taxes.
BIR Form 2316 — Certificate of compensation payment and tax withheld.
BIR Form 2307 — Certificate of creditable tax withheld at source.

XLIV. Documentation and Substantiation

The taxpayer must maintain records sufficient to prove income, deductions, and tax credits.

Important documents include:

Official receipts or invoices
Books of accounts
Bank records
Payroll records
BIR Form 2316
BIR Form 2307
Contracts
Billing statements
Proof of payment
Inventory records
Depreciation schedules
Withholding tax returns
Financial statements
Audited financial statements, when required

Failure to substantiate deductions or credits may result in disallowance.

XLV. Penalties

Failure to properly compute, file, or pay income tax may result in:

Surcharge
Interest
Compromise penalties
Deficiency tax assessment
Disallowance of deductions
Criminal liability in serious cases
Administrative sanctions

Common violations include late filing, late payment, underdeclaration of income, overstatement of deductions, failure to withhold, failure to remit withholding taxes, and failure to keep books.

XLVI. Tax Avoidance, Tax Evasion, and Substance Over Form

Taxpayers may lawfully arrange their affairs to reduce taxes, provided the arrangement is legitimate and consistent with law.

However, tax evasion is illegal. It generally involves fraud, deceit, concealment, false entries, sham transactions, or intentional nonpayment.

The BIR and courts may apply doctrines such as:

Substance over form
Business purpose doctrine
Step transaction analysis
Assignment of income doctrine
Related-party scrutiny
Transfer pricing rules

Thus, income tax computation is not merely mathematical. The legal character of transactions matters.

XLVII. Practical Summary

Income tax in the Philippines is computed by answering these core questions:

Who is the taxpayer?
Is the taxpayer taxable on worldwide income or only Philippine-sourced income?
What kind of income was earned?
Is the income taxable, exempt, subject to final tax, or subject to special tax?
Are deductions allowed?
Is the taxpayer using itemized deductions, OSD, or the 8% option?
What tax rate applies?
What taxes were already withheld or paid?
Is the taxpayer entitled to credits, refund, or carry-over?
Were filing, withholding, and substantiation requirements complied with?

The central computation may be simple, but the legal analysis behind it can be complex. Philippine income tax depends not only on arithmetic but also on taxpayer classification, source rules, income characterization, statutory exemptions, withholding rules, and compliance with BIR regulations.