Chapter 13-A - Regular allowable itemized deductions

What are the itemized deductions from gross income?

1. Interest expense – subject to the arbitrage limit or arbitrage cap

2. Taxes – in connection with the taxpayer’s trade business or exercise of profession (recovery of
taxes paid is part of gross income). Only the basic tax is deductible, tax surcharges for late
payments are not deductible.

3. Losses – actually sustained during the taxable year and not compensated for by insurance or
other indemnity (recovery of losses is part of gross income)

4. Bad debts – actually written off (recovery of written off bad debts is part of gross income)

5. Depreciation – reasonable allowance for the exhaustion and wear and tear (including reasonable
allowance for obsolescence)

6. Depletion – provision for the periodic return of capital investment in wasting assets such as
minerals, gas and oil

7. Charitable and other contributions – deductible in full and subject to limitations

8. Contributions to pension and trusts – employer’s share

9. Research and development costs – research activities geared towards discovery of new
knowledge and development activities are geared towards determining application of research
knowledge which could provide income and benefits for the business.

10. Other ordinary and necessary trade, business or professional expenses – substantiated by
official receipts and other pertinent records (operating expenses of the business)

What is the current arbitrage limit or arbitrage cap?

33% of the interest income which is subject to the final tax of 20% (Interest income from a private
individual or not subject to 20% final tax is not covered)

What are the other deductible interest expense?

1. Interest from tax delinquency

2. Interest from scrip dividends

What are the optional treatment of interest expense?

1. Outright deduction from gross income

2. Capital expenditure claimable through depreciation

What are examples of non-deductible interest?

1. Interest on personal loans

2. Interest incurred with a related party

3. Discount or pre-deducted interest applicable to future periods for individual taxpayers

4. Interest expense incurred to finance petroleum operations

5. Interest on redeemable preferred shares

6. Imputed interest

What taxes are not allowed as deduction from gross income?

1. Philippine income taxes, except fringe benefit tax

a. Final income tax

b. Capital gains tax

c. Regular income tax

2. Foreign income tax, if claimed as tax credit

3. Estate and donor’s tax

4. Special assessment

What are examples of deductible taxes?

1. Percentage tax

2. Excise tax

3. Documentary stamp tax

4. Occupational tax

5. License tax

6. Fringe benefit tax (FBT)

7. Local taxes except special assessment

8. Community tax

9. Municipal tax
10. Foreign income tax if not claimed as tax credit

What are the requisites for the deduction of losses?

1. It must be incurred in trade, profession or business of the taxpayer (business loss, not personal
loss)

2. It must pertain to property connected to trade, business or profession, if the loss arises from fires,
storms, shipwrecks or other casualties, or from robbery theft or
embezzlement (ordinary loss)

3. The loss must not be compensated by insurance or indemnity contract (actually sustained, not
temporary)

4. A declaration of loss must have been filed by the taxpayer within 45 days from the date of
discovery of the casualty or robbery, theft or embezzlement giving rise to the loss

5. The loss must not have been claimed as a deduction for estate tax purposes in the estate tax
return (double deduction not allowed)

What are examples of deductible ordinary loss?

1. Loss on disposal or destruction of any ordinary asset

2. Loss due to voluntary removal of building incident to renewal or replacement

3. Permanent or irreversible loss in the value of assets due to changes in business conditions, only
to the extent actually realized

4. Abandonment losses

What are the requisites for deduction of bad debts?

1. The debt must have been ascertained to be worthless

2. It must be charged off within the taxable year

3. It must be connected with the taxpayer’s profession, trade or business

4. The taxpayer must be under the accrual basis of accounting

5. It must not be incurred from a related party

What are examples of capital losses not deductible as bad debts?

1. Bad debts from personal receivables

2. Securities becoming worthless of taxpayers other than domestic banks and trust companies a
substantial part of whose business is the receipts of deposits

3. Loss on capital investments in partnerships, joint ventures or corporations

What is the tax treatment of Intangible exploration and development costs?

Before commercial production – capitalized as cost of the wasting asset

After commencement of commercial production, if incurred with:

1. Non-producing wells or mines – deducted in the period paid or incurred

2. Producing wells or mines, at the option of the taxpayer, either:

a. Capitalized and amortized using the cost-depletion method or

b. Deducted in the year paid or incurred

What are the requisites of claim for deduction on contributions?

1. The donee institution must be a domestic institution

2. No income of the done institution must inure to the benefit of any private stockholder or individual

3. The contribution must be valued at the tax basis of the property donated

4. The taxpayer must be engaged in trade or business

5. The done must issue a CERTIFICATE OF DONATION (BIR Form 2322) which includes a donor’s
statement of values

6. If the amount of donation is at least P50,000, the donor shall file a NOTICE OF DONATION to the
RDO where he is registered within THIRTY (30) DAYS upon receipt of the Certificate of Donation

What is the percentage of limitation for contributions subject to limitation?

1. 10% for individual taxpayers

2. 5% for corporations

To be based on the net income before deduction of any contribution

What are the requisites of deductibility of pension expense?

1. The employer must have established a pension or retirement fund to provide for payment of
reasonable pensions to employees

2. The actuarial assumptions used by the fund must be sound and reasonable

3. The fund must be actually funded by employer

4. The fund assets must be independent from and not subject to the control or disposal of the
employer

5. Contribution for current service cost is deductible in full

6. Contribution for past service cost is amortized over a period of 10 years

What are the rules in computing the deductible pension expense?

1. The contribution to the fund is first attributed to current service cost which is deductible in FULL

2. The excess funding is attributed to any unfunded past service cost, which is amortized for 10
years (so only 1/10 can be claimed)

3. Overfunding of the fund is a prepaid pension expense deductible in the future as funding of future
current service cost

What is the tax treatment of Research and Development Costs (R&D)?

1. R & D costs related to capital accounts are to be capitalized then deducted through depreciation
expense.

2. R & D costs not related to capital accounts are treated as follows at the option of the taxpayer:

a. Outright expense

b. Deferred expense amortized over a period not less than 60 months

What are the other legal, ordinary, actual and necessary expenses of the business?

1. Salaries and allowances

2. Fringe benefits

3. SSS, GSIS, PhilHealth, HDMF and other contributions (employer’s share)

4. Commissions

5. Outside services
6. Advertising expense

7. Rental expense

8. Insurance expense

9. Royalties paid

10. Repairs and maintenance expense

11. Entertainment, amusement and recreation expenses (EAR)

12. Transportation and travel expense

13. Fuel and oil

14. Communication, light and water

15. Supplies expense

16. Miscellaneous expenses

What is the ceiling on deduction for EAR?

For taxpayers engaged in sales of goods or properties - 0.5% of net sales (gross sales – sales
returns and allowances and sales discounts)

For taxpayers engaged in the sales of services – 1% of net revenues (gross revenue less discounts)

For taxpayers engaged in the sales of both goods or properties and services :

EAR = Net Sales or Net Revenue / Total net sales and net revenue x actual EAR

A taxpayer incurred an interest expense payable to a bank amounting to P50,000 and earned
the amount of P6,000 gross interest income from bank deposits. How much is the deductible
interest expense?

P48,000

A taxpayer incurred an interest expense payable to a bank amounting to P50,000 and earned
the amount of P6,000 gross interest income from an individual borrower. How much is the
deductible interest expense?

P50,000, no arbitrage for interest income not subject to 20% final tax

A percentage tax of P5,000 was imposed on a business plus P200 as tax surcharge for late
payment. How much is the total allowable deduction as taxes?

P5,000, tax surcharge is not deductible