INCOME TAXATION

Pre-Final
Learning Objectives
Determine deductible from non-deductible
expenses/losses.

Describe the concept of allowable tax deductions.

Distinguished between optional standard and itemized

deduction.

Enumerate the items composing the itemized deductions.

Learning Objectives
State the requisites for business expenses to be deductible.

Describe the tax treatment of interest expense.

Describe the concept of taxes, losses, bad debts,

depreciation, research and development and pension trust
as allowable business deductions.

Identify the charitable contributions that are deductible in

full or subject to limitations.
 Nature of Deductions
In general, deductions or allowable deductions are
business expenses and losses incurred which the laws
allow to reduce gross business income to arrive at net
income subject to tax.

Deduction are strictly construed against the taxpayer

and not presumed but allowable only by reason of
specific provisions or law and not under any general
equitable or Constitutional concept.
DEDUCTIBLE EXPENSES
1. Business Expenses
2. Interest
3. Taxes
4. Losses
5. Bad Debts
6. Depreciation
7. Depletion of Oil and Gas Wells and Mines
8. Charitable and other contributions
9. Research and Development
10. Pension Trusts
NON-DEDUCTIBLE EXPENSES
1. Personal, living or family expenses.

2. Any amount paid out for new building or for permanent

improvements or betterment made to increase the value of any
property or real estate. Capitalized.

3. Any amount expended in restoring property or in making good the

exhaustion thereof for which an allowance is or has been made.
Capitalized.

4. Premium paid on any life insurance policy covering the life of any
officer or employee, when the taxpayer/company is directly or
indirectly a beneficiary under such policy.

5. Losses from sales or exchange of property between related taxpayers.

 Revenue vs. Capital Expenditure
Revenue expenditures - are ordinary expenditures that
provide benefits to the current accounting period. They
are usually called “period cost” because they are related to
a particular period of time of business operation.

Capital expenditure - are non-recurring expenditure

related to the acquisition of depreciable assets to be used
in the business, but not for sale, having useful life of
several years. They are usually called “CapEx” and provide
current and future benefits in business operation.
WHAT TO CLAIM
Itemized Deductions
In General. - There shall be allowed as deduction from
gross income all the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on
or which are directly attributable to, the development,
management, operation and/or conduct of the trade,
business or exercise of a profession.
Optional Standard Deduction (OSD)
In place of itemized deduction, resident citizen, non-
resident citizens, resident aliens and taxable estate and
trusts, may deduct a standard deduction in an amount
not exceeding 40% of their gross sales or gross
receipts.

Domestic and resident foreign corporation may also

elect 40% OSD of its gross income (Section 3 of
RA9504, June 17, 2008)
Illustration
Assume the following data of a taxpayer:

Gross sales P 1,000,000

Cost of sale 800,000

How much is the OSD if the taxpayer is/an

1) Individual
2) Corporation
Solution
Individual Corporation
Gross sales P1,000,000 P1,000,000
Less: Cost of sales - 800,000
Gross income P1,000,000 P 200,000
OSD rate 40% 40%
OSD Amount P 400,000 P 80,000
Section 4, Rev, Regs. No. 16-2008
“Passive income” which have been subjected to final tax
at source shall NOT form part of the gross income for
the purpose of computing forty percent (40%) optional
standard deductions”.

Accordingly, other items of income that were not

subjected to final taxes are NOT precluded as part of the
gross income in computing the 40% corporate OSD.
Business Expenses
In general, all the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on
or which are directly attributable to the development,
management, operation and/or conduct of the trade,
business or the exercise of a profession are deductible.

For an expense to be allowed, the reasonableness of

the amount being claimed is a prime consideration.
Business Expenses
Payments, which constitute bribes, kickbacks and other of
similar nature, shall not be allowed as deductions from
gross income.

Compensation payments – must be for personal services

actually rendered by employees under an employer-
employee relationship.

Fringe benefits – The gross-up monetary value of fringe

benefits is deductible provided that the final tax has been
paid.
Business Expenses
Travel Expenses – here and abroad while away from
home in pursuit of a trade, business or profession.

Rental – includes other payments required to be

made as a condition to the continued use or
possession, for the purpose of the trade, business or
profession, of property to which the taxpayer has not
taken or is not taking title or in which he has no equity
other than that of a lessee, user or possessor.
Business Expenses
Entertainment, Amusement and Recreation Expenses –
expenses during the taxable year that are directly connected or
related to the operation or conduct of the trade, business or
profession or that are directly related to or in furtherance of
the conduct of his/its trade, business or exercise of a profession
not to exceed such ceilings prescribed by rules and regulations.

Limitation: not more than 0.50% of net sales for taxpayer

engaged in sales of goods and properties OR 1% of net revenue
of taxpayer engaged in sale of services, exercise of profession
and use or lease of properties.
Business Expenses
Repairs – are expenditures to restore assets to good
operating condition upon breakdown by replacing
broken parts. Ordinary repairs are normally charged as
expense when incurred

Extraordinary repairs are material replacement of parts,

involving large sum of money, that extend the useful
life of the assets. This type of repairs are usually
capitalized and depreciated over a period of time.
Business Expenses
Cost of materials and supplies – either of the
following methods may be used in deducting the cost
of materials and supplies as a business expenses.

Cost and expenses of a Regular Banking Unit –

only those attributed to the operation of the RBU can
be claimed as deduction to arrive at the taxable income
of the RBU subject to regular income tax.
Business Expenses
Additional Deductions to a Private Education
Institution:

Private education institution may deduct expenditures

otherwise considered as capital outlay of depreciable
assets incurred during taxable year for the expansion
of school facilities; or deduct allowance for
depreciation.
Business Expenses
Deductions for Corporations engaged in Farming

1. Cost of ordinary tools or short life tools.

2. Cost of feeding and raising livestocks representing

actual outlay but not including the value of farm
products grown upon the farm.

3. Cost of gasoline or fuel, repairs and upkeep of the

transportation equipment.
Business Expenses
Expenses not allowed for Farming Entity

1. Cost of farm machinery, equipment and farm building.

2. Amounts expended in the development of farms, orchards and

ranches, prior to the time when productive state is reach.

3. Amounts expended in purchasing work, breeding or dairy animals

unless such animals are included in an inventory.

4. Cost of gasoline or fuel, repairs and upkeep of transportation

equipment used for pleasure or convenience of the farmers.
Business Expenses
Discount Allowed for Senior Citizens:

 Any Filipino citizen who is resident of the Philippines and who is

60 years old or above including those with “dual citizenship” for
at least 6 months residency in the Philippines.

 All establishment supplying any of the following goods and

services to senior citizens shall give 20% discount.

 The grant of the discount is only for the purchase of goods and
services for the exclusive use and enjoyment or availments of
the senior citizen only.
Business Expenses
Items included in senior citizen discount:

1.Medicines including influenza and pneumococcal vaccine and such

other essential medical supplies, accessories and equipment as
determined by DOH subject to 20% discount.

2.Professional fees of attending physicians in all private hospital, medical

facilities, outpatient clinics and home health care services shall be
subject to 20% discount and VAT exemptions.

3.Professional fees of licensed health workers providing home health

care services as endorsed by private hospitals or employed through
home health care employment agencies (entitled to 20% discount).
Business Expenses
4.Medical and dental services, diagnostic and laboratory fees in all private
hospital, medical facilities, outpatient clinics and home health care services
in accordance with DOH rules and regulations in coordination with
Philhealth.

5.Actual fare for land transportation, travel in public utility buses, public
utility jeepney’s, Asian Utility Vehicles, shuttle services and public railways,
LRT’s, MRT’s and PNR trains. Taxi fares are subject to the 20% senior citizen
discount.

6.Actual transportation fare for domestic air transport and shipping vessels
based on actual fare and advance booking. Fares shall be subject to the 20%
discount and VAT.
Business Expenses
7.Services in hotels and similar lodging establishments, restaurant and recreation
centers.

8.Admission fees and charged by theaters, cinema house and concert hall, circuses,
carnivals and other similar places of cultures, leisure and amusement. The discount
shall be on the admission fees charged by the establishment.

9.Funeral and burial for senior citizen. Beneficiary or person who shoulder the funeral
expenses shall claim the discount. Excluded from discounts are obituary publication
and cost of memorial lot.

10.On basic necessities and prime commodities. Special discount of 5% on basic

necessities and prime commodities, taking into consideration that said purchases is
for personal/exclusive consumption of the senior citizens.
Business Expenses
Discount Allowed for Persons with Disability

RA 9442 provides that person/individual suffering from

restriction or different abilities as a result of mental,
physical or sensory impairment to perform activity in a
manner or within the range considered normal for
human being shall be entitled to claim at least 20%
discount from establishment relative to the sales of
goods or services for their exclusive use or enjoyment.
Business Expenses
Establishment required to give discount:

1. Hotels and similar lodging establishment

2. Sports and recreation centers
3. Theaters, cinema houses, concert halls, carnivals, leisure and
amusement places
4. All drugstore for purchase of medicine
5. Medical and dental privileges in government facilities
6. Medical and dental privileges in private facilities
7. Domestic air and sea transportation
8. Land transportation privileges in bus fares, LRT, MRT, PNR and
toll way fee of vehicle owned by PWD.
Interest
Shall refer to the payment for the use or forbearance or
detention of money, regardless of the name it is called or
denominated. It includes the amount paid for the
borrowers use of money during the term of the loan as well
as for his detention of after due date for its repayment.

Limitation: The taxpayer’s allowable deduction for interest

expense shall be reduced by an amount equal to the 33% of
the interest income subjected to final tax. Moreover, all
interest incurred or paid to related parties cannot be
claimed as deductions to income.
Requisite for Deductibility of Interest
1. There must be indebtedness.
2. There should be an interest expense paid or incurred upon such
indebtedness.
3. The indebtedness must be that of the taxpayer.
4. The indebtedness must be connected with the taxpayer
trade/business/profession.
5. The interest must have been paid/incurred during the taxable year.
6. The interest must have been in writing.
7. The interest must be legally due.
8. The interest payment must not be between related taxpayer.
9. The interest must not be incurred to finance petroleum operations.
10. In case of interest incurred to acquire property used in
trade/business/profession and not capitalized.
Illustration
On Jan. 25, 2014, A Company, a depositor of B Bank,
obtained a loan from C Financing Corp. to operate its
business. For the year 2014, interest income from A
Company deposit with B Bank is P180,000 on which a final
tax of P36,000 was withheld; its interest expense on the
loan obtained from C Financing is P150,000. The deductible
interest expenses is computed as follows:

Interest Expense P150,000

Less: 33% x P180,000 59,400
Deductible interest expense 90,600
Amendment from Create Law
Taxpayer otherwise allowed deduction for interest
expense shall be reduce by an amount equivalent to
twenty percent (20%) of interest income subject to
final tax.

However, if the final withholding tax rate on interest

income of 20% will be adjusted in the future, the
interest expense reduction rate shall be adjusted
accordingly.
Amendment from Create Law
For other domestic corporation subject to 20% income
tax rate, the deduction is zero (0%) since there is no
difference in the income tax rate on taxable income
(20%) with the tax rate applied on the interest income
subject to final tax (20%).

However, in the case of individual engaged in business

or practice of profession , such deduction shall take
effect upon the effectivity of CREATE.
Illustration
On Jan. 25, 2021, A Company, a depositor of B Bank, obtained a
loan from C Financing Corp. to operate its business. For the year
2021, interest income from A Company deposit with B Bank is
P180,000 on which a final tax of P36,000 was withheld; its
interest expense on the loan obtained from C Financing is
P150,000. The deductible interest expenses assuming the
company is subject to 25% income tax rate will be computed as
follows:

Interest Expense P150,000

Less: 20% x P180,000 36,000
Deductible interest expense 114,000
Taxes
Only taxes proper are deductible from gross income.
Interest and penalties incident to tax delinquency are
not deductible from gross income.

As a general rule, all taxes, national or local, paid or

incurred within the taxable year in connection with
the taxpayer’s trade, business or profession are
deductible from gross income.
Deductible Taxes
1. Documentary stamps taxes
2. Occupational taxes
3. Privileges and license tax
4. Excise tax
5. Import duties
6. Local business tax
7. Automobile registration fees
8. Community tax
9. Municipal tax
10. Foreign income tax if not claimed as tax credit
Non-deductible Taxes
1. Philippine Income Tax.

2. Income taxes imposed by authority of any foreign country if

claimed as tax credit. But in case a taxpayer does not signify in
his return his desire to avail of the foreign tax credit, this may be
deductible from gross income.

3. Estate and donor’s taxes.

4. Taxes assessed against local benefits of a kind tending to

increase the value of the property assessed.
Non-deductible Taxes
5. Value added tax
6. Percentage tax on stock transaction
7. Taxes not related to business, trade or profession
8. Special assessment tax
9. Surcharges
10. Compromise penalty
Tax Refund Benefits
Taxes when refunded or credited shall be included as
part of the gross income of the year or receipt to the
extent of the income tax benefit of said deduction.

In case of non-resident alien and resident foreign

corporations engaged in trade/business in the
Philippines, deduction is allowed only to the extent
that they are connected with income from Philippines.
Losses
Losses of property arising from fire, storms,
shipwreck, other casualties, robbery, theft of
embezzlement; and other losses, if incurred in
connection with trade, business or profession actually
sustained during the taxable year and not
compensated for by insurance or other forms of
indemnity, shall be allowed as deductions.
Requisites for Deductibility
1. The loss must be actually sustained in a closed and
completed transaction.
2. The loss must be that of the taxpayer and incurred in
trade, profession or business.
3. The loss must not be compensated by insurance or
other forms of indemnity
4. If a loss results from casualty, robbery, theft or
embezzlement, the loss must be reported to the BIR
from 30 days to 90 days from the date of its discovery.
Classification of Deductible Losses
1. Business losses such as losses incurred in trade or
profession
2. Casualty losses such as losses due to storm, fires,
shipwreck or other casualties of property connected
with profession, trade or business
3. Losses of business property due to theft, robbery or
embezzlement; and
4. Net operating loss carry over (NOLCO)
Net Operating Loss Carry Over (NOLCO)
NOLCO – shall mean the excess allowable deductions
over business gross income in a taxable year.

NOLCO and any item of incentive deduction under any

special law are not part of the itemized deductions.

The NOLCO shall be carried over as a special deduction

from gross income for the next three (3) consecutive
taxable years immediately following the year of such
loss.
Taxpayer Entitled to NOLCO
1. Individual taxpayer engaged in trade or business or
in exercise of his profession.

2. Domestic and resident foreign corporation subject to

normal income tax (NIT).

3. Special corporation subject to preferential tax rates

such as proprietary educational institution, hospital
and regional operating headquarters.
Bad Debts
Refer to those debts resulting from the worthlessness or
uncollectibility, in whole or in part, of amount due the
taxpayer by others, arising from money lent or from
uncollectible amounts of income from goods sold or
service rendered.

Tax benefit rule – The recovery of bad debts previously

allowed as deduction in the preceding year or years shall
be included as part of the taxpayer’s gross income in the
year of such recovery to the extent of the income tax
benefit of said deduction.
Reason for worthlessness
1. Insolvency of the debtor.
2. Death of the debtor without sufficient properties to
cover his debts.
3. Disappearance of the debtor.

A bad debt account cannot be ascertained worthless

when supported by a guarantor or surety. The creditor
cannot deduct the amount until all effort have been
done to collect from the guarantor or surety.
Depreciation
In general, there shall be allowed as deduction for
depreciation, a reasonable allowance for the exhaustion,
wear and tear, including reasonable allowance for
obsolescence, of property used in the trade or business.

When the taxpayer and the Commissioner have entered

into an agreement in writing specifically dealing with
the useful life and rate of depreciation of any property,
the rate so agreed upon shall be binding on both the
taxpayer and the Government.
Methods of Depreciation
Straight-line method

Declining balance method

Sum of the years digit method

Any other method which may be prescribed by the

Secretary of Finance upon the recommendation of the
Commissioner.
Depletion
The allocation of the cost or other basis of a wasting
assets over the period the natural resources is extracted
or produce.

Wasting assets or natural resources usually include coal,

oil, ore, precious metals like gold, silver and timber.
Wasting assets are consumable and irreplaceable.

Depletion allowance enables the taxpayer to recover that

capital interest free from income tax or some other basis.
Charitable and Other Contributions
Contributions Deductible in Full

1. Donation to the Philippine Government

2. Donation to certain foreign institution or international organization in

compliance with treaties or commitment entered into by government.

3. Donations to accredited non-governmental organization for scientific,

research, educational , sports, social welfare, cultural or charitable purposes
or combination thereof.

4. Donation to Integrated Bar of the Philippines

5. Contribution to the Philippine Red Cross Annual Fund Campaign

Charitable and Other Contributions
Contribution Subject to Limitations (5% or 10%)

1. Donation to the Philippine Government or to any of its

agencies or political subdivision exclusively for public use.

2. Donation to accredited domestic corporation or

association organized and operated exclusively for
religious, charitable, scientific, youth and sports
development, cultural or educational purposes, or for the
rehabilitation of veterans or to social welfare institution
or to NGOs.
Charitable and Other Contributions
Limitation: Donation, contribution or gifts actually paid
or made within the taxable year shall be allowed limited
deductibility in an amount not to exceed 10% for an
individual donor, and 5% for a corporations donor, of
the donor’s income derived from trade, business or
profession minus expenses but before the deduction for
charitable contributions.

The amount of any charitable contribution of property

other than money shall be based on the acquisition cost
of said property.
Illustration
Assuming that a taxpayer has a gross income of
P1,000,000 with allowable deductions of P240,000
excluding the donation of P40,000 to a non-stock and
non-profit religious association .

How much will be the allowable deduction for donation

if the taxpayer is:

a. Individual
b. Corporation
Solution
Individual Corporation
Gross income P1,000,000 P1,000,000
Less: Expenses (w/o donation) 240,000 240,000
Taxable income 760,000 760,000
Rate 10% 5%
Allowed deductions 7,600 3,800
Research and Development Cost
R & D Cost- are materials, equipment, facilities, personnel,
purchased intangibles, contract services and a reasonable
allocation of indirect costs that are specifically related to
research and development activities and that have no alternative
future use.

Research – are activities undertaken to discover new knowledge

that will be useful in developing new product service or process.

Development – activities involve the application of research

findings to develop a product, service or process.
Option for Treatment of R&D
1. Ordinary and necessary expenses deductible from the
business gross income in the year the expenses are
paid or incurred.

2. Deferred expense chargeable to the capital account but

not chargeable to property subject to depreciation or
depletion. Expenses will be allowed as deduction
ratably distributed over a period of not less than 60
months beginning with the month in which the
taxpayer first realizes benefits from such expenditures.
Pension Trusts
An employer establishing or maintaining a pension trust to
provide for payment of reasonable pensions to his employees
shall be allowed as a deduction a reasonable amount
transferred or paid into such trust during the taxable year in
excess of such contributions, but only if such amount:

1. Has not been allowed as a deduction

2. Is apportioned in equal parts over a period of ten (10)

consecutive year beginning with the year in which the transfer
or payment is made.
Types of Pension Trusts
1. Defined benefit plan. The employer handles and
manages the fund. The benefit that the retiree would
receive are defined and normally based on certain
percentage of the salary of the employees eligible to the
benefit plan.

2. Defined contribution plan. The trust fund is handled by

a third party, normally an insurance company or bank as
the “administrator”. The liability of the employer is to
contribute the defined or contracted periodic
contribution as per agreement with the administrator.
Requirements of Plan
It is nor important whether the benefit plan is defined
benefit or defined contribution as long as the
following BIR requirements are met:

1. The plan must be reasonable and actuarially sound.

2. The plan must be approved by the BIR. To be
approved by the BIR, the plan must comply with
requirements of Rev. Regs No. 1-68 and Rev. Regs.
No. 1-83.
Amendment from Create Law
Provided, further, that for the additional deduction for
enterprise-based training of student from the Public
Educational Institutions, the enterprise shall secure
proper “certification” from Department of Education,
Technical Educations and Skills Department Authority
or Commission on Higher Education .

Provided, finally, that such deduction shall not exceed

Ten Percent (10%) of Direct Labor Wages.
Amendment from Create Law
Upon the effectivity of the Create Law – an additional
deduction from taxable income of one-half (1/2) of the
value of labor training expenses incurred for skills
development of enterprise based trainees enrolled in
Public Senior High Schools, Public Higher Education
Institutions or Public Education Institutions or Public
Technical and Vocational Institution and duly covered
by an apprenticeship agreement under PD442, series
of 1974 or the Labor Code of the Philippines as
amended, shall be granted to enterprises.
The End