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Deductions
Deductions
DEDUCTIONS: are the amounts which the laws allow to be deducted from gross income to arrive at taxable income.
Burden of Proof: is with the taxpayer to establish the validity of the deductions claimed. He must point to some specific provisions of the statute in which that
deduction is authorized, and must be able to prove that he is entitled to deduction which the law allows.
Nature: deductions partake of the nature of tax exemptions and as such, they are to be construed strictissimi juris against the taxpayer.
As discussed under Tax on Individuals, the Optional Standard Deduction (OSD) is 40% of Gross Income and in lieu of the itemized deductions.
OSD for individuals are in all respects similar to the OSD available to an individual earning business income or income from profession, EXCEPT that the basis
of the 40% OSD is the gross income, which is net of the cost of sales or services (similar to MCIT), while for individuals, the basis is gross sales or receipts,
before any such costs.
Likewise, Gross Income for OSD purposes does not include income items which have been already subjected to Final Tax or Capital Gains Tax.
Election of the OSD must be communicated in the 1st quarter return. Meaning, if the corporation used the OSD instead of the itemized deduction in its 1st quarter
return, it cannot later on used the itemized deductions for the Annual Income Tax Return. (RR No. 2-2010)
Applicability: the OSD is available to domestic corporations and resident foreign corporations only.
B. ITEMIZED DEDUCTIONS
General Requirements:
1. Should be ordinary and necessary expenses paid/incurred during the taxable year for the development, management, operation and/or conduct of the
trade, business or profession such as, salaries and other remuneration, travel expenses, rentals, and entertainment, amusement and recreation expenses
directly related to or in furtherance of trade. (Sec. 34[A][1] of the Tax Code);
2. Substantiated by Adequate Proof - documented by official receipts or adequate records which reflect the: (a) amount being deducted and (b) connection
or relation of expense to business/trade. (Sec. [34][A][1][b]);
3. Not contrary to law, morals, public policy or order (e.g., bribes, kickbacks or similar payments) (Sec. 34[A][1][c])
4. The taxes required to be withheld (if applicable) have been properly withheld and remitted on time (Sec. 34[K])
Note that under RR No. 12-2013, amending RR No. 2-98, any deduction which was not subjected to the required withholding tax shall be non-deductible
for income tax purposes, even if the amount of withholding tax is paid during or after an investigation. This rule, however, has been amended by RR No.
6-2018, which reinstated the old rule that a deduction will still be allowed in the following cases:
a. The payee reported the income and pays the tax due thereon and the withholding agent pays the tax including the interest incident to the failure to
withhold the tax, and surcharges, if applicable at the time of the audit/investigation or reinvestigation/reconsideration.
b. The recipient/payee failed to report the income on the due date thereof, but the withholding agent/taxpayer pays the tax, including the interest
incident to the failure to withhold the tax, and surcharges, if applicable at the time of the audit/investigation or reinvestigation/reconsideration.
c. The withholding agent erroneously under-withheld the tax but pays the difference between the correct amount and the amount of tax withheld
including the interest, incident to such error, and surcharges, if applicable, at the time of the audit/investigation or reinvestigation/reconsideration.
Items of deduction representing return of capital such as those pertaining to purchase of raw materials forming part of finished product or purchases of
goods for resale, shall be allowed as deductions upon withholding agent’s payment of the basic withholding tax and penalties incident to non-withholding
or under-withholding.
1. TRAVEL EXPENSES: include transportation expenses and meals and lodging paid by the employer. It also includes laundry and other incidental expenses
that are directly connected with the trip.
The term “away from home” means away from the taxpayer’s employee’s place of employment regardless of where the family residence is maintained.
If an individual is not away from home, expenses related to business may nevertheless be claimed as transportation expenses.
2. RENTAL EXPENSES: a reasonable allowance for rentals and/or other payments which are required as a continued use or possession, for purposes of the
trade, business or profession, or 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.
Bribes, Kickbacks and Similar Payments: if the payment constitutes a bribe or kickback, it shall not be allowed as a deduction from gross income.
However, even if the same is not considered deductible, it shall form part of the recipient’s gross income.
4. INTERESTS (Sec. 34[B]): interest is defined as compensation for the use or forbearance or detention of money, regardless of the name it is called or
denominated. (RR No. 13-2000)
The amount of deductible interest shall be reduced by an amount equal to 33% of interest income earned which had been subjected to final withholding
tax.
Illustration: X corporation earned P100,000 interest income from bank deposits subject to the 20% final tax and incurred P50,000 interest expense from
its loans.
The amount deductible shall be reduced by P33,000 (33% of the P100,000 interest income). Thus, the deductible interest expense shall only be P17,000.
DEDUCTIBLE: Taxes paid or incurred within the taxable year in connection with the taxpayer’s trade or business which are deductible for income tax
purposes, examples of which are:
a. Local business taxes;
b. Real property taxes;
c. License and permit fees;
d. Gross receipts tax for banks and financial institutions;
e. Percentage taxes;
f. Documentary stamp taxes.
VAT is not considered a tax incurred in connection with the taxpayer’s trade or business, since it is a tax on consumption. However, if the input VAT on
purchases is attributable to VAT-exempt sales, it shall form part of the cost or expense to which it is related and may thus be claimed as a deductible
expense for income tax purposes. The same is true with regards the excess of the input VAT attributable to sales to government or directly related thereto
over the standard input VAT.
However, under Sec. 4(C) of RR No. 13-00, interest incurred or paid by the taxpayer on all unpaid business-related taxes shall be fully deductible from
gross income and shall not be subject to the limitation on deduction of interest expense. Thus, such interest expense incurred or paid shall not be diminished
by the percentage of interest income earned which had been subjected to final withholding tax.
▪ The interest on deficiency donor’s tax is deductible. The SC explained that taxes here are considered obligation or indebtedness. And it ruled that we
have to relax the distinction between tax and ordinary obligation in this respect.
▪ Interest on deficiency income tax can also be claimed as deductible interest expense because taxes here are considered ordinary obligations.
Tax Credit: resident citizens and domestic corporations are allowed a credit for taxed paid in foreign countries. Note that this is not allowed for non-
residents and alien individuals, as well as foreign corporations, since they are only taxable in their income from within the Philippines.
Limit:
P600,000
x P450,000 = P180,000
P1,500,000
The allowable tax credit will be the actual amount paid or the limit, whichever is lower. Since the amount of tax paid in the foreign country (P40,000) is
less, X Corporation may claim the whole amount as tax credit against his Philippine income tax.
Under limit (a), the limit is computed on a per country basis, using the same formula as that used in a single country limit
P300,000
x P180,000 = P90,000
P600,000
The limit computed above (under letter b) is then compared with the total amount paid, which is P95,000, the lower amount of P90,000
would then be limit b.
Limit a (P80,000) and b (P90,000) are then compared, and the limit of tax credit shall be whichever is lower between the two. In this case, the allowable
tax credit shall be the P80,000 computed under limitation (a).
Taxes as credit vis-à-vis as deduction:
Insurance: insurance received as compensation for a loss must be subtracted in arriving at the amount of the loss. If the insurance proceeds exceed the
net book value of the damaged assets, such excess shall be subject to the regular income tax, but not to the VAT, since the indemnification is not an actual
sale of goods by the insured company to the insurance company. (RMO No. 31-09)
ILLUSTRATION: ABC Company’s machinery broke down due to floods that inundated its factory. The machinery costs P1,000,000 and at the time of
the flood, it had a carrying amount of P200,000, and a fair market value of P250,000.
How much is deductible loss? P200,000 – the carrying amount of the asset at the time of loss.
If ABC Company received P80,000 as compensation for such loss from insurance, how much is deductible loss? P120,000 – the portion reimbursed by
insurance is not deductible.
If ABC Company received P250,000 from the insurance company, how much is deductible loss? P0. Since the carrying amount (the amount of loss) is
fully compensated by the insurance proceeds. In fact, the excess of P50,000 is subject to regular corporate income tax.
Loss arising from casualty, robbery, theft or embezzlement: shall file a sworn declaration of loss to be filed within 45 days from the date of the event.
Failure to report a theft or robbery to the police can be held against the taxpayer. However, a mere report of an alleged theft or robbery to the police
authorities is not considered as conclusive proof of the loss arising therefrom. (RMO No. 31-09)
Casualty Loss: is one that has occurred in an identifiable event that was sudden, unexpected or unusual. Examples include loss caused by fire, unless
the taxpayer sets the fire, in which case no deduction is available.
ILLUSTRATION: For 2016, X Company had gross income amounting to P200,000 and operating expenses amounting to P500,000.
In this case,
• X Company has a Net Operating Loss of P300,000
• This loss can be carried over and claimed as additional deduction in the next three consecutive taxable years, until 2019.
• If X Company avails of the OSD instead in 2017, it cannot claim as a deduction the P300,000 NOLCO. Same is true if in the next three years,
the Company is an MCIT position. Still, the expiration date of the NOLCO to be claimed as deduction remains to be 2019.
Loss from wash sales of shares of stocks or securities: A taxpayer cannot deduct any loss claimed to have been sustained from the sale or other
disposition of stock, if, within a period beginning thirty (30) days before the date of such sale or disposition and ending thirty (30) days after such date
(referred to as the sixty-one (61)-day period), he has acquired (by purchase or by an exchange upon which the entire amount of gain or loss was recognized
by law), or has entered into a contract or option so to acquire, substantially identical stock.
However, this prohibition does not apply in the case of a dealer in stock if the sale or other disposition of stock is made in the ordinary course of the
business of such dealer. (Sec. 6[c.6] of RR No. 6-08)
Substantially identical: means that the stock must be of the same class, or in the case of bonds, the terms thereof must be the same.
Losses from wagering: deductible only to the extent of gains from wagering transactions and cannot be deducted from other gains or income items.
While gains from wagers are taxable in full.
Impairment: reduction in the value of assets through fluctuation of the market prices or otherwise, are not deductible for income tax, unless they are
actually disposed of, destroyed, or sold for less than their actual value.
7. BAD DEBTS (Sec. 34[E]): are those debts or receivables due to the taxpayer which are actually ascertained to be worthless and charged off within
the taxable year.
Currently, under BSP regulations, the BSP must be notified of the decision of the Board of Directors to declare receivables as worthless.
Worthless debts: the determination of whether a debt is worthless must be made by reference to all the pertinent evidence, including the general
financial condition of the debtor and whether the debt is secured by collateral. A receivable is deemed worthless if after taking reasonable steps to
collect the debt, there is no likelihood of recovery at anytime in the future.
It must be noted, however, that a collection suit need not be filed in court, it is sufficient that reasonable efforts were exerted to collect the debt, and
such efforts proved to be insignificant.
Recovery of bad debts previously written off: is taxable only if there was a previous benefit derived therefrom, i.e., it was previously claimed as a
deduction for income tax purposes. If there is no such deduction claimed, then subsequent recovery of a bad debt or uncollectible account is not taxable,
this is otherwise known as the tax benefit rule.
8. DEPRECIATION (Sec. 34[F]): is the gradual diminution in the useful value of the property used in the trade or business resulting from exhaustion, wear
and tear, and normal obsolescence.
9. DEPLETION OF OIL AND GAS WELLS and MINES (Sec. 34[G]): depletion is the removal, extraction or exhaustion of a natural resource like mines and
gas wells as a result of production or severance from such mines or wells.
Campaign Contributions: under RR No. 7-2011, the campaign contributions may be treated as a deductible item only if the same is declared in the Statement
of Expenditures submitted by the candidate to the COMELEC.
LIMITATIONS ON DEDUCTIONS
Contribution made to a pension trust may be claimed as deduction in the following manner:
a. Amount contributed for the normal service cost – 100% deductible; and
b. Amount contributed for the past service cost – 1/10 of the amount contributed is deductible in year the contribution is made, the remaining balance
will be amortized equally over nine consecutive years
ILLUSTRATION: X Corporation established a pension trust for its employees. For the year 2016, the current service cost as determined by the actuary
amounted to P1M. X Corporation made a total of P1.2M as total contributions for the year.
In this case, the whole P1M will be considered as normal service cost; while the excess of P200,000 will considered for past service cost and shall be
amortized over a period of 10 years, thus, the amount deductible for past service cost is only P20,000 (P200,000/10 years). The total amount deductible
for pension cost is P1,020,000. The remaining P180,000 contributed during the year will be deductible for the succeeding 9 years at the rate of P20,000
annually.
13. SENIOR CITIZEN AND PWD DISCOUNT: the 20% discount granted to senior citizen shall not be deducted from the gross sales as are regular discounts,
but forms part of itemized deductions/operating expenses.