ALLOWABLE

DEDUCTIONS
ALLOWABLE DEDUCTIONS

Are business expenses and losses incurred

which the law allows to reduce gross business
income to arrive at net income subject to tax
In times of conflict whether an expense is
deductible from gross income or not, the rule of
deductibility should be strictly construed against
the taxpayer
TYPES OF ALLOWABLE
DEDUCTIONS

Kinds of allowable deductions:

Itemized deductions:
Business expenses - Bad debts
Interest - Depreciation
Taxes - Depletion
Losses - Pension trusts
Charitable contributions - Research & devt
Premium payment for health/hospitalization insurance
TYPES OF ALLOWABLE
DEDUCTIONS

Optional standard deduction (OSD) in lieu of the

itemized deduction (except premium payment for
health/hospitalization insurance) the taxpayer may claim
optional standard deduction equivalent to the following:
For individual taxpayers 40% of gross sales /
revenue
For corporate taxpayers 40% of total gross income
In case the taxpayer opted to deduct the OSD, the
deductions claimed may not be substantiated by
adequate evidences (only documents supporting the
computation of gross income should be substantiated)
APPLICATION OF OPTIONAL STANDARD
DEDUCTION (OSD)

A taxpayer who elected to avail of the OSD shall signify

in his / its return such intention, otherwise he / it shall be
considered as having availed himself of the itemized
deductions allowed under Section 34 of the Code
Once the selection is made, the same type of deduction
must be consistently applied for all succeeding quarterly
returns and in the final income tax return for the taxable
year
OSD FOR GENERAL PROFESSIONAL
PARTNERSHIP (GPP)

For general professional partnership for purposes of

computing the distributive share of the partners, the net
income of the GPP shall be computed in the same
manner as a corporation (such being the case, a GPP
may claim either itemized deductions or OSD in
computing its distributive net income)
The partners of the GPP shall not be permitted from
claiming further deductions from their share in the net
income once the GPP avails of the OSD in computing its
net income
OSD FOR GENERAL PROFESSIONAL
PARTNERSHIP (GPP)

Specifically, if the GPP claimed itemized deductions, the

partners comprising it can only claim itemized deductions
which are in the nature or ordinary and necessary
expenses for the practice of profession which were not
claimed by the GPP during the year (such as
representation expenses incurred by the partner covered
by receipts and invoice issued in his name, traveling
expenses away from home not liquidated by the
partnership, depreciation of car used in the practice of
profession where said car is registered in the name of the
partner and other similar expenses)
ITEMIZED DEDUCTION

General requirements to deduct business expenses:

1. The expenses incurred shall be directly attributable to
the development, management, operation and/or
conduct of the trade, business or exercise of profession
of the taxpayer
2. It should be paid or incurred during the taxable year
3. It should be reasonable as to amount
4. It should be supported by adequate evidences (such as
official receipts, payroll schedule, etc.)
5. If applicable, the corresponding withholding tax should
be paid or remitted with the BIR
REVENUE VS. CAPITAL
EXPENDITURE

There are two major classification of business expenditures:

1. Revenue expenditure
Are ordinary recurring expenditures that provide
benefits to the current accounting period
Are usually called period costs because they are
related to a particular period of time of business
operation
They are charged to expense as incurred, and are
deductible from gross income, provided, as they
satisfy the conditions prescribed by the Tax Code
(deductible on the taxable period incurred or paid)
REVENUE VS. CAPITAL
EXPENDITURE

2. Capital expenditure
Are nonrecurring expenditures related to acquisition
of assets to be used in the business, but not for sale,
having a useful lives of several years
They provide current and future benefits in business
operations
Cost incurred (or paid) for acquiring such assets are
capitalized and not immediately expensed
They are gradually expended from period to period in
the form of depreciation or amortization within their
estimated useful life
ITEMS NOT DEDUCTIBLE FROM GROSS
INCOME

As a general rule, no deductions shall be made from gross

income in any case with respect to:
Personal, living and family expense
Any amount paid out for new buildings or for permanent
improvements, or betterments made to increase the
value of the property or estate
Any amount expended in restoring property for which an
allowance is or has been made
Transactions between related taxpayers resulting to
losses from sales or exchange of property, interest
expense or bad debts
ITEMS NOT DEDUCTIBLE FROM GROSS
INCOME

As a general rule, no deductions shall be made from gross

income in any case with respect to:
Premiums paid on any life insurance policy covering the
life of any officer or employee, or of any person financially
interested in any trade or business carried on by the
taxpayer, when the taxpayer is directly or indirectly a
beneficiary under such policy
Bribes, kickbacks and other similar payments
Donations made to employees and others, which do not
have in them the element of compensation or are in
excess of reasonable compensation for services
 SPECIAL TREATMENT ON
DEDUCTIONS ALLOWED TO PRIVATE
EDUCATIONAL INSTITUTIONS

Capital outlays of depreciable assets for expansion of

school facilities may at its option be:
Deducted during the taxable year (outright method or
revenue expenditure method); or
Depreciated over the estimated life (allowance method
or capital expenditure method)
BUSINESS EXPENSES

Examples of business expenses are:

Salaries, wages, management expenses, fringe benefits,
commissions and labor
Supplies, repairs and maintenance, and other incidental expenses
Operating expenses of transportation equipment used in the trade,
profession of business
Rental for the use of business property
Advertising and selling expenses
Travelling expenses while away from home solely in the pursuit of
trade, business or profession
Insurance premiums against fire, storm, theft, accident or other
similar losses in the trade or business
SALARY EXPENSE

Salary expense are allowed as deductions from gross

business income only if the corresponding withholding
tax has been deducted and remitted to the BIR (except
for those exempted from income tax such as
compensation of minimum wage earners and other
nontaxable compensation)
For fringe benefits, the amount deductible should be
inclusive of fringe benefit tax paid be the employer to the
BIR
MATERIALS AND SUPPLIES

Cost of materials or supplies are deductible when paid /

incurred or consumed / used in the business operation
during the taxable period
Two methods may be used in deducting the cost of
materials and supplies as business expense:
1. Actual consumption the taxpayer should maintain a
record of consumption of materials and supplies and
takes physical inventories at the end of the taxable period
(the amount deductible is the actual materials and
supplies consumed during the taxable period)
2. Purchase method the amount of materials and supplies
purchased during the year is the amount deductible
REPAIRS AND MAINTENANCE

Repairs are expenditures to restore assets to good

operating condition upon breakdown by replacing parts
Two classification of repairs:
Extraordinary repairs are material replacement of
parts, involving large sum of money, that may either
extend the life or improve the performance of the
asset (capital expenditure method shall be used)
Ordinary repairs are minor replacements of parts,
involving small sum of money (revenue expenditure
shall be used)
RENT EXPENSE

Rent expense are payments required to be made as a

condition to the continued use or possession of property
to which the taxpayer has not taken or is not taking title or
in which has no equity other than that of a lessee, user or
possessor
Rent is deductible when liability is incurred during the
period of use (while on cash basis, rent is deductible
when incurred or paid)
LEASEHOLD IMPROVEMENTS

When the lessee constructed an improvement on the

leased property, the costs of such improvement shall be
depreciated over the life or the term of the lease contract,
whichever is shorter
Deductible amount = Cost of leasehold improvement
Useful life or lease term,
whichever is shorter
REPRESENTATION EXPENSES

Representation expense shall refer to expenses incurred

by a taxpayer in connection with the conduct of his trade,
business or exercise of profession, in entertaining,
providing amusement and recreation to, or meeting with,
a guest or guests at a dining place, place of amusement,
country club, theater, concert, plat, sporting event, and
similar events and places
Representation expense also includes allowance for
depreciation of entertainment facilities such as yacht,
vacation home or condominium and other similar item of
real or personal property
REPRESENTATION EXPENSES

The deductible representation expense should not

exceed to the following ceiling amounts:
of 1% of net sales for taxpayers engaged in sale of
goods / properties
1% of net revenue for taxpayers engaged in sale of
services including exercise or profession and use or lease
or properties
If the taxpayer is deriving income from both sale of goods /
properties and services, the allowable representation
expense shall be determined based on an apportionment
formula taking into consideration the percentage of the net
sales / net revenues, but not to exceed the maximum
percentage ceiling as provided above
REPRESENTATION EXPENSES

Requisites for deductibility of representation expense:

It must not be contrary to law, morals, public policy or
public order
It must be substantiated with sufficient evidence
There must be some definite reasonable purpose
connected with ones business (receipts / invoices shall be
in the name of the taxpayer claiming the deduction)
It does not constitute bribe, kickback or other similar
payment
If applicable, the appropriate withholding tax has been
deducted and remitted to the BIR
INTEREST EXPENSE

Interest in the cost of money incurred within a taxable

year on indebtedness in connection with the taxpayers
profession, trade or business
Requites for deductibility are as follows:
There must be an indebtedness
The indebtedness must be that of the taxpayer
The indebtedness must be in connection with the his
trade, business or profession
The interest must be paid or incurred during the year
The interest must be stipulated in writing
The interest must be legally due
INTEREST EXPENSE

Nondeductible interest expense are as follows:

If within the taxable year, an individual taxpayer
reporting income on the cash basis incurs an
indebtedness on which interest is paid in advance
through discount, such interest shall be deductible in
the year the indebtedness is paid (but if debt is
payable in periodic amortization, the amount of
interest which corresponds to the amount of the
principal amortized or paid during the year shall be
allowed as deduction for such taxable year)
INTEREST EXPENSE

Nondeductible interest expense are as follows:

Interest payment arrangement between related
taxpayers
Indebtedness on which interest expense is paid or
incurred to finance petroleum operations in the
Philippines
Interest which was treated as a capital expenditure
(borrowing costs)
RELATED PARTIES

Considered as related parties as provided by the Tax Code

are the following:
Transactions entered between family members such as wife,
brothers, sisters, ancestors and other lineal descendants
Between individual and corporation of which such individual is
owner of more than 50%
Between two corporations in which the same individual owns
interest of more than 50% in each corporation
Between the grantor and fiduciary of any trust
Between the fiduciary and beneficiary of any trust
Between two fiduciaries of any trusts with a common grantor
INTEREST EXPENSE

The amount deductible as interest expense should be

reduced by an amount equal to the following percentages
of interest income subject to final tax:
Year % of Reduction
Starting 01/01/1998 41%
Starting 01/01/1999 39%
From 01/01/2000 to 10/31/05 38%
From 11/01/05 to 12/31/08 42%
Starting 01/01/09 33%
(This limitation was put in place to address tax arbitrage
schemes)
INTEREST EXPENSE

Interest expenses in favor of the government such as

interest on tax delinquency are fully deductible, hence
may not be reduced by 42% of interest income subject to
final tax.
TAXES

In general, taxes are allowed as deduction when paid or

incurred within the taxable year in connection with the
taxpayers trade, business or practice of profession
However, the following taxes are not deductible:
1. Philippine income tax
2. Transfer taxes (estate and donors tax)
3. Stock transaction tax
4. Value-added tax
5. Special assessment tax
6. Foreign income tax, if claimed as a foreign tax credit
BAD DEBT EXPENSE

Bad debts refer to those debts resulting from the

worthlessness or uncollectibility, in whole or in part, of
amounts due to the taxpayer by others, arising from
money lent or from uncollectible amounts of income from
goods sold or services rendered
For bad debts to be deductible, the claim must be
ascertained to be worthless and the corresponding
receivable should have been written-off within the taxable
period (thus bad debt expense as a result of providing
allowance for doubtful account is not deductible)
BAD DEBT EXPENSE

Requisites for deductibility of bad debts:

There must be a valid and subsisting claim
The claim must be connected with the taxpayers
trade, business or practice of profession
The claim must not be between related parties
The claim must be ascertained to be worthless and
uncollectible
The claim must be written off with the taxable period
The taxpayer uses the accrual method on reporting his
income (if cash method was used, bad debt expense
is not deductible)
DEPRECIATION EXPENSE

In general, methods of depreciation may be used for tax

purposes are the following:
Straight-line method
Declining balance method
Sum of years digit method
Any other method which may be prescribed by the
Secretary of Finance upon the recommendation of the
Commissioner
DEPRECIATION EXPENSE

Useful life or depreciation rate to be used should be

binding between the taxpayer and the Government if:
There is a written agreement as to the useful life of
any property; or
If the taxpayer adopted such useful life without any
written objection on the part of the Commissioner or
his duly representatives
Any change in estimated useful life should be adjusted
prospectively and not retrospectively
DEPRECIATION OF PROPERTIES
USED IN PETROLEUM OPERATIONS

The following rules shall apply for depreciating properties

used in petroleum operations:
Properties directly related to production of petroleum
shall be depreciated using either the following methods:
Straight-line method
Declining balance method
The useful life of properties shall be as follows:
Related to production or petroleum shall be 10 years
or such shorter life as may be permitted by the BIR
Not used in production of petroleum shall be
depreciated under straight-line method with a useful
life of 5 years
DEPRECIATION OF PROPERTIES
USED IN MINING OPERATIONS

Depreciation of properties used in mining operations, other

than petroleum operations, shall be determined as
follows:
Normal life if expected useful life of the property is 10
years or less
Depreciated over any number of years between 5 years
or the expected life if the latter is more than 10 years
DEPLETION

Depletion is the exhaustion of natural resources like

mines, oil and gas wells due to production
The cost-depletion method shall be used in determining
the deductible allowance for depletion
Intangible exploration and development expenditures
shall be deductible as follows:
On non-producing wells deductible in the year incurred
(outright expense)
On producing wells, either the following method may be
used
1. Deductible in full in the year paid or incurred (outright); or
2. To be capitalized and added as cost of wasting asset & shall
be subject to allowance for depletion (capital expenditure)
DEPLETION

If intangible exploration and development cost on

producing wells is deducted in full in the year incurred or
paid, the following limitations shall be considered:
Total amount deductible for exploration and
development expenditures shall not exceed 25% of
the net income from mining operations
The actual exploration and development cost minus
25% of the net income from mining shall be carried
forward to succeeding years until fully deducted
PENSION TRUSTS

Pension plan comprises a fund intended to provide

retirement benefits to the employees
Usually, employers set up a pension plan for its
employees after some years of operations when the
employer can already provide benefits to employees,
thus, any amount of periodic contribution to pension fund
made by the employer should be deducted as follows:
Contribution to cover pension liability accruing for the
current year (current-service cost) deductible in full
Amortization of contribution to cover pension liability for
past years services (past-service cost) to be prorated
over a period of 10 years beginning with the year in which
payment was made
CHARITABLE AND OTHER
CONTRIBUTIONS

Charitable contribution is synonymous to donation, and is

a non-operating expenses
Requisites for deductibility of charitable contributions are
as follow:
The taxpayer making the gift must be engaged to
trade, business or practice of profession
There must be an actual payment of contribution / gift
The recipient must be an entity or institution specified
by law
The net income of the institution must not inure to the
benefit of any individual or private stockholder (must
be a non-profit entity / organization)
CHARITABLE AND OTHER
CONTRIBUTIONS

Valuation of gift should be as follows:

If given in cash, the amount deductible should the face
value of the cash given
If given in kind other than case, the amount deductible
should be the cost of the said property given as gift
(cost is determined using the same basis as what has
been discussed on Dealings in Properties)
CHARITABLE AND OTHER
CONTRIBUTIONS

Contributions to the following entities specified by law

shall be deductible in full:
1. Government of the Philippines, or any of its agencies, or
political subdivisions, including government corporations
exclusively to finance, to provide for, or to be used in
undertaking specific priorities in education, health, youth
and sports development, human settlements, science and
culture and economic development
2. Donations to international organization in compliance with
agreements, treaties or commitments entered into by the
Government of the Philippines and the foreign institutions
or international organizations or in pursuance of specific
laws
CHARITABLE AND OTHER
CONTRIBUTIONS

Contributions to the following entities specified by law

shall be deductible in full:
3. Donations to Accredited Non-Government Organizations
subject to the following requisites:
Not more than 30% of the gift should be used for
administrative purposes
The contribution should be utilized not later than the
15th day of the third month after the close of its taxable
year
Upon, dissolution, a court shall distribute the assets of
the said NGO to another non-profit corporation of the
state or to other similar organization
CHARITABLE AND OTHER
CONTRIBUTIONS

If the requirements for full deductibility of contributions in

in the previous slides were not met, the donation shall be
subject to limit
The following limitations shall apply:
If the donor is an individual taxpayer, the limit is 10%
of the taxable income before contributions and
personal exemptions
If the donor is a corporation, the limit is 5% of the
taxable income before contribution
In this case, that the allowable deduction for charitable
contribution should not exceed the prescribed limitations
RESEARCH AND DEVELOPMENT

Research and development expenses are costs of

materials, equipments, facilities, personnel, purchased
intangibles, contract services and a reasonable allocation
of indirect costs that are specifically related to research
and development activities and the have no alternative
future uses
There are 2 methods than can be used in deducting
research and development:
Outright deduction on the year incurred or paid
Treated as deferred expenses and to be amortized for a
period of not less than 60 months (5 years)
LOSSES

Losses represent reductions on resources due to

unintended destruction on deprivation of things not in the
ordinary course of business
The following are examples of deductible losses (but not
limited to the following):
Casualty losses
Losses due to theft, robbery or embezzlement
Net operating loss carry over (NOLCO)
Loss from stocks becoming worthless
Loss from sale, exchange or disposition of assets
Loss on abandonment of operations
Loss of useful value
CASUALTY AND OTHER LOSSES

Losses arising from fire, storms, shipwreck and other

casualties, robbery, theft or embezzlement during the
taxable year, in connection with the taxpayers trade,
business and practice of profession actually sustained
during the taxable year and not compensated by
insurance or other forms of indemnity, shall be allowed as
deduction
However, the taxpayer shall submit a declaration of loss
not less than 30 days nor more than 90 days from the
date of discovery of such loss as a requisite for the
deduction
CASUALTY AND OTHER LOSSES

No deduction shall be made on such losses, if it has

been claimed as a deduction for estate tax purposes in
the estate tax return
If the loss does not result in total destruction of the
property, the amount of deduction shall be:
Book value at time of loss or cost to restore the
property to its normal condition, whichever
is lower P xxx
Less: Recovery from insurance and other indemnity xxx
Deductible loss P xxx
NET OPERATING LOSS CARRY-OVER
(NOLCO)

Net operating loss shall mean the excess of allowable

deduction over gross income of the business in a taxable
year
Net operating loss sustained during the year may be
carried over as a special deduction for the next 3
consecutive years immediately following the year of such
loss
Application of NOLCO shall be on a first-in, first-out basis
Taxpayers whose tax is based on taxable income (gross
income less allowable deductions) are permitted to
deduct NOLCO
NET OPERATING LOSS CARRY-OVER
(NOLCO)

The following NOLCO shall not be allowed as deduction:

NOLCO sustained during the taxable year in which the
taxpayer was exempt from income tax (taxpayers who
enjoys income tax holiday status)
NOLCO sustained during the year in which there is
substantial change in the ownership of the business
There is no substantial change in the ownership of the
business when:
Not less than 75% in nominal value of outstanding
shares or of the paid-up capital of the corporation, is
held by or on behalf of the same persons
NOLCO OF MINES OTHER THAN GAS
WELLS

For mines other than gas wells, NOLCO incurred in any

of the first 10 years of operation may be carried over as a
deduction from taxable income for the next 5 years
immediately following the year of such loss
NOLCO incurred starting on the 11th year of operations
may be carried over on the next 3 consecutive years
immediately following the year of such loss
LOSS FROM DECLINE IN VALUE OF
STOCK

Loss from shrinkage in the value of stock through

fluctuation of the market are not allowed as deductible
losses
Loss from stocks becoming worthless shall be treated as
a capital loss, hence, deductible only to the extend of
capital gain (taxpayer has to prove through clear and
convincing evidence that the securities are in fact
worthless)
LOSS OF USEFUL VALUE

Assets may lose their useful value due to technological

changes or new legislation
Losses sustained due to loss of useful value shall be
deductible from gross income on the year in which the
asset is permanently abandoned as to its use (amount
deductible is the book value of the property)
ABANDONMENT LOSS

In the event a contract area where petroleum operations

are undertaken is partially or wholly abandoned, the
taxpayer may claim the following as deduction on the
year of abandonment:
Unamortized cost of all accumulated exploration and
development expenditures
Undepreciated costs of equipment directly used in
producing wells
However, if such operation is reentered and production is
resumed, said costs of equipment or facilities previously
claimed as deduction shall be included as part of gross
income in the year of restoration or resumption
LOSS FROM WASH SALE

Wash sale is a sale of stock or securities within a period

beginning 30 days before the date of such sale or
disposition and ending 30 days after such date, the
taxpayer has acquired, or has entered into a contract or
option to acquire, substantially identical stock or
securities
Loss from wash sale by taxpayer other than a dealer of
securities is not deductible
Any non-deductible loss from wash sale shall be deferred
and be used in determining the adjusted cost basis of the
stocks acquired