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MSJG TAX 1 Chap 8

Mar Sean Jan Gabiosa

Chapter Notes
Income Taxation 7th edition Valencia and Roxas
Chapter 8 Deductions from gross Income
Deductions or allowable deductions are construed against taxpayers. Deductions
are not presumed.
Revenue regulation No 12-2013:
a) No deduction shall be allowed if withholding taxes are not withheld.
b) No deduction also for during tax assessment on deficiency of withholding
taxes for alleged failure the taxpayer paid the withholding taxes.
Business expenditure, major classification:
a) Revenue expenditure period costs; period of time operation expense;
DEDUCTIBLE.
Ex. Salary expense, Supplies, Repairs
- And other recurring expenditures that benefit only the
current operation, and do not improve the life of the asset used
in business.
b) Capital expenditure nonrecurring; acquisition of depreciable assets but
not for sale.
The cost incurred is capitalized, and not immediately expensed.
Capitalize costs conditions:
a) Increase in useful life; or
b) Increase in capacity; or
c) Increase in efficiency
If neither one of the conditions is met, the expenditures should be repairs and
maintenance which is revenue expenditure (DEDUCTIBLE).
Situs of expense When there is Operating expenses incurred both Within Phil and Outside Phil,
the mixed expenses should be allocated based on gross income
Not deductible from gross income (meaning negative effect to taxpayer because
not deductible):
a) Personal, living expenses;
b) Improvement to property or estate
c) Restoration of property
d) Premiums on life insurance which the taxpayer is a beneficiary to it
c) Transaction loss from sale of property, interest, and bad debts
d) Bribes, kickbacks, others
e) Donations, excess of compensation for services
f) Donations to political candidates.
Tax Law prevails over GAAP
Not deductible expenses which are on GAAP but not allowed on Tax code:
Estimated uncollectible expense
Misc. Expenses without receipts
Compensation income deductions:
a) Personal Exemption (50,000 per individual, Sec 35 NIRC)
b) PPHHI (Premium payments of health and/or hospitalization insurance)
2,400 per year with total family income not exceed 250,00 per year.
Corporations are not allowed to deduct personal deductions.
Classifications of Deductions
Optional standard deduction (OSD)

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Regular allowable itemized deductions; and

Special allowable itemized deduction
Optional or Itemized deduction is irrevocable once elected for the taxable year of a
taxpayer.
Revenue Memorandum Circular (RMC) No. 16-10; requires taxpayer to declare
intention or election of their 1st quarter income tax return their deduction option
(optional or itemized)
OSD
Passive income (Final taxes) shall not form part of the 40% OSD gross income. In
reverse, Other items not subject to final taxes are included in OSD gross income
computation.
Allowed to claim OSD:
Individual
Resident citizen
Nonresident citizen
Resident citizen
Taxable estates and trusts
Corporations
Domestic
Resident foreign
Capital gain may no longer offset losses of taxpayer if he claims the OSD

REGULAR ALLOWABLE ITEMIZED DEDUCTIONS

Itemized deductions are allowed deductible ordinary and necessary business
expenses. These deductions require supporting documents to justify reduction from
gross income
Compensation income are not allowed for OSD and Itemized deductions
Each spouse may either use OSD or Itemized deductions.
Income subject to RAID:
Business/professional income: Within and without by resident citizen
Within by nonresident citizen; resident and
nonresident alien
General co-partnership
Business income:
Within and without by Domestic corp.
Within by Foreign corp.
Proprietary educational institutions and nonprofit
hospitals
Proprietary government-owned or controlled
corporations
RAID comprise of itemized deduction from Section 4 A to J of NIRC
Requisites for deductibility of general expenses: (all should be met)
a. ordinary and necessary
b. recorded/substantiated with official receipts
c. reasonable amount
d. withheld with tax
e. not contrary to Laws ,Morals, Public police or Public order
f. incurred or paid and deducted within the taxable year
Expenses should be deducted within its year of incurrence
Ordinary is to reasonable and common development, management, operation,
business and trade.
Necessary is to useful or helpful - need not to be essential or indispensable

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Salaries and Wages and other forms of compensation plus GMV of FBT are ordinary
expense.
Not subject to withholding tax:
a. Holiday pay, overtime pay, night shift, MWE
b. De minimis
Tax exempt compensations not subject to withholding tax are still deductible
expense.
Deductible Compensation for injuries and pensions; Salary after a death; Death
benefits.
(reminder: This is from the eyes of the business. It is deductible or not from
their part is the question)
*Donations are not business or compensation related
Materials and Supplies
Actual Consumption method generally, the cost of materials and supplies
are deductible expense.
Total purchases method if the taxpayer carries incidental materials or
supplies on hand, deduct it from gross income as it were purchased for the year.
Production cost method if it is used for directly or indirectly in producing
products, it shall form part of the cost of the product.
Office supplies is to deductible expense
Factory supplies is to inventoriable cost
Traveling expense should be incurred solely for business or profession.
Rent expense for continue use or possession of property is deductible.
Advance payment of rent (for the part of the lessee) is only deductible on the
period it is used. However when the cash method is used, rent expense is only
deductible when paid.
Leasehold improvement shall be depreciated over, the life of the leasehold >or<
lease contract, whichever is shorter.
Representation expense /amusement/recreation/entertainment
Deductible when:
a. lawful
b. with receipt/record
c. ceiling requirement: % of net sales(good) or 1% of net revenue(services)
EAR entertainment amusement and recreation
INTEREST
Deductible Interest expense: (only when indebted)
a. indebted in writing
b. indebt in connection of trade
c. paid or accrued on the year
d. interest must not be in favor of a relative
33% of Interest income earned (that was subject to 20% final taxes) shall reduce
the amount of deductible interest expense. (R.A. 9337 Jan 1, 2009) (individual or a
corporation)
Interest expense is deductible in full when:
a. business has no interest income subject to 20% final tax; or
b interest expense is paid in favor of the government.
Interest on delinquent taxes is Deductible.
Nondeductible interest expense:
a. paid not business related;
b. paid in favor of a relative;
c. paid in advance;
d. to purchase or carry tax-exempt transactions;
e. paid on indebtedness to finance petroleum explorations;
f. unclaimed salary.

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Related debtor and creditor:

When interest in loan:
a. between family members.
b. between individual who owned more than 50% of the corp.
c. between two corp where an individual owns more than 50% in each
corp.
d. between fiduciaries(two trusts) owned by the same grantor.
Prepaid interest (cash basis-individual)
a. Interest expense (prepaid) is deductible on the year the principal
indebtedness is fully paid. (ex. When there is a loan net of interest expense, the
interest is deductible only in the year the loan is to be paid)
b. Proportionate amortization
Amortization Principal
Fraction
Deductible interest expense
3
6
6/9
6/9 of total
3
3
3/9
3/9 of total
6
9
total interest
Finance Petroleum Exploration nondeductible interest expense because
appropriately capitalized as Deferred Exploration Cost.
Option of taxpayer for interest:
Either
{ Outright Deduction deductible expense
{ Capital Expenditure capitalize cost, and deductible depreciation
expense.
TAXES
Generally, taxes are allowed as deduction (with exemptions from the law provide).
Nonresident alien (engaged in trade and business);
Foreign Corporation;
- Taxes are allowed to be deductible if and to the extent they are
connected with income from within.
Income tax paid to foreign country:
Taxpayer option is to:
a. item of deduction;
b tax credit.
Requisites for Tax Deductibility: [all]
a. paid/incurred within taxable year
b. paid/incurred of taxpayers profession/trade/business; and
c. imposed directly to taxpayer.
Allowed Deductible Taxes:
Documentary stamp
Occupational
Privilege and license
Excise
Import
Local Business
Automobile registration
Community
Municipal
Income tax paid to foreign country if not claimed as tax credit
Nondeductible taxes (from gross income):
Philippine income
Estate or Donors
Foreign income tax, claimed as tax credit
Percentage tax on stock transaction

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VAT
Taxes not related to profession/trade/business
Other items (Special assessment; Surcharges; Compromise penalty)
Deductible taxes are limited only to basic tax.
Surcharge or Penalty is not included.
But interest on delinquent taxes is deductible interest expense.
*therefore there is deductible tax, and deductible interest expense
Bad Debts
Charge to bad debt expense due to estimated uncollectible receivable is not
deductible.
To be deductible, a claim must be ascertained and must be written off within
taxable year.
Worthlessness:
a. Insolvency; or
b. Death; or
c. Disapperance.
Worthlessness all efforts have been done to collect from the
guarantor, if there is grantor.
Deductibility of Bad Debts: [requisites-all]
a. Existing valid and subsisting claim;
b. Claim must be connected with prof/trade/business;
c. Claim must not be between related parties under Sec 36(B);
d. Ascertained to be worthless;
e. Written off.
Nondeductible Bad Debts:
a. Not connected with p/t/b; or
b. unpaid wages/salaries, rents, similar items; or
c. contract between related taxpayers or relatives.
Valuation of Bad debts
When the businesses purchase receivable and then it cannot collect the receivable:
Without recourse the bad debt is deductible
With recourse the bad debts is not deductible because it still can collect to
the seller of receivables.
Original amount of receivable is deductible; interest from it is not deductible.
Installment price XX
Cash price
(XX)
Interest (not deductible)
Cash Price
XX
Paid/Downpayment (XX)
Uncollectible amount (deductible)
If the debtor is bankrupt, the allowed deduction is
Total liab to one creditor
Toal liab to ordinary creditors
Bad debt of cash basis taxpayer
Ex. In a servicing business cash basis, the uncollectible account is not an
income, therefore it is not deducible bad debts.
Depreciation
Depreciation expense is deductible; it enables taxpayers to recover the acquisition
cost of the property.
Intangible assets refer to amortization not depreciation.
Deductibility: [requisites]

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a. reasonable
b. charged off during the year
c. p/t/b
d. assets must have limited useful life
e. located within (for nonresident alien or a foreign corp.)
Straight-line method when the problem is silent.
Vehicle depreciation expense
-only one vehicle is allowed for use of an employee, and the value should
not exceed 2.4 million.
If exceed 2.4 million:
a. totally barred from claiming any depreciation expense &
maintenance expense;
b. input taxes on purchase and maintenance is nondeductible.
Unless the main line of business is about vehicle, therefore
depreciation expense is allowed deductible. (Take effect on Oct 17 2012, all
prior date purchase is not covered by this regulation)
Therefore:[checklist]
a. if one employee has two cars, only one vehicle is to be a deductible
depreciation.
b. all prior purchases (oct 17, 2012) is deductible depreciation
expense.
Depreciation in Petroleum Operations:
a. Properties directly related to production of petroleum in a taxable year:
[option of taxpayer]
a. Straight line
b. Declining balance
b. Change of depreciation
-only from declining then shift to straight line.
c. Estimated useful life:
a. Properties related to production - 10 years estimated life or shorter
as per BIR commissioner
b. Properties not related 5 years straight line method
Mining Operation Allowed depreciation:
a. If expected life is 10 years or less Normal rate; or
b. If expected life is more than 10 years Any number of years between 5 yrs
and expected life;
c. Allowed by BIR[?].
Depletion expense allowed as deductible also for the purpose of recovery of
invested capital.
Cost of property
Less: Salvage value (plus if any restoration cost)
Depletion
Divide by estimated amount to be extracted (tons)
Depletion per unit
Multiply by amount of extracted resources
Depletion expense
Exploration and Development expenditures means expenses paid/incurred to
ascertain the deposit or the resource; means Development stage.
Tax treatment:
a. Adjusted cost basis; or
Cost of property

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Less: Depletion
(Cost of property/Estimated Amount of
resource Resource extracted)
Balance
Add: Current Exploration cost
New Depletion per unit
b. Deduction to compute taxable income.
Conditions:
a. Not exceed 25% of the net income, without any tax law

benefits
b. Actual Exploration Cost minus 25% Net income
allowed deduction for the year, and the remaining
is for the succeeding year.
Production
Less: Production and selling cost
Net income
Actual current exploration
Less: 25% of Net income deductible for the current year
Chargeable to succeeding year
Capital expenses of a Private Educational Institution:
Option/Treatments:
a. Immediate deductible expense; or
b. Allowance for depreciation.
method)

(per se Outright method)

(per se Spread out

For tax purpose, it is not important whether the benefit plan is Defined Benefit or
Defined Contribution, as long as the ff requirements are met:
a. Reasonable and Actuarially sound; and
b. BIR approved, requirements of Rev. Reg. No 1-68 and No. 1-83.
Allowable deduction is equal to normal or actual contribution, whichever is
lower.
With excess of actual over actuarial to be amortized over 10 years.
Charitable contributions: [requisites to be deductible]
a. must be engaged in p/t/b;
b. actual payment of contribution or gift;
c. recipient is an entity or institution;
d. net income must not inure to the benefit any person.
Contributions deductible in full: [if conditions not met, deductibility is subject to
limit]
a. Donations to Philippine Government;
b. Donations to international organizations in compliances;
c. Donations to Accredited NGO:
c.1 not more than 30% for administrative purpose;
c.2 must be utilized before fifteenth day third month of taxable year;
c.3 upon dissolution, assets shall be distributed.
Contributions deductible subject to limit
Based on Net income before contribution or Actual contribution, whichever is
lower:
a. Individual taxpayer, 10%;

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b. Corporation, 5%.

Donations to political parties are not deductible.

Not subject to donors tax as long as duly reported to COMELEC.
Any unutilized/excess campaign funds is subject to income tax of the
candidate.
A taxpayer has the option to consider research and development expenditures as:
a. Ordinary and necessary expense Outright method
b. Deferred expense distribute not less than 60 months beginning first
month of realization.
Premium Payments for Health/Hospitalization Insurance (PpHHI)
2,400 per family or 200 per month, whichever is lower during taxable
year
Provided gross income for the year do not exceed 250,000 for
the calendar year.
Nuclear family is the basis for this gross income, a single person living alone is
considered to be one.
SPECIAL ALLOWABLE ITEMIZED DEDUCTIONS (SAID)
SAID are additional incentives allowed to be deducted from gross income:
[over and above ordinary and necessary deductible expenses]
Adopt-a-school program
RA 8525
15% additional deduction of salaries/wages paid to senior citizen
Senior Citizen Discount
RA 9257
Discounts to Person with Disability
RA 9442
Rooming-in and Breast-feeding Practices
RA 7600
Free legal assistance
RA 9999
Qualified Productivity Bonus
RA 6971
Income currently distributed to beneficiaries under estate and trusts
NOLCO
Special deduction allowed to insurance companies
Adopt-a-School program
Deductible amounts of gross income:
a. actual amount of assistance/donation { part of regular itemized
deduction}, plus;
b. additional amount of 50% actual contribution { part of SAID}
*exempt from donors tax
Seniors Citizen Salaries and discounts
Salary/wage conditions:
a. 6 month employment;
b. Minimum wage.
SC Discount rates:
a. Good and services, 20%;
b. Water(>30m3) and Electricity(>100kwh), 5%
c. Electricity, water and telephone by Senior Citizen Center by
Government or Domestic NGOs, 50%.
Sales discount to PWD
20% of gross selling price or gross receipt (pwd or senior citizen)
Rooming-in or Breast-feeding practices
Deductible amount is twice the actual amount incurred.

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Free legal assistance

Whichever is lower:
10% of gross income form actual performance; or
Professional fee Total voluntary hours less of 60 hours (mandatory
legal aid under BAR Matter No. 2012)
Qualified Productivity Incentive Bonuses 50% of
Productivity Incentive Act of 1990
Deductible requirements:
a. payment of bonus is in fact a compensation;
b. must be for personal services rendered;
c. reasonable amount.
Ex. profit sharing; manpower training; and special studies.