Allowable Business

Deductions

Learning Objectives
1. Distinguish deductible from nondeductible business expenses for
purposes of taxation;
2. Summarize the requisites for
deductibility of business
deductions from gross income;
3. Compute for allowable business
deductions.

Deductions
Are expenses and losses incurred in
connection with the realization of
gross income, which the law allows
to be deducted from such income to
arrive at net income subject to tax.
As a rule, if the taxpayer does not deduct
his ELIT, he can no longer deduct them
from the income of any succeeding year.

Kinds of Deductions
Itemized deductions
Optional standard deductions
Special deductions
Premium paid on hospitalization
insurance
Income currently distributed to
beneficiaries under estates and trusts

Taxpayers Allowed
OSD
1. Resident citizens
2. Non-resident citizens
3. Resident aliens
4. Taxable estates and trusts
5. Domestic corporations
6. Resident foreign corporations

Optional Standard
Deduction
INDIVIDUAL
TAXPAYER

If taxpayer is under
the accrual basis,
OSD is 40% based
on gross sales;
If taxpayer is under
the cash basis, OSD
is 40% based on
gross receipts;

CORPORATION

OSD is 40%
based on
gross income

Compositions of
Itemized Deductions
1. General business expenses
2. Losses
3. Interest
4. Taxes
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 Trust

Income Subject to Allowable

Deductions
1. Business and professional income received by
individual taxpayers
2. Business and professional income of a general copartnership
3. Business income derived by domestic corporation
4. Business income of proprietary educational
institution and non-profit hospitals
5. Business income of proprietary government-owned
or controlled corporations
6. Business income within the Philippines earned by a
foreign corporation.

General Business
Expenses
Ordinary and/or necessary expenses paid or
incurred during the taxable year which are
directly attributable to the development,
management, operation and/or conduct of
trade, business or exercise of a profession.
Examples: salaries, fringe benefits (subject
to FBT), supplies, repairs and maintenance,
gasoline or transportation expense,
insurance, advertising, rent, representation,
and other incidental expenses

Requisites for Deductibility of

General Business Expenses
(DINORS)
1. Directly attributed to the development,
2.
3.
4.
5.
6.

management, operation, and/or conduct of

trade, business or exercise of profession;
Incurred or paid within the taxable year;
Not contrary to law, morals, public policy, or
public order;
Ordinary and/or necessary for the conduct of
business or exercise of profession;
Reasonable in amount;
Substantiated with official receipts or any
other adequate records.

Representation
Expenses (EAR)
These are entertainment, amusement, and recreation
expenses incurred or paid during the year that are
directly connected to the development, management and
operation of the trade, business or profession of the
taxpayer.
Subject to ceilings:
1. % of net sales trading business
2. 1% of net revenue service business
3. Net sales/net revenue

X Actual
Total net sales and net revenue
expense

Note: Allowable lower amount

Exclusions from EAR

1. Expenses which are treated as compensation or
fringe benefits for services rendered under
employee-employer relationship;
2. Expenses for charitable or fund raising events;
3. Expenses for bonafide business meetings of
stockholders, partners or directors;
4. Expenses for attending or sponsoring an
employee to a business league or professional
organization meeting;
5. Expenses for events organized for promotion,
marketing and advertising;
6. Other expenses of a similar nature.

Illustrative Problem
MCL Corp. is engaged both in sale of goods
and services. Following are the data
relevant to EAR expenses.
Sale of goods P1,000,000
Sale of services
Actual EAR expenses

400,000
250,000

How much is the deductible EAR expense?

EAR apportio
nment
basis
Sale of goods

1,000,000

Allowabl
Ceiling e

178,571 5,000

5,000

Sale of services 400,000

71,429

4,000

4,000

Total

250,000 9,000

9,000

1,400,000

Lease/Leasehold
Improvements
Shall be treated as capital
investment;
Subject to depreciation allowable
business expense
Basis: term of lease or estimated
useful life of improvement
whichever is shorter.

Interest
Shall refer to the payment for the use
or forbearance or detention of money.
It includes the amount paid for the
borrowers use of money during the
term of the loan, as well as for his
detention of money after the due date
for its repayment.

Requisites for Deductibility of

Interest Expense (WINDP)
1. There must be an indebtedness stipulated in writing.
2. The indebtedness must be that of the taxpayer in
connection with trade, business or profession.
3. The interest expense must not be in favor of a relative.
4. Interest must be legally due;
5. The interest must have been paid or accrued during
the taxable year.
6. For interest incurred to acquire property used in
trade, the same was not treated as capital
expenditure;
7. Must not be incurred to finance petroleum operations.

Interest Expense Deductible

with Limitation
Allowed provided it is reduced by an
amount equal to the percentage of
interest income subjected to final tax.
Tax difference of 10%
In order that the difference be offset
against another, the allowable
interest expense shall be reduced by
(10/30) or 33% of the interest income
of the same year.

Illustration:
Mr. Nyas record shows the following data:
P5,000 interest expense on personal loan;
P25,000 interest on business loan; P10,000
interest income on time deposit. How much is
the allowable interest expense?
Actual interest expense

P25,000.00

Less: Tax differential on int. income

(P10,000 x 33%)
Allowable interest expense
P21,666.67

3,333.33

Interest Expense
Deductible in Full
Interest expense on capital
expenditure incurred to acquire
a property used in trade,
business or exercise of a
profession.

Non-deductible Interest
Expense
Debtor and creditor are related
1. between family members
2. between individual and corporation, in which the
individual owns more than 50% of the corporations equity.
3. between 2 corporations, where more than 50% is owned
by the same individuals.
4. between fiduciaries of 2 trusts both owned by the same
grantor.
Prepaid interest by a cash basis taxpayer
Indebtedness is incurred to finance petroleum exploration

Requisites for Deduction of

Losses
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, business or profession;
3. Must not be compensated by insurance or other forms of
indemnity;
4. Loss must be reported to the BIR within 30-90 days from
date of its discovery;
5. Said properties must have been properly reported as
part of the taxpayers assets in the FS in the year
immediately preceding the occurrence of the loss;
6. Deduction of assets as capital losses must be properly
recorded.

Classification of
Deductible Losses
1. Business losses
2. Casualty losses
3. Losses due to theft, robbery
or embezzlement
4. Net operating loss carry over
(NOLCO)

Illustration
In 2015, D Company had a shipment with a
cost of P600,000 and insured the same
amount against marine perils. The vessel
carrying the property sank but the insurance
company refused to admit liability under the
policy. An action was brought in court and
the insurance company was asked to pay
damages for P500,000.
How much loss is to be reported in the
income statement?

How to Measure Loss

Adjustment must be made for any
expenditure or loss properly chargeable to
the asset account, and for depreciation,
obsolescence, amortization, and depletion.
In case of partial loss of property used in
trade or business or in the practice of
profession, the measure of loss is:
Cost to restore the property back to its
normal operating condition or book
value whichever is lower less insurance
recovery or any form of indemnity.

Illustrative Problem
Office equipment with a book value
of P400,000 was partially
destroyed by fire. The cost to
restore the property to its normal
operating condition was P300,000.
Covering insurance on the
equipment was P250,000.
How much is the deductible loss?

Seatwork:
ABC Corp. incurred the ff. losses:
1. Building razed by fire, cost P5M,
accum. depn. P3M, insurance
payment received, P1.6M, salvage
value P250,000.
2. Loss on robbery of office equipment,
cost, P90,000; AD, P25,000;
insurance recovered, P25,000

Requisites for Deduction

of Taxes
1. Must be paid or incurred within the
taxable year.
2. Must be paid or incurred in
connection with the taxpayers
profession, trade or business.
3. Must be imposed directly upon the
taxpayer.

Allowable Tax
Deductions (DOPECLAIM)
Documentary stamp taxes
Occupational taxes
Privilege and license taxes
Excise taxes
Community tax
Local business taxes
Automobile registration fees
Import duties
Municipal tax

Illustration:
Z Corp. paid in 20XX the following taxes
which were incurred in connection with the
business. Community tax, basic amount of
P1,000 and surcharge of P250 plus interest
of P125. Real property tax of P5,000 plus
surcharge of P1,250 and interest of P500.
Income tax, P100,000, plus surcharge of
P25,000 and interest of P10,000.
What would be the allowable taxes and
interest expenses? (compute separately)

Answer:
Community tax 1,000 Interest on:
Real property tax 5,000

community tax

Total taxes expense

6,000

real property tax 500

income tax

125
10,000

Total interest exp.

10,625

Net Operating Loss

Carry-Over (NOLCO)
Net operating loss is the excess of
allowable deductions over gross income
of the business for any taxable year.
The net operating loss which had not
been previously offset as deduction from
gross income, shall be carried over as a
deduction from gross income for the next
3 consecutive taxable years immediately
following the year loss was sustained.

Conditions for
NOLCO
NO substantial change in ownership of the
business;
> Not less than 75% in nominal value of the
outstanding issued shares, if the business is
in the name of the corporation, is held by or
on behalf of the same persons; or
> Not less than 75% of the paid-up capital
of the corporation if the business is in the
name of the corporation, is held by or on
behalf of the same persons.

NOLCO for Mines

Loss incurred in any of the 1st 10 years
may be carried over as a deduction
from the taxable income for the next 5
years immediately following such loss.

Taxpayers Entitled to
Deduct NOLCO
1. Any individual (including estates and
trusts) engaged in trade, business or
profession. An individual who claims the
40% OSD shall NOT simultaneously claim
deduction of NOLCO.
2. Domestic and resident foreign corporation
subject to NCIT;
3. Domestic and resident foreign corporation
subject to the preferential rates.

Illustrative Problem
DD Co. had the following data on income
and expenses for a taxable year:
Taxable income

P500,000

Nontaxable income
Deductible expenses

400,000
600,000

Nondeductible expenses 100,000

How much is net operating income or loss?

Bad Debts
Requisites for deductibility:
1.Debts due the taxpayer;
2.Connected with trade, business, or
practice of profession;
3.Actually ascertained to be worthless;
4.Charged off within the taxable year;
5.There must be a valid and subsisting
claim.

Depreciation
Requisites for deductibility:
1. allowance must be reasonable
2. allowance must be charged off during the year
3. asset must be used in profession, trade or
business
4. asset must have a limited useful life.
Shall be allowed on:
a. tangible property
b. intangible property through amortization

Depreciation - Vehicles
Requisites for deductibility (Rev Memo
Circular 2-2013):
1.Purchase is substantiated with OR and other
adequate records.
2.Only one vehicle for land transport is allowed
for the use of an official or employee, value not
exceeding P2.4M.
3.No depreciation for yachts, helicopters,
airplanes, and/or aircrafts, and land vehicles
exceeding P2.4M, unless main line of business is
transport operations or lease of transportation
equipment.

Pension Trusts
Apply to pension plans that are funded.
Deduction for pension trust:
1. Contributions to such trust during the taxable year
to cover pension liability accruing during the year
2. A reasonable amount transferred or paid into such
trust during the year in excess of:
a. if such amount has not been allowed as a
deduction
b. and is apportioned in equal parts over a period
of
10 years, beginning with the year in which the
transfer or payment is made.

Illustrative Problem
ABC put up a qualified retirement plan approved by the BIR. It
appointed B Corp. to administer the plan, which called for the
payment of P1,000,000 to cover the retirement of employees
for past services rendered and a yearly contribution of
P100,000. The following amounts were paid for the first three
years of the plans operation.
Contribution of Services
Past Years Current Years
1st Year

P500,000

P100,000

2nd Year

300,000

100,000

3rd Year

200,000

100,000

Compute the pension expense for years 1-3.

1st
Year

2nd
Year

3rd
Year

Current Year

100,00 100,0 100,00

0
00
0

Apportionme
nt

80,00 100,00
50,000 0
0

Total Amount
Deductible

150,00 180,0 200,00

0
00
0

4th-10th
Year
100,000

100,000

Charitable
Contributions
Requisites for deductibility:
1. Taxpayer must be engaged in trade, business
or exercise of profession.
2. There must be actual payment of contribution
or gift.
3. Recipient must be an entity or institution
specified by law.
4. Net income of the institution must not inure to
the benefit of any individual or private
stockholder

Classification of Charitable
Contribution
Contribution deductible in full
donations to the government or any of its
agencies, or political subdivisions exclusively to
finance, to provide for or to be used in undertaking
priority activities (determined by NEDA) in:
1. health
2. education
3. youth and sports development
4. science and culture
5. human settlements
6. economic development

Classification of Charitable
Contribution
Donations to international organizations
Donations to accredited non-government
organizations subject to the following requisites:
1. administration expense must not exceed 30% of
the total expenses.
2. contributions must be utilized not later than the
15th day of the 3rd month after the close of the
taxable year.
3. upon dissolution, assets of the said NGO must
be distributed to another non-profit domestic
corporation.

Classification of Charitable
Contribution
Contributions subject to limitation
If donor is an individual taxpayer, the limit is
10% of the taxable income derived from
business, trade or profession or the actual
contribution whichever is lower.
If the donor is a corporation, limit is 5% of
the taxable income derived from business,
trade or profession or the actual
contribution whichever is lower.

Examples of Charitable & Other

Contributions Subject to Limit:
Donations for the use of the government of the Philippines or
any of its agencies, or any political subdivisions exclusively for
public purposes.
Donations to non-government organizations
Donations to social welfare institutions
Donations to accredited domestic corporations exclusively for
the following purposes:
1. religious
2. charitable
3. scientific
4. youth and sports development
5. cultural
6. educational
7. rehabilitation of veterans

Illustration

Brian revealed the following data regarding his income and

expenses for the current taxable year:
Gross income from business

P800,000

Allowable Business expenses, excluding

charitable contributions

600,000

Contributions:
To the govt for priority activities

50,000

To the govt for public purposes

60,000

To church

15,000

Compute the allowable contributions assuming taxpayer is

a:
1.Individual taxpayer
2.corporation

Research & Development

Can be treated as:
Ordinary and necessary expenses deductible from
the business gross income in the year the expenses
are paid or incurred.
Deferred expenses chargeable to the capital account
but not chargeable to property subject to
depreciation or depletion.
If treated as Deferred expenses, such should be
distributed ratably for a period of 5 years beginning
on the month in which the taxpayer first realizes
benefits from such expenditure.

Limitations on
Deduction
Any expenditure for the acquisition or
improvement of land, or for the improvement of
property to be used in connection with research
and development of a character which is subject
to depreciation and depletion;
Any expenditure paid or incurred for the
purpose of ascertaining the existence, location,
extent, or quality of any deposit of ore or other
mineral, including oil or gas.

Illustration
In 2013, XYZ Corp. incurred total research and
development cost amounting to P15M in relation to
2015 electronic problems of automatic transmission
cars. The research became a success and on Apr. 1,
2015, XYZ was able to sell the software for P50M.
Assuming XYZ opted to charge the R&D cost as
ordinary expense, what is the amount of deductible
R&D expense in 2013? Succeeding years?
Assuming it was treated as deferred expense, R&D
expense is?