Chapter 6
Deductions
Deductions
• If their is no laws, statutes or BIR regulations
that allow the expenses to be deductible , even if
such expenses are related to business operation
and the amount is reasonable, the concerned
taxpayer cannot deduct the expenses from the
gross taxable income.
Kinds of Deduction
1. Optional Deductions
2. Itemized Deductions
3. Special deductions allowed
under special cases.
Optional Standard Deduction
• The OSD can be claimed IN LIEU of itemized deductions.
The following guidelines shall be observed in applying the
optional standard deduction:
1. The maximum allowable amount for individual
taxpayers is 40% of Gross Sales or Gross Receipts.
2. For corporate taxpayer, the total optional deductions
shall not be exceed 40% of the Gross Income.
3. OSD is not allowed for taxpayers earning
compensation income arising from employer-employee
relationship.
4. The following taxpayers are allowed to adopt the OSD:
a. Resident Citizen
b. Non- Resident Citizen
c. Resident Alien
d. Taxable Alien
e. Trusts
f. Domestic Corporation
g. Resident Foreign Corporation
5. Non-resident aliens and non-resident foreign corporations
cannot adopt the OSD.
6. Taxpayers who opted to claim OSD are not required to submit
their FS with their income tax return.
7. Taxpayers who select OSD should signify so in his/her return,
and such election shall be irrevocable during the taxable year.
NOTE:
1. Individual taxpayer who opted for the optional
standard deduction shall keep the records
pertaining to their gross sales or gross receipts,
and
2. For the corporation, such records pertaining to
its gross income as defined in Section 32 of the
Tax Code during the taxable year.
Illustration 6.1
Mr. Delfin, a mixed income earner, has the
following data for the current taxable year:
Annual Salary P3, 000, 000
Allowances 100, 000
Gross sales from business 6, 000,
000
Cost of sales 5, 000,
000
6M x 40% = 2.4M
Itemized business allowable
6M -expenses
2.4M = 3.6M + 500,
3.1M 000
(total compensation) =
Required: Determined the6.7M
net taxable income using
• Illustration 6.2
Shark Tank Company presented the
following data for the current taxable year:
Sales P10, 000, 000
Sales Returns and Allowances 200, 000
Cost of Sales 3, 500, 000
Itemized operating expenses 4,200, 000
Required: Compute the taxable net income
using the optional standard deduction.
10M – 200k – 3.5m =
• Answer: 3, 780, 000 6.3M
6.3M x 40% = 2.520M
6.3M - 2.520M = 3.780M
Itemized Deductions
• Is a listing of specific expenses allowed
by the tax code and related tax
regulations to be deducted from gross
taxable income to arrive at the taxable net
income.
Composition of Itemized Deduction
• Section 34 of the NIRC, as amended, enumerates the following
items as allowable deductions against the gross taxable income:
1. Interest
2. Taxes
3. Losses
4. Bad debts
5. Depreciation
6. Depletion of oil and gas well and mines
7. Charitable & other contribution
8. Research and development costs
9. Contribution to Pension and trusts
10.Other ordinary and necessary expenses
Interest Expense
Requisites on the deductibility of interest:
1. The indebtedness must be that of the taxpayer
2. Interest must have been stipulated in writing
3. Interest must be legally due.
4. Interest payments must not be between related
taxpayers.
5. Interest must not be incurred to finance petroleum
operation.
6. In case of interest incurred in the acquisition of
property, used in trade, business or profession, the
same is not treated as a capital expenditure.
Deductible amount of Interest expense
• The deductible amount of interest expense is the
gross interest expense reduced by the following
percentage of the interest income subject to
Effectivity
20% final tax: Percentage
January 1, 2009 33%
July 30, 2020 20%
Illustration 6.3
• ABC Corporation has a gross interest
expense of ₱200,000 for the year 2023.
The corporation also earned ₱50,000 in
interest income from bank deposits.
Required: Calculate the deductible interest
expense for ABC Corporation.
Answer: 190, 000
Taxes
As a general rule, taxes paid or incurred within
the taxable year in connection with the taxpayer’s
profession, trade or business, shall be allowed as
deduction.
Non- deductible taxes Deductible taxes
1. Income tax except fringe benefit 1. OPT
a. Final tax
b. CGT
c. Regular income tax
2. Income tax abroad if claimed as tax credit 2. Excise
3. Transfer taxes 3. DST
4. Special assessment 4. Occupational tax
5. License
6. Fringe benefits tax
5. VAT 7. Local taxes except
special assessment
8. Community tax
6. Surcharges or penalties on delinquent 9. Municipal tax
taxes
10. Foreign income
tax if not claimed as
Foreign Income tax
Income taxes paid in a foreign country can either be claimed
as:
1. Deduction
2. Tax Credit
• Illustration 6.4
A domestic corporation reported the following result
of operations:
Taxable income from the Philippines P 1, 800, 000
Taxable income from Japan 1, 200, 000
Income tax paid in Japan 300, 000
Required: Compute the income tax payable using deduction
approach
Answer: 675, 000
• Illustration 6.5
A domestic corporation reported the following result
of operations:
Taxable income from the Philippines P 1, 800, 000
Taxable income from Japan 1, 200, 000
Income tax paid in Japan 300, 000
Required: Compute the income tax payable using tax credit
approach
Answer: 250, 000
Losses
Requisites for deduction of losses
1. It must be incurred in trade, profession, or business or the taxpayer.
2. The losses arises from fires storms, shipwreck, or the other
casualties, or from robbery, theft or embezzlement connected with
trade, business or practice of profession.
3. Losses actually sustained during the taxable year and not
compensated by insurance or other indemnity
4. A declaration of loss must have been filed by the taxpayer within 45
days from the date of discovery of the casualty or robbery, theft or
embezzlement giving rise to the loss.
5. The loss must not have been claimed as a deduction for estate tax
purposes.
Kinds of losses
1. Casualty losses
2. Net operating loss carry over (NOLCO)
3. Capital losses and securities becoming worthless
4. Special losses
a. Losses from wash sales of stock
b. Wagering losses
c. Abandonment losses
• Illustration 6.6
• Ms. Annabelle owns and operates a bakery business. During
the taxable year, the business building and all its equipment
were razed completely by fire. The following are the relevant
data:
Cost of the building P 1, 500, 000
Accumulated depreciation-building 600, 000
Cost of equipment 400, 000
Accumulated depreciation-equipment 320, 000
• There were no salvage value, and the assets were not covered
by insurance
• Required: Compute the amount of deductible loss.
NOLCO
• The excess of allowable deduction over gross income in a
particular taxable year.
• Net operating loss carry-over (NOLCO) pertains to the amount of
net operating loss that is allowed by the law to be carried over as
deduction against available net income in the following 3 years.
• Rationale of NOLCO:
NOLCO is intended to allow the taxpayer to recoup his losses before
taxation go full swing. Without NOLCO, income taxation would result
in taxation of recoveries of lost capital.
Illustration 6.7
The records of Davao Manufacturing Co. for
the past 5 years show the following data:
Year 1 Year 2 Year 3 Year 4 Year 5
Taxable (350, 100,000 200,000 150,000 300,000
000)
Income
(Loss)
Required: Determine how to charge properly the
operating loss of prior years to the succeeding
years.
Treatment of NOLCO during pandemic
( CREATE LAW)
• The CREATE LAW allowed NOLCO incurred during the
taxable years 2020 and 2021 to be carried over a period
5 years. However, NOLCO incurred after this period will
revert back to the original 3 year carry-over period.
Illustration 6.8
• A Corporate taxpayer reported the following net income
and loss from business:
2020 2021 2022 2023
Gross 400, 000 500, 000 720, 000 900, 000
Income
Less: 600, 000 450, 000 610, 000 650, 000
Deduction
s
Net (200, 000) 50, 000 110, 000 250, 000
Income
(NOLCO)
• Required: Compute the taxable net income from 2021 to
2023
Note:
• Any unused NOLCO after the 3-year prescriptive period
will expire and will not be creditable in future periods.
Loss recoupment is legally allowed only over 3 years.
• For NOLCO sustained during pandemic, apply the same
rules but with a longer 5-year carry-over period.
Requisites for the deductibility of NOLCO:
1. The taxpayer must not be exempt from income tax
during the taxable year when the NOLCO was incurred.
2. There has been no substantial change in the ownership
of the business or enterprise.
A change of at least 75% of either the paid up capital or
nominal value of the outstanding shares of a corporation
is deemed a substantial change in business ownership.
Illustration 6.9
• An individual taxpayer reported the following net income
and loss from business:
Y1 Y2 Y3
Gross Income 400, 000 700, 000 1, 500, 000
Less: 650, 000 800, 000 1, 000, 000
Business
expenses
Net Income (250, 000) (100,000) 500, 000
(Loss)
• Required: Compute the taxable net income in year 3.
Bad debts
• Refers to worthless or uncollectible amounts, in whole or
in part, which is due to a taxpayer by others. Arising from
money lent or from uncollectible amounts of income from
goods sold or services rendered.
Requisites of claim for deduction of bad
debts
1. The debt must have been ascertained to be
worthless.
2. It must be charged off within the taxable year.
3. It must be connected with the taxpayer’s
profession, trade or business.
4. The taxpayer must be under the accrual basis of
accounting
5. It must not be incurred from related party.
Note:
• The accounting bad debt expense called “
estimated bad debt expense” is not deductible
in taxation because it is mere estimate rather
than an actual loss. The deductible bad debt
expense pertains to the write-off of
uncollectible receivables after having been
actually ascertained to be worthless.
Illustration 6.10
Mr. Allan, a self-employed and married individual, granted
the following loans:
To Customers of the 3, 000, 000
business
To his father 150, 000
During the year, estimates revealed that 40% of the amounts
lent to customers could no longer be collected. However, Ms.
Lenette, with a debt amounting to P200, 000, had been
declared by the appropriate court bankrupt and his account
worthless. Similarly, Mr. Allan had fully ascertained that the
collectible amount from his father could never be collected.
Required: Determine the collectible bad debts
Depreciation
• Is the reduction in the value of tangible assets brought
about wear, tear and obsolescence.
Depletion of Oil and Gas Wells and Mines
• The term depletion is synonymous with depreciation and
amortization, since it connotes reduction in the carrying
value of the asset. Technically, however, it is appropriately
used to refer to reduction of value of wasting assets.
• Wasting assets- refers to assets which are natural
resources physically consumed and not replaceable,
such as oil, ore, coal, timber, and precious metals like gold
and silver.
Capital invested = Allowance for depletion
• When the allowance for depletion equals the capital
invested, no further allowance shall be granted.
• After production in commercial quantities has commenced,
intangible exploration and development drilling cost shall
be treated as follows:
Formula: Using the Cost-depletion Method
Note: Total estimated units= units extracted for the year + estimated remaining units.
Illustration 6.11
• Pedrodrill Corporation incurred a total development cost
of P120, 000, 000 to bring its well to commercial
production in 2021. The following were the results of its
extraction activities until 2021
2022: 2022
Barrels 4, 000, 000 9, 000, 000
extracted per
year
Estimated 56, 000, 000 36, 000, 000
barrels
remaining
Required: Compute the annual depletion expense of the
wasting asset.
Depletion of Oil and Gas Wells and Mines
Deductible by a NRA or Foreign Corporation
• Depletion shall be allowed only if the oil and gas well or
mines are located in the Philippines.
Charitable Contributions
• In general, contributions or gifts actually paid or made
within the taxable year to, or for the use of ,the
government of the Philippines or any of its agencies or
any political subdivisions exclusively for public purpose
shall be deductible from the gross taxable income of the
taxpayer.
Requisites of claim for deduction on contributions:
1. The donee institution must be a domestic institution.
2. No income of the donee institution must inure to the benefit of
any private stockholder or individual.
3. The contribution must be valued at the tax basis of the property
donated.
4. The taxpayer must be engaged in trade or business.
5. The donee must issue a certificate of donation (BIR FORM
2322) which includes a donor’s statements of values.
6. If the amount of donation is at least P50, 000 the donor shall
file a NOTICE OF DONATION to the RDO where he is
registered within 30 days upon receipt of the certificate of
Donation.
Classification of Contributions
Note: This is an exception to the rule that the donee
institution must be a domestic organization.
Limit
Taxpayer Rate Base
Corporation 5% Taxable income from
trade, business or
Individual 10% practice of profession
before charitable
contributions
Valuation of Property Donated other than
Money or Non-cash property
• The amount of any charitable contribution
of property other than money shall be
based on the acquisition cost of said
property.
Illustration 6.12
• During the current taxable year, the taxpayer presented the
following data related to the operation of his merchandising
business:
Sales P 3, 000, 000
Cost of Sales 1, 800, 000
Allowable business expenses 700, 000
Charitable and other contributions
To the national government for 120, 000
educational purpose
To the provincial government for 80, 000
general purpose
To an organization which will go on 20, 000
strike
• Required: Compute the deduction for charitable contribution:
1. Donor is Individual taxpayer 2. Donor is a corporation
Research and Development Cost
• Refers to expenses incurred by taxpayers relative to
scientific or technical evaluation and findings of improving,
formulating, and testing products or processes prior to
full-scale commercial production.
Illustration 6.13
• During 2021, Samal Manufacturing Company incurred P 2,
000, 000 in the conduct of research relative to a new
product to be introduced to the market. The company finally
started full-scale commercial production in year 2023.
• Required: Compute the deductible research and
development expenditures for 2021, 2022 and 2023 under
the following options:
1. Outright expense
2. Capitalized and later amortized.
Note:
When research expenditures are capitalized,
amortization will start in the period when the
taxpayer is already benefitted by such expenses. In
the illustration, the taxpayer was benefitted
already in year 2023 when there was a full
commercial production.
Pension Trusts
• An employer establishing or maintaining a
pension trust to provide for payment of
reasonable pensions to his/her employees shall
be allowed a deduction in addition to the
contributions to such trust fund during the
taxable year to cover the pension liability
accruing during the year.
Deductible pension trust
• The following contributions or payments to pension trust
are deductible with their corresponding tax treatment:
Deductible pension trust Proper tax
contributions treatment
1. Contributions or payments to cover Deduct the full
pension liabilities accruing during the amount
taxable year ( current pension cost)
2. Contributions or payments to Prorated in equal
cover the pension trust in excess of period of 10 years
the contributions or contributions beginning in the
year in which
for past pensions
payment is made.
Illustration 6.14
• The records of Bukidnon Manufacturing Company about
pension payments and contributions are shown below:
Year 1 Year 2
Payment for current 350, 000 380, 000
pension
Payment for past pension 1, 500, 000 1, 800, 000
Required: Compute the deductible pension contributions for
year 1 and year 2.
Representation and Entertainment expenses
Expenses paid for amusement and recreation during the
taxable year, which are directly connected with the business
activities or profession of the taxpayer.
The allowable amount is subject to the following limitation:
Taxpayer engaged in ½% of net sales
sale of goods
Taxpayer engaged in 1% of net revenue
sale of services
• End
