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Deduction - From - Gross - Income Notes Tamayo - Garcia Resa 2
Deduction - From - Gross - Income Notes Tamayo - Garcia Resa 2
TAXATION TAMAYO/GARCIA
a. Expenses in General
1) Requisites for a) Ordinary and necessary;
deductibility of b) Paid or incurred during the taxable year;
expenses, in general c) Directly attributable to the development, management, operation and/or conduct of the
trade, business or exercise of profession;
d) Substantiated with sufficient evidence, such as official receipts or other adequate
records.
2) Requisites for deductibility a) Reasonable;
of salaries, wages, and b) Personal services actually rendered;
other forms of c) Withholding tax imposed has been paid.
compensation including
the grossed-up monetary
value of fringe benefits
3) Requisites for a) Reasonable;
deductibility of travel b) Incurred or paid while away from home;
expenses, here and abroad c) Incurred or paid in the pursuit of trade, business or profession.
4) Requisites for a) Reasonable;
deductibility of rentals b) For purposes of trade, business or profession;
c) 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.
5) Requisites for a) Must be paid or incurred during the taxable year;
deductibility of b) Must be directly connected to the development, management and operation or to
entertainment, conduct of trade, business or profession or directly related to or in furtherance of the
amusement and conduct of his or its trade, business or exercise of profession;
recreation expenses c) Must not be contrary to law, morals, public policy or public order;
d) Must not have been paid, directly or indirectly, to an official or employee of the national
government, or any local government unit, or of any government-owned or controlled
corporation (GOCC), or of a foreign government, or to a private individual, or
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corporation, or general professional partnership, or a similar entity if it constitutes a
bribe, kickback or other similar payments;
e) Must be duly substantiated by adequate proof. The official receipts or invoices or bills or
statements of accounts must be in the name of taxpayer claiming the deduction;
f) The appropriate amount of withholding tax, if applicable, should have been withheld
therefrom and paid to the BIR.
6) Ceiling on deductible a) Sales of goods or properties – One-half percent (0.50%) of net sales (gross sales less
entertainment, sales returns/allowances and sales discount)
amusement and b) Sale of services, including exercise of profession and use or lease of property
recreation expenses – One percent (1%) of net revenue (gross revenue less discounts)
7) Exercise
ERA Corporation is engaged in the sale of goods and services with net sales/net revenue of P200,000 and P100,000
respectively. The actual entertainment, amusement and recreation expense for the taxable quarter totaled to P3,000.
How much is the amount of the deductible entertainment, amusement and recreation expense?
b. Interest Expense
1) Requisites for a)
There must be an indebtedness;
deductibility of interest b)
Paid or incurred upon such indebtedness;
expense c)
The indebtedness must be that of the taxpayer;
d)
Connected with taxpayer’s trade or business or exercise of profession;
e)
Must have been paid or incurred during the taxable year;
f)
Must have been stipulated in writing;
g)
Must be legally due;
h)
Must not be between related taxpayers;
i)
Must not be incurred to finance petroleum operation;
j) In case of interest incurred to acquire property used in trade, business or exercise of
profession, the same was not treated as capital expenditure.
2) Reduction of deductible The allowable deduction for interest shall be reduced by an amount equal to the following
interest expense percentages of the interest income subject to final tax.
Beginning January 1, 2000 – 38%
Beginning November 1, 2005 to December 31 2008 – 42%
Beginning January 1, 2009 – 33%
3) Interest incurred or paid Interest incurred or paid by the taxpayer on all unpaid business-related taxes shall be fully
on all unpaid business- deductible from the gross income and shall not be subject to reduction by an amount equal
related taxes to certain percentage of the interest income subject to final tax.
4) Prepaid interest of an Deductible not in the year that the interest was paid in advance but in the year that the
individual under cash basis indebtedness was paid.
5) Exercises
a) In 2010, an individual taxpayer, using cash basis of accounting, obtained a P500,000 loan from a bank for business use.
The bank deducted in advance an interest of P50,000. In 2011, the P500,000 loan was paid in full by the taxpayer.
How much was the deductible interest in 2010 and 2011?
b) Using the same information in letter a. except that payments were made as follows: 2011, P300,000; 2012, P200,000.
How much was the deductible interest expense in 2010, 2011 and 2012?
c) AJD Corporation used accrual basis yearly since it was organized. On March 1, 2010 it purchased an equipment for
P1,120,000, VAT inclusive. The equipment was estimated to have a life of 5 years. The equipment was financed through a
one-year loan with Banco de Plata with interest at the rate of 18% per annum beginning January 16, 2010, which was
discounted in full. During the same year, the corporation also paid interest on business-related taxes amounting to P50,000.
In 2010, AJD had interest income from its bank deposit in the amount of P100,000. AJD decided to expense outright the
interest incurred to acquire the equipment.
Question 1 - How much was the deductible interest?
2 - Assuming AJD Corporation decided to capitalize the interest incurred to acquire the equipment, how much
would be the total cost of the equipment?
d) COU Corporation paid the following during the year 2011:
Interest for late payment of income tax for 2010 P 5,000
Surcharge and compromise penalty for late payment of income tax for 2010 7,250
Interest on bonds issued by COU Corporation 100,000
Interest on money borrowed by the Corporation from Conrad Uberita, 60% owner of COU Corporation 50,000
Interest on preferred stock which in reality is a dividend 20,000
How much is the deductible interest?
c. Taxes
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d. Losses
1) Requisites for a) Actually sustained during the taxable year;
deductibility of losses b) Not compensated for by insurance or other forms of indemnity;
c) Incurred in trade, profession or business;
d) Property is connected with trade, business or profession;
e) Arising from fires, storms, shipwreck, or other casualties, or from robbery, theft or
embezzlement;
f) Declaration of loss is submitted within 45 days from the date of discovery of the
casualty or robbery, theft or embezzlement giving rise to the loss;
g) Not claimed as deduction for estate tax purposes in the estate tax return.
2) Net operating loss a) Meaning of net operating loss - Excess of allowable deduction over gross income of
the business in a taxable year.
b) Net operating loss carry over - Pertains to net operating loss of the business or
enterprise for any taxable year immediately preceding the current taxable year.
c) Requisites for deductibility of NOLCO
(1) The operating loss had not been previously offset as deduction from gross income;
(2) There has been no substantial change in the ownership of the business or enterprise
in that:
(a) not less than 75% in nominal value of outstanding issued shares, if the business
is in the name of a corporation, is held by or on behalf of the same persons;
(b) not less than 75% of the paid up capital of the corporation, if the business is in
the name of a corporation, is held by or on behalf of the same persons.
d) Carry over period - The net operating loss shall be carried over as a deduction from
gross income for the next 3 succeeding taxable years immediately following the year
of such loss.
e) Net operating loss for mines other than oil and gas wells
(1) For mines other than oil and gas wells, a net operating loss incurred in any of the
first 10 years of operation may be carried over as a deduction from the taxable
income for the next 5 years immediately following the year of such loss.
(2) The entire amount of the loss shall be carried over to the first 5 taxable years
following the loss, and any portion of such loss which exceeds the taxable income of
such first year shall be deducted in like manner from the taxable income of the next
remaining 4 years.
3) Capital loss Deductible from capital gain only
4) Loss on wash sales a. Losses from wash sales are not deductible
b. Gains from wash sales are taxable
5) Wagering losses Deductible to the extent of the gains from wagering transactions
6) Abandonment losses a. If contract area where petroleum operations are undertaken is partially or wholly
abandoned, all accumulated exploration and development expenditures pertaining to
contract area shall be allowed as a deduction.
b. If producing well is subsequently abandoned, the unamortized costs, as well as the
undepreciated costs of equipment directly used, shall be allowed as deduction in the
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c) J. Ireneo acquired machinery for use in his business. After a strong typhoon, the machinery suffered partial damage.
The following data were made available in connection with the determination of the deductible loss:
Cost P500,000
Accumulated depreciation 300,000
Restoration cost 250,000
Estimated remaining useful life 5 years
Question 1 – How much was the deductible loss?
2 – How much would be the new basis for depreciation?
d) A taxpayer under calendar year has the following selected transactions:
Sept. 9, 2004 – Purchased 100 shares of Kaye Co. common for P5,000.
Dec. 21, 2006 – Purchased 50 shares of Kaye Co. common for P2,750.
Dec. 26, 2006 – Sold the 100 shares purchased on Sept. 9, 2004 for P4,000.
Jan. 2, 2007 - Purchased 25 shares of Kaye Co. common for P1,125.
Compute the following:
1) Shares sold at a loss without covering acquisition
2) Loss on wash sale and the capital loss
3) The adjusted cost of the shares bought on December 21, 2006 and January 2, 2007
e) Anton Corporation was merged with Conrad Corporation. A stockholder of Anton Corporation, which ceased to exist,
surrendered his Anton Corporation shares valued at P8,000 in exchange for Conrad Corporation shares valued at
P10,000. How much is the gain to be recognized?
f) A stockholder of a corporation that was merged with another corporation had the following data:
FMV of shares received P10,000
Cash received 3,000
FMV of property received 500
Cost of the shares surrendered 9,000
Compute the following: 1) The amount of gain recognized 2) Adjusted basis of the shares received.
g) (Phil. CPA) Mr. Juan de la Cruz transferred his commercial land with a cost of P500,000 but with a fair market value of
P750,000 to JDC Corporation in exchange of the stocks of the corporation with a par value of P1,000,000. As a result
of the transfer, he became the majority stockholder of the corporation.
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f. Depreciation
1) Requisites for a. Reasonable;
deductibility b. Property is used in the trade or business;
c. Property must have a limited useful life;
d. Allowance must be charged off during the year.
2) Methods of depreciation a. Straight line method;
b. Declining balance method;
c. Sum-of-the-years-digit method;
d. Other methods which may be prescribed by the Secretary of Finance upon recommendation
of the Commissioner.
3) Depreciation of a. Depreciation of properties directly related to production of petroleum initially placed in
properties used in service in a taxable year shall be allowed under straight-line method or declining balance
petroleum operations method on the basis of an estimated life of 10 years or such shorter life as may be
permitted by the Commissioner.
b. Properties not used directly in the production of petroleum shall depreciated under the
straight-line method on the basis of an estimated life of 5 years.
4) Depreciation of a. At the normal rate of depreciation if the expected life is 10 years or less;
properties used in mining b. Depreciated over any number of years between 5 years and the expected life if the latter is
operations other than more than 10 years.
petroleum operations
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j. Pension Trusts
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k. Optional Standard Deductions (OSD) (RR No. 16-2008 as amended by RR No. 2-2010)
1) Persons covered The following may be allowed to claim OSD in lieu of the itemized deductions (i.e. items of
ordinary and necessary expenses allowed under Section 34 (A) to (J) and (M), Section 37,
other special laws, if applicable):
a) Individuals b) Corporations
(1) Resident citizen (1) Domestic corporation
(2) Non-resident citizen (2) Resident foreign corporation
(3) Resident alien
(4) Taxable estates and trusts
2) Determination of the a) The OSD allowed to individual taxpayers shall be a maximum of forty percent (40%) of
amount of OSD for gross sales (if on accrual basis) or gross receipts (if on cash basis) during the taxable year.
individuals b) The “cost of sales” in case of individual seller of goods, or the “cost of services” in the case
of individual seller of services, are not allowed to be deducted for purposes of determining
the basis of the OSD
c) For other individual taxpayers allowed by law to report their income and deductions under a
different method of accounting (e.g. percentage of completion basis, etc.) other than cash
and accrual method of accounting, the “gross sales” or “gross receipts” shall be determined
in accordance with said acceptable method.
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6) Exercises
a. A retailer of goods, whose accounting method is under the accrual basis, has a gross sales of P1,000,000 with a cost of
sales amounting to P800,000 for year 2009. The taxpayer is qualified to choose OSD as deductions.
Question 1 – How much is the amount of OSD assuming the taxpayer is: 1) an individual; 2) a corporation.
2 – How much is the net taxable income assuming the taxpayer is: 1) an individual, single with no qualified
Dependents. 2) a corporation.
b. The following data pertain to ME and Company, CPAs, a general professional partnership, for the current year:
Gross receipts P5,000,000
Returns and allowances 100,000
Discounts 200,000
Cost of services 1,000,000
Total itemized deductions 500,000
Partner M (50% partner) who is married and has five (5) qualified dependents is also engaged in trading business. His
sales and other data for the current year are as follows:
Gross sales, trading business P4,000,000
Returns and allowances 250,000
Discounts 150,000
Cost of sales 1,500,000
Total itemized deductions 600,000
Compute the taxable net income of Partner M assuming the general professional partnership uses:
1) itemized deductions. 2) optional standard deduction.
l. Integrative cases
a. (Phil. CPA) From the following data, compute the income tax still due from a domestic corporation engaged in
merchandising business. For the calendar year 2009, the net income per books is P150,000, after considering among
others:
Non-taxable income (others) P 5,500
Inter-corporate dividends 5,000
Net capital loss 2,500
Bad debts written off 6,500
Non-deductible expenses (others) 12,000
Contribution to a non-profit religious organization 12,000
Contribution to Government’s priority program 1,500
Quarterly income tax payments 65,000
Provision for bad debts 8,000
The net income per books should be reconciled with the provisions of the Tax Code, meaning, items which are not taxable
must be excluded, and items which are not deductible are to be added back.
How much is the net tax due and payable?
b. (Phil. CPA) The following were taken from the Statement of Income and Expenses of ABC Corporation for the taxable year
2011:
Gross profits from sales P800,000
Less: Business expenses P440,000
Provision for bad debts 80,000 520,000
Net income before tax P280,000
Additional information:
1) Accounts written off during the year and charged to allowance for bad debts, P50,000;
2) Recoveries on accounts receivable previously written off in 2010 and credited to allowance for bad debts:
Allowed as deduction by BIR, P30,000;
Disallowed as deduction by BIR, P20,000.
How much was the taxable net income?
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