Tranzen1A Income Tax

tranzen A-1 | P a g e
TAX GUIDE
PART I General Issues
A. INCOME TAX
1. Background
The Group is subject to the Regular Corporate Income Tax (RCIT) at 30% (effective
starting the calendar year of 2009) based on the Group’s taxable income derived from
sources within and without the Philippines [Sec. 27 (A) of the Tax Code, as amended] or
the Minimum Corporate Income Tax (MCIT) of 2% based on gross income, whichever
is higher.
2. Regular Corporate Income Tax (RCIT)
For RCIT purposes, the taxable income is derived by deducting the allowable expenses
from the taxable gross income.
Taxable income, as defined under Section 31 of the Tax Code, means the pertinent items
of gross income specified in the same Code, less the deductions, if any, authorized for
such types of income by the Code or other special laws.
The items of gross income and deductions for income tax purposes will be discussed in
the succeeding sections.
2.1 Gross Income
Items of Gross Income
Based on Section 32 of the Tax Code, the gross income of a corporation includes all
income derived from whatever source, including (but not limited to):
a. Gross income derived from the conduct of trade or business or the exercise of a
profession
b. Gains derived from dealings in property (sale of real, sale of personal property)
c. Interest
d. Rentals
e. Royalties
f. Dividends
g. Annuities
h. Prizes and Winnings
i. Other income items, e.g. realized foreign exchange gain
Income subject to final tax/exempt from income tax
Income subject to final tax, such as interest on domestic bank deposits and passive
royalties, is not included in determining the taxable income subject to RCIT. [Section 27
(D) (1) of the Tax Code]
The same is true for income which is exempt from income tax such as dividends received
from another domestic corporation and income from those activities covered by any
income tax holiday incentive of the Group. [Section 27 (D) (4) of the Tax Code]
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Recognition of revenue/income
In general, the accrual method of accounting is used. Under this method, a taxpayer
recognizes an item into income or deduction when all the events have occurred which fix
the right to receive such income or fix the liability for the said deduction and the amount
thereof can be determined with reasonable accuracy. (Merten’s Law of Federal Income
Taxation, Chapter 12A, p.177)
Thus under the accrual method, it is the right to receive income and not the actual receipt,
that determines when to include an amount in gross income. Following this notion, the
requisites of accrual method of accounting are: “(1) the right to receive the amount must
be valid, unconditional and enforceable, i.e., not contingent upon future time; (2) the
amount must be reasonably susceptible of accurate estimate; and (3) there must be a
reasonable expectation that the amount will be paid in due course.” [Filipinas Synthetic
Corp. vs. Court of Appeals, CTA and Commissioner of Internal Revenue (CIR), G.R. Nos.
118498 & 124377 dated October 12, 1999].
Accordingly, in case of a contingent claim by the Group where its right to income has not
yet been established, no accrual of income is required.
Capitals assets vs. Ordinary Assets
Capital assets shall refer to all real properties held by a taxpayer, whether or not
connected with his trade or business, and which are not included among the real
properties considered as ordinary assets.
Ordinary assets shall refer to all real properties specifically excluded from the definition of
capital assets namely:
1. Stock in trade of a taxpayer or other real property of a kind which would properly
be included in the inventory of the taxpayer if on hand at the close of the taxable
year; or
2. Real property held by the taxpayer primarily for sale to customers in the ordinary
course of his trade or business; or
3. Real property used in trade or business (i.e., buildings and/or improvements) of a
character which is subject to the allowance for depreciation provided for under or
4. Real property used in trade or business of the taxpayer.
[Section 39 (A) (1) of the Tax Code; Section 2 of Revenue Regulations (RR) No. 7-2003]
RR No. 7-2003 provides the guidelines in determining whether a particular real property is
a capital asset or an ordinary asset for purposes of imposing the 6% Capital Gains Tax
(CGT) or the RCIT and MCIT, respectively. The following are guidelines on determining
whether a particular real property is a Capital Asset or an Ordinary Asset as set forth in
Section 3 of the said Ruling:
a. Taxpayers engaged in the real estate business
1. Real Estate Dealer — All real properties acquired by the real estate dealer shall be
considered as ordinary assets.
2. Real estate Developer — All real properties acquired by the real estate developer,
whether developed or undeveloped as of the time of acquisition, and all real
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properties which are field by the real estate developer primarily for sale or for
lease to customers in the ordinary course of his trade or business or which would
properly be included in the inventory of the taxpayer if on hand at the close of the
taxable year and all real properties used in the trade or business, whether in the
form of land, building, or other improvements, shall be considered as ordinary
assets.
3. Real Estate Lessor — All real properties of the real estate lessor, whether land
and/or improvements, which are for lease/rent or being offered for lease/rent, or
otherwise for use or being used in the trade or business shall likewise be
considered as ordinary assets.
4. Taxpayers habitually engaged in the real estate business — All real properties
acquired in the course of trade or business by a taxpayer habitually engaged in
the sale of real estate shall be considered as ordinary assets. Registration with the
Housing and Land Use Regulatory Board (HLURB) or Housing and Urban
Development Coordinating Council (HUDCC) as a real estate dealer or developer
shall be sufficient for a taxpayer to be considered as habitually engaged in the sale
of real estate. If the taxpayer is not registered with the HLURB or HUDCC as a
real estate dealer or developer, he/it may nevertheless be deemed to be engaged
in the real estate business through the establishment of substantial relevant
evidence (such as consummation during the preceding year of at least six (6)
taxable real estate sale transactions, regardless of amount; registration as
habitually engaged in real estate business with the Local Government Unit or the
BIR, etc.).
A property purchased for future use in the business, even though this purpose is later
thwarted by circumstances beyond the taxpayer's control, does not lose its character
as an ordinary asset. Nor does a mere discontinuance of the active use of the
property change its character previously established as a business property.
b. Taxpayer not engaged in the real estate business
In the case of a taxpayer not engaged in the real estate business, real properties,
whether land, building, or other improvements, which are used or being used or have
been previously used in the trade or business of the taxpayer shall be considered as
ordinary assets. These include buildings and/or improvements subject to depreciation
and lands used in the trade or business of the taxpayer.
A depreciable asset does not lose its character as an ordinary asset, for purposes of
the instant provision, even if it becomes fully depreciated, or there is failure to take
depreciation during the period of ownership.
Monetary consideration or the presence or absence of profit in the operation of the

property is not significant in the characterization of the property. So long as the
property is or has been used for business purposes, whether for the benefit of the
owner or any of its members or stockholders, it shall still be considered as an ordinary
asset. Real property used by an exempt corporation in its exempt operations, shall not
be considered used for business purposes, and therefore, considered as capital asset.
Real property, whether single detached; townhouse; or condominium unit, not used in
trade or business as evidenced by a certification from the Barangay Chairman or from
the head of administration, in case of condominium unit, townhouse or apartment, and
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as validated from the existing available records of the BIR, owned by an individual
engaged in business, shall be treated as capital asset.
c. Taxpayers changing business from real estate business to non-real estate business
In the case of a taxpayer who changed its real estate business to a non-real estate
business, or who amended its Articles of Incorporation from a real estate business to a
non-real estate business, such as a holding company, manufacturing company,
trading company, etc., the change of business or amendment of the primary purpose
of the business shall not result in the re-classification of real property held by it from
ordinary asset to capital asset. For purposes of issuing the certificate authorizing
registration (CAR) or tax clearance certificate (TCL), as the case may be, the
appropriate officer of the BIR shall at all times determine whether a corporation
purporting to be not engaged in the real estate business has at any time amended its
primary purpose from a real estate business to a non-real estate business.
d. Taxpayers originally registered to be engaged in the real estate business but failed to
subsequently operate
In the case of subsequent non-operation by taxpayers originally registered to be

engaged in the real estate business, all real properties originally acquired by it shall
continue to be treated as ordinary assets.
e. Treatment of abandoned and idle real properties
Real properties formerly forming part of the stock in trade of a taxpayer engaged in
the real estate business, or formerly being used in the trade or business of a taxpayer
engaged or not engaged in the real estate business, which were later on abandoned
and became idle, shall continue to be treated as ordinary assets. Real property initially
acquired by a taxpayer engaged in the real estate business shall not result in its
conversion into a capital asset even if the same is subsequently abandoned or
becomes idle.
Provided however, that properties classified as ordinary assets for being used in
business by a taxpayer engaged in business other than real estate business are
automatically converted into capital assets upon showing of proof that the same have
not been used in business for more than two (2) years prior to the consummation of
the taxable transactions involving said properties.
f. Treatment of real properties that have been transferred to a buyer/transferee, whether

the transfer is through sale, barter or exchange, inheritance, donation or declaration of
property dividends
Real properties classified as capital or ordinary asset in the hands of the seller/
transferor may change their character in the hands of the buyer/transferee. The
classification of such property in the hands of the buyer/transferee shall be determined
in accordance with the following rules:
1. Real property transferred through succession or donation to the heir or donee who
is not engaged in the real estate business with respect to the real property
inherited or donated, and who does not subsequently use such property in trade or
business, shall be considered as a capital asset in the hands of the heir or donee.
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2. Real property received as dividend by the stockholders who are not engaged in
the real estate business and who do not subsequently use such real property in
trade or business shall be treated as capital assets in the hands of the recipients
even if the corporation which declared the real property dividend is engaged in
real estate business.
3. The real property received in an exchange shall be treated as ordinary asset in the
hands of the transferee in the case of a tax-free exchange by taxpayer not
engaged in real estate business to a taxpayer who is engaged in real estate
business, or to a taxpayer who, even if not engaged in real estate business, will
use in business the property received in the exchange.
g. Treatment of real property subject of involuntary transfer
In the case of involuntary transfers of real properties, including expropriation or

foreclosure sale, the involuntariness of such sale shall have no effect on the
classification of such real property in the hands of the involuntary seller, either as
capital asset or ordinary asset, as the case may be.
For example, real properties forming part of the inventory of a real estate dealer,
which are foreclosed, shall, for purposes of determining the applicable tax on such
foreclosure sale, be treated as ordinary assets. On the other hand, the nature of such
real property in the hands of the foreclosure buyer shall be determined in accordance
with the rules stated in f. above.
Joint Venture Agreements
Joint Ventures in general
Joint ventures are generally taxable as corporations except for the following:
 Joint venture formed for the purpose of undertaking construction projects
 Joint venture engaged in petroleum, coal, geothermal and other energy operations
pursuant to an operating or consortium agreement under a service contract with
the Government (Section 22 (B) of the Tax Code)
A joint venture has generally been referred to as an association of persons with the intent,
by way of a contract, express or implied, to engage in and carry out a single or joint
business venture for which purpose they combine their efforts, properties, money, skills
and knowledge, without creating a partnership or a corporation, pursuant to an agreement
that there shall be a community of interest among themselves as to the purpose of the
undertaking and that each joint venturer shall stand in relation of principal, as well as
agent, as to each of the other co-venturer, with an equal right of control of the means
employed to carry out the common enterprise.
Factors that must concur to constitute a joint venture:
1. A contribution by the parties of money, property, effort, knowledge, skill or

assets to a common undertaking;
2. A joint property interest in the subject matter of the venture;
3. A right of mutual control or management of the enterprise;
4. An expectation of profit, or the presence of adventure;
5. A right to participate in the profits;
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6. Usually, a limitation of an objective of a single undertaking or ad hoc

enterprise; and
7. A duty to share losses. [Rizal Theatrical Co., Inc. and Ayala Corporation
vs. CIR (CTA Case No.3463 dated April 24, 1989)]
A joint venture may be incorporated or unincorporated
Unincorporated joint venture:
 Without a charter
 Not registered with the Securities and Exchange Commission
The term corporation shall include partnerships, no matter how created or organized,
joint-stock companies, joint accounts (cuentas en participacion), associations, or
insurance companies, but does not include general professional partnerships and a joint
venture or consortium formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to an
operating or consortium agreement under a service contract with the Government.
"General professional partnership" are partnerships formed by persons for the sole
purpose of exercising their common profession, no part of the income of which is derived
from engaging in any trade or business. (Section 22 (B) of the Tax Code, CTA Case No.
4039 dated October 19, 1992; BIR Ruling DA-397-03 dated November 4, 2003)
On this basis, it can be inferred that, for tax purposes, there may be no difference
between an incorporated and an unincorporated joint venture, in that, both may be
considered taxable entities, unless deemed otherwise as provided by the above definition
of a “corporation” provided in the Tax Code.
Joint ventures as taxable corporations
Taxable joint ventures are subject to 30% RCIT/2% MCIT, whichever is applicable. The
income to be received by the joint venture from its operations is income of the joint
venture. The deductions specified in Section 34 of the Tax Code can be deducted in
computing the net taxable income of the joint venture, insofar as such deductible items
were incurred or sustained in connection with the joint venture’s operations. [BIR Ruling
No. 317-92 dated October 28, 1992]
The share of the venturer in the net income of the joint venture will be considered as
dividends. This will be exempt from tax if paid to a domestic or resident foreign
corporation assuming the joint venture is considered a domestic corporation. However, if
this will be paid to nonresident corporations, it may be subject to final withholding tax.
[BIR Ruling No. 317-92 dated October 28, 1992]
Capital Contribution
The capital contribution of land by the parties to a joint venture project is not a taxable
event that will give rise to the payment of capital gains tax and creditable withholding tax,
since contribution of land to the joint venture project is but a capital contribution to the
said joint venture project, and therefore, no taxable event has yet taken place. [BIR
Ruling [DA-165-99] dated March 18, 1999]
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Thus, joint ventures are generally taxable as corporations except those joint ventures
specifically enumerated as exempt under the Tax Code. The taxable joint ventures, either
incorporated or unincorporated, may be subject to 30% RCIT or 2% MCIT. Moreover,
shares of the venturer in the net income of the joint venture will be considered as
dividends which will either be exempt from tax if paid to a domestic or resident foreign
corporation assuming the joint venture is considered a domestic corporation.
Furthermore, the capital contribution of land by the parties to a joint venture project is not
a taxable event that will give rise to the payment of capital gains tax and creditable
withholding tax.
2.2 Deductions
At the outset, effective July 1, 2008, a corporation subject to tax under Section 27 (A) (i.e.,
domestic corporations subject to 30% RCIT) and Section 28 (A) (i.e., resident foreign
corporations subject to 30% RCIT) of the Tax Code may elect a standard deduction in an
amount of 40% of its gross income in lieu of the actual operating expenses deductible
under the itemized deduction method. Thus, the Group has an option on whether to use
itemized deductions or avail of the optional standard deduction (OSD).
In this regard, there is a risk that corporations subject to special tax rates (e.g.,
Renewable Energy corporations subject to 10% income tax rate) may not avail of the
optional standard deduction (OSD).
Implications of the OSD
A corporation who elected to avail of the OSD shall signify in its return such intention;
otherwise, it shall be considered as having availed of the itemized deductions allowed
under Section 34 of the Tax Code. Once the election to avail the OSD is signified in the
return, it shall be irrevocable for the taxable year for which the return is made. This means
that a taxpayer who initially filed a return availing OSD is precluded from amending said
return in order to shift to the itemized deductions. However, the availing corporation is still
required to submit its financial statements when it files its annual income tax return and to
keep such records pertaining to its gross income.
RR No. 2-2010, amending Sections 6 and 7 of RR No. 16-2008, provides that the election
to claim either the OSD or the itemized deduction for the taxable year must be signified by
checking the appropriate box in the income tax return filed for the first quarter of the
taxable year adopted by the taxpayers. Once the election is made, the same type of
deduction must be consistently applied for all the succeeding quarterly returns and in the
final income tax return for the taxable year. Any taxpayer who is required but fails to file
the quarterly income tax return for the first quarter shall be considered as having availed
of the itemized deductions option for the taxable year.
Thus, a taxpayer who avails of the OSD in the first quarter of its/his taxable year shall
have to claim the same OSD in determining its/his taxable income for the rest of the year,
including the final income tax return which is due to be filed on or before the 15th day of
the fourth month, following the close of the taxable year. Likewise, a taxpayer who avails
of the itemized deduction in the first quarter of its/his taxable year or fails to file an income
tax return for the first quarter of the taxable year, shall have to claim the itemized
deduction in determining the taxable income for the rest of the year, including the final
income tax return which is due to be filed on or before the 155h day of the fourth month,
following the close of the taxable year.
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Moreover, with the issuance of RMC No. 16-2010, taxpayers who are electing to avail for
the OSD are reminded to check the appropriate box in the income tax return filed for the
first quarter of the taxable year 2009, regardless of whether such taxpayer is adopting the
calendar or fiscal year. Otherwise, the taxpayer shall be considered as having availed of
the itemized deductions allowed under Section 34 of the Tax Code. The election to avail
of the OSD or itemized deduction as signified in the return shall be irrevocable for the
taxable year 2009 upon filing thereof. Any subsequent amendment of such income tax
return filed for the first/initial quarter of the taxable year 2009 shall not affect the
irrevocable character of the election to avail of the OSD or itemized deduction, as the
case may be.
2.2.1 Itemized Deductions
Items of Deduction
In general, deductions allowed to a corporation under Section 34 of the Tax Code are as
follows:
a. Ordinary and Necessary Business Expenses;

b. Interest;
c. Taxes;
d. Losses;
e. Bad Debts;
f. Depreciation;
g. Charitable and Other Contributions;
h. Research and Development; and
i. Pension Trusts.
Detailed Discussion on Items of Deduction
a. Business Expenses
In general, the Group shall be allowed to deduct from its gross income all the ordinary and
necessary expenses paid or incurred during the taxable year in carrying on or which are
directly attributable to the development, management, operation and/or conduct of the
Group’s trade, business or exercise of profession under Section 34 (A) (1) (a) of the Tax
Code.
Below are the requisites for deductibility of business expenses.
i. Based on Section 34 (A) (1) (a) of the Tax Code, the expense must be ordinary1
and necessary2
These expenses may include, but are not limited to the following [Section 65 of
Revenue Regulation (RR) No. 2]:
1
“Ordinary” means normal, usual, or customary (in size and character) for the taxpayer’s trade or business.
The main point is that it must be the normal type of expenditure for the type of business involved. (RR No. 9-
83)
2
“Necessary” – when the expenditure is appropriate and helps develop and maintain the taxpayer’s business.
It must be reasonable to expect business benefits to result from the expense. (RR No. 9-83)
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 Management expense;
 Commissions;
 Labor;
 Supplies;
 Repairs;
 Gasoline expenses of transportation equipment used in the trade,
profession or business;
 Rental for the use of business property;
 Advertising and other selling expenses
ii. It must be paid or incurred within the taxable year [Sec. 34 (A) (1) (a) of the Tax
Code]
In the case of accrual of expense, the Group may be allowed to claim the accrued
expenses as deductions for income tax purposes, if these meet the requirements
under the “all events” test and are properly substantiated and subjected to
withholding taxes. Please refer to detailed discussion on page A-12.
iii. It is connected with the trade or business (Ibid.)
iv. The tax required to be deducted and withheld therefrom has been paid.
Any expense shall be allowed as a deduction from gross income only if the
income tax required to be withheld there from has been paid to the BIR in
accordance with Sections 57 and 58 of the Tax Code. (Sec. 2.58.5 of RR No. 2-
98, as amended)
The following expenses, for example, will not be allowed as proper deductions
from gross income if the taxes required to be withheld therefrom had not been
paid:
 Salaries and Wages – Withholding Tax on Wages (WTW)

 Fringe benefits provided to non-rank and file employees – Fringe
Benefits Tax (FBT)
 Local contractor’s fees and rental of real property – Expanded
Withholding Tax (EWT)
 Interest payments to non-residents – Final Withholding Tax (FWT)
Based on Section 6 of RR No. 14-2002, which amends Section 2.58.5 of RR No.

2-98, a deduction will also be allowed in the following cases where no
withholding of tax was made:
 The payee reported the income and pays the tax due thereon and the
withholding agent pays the tax including the interest incident to the
failure to withhold the tax, and surcharges, if applicable, at the time of
the audit investigation or reinvestigation/reconsideration.
 The recipient/payee failed to report the income on the due date

thereof, but the withholding agent/taxpayer pays the tax, including the
interest incident to the failure to withhold the tax, and surcharges, if
applicable, at the time of the audit/investigation or
reinvestigation/reconsideration.
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 The withholding agent erroneously under withheld the tax but pays the
difference between the correct amount and the amount of tax withheld,
including the interest, incident to such error, and surcharges, if
applicable, at the time of the audit/investigation or
reinvestigation/reconsideration.
v. It must be substantiated by invoices, official receipts (ORs) or other adequate

records. [Section 34 (A) (1) (b) of the Tax Code]
It is required that the claimed deduction be supported by sufficient evidence such

as third party invoices, ORs issued in the name of the Group or other adequate
records. Otherwise, the same may be disallowed. Moreover, the third party
documents should be in the name of the particular company of the Group
claiming the expense and not in the name of its parent or its affiliates.
vi. It must not be contrary to law, morals, public policy or public order
No deduction from gross income shall be allowed for any payment to an official
or employee of the national government if such payment constitutes bribe or
kickback. [Section 34 (A) (c)]
There may be additional rules in the deductibility of certain types of expenses. Discussed
below are the rules on deductibility of certain types of expenses:
Entertainment, Amusement and Representation Expenses (EAR)
Section 2 of RR No. 10-02 defines representation expenses as “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, play, sporting event,
and similar events or places. The representation expenses shall not refer to fixed
representation allowances that are subject to withholding tax on wages pursuant to
appropriate revenue regulations.”
The same Regulation also defines “entertainment facilities” and “guests”, as follows:
 Entertainment Facilities - shall refer to (1) a yacht, vacation home or condominium;

and (2) any similar item of real or personal property used by the taxpayer primarily for
the entertainment, amusement, or recreation of guests or employees.
To be considered an entertainment facility, such yacht, vacation home or

condominium, or item of real or personal property must be owned or form part of the
taxpayer's trade, business or profession, or rented by such taxpayer, for which the
taxpayer claims a depreciation or rental expense. A yacht shall be considered an
entertainment facility under these Regulations if its use is in fact not restricted to
specified officers or employees or positions in such a manner as to make the same a
fringe benefit for purposes of imposing the fringe benefits tax.
 Guests - shall mean persons or entities with which the taxpayer has direct business
relations, such as but not limited to, clients/customers or prospective clients/
customers. The term shall not include employees, officers, partners, directors,
stockholders, or trustees of the taxpayer.
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Representation expenses may be deductible from the gross income, if the following
conditions are met:
i. It must be paid or incurred during the taxable year;
ii. It must be: (a) directly connected to the development, management and
operation of the trade, business or profession of the taxpayer; or (b) directly
related to or in furtherance of the conduct of his or its trade, business or exercise
of a profession;
iii. It must not be contrary to law, morals, good customs, public policy or public
order;
iv. It 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 corporation, or general professional partnership (GPP), or a similar
entity, if it constitutes a bribe, kickback or other similar payment;
v. It must be duly substantiated by adequate proof. The official receipts, or invoices,

or bills or statements of accounts should be in the name of the taxpayer claiming
the deduction; and
vi. The appropriate amount of withholding tax, if applicable, should have been
withheld therefrom and paid to the Bureau of Internal Revenue.
[Section 4 of RR No. 10-02]
Section 5 of RR No. 10-02 provides a ceiling on the amount of entertainment, amusement

and recreation expense that may be deducted for income tax purpose. For taxpayers
engaged in sale of goods or properties, the deduction should not exceed 0.50 percent
(.50%) of net sales (i.e., gross sales less sales returns/allowances and sales discounts).
For taxpayers engaged in sale of services, including exercise of profession and use or
lease of properties, the deduction should not exceed 1.00 percent (1%) of net revenue
(i.e., gross revenue less discounts).
Illustration:
If the Company is engaged in the sale of goods
Net Sales P 100,000,000

Multiply by 0.50%
EAR Ceiling P 500,000
In the above illustration, the Group’s allowable deduction for entertainment, amusement
and recreation expense must not exceed P 500,000.
If the Company is engaged in the sale of services
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Net Sales P 100,000,000

Multiply by 1%
EAR Ceiling P 1,000,000
In the above illustration, the Company’s allowable deduction for entertainment,

amusement and recreation expense must not exceed P1, 000,000.
If the Company is engaged in the sale of both goods and services with net sales/net
revenue of P200,000,000 and P100,000,000 respectively. The actual entertainment,
amusement and recreation expense totaled to P 3,000,000.
Net Sales Percentage EAR EAR Ceiling Allowable

Revenue apportioned (Sales x EAR
(Actual EAR 0.5% and 1% (whichever
x respectively) is lower of
Percentage) col. 4 and
5)
Sale of 200,000,000 2/3 2,000,000 1,000,000 1,000,000
Goods
Sale of 100,000,000 1/3 1,000,000 1,000,000 1,000,000
Services
Total 300,000,000 3,000,000 2,000,000 2,000,000
In the above illustration, the Company’s allowable deduction for entertainment,

amusement and recreation expense must not exceed P 2,000,000.
Moreover, Section 6 of the same RR requires as follows:
“SECTION 6. Reporting. – The taxpayer is hereby required to use in its financial

statements and income tax return the account title “entertainment, amusement and
recreation expense”, or in the alternative, to disclose in the notes to financial
statements the amount corresponding to thereto when recording expenses paid or
incurred of the nature as defined in Section 2 of these Regulations. However, such
expense should be reported in the taxpayer’s income tax as a separate expense
item.”
Accrued Expenses
The Group may be allowed to claim accrued expenses, which meet the requirements of
the “all events” test and are properly substantiated and subjected to withholding taxes, as
deductions for income tax purposes.
(a) All-Events Test: Under the all-events test, accrued expenses may be claimed as
deductions when, among other requirements, the liability for the expense is fixed,
as evidenced by bills, requests for payments, contracts, etc. Hence, accruals that
are mere estimates not supported by bills, contracts, etc. may not yet be
deductible. However, it can also be argued that accrued expenses, even if not
supported by billings or contracts, should still be expensed if the Company can
establish with reasonable accuracy the amount of such liability based on facts it
knew, or could reasonably be expected to have known by year-end. (CIR vs.
Isabela Cultural Corporation, SC GR No. 172231 dated February 12, 2007)
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(b) Withholding Tax Requirement: In addition to the all-events test, under Section
34(K) of the Tax Code, expenses may be disallowed as tax deductions if they are
not subjected to the applicable withholding taxes, if any. Thus, the Group may not
yet be allowed to claim these accrued expenses as deductions for income tax
purposes if it has not yet subjected these to the applicable withholding taxes, if
any.
However, if the expenses are properly accruable in the current year and not
claimed as an expense due to non-withholding of tax in the said year, there is a
risk that said expense may not be allowed as a deduction in the succeeding year
when it will be subjected to withholding taxes, if these are really expenses of the
current year. Section 2.58.5 of RR 2-98, as amended, provides remedies for
disallowance of expense due to non-withholding. It says that a deduction will also
be allowed in certain cases where no withholding of tax was made.
Advertising expenses
To be deductible from gross income, advertising expense must comply with the following
requisites: (a) the expense must be ordinary and necessary; (b) it must have been paid or
incurred during the taxable year; (c) it must have been paid or incurred in carrying on the
trade or business of the taxpayer; and (d) it must be supported by receipts, records or
other pertinent papers.
Advertising is generally of two kinds:
(1) advertising to stimulate the current sale of merchandise or use of services; and
(2) advertising designed to stimulate the future sale of merchandise or use of

services.
The second type involves expenditures incurred, in whole or in part, to create or maintain
some form of goodwill for the taxpayer's trade or business or for the industry or profession
of which the taxpayer is a member. If the expenditures are for the advertising of the first
kind, then, except as to the question of the reasonableness of amount, there is no doubt
such expenditures are deductible as business expenses. If, however, the expenditures
are for advertising of the second kind, then normally they should be spread out over a
reasonable period of time.
There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of
an advertising expense. There being no hard and fast rule on the matter, the right to a
deduction depends on a number of factors such as but not limited to: the type and size of
business in which the taxpayer is engaged; the volume and amount of its net earnings;
the nature of the expenditure itself; the intention of the taxpayer and the general economic
conditions. It is the interplay of these, among other factors and properly weighed, that will
yield a proper evaluation.
[G.R. No. 143672 dated April 24, 2003, Commissioner of Internal Revenue vs. General
Foods (Phils.), Inc.]
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b. Interest Expense
i. Requisites for deductibility of interest expense
Based on Section 3 of RR No. 13-2000, dated November 20, 2000, among are the
requisites for the deductibility of interest expense are as follows:
 There must be an indebtedness;
 There should be an interest expense paid or incurred upon such indebtedness;
 The indebtedness must be that of the taxpayer;
 The indebtedness must be connected with the taxpayer’s trade, business or

exercise of the profession;
 The interest expense must be paid or incurred during the taxable year;
 The interest must be stipulated in writing;
 The interest must be legally due;
 The interest payment arrangement must not be between related taxpayers

enumerated in Section 36 (B) of the Tax Code [see (ii) below];
 In the case of interest incurred to acquire property used in trade, business or

exercise of profession, the same should not be treated as capital expenditure to
be allowed as an outright deduction;
 Interest incurred on preferred stock and interest on capital should not be claimed
as a deduction.
ii. Definition of related taxpayers for this purpose
As earlier mentioned, interest between related taxpayers are not deductible for income tax
purposes. Based on Section 36 (B) of the Tax Code and Section 4 (d) (2) of RR 13-2000,
the more pertinent examples of related parties referred to for purposes of this rule are the
following:
 Between an individual and a corporation more than 50% in value of the

outstanding stock of which is owned, directly or indirectly, by or for such
individual; or
 Between two corporations more than 50% in value of the outstanding stock of
each of which is owned, directly or indirectly, by or for the same individual; or
 Between the grantor and a fiduciary of any trust; or
 Between the fiduciary of a trust and the fiduciary of another trust if the same
person is a grantor with respect to each trust; or
 Between a fiduciary of a trust and a beneficiary of such trust.
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iii. Limitation on the deductibility of interest expense
Please note that Section 34(B)(1) of the Tax Code, as amended, provides that the amount
of interest paid or incurred within a taxable year on indebtedness in connection with the
taxpayer's profession, trade or business which shall be allowed as deduction from gross
income shall be reduced by 33% of interest income subjected to final withholding tax.
To illustrate: X Group incurred a deductible interest expense of P180,000 in 2009. In the

same year, its bank deposit realized interest income of P50,000, gross of the 20% final
tax withheld by the bank. Deductible interest expense would then be computed as
follows:
Total Interest Expense P180,000

Less: Adjustment for interest income subject
to final tax (33% of P50,000) 16,500
Deductible interest expense P163,500
If the interest income from bank deposits are recorded in the books net of final withholding
tax, the same should be grossed up by 80% (if peso bank deposit with final tax of 20%) or
by 92.5% (if FCDU account with final tax of 7.5%), before computing for the interest
expense arbitrage.
To illustrate: X Group incurred a deductible interest expense of P180,000 in 2009. In the

same year, its peso bank deposit realized interest income of P50,000, net of 20% final tax
and its FCDU account realized interest income of P40,000, net of 7.5% final tax.
Deductible interest expense would then be computed as follows:
Grossed-up interest income from peso bank deposit = 50,000/80% = 62,500

Grossed-up interest income from FCDU account = 40,000/92.5% = 43,243
Total Interest Expense P180,000

Less: Adjustment for interest income subject
to final tax
(62,500 x 33%) 20,625
(43,243 x 33%) 14,270
Deductible interest expense P145,105
iv. Option to capitalize interest expense
At the option of the Group, interest incurred to acquire capital assets used in trade or
business may be allowed as a deduction or treated as capital expenditures [Sec. 34 (B)
(3) of Tax Code].
Thus, interest expense related to the acquisition of capital assets to be used in trade or
business may be treated in either of two ways:
 as an outright expense when incurred, to be deducted from gross income;

or
 as a capital expenditure, or part of the cost of the property acquired.
If the interest is treated as a capital expenditure, the interest paid is capitalized and the
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corresponding depreciation is taken up as deduction.
However, there is an issue on whether the amount of capitalizable interest shall also be
subject to the limitation discussed in item iii above.
v. Interest paid on deficiency taxes
Taxes constitute indebtedness for purposes of income tax; thus, the interest paid for
delinquency in the payment of tax is deductible for income tax purposes. (Commissioner
of Internal Revenue vs. Carlos Palanca, Jr., G.R. No. L-16626, Oct. 29,1966)
However, fines and penalties (surcharge and compromise) for late payment of taxes, are
not deductible (Lino Gutierrez vs. Collector, G.R. No. L-195357, May 20,1965)
c. Taxes and Licenses
i. Deductible taxes and license expenses
Based on Section 80 of RR No. 2, the Group may claim as deduction the following taxes:
 Import duties paid to customs officers

 Business taxes
 Occupation taxes
 License taxes
 Privilege taxes
 Documentary Stamp Taxes;
 Fringe Benefits Tax [Sec. 2.33(D), RR No. 3-98] ;
 Automobile Registration Fee and
 Any other taxes of every amount and nature paid directly to the government or
any political subdivision.
ii. Non-deductible taxes and licenses
The following taxes may not be deducted from gross income:
 Amounts representing surcharge, penalties and fines incident to delinquency

(Sec. 80, RR No. 2);
 Philippine income tax [Section 34 (C) (1) of the Tax Code];
 Donor’s taxes (Ibid.);
 Taxes assessed against local benefits of a kind tending to increase the value of
the property assessed (Special assessments) (Ibid.);
 Tax on the sale, barter or exchange of shares of stock listed and traded through
the local exchange or through initial public offering [Sec. 127 (A) and (B) of the
Tax Code]; and
 Value Added Tax (VAT). However, revenue is reported for income tax purposes
net of output VAT. On the other hand, purchases of a VAT-registered person are
reported for income tax purposes net of input VAT, if any. In certain cases,
however, input taxes are ruled to be deductible subject to certain conditions.
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d. Losses
i. Requisites for deductibility of losses
In general, the following are the requisites for the deductibility of losses:
 It must be actually sustained and charged off within the taxable year and not
compensated for by insurance or otherwise. (Section 94 of RR No. 2)
The amount of the loss must be reduced by the amount of any insurance or other
compensation received, and by the salvage value, if any, of the property. (Section
96 of RR No. 2)
 It must be evidenced by a closed and completed transaction. (Ibid.)
 The loss must be connected with the trade or business of the taxpayer. [Section
34 (D) (1) (a) of the Tax Code]
ii. Casualty losses
Documentary Requirements
Section 34 (D) of the Tax Code requires taxpayers to submit a declaration of loss
sustained from casualty or from robbery, theft or embezzlement during the taxable year in
order to claim the loss as a deduction for income tax purposes.
In this regard, RMO No. 31-2009 provides the following requirements for the filing of
claims of casualty losses:
1. Sworn Declaration of Loss to be filed within 45 days after the date of the event,
stating the following:
 Nature of the event that gave rise to such loss(es), and the time of its
occurrence;
 Description and location of the damaged property(ies);
 Items needed to compute the loss(es), such as: a) cost or other basis of the
property(ies); (b) depreciation allowed, if any; c) value of the property(ies)
before and after the event; d) cost of repair; and
 Amount of insurance or other compensation received or receivable.
The Sworn Declaration of Loss must be supported by the Financial Statement for the year
immediately preceding the event and copies of Insurance Policy(ies), if any, for the
concerned property(ies).
2. Proof of the elements of the loss(es) claimed, such as, but not limited to, the following:
 Photograph of the property(ies):
o Photographs taken showing the property(ies) before the typhoon; and,
o Photographs taken after the typhoon, showing the extent of the
damage sustained
 Documentary evidence for determining the cost or valuation of the damaged
property(ies), such as, but not limited to: cancelled checks, vouchers, receipts,
and other evidence of costs
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 Insurance policy, in the event that there is an insurance coverage for the
property(ies)
 Police report, in cases of robbery/theft during the typhoon and/or as a
consequence of looting.
All documents and other evidence submitted to prove such loss(es) shall be subject to
verification by the concerned Bureau office, and should be kept by the taxpayer as part of
his tax records, and be made available to the duly authorized Revenue Officer(s), upon
audit of his Income Tax return and declaration of loss.
Note that RR No. 12-77 defines the term “casualty” as the complete or partial destruction
of the property resulting from an identifiable event of a sudden, unexpected, or unusual
nature. It denotes accident, some sudden invasion of hostile agency, and excludes
progressive deterioration through steadily operating cause.
Non-compliance of this requirement may result in the disallowance of the loss as

deduction for income tax purposes. (Manotok Realty, Inc. vs CIR, CTA Case No. 5485
dated October 18, 1999).
iii. Capital losses
Capital losses are deductible only to the extent of capital gains as provided for under
Section 39 (C) of the Tax Code.
Capital losses may include:
 Losses from sales or exchanges of capital assets3 [Section 34 (D) (4) (a) and
Section 39 of the Tax Code]
 Losses resulting from securities becoming worthless, and considered as capital
assets [Section 34 (D) (4) (a) and Section 39 of the Tax Code]
 Losses from short sale of property [Section 39 (F) (1) of the Tax Code] and
 Losses due to failure to exercise privileges or options to buy or sell property
[Section 39 (F) (2) of the Tax Code]
iv. Foreign exchange (forex) losses
Section 94 of RR No. 2 provides that domestic corporations may deduct losses actually
sustained and charged off within the year and not compensated for by insurance or
otherwise. It was further stated in Section 96 of the same regulation that losses must be
evidenced by a closed and completed transaction.
Thus, forex loss may be deductible for income tax purposes only when the same is
realized, i.e., when it arises from a closed and completed transaction. Unrealized forex
losses, on the other hand, may not be considered deductible for income tax purposes
since there is no closed and completed transaction.
Thus, in BIR Ruling 144-85 dated August 26, 1985, the BIR held that foreign exchange
losses sustained as a result of devaluation of the peso vis-a-vis the foreign currency e.g.,
US dollar, but which remittance of scheduled amortization consisting of principal and
interests payments on a foreign loan has not actually been made, are not deductible from
3
Please refer to the definition of capital assets in page A-2.
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gross income for income tax purposes. The increase in value, i.e., the gain, could only be
taxed when a disposition of the property occurred which was of such a nature as to
constitute a realization of such gain, that is, a severance of the gain from the original
capital invested in the property. The same conclusion obtains as to losses. The annual
decrease in the value of property is not normally allowable as a loss. Hence, to be
allowable the loss must be realized. [Surrey and Warren, Federal Income Taxation (1950),
pp. 422-4]
Based on the foregoing, the foreign exchange loss may be deductible for income tax
purposes only when realized (e.g., if it arose from actual payouts of the related debt or
from collection of the related receivable).
[Note: In the same manner, forex gain is also recognized for income tax purposes only
when realized (e.g., if it arose from settlement of the related debt or from collection if the
related receivable).]
v. Net Operating Loss Carry – Over (NOLCO)
NOLCO refers to the excess of allowable deductions over the gross income of the
business for any taxable year which had not been previously offset as deduction from
gross income.
Based on Section 34 (D) (3) of the Tax Code, this can be carried over as deduction from
gross income for the next three (3) consecutive years. Provided that the following
conditions are met:
i. If the net loss is incurred in the taxable year during which the Group was not
exempt from income tax; and
ii. There has been no substantial change in the ownership of the business.
There is no substantial change in the ownership of the business when:
 Not less than seventy-five percent (75%) in nominal value of

outstanding issued shares is held by or on behalf of the same persons;
or
 Not less than seventy-five percent (75%) of the paid-up capital of

the corporation is held by or on behalf of the same persons.
Presentation requirements
The NOLCO shall be allowed as a deduction in computing the taxpayer’s income taxes
per quarter and annual final adjustment income tax returns.
If the taxpayer's entire operations for the year resulted to a net operating loss, such net
operating loss may be claimed as NOLCO deduction in the immediately succeeding
taxable year. However, the NOLCO may be claimed as deduction only within a period of
three (3) consecutive taxable years immediately following the year the net operating loss
was sustained or incurred. (Section 6.4 of RR No. 14-2001)
In order that compliance with this three-year statutory requisite may be effectively
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monitored, the taxpayer shall, at all times, show its NOLCO deduction, as follows:
 In the income tax return (also shown in the Reconciliation Section of the Tax
Return), as a separate item of deduction.
In no case may NOLCO be claimed, as a part of the taxpayer's other itemized

deductions, like under deduction of ‘losses’, in general.
 The Unused NOLCO shall be presented in the Notes to the Financial Statements
showing, in detail, the taxable year in which the net operating loss was sustained
or incurred, and any amount thereof claimed as NOLCO deduction within three (3)
consecutive years immediately following the year of such loss.
Failure to comply with these requirements will disqualify the taxpayer from
claiming the NOLCO. (Section 7 of RR No. 14-2001)
vi. Other kinds of losses
The following are the general rules on the deductibility of certain types of losses:
 Losses from wash sales of stock or securities may not be deductible for
income tax purposes. (Sec. 38 (A) of the Tax Code)
The same section outlines the different scenarios where wash sales of stocks or
securities occur.
 Losses due to voluntary removal or demolitions of buildings, the scrapping

of old machinery, equipment, etc. incident to renewals or replacements will be
deductible from gross income. (Section 97 of RR No. 2)
However, based on the same section of RR No. 2, when a taxpayer buys real
estate upon which is located a building, which he proceeds to raze with a view to
erecting thereon another building, it will be considered that the taxpayer has
sustained no deductible expense on account of the cost of such removal, the
value of the real estate, exclusive of old improvements, being presumably equal
to the purchase price of the land and building plus the cost of removing the
useless building.
 Loss of useful value of capital assets due to some changes in business

conditions.
Based on Section 98 of RR No. 2, when through some change in business

conditions, the usefulness in the business of some or all of the capital assets is
suddenly terminated, so that the taxpayer discontinues the business or discards
such assets permanently from use in such business, the taxpayer may claim the
actual loss sustained as deduction from its gross income. In determining the
amount of the loss, adjustment must be made, however, for improvements,
depreciation and salvage value of the property. This is an exception to the rule
requiring a sale or other disposition of property in order to establish a loss. It
requires proof of some unforeseen cause by reason of which the property has
been prematurely discarded, as, for example, where new legislation directly or
indirectly makes the continued profitable use of the property impossible. The
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exception applies to buildings only when they are permanently abandoned, or

permanently devoted to a radically different use, and to machinery only when its
use as such is permanently abandoned. Any loss to be deductible under this
exception must be charged off in the books and fully explained in returns of
income.
e. Bad Debts
The following are the requisites for deductibility of bad debts based on Section 3 of RR
No. 5-99 dated March 10, 1999:
i. There must be an existing indebtedness due to the taxpayer which must be valid
and legally demandable;
ii. The same must be connected with the taxpayer's trade, business or practice of
profession;
iii. The same must not be sustained in a transaction entered into between related
parties enumerated under Section 36 (B) of the Tax Code;
iv. The same must be actually charged off in the books of accounts of the taxpayer
as of the end of the taxable year; and
v. The same must be actually ascertained to be worthless and uncollectible as of

the end of the taxable year.
Under Section 3 of RR No. 5-99, before a taxpayer may charge off and deduct a debt, he
must ascertain and be able to demonstrate with reasonable degree of certainty the
uncollectibility of the debt. The CIR will consider all pertinent evidence, including the value
of the collateral, if any, securing the debt and the financial condition of the debtor in
determining whether a debt is worthless, or the assigning of the case for collection to an
independent collection lawyer who is not under the employ of the taxpayer and who shall
report on the legal obstacle and the virtual impossibility of collecting the same from the
debtor and who shall issue a statement under oath showing the propriety of the
deductions thereon made for alleged bad debts. Thus, where the surrounding
circumstances indicate that a debt is worthless and uncollectible and that legal action to
enforce payment would in all probability not result in the satisfaction of execution on a
judgment, a showing of those facts will be sufficient evidence of the worthlessness of the
debt for the purpose of deduction.
f. Depreciation and Depletion
Depreciation
There shall be allowed as a depreciation deduction a reasonable allowance for the

exhaustion, wear and tear (including reasonable allowance for obsolescence) of property
used in trade or business. [Sec. 34 (F) (1) of the Tax Code]
The requisites for deductibility of depreciation expense are:
i. The allowance for depreciation must be reasonable [Sec. 34 (F) (1) of the Tax
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Code];
ii. It must be for property used in trade or business (Ibid.); and
iii. It must be charged off during the taxable year. ( Section 113 of RR No. 2);
The term “reasonable allowance”, as used in the Tax Code, includes (but is not limited to)
an allowance computed in accordance with regulations prescribed by the Secretary of
Finance under any of the following methods:
 The straight-line method;

 Declining balance method;
 The sum of the years-digits method; and
 Any other method which may be prescribed by the Secretary of Finance
upon recommendation of the Commissioner of Internal Revenue [Sec. 34
(F) (2) (C)].
However, generally, the BIR allows the straight-line method of depreciation, unless the
use of other method is specifically allowed or authorized.
Change in depreciation method
Any subsequent change in the depreciation method requires prior consent of the BIR
pursuant to Section 168 of RR No. 2. This provision requires that a taxpayer who
changes the method of accounting employed in keeping his book shall, before computing
his income upon such new method for purposes of taxation, secure the consent of the
Commissioner of Internal Revenue.
Application for permission to change the method of accounting employed and the basis
upon which the return is made shall be filed within 90 days after the beginning of the
taxable year to be covered by the return. The application shall be accompanied by a
statement specifying all amounts which would be duplicated or entirely omitted as a result
of the proposed change.
Permission to change the method of accounting will not be granted unless the taxpayer
and the Commissioner of Internal Revenue agree to the terms and conditions under which
the change will be effected.
Capitalization of expenses subject to depreciation
Section 167 of RR No. 2, provides as follows:
“Section 167. Methods of accounting. — It is recognized that no uniform method of

accounting can be prescribed for all taxpayers, and the law contemplates that
each taxpayer shall adopt such forms and systems of accounting as are in his
judgment best suited to his purpose. xxx Among the essentials are the following:
xxx xxx xxx
2. Expenditures made during the year should be properly classified as between

capital and income; that is to say, expenditures for items of plant, equipment,
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etc., which have a useful life extending substantially beyond the year should be
charged to a capital account and not to an expense account; and
3. In any case in which the cost of capital assets is being recovered through
deductions for wear and tear, depletion, or obsolescence, any expenditure
(other than ordinary repairs) made to restore the property or prolong its useful
life should be added to the property account or charged against the appropriate
reserve and not to current expenses.”
Thus, in ascertaining whether an expenditure may be capitalized, the

controlling factor is not the amount of such expenditure but the main purpose
for which it was incurred. Hence, in the case of asset acquisitions, if the asset
has a useful life extending substantially beyond the year, then the expenditure
should be treated as a capital expenditure. In cases of repair and
maintenance expenditures, if the expenditure prolongs the life of the property,
increases its value or makes it adaptable to a different use, then the expense
should be capitalized instead of expensed outright. The BIR, in a 1958 BIR
Ruling, has rejected a taxpayer’s proposal to set a capitalization policy based
on the materiality of the purchases.
g. Charitable Contribution
Deductibility of Donations
i. Limited deductibility
Based on Section 34 (H) of the Tax Code, as implemented by RR No. 13-98, donations,
contributions or gifts actually paid or made within the taxable year to the following shall be
allowed limited deductibility in an amount not in excess of five percent (5%) of the Group’s
taxable income derived from trade, business or profession as computed without the
benefit of the amount of donation and contribution.
 Donations to the Government of the Philippines or

any of its agencies or any political subdivision thereof exclusively for public
purposes;
 Accredited non-stock non-profit corporations
“Non-stock, non-profit corporation” shall refer to a corporation or

association/organization referred to under Section 30 (E) and (G) of the Tax
Code created or organized under Philippine laws exclusively for one or more of
the following purposes, no part of the net income or asset of which shall belong
to or inure to the benefit of any member, organizer, officer or any specific person:
– religious;
– charitable;
– scientific;
– athletic;
– cultural;
– rehabilitation of veterans; and
– social welfare
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ii. Full deductibility
Notwithstanding the above, donations to the following institutions shall be deductible in

full:
 Certain donations to the Government
Donations to the Government of the Philippines or to any of its agencies or political

subdivisions, including fully-owned government corporations, exclusively to finance,
to provide for, or to be used in undertaking priority activities in education, health,
youth and sports development, human settlements, science and culture, and in
economic development according to a National Priority Plan determined by the
National Economic and Development Authority (NEDA), in consultation with
appropriate government agencies, including its regional development councils and
private philanthropic persons and institutions: Provided, That any donation which is
made to the Government or to any of its agencies or political subdivisions not in
accordance with the said annual priority plan shall be subject to the limitations stated
in (i) above;
 Donations to certain foreign institutions or international organizations
Donations to foreign institutions or international organizations which are fully

deductible in pursuance of or in compliance with agreements, treaties, or
commitments entered by the Government of the Philippines and the foreign
institutions or international organizations or in pursuance of special laws.
 Donations to accredited non-government organizations (NGO)
For this purpose, “accredited NGO” shall refer to a non-stock, non-profit domestic
corporation or organization as defined under Section 34 (H)(2)(c) of the Tax Code
organized and operated exclusively for scientific, research, educational, character-
building and youth and sports development, health, social welfare, cultural or
charitable purposes, or a combination thereof, no part of the net income of which
inures to the benefit of any private individual, duly accredited in accordance with RR
No. 13-98 by an entity duly designated by the Secretary of Finance [Currently the
accrediting entity is PCNC].
Substantiation Requirements
Donations to the Government
Donations to the Government and its agencies or political subdivisions are deductible in
full. However, donations to the Government that are not in accordance with the National
Priority Plan of NEDA are subject to limited deductibility. In this case, the Group is only
entitled to deductions not exceeding 5% of the taxable net income computed without the
benefit of the donation.
In BIR Ruling DA-321-06 dated May 17, 2006, the BIR held that for purposes of
entitlement to the full deductibility of the contribution/donation from gross income of the
donor under Section 34(H) of the Tax Code of 1997, a certification must be secured from
the NEDA that the contribution/donation to the Government is in accordance with priority
programs, projects and activities included in the current National Priority Plan.
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However, the certification from NEDA may not be a requirement imposed by Section
34(H) (2) (a) of the Tax Code above. In BIR Ruling No. 9-06 dated September 21, 2006,
the Society of Judicial Excellence (Society), which is a government entity, requested for
exemption from the requirement of securing a certificate from NEDA that donations to the
Society are in accordance with the current National Priority Plan in order to be fully
deductible from the gross income of the donors. In this case, the BIR held as follows:
“The requirement of securing a certification from the NEDA, although precisely for
purposes of determining whether or not a donee institution is qualified based on the
projects listed in the National Priority Plan and being used by the BIR as a basis for
allowing the donation as deduction from the taxable net income of the donor, is,
however, not provided under the abovementioned law or the regulations implementing
the same. To require said certification, would be incorporating matters by executive
ruling which is beyond the province of this Office.
Accordingly, this Office is of the opinion that the Society need not secure the
aforestated certification from the NEDA.”
Based on the foregoing, the NEDA certification is not necessary to claim the donations as
full deductions for RCIT purposes.
The Group should request for proof of tax exemption (i.e., copy of laws mandating the
establishment of the institution as a government entity) to confirm the tax-exempt nature
of the donation. Moreover, to confirm that the donation is entitled to full deductibility, the
Group may secure a NEDA certification, as required in BIR Ruling DA-321-06, to be
prudent.
Donations to foreign institutions or international organizations
The Group should request for proof of tax exemption (i.e., copy of agreements, treaties, or
commitments entered by the Government of the Philippines and the foreign institutions) to
confirm the tax-exempt nature of the donation.
Donations to accredited corporations/associations
Donations to accredited corporations/associations are generally subject to limited

deductibility (i.e., deductions not exceeding 5% of the taxable net income computed
without the benefit of the donation). However, the donation may be subject to full
deductibility provided that the accredited organization complies with the requirements
provided in Section 34(H)(2)(c) of the Tax Code and Section 3(2) of RR No. 13-98 both
cited above.
Section 1(d) of RR No. 13-98 provides that the Philippine Council for NGO Certification
(PCNC) has been designated by the Secretary of Finance as the proper accrediting entity.
Hence, for donations to accredited corporations/association, the Group may secure a
copy of PCNC accreditation of such corporation/association.
Moreover, Section 8 of RR No. 13-98 provides the following substantiation requirements

for donations to accredited corporations/associations:
“SECTION 8. Substantiation Requirements. —
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(a) For Donors. — Donors claiming donations and contributions to accredited non-
stock, non-profit corporation/NGO as deductions from their taxable business income
should submit evidences or proofs to the BIR by showing the Certificate/s of Donation
and indicating therein the following:
(i) Actual receipt by the accredited non-stock, non-profit corporation/NGO of the

donation or contribution and the date of receipt thereof; and
(ii) The amount of the charitable donation or contribution, if in cash; if property,

whether real or personal, the acquisition cost of the said property.
On the other hand, donors claiming exemption from donor's tax on their donations
and contributions to accredited non-stock, non-profit corporations/NGOs should
submit evidences or proofs showing the amount of donation, if in cash; if real
property, the zonal value thereof at the time of donation; and if personal property,
the acquisition cost thereof, but if said personal property had already been used at
the time of donation, the depreciated or book value thereof.”
Hence, to claim deductibility of the donations to accredited corporations/NGOs, this

should be evidenced by a Certificate of Donation indicating the above required
information.
Moreover, to claim full deductibility of the donations and claim exemption from donor's tax,
a notice of donation for every donation worth at least P50,000 should be submitted to the
BIR pursuant to Section 13(C) of RR No. 2-03 which provides as follows:
“(C) Notice of donation by a donor engaged in business. — In order to be exempt

from donor's tax and to claim full deduction of the donation given to qualified donee
institutions duly accredited by the Philippine Council for NGO Certification, Inc.
(PCNC), the donor engaged in business shall give a notice of donation on every
donation worth at least Fifty Thousand Pesos (P50,000) to the Revenue District
Office (RDO) which has jurisdiction over his place of business within thirty (30) days
after receipt of the qualified donee institution's duly issued Certificate of Donation,
which shall be attached to the said Notice of Donation, stating that not more than
thirty percent (30%) of the said donation/gifts for the taxable year shall be used by
such accredited non-stock, non-profit corporation/NGO institution (qualified-donee
institution) for administration purposes pursuant to the provisions of Section 101(A)
(3) and (B)(2) of the Code.”
Accredited donee institutions are required to provide certificates of donation to the Group
on every donation received under Section 5 of RR No. 13-98, as follows:
“SECTION 5. Certificate of Donations. — All accredited non-stock, non-profit

corporation/NGO are required to issue a certificate of donation in such form as
prescribed by the BIR, on every donation or gift they receive. Such certificate shall
be accomplished by the said accredited non-stock, non-profit corporation/NGO in
triplicate and distributed within thirty (30) days after the receipt of the donation, as
follows:
(a) Original copy - Donor

(b) Duplicate copy - BIR
(c) Triplicate copy - Donee”
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Valuation
The amount of any charitable contribution of property other than money shall be based on
the acquisition cost of said property. [Section 34 (H) (3) of the Tax Code]
h. Research and Development
Based on Section 34 (I) of the Tax Code, research and development (R and D)
expenditures may be allowed as deduction:
i. if they are incurred in connection with the trade, business or profession of the
taxpayer; and
ii. if they are not chargeable to capital account.
The following R and D expenditures may be treated as deferred expenses:
i. if they are paid or incurred in connection with trade, business or profession;

ii. if they are not treated as expense; and
iii. if they are chargeable to capital account but not chargeable to property of a
character which is subject to depreciation or depletion.
If treated as a deferred expense, the R and D cost shall be amortized over a period of not
less than 60 months.
Based on Section 34 (I) (3) (a) of the Tax Code, expenditures for the acquisition or
improvement of land, or for the improvement of property to be used in connection with R
and D of a character which is subject to depreciation and depletion may not be
considered as R and D for income tax purposes.
In the absence of a more detailed definition of R and D expenditures in the Tax Code, it
may be possible to make reference to related definitions used for accounting purposes to
the extent that these are not inconsistent with the provisions of the Tax Code.
Under International Accounting Standards (IAS) No. 38, “research and development”
expenditures comprises all expenditure that is directly attributable to research or
development activities or that can be allocated on a reasonable and consistent basis to
such activities.
Research is original and planned investigation undertaken with the prospect of gaining
new scientific or technical knowledge and understanding.
Development is the application of research findings or other knowledge to a plan or

design for the production of new or substantially improved materials, devices, products,
processes, systems or services prior to the commencement of commercial production or
use.
i. Pension
Based on Section 34 (J) of the Tax Code, contributions made to a pension trust may be
claimed as deduction in the following manner:
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i. Amount contributed for the normal service cost - 100% deductible; and
ii. Amount contributed for the past service cost - 1/10 of the amount contributed is
deductible in year the contribution is made, the remaining balance will be
amortized equally over the next nine years
The determination of the normal cost and past service cost (which is the excess of the
contribution over the normal cost) is generally based on the actuarial valuation for
funding).
Hence, mere accrual of the pension liability will not be allowed as deduction.
Under Section 118 of RR No. 2, the requisites for deductibility of payments to pension
trusts are:
i. There must be a pension or retirement plan to provide for the payment of

reasonable pensions to employees;
ii. The pension plan is reasonable and actuarially sound;
iii. It must be funded by the employer;
iv. The amount contributed must no longer be subject to the Group’s control or
disposition; and
v. The payment has not theretofore been allowed as a deduction.
Furthermore, Section 32 (B)(6) of the Tax Code defines a “reasonable private benefit
plan” as a “pension, gratuity, stock bonus or profit-sharing plan maintained by an
employer for the benefit of some or all of his officials or employees, wherein contributions
are made by such employer for the officials or employees, or both, for the purpose of
distributing to such officials and employees the earnings and principal of the fund thus
accumulated, and wherein it is provided in said plan that at no time shall any part of the
corpus or income of the fund be used for, or be diverted to, any purpose other than for the
exclusive benefit of the said officials and employees”.
Also, pursuant to RR No. 1-68, as amended by RR No. 1-83, and as confirmed in various
rulings issued by the BIR, a “reasonable private benefit plan” must be BIR
qualified/accredited.
2.2.2 Optional Standard Deduction (OSD)
Pursuant to RR No. 16-08, the Group may be allowed to claim OSD in lieu of the itemized
deductions [i.e. items of ordinary and necessary expenses allowed under Sections 34 (A)
to (J) and (M) and Section 37 of the Tax Code and other special laws, if applicable].
Determination of the amount of OSD
The OSD allowed shall be in an amount not exceeding forty percent (40%) of the Group’s
gross income for corporations engaged in trading and manufacturing or gross receipt for
sellers of services.
Gross income for a trading and manufacturing concern
The “gross income” shall mean the gross sales less sales returns, discounts and
allowances and cost of goods sold. “Gross sales” shall include only sales contributory to
income taxable under Sec. 27 (A) of the Tax Code. “Cost of goods sold” shall include the
purchase price or cost to produce the merchandise and all expenses directly incurred in
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bringing them to their present location and use.
For trading or merchandising concern, “cost of goods sold” means the invoice cost of
goods sold, plus import duties, freight in transporting the goods to the place where the
goods are actually sold, including insurance while the goods are in transit.
For manufacturing concern, “cost of goods sold” means all costs incurred in the
production of the finished goods such as raw materials used, direct labor and
manufacturing overhead, freight cost, insurance premiums and other costs incurred to
bring the raw materials to the factory or warehouse. The term may be used
interchangeably with “cost of goods manufactured and sold”.
Gross receipts for sellers of services
In the case of sellers of services, the term “gross income” means the “gross receipts” less
sales returns, allowances, discounts and cost of services. “Cost of services” means all
direct costs and expenses necessarily incurred to provide the services required by the
customers and clients including:
(a) salaries and employee benefits of personnel, consultants and specialists directly
rendering the service; and
(b) cost of facilities directly utilized in providing the service such as depreciation or rental
of equipment used and cost of supplies.
The “cost of services” shall not include interest expense except in the case of banks and
other financial institutions.
The term “gross receipts” as used herein means amounts actually or constructively
received during the taxable year. However, for taxpayers engaged as sellers of services
but employing the accrual basis of accounting for their income, the term “gross receipts”
shall mean amounts earned as gross revenue during the taxable year.
The items of gross income under Section 32 (A) of the Tax Code (refer to detailed
discussion on itemized deductions in page A-7) which are required to be declared in the
income tax return of the taxpayer for the taxable year are part of the gross income against
which the OSD may be deducted in arriving at taxable income. Passive income which
have been subjected to a final tax at source shall not form part of the gross income for
purposes of computing the forty percent (40%) optional standard deduction.
2.3 Computation of Taxable Income
The taxable income subject to the 30% RCIT may generally be computed using the
following formula:
Using itemized deductions:
Net income per books xxx

Add: Unallowable deductions xxx
Taxable income not recognized in books
during the current taxable year xxx
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Less: Deductible expenses not recognized in

books during the current taxable year xxx
Income Exempt from tax xxx
Income subject to final tax xxx xxx
Taxable net income xxx
RCIT (Taxable net income x 30%) xxx
Using OSD:
Gross Sales xxx

Less: Cost of Goods Sold xxx
Gross Income xxx
Less: OSD Amount (Gross Income x 40%) xxx
Taxable Income xxx
RCIT (Taxable net income x 30%) xxx
3. Minimum Corporate Income Tax (MCIT)
The MCIT is a tax imposed under Republic Act (RA) No. 8424 which took effect on
January 1, 1998. Under Section 27(E) of the Tax Code, as amended, a minimum
corporate income tax of two percent (2%) of gross income as of the end of the taxable
year shall be imposed on every taxable corporation beginning on the fourth taxable year
following the year in which such corporation commenced its business operations, which is
the date of registration with the BIR, as defined under RR No. 9-98.
Under RR No. 9-98, the MCIT shall be imposed whenever a corporation has zero or
negative taxable income (i.e., the corporation is in a net tax loss position) or whenever the
amount of MCIT is greater than the RCIT due from such corporation.
Under RR No. 12-2007, the computation and the payment of MCIT shall likewise apply at
the time of filing the quarterly corporate income tax as prescribed under Section 75 and
Section 77 of the Tax Code, as amended.
3.1 Gross Income
Based on RR No. 9-98, the term “gross income” means gross sales less sales returns,
discounts and allowances and cost of goods sold. "Gross sales" shall include only sales
contributory to income taxable under Sec. 27(A) of the Tax Code. “Cost of goods sold"
shall include all business expenses directly incurred to produce the merchandise to bring
them to their present location and use.
This was further clarified in RR No. 12-2007, which defines the term “gross income” for
MICT purposes as follows:
“‘Gross income’ defined — For purposes of the minimum corporate income

tax prescribed under this Subsection, the term "gross income" means gross
sales less sales returns, discounts, and allowances and cost of goods sold,
in case of sale of goods, or gross revenue less sales returns, discounts,
allowances and cost of services/direct cost, in case of sale of services. This
rule, notwithstanding, if apart from deriving income from these core
business activities there are other items of gross income realized or earned
by the taxpayer during the taxable period which are subject to the normal
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corporate income tax, the same items must be included as part of the
taxpayer's gross income for computing MCIT. This means that the term
"gross income" will also include all items of gross income enumerated
under Section 32(A) of the Tax Code, as amended, except income exempt
from income tax and income subject to final withholding tax described in the
succeeding subparagraph.”
The said RR further provides that:
“’Gross sales’ shall include only sales contributory to income taxable under
Sec. 27 (A) of the Code." "Cost of goods sold" shall include all business
expenses directly incurred to produce the merchandise to bring them to
their present location and use. Gross Revenue shall include income from
sale of services, likewise, taxable under Sec. 27 (A). Cost of Services or
Direct Cost of Services shall include business expenses directly incurred or
related to the gross revenue from rendition of services.
Passive incomes which are subject to final tax at source shall not form part
of gross income for purposes of minimum corporate income tax.”
3.2 Cost of Goods Manufactured and Sold
For a manufacturing concern, “cost of goods manufactured and sold” means all costs of
production of finished goods, such as raw materials used, direct labor and manufacturing
overhead, freight cost, insurance premiums and other costs incurred to bring the raw
materials to the factory or warehouse.
In the case of sales of services, “cost of services” means all direct costs and expenses
necessarily incurred to provide the services required by the customers and clients
including (a) salaries and employee benefits of personnel, consultants and specialists
directly rendering the service, and (b) cost of facilities directly utilized in providing the
service such as depreciation or rental of equipment used and cost of supplies. [Section
27(E)(4) of the Tax Code and RR No. 9-98]
3.3 Cost of Services for MCIT purposes per Specific Types of Services
a. Banks and non-bank financial intermediaries performing quasi-banking activities
Their cost of services shall refer to those incurred directly and exclusively for the following
activities:
1. Lending/investment of funds;
2. Obtaining of funds from the public through the receipt of deposits; and,
3. Trading of foreign exchange and other financial instruments
and shall be limited to the following:
i. Salaries, wages and other employee benefits of personnel directly engaged in

any of the said activities;
ii. Interest expense except interest charged by or paid to the head office on
funds considered/classified as assigned capital of the branch;
iii. PDIC premium payments; and
iv. BSP supervision fee.
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b. Insurance and pension funding companies
Their costs of services shall refer to those incurred directly and exclusively in the
insurance and pre-need business, including the generation of investment income not
subject to final taxes, and shall be limited to the following:
01. Salaries, wages and other employee benefits of personnel directly engaged in
said activities;
02. Commissions on direct writings/agents of pre-need companies;
03. Claims, losses, maturities and benefits net of reinsurance recoveries; and,
04. Net additions required by law to reserve fund (for insurance companies) and
in the case of pre-need companies, contributions to the trust funds to be set
up independently as mandated by the SEC.
c. Finance companies and other financial intermediaries not performing quasi-banking

activities
Their costs of services shall refer to those incurred directly and exclusively in their
lending, financing and generating of investment income not subject to final taxes, and
shall be limited to the following:
01. Salaries, wages and other employee benefits of personnel directly doing such
functions; and,
02. Interest expense.
d. Brokers of securities (excluding banks)
Their costs of services shall refer to those incurred directly and exclusively for such
activity, and shall be limited to the following:
said activities;
02. Philippine Stock Exchange (PSE) terminal fees;
03. Communication charges related to trading/sales of securities;
04. Research fees such as access to Bloomberg and Reuters stock data;
05. Commissions paid to its agents who are not employees of the brokerage firm;
and,
06. Settlement/processing costs of trades, commonly known as “exchange dues”.
e. Customs, insurance, real estate, immigration and commercial brokers
Their gross receipts shall mean actual or constructive receipts in the form of brokerage
fees, commissions and remuneration as such broker. Their costs of services shall refer to
those incurred directly and exclusively for brokering activities, and shall be limited to the
following:
brokering activities; and
02. Commissions paid to its agents who are not employees of the brokerage firm
f. General engineering and/or building contractors
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activities, and shall be limited to the following:
01. Cost of materials used in construction;

02. Salaries, wages and other employee benefits of site laborers and supervisors;
03. Health insurance, workers compensation and general liability insurance of site
laborers and supervisors;
04. Fees and costs paid to sub-contractors;
05. Costs of performance bonds on the particular contract;
06. Depreciation/amortization, rentals, repairs and maintenance of equipment
directly used in the said activities;
07. Costs of moving equipment and materials to and from the contract site;
08. Costs of design and technical assistance; and
09. Supplies and tools directly used in the said activities
g. Common carriers or transportation contractors
activities, and shall be limited to the following:
the operation of the transportation equipment;
02. Toll fees (representing rental for the use of road);
03. Parking fees (for aircraft, sea craft and motor vehicles),
04. Franchise fees (representing rental for the use of road network);
05. Depreciation/amortization, rentals, repairs and maintenance of:
 Transportation equipment, and
 Properties, building and improvements exclusively used as parking for
aircrafts, sea crafts or motor vehicles;
06. Fuel and lubricants of motor vehicles, aircraft or sea craft directly used in
transporting passengers and/or goods/cargoes;
07. Meals provided to passengers;
08. Cost of safety paraphernalia and other supplies for use by passengers (e.g.
lifejacket, mask, etc.); and,
09. Annual transportation equipment registration fee.
h. Hotel, motel, rest/pension/lodging house and resort operators
Their costs of services shall refer to those incurred directly and exclusively for providing
rooms and other related facilities (e.g. hotel premises, kitchen, restaurants, recreational
facilities, other spaces used by customers, but should not include office premises of
administrative staff) for the enjoyment of customers, and shall be limited to the following:
01. Salaries, wages and other employee benefits of housekeeping staff, concierge
personnel and other hotel/house/resort attendants;
02. Depreciation/amortization, rentals, repairs and maintenance of building,
properties and facilities, and equipment directly used in the said activities;
03. Commissions paid to travel agents for bookings of guests for such
establishments;
04. In case the operator also serves food and beverage, its direct costs shall
include those allowed to food service establishments; and
05. Supplies (e.g. hotel room/housekeeping, kitchen and laundry).
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i. Food service establishments
Their costs of services shall refer to those incurred directly and exclusively in the
preparation and serving/selling of foods and drinks and other requirements of the
customers, and shall be limited to the following:
01. Cost of raw/cooked foods and drinks prepared and served/sold;

the said activities;
03. Depreciation/amortization, rentals, repairs and maintenance of properties,
buildings, furniture and fixtures, and equipment directly used in the
performance of said activities;
04. Cost of cooking oil, condiments and other ingredients used in cooking the
food; and
05. Royalties paid by franchisee.
j. Lessors of property
Their costs of services shall refer to those incurred directly and exclusively for the
property leased, and shall be limited to the depreciation/amortization, rentals, real
property taxes/charges, and repairs and maintenance, of the properties being leased, as
well as salaries of employees and fees of contractors hired to provide maintenance
(repairs, cleaning/maintenance of leased properties) and collection services.
k. Telephone and telegraph, electric, gas, and water utilities
Their costs of services shall refer to those incurred directly and exclusively for the
production and delivery of such systems/utilities, and shall be limited to the following:
the said activities;
02. Depreciation/amortization, rentals, repairs and maintenance of properties and
equipment directly used in the said activities (i.e., water pipes, electric poles,
antennas, etc.);
03. Interconnection fee and/or share of foreign telecommunications administration
(FA) for the services they perform;
04. Fuel and lubricants on vehicles or equipment directly utilized in the said
activities;
05. Amortization of franchise or development fees;
06. Franchise fees; and
07. Royalties.
l. Radio and/or television broadcasting
production and broadcasting, and shall be limited to the following:
01. Fees of talents hired for production/broadcasting;

02. Salaries, wages and other employee benefits of production and broadcasting
personnel;
03. Tapes and other production materials & supplies;
04. Satellite charges & wire services;
05. Film rights royalties & dubbing expenses;
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06. Set requirements;

07. Rentals for production equipment & facilities;
08. Rentals for locations used exclusively for production/broadcasting;
09. Costumes, props & prizes; and,
010. Depreciation on production and broadcasting equipment.
(RMC No. 4-2003)
3.4 MCIT Illustrated
Year-end income tax computation
For a better understanding of the concept of MCIT, below is an illustration of applying

MCIT.
Assume the following data:
Regular Corporate Income Tax (RCIT) P 10,000

Gross Income 600,000
MCIT (600,000 x .02) P 12,000
Based on the above data, the Company will be liable for the computed amount of the
MCIT since it is greater than the RCIT. If in the above illustration, the Company has no
income for the taxable year and thus no RCIT is payable, the Company will still be liable
for the amount of MCIT.
Quarterly income tax computation
The case below illustrates computation of MCIT on a quarterly basis:
Illustration: X Co. computed normal income tax and MCIT, and creditable income taxes
withheld for the 1st to 4th quarters in 2009 including excess MCIT and excess withholding
taxes from prior year/s, as follows:
Quarter Normal MCIT Taxes Excess Excess

Income Tax Withheld MCIT Taxes W/tax from
from prior prior year
year
1st 100,000 80,000 20,000 30,000 10,000
2nd 120,000 250,000 30,000
3rd 250,000 100,000 40,000
4th 200,000 100,000 35,000
For the 1st quarter, the quarterly income tax payable by X Co. shall be computed as
follows:
Quarterly corporate income tax due (higher P100,000

amount between normal income tax and
MCIT) — normal income tax
Less: Taxes Withheld — Prior Year 10,000
Taxes Withheld — 1st qtr 20,000
Excess MCIT prior year 30,000 60,000
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Net Income Tax Due, 1st quarter — normal

income tax P40,000
For the 2nd quarter, the quarterly income tax payable by X Co. shall be computed as
follows:
Quarterly corporate income tax due(higher P330,000

amount between normal income tax and
MCIT) — MCIT
Taxes Withheld — 2nd qtr 30,000
Net income tax payment — 1st qtr 40 000 100,000
Net Income Tax Due, 2nd quarter — MCIT P230,000
For the 3rd quarter, the quarterly income tax payable by X Co. shall be computed as
follows:

amount between normal income tax and MCIT) —
normal income tax
Taxes Withheld — 3rd qtr 40,000
Net income tax payment — 1st qtr 40 000
MCIT paid in the 2nd quarter 230,000
Excess MCIT in prior year 30,000 400,000
Net Income Tax Due, 3rd quarter — normal income
tax P70,000
At year end, the computation of the annual income tax payable by X Co. shall be
computed as follows:

amount between normal income tax and MCIT)
— normal income tax
Taxes Withheld — 4th qtr 35,000
Net income tax payment — 1st qtr 40 000
Net income tax payment — 3rd qtr 70,000
MCIT paid in the 2nd quarter 230,000
Excess MCIT in prior year 30,000 505,000
Annual Net Income Tax Due – normal income
tax P165,000
Based on the above, in the computation of the tax due for the taxable quarter, if the
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computed quarterly MCIT is higher than the quarterly normal income tax, the tax due to be
paid for such taxable quarter at the time of filing the quarterly corporate income tax return
shall be the MCIT which is two percent (2%) of the gross income as of the end of the
taxable quarter. In the payment of said quarterly MCIT, excess MCIT from the previous
taxable years shall not be allowed to be credited. Expanded withholding tax, quarterly
corporate income tax payments under the normal income tax, and the MCIT paid in the
previous taxable quarter/s of the same year are allowed to be applied against the
quarterly MCIT due.
At year end, as can be seen from the above illustrative computation, quarterly MCIT paid
on the Quarterly Income Tax Return shall be credited against the normal income tax at
year end if in the preparation and filing of the annual income tax return and in the final
computation of the annual income tax due, it appears that the normal income tax title is
higher than the computed annual MCIT. Moreover, in addition to the quarterly MCIT paid
and quarterly normal income tax payments in the taxable quarters of the same taxable
year excess MCIT in the prior year/s (subject to the prescriptive period allowed for its
creditability), expanded withholding taxes in the current year and excess expanded
withholding taxes in the prior year shall be allowed to be credited against the annual
income tax computed under the normal income tax rules.
However, if in the computation of the annual income tax due, the computed annual MCIT
due appears to be higher than the annual normal income tax due, what may be credited
against the annual MCIT due shall only be the quarterly MCIT payments of the current
taxable quarters, the quarterly normal income tax payments in the quarters of the current
taxable year, the expanded withholding taxes in the current year and excess expanded
withholding taxes in the prior year. Excess MCIT from the previous taxable year/s shall
not be allowed to be credited therefrom as the same can only be applied against normal
income tax.
Thus, in the above illustration, suppose the MCIT at year end is higher than the normal
income tax, then computation of the income tax liability of X Co. shall be as follows:
Quarter Normal MCIT Taxes Excess Excess

Income Tax Withheld MCIT Taxes W/tax from
from prior prior year
year
1st 100,000 80,000 20,000 30,000 10,000
2nd 120,000 250,000 30,000
3rd 250,000 100,000 40,000
4th 50,000 120,000 35,000
Total 520,000 550,000 125,000
Annual corporate income tax due (higher P550,000

amount between normal income tax and MCIT)
— MCIT
Taxes Withheld – 1st qtr 20,000
Taxes Withheld — 4th qtr 35,000
Net income tax payment — 1st qtr 40,000
Net income tax payment — 3rd qtr 70,000
MCIT paid in the 2nd quarter 230,000 475,000
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Annual Net Income Tax Due — MCIT P75,000
3.5 Creditability of MCIT against RCIT
Any excess of the minimum corporate income tax over the normal tax shall be carried
forward and credited against the normal tax for the three (3) immediately succeeding
taxable years. [Sec. 27 (E)(2) of 1997 Tax Code]
3.6 Relief from MCIT
Based on Section 27 (E)(3) of 1997 Tax Code, the Secretary of Finance is authorized to
suspend the imposition of the minimum corporate income tax on any corporation which
suffers losses on account of prolonged labor dispute, or because of force majeure, or
because of legitimate business reverses.
4. Improperly Accumulated Earnings Tax (IAET)
General Principles
A tax of 10% will be imposed on the improperly accumulated taxable income of

corporations formed or availed of for the purpose of avoiding the income tax with respect
to its shareholders or the shareholders of any other corporation, by permitting the
earnings and profits of the corporation to accumulate instead of dividing them among or
distributing them to the shareholders.
The rationale of IAET is that if the earnings and profits were distributed, the shareholders
would then be liable to income tax thereon, whereas if the distribution were not made to
them, they would incur no tax in respect to the undistributed earnings and profits of the
corporation.
Thus, IAET is a tax imposed, in the nature of a penalty, to the corporation for the improper
accumulation of its earnings, and as a form of deterrent to the avoidance of tax upon
shareholders who are supposed to pay dividends tax on the earnings distributed to them
by the corporation.
Coverage of IAET
The IAET is imposed on domestic corporations classified as closely held corporations.
Closely-held corporations are those which have at least 50% in value of the outstanding
capital stock, or at least 50% of the total combined voting power of all classes of stock
entitled to vote is owned, directly or indirectly, by or for not more than 20 individuals.
Under RR No. 2-2001, the following entities are exempt from IAET4:
4
Under Section 29 (B) (2) of the Tax Code, only the following entities are exempt from IAET:
a. Publicly-held corporations;
b. Banks and other nonbank financial intermediaries; and
c. Insurance companies.
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1. Banks and other non-bank financial intermediaries

2. Insurance companies
3. Publicly held corporations (see previous definitions)
4. Taxable partnerships
5. General professional partnerships
6. Non-taxable joint ventures
7. PEZA-registered enterprises
8. BCDA-registered enterprises
9. Other entities registered under special economic zones enjoying special tax rates on
their registered operations or activities in lieu of other taxes, national or local
10. Branches of a foreign corporation or resident foreign corporation.
Determination of the Reasonable Needs of the Business
An accumulation of earnings or profits (including undistributed earnings or profits of prior

years) is unreasonable if it is not necessary for the purpose of the business, considering
all the circumstances of the case. The term “reasonable needs of the business” is hereby
construed to mean the immediate needs of the business, including reasonably anticipated
needs. In either case, the corporation should be able to prove an immediate need for the
accumulation of the earnings and profits, or the direct correlation of anticipated needs to
such accumulation of profits. Otherwise, such accumulation would be deemed to be not
for the reasonable needs of the business, and the penalty tax would apply.
The following constitute accumulation of earnings for the reasonable needs of the
business:
a) Allowance for the increase in the accumulation of earnings up to 100% of the paid-up
capital of the corporation as of Balance Sheet date, inclusive of accumulations taken
from other years;
b) Earnings reserved for definite corporate expansion projects or programs requiring
considerable capital expenditure as approved by the Board of Directors or equivalent
body;
c) Earnings reserved for building, plants or equipment acquisition as approved by the
Board of Directors or equivalent body;
d) Earnings reserved for compliance with any loan covenant or pre-existing obligation
established under a legitimate business agreement;
e) Earnings required by law or applicable regulations to be retained by the corporation or
in respect of which there is legal prohibition against its distribution;
f) In the case of subsidiaries of foreign corporations in the Philippines, all undistributed
earnings intended or reserved for investments within the Philippines as can be proven
by corporate records and/or relevant documentary evidence.
Computation of IAET
Taxable income for the year xxx

Add:
Income exempt from tax xxx
Income excluded from gross income xxx
Income subject to final tax, and xxx
In this regard, there is a risk that entities other than those enumerated above are subject to IAET. The Group
may obtain a ruling from the BIR if it falls under entities not enumerated in the Tax Code.
INCOME TAX
TAX GUIDE
Amount of NOLCO deducted xxx

Deduct:
Income tax paid/payable for the taxable year (xxx)
Dividends actually or constructively paid/issued from
the applicable year’s taxable income (xxx)
Amount reserved for reasonable business needs
emanating from the covered year’s taxable income (xxx)
Tax Base for IAET xxx
Multiply by 10% 10%
IAET xxx
Computation Guidelines
 Profits already subjected to IAET will no longer be subjected to said tax in later years
even if not declared as dividends.
 Profits which have been subjected to IAET, when finally declared as dividends, shall
still be subject to tax on dividends, if any.
 For purposes of determining the source of earnings declared or distributed from
accumulated income for each taxable year, dividends shall be deemed to have been
paid out of the most recently accumulated profits or surplus and shall constitute part
of the annual income of the distributee for the year of receipt.
 Exceptions: Where dividends declared or portion of the said dividends declared forms
part of the accumulated earnings as of December 31, 1997 or of a particular year, and
therefore is an exception to the preceding statement, such fact must be supported by
a duly executed Board Resolution to that effect.
Time of Payment
Dividends must be declared and paid or issued not later than one (1) year following the
close of the taxable year. Otherwise, the IAET should be paid within 15 days thereafter.
(RR No. 2-2001)
5. Bookkeeping Requirements
5.1 Preservation of books of accounts and other accounting records
Pursuant to Section 235 of the Tax Code, all the books of accounts, including the
subsidiary books and other accounting records of the Company shall be preserved for a
period beginning from the last entry in each book until the last day prescribed by Section
203, within which the Commissioner is authorized to make an assessment. The said
books and records shall be subject to examination and inspection by internal revenue
officers.
Section 203 of the Tax Code provides that internal revenue taxes shall be assessed within
three (3) years after the last day prescribed by law for the filing of the return or the time
when the return is actually filed whichever comes later.
5.2 Subsidiary books
Based on Section 233 of the Tax Code, the Company, may at its option, keep subsidiary
books in place of books of accounts mentioned above as the needs of its business may
INCOME TAX
TAX GUIDE
require. Provided, that where such subsidiaries are kept, they shall form part of the
accounting system of the Company and shall be subject to the same rules and regulations
as to their keeping, translation, production and inspection as are applicable to the journal
and the ledger.
5.3 Additional Compliance Requirements in Light of Mandatory Adoption of the

Philippine Financial Reporting Standards in Recording and Presenting Business
Transactions and Results.
Under the Philippine Financial Reporting Standards (PFRS), the recording and the
recognition of business transactions for financial accounting purposes, in a majority of
situations, differ from the application of tax rules on the same transactions resulting to
disparity of reports for financial accounting vis-a-vis tax accounting.
Hence, there is a need to reconcile the disparity in a systematic and clear manner to
avoid irritants between the taxpayer and the tax enforcer. Accordingly, concerned
taxpayers are hereby mandated to maintain books and records that would reflect the
reconciling items between Financial Statements figures and/or data with those
reflected/presented in the filed Income Tax Return (ITR).
The recording and presentation of the reconciling items in such books and records shall
be done in such a manner that would facilitate the understanding by the examiners/
auditors of the BIR tasked to undertake audit/investigation functions, providing in sufficient
detail the computation of the differences and the reasons therefor, aimed at bringing into
agreement the PFRS and ITR figures. [Section 2 of RR No. 8-07]
5.4 Registration of books with the BIR
Manual Books of Accounts
Section 3 of RR No. V-1 or otherwise known as the Bookkeeping Regulations provides

that persons required by law to pay internal revenue taxes whose gross quarterly sales,
earnings, receipt, or output, whether subject to percentage tax or not, exceed five
thousand pesos (P5,000), are required to keep books of accounts in accordance with the
standard accounting system. The said books of accounts shall consist of journal and a
ledger, or their equivalents, and shall contain all information necessary for the accurate
determination of the internal revenue taxes due on their businesses.
The following are the existing rules with respect to the registration of manual books of
accounts:
(1) Manual books of accounts previously registered but whose pages are not yet fully
exhausted can still be used in the succeeding years without the need of re-
registering or re-stamping the same, provided, that the portions pertaining to a
particular year should be properly labeled or marked by taxpayer;
(2) The registration of a new set of manual books of accounts shall only be at the time
when the pages of the previously registered books have all been already
exhausted. This means that it is not necessary for a taxpayer to register a new set
of manual books of accounts each and every year.
(3) The registration deadline of “January 30 of the following year” as enunciated in

RMO 29-2002 applies only to computerized books of accounts and not to manual
INCOME TAX
TAX GUIDE
books accounts. The “15 days after the end of the calendar year” deadline under
RMC 13-82 refers to loose-leaf bound books of accounts and not to manual books
of accounts;
(4) Newly Registered taxpayers shall present the Manual Books of Accounts before
use to the RDOs where the place of business is located or concerned office under
the Large Taxpayer Service for approval and registration;
(5) Subsidiary manual books of accounts to be used by taxpayers, in addition to the

manual books of accounts, required by the National Internal Revenue Code of
1997 and existing rules, shall likewise be registered before use, following the
same rules abovementioned;
(6) It is to be emphasized that the Taxpayer Service Section (TSS) of the RDOs or
concerned office under Large Taxpayer Service has no authority to examine
whether the previously registered books are complete and/or updated prior to the
approval of the registration.
(RMC No. 82-08)
Computerized Books of Accounts
If the Group or its affiliates will use or develop a computerized accounting system (CAS)
or its components, it is required to apply for a “Permit to Adopt Computerized Accounting
System or Components Thereof” with the BIR.
Moreover, the Group is also required to re-apply for the above permit if there are system
enhancements/modifications on the existing CAS or its components that will result to
changes in system release and/or upgrade in version number.
A CAS is the integration of different component systems to produce computerized books

of accounts and computer-generated accounting records and documents. Any system
application adopted to generate accounting records, reports and/or documents are
considered as components of CAS. A “Computerized Books of Accounts” refer to books of
accounts such as General Ledger, General Journal, Sales Book, Purchase Book,
Disbursement Book, etc., which are systems generated.
(RMO No. 29-2002; RMC No. 71-2003)
Electronic Record Keeping Requirements for Large Taxpayers
All Large Taxpayers classified under RR No. 1-98 are required to maintain and/or adopt a
CAS or components thereof. Accordingly, all books of accounts and accounting records
shall be in electronic formats.
A Large Taxpayer using commercial and/or customized software to keep books and
records electronically is not relieved of the responsibility to keep adequate electronic
records because of deficiencies in the software.
Electronic record keeping requirements in general:
1. Maintain all necessary records for the determination of the correct tax liability. All
records must be available upon request of the Commissioner of Internal Revenue or
INCOME TAX
TAX GUIDE
its authorized representatives.
2. If taxpayer retains required records in both electronic and hard-copy formats, taxpayer
shall make the records available to the BIR in electronic format upon request of the
Commissioner of Internal Revenue or its authorized representatives.
3. Taxpayer can still use hard-copy documents to demonstrate tax compliance. However,
the taxpayer still has the obligation to comply with the second requirement mentioned
above.
The following are the general electronic recordkeeping requirements for electronic
records:
 Electronic records used to establish tax compliance shall contain sufficient

transaction level detail information so that the details underlying the electronic
records can be identified and made available to the BIR upon request. A taxpayer
has discretion to discard duplicated records and redundant information provided
its responsibilities under the regulation are met.
 At the time of an examination, the retained records must be capable of being

retrieved and converted to a standard record format in accordance with RR 16-06
All records required to be retained shall be preserved pursuant to Section 235 of the
NIRC unless the BIR has provided in writing that the records are no longer required.
All computerized books of accounts, electronic recordkeeping, electronic business

systems and components thereof shall be registered with the BIR.
(RR No. 9-2009; RMO No. 29-2002)
6. Income tax computation where the financial statements are in foreign

functional currency
With the issuance of RR No. 6-2006, there arose an issue on the appropriate translation
procedure to be used for income tax purposes. Moreover, it is not yet clear under the
current functional currency regulations whether a company that has adopted the USD as
its functional currency will now consider the peso as a foreign currency. Note that this will
affect the forex gain and loss computations.
Sections 7 and 8 of RR No. 6-06 provide as follows:
“SECTION 7. Currency to be Used for Income Tax Purposes. — The income tax
returns (ITRs) of taxpayers which have adopted functional currency (other than
Philippine peso) in their financial statements and books of accounts shall still be
prepared in Philippine pesos. Thus, all entries in the ITR shall be in Philippine
pesos.
For purposes of translating the functional currency income and expenses to

Philippine Pesos, the translation shall be done on a monthly basis using the
average exchange rate during the month (under the Philippine Dealing System or
PDS). The total translated amounts per month shall be added to arrive at the
income and expenses in Philippine pesos for the quarter/year, which shall be the
INCOME TAX
TAX GUIDE
basis in computing the taxpayer's income tax liability. The total figures in the ITR for
the year should be reconciled with the total of the equivalent peso figures as
converted from the functional currency figures in the subsidiary ledgers maintained
to serve as the source of the figures reflected in tax returns other than income tax.
The reconciliation of the figures shall be done at the end of the year and the
reconciling items shall be reflected in the annual or final adjustment income tax
return. Thus, after such reconciliation, the figures in the annual ITR should tally with
the total annual figures in the other tax-type tax returns such as the tax returns for
VAT, Percentage Tax, Withholding Tax, Documentary Stamp Tax, etc.
Tax credits applied against the income tax due (in Philippine pesos), if any, shall be
equal to the actual amounts of such credits in Philippine pesos, as shown in the
supporting documents (e.g. withholding tax certificates issued by the other party
withholding agents, proof of advance payment of the tax and prior year's income tax
return).
SECTION 8. Currency to be Used in the Filing of Tax Returns Other than Income
Tax. — All tax returns other than the ITR shall likewise be filed in Philippine peso
currency using historical peso amount or actual conversion/prevailing PDS rate on
transaction day, whichever is applicable.”
Based on the foregoing rules, there is an issue on how the income and expenses will be
determined for purposes of calculating the Group’s income tax liabilities (if functional
currency is used). There are three views:
a. Historical amounts
Under this view, historical peso amounts are used for the year-end computation of income
tax liability. The transactions entered into by the Group using the Philippine peso are
presented in their historical amounts. Forex transactions, on the other hand, are to be
converted to peso amounts using the historical PDS rates.
b. Converted Amounts
Under this view, all of the transactions entered into by the Group are initially recorded
using the functional currency, regardless of whether these are originally in Philippine
pesos or foreign currency. Peso-denominated transactions and transactions denominated
in foreign currencies other than the Group’s functional currency are initially translated to
the corresponding functional currency amounts using historical PDS forex rates. At the
end of each month, the functional currency amounts are translated to peso amounts using
the average PDS forex rate for each month.
c. Hybrid
Under this view, the determination of peso amounts for the computation of the income tax
liability is as follows:
i. For income and expenses reported in the Withholding Tax Returns and other National
Tax Returns
Section 8 of RR No. 06-06 provides that tax returns other than the ITR shall be presented
in historical peso amounts. Section 7 of the same Regulations further provides for the
INCOME TAX
TAX GUIDE
year-end reconciliation between the total figures in the ITR for the year with the total
annual figures in the other tax-type tax returns.
Thus, the Group (if using functional currency) should determine the income and expenses
which have an impact on tax returns other than the ITR. These transactions entered into
by the Group using the Philippine peso are presented in their historical amounts. Forex
transactions, on the other hand, should be converted to peso amounts using the historical
PDS rates.
ii. For income and expenses not reported in the Withholding Tax Returns and other
National Tax Returns
For the transactions entered into by the Group (if using functional currency) that do not
have an impact on tax returns other than the ITR, such transactions entered into by the
Group are initially recorded using the functional currency. Peso-denominated transactions
and transactions denominated in foreign currencies other than the Group’s functional
currency are initially translated to the corresponding functional currency amounts using
historical PDS forex rates. At the end of each month, the functional currency amounts are
translated to peso amounts using the average PDS forex rate for each month.
Considering the above issue, the Group (if using functional currency) may secure a BIR
ruling to confirm the proper method of computation.
7. Timing and Venue of Filing of Returns and Payment of Income Tax
7.1 Filing and Payment of Taxes
Please refer to Annex B for the required BIR Forms, deadlines and venue of
filing/payment of the Income Tax return.
7.2 Required attachments to the income tax returns
a. Summary Alphalist of Withholding Agents of Income Payments Subjected to

Creditable Withholding Taxes (SAWT) - Please refer to Annex H for the proper format.
b. Creditable Withholding Tax (CWT) Certificates [BIR Form No. 2307]
c. Audited Financial Statements (AFS)
d. Reconciliation from income per books to taxable income, if not shown in the Annual
Income Tax Returns
e. Account Information Form (AIF) is not required since the AFS is in lieu of this form but
schedules required in the AIF but are not presented in the AFS should be included as
additional attachments (e.g., schedule of taxes and licenses, schedule of depreciation,
etc.).
7.3 No-Payment Returns
The Group should still file an Income Tax return even if there is no payment.
All “no-payment” (refundable, breakeven, exempt and no operation/transaction) returns

including returns to be paid on second installment, withholding tax returns (WTRs)
covered by Tax Remittance Advice (TRA) and returns paid through a Tax Debit Memo
(TDM)/Credit Memo (CM) shall be filed with and accepted by the concerned RDO where
the taxpayer is registered.
INCOME TAX
TAX GUIDE
However, no payment returns filed late shall be filed with the AAB or Collection
Officer/Deputized Municipal Treasurer, where there are no AABs, for payment of
necessary penalties.
(RMO No. 32-2000)
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PART I General Issues

2. Regular Corporate Income Tax (RCIT)

2.1 Gross Income

Items of Gross Income

Income subject to final tax/exempt from income tax

Capitals assets vs. Ordinary Assets

a. Taxpayers engaged in the real estate business

b. Taxpayer not engaged in the real estate business

Monetary consideration or the presence or absence of profit in the operation of the

In the case of subsequent non-operation by taxpayers originally registered to be

e. Treatment of abandoned and idle real properties

f. Treatment of real properties that have been transferred to a buyer/transferee, whether

g. Treatment of real property subject of involuntary transfer

In the case of involuntary transfers of real properties, including expropriation or

Joint Venture Agreements

Joint Ventures in general

Factors that must concur to constitute a joint venture:

1. A contribution by the parties of money, property, effort, knowledge, skill or

6. Usually, a limitation of an objective of a single undertaking or ad hoc

A joint venture may be incorporated or unincorporated

Unincorporated joint venture:

 Not registered with the Securities and Exchange Commission

Joint ventures as taxable corporations

Implications of the OSD

2.2.1 Itemized Deductions

a. Ordinary and Necessary Business Expenses;

Detailed Discussion on Items of Deduction

Below are the requisites for deductibility of business expenses.

iii. It is connected with the trade or business (Ibid.)

 Salaries and Wages – Withholding Tax on Wages (WTW)

Based on Section 6 of RR No. 14-2002, which amends Section 2.58.5 of RR No.

 The recipient/payee failed to report the income on the due date

v. It must be substantiated by invoices, official receipts (ORs) or other adequate

It is required that the claimed deduction be supported by sufficient evidence such

Entertainment, Amusement and Representation Expenses (EAR)

Section 2 of RR No. 10-02 defines representation expenses as “expenses incurred by a

 Entertainment Facilities - shall refer to (1) a yacht, vacation home or condominium;

To be considered an entertainment facility, such yacht, vacation home or

i. It must be paid or incurred during the taxable year;

v. It must be duly substantiated by adequate proof. The official receipts, or invoices,

[Section 4 of RR No. 10-02]

Section 5 of RR No. 10-02 provides a ceiling on the amount of entertainment, amusement

If the Company is engaged in the sale of goods

Net Sales P 100,000,000

If the Company is engaged in the sale of services

Net Sales P 100,000,000

In the above illustration, the Company’s allowable deduction for entertainment,

Net Sales Percentage EAR EAR Ceiling Allowable

In the above illustration, the Company’s allowable deduction for entertainment,

Moreover, Section 6 of the same RR requires as follows:

“SECTION 6. Reporting. – The taxpayer is hereby required to use in its financial

Advertising is generally of two kinds:

(2) advertising designed to stimulate the future sale of merchandise or use of

i. Requisites for deductibility of interest expense

 There must be an indebtedness;

 There should be an interest expense paid or incurred upon such indebtedness;

 The indebtedness must be that of the taxpayer;

 The indebtedness must be connected with the taxpayer’s trade, business or

 The interest must be stipulated in writing;

 The interest must be legally due;

 The interest payment arrangement must not be between related taxpayers

 In the case of interest incurred to acquire property used in trade, business or