Chapter 8 Deductions from Gross Income

 Deductions from Gross Income

General rules
To be deductible as a business expense:
1. The expense must be ordinary and necessary,
2. It must be paid or incurred within the taxable year, and
3. It must be paid or incurred in carrying on a trade or business.
4. The expense must be substantially proved by evidence or records the deductions
claimed under the law, otherwise, the same will be disallowed.

Note: Any income payment which is otherwise deductible under the Code shall be
allowed as a deduction from the payor's gross income only if it is shown that the
income tax required to be withheld has been paid.

Return of capital (cost of sales or services)

1. Sale of inventory of goods by manufacturers and dealers of properties – the
portion of the receipt representing the cost of goods manufacture and sold
(manufacturers) and cost of sales (dealers) are deducted from the gross sales.
2. Sale of stock in trade by a real estate dealer and dealer in securities – generally,
the return of capital are not allowed to be deducted from the gross sales. Rather,
they are required to deduct the total cost specifically identifiable to the real
property or shares of stock sold or exchanged.
3. Sale of services – not allowed to deduct any return of capital; thus the entire gross
receipts are treated as part of income.

Itemized deductions (EIT LBDD CRP)

1. Expenses
2. Interest
3. Taxes
4. Losses
5. Bad Debts
6. Depreciation
7. Depletion of Oil and Gas Wells and Mines
8. Charitable and Other Contributions
9. Research and Development
10. Pension Trusts (Sec. 34, NIRC)

Premium payments on health and/or hospitalization insurance (See Chapter 3 Taxation of Individuals)

Optional Standard Deduction (OSD) (As amended by R.A. 9504 which took effect July 6, 2008)
1. An individual, other than a nonresident alien, may elect a standard deduction of
40% of his gross sales or gross receipts. (Prior to RA 9504, rate is 10% of gross
income) (See Chapter 3 Taxation of Individuals)
2. In the case of a corporation, it may elect standard deduction of 40% of its gross
income as defined in Section 32 of the Tax Code. (Prior to RA 9504, no OSD
benefit for corporation) (See Chapter 4 Taxation of Corporations)
 Such election should be signified in his return and shall be irrevocable for
the taxable year for which the return was made.

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Personal and Additional Exemption (See Chapter 3 Taxation of Individuals)

Items not deductible

General rules:
An expense will only be allowed as deduction only if the tax required to be deducted and
withheld therefrom has been remitted to the BIR.

Specific Items enumerated under Section 36 NIRC:

1. Personal, living or family expenses
2. Amounts paid out for new buildings or for permanent improvements or betterments
made to increase the value of any property or estate (not applicable to intangible
drilling and development costs incurred in petroleum operation) should be capitalized
3. Amounts expended in restoring property or in making good the exhaustion thereof
for which an allowance is or has been made
4. Premiums on life insurance policy when the taxpayer is directly/indirectly a
beneficiary under such policy
5. No deduction shall be allowed in losses from sales or exchanges of property
directly/indirectly:
 Between members of a family (include only brothers and sisters, spouse,
ancestors, and lineal descendants)
 Between an individual and a corporation more than 50% in value of
outstanding stock is owned by such individual (except in case of
distributions in liquidation)
 Between 2 corporations more than 50% in value of outstanding stock
owned by same individual, if either one is a personal holding company or
a foreign holding company during the taxable year preceding the date of
sale/exchange
 Between grantor and fiduciary of any trust
 Between fiduciary of a trust and the fiduciary of another if same person is
a grantor to each trust

 Expenses

Requisites for deductibility

1. Must be ordinary and necessary (both must be complied with) trade, business or
professional expenses only.
2. Must be paid or incurred during the taxable year.
3. Must be paid or incurred in carrying on or which are directly attributable to, the
development, management, operation and or conduct of the trade, business or
exercise of a profession.

Substantiation requirements: sufficient evidence (i.e. official receipts, financial

statements or other adequate records) to substantiate:
1. Amount of expense deducted.
2. Direct connection/relation of the expense to the development, management
operation and/or conduct of the trade, business or profession of the taxpayer.

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Classification of expenses:
1. Ordinary expense – Normal or usual in relation to the taxpayer’s business and
the surrounding circumstance.
2. Necessary expense – Appropriate and helpful in the development of taxpayer’s
business and are intended to minimize losses or to increase profits. These are the
day to day expenses.
 While illegal income will form part of the income of the taxpayer, expenses
which constitute bribe, kickback, and other similar payment, being
against law and public policy are not deductible from gross income.
3. Business expense – Expenditure related to the business that is deductible in the
year incurred, in the same taxable year.
4. Capital expense – Expenditure that improves or adds to the value of your
property or equipment. Not immediately deductible. It is deductible over time, such
as in the form of depreciation.

Note: Expenses allowable to private educational institutions: In addition to the

expenses allowable as deductions, a private educational institution has the option
to elect either:
 To deduct as expense those otherwise considered as capital outlays of
depreciable assets for the expansion of school facilities.
 To capitalize asset & deduct allowance for depreciation.

Expenses to be deductible:
1. Amount must be reasonable.
2. Amount must be substantiated.
3. It is not contrary to law, public policy or morals.
4. Tax required to be withheld must have been paid to the BIR.

Salaries, wages and other forms of compensation for personal services actually
rendered (including grossed-up monetary value of FB); but the final tax should have
been paid
Among the ordinary and necessary expenses paid or incurred in carrying on any
trade or business may be included a reasonable allowance for salaries or other
compensation for personal services actually rendered. The test of deductibility in
the case of compensation payments is whether they are reasonable and are, in
fact, payments purely for service.

Travel expenses in pursuit of trade, business/profession

Traveling expenses include transportation expenses and meals and lodging
incurred solely on business.

Cost of materials
In general, the cost of materials or supplies is deductible as expense when
consumed or used in business operation during the taxable period. Unused
supplies and supplies not used for business operation are not allowable
deductions.

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If the materials or supplies are used directly or indirectly in the production of the
product, the related cost shall for part of the cost of the product and will be
deductible as such when the products are sold.

Rentals and/or other payments as lessee, user or possessor

On the accrual basis, rent is deductible as expense when liability is incurred during
the period of use. While on cash basis, rent is deductible when incurred and paid.

An advance payment is not deductible expense of the lessee until the period is
used, although the lessor may be required to report the amount when received.

Repairs and maintenance

1. Incidental (minor) repairs – deductible from gross income; does not materially
add to the value of the property nor appreciably prolong its life, but keep it in an
ordinarily efficient operating condition.
2. Major repairs (replacement) – not deductible since it prolongs the life of the
asset; should be capitalized.
Expenses under lease agreements

Expenses for professionals

The cost of supplies in the practice of his profession, expenses paid in the
operation and repair of transportation equipment used in making professional
calls, dues to professional societies and subscriptions to professional journals, the
rent paid for office rooms, the expenses of the fuel, light, water, telephone, etc.;
used in such offices, and the hire of office assistants.

Amounts currently expended for books, furniture, and professional instruments

and equipment, the useful life of which is short, may be deducted.

But amounts expended for books, furniture, and professional instruments and
equipment of a permanent character are not allowable as deductions

Entertainment, amusement and recreation expenses directly connected to the

development, management and operation of trade, business/profession
(Includes representation expenses and/or depreciation or rental expense relating to entertainment facilities)
Directly connected to the development, management and operation of the trade,
business of profession of the taxpayer.

Subject to a limit of:

 0.5% of net sales (gross sales less sales returns/allowances & sales
discounts) for taxpayers engaged in sale of goods or properties;
 1% of net revenue (gross revenue less discounts) for those engaged in
sale of services, including exercise of profession and use or lease of
properties. RR 10-2002
 If taxpayer is deriving income from both sales of goods and services, the
allowable EAR expense shall be based on an apportionment formula, but
which in no case shall exceed the minimum percentage ceiling.

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 Formula: Whichever is lower

Limit A = Net Sales (Sale of Goods) X 0.5%
Net Revenue (Sale of Service) X 1%

Limit B = Net Sales (Sale of Goods) X Actual Expense

Total Net Sales & Net Revenue

Net Revenue (Sale of Service) X Actual Expense

Total Net Sales & Net Revenue
Training expenses
 Interest
Requisites for deductibility: as implemented by RR 13-2000
1. There must be an indebtedness
2. There should be an interest expense paid or incurred upon such indebtedness
3. Indebtedness must be that of the taxpayer
4. Indebtedness must be connected with the taxpayer’s trade, business or exercise
of profession
5. Interest expense must have been paid or incurred during the taxable year
6. Interest must have been stipulated in writing
7. Interest must be legally due
8. Interest payment arrangement must not be between related taxpayers
9. Interest must not be incurred to finance petroleum operations
10. In case of interest incurred to acquire property used in trade, business or exercise
of profession, the same was not treated as a capital expenditure
11. The interest is not expressly disallowed by law to be deducted from gross income
of the taxpayer.
Note: General rule on deduction
The amount of interest expense paid or incurred within a taxable year of
indebtedness in connection with the taxpayer’s trade, business, or exercise of
profession shall be allowed as a deduction from the taxpayer’s gross income.
Limitation on deduction
Interest expense shall be reduced by an amount equal to the following % of interest
income subjected to final tax: (1/1/98 - 41%; 1/1/99 - 39%)
1/1/00 38%
1/1/06 42%
1/1/09 33%
Example: Year 2012 Interest expense = P2,000
Interest income subject to final tax = P1,500
Deductible interest expense = P1,505 [P2,000 – (P1,500 x 33%)]

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The objective of the limitation is to discourage tax arbitrage on back-to-back loans, the
proceeds of which are invested in income earning interest that is subject to 20% final
tax.
Tax arbitrage – is a method of borrowing without entering into a debtor/creditor
relationship, often to resolve financing and exchange control
problems. In tax cases, back-to-back loan is used to take
advantage of the lower rate of tax on interest income and a higher
rate of tax on interest expense deduction.
Deductible interest expense:
1. Interest on taxes, such as those paid for deficiency or delinquency, since taxes are
considered indebtedness (provided that the tax is a deductible tax, except in the
case of income tax). However, fines, penalties, and surcharges on account of
taxes are not deductible. The interest on unpaid business tax shall not be
subjected to the limitation on deduction of 42%/33%.
2. Interest paid by a corporation on scrip dividends.
3. Interest on deposits paid by authorized banks of the BSP to depositors, if it is
shown that the tax on such interest was withheld.
4. Interest paid by a corporate taxpayer who is liable on a mortgage upon real
property of which the said corporation is the legal or equitable owner, even though
it is not directly liable for the indebtedness.
Non-deductible interest expense:
1. Interest paid in advance through discount or otherwise (in case of cash basis
individual taxpayer)
 Allowed as deduction in the year the debt is paid.
 If indebtedness is payable in periodic amortizations, interest is deducted
in proportion of the amount of the principal paid.
2. Payments made:
 Between members of a family (include only brothers & sisters, spouse,
ancestors, and lineal descendants)
 Between an individual and a corporation more than 50% in value of
outstanding stock is owned by such individual (except in case of
distributions in liquidation)
 Between 2 corporations more than 50% in value of outstanding stock
owned by same individual, if either one is a personal holding company or
a foreign holding company during the taxable year preceding the date of
sale/exchange
 Between grantor and fiduciary of any trust
 Between fiduciary of a trust & the fiduciary of another if same person is a
grantor to each trust
 Between fiduciary and a beneficiary of a trust
 Indebtedness is incurred by a service contractor to finance petroleum
corporation
 Interest on preferred stock which in reality is dividend
 Interest on unpaid salaries and bonuses
 Interest calculated for cost keeping on account of capital or surplus
invested in business which does not represent charges arising under
interest-bearing obligation
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 Interest paid when there is no stipulation for the payment thereof

Interest subject to special rules
1. Interest paid in advance
2. Interest periodically amortized
3. Interest incurred to acquire property used in trade or business
At the option of taxpayer, the interest may be allowed as:
 as expense (outright deduction)
 as capital expenditure (subject to depreciation)

 Taxes
The term “taxes” refers to national and local taxes, and means taxes proper, hence, no
deductions are allowed for:
1. Interests*
2. Surcharges
3. Penalties or fines incident to delinquency (Sec. 80, RR. 2)

* Interest incurred or paid by a taxpayer on all unpaid business-related taxes shall

be fully deductible from gross income and shall not be subject to the limitation on
deduction of 42%/33% of interest income. (RR 13-2000)

Deductible taxes
All taxes, national, or local, paid or incurred during the taxable year in connection with the
taxpayer’s profession, trade or business, are deductible from gross income.

Requisites for deductibility

1. It must be paid or incurred within the taxable year.
2. It must be paid or incurred in connection with the taxpayer’s trade, profession or
business.
3. It must be imposed directly on the taxpayer.
4. It must not be specifically excluded by law from being deducted from the
taxpayer’s gross income.

Non-deductible taxes:
1. Philippine income tax (but FBT can be deducted from gross income as provided
for in RR 8-98)
2. Income tax imposed by authority of any foreign country (except when the taxpayer
signifies his desire to avail of the tax credit for taxes of foreign countries)
3. Estate and donor’s taxes
4. Taxes assessed against local benefits of a kind tending to increase the value of
the property assessed
5. Final taxes, being in the nature of income tax
6. Special assessments
 Taxes, when refunded or credited, shall be included as part of gross
income in the year of receipt to the extent of income tax benefit of said
deduction. (Tax Benefit Rule)

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 For NRAETB and RFC, taxes paid or incurred are allowed as deductions
only if and to the extent that they are connected from income within the
Philippines.
 Exceptions to the rule that only such persons on whom the tax is imposed
by law can claim deduction thereof:
a) Taxes of shareholder upon his interest as such and paid by the
corporation without reimbursement from him, can be claimed by
the corporation as deduction.
b) A corporation paying the tax for the holder its bonds or other
obligation containing a tax-free covenant clause cannot claim
deduction for such taxes paid by it pursuant to such covenant.

Limitations on deductions
In case of a nonresident alien individual engaged in trade/business in the Philippines, taxes
to be deducted shall be allowed only if and to the extent that they are connected with
income from sources within the Philippines.

Tax credit – is a right of an income taxpayer to deduct from income tax payable the foreign
income tax he has paid to his foreign country subject to limitation.

1. Who can Claim?

 Citizen
 Domestic Corporation
 Member of GPP
 Beneficiary of an estate or trust

2. Who cannot claim?

 Alien individual (except resident aliens deriving income from within and
without the Philippines, if there is reciprocity)
 Foreign Corporation

3. Substantiation requirements – The tax credit shall be allowed only if the taxpayer
establishes to the satisfaction of the Commissioner the following:
 The total amount of the income derived from sources without the
Philippines;
 The amount of income derived from each country, the tax paid or incurred
to which is claimed as a credit under said paragraph, such amount to be
determined under rules and regulations prescribed by the Secretary of
Finance; and
 All other information necessary for the verification and computation of
such credits.

4. What amount may be taken as tax credit: (See Chapter 3 Taxation of Individuals)

5. When credit for taxes may be taken:

 The credit for taxes provided by Section 34(C) (3) to (7) may ordinarily be
taken either in the return for the year in which the taxes accrued or on
which the taxes were paid, dependent upon whether the accounts of the

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taxpayer are kept and his returns filed upon the accrual basis or upon
cash receipts and disbursements.

 Losses

Requisites for deductibility of ordinary loss

1. Loss must be of the taxpayer
2. Actually sustained during the taxable year
3. Not compensated for by insurance or other forms of indemnity
4. Incurred in trade, business or profession or property connected with trade,
business or profession lost through fires, storm, shipwreck, or other casualties or
from robbery, theft or embezzlement
5. Evidenced by a completed transaction
6. Not claimed as a deduction for estate tax purposes
7. Notice of loss must be filed with the BIR within 30 days but not more than 45 days
from the date of discovery of the casualty or robbery, theft or embezzlement

Category and types of losses

1. Ordinary losses
 incurred in trade or business, or practice of profession
 of property connected with the trade, business, or profession, if the loss
arises from fires, storms, shipwreck or other casualties, or from robbery,
theft or embezzlement

Note: Rev. Reg. No. 12-77 requires that a declaration of loss should be
filed with the BIR within 45 days after the occurrence of the casualty,
robbery, etc. Failure to submit the declaration within 45 days will result in
the disallowance of the loss.

2. Net Operating Loss Carry-Over (NOLCO)

 Refers to the excess of allowable deductions over gross income of the
business for any taxable year, which has not been previously offset as
deduction from gross income.

 The net operating loss of a business shall be carried over as deduction

from gross income for the next 3 consecutive taxable years immediately
following the year of such loss.

 The 3 year period shall continue to run notwithstanding that the

corporation paid its taxes under MCIT, or that the individual availed of the
Optional Standard Deduction.

 For mines other than oil & gas wells, if loss incurred in any of the 1 st 10
years of operation, carry-over for the next 5 years.

 Requirements:

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a) the taxpayer was not exempt from income tax in the year of such
net operating loss;
b) the loss was not incurred in a taxable year during which the
taxpayer was exempt from income tax, and
c) there has been no substantial change in the ownership of the
business or enterprise.

There is no substantial change in the ownership of the business

when:
(1) not < 75% in nominal value of outstanding issued
shares is held by same persons
(2) not < 75% of paid up capital of corp. is held by same
persons

Note: No actual change in ownership is involved in when: (1) in

case the transfer involves change from direct ownership to
indirect ownership (2) merger of the subsidiary into the parent
company.
3. Special types of losses
 Capital losses – deductions allowed only to the extent of the gains from
such sales or exchanges of capital assets (does not apply to banks and
trust companies)
a) losses from sale or exchange of capital assets
b) losses resulting from securities becoming worthless and which
are capital assets
c) losses from short sales of property
d) losses due to failure to exercise privilege or option to buy or
sell property
 Losses from wash sales of stock or securities
a) 30 days before and after the date of the sale, the taxpayer has
acquired or has entered into a contract or option so as to acquire,
substantially identical stock/securities
b) General rule: Not deductible unless claim is made by a dealer in
stock/securities and made in ordinary course of business
 Wagering losses – allowed only to the extent of the gains from such
losses.
 Abandonment losses
a) In case of abandoned petroleum operations, accumulated
expenditures incurred prior to 1/1/79 allowed as deduction only
from income derived from same contract area; notice of
abandonment shall be filed with Commissioner.
b) In case of abandoned producing well, unamortized cost &
undepreciated costs of equipment directly used, allowed as
deduction in the yr. of abandonment
 Losses from illegal transactions - Not deductible.
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 Losses due to voluntary removal of building incident to renewal or

replacements – deductible expense from gross income.
 Loss of useful value of capital assets due to charges in business
conditions – deductible expense only to the extent of actual loss sustained
(after adjustment for improvement, depreciation, and salvage value).
 Losses from sales or exchanges of property between related taxpayers –
Not deductible as provided under Section 36 of the NIRC but the gains
are taxable.

 Bad Debts
Debts due to the taxpayer actually ascertained to be worthless and charged off during the
year may be claimed as deduction. It must be uncollectible even in the future.
Requisites for deductibility:
1. Existing indebtedness due to the taxpayer which must be valid and legally
demandable,
2. Connected with the taxpayer’s trade, business or practice of profession,
3. Must not be sustained in a transaction entered into between related parties,
4. Actually ascertained to be worthless and uncollectible as of the end of the taxable
year, and
5. Actually charged off in the books of accounts of the taxpayer as of the end of the
taxable year.
Note: Tax Benefit Rule – Recovery of bad debts previously allowed as deduction
in the preceding years shall be included as part of gross income in the year of
recovery to the extent of the income tax benefit of such deduction.

 Depreciation
It is the gradual diminution in the service or useful value of tangible property due from
exhaustion, wear and tear and normal obsolescence. Also applies to amortization of
intangible assets, the use of which in trade or business is of limited duration.
Requisites for deductibility:
1. The allowance for depreciation must be reasonable.
2. It must be for property used for employment in trade or business or out of its not
being used temporarily during the year.
3. The allowance must be charged off.
4. Schedule on the allowance must be attached to the return.
Methods of depreciation
1. Straight-line method
2. Declining balance method
3. Sum of years digits method
4. Other method prescribed by the Secretary of Finance
Special types of depreciation
1. Petroleum operations
 Depreciation of all properties directly related to production of petroleum
shall be allowed under straight-line or declining-balance (DB) method
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 May shift from DB method to SL method

 Useful life: 10 yrs. or shorter life as may be permitted by Commissioner
 Useful life of property not used directly: 5 yrs. under straight-line method

2. Mining operations
 Depreciation on all properties in mining operations other than petroleum
operations at the normal rate if expected life is 10 yrs or less.
 If expected life is > 10 yrs., depreciate over any no. of yrs. bet. 5 yrs. &
the expected life

Note: Depreciation is deductible by non-resident aliens engaged in

trade/business or Non-resident Corporation only when such property is
located in the Philippines.

The BIR and the taxpayer may agree in writing on the useful life of the
property to be depreciated. The agreed rate may be modified if justified by
facts or circumstances. The change shall not be effective before the
taxable year on which notice in writing by certified mail or registered mail
is served by the party initiating.

 Depletion of Oil and Gas Wells and Mines

The reduction of cost or value of natural resources such as oil and gas wells, and mines as
the resources are converted into inventories.

No further allowance is granted if the allowance for depletion = the capital invested

Intangible exploration and development drilling cost:

1. Deduct in the year incurred if incurred for non-producing wells and mines.
2. Deduct in full or capitalize and amortize if incurred for producing wells and mines
in same contract area.

Election to deduct exploration and development expenditures for mining operations:

1. Deduct as cost.
2. Deduct as adjusted basis provided, total amount deductible shall not exceed 25%
of net income.

Actual exploration & development expenditures net of 25% of NI shall be carried

forward to succeeding years until fully deducted.

Exploration expenditures – incurred for the purpose of ascertaining the

existence, location, extent, or quality of any deposit of ore/other mineral and
paid/incurred before the beginning of the development stage of the mine/deposit.

Development expenditures – incurred during development stage of the mine or

other natural deposits.

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Note: Depletion of oil and gas wells and mines deductible by a non-resident alien
or foreign corporation only in respect of oil and gas wells or mines located
in the Philippines.

 Charitable and Other Contributions

Requisites for deductibility:

1. The contribution or gift must be actually paid.
2. It must be given to the organizations specified in the code.
3. The net income of the institution must not inure to the benefit of any private
stockholder or individual.

Valuation
The amount of any charitable contribution of property other than money shall be
based on the acquisition cost of said property.

Contributions subject to limitations:

1. Contributions or gifts actually paid or made within the taxable year
2. To or for the use of the government or its agencies or any political subdivision,
exclusively for public purpose, or
3. To accredited domestic corporations/associations organized and operated
exclusively for:
 Religious
 Charitable
 Scientific
 Youth & sports development
 Cultural or educational purposes
 For the rehabilitation of veterans
 To social welfare institutions
4. To NGOs
No part of NI inures to the benefit of any private stockholder or individual

Limitation
1. For individual: not more than 10% of taxable income before deducting the
charitable contributions.
2. For corporation: not more than 5 % of taxable income before deducting the
charitable contributions.

Contributions deductible in full

1. Donations to the government – 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 National Priority Plan determined by NEDA.
 If not in accordance with annual priority plan, donation is subject to
limitations in above.

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2. Donations to certain foreign institutions or international organizations – in

compliance with agreements, treaties, or commitments entered into by Philippines
government and foreign institutions/international organizations.

3. Donations to accredited NGOs

 Organized and operated exclusively for scientific, educational, character-
building and youth and sports development, health, social welfare, cultural
or charitable purposes or combination thereof (no part of net income
inures to the benefit of any private individual)
 Must be utilized within 15th of the 3rd month after the close of the taxable
year, directly for the active conduct of activities constituting the purpose of
the organization, unless period is extended
 Administrative expense should not be greater than 30% of total expenses
 Upon dissolution, assets would be distributed to another nonprofit
domestic corp. organized for similar purpose or to the state for public
purpose or to another org. to be used in same purpose as the dissolved
corporation.

 Research and Development

Paid or incurred by a taxpayer during the taxable year in connection with his trade,
business or profession as ordinary and necessary expenses which are not chargeable to
capital account; allowed as deduction during the taxable year when paid/incurred.

Requisites for deductibility (as an expense)

1. Paid or incurred during the taxable year
2. Ordinary and necessary expenses in connection with trade business or profession
3. Not chargeable to capital account

Requisites for amortization of certain R&D expenditures (treated as deferred

expenses):
1. Paid/incurred by the taxpayer in connection w/ his trade/business
2. Not treated as expense
3. Chargeable to capital acct. but not chargeable to property of a character w/c is
subject to depreciation/depletion
4. Amortized over a period of not < 60 months as may be elected by the taxpayer

This subsection on research and development cost is not applicable to:

1. Any expenditure for the acquisition or improvement of land, or for the improvement
of property to be used in connection with R&D of a character subject to
depreciation and depletion
2. Any expenditure paid/incurred for the purpose of ascertaining the existence,
location, extent, or quality of any deposit of ore or other mineral, including oil or
gas (exploration expense)

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 Pension Trusts (Past Service Cost)

Pension trust contributions – a deduction applicable only to the employer on account of

its contribution to a private pension plan for the benefit of its employee. This deduction is
purely business in character.

Established or maintained by employer to provide for the payment of reasonable pensions

to his employees.

Normal cost – the contributions during the taxable year to cover the pension liability
accruing during the taxable year. Allowed as a deduction under Sec. 34(A)(1) as
“expenses in general”.

Past service cost – amount in excess of the above contribution (covering pension liability
pertaining to old employees, which accrued during the years previous to the establishment
of the pension trust); allowed as deduction only if:
1. Such amount not been allowed as a deduction.
2. Apportioned in equal parts over 10 consecutive years beginning with the year in
which the payment is made.

Requisites for Deductibility of Past Service Cost

1. The employer must have established a pension or retirement plan to provide for
the payment of reasonable pensions to his employees;
2. The pension plan is reasonable and actuarially sound;
3. It must be funded by the employer;
4. The amount contributed must be no longer subject to the control and disposition of
the employer;
5. The payment has not yet been allowed as a deduction; and
6. The deduction is apportioned in equal parts over a period of 10 consecutive years
beginning with the year in which the transfer of payment is made.

Summary rules on Retirement Benefits Plan/Pension Trust:

1. Exempt from income tax – employees’ trust under Sec. 60(B)
2. Exclusion from gross income – amount received by the employee from the fund
upon compliance of certain conditions under Sec. 32(B)(6)
3. Deduction from gross income

Note: Amounts contributed by the employer during the taxable year into the
pension plan to cover the pension liability accruing during the year – considered as
ordinary and necessary expenses under Sec. 34(A)(1).

1/10 of the reasonable amount paid by the employer to cover pension liability
applicable to the years prior to the taxable year, or so paid to place the trust in a
sound financial basis – deductible under Sec. 34 (J).

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