TAXATION 1 – INCOME TAXATION 2020

Chapter 8

DEDUCTIONS FROM GROSS INCOME

NATURE OF DEDUCTIONS
In general, deductions or allowable deductions are business expenses and losses incurred which the
law allows to reduce gross business income to arrive at net income subject to tax.

They are equivalent to operating expense reported under Generally Accepted Accounting Principle
(GAAP) which are adjusted to conform to the Tax Code (Sec 65, Rev. Reg. No.2)

REVENUE vs. CAPITAL EXPENDITURES

Revenue Expenditures are ordinary recurring expenditures that provide benefits to the current
accounting period. They are usually called “period costs” because they are related to a particular period
of time of business operation.
Examples of revenue expenditures are:

1. Salary Expense;
2. Supplies expense;
3. Repairs and maintenance such as painting, lubricating, cleaning expenditures; and
4. Other recurring expenditures that benefit only current operation and do not improve or extend
the life of the asset used in business.

Capital Expenditures are nonrecurring expenditures related to the acquisition of depreciable assets to
be used in the business, but not for sale, having a useful life of several years. They provide current and
future benefits in business operations.

The cost incurred (or paid) for acquiring such assets is capitalized and not immediately expensed from
period to period in the form of depreciation or amortization within their useful life.

SITUS OF EXPENSES

The place of business becomes the basis of business expenses are deductible only if they are incurred
in relation to the business income taxable in the Philippines.

ITEMS NOT DEDUCTIBLE FROM GROSS INCOME

1. Personal, living or family expenses

2. Any amount paid out for new buildings or for permanent improvements, or betterments made
to increase the value of any property or estate.
3. Any amount expended in restoring property for which an allowance is or has been made.
4. Premiums paid on any life insurance policy covering the life of any officer or employee, or of
any person financially interested in any trade or business carried on by the taxpayer, when the
taxpayer is directly or indirectly a beneficiary under such policy.
5. Transactions between related taxpayers resulting to losses from sales or exchanges of property,
interest expense or bad debts.
6. Bribes, kickbacks and other similar payments. Payment for police protection is illegal.
7. Donations made to employee and others, which do not have in them the element of
compensation or are in excess of reasonable compensation for services, are not deductible from
gross income.

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NET REPORTABLE TAXABLE INCOME
Gross Compensation Income P xxx
Less: Non-Taxable Compensation xxx
Taxable Compensation Income P xxx
Add: Business Income xxx
Less: Business Expenses xxx
Net Business Income xxx
Total Taxable Income P xxx

TAX LAWS vs. GAAP

For taxation process, whenever there is a conflict between Tax laws and GAAP, the former prevails
over the latter.
CLASSIFICATION OF DEDUCTIONS FROM GROSS INCOME
Itemized Deductions
Itemized deductions or business expenses are available to both the natural persons and juridical persons
that are engaged in business. The most common examples of business expenses are operating
expenses, such as:
1. General and administrative expenses;
2. Selling expenses; and
3. Other operating expenses.
Optional Standard Deduction (OSD)
In lieu of itemized allowable deductions, the OSD may be deducted from the gross income as follows:
If the taxpayer is
1. An individual other than Nonresident Alien, the OSD is 40% of his Gross Sales or Gross
Receipts.
2. A corporation, the OSD is 40% of its gross income.

Individual: Corporation:
Gross Sales/Receipts Gross Sales/Receipts
x 40% Less: Direct Costs
OSD Gross Income
x 40%
OSD
INCOME SUBJECT TO ITEMIZED DEDUCTIONS
1. Business/professional income derived within and outside the Philippines by a resident citizen;
2. Business/professional income derived within the Philippines by nonresident citizen; a resident
alien; and a nonresident alien;
3. Business/professional income of general co-partnership;
4. Business income derived within and outside the Philippines by a domestic corporation;
5. Business income of proprietary educational institution and nonprofit hospitals;
6. Business income of proprietary government-owned or controlled corporation; and
7. Business income within the Philippines earned by a foreign corporation.
COMPOSITION OF ITEMIZED DEDUCTIONS
1. General business expenses
2. Interest
3. Taxes
4. Losses
5. Bad debts
6. Depreciation

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7. Depletion of oil and gas wells and mines
8. Charitable and other contribution
9. Research and development
10. Pension trust
GENERAL BUSINESS EXPENSES
Expenses in general include all 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 trade, business or exercise of a profession. Example of business expenses are:
a. Salaries, wages, management expenses, commissions, and labor
b. Supplies, and repairs and maintenance, and other incidental expenses
c. Operating expenses of transportation equipment used in the trade, profession or business
d. Rental for the use of business property
e. Advertising and other selling expenses
f. Travelling expenses while away from home solely in the pursuit of trade, profession or
business
g. Insurance premiums against fire, storm, theft, accident, or other similar losses in the trade or
business.
REQUISITES FOR DEDUCTIBILITY OF GENERAL EXPENSES
In order that a general expense will be allowed as deduction from gross income, all of the following
requirements should be met:
It must be:
1. Ordinary and necessary for the conduct of business or exercise of profession;
2. Substantiated with official receipts or any other adequate records
3. Reasonable in amount
4. Withheld with tax and to the BIR, if required such as salary expense;
5. Not contrary to law, morals, public, policy, or public order and
6. Incurred and paid and deducted within the taxable year.
A taxpayer has all right to deduct all authorized expenses. It thus follows that if he does not, within any
year, deduct any of his expenses, losses, interest, taxes, or other charges, he cannot deduct them from
the income of ant succeeding year.
REPRESENTATION EXPENSES
These are entertainment, amusement and recreation expenses incurred or paid during the year that are
directly connected to the development, management and operation of the trade, business or profession
of the taxpayer.
a. ½ % of net sales for taxpayers engaged in sale of goods/properties, or
b. 1% of net revenue for taxpayers engaged in sale of services, including exercise of profession
and use or lease of properties.
INTEREST EXPENSE
The following are requisites for interest expense to be allowed as deduction from business and or
professional income.
1. There must be an indebtedness stipulated in writing;
2. The indebtedness must be that of the taxpayer in connection with the trade, business or
profession;
3. The interest must have been paid or accrued during the taxable year; and
4. The interest payment must not be in favor of a relative.

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TAXES
In general, taxes are allowed as deduction when paid or incurred within the taxable year in connection
with the taxpayer’s profession, trade or business.
REQUISITES FOR DEDUCTUBILITY
1. It must be paid or incurred within the taxable year;
2. It must be paid or incurred in connection with the taxpayer’s profession, trade or business; and
3. The tax must be imposed directly upon the taxpayer.
TAXES DEDUCTIBLE FROM GROSS INCOME
1. Documentary stamp
2. Occupational taxes
3. Privilege and license taxes
4. Excise taxes
5. Import duties
6. Local Business Taxes
7. Automobile registration fees
8. Community tax
9. Municipal tax
LOSSES
Losses actually sustained during the taxable year and not compensated for by insurance or other forms
of indemnity shall be allowed as deductions:
1. If incurred in trade, profession or business;
2. If 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.
3. No loss shall be allowed as a deduction under this Subsection if at the time the filing of the
return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return.

Proof of Loss
In the case of a non-resident alien individual or foreign corporation, the losses deductible shall be those
actually sustained during the year incurred in business, trade or exercise of a profession conducted
within the Philippines, when such losses are not compensated for by insurance or other forms
indemnity.
BAD DEBTS EXPENSE
A bad debt is a claim that becomes worthless or uncollectible arising from money lent or from goods
sold or services rendered.
WHEN IS A CLAIM ASCERTAINED TO BE WORTHLESS
An account or a claim is ascertained to be worthless when the creditor determined with reasonable
degree of certainty that the claim would not be collected despite the fact that the creditor took
reasonable steps to collect.
1. Insolvency of the debtor,
2. Death of the debtor without sufficient properties to cover his debts, or
3. Disappearance of the debtor.
REQUISITES FOR DEDUCTUBILITY OF BAD DEBTS
1. There must be a valid and subsisting claim;
2. The claim must be connected with the profession, trade or business;
3. The claim must not be between related parties enumerated in Section 36(B) of the Tax Code;
4. The claim must actually be ascertained to be worthless and uncollectible as of the end of the
taxable year; and

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5. The claim must be written off within the taxable year.
DEPRECIATION EXPENSE
An annual reasonable allowance to reduce the useful value of the tangible fixed assets resulting from
wear and tear and normal obsolescence is allowed as a deduction from gross income to enable
taxpayers to recover the acquisition cost of the property used in the practice of profession, business or
trade.
For intangible assets such as patents, copyrights and franchise, the annual allowance to reduce their
useful value is called “amortization”.
REQUISITES FOR DEDUCTIBILITY OF DEPRECIATION
1. It must be reasonable.
2. It must be charged off during the year.
3. The asset must be used in profession, trade or business.
4. The asset must have a limited useful life.
5. The depreciable asset must be located in the Philippines if the taxpayer is a nonresident alien or
a foreign corporation.
DEPLETION EXPENSE
Depletion is the exhaustion of natural resources like mines, oil and gas wells due to production. It is
similar to depreciation allowance, the purpose of which is to recover the invested capital in the
property.
DEDUCTIBLE PENSION TRUSTS
A pension plan comprises a fund intended to provide retirement benefits to the employees. It is usually
set up after some years of operations when the employer can already provide benefits to employees.
An employer is allowed to deduct from business gross income contributions or payments made to
pension trust in accordance with a ‘reasonable private benefit plan’.
1. Defined benefit plan. The employer handles and manages the fund. The benefits that the retiree
would receive are defined and normally based on certain percentage of the salary of the
employees eligible to the benefit plan.
2. Defined contribution plan. The trust fund is handled by a third party, normally an insurance
company or bank as the “administrator”. The liability of the employer is to contribute the
defined or contracted periodic contribution as per agreement with the administrator.
REQUISITES OF PLAN
1. The plan must be reasonable and actuarially sound (actuarial valuation).
2. The plan must be approved by the BIR. To be approved by the BIR, the plan must comply with
requirements of Rev. Regs. No. 1-68 and Rev. Regs. No. 1-83.
REQUISITES FOR DEDUCTIBILITY OF CONTRIBUTIONS
1. The taxpayer making the charitable contribution must be engaged in a profession, trade or
business;
2. There must be an actual payment of contribution or gift;
3. The recipient must be an entity or institution specified by law; and
4. The net income of the institution must not inure to the benefits of any individual or private
stockholder.
CONTRIBUTION DEDUCTIBLE IIN FULL
1. Donations to the Government of the Philippines, or to any of its agencies, or political
subdivisions, include fully owned government corporations exclusively to finance, to provide
for, or to be used in undertaking specific priority activities in
a. Education;

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b. Health;
c. Youth and sports development;
d. Human settlements;
e. Science and culture; and
f. Economic development.

2. Donations to international organizations in compliance with agreements, treaties, or

commitments entered into by the Government of the Philippines and the foreign institutions or
international organizations or in pursuance of special laws.
3. Donations to Accredited Non-Government Organizations subject to the following requisites to
be deducted in full:
a. Not more than 30% of which should be used for administration purposes.
b. The contribution must be utilized not later than the fifteenth day of the third month after the
close of its taxable year.
c. Upon dissolution, a court shall distribute the assets of the said NGO to another nonprofit
domestic corporation, or to the state, or to another similar organization.
CONTRIBUTIONS SUBJECT TO LIMIT
1. If the donor is an individual taxpayer, the limit 10% of the taxable income derived from
business, trade or profession (before the contribution) or the actual contribution, whichever is
lower.
2. If the donor is corporation, the limit is 5% of the taxable income derived from trade or business
(before the contribution) or the actual contribution, whichever is lower.
TAX INCENTIVES TO ADOPTING PRIVATE ENTITIES
The amount for assistance, contribution, donation to public schools, made by private entities, that were
actually, directly and exclusively incurred for the program in team up with the Department of
Education, Commission on Higher Education, or with TESDA may be deducted from the gross income
RESEARCH AND DEVELOPMENT
A taxpayer has the option to consider research and development expenditures that are paid or incurred
during the taxable year in connection with profession, trade or business either as:
1. Ordinary and necessary expenses deductible from the business gross income in the year the
expenses are paid to incurred.
2. Deferred expense changeable to the capital account but not chargeable to property subject to
depreciation or depletion.
If the research and development expenditures are treated as deferred expenses, such expenses will be
allowed as deductions ratably distributed over a period of not less than 60 months beginning with the
month in which the taxpayer first realizes benefits from such expenditures.
SPECIAL DEDUCTIONS
1. Mandatory Contributions;
2. Income currently distributed to beneficiaries under estates and trusts (Sec. 61[A], NRIC), but
such amount shall be taxable to the latter.
3. Net-Operating Loss Carry-Over (NOLCO)
4. Special deduction allowed to insurance companies such as
a. Net additions to reserve funds within the year.
b. Premium deposits returned to their policyholders.
c. Actual deposits of sums with the officers of the Government of the Philippines (Sec. 37 (A to
D), NIRC)
5. Incentives under Republic Act No. 8525. (Adopting Private Entity Incentives per Revenue
Regulations No. 10-2003)
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