Taboclaon, Krizza Mae S.

BSA 2A

1. Distinguish a business expense and a personal expense.

Business expense are costs of generating income or gains for the current period, they
are deductible against gross income in the current period. Business expense benefit only
the current accounting period. Personal expenses include the living and family
expenses of individual taxpayers such as family food, personal recreation and
transportation, medication, home rentals and utilities, tuition fees of dependents and
other similar expenses.
2. Enumerate and discuss the four general principles of deductions.
(a) The taxpayer seeking a deduction must point to some specific provisions of the statute
authorizing the deduction.
1. Expenses must be legitimate, ordinary, actual and necessary (LOAN).
2. The Matching Principle. Only business expenses which contribute to or are
incurred in connection with, the generation of income, gain or profits subject to
regular income tax are deductible.
3. The Related Party Rule. In case of transaction between related parties, gains
are taxable but losses are not deductible.
(b) The Withholding Rule. Any amount paid or payable which is otherwise deductible from,
or taken into account in computing gross income or for which depreciation or
amortization may be allowed, shall be allowed as deduction only if it is shown that the
tax required to be deducted and withheld therefrom has been paid to the BIR.

3. What are the classifications of deductions in tax reporting? Explain each briefly.

1. Cost of sales or cost of services

Deducted outright against sales, revenues, receipt or fees of individual taxpayers in
the measurement of gross income from operations.
2. Regular allowable itemized deductions
These pertain to all necessary and ordinary expenses paid or incurred during the
taxable year including directly attributable costs in carrying the development,
management, operation and/or conduct of the trade, business or exercise of
profession.
3. Special allowable itemized deductions
Additional deductions as provided under the NIRC or special laws. Categorized into
two types:
1. Actual compliance expenses
2. Deduction incentives
4. Net Operating Loss Carry Over (NOLCO)
NOLCO pertains to the excess of deductions over gross income during a taxable
year which is allowed by the law to be deducted against the net income of the
following three years.
 4. How are deductions claimed? Discuss the two modes of deductions.
 Itemized deductions
The taxpayer lists every item of business expense he claims as a deduction.
 Optional standard deductions
The optional standard deduction (OSD) is in lieu of the itemized deductions, regular
or special, including NOLCO. The deduction is merely presumed as a fixed
percentage of gross income for corporations and gross sales or gross receipts for
individuals.

TRUE or FALSE. Write True if the statement is correct, otherwise write False. Write your
answer before each number. (2 points each)

TRUE 1. Capital expenditures are deductible against future income.

FALSE 2. Personal expenses are deductible from gross income.

TRUE 3. Expenses intended for the business and the personal use of the taxpayer must be
allocated between the two. Only the portion pertaining to the business is deductible.

FALSE 4. Immaterial expenditures must always be capitalized.

FALSE 5. So long as the expense relates to the generation of an income subject to

any income tax, the same is deductible against gross income subject to the regular tax.

TRUE 6. The failure to deduct creditable withholding tax on income payments will render the
expense non-deductible.

FALSE 7. Taxpayers opting to use the optional standard deduction must also maintain records
of their expense.

TRUE 8. For an expense to be deductible it must be ordinary and necessary. Therefore, an

extraordinary expense can never be allowed as a deductible expense.

FALSE 9. A capital expenditure is a legitimate business expense so long as it is used for

business purposes.

TRUE 10. Repairs that increase property useful life is capitalized.

 IDENTIFICATION EXERCISE. Identify whether the following is a business expense or
personal expense by checking the appropriate box corresponding to the the item: (2 POINTS
EACH)

Business Personal
Expense Expense

1. Medical expense of the proprietor.

✓

2. Transportation expense from office to client

✓
establishments.

3. Cost of entertaining family members of the proprietor.

✓

4. Interest expense to finance the construction of the

✓
office building.

5. Office utilities expense.

✓

6. Repairs that restores the value of the destroyed

✓
business properties.

7. Tuition fee of the taxpayer’s dependents.

✓

8. Salary of household help and maids.

✓

9. Travel expense to attend seminar.

✓

10. Costs of renewal if the taxpayer’s professional

✓
license.
DISCUSSION QUESTIONS. (5 points each)

1. Discuss the deductibility of taxes and enumerate the non-deductible taxes.

Deductible taxes are all tax proper, hence, no deductions arising from interest,
surcharges or penalties.
Taxes that are not deductible:
a. Income tax;
b. Estate and donor’s tax;
c. Special assessment
d. Excess electric consumption tax;
e. Foreign income tax, war profits and excess profits tax, if the taxpayer makes use of
tax credit; and
f. Final taxes, being in the nature of income tax.

Taxes allowed as deductions, when refunded or credited, shall be included as part of

gross income in the year of the receipt to the extent of the income tax benefit of said
deduction (Tax Benefit Rule)

2. Discuss the requisites on deductibility of contributions.

1. There must be a valid indebtedness.
2. The indebtedness must be that of the taxpayer.
3. The indebtedness must be connected with the taxpayer’s trade, business or exercise
of profession.
4. Interest must have been paid or incurred during the taxable year.
5. Interest must have been stipulated in writing.
6. Interest must be legally due.
7. Interest payments must not be between related taxpayers.
8. Interest must not be incurred to finance petroleum operations.
9. In case of interest incurred in the acquisition of property, used in trade, business or
profession, the same was not treated as a capital expenditure.
10. The interest is not expressly disallowed by law to be deducted from gross income of
the taxpayer

3. Explain the arbitrage scheme and how to determine the arbitrage limit.
Arbitrage can be defined as the process of exploiting differences in the price of
an asset by simultaneously buying and selling it. The theory of limits to arbitrage
says that these prices may stay in an unbalanced state for a significant period of
time due to restrictions on so-called rational traders. Arbitrage happens when a
rational trader spots a price difference in an asset in two different markets and
invests accordingly. The efficient market hypothesis states that this intervention
will help correct and balance the markets. However, if these rational traders work
for asset management firms and invest other people's money, their actions will
be heavily scrutinized. If they engage in arbitrage and the prices remain
 unbalanced for a while, the clients may be unhappy and the trader may have to
unwind the position at a loss. Therefore, there is a limit to the arbitrage that the
trader can engage in.

TRUE OR FALSE. Write True if the statement is correct, otherwise write False. Write your
answers before each number. ( 2 points each)

FALSE 1. Interest expenses incurred with related parties are deductible.

TRUE 2. The arbitrage limit applies to all taxpayers including individuals.

TRUE 3. Losses must be reported to the BIR within 45 days from the occurrence of the
casualty, robbery, theft or embezzlement giving rise to the loss.

FALSE 4. The allowable deduction for deductible taxes includes the basic tax, surcharge and
interest.

FALSE 5. Depreciation on revaluation surplus of properties can be deducted as part of

depreciation expense.

TRUE 6. The recovery of bad debts by accrual basis taxpayers may be reverted back to gross
income.

FALSE 7. Bad debts expenses between related parties can be deducted so long as adequately
supported with documentary evidence.

TRUE 8. With the exception of domestic corporations and resident citizens, expenses incurred
abroad cannot be deducted unless incurred in connection with the Philippine business.

TRUE 9. The loss in value of assets is deductible only when sustained and realized.

FALSE 10. Purely employed individuals can claim deductions for donations made.

TRUE 11. Intangible exploration and development costs incurred before commercial
production in a wasting asset operation are capitalized as cost of the wasting asset.

TRUE 12. After commencement of commercial production, intangible exploration and

development costs incurred on non-producing wells or mines are deductible in the period paid
or incurred.

TRUE 13. Contribution expenses are deductible if the donee is a domestic institution.

TRUE 14. Research and development costs not related to capital accounts are either deducted
outright or deferred and amortized over a period of not less than 60 months.
TRUE 15. Petroleum operations are not subject to the limit on the deduction of intangible
exploration and development costs after the commencement of commercial production.

MULTIPLE CHOICE PROBLEMS. Compute what is being required and write the letter of
your answer on the space before each number. Show your solutions on the space
provided after each question. (5 points each)

1. Gawan Merchandising paid P400,000 to employees, net of P60,000 total

withholding tax on compensation. What is the deductible amount of expense by
the employer?
P400,000 - payment to employees
60,000 - tax withheld
P460,000 - Deductible amount of expense

2. A taxpayer under the cash basis had the following expenditures:

Acquisition of office equipments at the middle of the year

(5 years useful life) P200,000

Payment of employees salaries 40,000

Payment of office utilities expenses 60,000

How much is claimable as deductible expense for the year?

P200,000 - acquisition of equipment

40,000 - payment of employee salaries
60,000 - payment for utilities expense
P300,000 - deductible expense for the year

3. The following relates to a taxpayer’s warehouse:

Cost P2,000,000

Accumulated depreciation 600,000

Residual value 200,000

Current fair market value 2,500,000

Remaining useful life 12 years

Compute the depreciation expense.

P2,000,000 - cost
600,000 - accumulated depreciation
200,000 - residual value
P1,200,000
divided by: 12 years
P100,000 - Deductible depreciation expense