R. Z.

Palma 1

CHAPTER 5
DEDUCTIONS FROM GROSS INCOME
NATURE OF DEDUCTIONS

In general deductions or allowable deductions are business expense and losses incurred which the law
to reduce gross business income to arrive at net income subject to tax. (Sec. 65, Rev. Reg. No. 2)

Deductions are strictly constructed against the taxpayer (People vs. Castaneda, 165 SCRA 327). They are not
presumed but allowable only by reason of specific provisions of law and not under any general equitable
or Constitutional concept. (Menchie, p.305; Baltimore Dairy Lunch Inc. vs. U.S., 231 F (2d) 870)

The taxpayer seeking a deduction must be able to prove that he is entitled to the deduction which the
law allows, (White vs. U.S., 305 U.S.2181). Adequate records should be kept to support deductions, (Prentice – Hall,
Federal Tax Course, p. 180) except when the law dispenses the records, documents or receipts to support the
deductions.

The purpose of deductions from gross income is to provide the taxpayer a just and reasonable taxable
amount as the basis of income tax. It is because many taxpayer spend adequate expenditures in order to
obtain a legitimate income.

Mandatory Withholding of Taxes. BIR issued RR No. 12-2013 amending Sec. 2.85.5 of RR. No. 2-98 as
amended, relative to the requirements for deductibility of certain income payments.

The salient features of Revenues Regulations No. 12-2013 are:

1) No deduction shall be allowed on income payments if it is shown that the applicable withholding taxes
required by the rules had not been withheld.
2) No deductions will also be allowed if during tax assessment on deficiency withholding taxes for
alleged failure to withhold the taxpayers paid the withholding taxes.

Note: In effect Revenue Regulations No. 12-2013 makes it mandatory for taxpayers to withhold on expenses required to be withheld for
purposes of expenses deduction for income tax purposes in the Philippines.

Revenues Vs. Capital Expenditures

There are two basic major classification of business expenditures: (a) Revenue Expenditures, and Capital
Expenditures.

Revenue expenditures are ordinary recurring expenditures or expenses that provide benefits to current
accounting period. They are usually called “period cost or period expense” because they are related to a
particular period of time of business operation.

They are charged to expense as incurred, and are deductible from gross income if they satisfy the
conditions as prescribed by the Tax Code.
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Examples of revenue expenditures are:

1)Cost of sales or cost of goods sold
2)Cost of service
3) Salaries and wages
4) Supplies expense
5) Repairs and maintenance such as painting, lubricating cleaning expenditures;
6) Utility expense
7) Advertising expense
8) Rent expense
9) Depreciation expense
10) 13th month pay
11) SSS, Philhealth, and Pag-ibig employer’s contribution,
12) Transportation expense, and
13) Other recurring expenditures that benefit only operational and do not improve or extend life of asset
used in business.

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

The cost incurred (or paid) for acquiring such assets in capitalized not immediate expensed. They are
gradually expended from period to period in the form of depreciation or amortization within their
estimated useful life.

Expenditures After Acquisition

Costs after the acquisition of plant assets shall be capitalized when any of the following conditions are
met:
1) Increase in useful life. There is an increase in economic life of asset if its new useful life exceeds its
original life after the expenditures. For instance, the asset’s original useful life is 5 years; it becomes 9
years after the expenditures.
2) Increase in capacity. There is an increase in the units produced from the utilization of the asset after
the expenditures. For instance, if normal production per period is 10,000 units, it becomes 15,000 after
the expenditures.
3) Increase in efficiency. The asset provides better quality of services or products after the expenditures.

If neither of the conditions is met, the expenditures are intended only to sustain the ordinary level and
quality of services to be provided by the plant assets. Thus, expenditures should be designated as
revenue expenditures and recorded as repairs expense during the year of incurrence.
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Summary Application
Deductibility of Expenditures
As Usage As to Period Benefit Deductions from business income
========== ================================== Year 1 Year 2 Year 3
Personal use -O- -O- -O-

Business use: Capital expenditures allocated

as depreciation or amortization xxx

Revenue expenditures
Year 1 xxx
Year 2 xxx
Year 3 etc xxx

Situs of Expenses

The place of business becomes the basis business expenses are deductible for Philippine income tax
purposes.

As a rule, business expenses are deductible only when they are incurred in relation to the business
income taxable in the Philippines, (except when the taxpayer is a resident Filipino or a domestic
corporation). If a business expense could not be traced whether incurred with or not, such expense shall
be allocated based on the gross income within and without.

Illustration
Mr. Smith, a nonresident alien engaged in business in the Philippines, presented the following
incomes and expenses during the taxable year:
Philippines Foreign
Gross income P10,000,000 P30,000,000
Operating expenses 1,000,000 5,000,000

In addition, Mr. Smith presented P600,000 mixed or common operating expenses both used for the
Philippine and Foreign operations.

The total amount of operating expenses for Philippine income tax purposes would be

Operating expenses – Philippines P1,000,000

Add: Allocated share on mixed expenses
-Philippine (P600,000 x ¼) 150,000
Total amount of operating expenses – Philippines P1,150,000
=========
Note: The mixed expenses is allocated based on the gross income
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Summary Application
Situs of Deductible Expenses
Situs of Expenses Income Taxpayers
Incurred: RC/ DC NRC/ Aliens/ FC
Within Deductible Deductible
Without Deductible Not Deductible
Common expenses or Party Deductible Partly Deductible based
within and without on ratio of gross
income

ITEMS NOT DEDUCTIBLE FROM GROSS INCOME

As a general rule in computing net income, no deductions shall in any case be allowed with respect to:
1) Personal, living or family expenses (Sec. 36 (A),NIRC)
2) Any amount paid for new buildings or for permanent improvements, or betterments made to increase
the value of any property.
3) Premiums paid on any life insurance policy covering the life of any officer or employee, or if 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.
4) Transactions between related taxpayers resulting to losses from sales or exchanges of property,
interest expense or bad debts.
5) Bribes, kickbacks and other similar payments (Sec. 34 A [Ic], NIRC) Payment for Police protection is illegal.
(C.F. Calanoc vs. Collector of Internal Revenue, 3 SCRA 517)
6)Donations made to employees and others, which do not have in them the element of composition or
are in excess of reasonable compensation for services. (Sec. 72, Rev. Regs. No.2)
7) The amount spent for political campaign, campaign funds and donations to political parties or
candidates are NOT deductible either as business or contribution expenses from gross income.
(Felix Montenegro, Inc. vs. CIR, CTA Case 695, April 30,1969)

Tax Laws versus GAAP (Generally Accepted Accounting Principles)

For taxation purposes, whenever there is a conflict between Tax laws and GAAP, the former prevails over
the latter.

Comparative Presentation

Tax Code GAAP

Sales Pxxx Sales xxxx
Less: Cost of Sales Pxxx Less: Cost of Sales xxxx
Business Gross income xxx Gross income / profit xxxx
Less: Allowable itemized deductions xxx Less: Operating expenses xxxx
Net taxable income xxx Net income before tax xxxx
Income tax due xxx Income tax expense xxxx
Net income after tax Pxxx Net income after tax xxxx
====
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Illustration
Mr. Maginoo reports the following sales and expenses during 2019 taxable year:
Sales P500,000 Estimated un-collectibles P5,000 (bad debts)
Cost of sales 200,000 Miscellaneous expense
Salary expense 50,000 (without receipts) 2,000
Rent expense 24,000 Depreciation expense 6,000

The comparative computation would be

Tax Code GAAP

Sales P500,000 Sales P500,000
Cost of sales (200,000) Cost of sales (200,000)
Business income P300,000 Gross profit P300,000
Itemized allowable Operating expenses:
Deductions:
Salary expense (P50,000) Salary expense (P 50,000)
Rent expense ( 24,000) Rent expense ( 24,000)
Depreciation expense ( 6,000) Depreciation expense ( 6,000)
Estimated bad debts ( 5,000)
_______ Miscellaneous expense ( 2,000)
Total itemized deductions (P80,000) Total operating expense (P 87,000)
Taxable income P220,000 Net income P213,000
Income tax due ______ 0 Income tax expense 0
Net taxable income P220,000 Net income before tax P213,000

Notes:
1) Observe that there are expenses that are allowed as deductions under GAAP but disallowed under Tax
Code. The gross profit under GAAP is the business income under the Tax Code and operating expenses
under GAAP are the itemized deductions under the Tax Code.
2) Determination of the Net Taxable Income:
Employed Taxpayer. For individual taxpayer, the deduction of items specific in Sec. 34 NIRC are not
allowed with respect to compensation income arising from personal services rendered under an
employer-employee relationship.

Employed and Self-employed. The deductions allowed by law under Section 34 of NIRC are allowed
to reduce only the gross business income of an individual tax payer.

The format to compute the net taxable income of employed and the same time self-employed
taxpayer is

Compensation income Pxxx

Add: Gross income from business Pxxx

Less: Allowable itemized deductions xxx
Net business income xxx
Net taxable income Pxxx
====
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Corporation. The deduction allowed by law Section 34 of NIRC are allowed to reduce gross income
of the corporation.

The format to compute the net taxable income of corporations as defined by Tax Code would be

Gross income Pxxx

Less: Allowable itemized deductions xxx
Net taxable income xxx
====
Classification of Deductions from Gross Income
1) Optional standard deductions (OSD)
2) Regular allowable itemized deductions; and
3) Special allowable itemized deduction.

Unless the taxpayer signifies in his return his intention to elect the OSD, he shall be considered as having
availed himself of the allowable itemized deductions.

The Tax Code provides that once a taxpayer elected a deduction (optional or itemized) in his income tax
return, such election is irrevocable for the taxable year in which the return is made. (Sec. 34 (L), NIRC)

Quarterly OSD or Itemized Deductions: The BIR recently changed Memorandum Circular (RMC)
No. 16-10.

This new regulation requires tax payers to declare in their 1st quarter income tax return their election, or
intention to elect either the OSD or itemized deductions.

Once the election is made, the same type of deductions must be consistently applied in all the
succeeding quarterly returns and in the final income tax return for the taxable year.

Optional Standard Deduction (OSD)

In lieu of allowable itemized deductions, the OSD may be deducted, OSD may be deducted from gross
income as follows: (Sec. 34 (L), NIRC; Sec. 3, R.A. 9504)

If the tax payer is

1) An individual other than a nonresident alien, the OSD is 40% of his gross sales or gross receipts.
If an individual opted the use OSD, he is no longer allowed to deduct cost of sales or cost of services.
(Sec. 34(L), NIRC; Sec.3, Rev. Regs. No. 16-2008)

The Tax Law (R.A. 9504) is specific as to the basis of OSD which states that for individuals, the basis
of the 40% OSD shall be the “gross sales” or “gross receipts” and not the “gross income.”
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An individual who opts to avail of this deduction need not submit the Account Information form
(AIF)/Financial Statements.

2) A corporation, the OSD is 40% of its gross income / gross profit

OSD Illustration – Individual vs. Corporation

Sec. 5 Revenue Regulations No. 16-2008 provides the following examples in determining the basis of the
40% OSD for individuals and corporations.

Assume the following data of a taxpayer:

Gross sales P1,000,000 basis for individual
Cost of goods sold 800,000
Gross income 200,000 basis for corporation
How much is the OSD if the tax payer is a/an (1) individual, or (2) a corporation?

The OSD of the tax payer would be

If Individual If Corporation
Gross sales P1,000,000 P1,000,000
Less: Cost of goods sold 800,000
Basis of OSD P 200,000
Multiplied by OSD rate 40% 40%
OSD amount P 400,000 P 80,000
======== =========
If the taxpayer opts to use OSD in lieu of the itemized deduction allowed under Section 34 of the
Code as amended, his/ its net taxable income shall be as follows:
If Individual If Corporation
Gross sales P1,000,000 P1,000,000
Less: Cost of goods sold _________ 800,000
Sales/Gross income P1,000,000 P 200,000
Less: OSD amount 400,000 80,000
Net income P 600,000 P 120,000
========= =========
Query: Are other items of gross income not submitted to final taxes excluded from gross income for
corporate OSD purposes?

Answer: No Other items not subject to final taxes are included in the gross income in determining
corporate OSD Considered the following provisions of Revenue Regulations No. 16-2008.

“Passive incomes which have been subjected to final tax at source shall NOT form part of the gross
income for purposes of computing the forty percent (40%) optional standard deduction.”
(Sec. 4, Rev. Regs. No. 16-2008)
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It could be inferred that only those that have been subjected to final taxes are precluded to part of gross
income for corporate OSD purposes. Accordingly, other items that were not subject to final taxes NOT
precluded as part of the gross income in computing the 40% corporate OSD.

With the foregoing, the gross income basis of 40% corporate OSD should include other taxable income
not subjected to final tax.

Notes:
1) Section 2 of Revenue Regulations No. 16-2008 provides that the following may be allowed to claim
OSD in lieu of itemized deductions under Section 34 (A) to (J) and (M), Section 37, other special law, if
applicable):

Individuals:
a) Resident citizen
b) Nonresident citizen
c) Resident alien
d) Taxable estate and trusts
Corporations:
a) Domestic corporations
b) Resident foreign corporations
2) An individual who is entitled to claim for OSD shall not be required to submit with his tax return the
the supporting financial statements.
3) If an individual employs the accrual basis of accounting for his income and deductions, the OSD shall
be based on the gross sales during the taxable year. If he/she employs cash basis, the OSD shall be based
on his gross receipts during the year.
4) It is the authors’ opinion that the sales discounts, sales returns and sales allowances are deducted to
arrive at the basis of sales in computing OSD. This rule is supported by that the lower amount of
deduction will be allowed for income tax purposes.

5) Components of gross Income for purposes of Corporate OSD

“Gross income derived from business shall be equivalent to 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.” (RR No. 16-2008)

6) If a taxpayer elects to offset his capital losses against his capital gains, he may no longer claim the OSD
under Sec. 34 (L) NIRC because this section provides that the OSD shall be in lieu of itemized allowed
deductions under Sec. 34 which evidently include losses from sales or exchanges of capital assets. (BIR
Ruling, May 20,1955)

Regular Allowable Itemized Deductions

Itemized deductions are allowed deductible ordinary and necessary business expenses paid or incurred
during the taxable year. As. A rule, these deductions required supporting documents to justify the
reduction from gross income. (Sec. 34 (A to M), NIRC)

Notes:
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1) Compensation income is not allowed to be reduced by OSD or itemized deductions.

2) Each spouse may either use OSD or itemized deductions.
3) If any income of the husband and wife could not be definitely identified as income exclusively earned
or realized by either spouses, the same shall be divided equally between the spouses for the purpose of
determining their respective taxable income.
4) In the case of an individual entitle to claim the OSD “Allowable deductions” shall mean the aforesaid
OSD.

Income Subject to Regular Allowable Itemized Deductions

The following items of income are granted with itemized deductions:
1) Business/professional income derived within and outside the Philippines by the 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 a 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 Regular Allowable Itemized Deductions

1) General business 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 contribution;
9) Research and development; and
10) Pension trust

GENERAL BUSINESS EXPENSES

These expenses are directly attributable to the development, management, operation and/or conduct of
trade, business or exercise of profession (Sec.34A 1a, NIRC). These Include a reasonable allowance for the
following:
(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 use of business property;
(e) Advertising and other selling expenses;
(f) Traveling expenses while away from home solely in the pursuit of trade, profession or business; and
(g) Insurance premiums against fire, storm, theft, accident, or other similar losses in the trade or
business.

Requisites for Deductibility of General Expenses

In other that a general expense will be allowed as deduction from gross income, all of the following
 R. Z. Palma 10

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 (Sec.34A1b, NIRC);
3) Reasonable in amount (Ibid., (a)(i), NIRC);
4) Withheld with tax and paid to BIR, If required such as salary expense or income payments
(Sec. 2, Regs. No. 12-2013)
5) Not contrary to law, morals, public policy, or public order (Ibid.,(a)(w), NIRC); and
6) Incurred or paid and deducted within the taxable year (Sec.34A1b, NIRC)

A taxpayer has all the 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 from
them from income of any succeeding year. (Sec. 76, Rev. Regs. No.2)

Net Operating Loss Carry Over (NOLCO) and any item of incentive deduction allowable under any special
law are not part of regular itemized deductions (Rev. Reg. No.14-2001, Sec. 3.2).

NOLCO is not part of regular itemized deduction because such loss was not incurred during the taxable
year. The topic is discussed in the other Chapter of this book.

Meaning of Ordinary and Necessary

An expense is ordinary if it is reasonable and common to the particular business of the taxpayer as
distinguished from a capital expenditure. (Merten’s, Vol. 4A, pp. 41-43)

As long as the expense is attributed to the development, management, operation and/or conduct of the
trade, business or exercise of profession, such expense is ordinary.

An expense is necessary when it is useful or helpful to the business; it need not be essential or
indispensable to the business as distinguished from ordinary expenditure (Michie’s Federal Tax Handbook, p.309).
For instance, a lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees
may be so heavy that repletion is unlikely.

Meaning of Trade or Business

A business is an activity intended to make profit. Carrying on a business connotes regularity in
transaction that might result in profit. It is not necessary, however, that that activities in question from
the taxpayer’s principal trade or business. (Michie. P.309; Flint vs. Stone Tracy Co.,220 U.S. 107)

Salaries and Wages

Salaries, inclusive of wages and other forms of compensation for personal services actually rendered,
Including the grossed-up monetary value of fringe benefits furnished or granted by the employer to the
employee are ordinary expense.

As general rule, salary expenses are allowed as deductions from gross business income only if the
corresponding withholding tax has been deducted and remitted to the BIR. (Sec.34A1ai, NIRC)

To be deductible, payments of salary must be reasonable in amount. The excess over reasonable amount
may be disallowed as deduction from gross income or capitalized or treated as distribution of capital, as
the case may be.
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Illustration

In year 202x, Y Co. incurred and paid the salary of its workers amounting to P300,000. The company,
however, did not withhold and remit income taxes on said salary payments. In this case, Y Co. cannot
deduct salary expense from its gross income for year 202x.

Notes: The following compensations are not subject to withholding income taxes:
1) Compensation income including holiday pay, overtime pay, night shifts deferential pay and hazard pay
of minimum wage earner employee (both of private and public sector) is exempt from income tax and
consequent exempt from income tax withholding. (R.A. 9504; Rev. Regs. No.10-2008)
2) ’De minimis’ benefits received by employee (either managerial or rank-and-file) shall not be subject to
income tax consequently exempt from withholding tax wages. (R.A. 9504; Rev. Regs. No. 10-2008)
3) Since the above compensations are tax-exempt as expressed by law, they are deductible expenses
even if there is no withholding tax made.

Compensation for Injuries and Pensions

Compensation for injuries and pensions are deductible expenses. Even the amount of the salary of an
Employee paid for a limited period of time after his death to his widow or heirs, in recognition for the
Services, rendered may be deductible. (Sec. 73, Rev. Regs. No. 2)

The salary paid to an employee during the period of partial incapacity was held reasonable and, hence,
deductible. (S.W. Anderson Co. vs. Glenn, 43 F. Suppl. 334)

Illustration

On March 1,202x, Dexter, an electrical engineer of MPC, was electrocuted while performing his duty
resulting to his death. His family received the following compensation after his death:

Continuous salaries after death to assist Dexter’s family P 250,000

Death benefit 1,000,000
Terminal pay 1,500,000
Donation for coffin and other wake expenses 50,000

How much is the deductible expense of MPC?

The deductible expenses of MPC would be

Continuous salaries after death to assist Dexter’s family P 250,000

Death benefit 1,000,000
Terminal pay 1,500,000
Deductible expense P2,750,000
=========
Note: The donation for coffin and other wake expenses is not business or compensation relation and,
hence not deductible. (Sec. 72, Rev. Regs. No. 2)

Materials and Supplies

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Actual consumption method. In general, the costs of materials or supplies are deductible as expense
when consumed or used in the business operation during the taxable period. Unused supplies and
supplies not used for business purposes are not allowable deductions. (Sec.67, Rev. Regs. No. 2)

Total purchase method. If the taxpayer carries incidental materials or supplies on hand for which no
record of consumption is kept, or of which physical inventories are not taken (beginning and ending
Inventories), it will be permissible for the taxpayer to include in his expenses and deduct from gross
income the total cost of supplies and materials as were purchased during the year for which the return is
made, provided the net income is clearly reflected by this method. (Ibid)

Production cost method. If the materials or supplies are used directly in producing products to be sold,
the related cost shall form part of the cost of the product. Such cost shall be deductible as cost of goods
sold when the products produced are sold.

Illustration
In 202x, Mardonio Manufacturing Company’s materials and supplies show the following data:
Materials and Supplies
Office Factory
Beginning inventory P 2,000 P 50,000
Net purchase during the year 20,000 300,000
Ending inventory 3,000 30,000

How much is deductible material and supplies expense from gross income and the inventoriable cost of
materials and supplies as product cost?

The deductible expense and inventoriable cost is computed as follows

Materials and Supplies

Office Factory
Beginning inventory P 2,000 P 50,000
Add: Net purchase during the year 20,000 300,000
Total available for use P22,000 P350,000
Less: Ending inventory 3,000 30,000
Deductible supplies expense P19,000
Inventory cost – part of cost product produced ====== P320,000
=======
Traveling Expenses
These are expenses incurred within and outside the country while away from home in pursuit of trade,
business or professional. (Sec.34A]aii, NIRC)

Deductible traveling expenses include transportation expenses and meals and lodging as long as they are
incurred solely for carrying on trade, business or profession. (Sec. 66, Rev. Regs. No. 2)

Illustration
Acong reported the following traveling expenses:
 R. Z. Palma 13

Business seminars (registration fees, P5,000) P20,000

Meals and lodging on business seminars 10,000
Visiting friends 5,000

The deductible traveling expense would be

Business seminars (registration fees, P5,000) P20,000

Meals and lodging on business seminars 10,000
Traveling expense 30,000
======
Rent Expenses
These are expenses incurred for the continued use or possession of property to which the taxpayer has
not taken or is not taken or is not taking title to or in which he has no equity other than of a lessee, user
or possessor. (Sec. 34A1aiii, NIRC)
Rentals paid for property used in business, whether the property is real or personal, are deductible as
ordinary and necessary business expenses. (Menchie, p. 321)

When is Rent Deductible?

As a rule, the rent expense is deductible when incurred in relation to trade, business or profession and
the corresponding 5% creditable withholding tax has been made. (Rev. Regs. No. 17-2013)

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.

If the advance payment is a prepaid rental, such payment is a taxable income to the lessor in the year
when received even though the lessor is on the accrual basis or the cash method or reporting income
and expense.

However, 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. [Hyde Park realty, Inc. vs. Commissioner, 211 F. (2d)
462; Rev. Reg. No. 19-86, Sec. 2.01; [Pig Whistle Co., 9 B.T.A. 668 and Main & Mekemy Building Co. vs. Commissioner, 113 F. (2d) 61]

Application Summary
RENTAL EXPENSES

=========================== Deductible
Payment given by the lessee: Accrual Cash
Prepaid expense Prorate Prorate
Incurred and paid Yes Yes
Incurred but not paid Yes No

Illustration
On December 1,2020, M Company rents a store building for P10,000 a month. The lease contract
stipulates that advance payment for 10 months must be made before the lessee can occupy the store
building M paid the P100,000 as advice payment on November 1,2020. The related creditable
withholding tax has been withheld and remitted to the BIR.
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How much is the total deductible rental expense for the year 2020; under accrual cash methods
reporting? The deductible rental expense for the year 2000 would be
Accrual Cash
Deductible rental expense (P100,000/10) P10,000 P10,000
====== ======
Assuming that year 2021, M was not able to pay the rental expense from October to December, how
much is the deductible rental expense for the year 2021 using the accrual and cash methods of
reporting?

The deductible rental expense for the year 2021 would be

Accrual Cash
Applicable of advance payment (P10,000 x 9/10) P 90,000 P90,000
Add: Rent used but not paid (P10,000 x 3 months) 30,000 - O -__
Total deductible rental expense P120,000 P90,000
======= ======
Deductible Leasehold Improvement
When a lessee constructed an improvement on the leased property, the cost of such improvement shall
be depreciated over the life of the improvement or term of the lease contract, whichever period is
shorter. The computed depreciation expense is allowed as deduction from gross income.

A bonus paid to secure a lease is deduction on a pro-rata basis over the term of the lease.

Illustration
Q Corporation signed a 10-year lease contract to occupy a vacant lot for P10,000 per year. As part of the
lease agreement, Q constructed a warehouse building costing P200,000. The building has an estimated
life of 12 years. At the end of the lease contract the landlord will own the building.

The itemized deduction per year from the business income of Queen Corporation would be

Rent expense P10,000

Depreciation (200,000/10) 20,000
Total itemized deductions P30,000
======
1) Taxes paid by a tenant to for a landlord for business property are additional rent and constitute a
deductible item to the tenant and taxable income to the landlord, the amount of the tax being
deductible by the latter.
2) When property is leased for both residence and business purposes, the rental value of the residence
portion is personal and not deductible. The portion of the rent allocable to business is deductible.

Representation Expense
These are entertainment, amusement and recreation (EAR) 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.

They are subject to ceilings as prescribed by the rules and regulations provided by the Secretary of
Finance, as follows:
a) ½% of net sales for taxpayers engaged in sale of goods/merchandise,/inventories properties, or
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b) 1% of net revenue for taxpayers engaged in sale of services, including exercise of profession and use
or lease of properties.

Requisites: To be deductible, the entertainment/recreation expense must meet the following conditions:
1) It must not be contrary to law, morals, public policy or public order;
2) It must be substantiated with sufficient evident such as receipts and or adequate records
(Sec. 34[A]1aiv, NIRC)
3) It must be limited to the ceiling requirement (Rev. Reg. 10-2002); and
4) There must be some definite reasonable purpose connected with one’s business
(Limpan Investment Corp. vs Commissioner of Internal Revenue, CTA Case No. 1358, September 20,1967)
Mere giving of parties to entertain one’s employees and personnel does not indicate a definite business
purpose. (Roxas vs. CTA, 23 23 SCRA 276).

Illustration
Mr.Sacpa Teofilo, a manager of Maharlika Corporation with total net sale of goods amounting to
P10,000,000 in 2020, incurred a total entertainment and recreation expenses amounting to P60,000 with
adequate receipts. It was incurred to conduct a special meeting with major customers at
Supreme Hotel.

The representation expense allowed as deduction of Maharlika Corporation, if it is engage in selling

products, would be P50,000, determined as follows:

Actual entertainment and recreation and expenses P 60,000

=========
Total net sales during the year P10,000,000
Multiplied by limit percentage .005
Deductible representation expense P 50,000
=========
EAR Used Both for Trading and Servicing Business

If the taxpayer derives income from both sales of goods/properties and services, the allowable
Entertainment, Amusement and Recreation (EAR) expense shall in all cases be determined based on an
apportionment formula, taking into consideration the percentage of the net sales/net revenue to the net
sales/net revenue, but which in no case shall exceed the maximum percentage ceiling provided in the
Regulations. (Rev. Regs. No. 10-2002, July 18,2002)

Illustration
Watchworld is engaged in sale and repairs of all kinds of clocks showed the following revenues and
expenses:
Net sales P600,000
Net repairs revenue 200,000
Cost of sales 300,000
Itemized deductions including representation expense of P8,000 208,000

The deductible representation expense would be

Actual allowable EAR: Trading Servicing Lower amount
Trading (P8,000 x 6/8) P6,000
Servicing (P8,000 x 2/8) P2,000 P2,000
 R. Z. Palma 16

Statutory limit allowed:

Trading (P600,000 x 0.005) 3,000 3,000
Servicing (P200,000 x 0.01) 2,000 ______
Representation expense allowed P5,000

======
Interest Expense
The cost of money incurred within a taxable year indebtedness in connection with the taxpayer’s
profession, trade or business.

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
(Commissioner vs. Prieto, 1-13912, September 30,1960);
4) the interest must be legally due;
5) The interest must not be incurred to finance petroleum operation;
6) In case of interest incurred in the acquisition of property used in business, trade or profession, the
same is not treated as capital expenditure;
7) The interest payment must not be between related parties. (Sec. 34NIRC; Rev. Reg. 13-2000)

Interest Expense Deductible Subject to Limit

If the taxpayer has interest income subject to 20% final tax and at the same time incurred an interest
expense during the taxable year, the interest expense shall be reduced by thirty-three percent
(33% effective January 1,2009, as amended by R.A. 9337.

Illustration
Assume that the taxpayer engaged in business incurring an interest expense of P400,000. In the same
year, the business also earned P300,000 interest income from time deposit in the bank.

The deductible interest expense would be

Actual interest expense P400,000

Less: Tax differential on interest income (P300,000 x 33%) 99,000
Deductible interest expense P301,000
=======
Notes:
1) The tax differential rate on interest to reduce the actual interest expense is now 33% whether the
taxpayer is an individual or corporation as per amendment made by R.A. 9337.
2) This limitation apparently intended to counter tax arbitrage scheme where a taxpayer obtains an
interest-bearing loan and places the proceeds of the such loan in investments that yield interest income
subject to preferential tax rate of 20% final withholding tax.
 R. Z. Palma 17

Interest Expense Deductible in Full

Interest expense is deductible in full when:
a) The business has no interest income subjected to 20% final tax; or
b) The interest expense is paid in favor of the government (Rev. Regs. No. 13-2000)
Interest on delinquent taxes is deductible because taxes are considered legal debt when due. As a
rule, interest paid to the government shall not be reduced by tax differential because the beneficiary
of such interest is the government itself. (Commissioner vs. Palanca, 18 SCRA 496)

Illustration
On April 15,2020, Ramos was not able to pay income taxes amounting to P20,000 for the taxable year
2020. He was charged with twenty-five percent (25%) ordinary fines and penalties for late payment of
taxes plus twenty percent (20%) interest.

Assume that Ramos paid the taxes on April 15,2021, the interest deductible in full would be
Unpaid tax due P20,000
Multiply by interest expense rate 20%
Interest expense deductible in full P 4,000
======
Note: Taxes constitute indebtedness for purposes of income tax and the interest paid for delinquency in
the payment of tax is a deductible interest expense however, fines and penalties for late payment of
taxes are not deductible. (Commissioner VS Palanca, L-16626, 10-29-66)

Nondeductible Interest Expense

The following payments for interest expense are not allowed as deduction from business/professional
income:
1) Interest payment on indebtedness not business related (NIRC, Sec. 34 (B)(2)(a &b);
2) Interest payment in favor of a relative (relative debtor and creditor).
3) Interest paid in advance;
4) Interest to purchase or carry tax – exempt transactions;
5) Interest paid on indebtedness to finance petroleum explorations; and
6) Interest on unclaimed salary is not deductible from gross income. (Kuenzle & Streiff, Inc., vs. Collector of Revenue,
106 Phil. 355)

Related Debtor and Creditor

Debtor and creditor are related taxpayers when the following conditions are met:
1) Interest on loan between members of the family, which includes wife, brother, sisters, ancestors and
other lineal descendants/ascendants.
2) Interest on loan between two corporations of which such individuals owned more than 50%.
3) Interest on loan between two corporations where the same individuals owns more than 50% in each
corporation.
4) Interest on loan between fiduciaries of two trust which are both owned by the same grantor.

Prepaid Interest by a Cash Basis Individual Taxpayer

The following rules are to be observed on prepayments of interest:
1) Full payment of principal indebtedness
If an individual tax payer reporting income on cash basis incurs indebtedness on which an interest is
 R. Z. Palma 18

paid in advance through discount or otherwise, such interest shall be allowed as deduction in the
year that the principal indebtedness is fully paid.

Illustration
On December 31,202B, Mr. Acop whose business is using cash basis of accounting acquired a bank loan
of P100,000 for business purposes. The amount received as proceeds of the loan was P90,000, net of
interest.

How much is the interest expense allowed as deduction from 200B business income of Acop if the loan is
to be paid in 202C?

Acop cannot deduct in 202B the prepaid for the bank loan, but he is entitled to deduct the interest
expense of P10,000 from his 202C business income.

2) Proportionate to principal amortization

However, if the indebtedness is payable in periodic amortization, the amount of the interest which
corresponds to the amount of the principal amortized or paid during the year shall be allowed as
deduction in such taxable year.

Illustration
On Janaury 1,202B, Gloria borrowed P900,000 from PS Bank payable in equal periodic amortization
within three years starting December 31,202B. The bank deducted an interest expense in
advance amounting to P162,000.

The deductible interest expenses for 202B, 202C and 202D are computed as follows:
Year Amortization Principal Fraction Deductible interest expense
202B P300,000 P 900,000 9/18 P 81,000
202C 300,000 600,000 6/18 54,000
202D 300,000 300,000 3/18 27,000
Total P900,000 P1,800,000 P162,000
======= ======== =======

Interest to Finance Petroleum Exploration

Interest paid on indebtedness to finance petroleum exploration is nondeductible because this is exempt
from income tax. This is appropriately capitalized as “deferred exploration cost.”

Illustration
Driller Inc. borrowed P10,000,000 for its petroleum exploration activity in Palawan. During the year,
P1,200,000 interest was paid with supporting receipts.

Under this case, the P1,200,000 interest expenses is no longer claimed as deduction because petroleum
exploration is tax exempt.

Optional Treatment of Interest Expense

At the option of the taxpayer, interest incurred to acquire property used in trade or business or exercise
of profession may be allowed as either an outright deduction from business gross income, or treated as a
capital expenditure. (Sec.34B3, NIRC)
 R. Z. Palma 19

Illustration
Mr. Marvin Gannaban incurred P10,000 interest expense in 202B for P100,000 loan made for the
acquisition of an equipment used in the business.
1) Mr. Gannaban has the option of claiming the P10,000 interest expense as business income deduction
for 202B under accrual basis of accounting, or
2) He can opt to capitalize the P10,000 interest as part of the acquisition cost of the equipment and
subsequent avail himself of the deduction from business income in the form of depreciation.

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. (Sec.34C, NIRC)

In the case of a nonresidential alien individual engaged in trade or business in the Philippines and
resident foreign corporation, the deductions for taxes shall be allowed only if and to the extent that they
are connected with income from sources within the Philippines. (Sec. 80, Rev. Regs. No.2)

Requisites for Deductibility of Taxes

The requisites for taxes to be deductible are as follows:
1) It must be paid or incurred within the taxable year;
2) It must be paid or incurred in connection with the taxpayer’s professional, trade or business; and
3) It must be imposed directly upon the taxpayer.

Tax Deductible from Gross Income

As general rule, taxes are deductible, except for those to which the law does not permit deduction. The
following taxes, according to Section 80 of the Revenue Rev. Regs. No. 2 are allowed as deduction if
incurred in the conduct of business:
1) Documentary stamp taxes;
2) Occupational taxes
3) Privilege and license taxes;
4) Excise taxes;
5) Import duties;
6) Local business taxes;
7) Automobile registration
8) Community tax
9) Municipal tax; and
10) Income tax paid to foreign country if not claimed as tax credit. (Sec. 32 (C) (1)(a), NIRC)

Taxes Not Deductible from Gross Income

The law does not permit the deduction of income tax paid to or accrued in favor of National Government
of the Philippines and in no case may the taxpayer avail of such deduction.
(Sec.81, Rev. Regs. No. 2)

The following taxes are not allowed as deduction from gross income:
1) Philippine income tax; (Sec. 81, Rev. Regs. No. 2)
2) Estate and donor’s taxes; (Sec. 83, Rev. Regs. No. 2)
 R. Z. Palma 20

3)Foreign income tax, if claimed as a tax credit;

4) Percentage tax on stock transaction;
5) Value-added tax;
6) Taxes not related to business, trade, or profession; and
7) Other items related to tax such as:
a) Special assessment; (Ibid)
b) Surcharges; and
c) Compromise penalty

The amount of deductible taxes is limited to the basic tax and shall not include the amount for any
surcharge or penalty on delinquent taxes. However, interest on delinquent taxes, although not
deductible as tax, can be deducted as interest expense at its full amount. (Commissioner vs. Palanca , 18 SCRA 496)

Illustration
X Corporation paid 202B the following taxes which were incurred in connection with the business:
Community tax, basic amount of P1,000 and surcharge of P250 plus interest of P125. Real property tax of
P5,000 plus surcharge of P1,250 and interest of P500. Income tax, P100,000, plus surcharge of P25,000
and interest of P10,000.

The amount deductible of taxes and interest from business gross income of the X Corporation for 202B
would be
Basic community tax P 1,000
Real property tax 5,000
Total deductible taxes P 6,000
Add: Interest expenses on:
Community tax P 125
Real property tax 500
Income tax 10,000 10,625
Total deductible taxes
and interest expenses P16,625
======
Note: The income tax is not deductible, including all surcharges. Interest is deductible as interest
expense, not as a tax.

Bad Debts Expense

A bad debt is claim that becomes worthless uncollectible arising from money lent or goods sold or
services rendered.

A charge to bad debts expense due to estimated uncollectible receivable does not constitute
deductibility from gross income.

To be deductible, the claim must be ascertained worthless and the corresponding receivable should have
been written off within the taxable year. (Sec. 34E, NIRC; Sec. 102, Rev. Regs. No. 2)

When is a Claim Ascertained to be Worthless?

 R. Z. Palma 21

An account or a claim is ascertained to be worthless when the creditor determined with reasonable
degree of certainty that the claim could not be collected despite the fact that the creditor took
reasonable steps to collect.

The worthless of an account may be due to the following factors:

1) Insolvency of debtor.
2) Debts of debtor without sufficient properties to cover his debts, or
3) Disappearance of debtor.

A bad debt account cannot be ascertained worthless when supported by guarantor or surety. The
creditor cannot deduct the amount until all efforts have been done to collect from the guarantor or
surety.

Requisites for Deductibility of Bad Debts

In order for bad debts to be allowed as deduction for gross income, it should meet the following
requisites:
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 Tax Code;
4) The claim must actually be ascertain to be worthless and uncollectible as of the end of the taxable
year; and
5) The claim must be written off within the taxable year

Nondeductible Bad Debts

The following are non-deductible bad debts:
1) Not connected with the profession, trade or business;
2) Arising from unpaid wages, salaries, rents and similar items of taxable income which were not
included as income for the year in which the deduction as bad debts is sought to be made, or in a
previous year; and
3) Contract entered into between related taxpayers or members of the family.

Valuation of Bad Debts

The following rules shall be applied in determining the value of deductible bad debts:

1) Actual amount paid. An accounts receivable acquired by purchase which becomes uncollectible can be
deducted from gross income at the actual amount paid and not at the face value of the receivable.

Illustration
Cash Tight Corporation sold its P250,000 accounts receivable for P100,000 to Collecting Corporation
without recourse.

Assume that the latter cannot collect from client of the former despite efforts made, the actual amount
paid which is P100,000 is allowed deductible bad debt expense of the Collecting Corporation.

However, if the purchase contract is with recourse, Collecting Corporation cannot deduct the P100,000
as bad debts expense because it can still collect from Cash Tight Corporation, unless the latter becomes
insolvent.
 R. Z. Palma 22

2) Original amount. If receivables are acquired through sales of goods or services, the original amount of
receivable is deductible, but the related invest thereof, not reported as income, is not deductible.

Illustration
Balingit Furnitures sold its sala set on installment for P100,000 with the following terms: 50% down-
payment; the remaining balance is payable in five (5) annual installment. The cash price of the sala
set sold is P70,000.

Assuming that the remaining balance becomes uncollectible and was written off, the amount of bad
debts that can be deducted from gross income is P20,000, computed as follows:
Cash price of sala set P70,000
Less: Down payment received (P100,000 x 50%) 50,000
Deductible bad debts expense P20,000
======
3) Proportionate amount. If receivable becomes uncollectible due to debtor’s bankruptcy, the allowed
deduction is the proportionate amount uncollectible over the total claims of ordinary debtor’s creditors.

Illustration
Ordana Company has P50,000 collectibles from Mr.Saki Teen who died with the following assets anf
liabilities:
Assets Liabilities
Total P500,000 P900,000
======= =======
Assume that the liabilities are composed of the following:
Unpaid income tax (National Government) P100,000
Various creditors 800,000
Total liabilities P900,000
=======
The total indebtedness that cannot be paid shall be computed first as follows:
Total assets of Mr. Teen P500,000
Less: Payment to preferred creditor – Government 100,000
Assets available to ordinary creditors P400,000
Less: Total liabilities to various creditors 800,000
Total indebtedness that cannot be paid P400,000
=======
The deductible bad debts expense of Ordana Company is
Collectibles of Mr. Teen P 50,000
Multiply by percentage of uncollectibility (P400,000/P800,000) 50%
Deductibility bad debt expense of Mr. Teen. P 25,000
=======

Account for Worthless Accounts

The only acceptable method to record bad debts for tax purposes is the direct or actual method. Bad
debts computed using the allowance method are not acceptable for taxation purposes.

Illustration
The following data are available from the records of Pasarado Company:
Accounts receivable, beginning P100,000
 R. Z. Palma 23

Sales on account 900,000

Total collection during the year 600,000

Through the company’s net past experience, a 3% allowance of uncollectible accounts based on sales on
sales on accounts is estimated.

During the year, one of the company’s customer became insolvent and the related amount of collectibles
amounting to P20,000 is determined to be uncollectible.

The accounting for the writing off worthless accounts would be

GENERAL JOURNAL

Date Descriptions Pages Number………..10

Not
====== =============================== Debit Credit Deductible
(a) Bad debts expense 27,000 (Allowance or
estimated
Allowance for bad debt expense 27,000
bad debts)
To record estimated uncollectible
accounts, (P900,000 x 3%).
Deductions
(Actual accounts
(b) Allowance for bad debts expense 20,000 written off)
Accounts receivable 20,000
To write off worthless account.

Bad Debts of Cash Basis Taxpayer

A cash basis taxpayer generally reports income of principal business activities upon collection.
Consequently, such taxpayer cannot deduct worthless accounts from his gross receipts because income
is reported only when collected.

Illustration
Kings Court is real property lessor. For the year, the total rent collections were as follows:
Previous year’s rents:
November and December P 20,000
Current year’s rents:
January to November P110,000

The rent income of P10,000 for December of current year is proven uncollectible.

In this case, Kings Court cannot claim the P10,000 uncollectible rent as bad debt for the current year
because the business is a servicing business which reports income on cash basis. As such, this rent for
December is not reported as income. Consequently, it could not be claimed as deduction.
 R. Z. Palma 24

Depreciation Expense
Depreciation, one of the allowed deductions under the Tax Code refers to the periodic reduction of the
value of tangible permanent asset due to passage of time, wear and tear and obsolescence.
(La Frutera, Inc, Inc. vs. CTA, CA-G.R. SP. No. 69387, April 24,2006)

Depreciation expense is allowed as deductions from gross income to enable taxpayers to recover the
acquisition cost of the property used in the practice of profession, business or trade. (Sec.34F, NIRC)

For intangible assets such as patents, copyright and franchise, the annual allowance to reduce their
useful value is recalled “amortization”.

Requisites for Deductibility of Depreciation

The following requirements must be met by a depreciation expense to be deductible:
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 depreciation assets must be located in the Philippines if the taxpayer is nonresident alien or a
foreign corporation.

Methods of Depreciation
The methods for computing depreciation expense shall include but are not limited to the following:
1) Straight-line method;
2) Declining balance method;
3) Sum of the years digit method; and
4) Any other method which may be prescribed by the Secretary of Finance upon the recommendation of
the Commissioner.

Illustration
Cacal’s Merchandising purchased a delivery truck for the transportation of the business merchandise
from suppliers and to customers. The purchase price of the truck P110,000 with a salvage value of
P10,000 and within an estimated life of five years.

How much is the depreciation expense using the straight-line method?

Using the straight-line method, the annual depreciation expense is computed as follows:
Acquisition cost of delivery truck P110,000
Less: Salvage value 10,000
Balance P100,000
Divide by estimate useful life (years) 5
Annual deductible depreciation P 20,000
=======
Note: If the problem is silent use the straight-line method. The procedures of other methods of
depreciation are discussed in the higher accounting subjects.

Depreciation and Other Related Expenses of Vehicles

 R. Z. Palma 25

Revenue Regulations No. 12-2012 mandates that only one (1) vehicle for land transport is allowed for
use of an official or employee and the value of the vehicle involved should not exceed P2.4 million.
Once the value of the vehicle purchased breaches the P2,400,000 amount, the following sequences shall
be imposed:
1) The taxpayer shall be totally barred from claiming any depreciation expense and all maintenance
expenses of such vehicle.
2) The input taxes on the purchase of non-depreciation vehicles and all input taxes on maintenance
expense incurred thereon are likewise disallowed for taxation purposes.

No depreciation shall be allowed for yachts, helicopters, airplanes and/or aircrafts, and land vehicles
which exceed the above threshold amount unless the taxpayer’s main line business is transport
operations or lease of transportation equipment and the vehicles purchased are used in said operations.
(Sec. 3, Rev. Regs. No. 12-2012)

The said regulations shall taken effect starting October 17,2012. It does not cover land vehicle purchases
prior to its effectivity. (RMC No. 2-2013)

Illustration
E Company acquires cars to be used by its salespeople and its officers. The company has the policy to
depreciate motor vehicles by 10% annually.

Before the year 2012, it has a total 10 units of Toyota Vois used by its sales people and one Land Cruiser
Prado used by the company president with the following acquisition cost:
05/30/2011 10 units Toyota Vois (sales people) P3,600,000
12/30/2011 1 unit Land Cruiser Prado (used by president) 4,800,000

The company reported to the BIR the following new motor vehicle acquisition:
10/30/2015 2 units Mitsubishi Pajero P3,200,000
01/02/2018 5 units Totyota Vois 3,300,000

The two Mitsubishi Pajero cars (P1,600,000 each) are both used by the vice president for finance and the
Toyota Vios cars (P660,000 each) used by its new five (5) senior sales people. The company submitted to
BIR all necessary sufficient evidence to support the claim of depreciation.

The depreciation expense of E Company for the taxable 2018 would be:
From 2011:
10 units Toyota Vios P 3,300,000
1 unit land cruiser prado 4,800,000
From 2015: 1 Pajero car (P3,200,000/2) (only 1 allowed) 1,600,000
From 2018: 5 units Toyota Vios 3,300,000
Total costs of depreciation vehicles P13,300,000
Multiplied be depreciation rate 10%
Depreciation expense 2018 P 1,330,000
=========
Depreciation of Properties Used in Petroleum Operation
The following rules shall be applied for depreciating properties used in petroleum operations
1) Initially placed properties. If properties directly related to production of petroleum are initially placed
in service in a taxable year, the depreciation method may be either (a) straight-line method, or
 R. Z. Palma 26

(b) declining-balance method of depreciation, at the option of the service contractor.

2) Change of depreciation method. If the service contractor initially elects the declining-balance method,
it may at subsequent date, shift to straight-line method.
3) Estimated useful life:
a) The useful life of properties paid in or related to production of petroleum shall be ten years (10) years
or such shorter life as may be permitted by the BIR Commissioner.
b) Properties not used directly in the production of petroleum shall be depreciated under the straight-
line method on the basis of an estimate useful life of five (5) years. (Sec. 34(F)(4), NIRC)

Illustration
Assume the following depreciable assets of Linapacan Oil Corporation:
Estimated useful life Acquisition cost
Oil drilling machine 15 years P2,000,000
Computing (office) 6 year 300,000
Total costs P2,300,000
=========
The annually depreciation expense is determined as follows:
Drilling machine (P2,000,000/10) P200,000
Computers (P300,000,000/5) 60,000
Total annual depreciation P260,000
=======
Note: Since the oil drilling machine is used directly in the production of oil, its allowed maximum life for
depreciation is 10 years. The computers are not used directly in the production of oil; thus its maximum
life is 5 years.

Depreciation of Properties Used in Mining Operations

An allowance for depreciation in respect to all properties used in mining operations, other than
petroleum operations, shall be determined as follows:
1) At the normal rate of depreciation if the expected life ten (10) years or less; or
2) Depreciation over any number of between five (5) years and the expected life if the latter is more than
ten (10) years and
3) The depreciation thereon allowed as deduction from taxable income.
Depletion Expense
Depletion is the exclusion of natural resources like mines, oil and gas wells due to production (Castaneda,
Commentaries and Jurisprudence on NIRC). Its similar to depreciation allowance, the purpose of which is to recover
the invested capital in the property.

Illustration
Baguio Mining acquired a coal property with an estimated deposit of 2,000,000 tons for P4,200,000. It is
Estimated that the property has a salvage value of P200,000. If the Baguio Mining was able to produce
400,000 tons, deductible depletion expense during the year is P800,000, computed as follows:
Cost of coal property P4,200,000
Less: Salvage value 200,000
Depletion base P4,000,000
 R. Z. Palma 27

Divided by estimated tons to be extracted 2,000,000

Depletion per ton P 2
Multiplied by number of tons extracted during the year 400,000
Depletion expense during the year P 800,000
========
Note: If the property needs restoration so that it can be sold at its estimated salvage value, any
restoration cost incurred to restore the property should be charged against the salvage value.

Exploration and Development Expenditures

“Exploration expenditures” means expenses paid/incurred before the development stage of the mine
intended to ascertain the existence, location, extent, or quality of any deposit of one other mineral.

“Development expenditures” means expenditures paid or incurred during the development stage of the
mine or the other natural deposits.

The development stage of the mines or other natural deposits shall begin at the time when deposits or
mineral ores are shown to exist in sufficient commercial quantity and quality and shall end upon
commencement of actual commercial extraction.

Tax Treatment. Any intangible exploration, drilling and other development expenditures paid or incurred
during the taxable year may be treated as:
(1) part of adjusted basis for depletion cost, or
(2) deduction to compute taxable income from mining operations.

Should the taxpayer choose to use option two (2), the following limitations shall be followed:
1) The total amount deductible for exploration and development expenditures shall not exceed 25% of
the net income from mining operations computed without the benefit of any tax incentives under
existing laws.
2) The actual exploration and development expenditures minus 25% of the net income from mining shall
be carried forward to the succeeding years until fully deducted.

Note: “Net income from mining operations” shall mean gross from operations less allowable deductions
which are necessary or related to mining operations. “Allowable deductions” shall include mining and
marketing expenses, and depreciation of properties directly used in the mining operations.
(Sec. 34(G)(2),NIRC)
The election of the taxpayer to deduct the exploration and development expenditures is irrevocable and
shall be binding in succeeding taxable years.

Illustration
Assume the following given data of Benguet Mining Corporation
Ore reserved 50,000,000 tons
Ore produced-prior year 4,000,000 tons
Ore produced-current year 5,000,000 tons
 R. Z. Palma 28

Cost for depletion:

Mine property P5,000,000
Exploration cost (original) 3,000,000
Intangible development cost 2,000,000 P10,000,000
Tangible property 5,000,000
Value of production 25,000,000
Production cost and selling cost:
Mining cost, including depletion P10,000,000
Mining costs 8,000,000
Marketing cost 1,600,000
Depreciation 400,000 20,000,000
Actual exploration cost incurred during the year was P3,000,000.

Required: Compute the two options of the tax treatment for the P3,000,000 exploration costs.

1) Accounted as part of adjusted basis for depletion cost

Depletable costs before adjustments P10,000,000
Less: Depletion (P10,000,000/50M tons) x 4 M tons 800,000
Balance P 9,200,000
Add: Current exploration cost 3,000,000
Total P12,200,000
Divided by remaining ore reserves in ton 46,000,000
New depletion cost/tons P 0.2652
Multiplied by ore produced year in tons 5,000,000
Depletion expense P 1,326,000
==========
2) As deduction from income from mining:
Value of product P25,000,000
Less: Production and selling cost 20,000,000
Net income from operation P 5,000,000
Multiplied by limit percentage 25%
Deductible exploration cost (currently incurred) P 1,250,000
==========
Actual current exploration P 3,000,000
Less: Reported deductible exploration cost this year 1,250,000
Chargeable to succeeding year P 1,750,000
==========
Capital Expenditures of Private Educational Institution (not non-profit, non-stock educational
institution)
The capital expenditures of private educational institution may be treated in the following options:
1) Deduct immediate as expenditures, or
2) Deduct as allowance for depreciation. (Sec. 34(A) (6)(2), NIRC)

Illustration
On January 202x, Pines City College, a private educational institution, spent P1,200,000 to acquire school
furniture and fixtures with an average estimated life of ten years. How much deductible expense is
allowed to Pines City in 202x?
 R. Z. Palma 29

Answer: If Pines City opted to report the cash outlay as outright expense, the entire amount of
P1,200,000 is deductible in year 202x.

If Pines City opted to report the cash outlay as depreciation allowance, the deductible expense would
only be P120,000, computed as follows:

Cost of school furnitures and fixtures P1,200,000

Divided by estimated useful life 10
Deductible depreciation expense P 120,000

========
Deductible Pension Trusts
A pension plan companies 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 contribution or payments made to
pension trust in accordance with a ‘reasonable private benefit plan. (R.A. 4917 & Sec. 32(B)(6)(A), NIRC)

There are two general types of pensions that may be adopted by an employer.
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.

The amount of periodic contribution to be made by the employer is dependent on the estimated liability
based on the designed benefits.

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.

The administrator will manage the fund and is liable to the payment of retirement benefits of the
employees under the plan. The retirement benefit payable to retiree would be dependent on how the
administrator managed the fund to become profitable.

Requirements of Plan
For tax purposes, it is not important whether the benefit plan is defined benefit or defined as
contribution as long as the following requirements of the BIR are met:
1) The plan must be reasonable and actually sound (actuarial valuation).
2) The plan must be approved by the BIR. To be approved by the BIR, the plan must comply with
requirement of Rev. Regs. No. 1-68 and Rev. Regs. No. 1-83.

Sec. 34 (j) of the Tax Code provides that the allowable deduction as pension trust is equal to provision for
the payment of reasonable pensions to employees (based on the following normal or actuarian
valuation) or actual contribution to the plan whichever is lower, and the excess of the of actual
contribution over the actuarian valuation is to be amortized over the period of 10 years.
 R. Z. Palma 30

The amounts of tax deduction should be based on actuarial valuation for funding.

Illustration
A Co. maintains BIR-registered defined benefit retirement plan. The company’s normal cost per actuarian
valuation for funding is P900,000 and P950,000 for years 202A and 202B, respectively. The actual
contributions of A Co. to the retirement plan were P1,100,000 and P800,000 for 202A and 202B,
respectively. The 202A and 202B deductible retirement expense would be
202A 202B
Normal or actual contribution (lower) P900,000 P800,000
Add: 202A amortization of excess contribution over normal cost (P200,000/10) 20,000 20,000
Retirement expense P920,000 P920,000
======= =======

Notes:
1) The 202A excess contribution over normal cost is computed as follows:
202A 202B
Actual contribution P1,100,000 P800,000
Less: Normal cost 900,000 950,000
Excess of contribution over normal cost P 200,000 (150,000)
========= =======

2) If the retirement pension plan is not BIR-approved, the deduction will only be allowed if there is a
actual retirement payment. There is no deduction allowed for the retirement contribution.

Charitable and Other Contributions

A charitable contribution is non-operating expense, but the law allows some contributions or gifts given
within the taxable year as deductions from gross income. (Sec. 34 (H), NIRC)

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

Requirement for Deductibility of Contributions

The following are the requisites to allow contributions as deductions from gross income:
1) The taxpayer making the charitable contribution must be engaged in a profession, trade or business
2) There must be actual payment of contribution or gift;
3) The requirement must be entity or institution specified by law; and
4) The net income of the institution must not inure to benefit of any individual or private stockholder.

Contribution Deductible in Full

The law specified these contributions as deductible in full amount. Examples of contributions deductible
in full are:
1) 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 specific priority activities in
a) Education;
b) Health;
c) Youth and sports development;
d) Human settlements;
e) Science and culture; and
 R. Z. Palma 31

f) Economic development
2) Donations to international organizations in accordance 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 fifteen 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 another similar organization.

Contributions Subject to Limit

These contributions are not shall depend on whether the donor is individual or corporation subject to
the following rules:
1) If the donor is an individual taxpayer, the limit is 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 a corporation, the limit is 5% of the taxable income derived from trade or business
(before the contribution) or actual contribution, whichever is lower.
To be deductible, these donation must be properly documented.

Illustration – Donor is an Individual Taxpayer

Prasas revealed the following data regarding his income and expenses for the taxable year 202x:
Gross income from business P800,000
Business expenses allowed as deduction (except contributions) 600,000
Charitable contributions:
To government:
- for specific priority activities in education 50,000
- for public purposes 60,000
To church 15,000

The total deductible charitable contribution of Prasas would be

Contributions deductible in full:
To government – priority education activities
Contributions subject to limit: P50,000 100%
To government – public purposes P60,000 with limit
To church 15,000 with limit
Total actual contributions P75,000
Limit [(P800,000-P600,000) x 10%] ====== 20,000
Total deductible charitable contributions P70,000
======
Illustration – Donor is a Corporation
Assume that the donor in the preceding illustration is a corporation. The deductible charitable
contributions would be
To government – priority education activities
Contributions subject to limit: P50,000
To government – public purposes P60,000
 R. Z. Palma 32

To church 15,000
Total actual contributions P75,000
Limit [(P800,000-P600,000) x 5%] ====== 10,000
Total deductible charitable contributions P60,000
======
Donations to Political Parties or Candidates
Contributions to political parties registered with COMELEC are contributions that may not be claimed as
deductions from income since they are neither business-related expenses for nor deductible donations
similar to those given to accredited non-government or charitable organizations as provided in
Section 34(H) of the Tax Code.

The amount spent for political campaign funds and donations to political parties or candidates are NOT
deductible either as business or contribution expenses from gross income.
(Felix Montenegro, Inc. vs. CIR, CTA Case 695, April 30,1969)

Illustration
Tan Enterprises donated P10,000,000 for the campaign funds of Liberty Party. The donation is not
deductible from gross income of Tan Enterprises.
Notes:
1) Contributions given to candidates or political parties are not subject to donor’s tax as long as said
contributions as duly reported to Commissions on Elections. (Omnibus Code; R.A. 7166)

2) Any utilized/excess campaign funds, that is, campaign contributions net of the candidate’s
expenditures, shall be considered as subject to income tax, and such, must be included in the candidate’s
taxable income. (Rev. Regs. No. 007-11)

Research and Development

A taxpayers 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 or incurred.
2) Deferred expenses chargeable 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 will be allowed as
Deferred expenses such as expenses will be allowed as deduction 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. (Sec. 34I, NIRC)

Illustration
In 202B, CW, a domestic corporation, incurred total research and development cost amounting to
P1,500,000 in relation to year 202C computer problem. The research became a success. On March
1,202C, The company sold P10,000,000.

Assuming that CW opted to change the research and development cost as an ordinary expense, what is
the amount of deductible research and development in 202B and 202C?
 R. Z. Palma 33

The research and development expenditures changeable to business gross income in 202B is P1,500,000;
in 202C, none.

If the company opted to treat the research and development expenditures as deferred expenses the
related amount of deductible expenditures for 202B would be zero and for the year 202C would be
P250,000, computed as follows:
Total research and development expenditures P1,500,000
Divide by number of months (12 months x 5 years) 60
Monthly expenses P 25,000
Multiply by amount beginning March 1 to Dec. 31,202C 10
Deductible research and development expense – 202C P 250,000
=========
For 202D (12 mos. X P25,000) 300,000
For 202E 300,000

Note: The computation of related research and development expense chargeable against gross income
Shall start on March 1,202C because the law states that the deferred expenses shall be allowed as
deduction ratably distributed over a period of not less than sixty months in which beginning with the
month in which the taxpayer first realizes benefits from such expenditures.

Senior Citizens’ Salaries and Discounts

Salaries and wages of Senior Citizens
Private establishments employing Senior Citizens shall be entitled to additional deduction from gross
income equivalent to fifteen percent (15%) of the total amount paid as salaries and wages to Senior
Citizens provided the following conditions are met:
1) The employment shall have to continue for a period of at least six (6) months; and
2) The annual taxable income of the Senior Citizen does not exceed the poverty level. (Senior citizens are
covered with the minimum wage law). (Sec. 12, Rev. Regs. No. 7-2010)

Senior citizen’s discount

The discounts granted by the seller of qualified goods and services exclusively for the use of senior
citizens as provided by R.A. 9257 are classified as special itemized deductions (New BIR Form 1701). The
statutory rates of senior citizen’s discounts are enumerated as follows:
1) For goods and services, 20% discount;
2) For water and electricity consumption registered in the name of senior citizen, 5% discount if the
water and electricity consumption do not exceed thirty cubic meters and one hundred kilowatt hours,
respectively;
3) For electricity, water and telephone Consumption, 50% discount if consumed by a Senior Citizen
administrative by the Government or domestic NGOs.

Illustration
Senior Corporation employs senior citizens at minimum wage showing the following reports during the
year:
Gross sales P5,000,000
Cost of sales 3,000,000
Gross Profit 2,000,000
Salaries expense paid to senior citizens 500,000
 R. Z. Palma 34

Salaries expense paid to other workers 200,000

Senior citizens’ discount 10,000

The special itemized deduction would be

Incentive to senior citizens’ salary (P500,000 x 15%) P75,000
Senior citizen discount 10,000
Total special itemized deduction P85,000
======
Notes:
1) The incentives and discounts granted to senior citizens can only be claimed if the seller does not opt
for the OSD during the quarter/year.
2) Only the actual amount of discount granted or a sales discount not less than the statutory rate,
whichever is higher, based on the gross selling price can be deducted from gross income. (Sec. 12 Rev. Regs.
No. 7-2010)

Sales Discounts Granted to Person with Disability

Subject to the conditions provided by law, establishments granting sales discounts to persons with
disability may claim the sales discount as deduction from gross business income.
The special deduction would be the actual amount of sales discount granted or sales discount not
exceeding 20% of the gross selling price or gross receipt net value added tax, if applicable, for income tax
purposes. (R.A. 9442; Sec. 4, Rev. Regs. No. 1-2009)

Illustration
Gabriana Clinic, a VAT-registered entity, performed a prosthetic surgery on legs of Mongo Loyd, a person
with disability. The total cost of medical operation was P500,000. Being a disabled person, Loyd
received 20% discount from Gabriana.

How much is the special deduction allowed and the total amount to be paid by Loyd?

The special itemized deduction allowed would be P100,000 computed as follows:

Cost of medical operation P500,000
Multiplied by 20%
Special itemized deduction P100,000
=======
The total amount to be paid by Loyd would be P448,000, computed as follows:
Vatable amount (P500,000 x 80%) P400,000
Add: Value-added tax (P400,000 x 12%) 48,000
Total amount to be paid by Loyd P448,000
=======
Note: A person with disability who is at the same a senior citizen can only claim one 20% discount on a
particular sales transaction.

Rooming-in and Breast-Feeding Practices

The State adopts rooming-in as a national policy to encourage, protect and support the practice of
breastfeeding.
The expenses incurred by a private health institution in complying with the provisions of this Act, shall be
deductible expenses for income tax purpose up twice the actual incurred during the taxable period.
 R. Z. Palma 35

(R.A. 7600)

Illustration
Care Medical Center, a private hospital, conducted a free seminar and medical services regarding
“Lactation Management” in every barangay in Bagiou City. The hospital incurred the following expenses
related to the seminar:
Advertising and transportation P 200,000
Free medicines 500,000
Free materials 300,000
Total actual expenses P1,000,000
========
The total itemized deduction allowed would be
Total actual expenses P1,000,000
Add: Special itemized deduction – tax incentive 1,000,000
Total itemized deductions allowed P2,000,000
========
Free Legal Assistance
A lawyer or professional partnership rendering actual free legal services, as defined by the Supreme
Court, shall entitled to an allowable deduction from gross income, the amount that could have been
collected for the actual free legal services rendered or up to ten percent (10%) of the gross income
derived from the actual performance of the legal profession, whichever is lower.

The actual free legal services herein contemplated shall be exclusive of the minimum sixty (60)-hour
mandatory legal aid services rendered to indigent litigants as required under The Rule on Mandatory
Legal Aid Services for Practicing Lawyers, under BAR Matter No. 2012, issued by the Supreme Court.
(R.A. 9999)

Illustration
Atty. Abo Gado, a practicing lawyer, rendered a 300 hours rendering free legal assistance to indigent
Litigants. Atty. Gado’s legal fee per hour is P5,000. If his actual professional fee during the year amounted
to P10,000,000, how much is the special deduction allowed to be deducted from his gross
professional income?

The allowable special itemized deduction for Atty. Gado’s free legal assistance is P1,000,000, computed
as follows:
Professional fee per hour P 5,000
Multiplied by voluntary hours rendered
for free legal assistance (300 – 60) 240
Estimated professional fee given for free P 1,200,000
==========
Actual professional fee P10,000,000
Multiplied by statutory incentives rate 10%
Allowed special deduction, lower P 1,000,000
==========

Qualified Productivity Bonuses

A Company that grants productivity bonuses to its rank-in-file employees pursuant to the Productivity
 R. Z. Palma 36

Incentives Act of 1990 (Republic Act No. 6971) shall be entitle to a special deduction from its gross
income equivalent to 50% of the total productivity bonuses over and above the deductible ordinary and
necessary expenses.

In order for the bonuses to be deductible from gross income, the following requirements must be met:
1) The payment of bonuses, is in fact, compensation.
2) The payment must be for personal services actually rendered.
3) The bonuses are reasonable when measurable by the amount and quality of the services performed
by a particular employee. (BIR Ruling No. DA-041-20015, January 28,2005)

Illustration
Profit Company, together with its employee labor union, agreed to have a productivity incentives
program. During the year, the following productivity incentives benefits were received by the rank-in-file
employees as compensation:
Profit sharing P2,000,000
Manpower training 1,000,000
Special studies 1,000,000
Total qualified productivity bonuses P4,000,000
=========
The special itemized deduction would be P2,000,000, computed as follows:
Total qualified productivity bonuses P4,000,000
Multiplied by 50%
Special itemized deduction P2,000,000
=========

CHAPTER 4 – REVIEW QUESTIONS

1) Explain the nature of “deductions from gross income.”
2) Differentiate “revenue expenditures” from “capital expenditures.” Give examples for each.
3) State the conditions in order that cost after acquisition of depreciable assets shall be capitalized.
4) State the rule regarding situs of deductible expenditures.
5) What are the items of expenses that are not deductible from gross income?
6) Give the basic format in tax return to compute the net taxable income of a self-employed individual.
7) Identify the differences in application to Tax Law and GAAP as to reportable revenue and deductible
expenses.
8)Define “business expenses.”
9) Differentiate the allowable OSD for individual from that of the corporation.
10) Enumerate the taxpayers that are allowed to deduct OSD.
11) Can a husband claim OSD while the wife claim itemized deductions (vice versa) in their consolidated
consolidated ITR? Justify your answer.
12) Defined “itemized deductions”.
13) Enumerate the incomes that are granted with allowable itemized deductions.
14) What is a “general business expenses”?
15) Give the requisites for the deductibility of general expenses.
16) Are all ordinary expenses necessary?
 R. Z. Palma 37

17) When is salary expense deductible?

18) Is compensation for injuries and pensions deductible from business income of payor?
19) What are the tax treatments if materials and supplies are used directly in producing products?
20) State the rules on the deductibility of rent expenses are paid under accrual and under cash period.
21) State the ceilings for deductible representation expenses.
22) Explain the tax arbitrage on interest expense subject to limit.
23) What are the two allowed options in the treatment of interest expense incurred in relation to capital
expenditures?
24) Enumerate the taxes that are deductible from gross reportable income.
25)What are the requisites for bad debts expense to deductible from gross business income?
26) What are the requisites of a deductible depreciation expense?
27) State the consequences if a vehicle is acquired exceeding P2,400,000 to be used by an employee.
28) State the rules for depreciating properties used in petroleum operations.
29) State the rules for depreciating properties used in mining operations.
30) Explain the allowable tax treatments of exploration and development expenditures.
31) What are two alternatives treatments of capital expenditures incurred by private educational
institution?
32) Distinguish ”defined benefit plan” from “defined contribution plan.”
33)What are the limits for the amount of charitable contributions that could be deducted from gross
business income?
34) Why are contributions to political parties nondeductible from gross income?
35) Explain the tax incentives to adopting private entries according to R.A. 8525.
36) Give the valuation equivalents of assistance or donation as stated in R.A. 8525.
37) Give the allowed tax treated for research and development cost.
38) Enumerate the special deductions from gross income. Discuss their respective tax deductibility
treatment.
 R. Z. Palma 38

Name:________________________________________Score:________________________

Problem 4 – 1 Deductible or Nondeductible

Classify the item whether deductible or nondeductible from business gross income.
1) Depreciation expense of vehicle with an acquisition cost of P2,500,000.
2) Qualified productivity bonuses
3) Salary payments to MWE, without withholding income taxes
4) Define interest on unpaid income taxes
5) Acquisition of land
6) Personal, living or family expenses
7) Donations to political parties
8) Loses on related party transactions
9) Kickback payment to the government to the government official
10) Personal exemptions on corporations
11) Optional standard deduction from compensation income
12) NOLCO within three-year period
13) Tuition fee, Board and lodging incurred by a medical doctor while attending a continuing professional
education seminar
14) De minimis not subjected to withholding taxes
15) Fringe benefits granted to executives subjected to FBT
16) Overtime pay paid to rank-and-file employee
17) Fringe benefits paid to an officer of the company
18) Death benefits granted to employees
19)Nontaxable overtime pay of MWE
20) Distribution of profits to parties
 R. Z. Palma 39

Name:________________________________________Score:________________________

Problem 4 – 2 Deductible or Nondeductible

Classify the item whether deductible or nondeductible from business gross income.
1) Road users’ tax by common carriers

2)Prepaid rent interest

3) Cash dividends paid

4) Donations made to employees’ birthday party

5) Amounts paid for pensions of retired employees

6) Salaries of employee paid to his widow for a limited period after his death

7) Entire amount expanded for meals, lodgings, and travel connection with own business

8) Net capital loss carry-over

9) Philippine income tax

10) Income tax paid by resident citizen to foreign country

11) Research and development cost of unsuccessful development developed products

12) Net operating loss carry-over

13) Compromise penalty

14) Operating expenses incurred outside the Philippines by a nonresident alien engaged in business in
Philippines

15) Donations for coffin and wake expenses

 R. Z. Palma 40

16) Manager’s fixed allowances

17) Cost of technical books used by CPA in the practice of his profession

18) Allowances for doubtful accounts

19) Premium deposits returned to policy holders of life insurance

20) Withholding income tax on employees’ salaries

Problem 4 – 3 True or False

Write True if the statement is correct or False if the statement is incorrect.
1) As a rule, deduction means itemized deduction.

2) Deductions from gross income are not presumed.

3) Revenue expenditures are immediately expensed.

4) Business expense are deductible only if these are incurred in relation to business income taxable in
the Philippines.

5) No business and personal expenses are allowed as deductions from reportable gross income.

6) Optional standard deduction may be allowed as deduction from the gross income of partnerships.

7) The optional standard deduction allowed to individual taxpayer is 40% based on his gross income.

8) The depreciation expense is allowed to be deducted from gross income to two vehicles acquired with
an aggregate acquisition cost of P2,400,000 to be used by one employee.

9) A common carrier business is allowed to deduct depreciation expense even if vehicle used in
operation was acquired exceeding P2,400,000.

10) All business expenses are allowable deductions from gross business income.

11) Individuals taxpayer may opt for itemized deductions or OSD from his business income.

12) Individual taxpayer earnings salary compensation income may deduct optional standard deduction
from their gross compensation income.

13) NOLCO is among those that could be claimed as itemized deduction.

14) A bonus paid to secure a lease is deduction on a pro-rata basis over the term of the lease.

15) A representation expense is subject to limit of 1% of net sales of goods.

 R. Z. Palma 41

Problem 4 – 4 True or False

Write True if the statement is correct or False if the statement is incorrect.
1) Donations to political parties or candidates are deductible from the gross income of the taxpayers-
donor.

2) Special deductions are incentives in addition to the actual regular itemized deductions.

3) The entire amount of salaries discounts based on gross selling price of gross receipts inclusive of VAT
granted to person with disability are deductible from gross income.

4) Sales discounts granted to senior citizens deductible from gross income if the tax payers-self used
OSD.

5) A person with disabilities who is at the same a senior citizen can only claim one 20% discount on a
particular sales transaction.

6) Rooming-in a breast-feeding practices have an incentive special deduction amounting to 100% of the
actual expense incurred.

7) The adopt-a-schooling program is allowed to deduct 150% special deduction.

8) PPHHI is allowed to be deducted from gross income of any of any taxpayer for as long as the amount
does not exceed P2,400 during the taxable year.

9) A corporation with interest expense and at the same time earned interest income during the same
taxable period will be subject to a tax arbitrage of 38%.

10) Straight-line method of depreciation provides at the best tax saving over other allowable
depreciation methods.

11) Adopting private entries of public schools through TESDA can be get 150% of the actual assistance
made.

12) Corporations are allowed to deduct optional standard deduction.

 R. Z. Palma 42

13) Business and professional income derived within outside the Philippines by a nonresident Filipino
Citizen are granted with allowable deductions.

Problem 4 – 5 Multiple Choice

Select the letter that contains the best answer.
1) Which of the following is not allowed to deduction from a VAT registered business income if the
vehicle acquired exceeds P2,400,000 and primarily used in business in business?
a) Depreciation expense
b) Maintenance expense
c) Input taxes related to the acquisition of the vehicle
d) Repairs expense

2) Statement 1: In preparing financial statements, GAAP should prevail over the Ta Code.
Statement 2: In preparing Tax Returns, Tax Code should prevail over GAAP.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

3) Statement 1: Unless the taxpayer signified his return that he is electing the standard deduction, he is
deemed to have availed itemized allowable of deductions
Statement 2: In case of consolidation income tax return of husband and wife, each is allowed to
choose from either or itemized deductions.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

4) Statement 1: Self-employed taxpayer is required to file his quarterly income tax return.
Statement 2: The option to avail of optional standard or itemized deduction could be opted for each …
quarter.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

5) Statement 1: The taxpayer has the burden of justifying the allowance of any deduction deemed
 R. Z. Palma 43

claimed.
Statement 2: Deductions are strictly construed against the taxpayer.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are not correct.

6) Statement 1: Revenue expenditure are period cost that are related to a particular period of time of
business operation.
Statement 2: Capital expenditures are non-recurring expenditures related to acquisition of …
depreciable assets to be used in the business
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

7) Which of the following item is correct as to be deductibility of expense from gross income?
Item Deductible Nondeductible
a) Compromise penalty No Yes
b) Advanced payment of rent expenses Yes Yes
c) Interest on unclaimed salary No No
d) Accrued salary expense No Yes

8) Which of the following items is not included as entertainment, amusement and recreation expense of
a business?
a) Depreciation or rental of entertainment facilities
b) Amusement and recreation expenses
c) Expenses incurred in accommodating company guests
d) Fixed representations allowances of key offices subject to WTW

9) Which of the following taxes incurred in the conduct of business is not allowed as deduction from
business income?
a) Foreign income tax claimed as tax credit
b) Documentary stamp tax
c) Import duties
d) Local business taxes

10) Which of the following statement is incorrect?

a) Personal expenses are not allowed as deductions from compensation, profession, trade or business
income.
b) Personal expenses are not allowed as deductions from profession, trade or business income except
compensation income.
c) Personal exemption and additional exemption are allowed as deduction from compensation income.
d) All of the above
 R. Z. Palma 44

Problem 4 – 6 Multiple Choice

Select the letter that contains the best answer.

1) Which of the following cannot be deductions as business expense?

a) Donations made to employees.
b) Entire amount expanded for meals, lodging and travel in connection with own business.
c) Tuition fees, board, and lodging incurred by a medical doctor while attending a continuing a
professional educational seminar.
d) Cost of technical books used by a CPA in the practice of his profession.

2) Which of the following is not allowed as deductible in full from gross income?
a) Interest expense paid by the bank.
b) Interest expense paid by the taxpayer in relation in to the purchase of merchandise on installment.
c) Interest expense paid to relative of the taxpayer.
d) Interest expense withy reported interest income.

3) Which of the following taxes incurred in the conduct of business is allowed as deduction from
business income?
a) Income tax
b) VAT
c) Community tax
d) Withholding on wages of employees

4) Which of the following expenses of the business would be allowed deduction from its business
income?
a) Insurance premium on life insurance of employee where the employer is the beneficiary
b) Donation made to employees
c) Losses incurred on transactions with related party
d) Regular repairs of business property

5) The following taxes are not allowed as deductions from reportable gross income, except
a) Value-added tax.
b) Stock transaction tax.
c) Capital gains tax.
 R. Z. Palma 45

d) Documentary stamp tax

6) Which of the following is classified as deductible loss?

a) Allowance for bad debts
b) Embezzlement
c) Depreciation
d) All of the above

7) Which of the following income is allowed to be reduced with itemized deductions?

a) Compensation income
b) Business income
c) Passive income
d) Capital gain

8) Statement 1: Compensation income is allowed to be reduced with personal exemption.

Statement 2: All business income is allowed to be reduced with business expenses, and with excess of
personal exemption over compensation income.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

9) Statement 1: An individual taxpayer could claim both the itemized deduction and personalized
exemption in the same taxable year.
Statement 2: An individual single proprietor could claim both the itemized deduction and optional
standard deduction in the same taxable year
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

10) Which of the following is allowed with optional standard deductions?

a) Nonresident alien doing business in the Philippines
b) Resident Citizen whose taxable income is his compensation earned
c) Nonresident citizen claiming itemized deductions from his business income outside the Philippines
d) Resident alien with business income earned within and outside the Philippines

11) Statement 1: Insurance expense incurred in connection with the conduct of business is allowable
Statement 2: Insurance premium incurred to cover the file of key employee where the employer is
the beneficiary could be allowed as deduction.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
 R. Z. Palma 46

d) Both Statements are incorrect.

Problem 4 – 7 Multiple Choice

Select the letter that contains the best answer.

1) Which of the following is not a requisite for the deductible contributions?

a) It must be incurred in connection with the conduct of business.
b) The taxpayer making contribution must be engaged in business or profession.
c) There must be actual payment of contribution or gift.
d) The recipient of the contribution is an entity specified by law.

2) Statement 1: The optional standard deduction allowed to all individual taxpayers earning business
income.
Statement 2: The optional standard deduction is 10% of gross business income.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

3) Statement 1: Husband and wife may report their income and expenses in the same or common
tax return.
Statement 2: Husband may choose itemized deduction while the wife may choose optional standard
deduction or vice versa.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

4) Which of the following statement is correct?

a) Actual receivable written off in connection with the conduct of business are allowed as deduction.
b) Estimated bad debts based on account receivable balance is deductible.
c) Bad debts written off are deductible in the year when the allowance based on estimate was made.
d) Bad debts arising from unpaid salaries that are actually written-off are deductible in the year of
written off.
 R. Z. Palma 47

5) Which of the following is not correct?

a) Depreciation of assets used in business is allowed as deduction from business income.
b) Depreciation as recovery of capital invested should not be beyond the acquisition cost.
c) Depreciation should be determined on the basis of re-appraised value if revaluation is made.
d) Straight-line method, SYD, and declining balance methods of depreciation are all allowed for
claiming depreciation expense.

6) Which of the following statement is correct?

a) The employer making the contribution manages defined contribution plan.
b) The actual payment of benefits to employee is the expense of the employer under the defined
contribution plan.
c) Under defined benefit plan, the employer normally makes the actual payment of benefit to
employees.
d) Under defined contribution plan, the amount of contribution is equal to the payment of the benefits
due to the retiring employee.
7) Statement 1: Deductible business expenses must be ordinary and necessary.
Statement 2: Expenses from previous period which were not from previous period’s income could be
deducted from income in the current period.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

8) Which of the following expenses incurred in relation to the conduct of business could be deducted in
full, if the net sale is P1,000,000?
i. Salaries of employees, net of withholding tax
ii. P60,000 rent expense
iii. P50,000 traveling expense
iv. P10,000 entertainment expense

Choices:
a) i, ii, iii and iv
b) i, ii, and iii only
c) i, and ii only
d) i only

9) Which of the following interest expense is deducted in full?

a) Interest on tax delinquency
b) Interest on personal loan
c) Interest expense which is 200% of the interest income for the same year
d) Interest paid in advance

10) Which of the following is deductible as bad debts?

a) Bad debts which is estimated at 1% of net sale
b) Bad debts based on allowance of 1% of accounts receivable
c) Accounts receivable written off
d) Accounts receivable recovered
 R. Z. Palma 48

Problem 4 – 8 Multiple Choice

Select the letter that contains the best answer.

1) Which of the following statements is correct?

a) All contributions of person engaged in business are deductible.
b) All deductible contributions are deductible at their actual amount contributed.
c) Contributions to the government for priority program are deductible only up to 10% if being claimed
by single proprietorship.
d) Contributions by a domestic corporation to the government for general purposes is subject to 5% of
the income after itemized deductions before contribution.

2) Statement 1: Gains arising from transactions between related taxpayers are taxable.
Statement 2: Losses incurred from transaction between members of the family are not deductible
from business income.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

3) Statement 1: The amount of deductible taxes is limited to the basic tax and shall not include the
amount for any surcharges or penalty.
Statement 2: Interest on delinquent taxes is deductible from gross business income in full amount.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

4) Which of the following will be an appropriate deductible expense for the exhaustion of intangible
asset of wasting asset corporation?
a) Depreciation expense
b) Amortization expense
c) Depletion expense
 R. Z. Palma 49

d) Exploration expense

5) Statement 1: Research and development cost may be reported as deferred expense

Statement 2: Research and development cost be charged to property subject to depreciation or
depletion.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

6) Statement 1: Under the defined contribution plan, the pension expense of the employer is equal to
the agreed amount of periodic contribution.
Statement 2: Under the defined benefit plan, the pension expenses of the employer is equal to the
pension liability for the current year services plus the amortization of past years’ services.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

7) Statement 1: The charitable contribution must be connected in the conduct of business to be allowed
as deduction.
Statement 2: The charitable contribution must be as deduction from business income but not allowed
as deduction from compensation income.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both Statements are correct.
d) Both Statements are incorrect.

8) If the contribution is subject to limit, the allowable amount as deduction should be limited to
a) 5% of the business income after itemized deduction but before contribution of individual taxpayer.
b) 10% of the business income after itemized deduction and contribution of individual taxpayer.
c) 5% of the business income after itemized deduction but before contribution of corporate taxpayer.
d)10% of the business income after itemized deduction and contribution of contribution of corporate
taxpayer.

9) The amount allowed as deduction for assistance directly and exclusive incurred for the program
coordinated with DECS is
a) 50% of the actual value of the assistance
b) 100%of the actual value of the assistance
c) 150%of the actual value of the assistance
d) 200%of the actual value of the assistance

10) Statement 1: Premium payment on health and hospitalization insurance is a special itemized
deduction
Statement 2: All Charitable contributions to educational project of the government can be deducted
in full amount plus a special itemized deduction of 50%.
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
 R. Z. Palma 50

c) Both Statements are correct.

d) Both Statements are not correct.

Problem 4 – 9 Revenue vs. Capital Expenditures

D Trucking incurred the following additional expenditures in maintaining its delivery trucks:
Cost of truck’s new differential P50,000 c
Cost of overhauling materials 30,000 c
Cost of body repair and paint in repairing truck body 10,000 c
Total labor cost incurred in overhauling 10,000 c
Cost of regular changing of motor oil 1,250 e
The amounts to be immediately expensed and capitalized are
Expensed Capitalized
a) P90,000 P10,000
b) P11,250 P88,750
c) P100,000 P90,000
d) P 1,250x P100,000x

Problem 4 – 10 Revenue vs. Capital Expenditures

ABC Store incurred additional expenditures of P130,000 for its business fixed assets as follows:
Installation of new air condition, an improvement P60,000 c
Periodic cleaning of air conditioners 8,000 e
Expansion of store to accommodate additional items 50,000 c
Damages paid due to workers’ injury 20,000 e
Periodic painting of the store as regular maintenance 10,000 e
Cleaning of computers 9,000 e
Repair of furniture 1,000 e

The amounts to be immediately expensed and capitalized would be

Expensed Capitalized
a) P –O--- P158,000
b) P30,000 P128,000
c) P48,000 P110,000
d) P80,000 P 70,000

Problem 4 – 11 Situs of Expenses

 R. Z. Palma 51

Mr. Smith, a nonresident alien, who is engaged in business in the Philippines, presented the following
incomes and expenditures during the taxable year:
Philippines Australia
Gross Income P1,000,000 P4,000,000
Operating expenses 400,000 2,200,000

In additional, Mr. Smith presented P200,000 operating expenses which cannot properly be identified
whether or not incurred in the Philippines.

How much is the amount of the allowable operating expenses for Philippine income tax purposes?
a) P600,000 c) P450,000
b) P440,000x d) P400,000

Problem 4 – 12 Items Not deductible

Mr. Fonda, an entrepreneur, submitted the following expenses during the taxable year:
Personal expenses P 20,000 ND
Family expenses 150,000 ND
Renovation of his house 200,000 ND
Loss on sale of personal car 30,000 ND
Worker’s insurance premium (beneficiary, Mr. Fonda) 5,000 ND
Worker’s salary 60,000 D
Bad debts on money lend to his brother 20,000 ND

How much is the amount of total expenses deductible from his business gross income?
a) P60,000 X c) P80,000
b) P65,000 d) P85,000

Problem 4 – 13 Items Not deductible

Mr. Wallang, a businessman, submitted the following business expenses and losses during the taxable
year:
Salary of employees P120,000 D
Police protection 20,000 ND
Interest expense paid to his father 10,000 ND
Gifts made to employees during birth day 5,000 ND
Capital loss 4,000 D

How much is the amount of nondeductible expenses and losses from gross income?
a) P14,000 c) P35,000X
b) P29,000 d) P39,000

Problem 4 – 14 Deduction From Business Income

Mr. Bago incurred the following expenses and losses during the year:
Family expenses P 240,000 ND
Cost of family home, life 25 years (40% used in business) 1,000,000 16,000 D
 R. Z. Palma 52

Life insurance expense of his maid, the beneficiary is Mr. Bago 10,000 ND
Loss from sale of land to his brother 100,000 ND
Police protection 12,000 ND
Loss of business equipment reported to the BIR 38,000 D

The deductible expenses and losses from Mr. Bago’s business income is
a) P164,000 c) P60,000
b) P154,000 d) P54,000 X

Problem 4 – 15 Deductible from Gross Income

Mr. Apo Linar, married, works as a supervisor of Golden Construction receiving P240,000 as his annual
gross compensation income. He maintains a small consulting firm that earns P120,000 a year. He
incurred the following expenses during the year:

Premium payments of his life insurance P 25,000 ND

Depreciation of his house (10% is used as office for his firm) 20,000 2,000 D
Repair of his house (10% used as office for his firm) 100,000 10,000 D
Interest expense paid to his brother 10,000 ND
Office supplies used 6,000 D
Donation to the burial of his friend 5,000 ND

1) From the items above, how much is the total deduction from gross compensation income of Linar?
a) P – O -- x c) P20,000
b) P18,000 d) P25,000

2) From items above, how much is the total deduction from professional gross income of Linar?
a) P – O -- c) P20,000
b) P18,000 X d) P25,000

Problem 4 – 16 Tax Laws vs. GAAP

During the year, A Co. reported the following business expenses:
Salary expense, net of withholding tax of P20,000 P180,000 200,000 D
Estimated uncollectible accounts 10,000 ND
Depreciation expense 50,000 D
Compromise penalty expense 30,000 ND
Miscellaneous expense 5,000 ND

The miscellaneous expense was incurred but not reported last year. The deductible business expense
from a company’s earnings would be
Tax Laws GAAP
a) P205,000 P205,000
b) P230,000 P295,000
c) P250,000X P295,000X
d) P280,000 P295,000
 R. Z. Palma 53

Problem 4 – 17 OSD of Sales (Individuals) HW starting to 4-50 for friday

Miss Dianne Torres showed the following income and expenses during the year:
Compensation income as a teacher P250,000
Sales of wagwag business 300,000
Cost of sales 80,000
Operating expenses (without documentations) 50,000

How much is deductible cost of sales and operating expense if Dianne opted to deduct OSD?
Cost of sale Operating expense
a) P – O -- P120,000x
b) P 80,000 P120,000
c) P 80,000 P 88,000
d) P130,000 P 50,000

Problem 4 – 18 OSD of Gross Receipts (Individuals)

Mr. Lito Pusalang provides the following data:
Gross receipts from profession P100,000 GR
Rent income, net of withholding tax of 5% 475,000 GR = 500,000
Interest income from Metro Bank 40,000
Dividend income from San Miguel Corporation 10,000
Operating expenses without receipts 40,000
Compensation income 300,000

How much is the optional standard deduction?

a) P316,000 c) P230,000
b) P240,000 X d) P220,000

Problem 4 – 19 OSD (Nonresident Alien)

Teno Lang, a nonresident Chinese national engaged in business in the Philippines, reported the following
Philippine income and expenses during the year:
Sales P1,000,000
Cost of sales 300,000
Gross income P 700,000
Less: Operating expenses 500,000
Net income P 200,000
=========
There are no official receipt and documents to support his operating expenses. There is no reciprocity
law in his country to provide tax exemption to Filipino citizen. How much is the amount of the allowable
Deduction from the gross income of Teno Lang id he opted to deduct OSD because he cannot
substantiate with receipts his operating expenses?
a) P550,000 c) P330,000
b) P450,000 d) P – O --

Problem 4 – 20 OSD (Individual vs. Corporation)

T reported the following for the period:
 R. Z. Palma 54

Sales P1,000,000
Cost of sales 300,000
Operating expenses 100,000

Compute the OSD assuming that T is a (a) sole proprietor, or (b) Corporation
Sole
Proprietor Corporation
a) P400,000 P280,000
b) P400,000 P580,000
c) P360,000 P200,000
d) P280,000 P280,000

Problem 4 – 21 Itemized Deductions

Maharlika Corporation reported the following information:
Sales P20,000,000
Cost of sales 16,000,000
Operating expense, inclusive of representation expense amounting to P300,000
with proper documentations 2,000,000

The amount of the allowable regular itemized deductions is

a) P2,000,000 c) P1,700,000 e. None of these
b) P1,800,000 x d) P 400,000

Problem 4 – 22 Itemized Deductions x

Pasarado Corporation showed the following data during the taxable year:
Sales P500,000
Interest income, net of 20% final tax 24,000 passive income
Cost of sales 300,000
Salary expense 120,000
Interest expense 60,000 – (30,000 x 33%) 9,900= 50,100
Rent expense 24,000
Advertising expense 6,000
Depreciation expense 5,000

NOLCO 50,000

Note: NOLCO – net operating loss carry over

How much is the amount of regular itemized deduction?

a) P202,400 c) P252,400 e) 215,000
b) P205,100 x d) P265,000

Problem 4 – 23 Itemized Deductions vs. OSD x

 R. Z. Palma 55

Naly Lito, a resident Filipino sole proprietor, reported the following sales and expenses during the taxable
year:
Sales P1,200,000
Cost of sales with documentations 700,000
Gross income 500,000
Itemized deductions with no official receipts 200,000

Naly contemplates to avail of OSD because the itemized if cannot be supported by official receipts.

How much is the amount of deductible if she avails of OSD?

a) P480,000 x c) P220,000
b) P280,000 d) P220,000

Problem 4 – 24 Salary Expense

Phoenix Corporation paid the following salaries and fringe benefits to its officers and employees for
200B:
Gross salaries, employees P6,000,000
Less: Withholding income tax P 400,000
SSS premium 200,000
Advances 100,000 700,000
Net amount of payment P5,300,000
Grossed-up fringe for officers P1,000,000
Less: Final tax paid on fringe benefit payment*
(P680,000/ 68%) x 32% 320,000 680,000
Total cash payment for sales and fringe benefits P5,980,000
========
The total amount of allowable salary and fringe benefits expenses that could be claimed by Phoenix
Corporation would be
a) P7,000,000 c) P5,980,000
b) P6,000,000 d) P5,300,000

Problem 4 – 25 Deductible Bonus

In 200B, a domestic corporation, using the calendar period, had a net income of P75,000 after deducting
in full charitable contribution of P5,000 which is subject to limitation but before deducting bonus given
key officials and before 30% basic income tax. Bonus is 15% of the income before the bonus and after
the basic income tax. What is the amount of deductible bonus?
a) P7,067 c) P8,356
b) P7,752 d) P8,400

Problem 4 – 26 Compensation for Injuries and Pensions

While working, A, one of X Construction Co.’s workers, died by falling from 10 th floor of the building. The
company helped the worker’s family with following:
Monthly salary P 5,000
Death benefits 50,000
 R. Z. Palma 56

Terminal pay 25,000

Funeral expense 10,000
Continuous compensation after the burial for three months 15,000

Problem 4 – 27 Materials and Supplies x

C Co. reported the following data regarding its materials and supplies:
Materials Supplies
Beginning inventory P100,000 P20,000
Purchases 300,000 40,000
Increase (decrease) in inventory ( 20,000) 3,000

Beginning inventory 100,000 20,000

+ Purchases 300,000 40,000
= Total available for sale / use 400,000 60,000
Minus inventory end (80,000) (23,000)
= materials and supplies expense 320,000 37,000

How much is the amount of inventoriable cost and supplies expense?

Inventoriable cost Supplies expense
a) P400,000 P63,000
b) P380,000 P60,000
c) P320,000 x P37,000 x
d) P300,000 P40,000

Problem 4 – 28 Traveling Expenses

A Corporation incurs the following travel expenses:
(1) Plane tickets and hotel bills of its officers who were sent to business seminars:
In Davao P 50,000
In Taiwan 200,000
(2) Transportation expenses of its officers from home to office and vice versa as part to their
employment contact, P68,000 on which final tax of P32,000 was remitted. Transportation expenses of
of messengers from office to several clients’ places at P40,000, inclusive of meals amounting to P25,000.

How much is total allowable traveling expense that could be claimed by

a) P250,000 c) P350,000
b) P318,000 d) P390,000

Problem 4 – 29 Rent Expense

On October 31,200B, A acquired of lease with Tabora Builders regarding a space with the stipulations
that A should be responsible in paying the following:
Monthly rent P20,000
Share in annual nonlife insurance premium 3,000
Share in annual real property tax 1,500
Share in annual city services 24,000

If uses 60% of space for business and the remaining 40% for residence, how much is deductible rent
 R. Z. Palma 57

expense to be reported by A for the year ending December 31,200B?

a) P24,450 c) P26,850 x
b) P26,700 d) P44,750

Solution:
Rental for 2 months 40,000 x 60% 24,0000
Annual additional expense:
Insurance – 3,000
Real prop – 1,500
City service 24,000
Total 28,500 x 2/12 x60% 2,850
Total rent expense for 2 months deductible 26,850

Problem 4 – 30 Prepaid Rent

On June 30, 200B, G rents an apartment for P20,000 and subsequent sublease 80% of the apartment to
CPA reviewees for P25,000 a month beginning July 31, 200B. G’s records show the following rental
collections and payments during the year:
Total payments P 80,000
Total collections 150,000

1) How much is the deductible rent expense for the year?

a) P140,000 c) P96,000
b) P120,000 d)P80,000

2) How much is the taxable rent income for the year

a) P 80,000 c) P120,000
b) P100,000 d) P150,000

Problem 4 – 31 Leasehold Improvement

R signed an 8-year lease contract to occupy a vacant to for P2,000 a month. As a part of the lease
agreement, R constructed a restaurant building costing P600,000 completed at the start of the contract.
The building has an estimate life of 10 years. At the end of the lease contract, the landlord will own the
building.

The monthly deductible expense from the above contract would be

a) P2,000 c) P7,000
b) P6,250 d) P8,250 x 2,000 + 6,250 = 8,250

Problem 4 – 32 Leasehold Improvement

On August 1,2019, T Foods signed a 10-year lease contract to occupy a vacant lot for P5,000 a month. As
a part of the lease agreement, T foods constructed a restaurant building costing P950,000. The building
was completed and immediately used on January 31, 2020. The building has an estimate life 15 years
with a salvage value of P50,000. At the end of lease contract, the landlord will own the building.
 R. Z. Palma 58

Cost of the building P950,000

Depreciation expense per year = -------------------------------------------= 100,000
Useful life or lease contract whichever is shorter 9.5 years

Depreciation for 11 months = 100,000 x 11/12 = 91,667 + 60,000 = 151,667

The related deductible expenses of T in 2020 from the above contract would be
a) P142,500 c) P151,667 x
b) P150,000 d) P154,737

Problem 4 – 33 Representation Expense

A business reported a total net revenue of P5,000,000. The actual entertainment and representation
expenses incurred connection with the conduct of business amounting to P30,000.
1) If the business is a trading business, the deductible amount of representation and entertainment
expenses is
a) P 5,000 c) P30,000
b) P25,000 d) P50,000
2) If the business is a service business, the deductible amount of representation and entertainment
expenses is
a) P 5,000 c) P30,000
b) P25,000 d) P50,000

Problem 4 – 34 Representation Expense

Compairs, a sole proprietor, is engaged in computer sales and computer repairs, reported the following
Income and expenses during the year:
Net sales P700,000
Net repairs revenue 300,000
Cost of sales 500,000
Cost of service 80,000
Salaries expense 90,000
Rent expense 60,000
Representation expense 10,000
How much is the deductible representation expense?
a) P5,000 c) P 7,500
b) P6,500 d) P10,000

Problem 4 – 35 Interest Expense

A corporation earned income, inclusive of P50,000 interest income and net of interest expense of
P40,000, amounting to P1,500,000.

The deductible interest expense would be

a) P23,500 c) P16,800
b) P19,000 d) P – O --

Problem 4 – 36 Special Itemized Deductions

Care Medical Center reported the following expenses during the year:
 R. Z. Palma 59

Breast-feeding assistance to the needy P200,000

Salary of workers (20% senior citizens) 500,000

If the medical center reported health services revenue amounting P300,000 from senior citizen, how
much is the total special itemized deduction?
a) P275,000 c) P315,000
b) P300,000 d) P360,000

Problem 4 – 37 Deductible vs. Nondeductible Interest Expense

Mr. Tee a Taxpayer reporting in cash basis, showed the following interest expense related to his business
during the year:
Interest paid in a bank loan P20,000
Interest paid to brother 12,000
Interest paid on delinquency taxes 8,000
Interest on borrowings to finance his family home 30,000
Interest paid to finance petroleum exploration 100,000

If Mr. Tee has an interest income of P10,000 earned from the bank, and P20,000 interest income from
trade notes receivable, how much is the deduction interest expense during the year:
Deductible Nondeductible
a) P28,000 P142,000
b) P 8,000 P162,000
c) P 4,200 P165,800
d) P – O -- P170,000

Problem 4 – 38 Nondeductible Interest and Itemized Deductions

Gibo Manpower Services, a domestic corporation, reports the following incomes and expenses during
a taxable year:
Gross receipts P1,000,000
Interest income, net of 20% final tax 40,000
Salaries 600,000
Rent expense 200,000
Interest expense on unpaid salaries 60,000
Payment of bank loan balance, including interest expense of P40,000. 400,000

If Gibo opted to use itemized deductions, how much is the amount of nondeductible interest expense
and total amount of itemized deductions allowed to reduce business gross receipt?

Nondeductible Itemized
Itemized expense deductions
a) P79,000 P921,000
b) P76,500 P832,000
c) P60,000 P840,000
d) P19,000 P281,000

Problem 4 – 39 Tax Arbitrage

 R. Z. Palma 60

Ajoy Co., a domestic corporation, has average annual business income of P1,000,000 and an annual
average allowed operating expenses of P500,000 it has acquired a loan of P1,000,000 with interest
expense of 10% per year, and invested the same in a time deposit that earns 12% per year.

If there is no limitation on the deductibility of the interest expense, how much is the actual net tax
saving of Ajoy?
a) P12,000 c) P11,000
b) P11,880 d) P 6,000

Problem 4 – 40 Tax Expenses

Care Corporation incurred the following taxes during the taxable year:
Documentary stamp taxes P 1,000
Income taxes paid in favor of rank-officers (as fringe benefit) 13,600
Income taxes paid in favor of rank-in-file employees (as fringe benefit) 22,400
Local taxes, including surcharge of P800 and interest of P200 6,000
Philippine income tax 100,000
Municipal tax 2,000
Community tax 1,500
Value-added tax 90,000
Compromise penalty on taxes 50,000

The amount of taxes deductible from gross income of Care Corporation would be
a) P 9,500 c) P46,500
b) P45,500 d) P51,900

Problem 4 – 41 Tax Expenses

The following tax expenses related to business were paid by X Trading during the taxable year:
Business taxes other than VAT P 20,000
Documentary stamp taxes 1,000
Automobile registration fees (business use) 3,000
Import duty taxes 50,000
Postage stamp taxes 500
Stock transaction tax 2,500
Income tax 600,000
Value-added tax 240,000
Donor’s tax 5,000

How much is the amount of taxes deductible from gross income?

a) P73,000 c) P74,500
b) P73,500 d) P76,000

Problem 4 – 42 Tax Credit Paid to Foreign Country

Balong is a resident citizen with earnings within and outside the Philippines. His financial records
during the taxable year show the following:
Business income within and without P520,000
Business expenses within and without 200,000
 R. Z. Palma 61

The business expense includes P10,000 representing income tax payment made in foreign country.

If his personal exemption is P50,000, how much is the correct net taxable income to avail better tax
savings?
a) P320,000 c) P300,000
b) P310,000 d) P280,000

Problem 4 – 43 Bad Debt Expense

Fran Corporation has P100,000 collectibles from Oliva who became insolvent with P60,000 assets and
P200,000 liabilities of which 50% is an income tax liability.

How much is the deductible bad debts Fran Corporation?

a) P100,000 c) P30,000
b) P 40,000 d) P15,000

Problem 4 – 44 Bad Debts Expense

Mr. So reports the following bad debts as deductions from gross income for the year 200B:
Bad debts expense from business P200,000
Bad debts expense from practice of profession 50,000
Uncollectible salary 20,000
Uncollectible money lend to brother for operation 10,000
Total bad debts claimed P280,000
=======
Upon investigation, the following are gathered from the records of Mr. So:
1) Bad debts from business:
From insolvent customer with solvent guarantor P100,000
From other customers without guarantor (60% are estimated
collectible and 40% are actually written off during the year) 100,000
Total P200,000
=======
2) 100% of bad debts from profession are actually written off during the year
3) Uncollectible salary was due to employer’s bankruptcy.
4) Brother died from operation and could not pay anymore
How much is the deductible bad debts expense of Mr. So?
a) P50,000 c) P200,000
b) P90,000 d) P250,000

Problem 4 – 45 Depreciation Expense

On June 30,200B, the business acquired on equipment for P50,000. This depreciated over 5 years
serviceable life with a salvage value of P5,000.

The depreciation expense for 200B is

a) P10,000 c) P5,000
b) P 9,000 d) P4,500

Problem 4 – 46 Depreciation Expense

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In January 1,200B, Top Gun Inc., leased a portion of commercial lot owned by Nevada Co. for 12 years for
a monthly rent of P10,000.

The lessee constructed a building improvement amounting to P2,300,000 which h was completed on
July 1,200B. The building has an estimated life of 20 years. The improvement was eventually used in the
business on October 1,200B.

The 200B depreciation expense of Top Gun is

a) P100,000 c) P200,000
b) P191,667 d) P204,444

Problem 4 – 47 Depreciation Expense

Some of the actual financial operating expenses were deducted by Luzon Manufacturers, a sole
proprietorship that started business operation in 2013:
Depreciation expense:
2013 newly purchased car used by the manager
(Straight – line depreciation for 10 years) P 250,000
Maintenance expenses of 2013 newly purchased car 40,000
Actual pension contribution – BIR proved plan 500,000
Bad debts expense – written off 100,000
Salaries of senior citizens 200,000
Compromise penalty – BIR 10,000
Total P1,100,000
========
The pension plan’s normal computer is P400,000. The P100,000 receivable written – off is traced to the
client which was already declared bankrupt by the Court. The client has P1,000,000 total assets with
total liabilities P2,500,000. Employing the provision of Rev. Regs. No. 12 – 2012 regarding depreciation,
how much is the total overstated amount of financial operating expenses over itemized deductions for
the taxable year 2013?
a) P120,000 c) P360,000
b) P320,000 d) P400,000

Problem 4 – 48 Depreciation Expense

Zamba Oil’s fixed assets that are used in petroleum operations are as follows:
Estimation useful life Acquisition cost
Land
Oil drilling machine
Oil extracting machine
Computers (Office)
Delivery truck

If all depreciation assets have a salvage value of 10%, how much is the annual depreciation?
a) P270,000 c) P235,000
b) P250,000 d) P229,500

Problem 4 – 49 Depreciation Expense

 R. Z. Palma 63

Golden Ore acquired a mining property for P6,000,000 believed to have an estimated gold ore deposit of
5,000,000 tons. Its estimated that the property has a salvage value of P1,000,000 after P300,000
restoration cost.

If Gold Ore was able to produce 800,000 800,000 tons of gold ore, how much is the deductible deplition
expense?
a) P752,000 c) P848,000
b) P800,000 d) P960,000

Problem 4 – 50 Exploration and Development Expenditures

Benget Mining Co. reported the following data for 200x:
January 1, 200X depletion cost P12,500,000
January 1, 200X probable reserves 5,000,000 units
Mining cost P 2,000,000
Milling cost 3,000,000
Marketing expenses 1,500,000
Depreciation expense 1,000,000
Exploration costs 1,000,000
Intangible development cost 1,500,000

Other information during 200x:

(a) Additional probable reserves were determined to be 2,500,000 units.
(b) Actual production was 1,200,000 units.
(c) Selling price per unit is P12.

1) The new depletion rate if the additional exploration and development cost will be part of the
adjustment on depletion rate would be
a) P3.00 c) P2.38
b) P2.50 d) P2.00

2) The depletion cost for the year 200x using assumption 1 is

a) P2,400,000 c) P3,000,000
b) P2,856,000 d) P3,600,000

3) If the additional exploration and development cost are to be treated as direct deduction from the
taxable income, how much would be the allowable amount for 200x?
a) P2,500,000 c) P1,000,000
b) P1,725,000 d) P 625,000
4) Taking option 1, direct deduction from gross income, what amount of exploration and development
costs would be charged to succeeding years?
a) P625,000 c) P1,000,000
b) P775,000 d) P2,500,000

Problem 4 – 51 Capital Expenses of Educational Institution

In 200x, Benget University, a private educational institution, constructed a building with a contract price
of P10,000,000. The building has an estimated useful life of 50 years with a salvage value of 10%. How
much is the deductible expense allowed to Benget University for the year 200x under the two options?
 R. Z. Palma 64

Capitalized Outright expense

a) P 200,000 P 9,000,000
b) P 180,000 P10,000,000
c) P10,000,000 P 200,000
d) P 9,000,000 P 180,000

Problem 4 – 52 Retirement Expense

Cordillera University’s books of accounts reveal the following contributions for this retirement plan for
the years 200A, 200B and 200C.

200A 200B 200C

Actual contribution P1,000,000 P 900,000 P 500,000
Normal (actuarian) valuation 800,000 800,000 800,000

Actual retirement payments made were as follows:

200A 200B 200C
Actual retirement payments -- O -- P 400,000 P 300,000
1) If the retirement plan is BIR-registered, how much is the deductible retired expense for year 200C?
a) P300,000 c) P800,000
b) P530,000 d) P830,000
2) If the retirement plan is NOT BIR-registered, how much is the deductible retirement expense for year
200C?
a) P300,000 c) P800,000
b) P530,000 d) P – O --

Problem 4 – 53 Retirement Expense

X Co., maintains a BIR-registered defined benefit retirement plan. The company’s normal cost funding is
P700,000 and P670,000 for the year X and year Y, respectively. The following are expenses related to the
retirement plan:
Year X Year Y
Benefit expense for accounting purposes P750,000 P900,000
Actual contribution 800,000 600,000

How much retirement expense is deductible for year Y?

a) P610,000 c) P680,000
b) P670,000 d P900,000

Problem 4 – 54 Deductible Contribution Expense

What would be the allowable deduction for P15,000 contribution made by domestic corporation to a
religious organization from its P200,000 net income before contribution?
a) P 9,250 c) P10,750
b) P10,000 d) P15,000

Problem 4 – 55 Deductible Contribution Expense

What would be the allowable deduction for P5,000 contribution made by a resident citizen to an
 R. Z. Palma 65

accredited social welfare organization, from his P60,000 net income after contribution?
a) P6,000 c) P5,000
b) P5,500 d) P6,500

Problem 4 – 56 Deductible Contribution Expense

A domestic corporation made a P20,000 contribution to an accredited social welfare institution. Its
business income for 200A is P500,000. The related business expense inclusive of the P20,000
contribution is P150,000. The allowable deduction for charitable contribution would be
a) P17,500 c) P20,000
b) P18,500 d) P24,000

Problem 4 – 57 PPHHI
How much is the deductible amount of PPHHI if the amount paid is P3,000 during the taxable year by the
a resident alien and his total family. The payment for PPHHI was made in month of December of the
current year of the taxable year.
a) P 200 c) P3,000
b) P2,400 d) P2,000

Problem 4 – 58 PPHHI
Mr. Tyrone Velasquez has a total salary of P180,000, Mrs. Girlie Velasquez has P120,000 income for the
year, both earned from employment in the Philippines.

They paid P150 per month health insurance policy for the months of June to December 200X.
Mr. Velasquez as head of the family could claim special allowable itemized deduction for these payments
equal to
a) P 900 c) P2,400
b) P1,800 d) P – O --

Problem 4 – 59 Tax Incentives to Adopting Private Entities

X signed a MOA with Department of Education for Supply of books to Irisan National High School valued
at P1,000,000 for free. During the same year, X reported a business income of P31,500,000 and business
expenses of P22,500,000 before the amount of donation per MOA.

The deductible donation of X is

a) P675,000, if X is a corporation and the donation is the priority program of the government.
b) P1,350,000, if X is single proprietor and the donation is for the priority program of the Government.
c) P1,500,000, if X is a general co-partnership and the donation is for the priority program of the
Government.
d) P75,000, if X a is a sole proprietorship and the donation is not part of the priority program of the
Government.

Problem 4 – 60 OSD and NOLCO

X Co. reported the following income and expenses for the calendar year:
Sales P5,000,000
Cost of sales 2,000,000
Operating expenses during the year 1,000,000
NOLCO 500,000
 R. Z. Palma 66

Divided income from domestic corporation 60,000

Interest income, net of final tax 40,000

Only 30% of the operating expenses can be sustained with official receipts. Included in the operating
expenses is P50,000 interest expense.
Required:
1) Total deductible expenses using itemized deduction
2) Total deductible expenses using OSD
3) Net taxable income using the amount that provides tax advantage

Problem 4 – 61 Allowable Deductions

Mr. Joker Aroyo, widower with three (3) qualified dependent children and a practicing accountant has
the following receipt and expenditures for the calendar year ended December 31,200X:
Receipts:
Professional fees P500,000
Allowance as director of Corporation A 25,000
Interest on time and savings deposits, and net of 20% final tax 16,000
Commissions 5,000
Expenditures:
Salaries of assistance P 96,000
Partial payments to loan 20,000
Interest on loan ( The loan was used for repair of the residential house of Mr. Arroyo) 3,850
Traveling expenses 11,000
Light and water, Office 7,890
Light and water, Residence 6,500
Stationeries and supplies 1,960
Office rent 60,000
Contributions exclusively for religious purposes 38,500

Required: Compute for the allowable deductions from the business gross income

Problem 4 – 62 Total Allowable Deductions

Love Enterprises incurred the following business expenses in the taxable year 200X:

a) Allowance per aging of accounts receivable at the beginning and ending of year are P20,000 and
30,000 respectively. The firm’s provisions for bad debts during the year is P15,000.

b)Accumulated depreciation on machine at the beginning id P100,000 but the year P110,000. During the
year, the firm sold a machine with a cost of P300,000 and an accumulated depreciation of P30,000 and
purchase at the end of the year a new machine worth P400,000 with better capability.

c) Research and development cost of P500,000 treated as deferred expense.

d) Contribution during the year are as follows:

To the government for priority program in sports P 50,000
To the government for public purposes 10,000
To the accredited NGO’s total administrative expenses is 35% 110,000
To the church of Bagiuo 60,000
 R. Z. Palma 67

Net income before contribution 2,500,000

Required: Compute the total allowable deductions of Love Enterprises assuming that the firm is
1)Sole proprietorship.
b) Corporation.
c) Partnership.

Problem 4 – 63 Retirement Expense

X Corporation maintains a BIR-registered benefit retirement plan. The company’s normal cost per
actuarial valuation for funding is P1,000,000 and P1,200,000 for years 200A and 200B, respectively.

The following are expenses related to the retirement plan:

200A 200B
Retirement benefit expense (Recognized for accounting purposes) P1,100,000 P1,200,000
Actual contribution 1,250,000 900,000

X Co.’s Final net income for year 200A and 200B are P50,000,000 and
P60,000,000, respectively.
Required: Compute for the following:
1) Deductible retirement expense for years 200A and 200B
2) Net income before income tax for years 200A and 200B

Problem 4 – 64 Financial to Tax Reporting

X, reported income and expenses during the calendar year:
Sales income, net of final tax P10,000,000
Cost of sales 96,000
Salary expenses 4,000,000
Retirement expenses (actual contribution normal valuation P250,000)– BIR Registered 500,000
Representation expense 200,000
Interest expense paid to BIR 20,000
Interest expense paid to Metro Bank 100,000
Depreciation expense 40,000
Rent expense 250,000
Group insurance expense 50,000
Bad debts expense (of which only 20% actual written-off) 100,000
Income tax expense 120,000
Contribution to TESDA priority project 500,000
Contribution to local government 100,000
NOLCO 200,000
Required: Compute the allowable itemized if X is a
1) Corporate taxpayer
2) Individual taxpayer

Problem 4 – 65 Financial to Tax Reporting

Valentines Trading (VT) reported net sales of P3,500,000 and cost of sales of P1,500,000. TV incurred the
following business expenses during the taxable year 200X:
 Salaries expense as follows:
Workers last year’s salaries paid this year P 50,000
 R. Z. Palma 68

Salaries incurred and paid this year 250,000

Accrued salaries not yet paid 30,000
Withholding tax on salaries 25,000
Advances to employees 20,000

 Allowance per aging of accounts receivable at the beginning and ending of the year are P48,000
and P30,000 respectively. The firm’s allowance provision for bad debts during the year P15,000.

 Accumulated depreciation on machine at the beginning is P100,000 but at the year is P160,000.
during the year, the firm sold a machine with cost of P300,000 and an accumulated
depreciation of P30,000 and purchase at the end of the year a new machine worth P400,000
with better capability.

 Entertainment, amusement and recreation expenses:

Fixed representation allowance, net of P4,500 WTW P 50,000
Country clubs fees 100,000
Sporting fee 50,000
Entertainment of company guests 30,000

 Contribution during the year as follows:

To TESDA for priority educations programs P 200,000
To the church of Bagiuo 150,000
To the government for priority program in sports 60,000
To the accredited NGO (administrative expenses is 25% and all requirements
of BIR are complied) 40,000
Required: Compute the following:
1) If VT is sole proprietorship, how much is the amount of total allowable deductions, excluding
Personal exemption?
2) If VT is a partnership, how much is the amount to total allowable deductions?

Problem 4 – 66 Financial to Tax Reporting

X, reported a financial accounting income amounting P5,000,000 during a calendar year. The cost of sale
was P30,000,000. The operating expenses that were deducted reveal the following:
a) Salaries expense:
Salaries worked and paid P500,000
Advanced to employees 100,000
Accrued salaries (senior citizens workers) 80,000
Total salaries expense P680,000

b) Bad debts expense:

Accumulated written off determined to be worthless P100,000
Established uncollectible accounts 200,000
Related party bad debts 20,000
Worthless accounts not yet written off 50,000
Total bad debt expense P370,000
=======
c) Actual retirement expenses deducted P1,000,000. The retirement plan id BIR-approved. Normal
retirement per actuarial computation is P800,000. Actual retirement payments amounted to P620,000.
 R. Z. Palma 69

d) Representation expense, P500,000.

e) Rent expense:
Advance payment of which only 80% was used P200,000
=======
f) Taxes expense:
Municipal and licenses P 30,000
Surcharges and penalties 40,000
Quarterly income tax 230,000
Total taxes P300,000
=======
g) Life insurance expense:
Premium on employees group income P 50,000
Premium on officer’s insurance (beneficiary-X Co.) 100,000
Total life insurance expense P150,000
=======
h) Interest expense:
Interest expense (bank borrowings) P200,000
Interest expense (late payment of tax) 20,000
Interest expense (bank deposits) ( 50,000)
Interest expense (trade notes receivable) ( 10,000)
Net interest expense, deducted P160,000
=======
i) Contribution expense:
Donations to TESDA priority project P500,000
Donations for Rooming-in and Breast-feeding 200,000
Donations to accredited NGO’s (35% for admin.) 100,000
Total contribution expense P800,000
=======
Required: Computed for the following:
1) Total allowable deductions if X is an/a
a) Individual taxpayer.
b) Corporate taxpayer.
2) Net income for income tax purposes if X is an/a
a) Individual taxpayer.
b) Corporate taxpayer.