Chapter 13-A: REGULAR ALLOWABLE ITEMIZED Rationale of the Arbitrage Limit

DEDUCTIONS
Arbitrage- buy and sell
ITEMIZED DEDUCTIONS FROM GROSS INCOME
- Intended to recover the tax savings of
1. Interest expense taxpayers who take advantage of higher
2. Taxes regular tax savings created from
3. Losses interest expense deduction and a lower
4. Bad debts final tax on deposit interest income.
5. Depreciation - Motivate taxpayers to enter
6. Depletion unnecessary loan-and-deposit
7. Charitable and other contributions transactions to save from total income
8. Contributions to pension and trusts tax
9. Research and development costs
MSMEs qualified to 20% corporate taxpayer
10. Other ordinary and necessary trade,
business, or professional expenses - There is no arbitrage for qualified
MSMEs subject to 20% corporate tax
- Qualified MSMEs can deduct the full
ONE: INTEREST EXPENSE amount of interest expense without
deduction of arbitrage limit
Deductible Amounts of Interest Expense
Deductibility of Discount or Pre-deducted
The deductible amount of interest expense is
Interest
the gross interest expense reduced by the
following percentage of the interest income - Discount or pre-deducted interest is a
subject to final tax: prepayment
- It is not deductible upon the release of
- if the interest income is not subject to
the loan but upon payment of the same
final tax, therefore, it is not subject to
or as it accrues as expense
the limitation
- If the loan is due on installments, the
January 1, 2021 – 20% interest pertaining to each installment
shall be deductible
Illustration:
Examples of non-deductible interest
A taxpayer incurred an interest expense of
100,000 and earned 10,000 interest income on 1. Interest on personal loans
deposits in 2022. 2. Interest incurred with a related party
3. Discount/ pre-deducted interest
The deductible interest expense shall be applicable to future periods for
computed as: individual taxpayers
Gross interest expense 100,000 4. Interest expense incurred to finance
petroleum operations
Less: Arbitrage limit (10,000x20%) 2,000 5. Interest on redeemable preferred
Deductible interest expense 98,000 shares
6. Imputed interest
TWO: TAXES
- Taxes paid or incurred within the
taxable year in connection with the
taxpayer’s trade, business, or exercise
of profession shall be allowed as
deduction except:
1. Philippine income tax except fringe
benefit tax
2. Foreign income tax, if claimed as tax
credit
3. Estate tax and donor’s tax
4. Special assessment
Other non-deductible taxes
1. Business taxes, in particular VAT
2. Surcharges or penalties on delinquent
taxes
Examples of deductible taxes
Under the tax credit approach, the foreign taxes
paid are not deducted against gross income but
are credited against the income tax due on
world taxable income.
Determination of foreign tax credit
Foreign taxable income/ World taxable income
x Philippine income tax due
- The foreign tax credit is whichever is
LOWER between the actual foreign
income tax paid and the limit which is
computed above.
Who can claim tax credit or deduction for
foreign taxes paid?
- Only taxpayers taxable on world income
can claim deduction or tax credit for
foreign income taxes paid.

1. Percentage tax
2. Excise tax (THREE) LOSSES
3. Documentary stamp tax
4. Occupational tax - Losses are actually sustained during the
5. License tax taxable year and not compensated by
6. Fringe benefit tax insurance or other indemnity shall be
7. Local taxes except special assessments allowed as deductions
8. Community tax Types of Losses
9. Municipal tax
10. Foreign income tax if not claimed as tax 1. Ordinary Loss – deemed normal to the
credit taxpayer’s trade, business or profession
hence are deductible in full
Only basic tax is deductible 2. Capital Loss – deemed by law as
Foreign Income Tax unnecessary expenses hence deductible
only up to the extent of capital gains
Income taxes paid in a foreign country can
either be claimed as: Examples of deductible ordinary losses

1. Deduction- pertains to gross amount 1. Loss on disposal or destruction of any

2. Tax credit- amount of tax paid outside
the Philippines
Under the deduction approach, the foreign
taxes paid are deducted but will not be claimed
as tax credit.
ordinary asset
2. Loss due to voluntary removal of
building incident to renewal or
replacement
3. Permanent or irreversible loss in value
of assets due to changes in business
 conditions, only to the extent actually
realized
4. Abandonment loss

Rules on restoration or replacement of

destroyed properties

1. Total Destruction of properties

- Total replacement = the tax basis of the
old property shall be claimed as a loss
while the entire replacement cost is
capitalized as cost of the replacement
property subject to allowance of
depreciation.
2. Partial Destruction of Properties
- Partial replacement = restoration cost
shall be expensed up to the extent of
the tax basis of the property
immediately before the casualty.
- Any expense is capitalized subject to
allowance for depreciation

Losses of Value of Assets

- The value of assets, as a rule, is not

deductible due to their temporary and
reversible nature. However, impairment
losses that became actually sustained
can be deducted.
- CA is higher than FV = Impaired

Loss on Insured Property

- The excess of tax basis of the property

over the insurance reimbursement is a
deductible loss in the year of insurance
settlement

FOUR: BAD DEBTS

- Debts due to the taxpayer which were

actually ascertained to be worthless and
were charged off within the taxable
year.