LOSSES

Losses
These represent reduction on resources due to unintended destruction or deprivation of things not in the ordinary course of business.
These losses shall be allowed as deduction from gross income if actually sustained during taxable year and not compensated for by insurance or
other forms of indemnity. (Sec.34D), NIRC)

Kinds of Losses
1. Ordinary losses. These losses are usually incurred in relation to trade, profession or business, property used in business, profit-seeking
transaction incidental to business. These are generally deductible from gross income.
2. Capital losses. They are losses incurred in relation to capital asset transactions. Capital assets are resources not used in business. As a
rule, capital losses are deductible only from capital gains.
Example of capital losses are:
a. Losses from sale or exchanges of capital assets
b. Losses from short sales of property
c. Losses arising from securities becoming worthless provided that the securities are not ordinary assets
d. Losses due to failure to exercise privileges or option to buy or sell property
3. Special kinds of losses. These are losses incurred not related to ordinary business transactions or capital assets transactions.
Examples of these losses are:
a. Losses from sales or exchange of property between related taxpayers
b. Wagering losses
c. Losses due to voluntary removal of property such as building, machinery, etc.
d. Losses of useful value of capital assets due to some change in business conditions.
e. Abandonment losses in petroleum operations

Requisites for Deductibility of Ordinary Losses

1. The loss must be actually sustained in a closed and complete transaction;
2. The loss must be that of the taxpayer and incurred in trade, profession or business;
3. The loss must not be compensated by insurance or other forms of indemnity; and
4. The loss must be reported to the BIR from 30 days to 90 days from the date to its discovery.

Losses Not Allowed by Law as Deductions

1. Loss on voluntary removal of building on land purchased with a view to erect another building
2. Gambling losses not covered by gambling gains
3. Capital loss not covered by capital gains
4. Losses from exchanges of property in corporate readjustments
5. Losses from illegal transactions Losses from exchanges of property where the property received is not substantially different from the
property disposed of
6. Losses not incurred in trade, profession or business or in any transaction entered into for profit
7. Losses from sales or exchanges of property between related taxpayers

Classification of Deductible Losses

1. Business losses such as losses incurred in trade or profession;
2. Casualty losses such as losses due to storms, fires, shipwreck or other casualties of property connected with profession, trade or
business;
3. Losses of business property due to theft, robbery or embezzlement; and
4. Net operating loss carry over (NOLCO).

Partial Loss
If the loss is partial, the deductible loss is the lower amount of replacement cost of the damage portion or the book value of the asset. At the time
of loss, such amount shall de reduced by the amount of insurance recovery.

Net Operating Loss

“The term net operating loss shall mean the excess of allowable deduction over gross income of the business in a taxable year.”(Sec. 34D (3), NIRC)
For taxation purposes, the net operating loss comprises only of operating expenses and losses that are allowed by the law as deduction from gross
income.
Estimated losses or expenses are not allowed for taxation purposes.

NET OPERATING LOSS CARRY-OVER (NOLCO)

Net operating loss (NOLCO) shall mean the excess of allowable deductions over business gross income in a taxable year. (Sec. 34D (3), NIRC)
The NOLCO of the business shall be carried over as a special deduction from gross income for the next three (3) consecutive taxable years
immediately following the year of such loss.
An individual who claims the 10% optional standard deduction (OSD) shall not simultaneously claim deduction of the NOLCO. The three-year
reglementary period shall continue to run notwithstanding the fact that the aforesaid individual availed of the 10% OSD during the said period.
(Rev. Reg. 14-2001, Sec.2.5)

Domestic and resident foreign corporation taxed during the taxable year with MCIT cannot enjoy the benefit of NOLCO. Nevertheless, the running
of the three (3) year period for the expiry of NOLCO is not interrupted by the fact that such corporation is subject to MCIT. (Rev. Reg. 14-2001)
NOLCO shall be availed of on a “first-in, first-out” basis (Ibid. Sec. 2.7). It shall be allowed as deduction in computing the taxpayer’s income taxes
per quarter and annual final adjustment income tax returns.

Taxpayers Entitled to Deduct NOLCO

1. Individual taxpayers engaged in trade or business or in the exercise of his profession.
2. Domestic and resident foreign corporations subject to normal income tax.
3. Special corporation subject to preferential tax rates such as private educational institutions, hospitals and regional operating
headquarters.
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NOLCO incurred or sustained prior to January 1, 1998 shall not qualify for purposes of NOLCO. (Rev. Reg. No. 14-2001, Sec. 4)

Persons Not Entitled to Deduct NOLCO

As a rule, any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction.
Any person, natural or juridical, enjoying exemption from income tax pursuant to the provisions of the Tax Code and any special law shall not be
entitled to deduct NOLCO from gross income.

Entities Not Allowed of NOLCO

1. Offshore Banking Unit (OBU) of a foreign banking corporation, and Foreign Currency Deposit Unit (FCDU) of a domestic or foreign banking
corporation, duly authorized as such by the Bangko Sentral ng Pilipinas.
2. An enterprise registered with the Board of Investments (BOI) with respect to its BOI- registered activity enjoying the Income Tax Holiday
incentive. Its accumulated net operating losses incurred or sustained during the period of such Income Tax Holiday shall not qualify for
purposes of the NOLCO.
3. An enterprise registered with the Philippine economic Zone Authority (PEZA).
4. Enterprises registered under R.A 7227 or “Bases Conversion and Development Act of 1992.
5. Foreign corporations engaged in international shipping or air carriage business in the Philippines.

NOLCO of Mines Other than Wells

For mines other that gas wells, A NOLCO incurred in any of the first 10 years of the operation may be carried over as a deduction from taxable
income for the next 5 years immediately following the year of such loss.

NOLCO in the Tax Return and Unused NOLCO

NOLCO shall be separately shown in the taxpayer’s income tax return.
The Unused NOLCO shall be presented in the Notes to the Financial Statements showing in detail the taxable year in which the net operating loss
was sustained or incurred, and any amount thereof claimed as NOLCO deduction within three (3) consecutive years immediately following the year
of such loss.
Failure to comply with this requirement will disqualify the taxpayer from claiming the NOLCO.

SPECIAL RULES ON LOSSES

The Marcelo Steel Doctrine on Losses

Under the Marcelo Steel Doctrine on losses, a loss in one line of business is not permitted as allowable deduction from gain in another line of
business, if one of the two lines is exempted from tax.

Losses between Related Taxpayers

As a rule, gains in transaction between related taxpayers are taxable, but losses incurred from transaction between members of the family are not
deductible.
The law intends to prevent tax evasion by taxpayers who take advantage of the deduction for losses by means of purported or simulated sales or
exchanges to members of their families, controlled or in trust.
The law presumes that the transactions between these persons are devoid of free bargain between the buyer and the seller, as one party might
dictate on the terms and conditions of the sale or exchange. Furthermore, losses due to related party transactions might have been fabricated in
order to evade payment of income taxes.

Gambling Losses
As a rule, gambling losses can only be deducted from gambling winnings. They are not allowed as deduction from business income, compensation
income or even from gains from sale of capital assets. (Sec.34 (D)(6), NIRC)

Losses from Theft or Embezzlement

Losses from theft or embezzlement of business property not compensated with insurance occurring in the year and discovered in another year are
deductible for the year in which these were sustained.
Where the defalcation was committed and the taxpayer had no means of determining the actual date of the embezzlement, the loss is deductible
on the year of discovery.
When the loss is causes by embezzlement of funds by a known person, the loss sustained is not deductible on the year of commission or discovery,
but in the year when the right of recovery becomes worthless.

Mortgage Losses
When a mortgage property is foreclosed and subsequently purchased by the mortgage, the difference between the purchase price and the unpaid
indebtedness is not allowable as deduction from bad debts. The loss arising from mortgage foreclose is deferred until the property foreclose has
been disposed of.
Accordingly, the loss on mortgage is determined upon sale of the property by the mortgagee.

Losses due to Voluntary Removal of Property

The following rules should be observed when it comes to losses incurred due to voluntary removal of property:
1. As incidents to renewal and replacements. Losses due to voluntary removal of property such as building, machinery, and other similar
assets, incident to renewals and replacements, will de deductible from gross income. (Sec.97, Rev. Reg. No. 2)
2. As cost to remove useless structure in the real property acquired. When a taxpayer buys real estate upon which a building is located
which he proceeds to raze with a view to erecting thereon another building, the cost of removing the structure is not deductible expense
from gross income, instead, such cost will be added as part of the cost of the acquired land.

Losses due to shrinkage in Value of Stocks

Decline in value through market fluctuation of investments in stock of a corporation is not a deductible loss. To be deductible, the loss must be
suffered when the stock is disposed of. (Sec. 99, Rev. Reg. No. 2)

Losses of Useful Value

Generally, assets may lose their useful value due to:
1. Technological changes which make operation more expensive and the assets impractical to use.

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 2. New legislation which makes the continued profitable use of the property impossible.
Losses of value of assets are not deductible from gross income except when the asset involves building and machineries that are permanently
abandoned. Any loss to be deductible under this exception must be charged off in the books and fully explained in returns of income.

Abandonment of Petroleum Operation

If a contract area where petroleum operations are undertaken is partially or wholly abandoned, the following rules shall be observed:
1. All accumulated exploration and the development expenditures are allowed as deduction.
2. However, accumulated expenditures incurred in that areas prior to January 1, 1979 shall be allowed as deduction only from any income
derived from the same contract area.
3. In all cases, notices of abandonment shall be filed with the BIR Commissioner.

PROBLEMs and SOLUTIONS

Problem 9-1

Miss Xylene Lopez received a donation of jewelry with a fair market value of P40, 000. It was acquired by the donor at a price of P30, 000.
Miss Xylene Lopez sold the jewelry for P25, 000 at a time when its market value was P35, 000. The loss on the sale is?

a. P5, 000 b. P15, 000

c. P10, 000 d. P20, 000

Solution: (a)

Selling expense P25, 000

Less: Basis (basis to the
Donor of FMV at the
Time of donation
P40, 000 s P30, 000
Whichever is lower) 30,000
________
Loss on sale P 5, 000

Problem 9-2

Kale Company incurred the following losses for the year 2009:

1. Building razed by fire, costing P7, 000, 000; accumulated depreciation P3, 500, 000, insurance payment received P2, 350, 000, salvage
value P500, 000.
2. Loss of P50, 000 due to cash shortage embezzled by the cashier who absconded.
3. Loss on robbery of computer costing P80, 000; accumulated depreciation, P25, 000, insurance recovered P35, 000.

The deductible loss to be claimed by Kale Company would be?

a. P720, 000 b. P700, 000

c. P725, 000 d. P715, 000

Solution: (c)

Building P 650, 000

Loss on Embezzlement 50, 000
Loss on robbery 25, 000
_________
Total deductible loss P 725, 000

Problem 9-3

Tamara Inc. sustained fire loss on its machine in 2009. The machine, however, is partially damaged. Tamara spent P90, 000 for major repair.
Tamara received P55, 000 as insurance recovery. Prior to fire, document reveal that the machine had an acquisition cost of P300, 000 and
accumulated depreciation of P180, 000.

What would be the total deductible loss?

a. P30, 000 b. P40, 000
c. P120, 000 d. P35, 000

Solution: (d)

Replacement cost P90, 000

Less: Insurance recovery 55, 000
_______
Total Deductible Loss P35, 000

Problem 9-4

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Xyle Ivan is engaged in water delivery business. He has a second hand delivery truck which he purchases for P80, 000. He estimated the trucks’
useful life to be 4 years. After 3 years, however, due to inefficiency and constant repair, he sold the truck for P15, 000 to replace it with better one.

How much is the deductible loss due to replacement?

a. P20, 000 b. P5, 000

c. P15, 000 d. P O

Solution: (b)

Cost-delivery truck P80, 000

Accumulated Depreciation
(P80, 000/4) x2yrs (60, 000)
________
Book value- delivery truck P20, 000
Sales Proceeds (15, 000)
________
Deductible loss P5, 000

Problem 9-5

Mr. Neil John provides the following data during a taxable year:

Compensation Income P300, 000

Business Income 180, 000
Gambling gains 40, 000
Personal expenses 200, 000
Business expenses 100, 000
Gambling expenses 180, 000

How much is the taxable income before persona exemptions of Mr. John is?

Solution:

Business Income P180, 000

Business Expense (100, 000)
________
Income from business P 80, 000
Compensation Income 300, 000
________
Total income P380, 000
Gambling gains 40,000
Gambling Losses (80, 000)
_________
Taxable income before
Personal exemption P380, 000

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