DEDUCTIONS FROM GROSS INCOME

Principles of Gross Income

A. LOAN Principle
L – Legal
O – Ordinary
A – Actual
N – Necessary
B. Matching Principle

Exempt Income Non-deductible

Expense
Final Tax Non-deductible

Taxable Capital Gains Tax Non-deductible

Regular Income Tax Deductible

C. Related Party Rule

Loss, Interest Expense, and Bad debt Expense from a related party are not deductible
against gross income.
D. Withholding Rule
There are expenses paid that requires withholding. If the tax payer did not withhold the
tax as required, the tax payer will not be able to deduct a specific item in the gross income.
The following are the examples of taxes that needs to be withheld:
1. Goods = 1%
2. Services = in general 2%
Rent = 5%
Professional Services
Individual
Gross Receipts >3M = 10%
Gross Receipts 3M and below = 5%
Corporation
Gross Income >720,000 = 15%
Gross Income 720,000 and below = 10%
ITEMIZED DEDUCTIONS
A. Interest Income
Amount of Interest Expense xx
Less: 20% of Interest Income subject to Final Tax (xx)
Deductible Interest Expense xx

Non-deductible interest expense

1. Related Party
2. Interest Expense to finance petroleum operations
3. if treated as capital expenditure – (Capitalizable Borrowing Cost)

Illustrative example:
X borrowed 500,000 to Y with an annual interest of 10% payable in six months. X also has a
deposit of 300,000 to DBO a domestic bank. The interest rate on deposit is 12%.
1. How much is the deductible interest expense?
2. How much is the deductible interest expense if X and Y are related parties?

B. Taxes
These are taxes that may be deducted in the gross income:
A – taxes paid abroad opted to be claimed as OPEX.
P – Percentage Tax except Stock Transaction Tax
E – Excise Tax
L – Local business taxes
I – Import Duties
D – Documentary stamp tax
O – Occupational Tax
C. Losses
Ordinary Loss – deductible in full
Capital Loss – up to the extent of capital gains only
Total Loss = BV less insurance received
Partial Loss = BV vs. Cost to restore whichever is lower less insurance received
 Illustrative example:
A tax payer’s warehouse was burned. The following assets were destroyed partially.
Asset 1 Asset 2
Book Value of the asset at the time
of loss 200,000 200,000
Cost to restore the property 120,000 300,000
Insurance Recovery 50,000 None

How much is the deductible loss for Asset 1?

How much is the deductible loss for Asset 2?

D. Bad debt expense

1. Loss of Interest income (Loss of Income) = deductible only under Accrual basis
2. Loss of the Receivable itself (Loss of Capital) = deductible under Accrual Basis and Cash
Basis.
E. Depreciation
Any reasonable method is allowed.
Private Schools (Proprietary Educational Institutions) has the option to deduct the whole
amount of capital expenditure or capitalize the asset and claim depreciation over the useful
life.
F. Charitable Contributions
1. Must be actually paid (based on cost)
2. Given to organizations specified by law (Government or NGOs).
Fully Deductible (PTA)
1. Priority Activities
2. Treaty
3. Accredited NGOs
Partially Deductible – subject to limit
1. Government – non-priority activities
2. NGOs – non-accredited

Limit:
Individual – up to 10% of the operating income only.
Corporations – up to 5% of the operating income only.
 Illustrative Example:
A taxpayer has the following Gross Income subject to regular income tax.

Gross Income 1,200,000

Salaries Expense 200,000
Depreciation Expense 50,000
Interest Expense 40,000
Rent Expense net 95,000
Contributions to priority Activities 100,000
Contributions to non-priority act 150,000

How much is the total deductible expense?

G. Pension Expense
Contributions made by the employer to the employee benefits may also be deducted
from the gross income.
Defined Benefit Plan:
Contribution to the fund
CSC – deductible in full
PSC – amortized for 10 years.
Defined Contribution Plan
Contribution = Expense (deductible already)

Illustrative example:
ABC put up a qualified retirement plan approved by the BIR. It appointed B corp. to
administer the plan, which called for the payment of 200,000 to cover the retirement of the
employees for past services rendered and a yearly contribution of 50,000. The following
amounts were paid for the first 3 years of the plan’s operation.
Contribution for Services
Past Years Current Years
First Year 100,000 50,000
Second Year 60,000 50,000
Third Year 40,0000 50,000
The pension expense for the first year, second year, and third year is?
H. Research and Development
Related to:
1. Capital Expenditure = Capitalized as Asset
 2. Not capital expenditure
Option to expense outright or deferred and amortized for a min. of 60 months

I. Entertainment, Amusement, and Recreational Expenses

- Related to the furtherance of the business
- Not contrary to law, moral, good customs
- Not paid directly to government officials
- receipted to the business of the tax payer

Limit:
Goods = ½ of 1% of the Net Sales
Service = 1% of the Net Receipts
Illustrative examples:
1. A Corp. had a net sales of 1M. the actual entertainment, amusement, and recreation
expense amounted to 20,000. The deductible EAR is

2. A Corp. had a net revenues of 1M. the actual entertainment, amusement, and
recreation expense amounted to 20,000. The deductible EAR is

3. C Corp is engaged in the sale of goods and services with net sales and net revenues
of 2M and 1M, respectively. The actual EAR is 18,000. The deductible EAR is

J. Net Operating Loss Carry-over (NOLCO)

- Net Operating Loss can be carried over for the next 3 years.
Except:
1. Losses in 2020 and 2021 – 5 years
2. Mines other than oil and gas wells – 5 years if the loss is incurred in the 1 st 10 years
of operation.
Conditions:
1. Not exempt in the year of loss
2. No substantial change in ownership.