Rogationist College

(St. Anthony’s Boys Village), Inc.

Km.52 Emilio Aguinaldo Highway Lalaan II, Silang, Cavite

CHAPTER TEN

In Partial Fulfilment of the Requirements for the Degree

Bachelor of Science in Accountancy
Income Taxation

Submitted by:
Belista, Rhealyn N.
De Chavez, Randolf
BSA 301
S.Y. 2023-2024

Submitted to:
Dr. Armando L. Bañares, CPA

September 2023
ALLOWABLE DEDUCTIONS
NATURE & CONCEPT OF ALLOWABLE TAX DEDUCTIONS

DEDUCTIONS

Deductions refer to the amounts that are subtracted from the gross income to
arrive at the taxable income in order to reduce the amount of income that is subject to
taxation. Taxpayers cannot deduct reasonable business expenses from gross taxable
income if there are no laws, statues, or BIR regulations allowing such deductions. By
nature, deduction is a matter of legislative prerogative. Tax payers have the primary
obligation to provide proof of deduction correctness and legality, supporting them with
receipts and other documentary evidences.

KINDS OF DEDUCTIONS

A taxpayer engaged in business or in the practice of profession shall choose

either the optional or itemized deduction (described below) deduction. He shall indicate
his choice by marking with “X” the appropriate box, otherwise, he shall be deemed to
have chosen itemized deduction. The choice made in the return is irrevocable for the
taxable year covered.

OPTIONAL STANDARD DEDUCTIONS

Optional Standard Deduction (OSD) – A maximum of 40% of their gross sales or

gross receipts shall be allowed as deduction in for those who employ the cash basis of
accounting. This type of deduction shall not be allowed for non-resident aliens engaged
in trade or business. An individual who opts to avail of this deduction need not submit
the Account Information Return (AIF)/Financial Statements.

Illustration 1:

Angel, a mixed income earner, has the following data for the current taxable year.

Annual Salary
1,200,000
Allowances received from the employer
250,000
Gross Sales from business
5,200,000
Cost of Sales
3,120,000
Itemized business allowable expenses- total
420,000
REQUIRED: Determine the allowable amount of the OSD
 ASWER: The OSD is computed as follows:

Gross Sales from business

Multiply by:

Optional standard deduction

Illustration 2:

White Shark Company presented the following data for the current taxable year:

Sales
10,000,000
Sales returns & Allowances

Cost of Sales 200,000

Itemized Operating Expenses 3,500,000

REQUIRED: Compute the allowable amount of OSD
4,200,000
ANSWER: The allowable amount of OSD is as follows:

Net Sales (10,000,000 - 200,000)

Less: Cost of sales

Gross Income

Multiply by:

Optional Standard Deduction 9,800,000

ITEMIZED DEDUCTION
3,500,000
Itemized Deduction is a listing of specific expenses allowed by the tax code and
related tax regulations to be deducted from the gross taxable income to arrive at the
6,300,000
taxable net income. In general, the specific items allowed in the itemized deductions are
the items that appear in the income statement of the business entity.
40%

TAXPAYERS ENTITLED TO ITEMIZED DEDUCTIONS 2,520,000

General Professional Partnership

These are partnerships formed by persons for the sole purpose of exercising their
common profession.

Corporations, either Domestic or Foreign

A domestic corporation is a company that conducts its affairs in its home country. A
domestic business is often taxed differently than a non-domestic business and may be
required to pay duties or fees on the products it imports.

Estates and Trusts engaged in business

An estate is the economic valuation of all the investments, assets, and interests of an
individual. The estate includes a person's belongings, physical and intangible assets,
land and real estate, investments, collectibles, and furnishings.

Business trust means a trust created for the purpose of making a profit through the
combination of capital contributed by the beneficiaries of the trust and through the
administration or management of the capital by trustees or a person acting on behalf of
the trustees, for the benefit of the beneficiaries.

Individual Taxpayers who are engaged in trade, business or exercise of

profession

BIR Form 1701Q is a tax return needed for filing and/or payment quarterly by individual
taxpayer engaged in business, self-employment, freelancing, or practice of profession,
regardless of if with physical office/store or doing it online.

COMPOSITION OF ITEMIZED DEDUCTIONS

Section 34 of the Tax code, as amended, enumerates the following items as allowable
deductions against the gross taxable income:

1. Business Expenses
2. Interest Expenses
3. Taxes
4. Losses
5. Bad debts
6. Depreciation
7. Depletion of oil and gas wells and mines
8. Charitable and other contributions
9. Research and development costs
10. Pension Trust
BUSINESS EXPENSES

Business expenses are ordinary and necessary expenses paid or costs incurred to
operate business. It is directly attributable to the development, management and
operation and conduct of the trade, business or exercise of profession during the
taxable year shall be allowed as deductions from gross income.

The business expenses may include the following:

1. Salaries, wages and other forms of compensation

2. GUMV of fringe benefits granted by an employer to an employee.
3. Travel allowance and expenses in the pursuit of trade, business or profession.
4. Representation, entertainment, amusement and recreation expenses that is
directly attributable to the development of trade, business or profession.
5. Rental expenses for the use of property.
6. Commission
7. Supplies used
8. Advertising and other selling expense
9. Other similar business expense

Requisites for Business Expenses to Be Deductible the following requisites shall be met
for business expenses to be deductible:

1. The expenses must be both ordinary and necessary. The term "ordinary
business expenses" implies that the expenses are normally incurred by a
business of similar line or nature and are, hence, not unusual or extraordinary in
the business operation. Business expenses that are only ordinary but not
necessary, or necessary but not ordinary, are not deductible expenses.
2. The amount must be reasonable. The amount is reasonable when it is ordinary
paid for like services by like enterprises in like circumstances. In determining
whether the amount is reasonable, a comparison shall be made for the amount in
similar enterprises.
3. The expenses must be connected with trade, business, or profession. The
expenses are connected with trade, business, or profession when they are
incurred for the development of the business entity and for the attainment of its
objectives.
4. The expenses must be incurred or paid during the taxable year. There shall be
the actual incurrence of expenses during the taxable year. Expenses that are
future estimates are non-deductible expenses.
5. The expenses are not contrary to law, moral, public policy, or public order.
Allowable expenses shall neither violate any law nor be immoral, neither against
public policy nor against public order. 6. The expenses must be supported by
receipts or other forms of business documents. Business expenses shall be
substantiated with supporting and sufficient evidence such as official receipts,
 invoices, and other business records. The withholding tax on expenses paid must
have been withheld and remitted to the BIR

Ordinarily, there are no complicated tax issues and problems in determining the
correct amount of business expenses because these are shown in the audited
income statement of the business entity.

The following business expenses, however, are discussed for greater emphasis:

a. Salaries

Salaries include 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. Provided that the
final tax has been paid.
Normally, salary expenses are supported by payroll. The gross amount is
the deductible figure and not the net amount or take home pay of the employees.

b. Travel expenses
 Expenses for travel or transportation in the pursuit of trade, business, or
profession within the country or abroad are deductible.
 These expenses include money spent for meals and lodging while traveling,
provided that the expenses are connected with the business, and the amounts
are reasonable.

c. Rental expenses

These expenses include rents and other payments that are required as a
condition, for the continued use of possession, for the purpose of trade,
business, or profession, of property to which the taxpayer has not taken or is not
taking title or which he/she has no equity other than that of a lessee, user, or
possessor.
Other payments related to rent will include taxes and insurance paid by
the lessee for the business property of the lessor being used by the lessee
related to his/her business or profession.
When a leasehold improvement is acquired for business purposes for a
specified sum, he/she may take, as a deduction, a portion of such sum each year
based on the number of years the lease has to run.
Accordingly, when the lessee introduced leasehold improvements on the
leased property, the total cost of the leasehold improvements shall be
apportioned over the term of the lease or the life of the improvements. Whichever
is lower?
In the event the lessee made an advance payment for the rent, the
advance rental will be considered as expense pro-rata with the term of the lease.
On the part of the lessor, however, the advance rental collected shall be reported
as income in the period collected.
d. Representation and entertainment expenses

These include expenses paid for amusement and recreation incurred during the
taxable year that are directly connected with the business activities or profession of the
taxpayer.

The allowable amount is subject to the following limitations:

 Taxpayers engaged in the sale of goods. (inventories) ½ % of net sales

 Taxpayer engaged in the sale of services, exercise of profession, and rental of
properties ½% of net revenue
The allowable amount shall be the actual amount incurred or paid or the limitation,
whichever is lower.

Interest Expenses

Interest expense arises when an individual borrows money from a bank or when
a penalty is imposed in view of delinquent payment of financial obligations.

Requisites for Interest Expenses to Be Deductible

1. There is indebtedness as evidenced by a document. The indebtedness must be

made in writing.
2. The indebtedness must be that of the taxpayer. The debt must be that of the
taxpayer and not that of another person; otherwise, the interest shall not be
allowed as deductible item.
3. The indebtedness must be connected with the taxpayer's trade, business or
profession. Interests that are not related to trade or business, such as loan to
finance the construction of a house or for the purchase of a motor vehicle, are
non-deductible.
4. The interest must have been paid or accrued during the taxable year. An inter to
be deductible must be actually paid or accrued, that is, incurred but not yet paid
Prepaid interest is not deductible.

Classifications of Interest Expenses

While the Tax Code does not categorically classify interest expense, the following
classifications are suggested to facilitate discussion:

1. Deductible interest expense subject to limitation. The amount of interest expense

incurred or paid is deductible in full.
However, Section 34(B) of the Tax Code, as amended, mentions that the
amount of interest paid or incurred within a taxable year on indebtedness in
connection with the taxpayer's profession, trade, or business shall be allowed as
deduction from gross income, provided that the taxpayer's allowable deduction
 for interest expense shall be reduced by an amount equal to 33% of the interest
income subject to final tax
Simply stated, if a taxpayer incurred interest expense in connection with
the business and, at the same time, earned interest income subject to 20% final
tax. The allowable interest expense shall be reduced by an amount equivalent to
the interest income multiplied by 33%. 2.

Deductible interest expense in full amount

a) Interest for tax delinquency. Late filing of return and late payment of tax liabilities
are imposed with a 20% interest. However, surcharges and compromise for late
payment of income tax are non-deductible expenses.
b) Interest payment on scrip dividends. Scrip is a promissory note issued by
corporation for the payment of cash dividends on a future date.
c) Interest payment of deposits. This refers to interest paid by banks and other
types of financial institutions on the deposits of the customers.
d) Interest payment on bonds. Bonds are financial liabilities that have a maturity
period of more than one year and generally carry interest payable quarterly,
semi-annually, or annually.

Non-deductible interest expense

a) Interest paid in advance by a taxpayer using the cash basis method of
accounting
If, within the taxable year, an individual taxpayer reporting income using
the cash basis method incurs indebtedness for which an interest is paid in
advance through discount, such interest shall be allowed as a deduction in the
year the indebtedness is paid.
If the indebtedness is payable in periodic amortizations, the amount of
interest that corresponds to the amount of principal amortized or paid during the
year shall be allowed as a deduction in such a taxable year.
In other words, if the taxpayer is using the cash basis of accounting, the
period to deduct interest expense shall be in the period when the indebtedness
has been paid. The following guidelines may be followed:
 The taxpayer is using the cash basis method of accounting. The
interest has been paid in advance or has been discounted by the
bank.
 The interest expense shall be treated as a deductible expense in
the period when the indebtedness is paid. If the loan is paid on an
instalment basis, the interest expense shall be deductible pro-rata
based on the amount of principal paid.

b) Interest expense arising between related taxpayers

Interest expense shall be incurred between the following related taxpayers

under the following circumstances
 Between members of the family which include brothers, sisters,
spouses, ancestors, and lineal descendants
  Between the individual and the corporation, wherein the individual
owns more than 50% of the outstanding capital stock of the
corporation
 Between corporations, wherein the same individuals own more than
50% of the outstanding capital stocks of the two corporations
 Between the grantor and a fiduciary of any trust
 Between the fiduciary of a trust and the fiduciary of another trust, if
the same person is a grantor with respect to each trust
 Between a fiduciary of a trust and a beneficiary of such trust

Optional Treatment of Interest Expense

At the option of the taxpayer, interest incurred to acquire a property used in

trade. business, or exercise of a profession may be allowed as a deduction or
treated as capital expenditure The optional treatment of interest expense is only
applicable if the taxpayer borrow's money for the acquisition of a property for the use
of the business or exercise of profession The two alternative procedures are as
follows:
1) Outright expense
Under the outright expense method, the whole amount of interest incurred
relative to the acquisition of a property for business is deducted in the year the
loan is paid or incurred.
2) Capital expenditure
In the capital expenditure method, the interest is added to the cost of the
assets acquired and subsequently amortized over the life of the property. The
interest is deducted in the form of depreciation

Taxes

Taxes paid or incurred within the taxable year in connection with the taxpayer's
profession, trade, or business shall be allowed as deductions, except those expressly
not allowed by the Tax Code, as amended.

Requisites for Taxes to be Deductible

1) They must be paid or incurred during the taxable year. Only taxes that have been
paid or incurred during the taxable year are considered allowable deductions
from the gross taxable income Taxes paid in previous years, which were not
deducted, cannot be deducted during the current taxable year.
2) They must be connected with the taxpayer's trade, business, or profession.
3) Taxes that are not related to a taxpayer's business are considered personal and
are, hence, non-deductible.
4) They must be imposed directly on the taxpayer. Only the taxpayer, upon whom
the taxes have been imposed directly, is allowed to deduct. Thus, a taxpayer
cannot deduct taxes paid by him/her even if such have been separately billed on
 his/her purchases or transactions but not imposed upon him/her. The two
exceptions to the above rules are as follows:

a. Taxes paid by a bank or corporation on the shareholder's interest

b. Taxes paid by a corporation for the interests of others on the tax-free
bonds or any similar financial obligations

Classifications of Taxes To simplify the discussion, taxes are classified as

follows:

1. Non-deductible taxes

a. Philippine income tax

b. Estate tax

c. Donor's tax

d. Value-added tax

e. Special assessment

f. Stock transaction tax

g. Income taxes paid in a foreign country treated as tax credit

2. Deductible taxes

a. Import duties

b. Excise taxes

c. Occupation taxes

d. Documentary stamp taxes

e. Privilege and license taxes

f. Business taxes, except taxes on the sale of shares of stock through the local
stock exchange

g. Local business and municipal taxes

h. Automobile registration fees Deductible taxes, when refunded, shall be

included in the gross income in the year of to the extent of the income tax benefit
of the said deduction.
 Otherwise stated, if taxes paid are deductible from the gross income, the refund
of such is taxable. On the other hand, if taxes are non-deductible, the tax refund is
likewise non-taxable.

It should be noted, however, that interests and surcharges on tax delinquency

are not deductible as taxes but as interest expenses. The deductible taxes are equal
only to the amount of taxes due before any interest and surcharges.

Limitations on Taxes as Deduction

1. For a non-resident alien engaged in trade or business in the Philippines and a

resident foreign corporation, the deductible amount is limited to the extent of income
from within the Philippines.

2. For a citizen of a foreign country residing in the Philippines, whose income from
sources within such foreign country is not subject to Philippine income tax, only that
portion of the taxes paid to such foreign country which corresponds to his/her net
income subject to Philippine income tax shall be allowed as a deduction. The portion of
taxes paid to a foreign country, which is deductible, is computed as follows:

Losses

Losses actually sustained during the taxable year and not compensated by
insurance or other forms of indemnity shall be allowed as deductions if incurred in the
pursuit of trade, business, or profession. The losses may arise from fires, storms,
shipwreck, or other casualties or from robbery, theft, or embezzlement. The taxpayer
shall submit a declaration of loss sustained from a casualty or from neither robbery,
theft, nor embezzlement during the taxable year in no less than 30 days nor more than
90 days from the date of discovery of such losses.

No loss shall be allowed as a deduction if, at the time of the filing of the return,
such loss has been claimed as a deduction for estate tax purposes in the estate tax
return.

Requisites for Losses to Be Deductible

1. The loss must be actually sustained in a closed and completed transaction the loss
must be actually incurred, and the amount of loss must be determined definite and final
2. The loss must be that of the taxpayer and incurred in connection with trade, business,
or profession. Losses are deductible from the gross taxable income if they are
connected with the taxpayer's trade, business, or exercise of profession.

3. The loss must not be compensated by insurance or other forms of indemnity the
amount of lose that the taxpayer can claim shall be equal to the book value of the lost
assets

4. The loss must be reported to the BIR within the period of 30 days up to 90 days from
the date of the discovery of the loss. A taxpayer who incurred a loss shall file sworn
declaration of loss with the Revenue District Officer.

Classifications of Losses

Losses are broadly classified as

1. Deductible losses. The following losses are deductible subject, however, to

some requirements

a. Business losses and losses from theft, robbery, or embezzlement

b. Casualty losses arising from storms, fires, or shipwreck

c. Net operating loss carry-over (NOLCO)

d. Other types of losses

2. Non-deductible losses. In the computation of taxable income, losses arising

from sales or exchanges of properties under the following cases are not
deductible:
a. Losses incurred between members of the family; the family of an
individual shall include only his/her brothers and sisters (whether by
whole or half- blood), spouse, ancestors, and lineal descendants
b. Losses arising between an individual and a corporation, where
more than 50% in value of the outstanding stock of which is owned,
directly or indirectly, by or for such individuals, except in case of
distributions in Liquidation
c. Losses on sale or exchange between corporations, where more
than 50% in value of the outstanding capital stocks of which is
owned, directly or indirectly, by or for the same individual, if either
one of such corporations. with respect to the taxable year of the
corporation preceding the date of the sale or exchange was, under
the law applicable to such taxable year, a personal holding
company or a foreign personal holding company, except in case of
distribution in liquidation
d. Losses between the grantor and a fiduciary of any trust
 e. Losses between the fiduciary of a trust and the fiduciary of another
trust, if the same person is a grantor with respect to each trust
f. Losses incurred between a fiduciary of a trust and a beneficiary of
such trust

Measurement of the Amount of Loss

The amount of deductible loss depends on the extent of the loss, that is, total loss or
partial.
These are the simple guidelines to follow:
1. If the loss is total, the deductible amount is equal to the book value of the
lost asset.
2. If the loss is partial, the deductible loss is equal to the book value of the
asset at the time of the loss or the replacement cost, whichever is lower.
Whether the loss is partial or total, the amount of loss shall be reduced by
the following:
a. The scrap or salvage value of the damaged property
b. The recoverable amount of the insurance

Business Losses
Business entities sell goods and/or render services to customers on credit. Also,
business concerns use either the accrual or cash basis method of accounting

Credits extended to customers sometimes, if not often, are not paid; hence,
business losses are incurred.
Losses of income due to worthless debts are either deductible loss or not. The
simple rules to observe are as follows:

1. If the taxpayer reports income using the accrual method, business losses from unpaid
debts or other similar items such as interest are deductible items from the gross taxable
income.

2. If the taxpayer is using the cash basis method and income has not been reported,
business losses related thereto are non-deductible.

Net Operating Loss Carry-over (NOLCO)

Net operating loss refers to the excess of allowable deduction over gross taxable
income in a particular taxable year.

The net operating loss of the business or enterprise for any taxable year
immediately proceeding the current taxable year, which had not been previously offset
as deduction from gross income, shall be carried over as a deduction from gross
income for the next three consecutive taxable years immediately following the year of
such loss.

Limitations of NOLCO
The following are the limitations in applying the NOL.CO

1. The operating loss had not been previously offset as deductions from gross
income
2. Any net loss incurred in a taxable year that the taxpayer was exempt from
income tax should not be allowed as a deduction
3. The NOLCO shall be allowed only if there has been no substantial change in the
ownership of the business or enterprise in that:
a. Not less than 75% in nominal value of outstanding issued shares, if the
business is in the name of a corporation, is held by or on behalf of the
same persons
b. Not less than 75% of the paid-up capital of the corporation, if the business
is in the name of a corporation, is held by or on behalf of the same person
4. The net operating loss can be carried over only for the next three consecutive
taxable years immediately following the year of the incurrence of the loss.
5. For mines other than oil and gas wells, net operating loss incurred in any of the
first ten years of operations may be carried over as a deduction from taxable
income for the next five years immediately following the year of such loss
The entire amount of such loss shall be carried over to the first of the five
taxable years following the loss, and any portion of such loss which exceeds the
taxable income of such first year shall be deducted in like manner from the
taxable income of the next remaining four years.

Taxpayers Entitled to NOLCO

1. Self-employed individual taxpayers

2. Estates and trusts

3. Domestic and resident foreign corporations covered by normal basic tax

4. Domestic and resident foreign corporations (special corporations) subject to

preferential tax rates such as hospitals and private educational institutions

Taxpayers Not Entitled to Carry Forward Net Operating Loss

1 Individual taxpayers earning income purely from compensation (Net operating loss)
cannot be deducted from compensation income)
2. Offshore banking units of foreign banks duly authorized by the Bangko Sentral ng
Pilipinas

3. Foreign currency deposit units of both domestic and foreign banks duly authorized by
the Bangko Sentral ng Pilipinas

4. Taxpayers who are exempt by law from income taxation

Other Types of Losses

The other types of losses are as follows:

1. Capital losses. The concepts and principles on losses arising from the sale or
exchange of capital assets have been lengthily discussed in Chapter 7: Gains from
Dealings in Properties.
2. Loss from wash sales of shares of stock or securities. Similarly, the proper tax
procedures and treatment on losses sustained or incurred relative to wash sales on
shares of stock have been thoroughly discussed in Chapter 7.
3. Wagering losses. Wagering gains and losses refer to earnings or losses derived
from gambling whether legal or illegal. These basic procedures are followed in treating
wagering gains and losses

a. If there is only a wagering gain, the gain is included in the gross taxable income.
b. If there is only a wagering loss, the loss is a non-deductible item.

c. If there are both wagering gains and wagering losses, the wagering losses are follows
Deducted from the wagering gains, and the result is treated as
 Net wagering gains are included in the gross taxable income.
 Net wagering losses are non-deductible items

4. Losses from diminished value of shares of stock. When the market value of the
shares of stocks, classified as ordinary assets, decreases below their acquisition cost or
below the unit per share, the loss is not a deductible loss unless the shares of stock are
actually sold or exchanged
Losses from shares of stock held as capital assets, which have become
worthless during the taxable year shall be treated as capital losses as of the end of the
year. However, these losses are not deductible against the capital gains realized from
the sale, barter, exchange, or other forms of disposition of shares of stock during the
taxable year but must be claimed against other capital gains to the extent provided
under Section 34 of the Tax Code, as amended.

For the net capital gains tax to apply, there must be an actual disposition of the
shares of stock held as capital assets, and the capital gain and capital loss used as the
bases in determining the net capital gain must be derived and incurred respectively,
from the sale, barter, exchange, or other disposition of shares of stock

5. Losses from securities becoming worthless. If securities become worthless during

the taxable year and are capital assets, the loss resulting therefrom shall be considered
as a loss from the sale or exchange of capital assets on the last day of such taxable
year.

6. Abandonment losses. In the event that a contract area where petroleum operations
are undertaken is partially or wholly abandoned, all accumulated exploration and
development expenditures pertaining thereto shall be allowed as a deduction. In all
cases notices of abandonment shall be filed with the Commissioner
In case a producing well is subsequently abandoned, the amortized cost thereof,
as well as the depreciated costs of equipment directly used therein, shall be allowed as
a deduction in the year such well, equipment, or facility is abandoned by the contractor,
provided that, if such abandoned well is re- entered and production resumed, or if such
equipment or facility is restored in service, the said costs shall be included as part of the
gross income in the year of resumption or restoration and shall be amortized or
depreciated, as the case may be

Bad Debts

Bad debt refers to worthless or uncollectible amounts, in whole or in part, which

is due to a taxpayer by others, arising from money let or from uncollectible amounts of
income from goods sold or services rendered.

The Tax Code, as amended, provides that debts due to the taxpayer actually
ascertained to be worthless and charged off within the taxable year shall be allowed as
deductions from the gross income. However, this provision excludes debts not
connected with profession, trade, or business and those sustained in a transaction
between related parties.

Requisites for Bad Debts to Be Deductible

1. There must be an existing debt, which is valid, subsisting, and demandable. The
debt exists when the creditor has the right to collect from the debtor. Such debt is
considered valid, subsisting, and demandable when the right to collect is
enforceable and has not yet prescribed
2. The existing debts must be ascertained to be worthless. Bad debts computed
based on estimates are not deductible from the gross income. The taxpayer must
be certain that the debts can no longer be collected. The bankruptcy of the
debtor basically indicates that the debts are considered worthless and are,
hence, uncollectible. Partial recognition of debts as worthless or uncollectible is
not allowed.
3. The debts must be charged off within the taxable year. The term "charged off"
means that the receivable account shall be removed from the books of accounts
of the business entity.
4. The existing indebtedness must be connected with trade, business, or exercise
of profession. Therefore, bad debts that are not connected with trade or business
are non-deductible from the gross taxable income.
5. The debts must not be sustained or incurred between related parties. Bad arising
from a related party transaction are non-deductible

Classifications of Bad Debts

Bad debts may be classified as (1) deductible or (2) non-deductible.

  Deductible bad debts are those uncollectible accounts that have met the
requirements set by taxation laws and are, therefore, allowable deductions from
the gross taxable income.
 Non-deductible bad debts refer to worthless accounts and, by the process of
exclusion, have not met the conditions required by the law.

Collection of Bad Debts in Succeeding Years

Bad debts previously written off and collected in succeeding years shall be handled in in
the following manner:
1. The recovered amount shall be included in the gross table income if, at the time the
amount was written off as a bad debt, it was deducted from the grow taxable income
2. The recovered amount is not included in the gross taxable income if, at the time it
was written off an a bad debt, it was not deducted from the gross taxable Income

Depreciation

There shall be allowed as a deduction a reasonable allowance for the wear and tear as
well as obsolescence, of property used in trade or business. Depreciation is the
reduction in the value of tangible assets brought about by the trade, as well as
obsolescence

At the time the assets are acquired, the whole amount of acquisition costs is capitalized
and not treated as an outright expense. Expenses start to be recognized once the asset
is used in the operating activities of the business. Such an expense is called
"depreciation" or "amortization."

Requisites for Depreciation to Be Deductible

1. The assets must be connected with trade, business, or profession. Loss in the value
of personal assets sustained on account of depreciation is not a deductible item from
the gross taxable income.
2. The amount of allowance to be provided shall be reasonable. The term "reasonable
allowance shall include an allowance computed, in accordance with rules and
regulations prescribed by the Secretary of Finance, upon the recommendation of the
BIR Commissioner, using the straight line method, double declining balance method, or
sum-of-the-years digit method,
3 The amount of depreciation should be charged off during the year. The amount of
depreciation, in order that such will be a deductible item from the gross taxable income,
should be deducted from the related costs of the asset.

Methods Used in Computing Depreciation

The various methods of computing depreciation shall be, but not limited to, the
following
1. Straight-line method. The straight-line method allocates the depreciable amount of
the assets equally over the estimated life.

The depreciable amount is computed by deducting the residual value or scrap value of
the assets at the end of its useful life from acquisition costs. Residual or scrap value
refers to the estimated realizable amount at the end of the life of the assets. Estimated
useful life refers to the period where the assets are productively used in the operation of
the business

The formulas for computing depreciation using the straight-line method are as follows:

2. Double declining balance method. The Tax Code, as amended, provides that under
the double declining balance method, the depreciation rate shall not exceed twice the
rate that would have been used had the annual depreciation allowance been computed
under the straight-line method.
In computing the depreciation using the double declining balance method, the
following points should be remembered:

The residual value or scrap value is disregarded.

b. A uniform rate is applied (straight-line depreciation rate times two) c. At the end of the
asset's life, any scrap value may be simply deduced from the remaining book value. The
formula to compute the depreciation expense using the double declining balance
method is as follows:

3. Sum-of-the-years' digit (SYD) method. Under this method, the depreciable cost of the
assets is multiplied by a certain fraction; the numerator is equal to the life of the asset,
and the denominator is equal to the sum of the number of the life of the asset

The formula for computing the denominator is as follows:

Miscellaneous provisions on depreciations

a. Agreement as to the useful life of which the depreciation rate is based

Where under rules and regulation, the taxpayer and the BIR
Commissioner have entered into agreement in writing specifically dealing with
the useful life and rate of depreciation of any property, the rate so agreed upon
shall be binding on both the taxpayer and the national government in the
absence of facts and circumstances not taken into consideration during the
adoption of such agreement

Any change in the agreed rate and useful life of the depreciable property
as specified in the agreement shall not be effective for taxable years prior to the
taxable year. A notice in writing by certified mail or registered mail should be
served by the party initiating such change to the other party to the agreement.
 However, where the taxpayer has adopted such useful life and
depreciation rate for any depreciable asset and claimed the depreciation
expense as deduction from his/her gross income, without any written objection
on the part of the BIR Commissioner or the Commissioner's duly authorized
representative, the aforesaid useful life and depreciation rate so adopted by the
taxpayer for the aforesaid depreciable asset shall be considered binding.

b. Depreciation of properties used in petroleum operations

The following guidelines shall be observed in handling properties subject
to depreciation of a business entity engaged in petroleum operations

An allowance for depreciation in respect of all properties directly related to

production of petroleum initially placed in service in a taxable year shall be
allowed under the straight-line or double declining balance method of
depreciation at the option of the service contractor.

However, if the service contractor initially elects the double declining

balance method, it may, at any subsequent date, shift to the straight-line method.

The useful life of properties used in or related to the production of

petroleum shall be 10 years or such shorter life as may be permitted by the BIR
Commissioner. Properties not used directly in the production of petroleum shall
be depreciated under the straight-line method on the basis of an estimated useful
life of five years.

C. Depreciation of properties used in mining operations

An allowance for depreciation in respect of all properties med in other

mining operation shall be computed as follows:

At the normal rate of depreciation, if the expected life is ten years or l •

Depreciated over any number of years between five years and the expected life if
the latter is more than 10 years and the depreciation thereon allowed as
deduction from taxable income, provided thus the contractor notifies the BIR
Commissioner at the beginning of the depreciation period which depreciation rate
allowed will be used

d. Depreciation deductible by a non-resident alien engaged in trade or business or

resident foreign. Corporation
In the case of a non-resident alien engaged in trade or business or a
resident foreign corporation, a reasonable allowance for the deterioration of a
property arising out of its use or employment or its non-use in the business trade,
or profession shall be permitted only when such property in located in the
Philippines
E Options of a private education institution

A private education institution has the following options relative in

properties acquired subject to allowance for depreciation;
Expenses incurred in the acquisition of property that has been capitalized
can be deducted in full during the taxable year when the property was acquired.
Allocate the acquisition costs over the estimated useful life of the asset by
regularly providing the annual allowance for depreciation.

Charitable and Other Contributions

In general, contributions or gifts actually paid or made within the taxable

year to, not for the use of, the government of the Philippines or any of its
agencies or any political subdivisions exclusively for public purpose shall be
deductible from the gross taxable income of the taxpayer.

The amount of any charitable contribution of property other than money

shall be held on the acquisition cost of said property.

Requisites for Charitable Contributions to Be Deductible

1. There must be actual contributions made. The mere promise to give a donation either
in cash or in property does not give rise to a deductible contribution.
2. The taxpayer giving charitable donations must be engaged in business, trade, or
exercise of profession. Taxpayers who derive income purely from compensation are not
allowed to deduct charitable contributions made.
3 The entity receiving the donations is among those specified by law. Charitable
donations given to an entity not recognized by the law to receive donations are non-
deductible.
4. The net income of the institution must not inure to the benefit of any individual or
private stockholder.

Classifications of Charitable Contributions Charitable and other contributions are

classified as follows:

1. Deductible charitable contributions Deductible charitable contributions are further

classified into the following:
a. Charitable contributions deductible in full

Donations to the following entities or institutions are deductible in full

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 priority activities in the
following:
  Education
 Health
 Youth and sports development
 Human settlement
 Science and culture
 Economic development

Limitations. Donations for economic development shall be in accordance

with the National Priority Plan determined by the National Economic
Development Authority (NEDA), is consultation with appropriate
government agencies, including regional development councils and
private philanthropic person and institutions otherwise any donation made
to the government of the Philippines or any of its political subdivisions
shall be subject to limitations.

b. Foreign institutions or international organizations in compliance with agreements,

treaties, or commitments entered into by the government of the Philippines and the
foreign institutions or international organization or in pursuance of special laws

c. Accredited non-government organizations organized and operated exclusively for

scientific, research, educational, character-building, youth and sport development,
health, social welfare, cultural, and charitable purposes, provided that the following
conditions or requirements are fully complied with otherwise, deductions will be subject
to limitations

The donations or contributions must be utilized directly for the active

conduct for which it was organized not later than the 15th day of the third month
after the close of the taxable year.

The amount of administrative expenses shall in no case exceed 30% of

the total expenses.

In case of dissolution, the assets would be distributed to another non-profit

domestic corporation organized for a similar purpose.

The following are some of the non-profit organizations recognized by the government
where donations are fully deductible:

 Cultural Center of the Philippines Ramon Magsaysay Award Foundation

 Boy Scouts of the Philippines
 Girl Scouts of the Philippines Integrated Bar of the Philippines
 Roxas Educational and Welfare Committee
 National Social Action Council
 International Rice Research Institute Academy of the Philippines
 State colleges and universities
  Philippine School for the Deaf and Philippine National School for the Blind
 Philippine Amateur Athletic Association
 Artesian well funds
 National Museum, National Library, and National Archives of the Philippines

2. Charitable contributions subject to limitations

Charitable or other contributions to the following entities are subject to limitations;

hence, the amount donated or contributed cannot be deducted totally: a Government of
the Philippines or any of its political subdivisions exclusively for public purpose

b. Domestic corporations, associations or institutions organized and operating

exclusively for the following purposes

 Religious
 Charitable
 Scientific
 Youth and sports development
 Cultural or educational
 Rehabilitations of veterans

c. Social welfare institutions

d. Non-government organizations

Amount of Limitation

The ceilings of charitable contributions subject to limitation are as follows:

1. 10% if the donor is an individual taxpayer

2.5% if the donor is a corporation

The basis of the 10% or 5% ceiling is the taxable income before the contribution.

Similarly, the deductible amount is the limitation or the actual contribution,

whichever is lower.

Taxable income relative to the computation of the limitation means the gross
taxable income from trade, business, or exercise of profession minus the allowable
deductions

Non Deductible Charitable Contributions

Charitable and other contributions not expressly covered by taxation laws or any special
law or contributions that did not meet the requirements of the law are non- deductible
contributions,

Basic Procedures in Computing the Deductible Amount

1. Determine whether or not the contributions are excluded.

2. If the contribution is deductible, determine whether the donation is deductible in full or
subject to limitations
3. If the contribution is subject to limitations, compute the taxable income base. The
taxable income base is computed by subtracting allowable deductions, except
charitable contributions, from the gross taxable income.
4. Multiply the taxable income base by the following percentages:
a. 5% if the donor is a corporation
b. 10% if the donor is an individual taxpayer
5. Compare the actual contributions and the results obtained in step 4, and use the
lower amount as the deductible contribution.