chapter 13-A - Ordinary Allowable Itemized Deduct lions CHAPTER 13-A ORDINARY ALLOWABLE ITEMIZED DEDUCTIONS _ chapter Overview and Objectives qhis chapter discusses the rule: q net eductions under the NIRC. S of ordinary (regular) itemized allowable After this chapter, readers are expected to demonstrate: 1. Comprehension of the application of the principles of ded cti i of deduction . juctions on each item 2, Mastery of the deduction conditions, rul » Tules, i each item of deduction from gross ee Ee 3, Mastery of the procedures in computing foreign tax credits ITEMIZED DEDUCTIONS FROM GROSS INCOME 1, Interest expense 2, Taxes 3, Losses 4, Bad debts . . Depreciation Depletion Charitable and other contributions Contributions to pension and trusts 9. Research and development costs 10. Other ordinary and necessary trade, business, fh the selling of goods or rendering of services, these ied as “Ordinary allowable itemized deductions.” ers or professional expenses Ifnot directly connected witl items of expenses are classifi INTEREST EXPENSE Requisites on the deductibility of interest (RR13-2000): 1. There must be a valid indebtedness. 2. The indebtedness must be that of the taxpaye™: , ; 3. The indebtedness must be connected with the taxpayer's trade, business or exercise of profession. . Interest expense must . Interest must have been . Interest must be legally due. . Interest payments must not be between related taxpayers. . Interest must not be incurred t finance petroleum operations. 491 have been paid or incurred during the taxable year. stipulated in writing.NS Chapter 13-A - Ordinary Allowable Itemized Deductions 9. In case of interest incurred in the acquisition of property, used in business or profession, the same is not treated asa capital expenditure," 10. The interest is not expressly disallowed by law to be deducted from Bros 3s income of the taxpayer. Deductible amount of interest expense The deductible amount of interest expense is the gross by arbitrage limit or the arbitrage cap. interest expense req, mr This is referred to as te Mlustration ‘A taxpayer incurred an interest expense of P100,000 and earned P10,000 interest income on deposits in 2023. The deductible interest expense shal] be computed as: Gross interest expense P 100,000 Less: The arbitrage limit (P10,000 x 20%) ——2.000 Deductible interest expense P__98,000 Rationale of the arbitrage limit The limit is intended to recover the tax savings of taxpayers who take advantage of higher regular tax savings created from interest expense deduction and a lower final tax on deposit interest income. Ilustration: The Interest Arbitrate Scheme A corporate taxpayer which is subject to 25% regular corporate income tax borrowed P1,000,000 from a bank which charges 6% interest and invested the same proceeds o a 6% time deposit in the same bank. The following table summarizes the effect of the interest arbitrage within a year: Bank loan P 1,000,000 Interest expense 60,000 Bank deposits 1,000,000 60,000 Interest income Without an interest expense deduction limit, the financial effect of this scheme ca" b¢ analyzed as follows: Net interest income P 60,000 x (100%-20% final tax) P 48,000 Payment of interest expense to the bank ( 60,000 ) Tax savings on interest expense (P60,000 x 25%) ___ 15,000 Financial tax savings from the arbitrage P___3,900 492 — |ro chapter 13-A - Ordinary Allowable Itemized Deductions is will motivate taxpayers to enter into unnecessary loan-and-deposit transactions tosave from total income tax. petermination of the Arbitrage Limit eliminate the arbitrage savings, a deduction cap was set by regulations which is ‘athematically computed as: (Gomer Corporate income tax rate Effect of the Arbitrage Limit Under current corporate income tax rate, the arbitrage limit is (25-20)/25 or 20%. ‘The deductible interest expense with the arbitrage limit can be computed as follows: Gross interest expense P 60,000 Less: 20% x P60,000 interest income Deductible interest expense P 48,000 Multiply by: regular corporate tax rate 25% ‘Tax savings from allowable interest expense P__12,000 Lookat the net savings of the arbitrage with the arbitrage limit: Net interest income [P60,000 x (100%-20%)] P 48,000 Payment of interest expense to the bank (60,000) Tax savings from allowable interest expense __12,000 Overall net tax savings Pp __0 The arbitrage limit is an indirect application of the matching rule. The same result would have been achieved if the law simply provided that only interest expense connected with gross income subject to regular tax is deductible. Mlustration 2 sarge enterprise taxpayer had the following interest expense and interest income in 023: Interest expense on bank loan P 100,000 |nterest income from time deposit, net of final tax 10,000 |nterest income from promissory notes, net of CWT 40,000 The deductible interest expense shall be computed as follows: ies interest expense P 100,000 Ss: The arbitrage limit [(P10,000/80%) x 20%) ——2500 P_97,500 ‘Uctible interest expense 493 frSs It must be emphasized also that the basis of the arbitrage limit is the interest j con, subject to final tax because no arbitrage savings wil Ser a Sees income = subject to final tax. The net interest income must be grosset eae irst by the ercenge het of the final tax (i.e. 100% - 20%) before computing the ar! rage. 2 Chapter 13-A - Ordinary Allowable Itemized Deductions MSMEs qualified to 20% corporate tax | , Itis noteworthy to consider that there is no arbitrage for qualified MSMEs Subjeg to 20% corporate tax. The arbitrage limit would be computed as (20-20)/29 - % As such, qualified MSMEs can deduct the full amount of interest expense Without arbitrage ITmit. Arbitrage is deemed applicable to any taxpayer subject to regular tax. The arbitrage limit is apparently set in the context of corporate tax the NIRC did not distinguish between individuals and corporations of the rule. The revenue regulations did not set a separate |i taxpayers. The rule shall be aj plied to individuals and corporati law did not distinguish, neither should we. Payers. Howevey, in the applicatio, imit for individu ions alike. Since thy Moreover, in applying the limit, the law did not arbitrage limit based on intent. Therefore, whether or not there is an intentional arbitre regulations currently exempt thrift banks fro! Provide for any qualifi it is construed to apply ‘age. Interestingly, m the coverage of t cation of the regardless of however, the revenue the arbitrage limit. Deductibility of discount or pre-deducted interest Discount or pre-deducted interest is a upon release of the loan but upon If the loan is due on installments, be deductible. Prepayment. Hence, it is not deductible | Payment of the same or as it accrues as expense the interest pertaining to each installment shall f Optional Soon of interest expense . irbwitg Casts Interest inejirred in financing the acquisition of property ysed i busines: irre ised in trade or may, at the option of the taxpayer, be claimed as: 1. an outright deduction from 8ross income or 2. a capital expenditure claimable through depreciation Other deductible interest expense 1. Interest from tax delinquency 2. Interest from (CIR vs. Vda. De Prieto) scrip dividends Examples of non-deductible interest 1. Interest on personal loans : 2. Interest incurred with a related pal 3. Discount or pre-deducted inter, St appli ‘ods for individ” taxpayers est applicable to future periods fo 494hate” 13-A - Ordinary Allowable Itemized Deductions interest expense incurred to finance petroleum operations Interest on redeemable preferred shares 6 imputed interest TAXES od witht : Taxes paid or incurre' within the taxable year in connection with the taxpayer's rade, business, or exercise of profession shall be allowed as deduction except: income taxes except fringe benefit tax 1, Philippine i a. Final income tax ~ p. Capital gains tax ~ Regular income tax “ « 4 : » gn income tax, if claimed as tax credit 2, Forel Estate tax and donor's tax 4, Special assessment special assessme pationale of non-deductibility Income taxes are not costs of earning income but are impositions on net income accruing only after income is earned; hence, they are non-deductible. Foreign income tax is not a cost of earning income. However, it is allowed to be claimed as adeduction under the NIRC if not claimed as tax credit. Special assessment is nota taxexpense, but is capitalized to the cost of the land. Other non-deductible taxes 1, Business taxes, in particu! 2, Surcharges or penalties on d Jar the Value added tax (VAT) elinquent taxes and excise tax. Businesses pay VAT or anufacturers of excisable articles such y the excise tax. Business tax includes VAT, percentage tax, percentage tax on their sales or receipts. M: as sin products and non-essential commodities pa on taxes required by the government to In principle, business taxes are consumpti be collected from consumers through the businesses. Hence, they should be recognized by businesses as liability upon making the sales. This principle is well applied under the VAT; hence, VAT is not a deductible expense. However, this is Not the case with percentage tax. contrary to the principle, current regulatory developments treated percentage tax a deductible expense. This might be due to the fact that this treatment yields government higher tax collections: 495Chapter 13-A - Ordinary Allowable Itemized Deductions Businesses subject to excise tax normally include the tax on their Selli | Hence, excise taxes are deductible as tax expenses, PB rig, For the buyer, business taxes form part of the cost of purchases; hence, through cost of sales or other expense categories but not as tax expense. Examples of deductible taxes: Percentage tax * Excise tax Documentary stamp tax Occupational tax License tax Fringe benefit tax 1 Local taxes except special assessment | Community tax | . Municipal tax 10. Foreign income tax if not claimed as tax credit } Only basic tax is deductible Only the basic tax of a deductible tax is allowable as deduction. Tax surcharges for late payments are avoidable and unnecessary expenses; hence, they are noo. | deductible. Moreover, allowing these as deduction will relax policy on tx collection. Nevertheless, interest for late payment of tax was held deductible by the Supreme Court but as interest expense rather than as tax expense. Unused input VAT Historically, unused input VAT on zero-rated sales of services after the expiratice of the two-year prescriptive period is allowed as an item of deduction against gross income. However, the BIR reversed the rule in BIR Ruling 123-2013 by disallowing deduction for lack of legal basis. (See also RMC 57-2013) = FOREIGN INCOME TAX Income taxes paid in a foreign country can either be claimed as: PRI Rn ewNe 1. Deduction I 2. Tax credit Mlustration 1: One foreign country AMSME domestic corporation reported the following: Taxable income from the Philippines P 1,800,000 Taxable income from Japan 1,200,000 Quarterly estimated income tax paid in the Philippines 200,000 Income tax paid in Japan 300,000 496y er 13-A ~ Ordinary Allowable Itemized Deducti ctions hoot | peaution Approach | setiyable income and Income tax liability will si | asableincome from the Philippines simply be computed as follows: | ple income from Japan P 1,800,000 | t J taxable income 1,200,000 foreign income tax expense P3,000,000 qaable income - world —300,000 uly DY: Corporate tax rate P 2,700,000 orate income tax due ——20% omPiippine quarterly estimated tax payments P 540,000 income tax payable P tender the deduction approach, the forei yen as tax credit. \e foreign taxes paid are deducted but will not be tax Credit Approach Thable income from the Philippines P: foable income from Japan Ee eocni qaable income - world 3,000,000 Multiply by: Corporate tax rate 2 0% Corporate world income tax due P 600,000 Less: Tax credit 7 philippine income tax credit P 200,000 Foreign tax credit* “240,000 __440,000 P_160,000 income tax payable ote: Under the tax credit approach, th income but are credited against the inco foreign taxes paid are not deducted against gross me tax due on world taxable income. ne foreign country* Determination of Foreign Tax credit: 01 f the actual foreign income tax paid and the The foreign tax credit shall be the lower 0 fallowing limit: Foreign taxable income Philippine income tax due x World taxable income + Hence, Actual foreign income tax paid P_-300,000 Limit: (1,200,000/3,000,000 x P600,000) P_240,000 P_240,000 foteign tax credit - LOWER foreign country Sea Y ata on its Philippine and foreign lllstration 2: More than on F had the following Alarge domestic corporation Perations: 497Chapter 13-A - Ordinary Allowable Itemized Deductions ‘Taxable income in the Philippines P ope Taxable income from Japan aoe Taxable income from Taiwan : 000, Quarterly income tax paid in the Philippines onions Income tax paid in Japan soe oa Income tax paid in Taiwan x Tax Credit Approach Taxable in ae Philippines 1,800,000 Taxable income from Japan 1,200,000 Taxable income from Taiwan —1500,000 ‘Taxable income - World Income P4,500,000 Multiply by: ——25% Corporate income tax due P 1,125,000 Less: fax credit Philippine income tax credit P 300,000 Foreign tax credit* — 650,000 __ 950,000 Income tax still due B175,000 Determination of Foreign tax credit: With multi The final foreign tax credit shall be the lower of the total of t] country and the world income tax credit it imit computed as follows: Total foreign taxable income X Philippine income tax due World taxable income Per country tax credit: Japan: Actual amount paid P 400,000 Country limit: (P1.2M/4.5M x P1,125,000) 300,000 Lower amount P_ 300,000 Actual amount paid P 350,000 Country limit: (P1.5M/4.5M x P1,125,000) 375.000 Lower amount 2.350.000 Japan allowable tax credit P 300,000 Taiwan allowable tax credit y Total tax credit allowable per country P 650,000 World tax credit limit: [0.2M+1.5M)/4.5M x P1,125,000 tax due} 675,000 Foreign income tax credit (LOWER) P.650,000 498 SS | iple foreign countries* the tax credit allowablee- 1 13-A- Ordinary Allowable Itemized Deductions root! ote (0 readers: peaders are advised to master the tax credit computational pro pecause they also apply to estate tax and donor's tax. cedures herein ocan claim tax credit or deduction for foreign taxes paid? nt with the matching rule, only taxpayers taxable on wo rporations and resident citizens can claim deduction or tax taxes paid. consistel rid income such 4s domestic CO credit forforeign income tment of refunds or credit of taxes ‘The refund or credit of deductible taxes must be reverted back to gross income to fheextent of their tax benefit. Incidentally, the refund of non-deductible taxes is exempt from income tax. qaxtreal sustained during the taxable year and not compensated by LOSSES losses actually ity shall be allowed as deductions. jgsurance or other indemni equsites for the deduction of losses 1 tt must be incurred in trade, profession, or business of the taxpayer. (The loss must be a business loss, not a personal loss.) |. Itmust pertain to property connected with the trade, business or profession, if the loss arises from fires, storms, shipwrecks, or other casualties, or from robbery, theft, or embezzlement. (The loss must be an ordinary loss.) The loss must not be compensated by insurance or indemnity contract. (The lass must be actually sustained, not temporary.) ieee lon of loss must have been filed by the taxpayer within 45 days from the date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss. The loss must not have been claimed as a deduction for estate tax purposes in the estate tax return. (Double deduction is not allowed.) Types of losses 1, Ordinary loss 2 Capital loss Losses from ordinary assets are deemed normal to the taxpayer's trade, business ‘ profession; hence, these are deductible in full. Losses on capital assets are a by law unnecessary expenses not connected with business; hence, these 'edeductible only up to the extent of capital gains. hstration ‘axpayer engaged in farming incurred the following losses: 499Chapter 13-A - Ordinary Allowable Itemized Deductions Loss on destruction of residence bya storm P 1,200,000 Loss on sale of old farm equipment 50,000 Loss on assignment of receivables to a bank 40,000 Purchase cost of a bull lost during a storm , 30,000 Value of animal offspring killed by Black Leg disease 20,000 The following are deductible losses: Loss on sale of old farm equipment P 50,000 Purchase cost of a bull lost during a storm —— 30,000 Total deductible loss P__80,000 Note; 1. The loss on destruction of residence is a Personal loss, ; 2. The loss on assignment of receivable isa capital loss deductible only UP to the exe, ‘apital gain consistent with the tax benefit rule, The lose Of income not yet Fecognize Bross income is non-deductible. 3. The value of dead animal offspring is a loss of income rather than a loss of capital, Hence is non-deductible, Examples of deductible o1 rdinary losses a. Loss on disposal or de: b. Loss due to voluntai cP lue to changes in busing actually realized 4. Abandonment loss Placement of destroyed Properties Total destruction of properties If the restoration involves total replacement of the previous Property, theta basis of the old Property shall be claimed as a loss while the entie replacement cost is Capitalized as cost of the replacement Property subjectto allowance for depreciation, Partial destruction f properties If the restoration involves partial replacement of the Testoration cost shall be expensed up to the ext proberty immediately before the casualty, A\ allowance for depreciation, Mlustration: Total and An uninsured buil later restored at a Previous property, tht ent of the tax basis of the Ny excess is capitalized subject) Partial destruction ding had a boo! total cost of P1, k value of P1,000,000 when a fire broke out. [tw 00,000, Total lossye crate! 43-A - Ordinary Allowable Itemized Deductions sstoration cost of 1,000,000 jal loss ai st that the building was partially destroyed, the re 0 restoration cost shall be nin bt nimgxpensed a5 fire loss while the excess P200,00 Spitalized 25 part of the cost of the building. of value of assets ‘the loss of value of assets, 1m ible nature. However, impairment pededucted- iuustration 1 : rast corporation maintains a fleet of high speed passenger jets. These jets had been fgntyears in service and have an aggregate book value of 200,000,000. Due to the tnreasing incidence of aircraft accident, Congress passed a law shortening the service le of high-speed passenger jets to five years. This resulted in mandatory retirement tithe jets. The jets have current fair value totaling P90,000,000. inthis case, the P110,000,000 impairment loss is deductible, but only upon disposal of thepassenger jets when it becomes actually sustained. as a rule, is not deductible due to their temporary and t losses that became actually sustained can istration 2 D¢ Company uses a cel 600,000 of the preservat thesubstance and require pairment in value will be deductible upon co thorities. ervative in its food products. DC Company had passed a law prohibiting the use of mediate destruction. tain presi tive in stocks. Congress .d their submission to authorities for irm The P600,000 total im nfiscation or submission of the preservatives to au loss on Insured Property ‘the excess of the tax basis of the property over the insurance reimbursement is a deductible loss in the year of insurance settlement. Abandonment losses Inthe event a contract area where petroleum operations are undertaken is abandoned, the accumulated exploration and development expenditures pertaining thereto, including the adjusted tax basis of equipment directly used in the abandoned contract area, shall be ‘allowed as a deduction. Notice of atandonment must be filed with the Commissioner of Internal Revenue. production is resumed or if such then the abandoned well is reentered and ‘uipment or facility is restored into service, the amount of abandonment loss viously claimed shall be reversed and included in gross income in the year of an or restoration and shall also be amortized or depreciated as the case 2. 501OY Chapter 13-A - Ordinary Allowable Itemized Deductions assive activities ering transactions or pi 7 5 Losses rom wagering transactions such 8: gambIINg a other passive Wi shall be allowed only up tothe extent ofthe gains from the same transactac' "ty i n of the matching rule . Tanavere taxable on global income can deduct losses on properties whe, nana = situated, but taxpayers taxable only on Philippine income can only deduct lowe on properties situated in the Philippines. BAD DEBTS 7 Bad debts refer to debts due to the taxpayer which were actually ascertaineg tote worthless and were charged off within the taxable year. Requisites of claim for deduction of bad debt: 1. The debt must have been ascertained to be worthless. 2. It must be charged off within the taxable year. 3. It must be connected with the taxpayer's profession, trade or business (i, uncollectible personal credits are non-deductible). 4. The taxpayer must be under the accrual basis of accounti ing. 5. It must not be incurred from a related party. The accounting bad debt expense called “estimated bad debt expense” is not deductible in taxation because it is a mere estimate rather than an actual loss, The deductible bad debt expense pertains to the write-off of uncollectible receivables after having been actually ascertained to be worthless. In CIR vs. Goodrich, the Supreme Court held that it was essential that the ‘taxpayer did in fact ascertain the debt to be worthless in the year in which the deduction was sought and in doing so, he acted in good faith. Note that the requirement that the taxpayer must be under the accrual basis is inserted by regulations. There is no comparable provision in the NIRC. This rue should not be taken in general, It should be applied only to bad debts representing loss of income and not to bad debts representing loss of capital. Bad debi Tepresenting loss of capital can be deducted by both accrual basis and cash bas taxpayers, IMlustration Mr. Alibaba, a lending investor, loaned a i taxabl period, the corporation be ‘The onthe 000.000. after three me bankrupt, T} i ote interest P240,000 became totally worthless, © °Mtite principal and accrued i If Mr. Alibaba is under the accrual basis, he cing | : 5 he can dedi 1,000 consis 1,000,000 loss of capital plus P24a.agp loss of hricome retreatio expense. If M 502- ver ss $ : : : cropter 13-A - Ordinary Allowable Itemized Deductions pana is under the cash basis, he can, nevertheless, deduct the P1,000,000 as bad debt is se bue not the 240,000 receivable. n of the matching principle) -e-off of receivables in ase of receivables representing loss of income only writ wiih have been previously recognized in gross income can be claimed as bad debt expense- ‘Since accrued income is not reported in gross income under the cash basis: of accounting, cash basis taxpayers cannot claim bad debt expense. securities becoming wo! less > For domestic banks and trust companies a substantial part of whose business is fhereceipts of deposits, securities becoming worthless are bad debt expense and not capital loss. However, the term securities specifically covers only bonds, debentures, notes, certificates, or other evidence of indebtedness with interest pons or in registered form. cou Ilustration la Paz Mindanao Corporation, an accrual basis taxpayer, estimates additional Je accounts of P700,000 aside from the following accounts which probable uncollectibl to be worthless and were written off during the year: were ascertained geceivable from sale of goods to a bankrupt client — P-_ 200,000 investment in a subsidiary liquidated at a loss 1,500,000 aeceivable from sale of services to the subsidiary 100,000 500,000 ‘Advances to the president set off against his salaries ‘The following write-offs are deductible as bad debt expenses: Receivable from a bankrupt client P 200,000 Receivable from a liquidated subsidiary ——100.000 Bad debt expense P_300,000 Note: rvices shall be deductible as bad debt 1. The receivable arising from the sales of goods or se expense by taxpayers under the accrual basis. The est actual expense; hence, they are non-deductible. The loss from the sale or exchanges of property such as ba by arelated party is deductible under the NIRC. The advances to the president recouped agains Compensation expense, not bad debt expense. in the stocks of a subsidiary corporation is a 4 capital investment of a parent corporation ‘pital asset. Hence, the loss on the investment is a capital loss deductible only against ‘apa gains, nota bad debt expense. (China Banking Corporation vs. CTA, G.R. 125508) This le also applies in the case of advances in the nature of capital investments rather than I ‘ans. (Philex Mining Corporation VS. CIR, G.R. 148187) timated uncollectible accounts are not .d debts sustained in liquidation t his salaries should be treated as 503NS Chapter 13-A - Ordinary Allowable Itemized Deductions Examples of capital losses not ledactbte as bad debts 1. Bad debts from personal receivables 2. Securities scant worthless of taxpayers other than domesti c ba, trust companies a substantial part of whose business is ¢| deposits basa 3. Loss on capital investments in partnerships, joint ventures, or Corporation, he Feceipy Subsequent recovery of bad debts : Under the NIRC, the recovery of bad debts previously allowed as a dedu ony the preceding years shall be included as part of the gross income in the Year recovery to the extent of the income tax benefit of said deduction, See discussig, in Chapter 9, Subsequent change in accounting methods ; Bad debt expense sustained by the taxpayer under the cash basis of accountip should not be deducted even if the taxpayer subsequently chan, ged its accountiy method to the accrual basis of accounting. What cannot be done directly cannot be done indirectly, DEPRECIATION There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion and wear and tear (including reasonable allowance fe obsolescent) of property used in the trade or business, Depreciation refers to the gradual exhaustion in the value of tangible busines perties brought by ordinary wear and tear through usage or obsolescence by the passage of time. It isa provision for the periodic return of the invested capt on the property throughout its useful life. Depreciation methods 1. Straight-line method 2. Declining-balance method 3. Sum-of-the-year-digit method 4. Any other method which may be Prescribed by the Secretary of Finance up recommendation of the CIR These methods were discussed in the Preceding chapter, Special Rules on Depreciation 1. Life tenancy to a property 2. Properties held in trust 3. Revaluation on properties 4. Rules on depreciation of Passenger vehicles 504> cnaptet 13-A - Ordinary Allowable Itemized Deductions yyerenancy t0 2 property of property ‘held: by one-person for life with remainder to another deduction shall be computed as if the life tenant was the absolute the property and shall be allowed to the life tenant. 00, er of the erties held in trust .e of property held in trust, the allowable deduction shall be apportioned e income beneficiaries and the trustees in accordance with the -ovisions of the instrument creating the trust, or in the absence of such n the basis of the trust income allowable to each. pers own prop’ nthe ca petween th pertinent pre provisions, © Illustration on Pedro set his daughters, Ana and Karena. building to be given to Ana for her stu family support. The building earned P2,0 depreciation expense in 2020. up an irrevocable trust by transferring a commercial building in favor of Don Pedro designated 10% of the rent income of the dies while 20% shall be given to Karena for her 00,000 rentals and reported P400,000 ye split among the trust and the ‘The gross income and the depreciation expense shall be follows: 10% to Ana, 20% to beneficiaries based on the provision of the trust as Karena and 70% to the trust. Hence, Ana ren Trust__ __Total__ Gross income P 200,000 P 400,000 P.1,400,000 P2,000,000 280,000 400,000 Depreciation expense 40,000 80,000 Note: This provision applies only to a taxable trust. Depreciation on revalued property The depreciation of an asset must be premised on its acquisition cost and not on is reappraised value. (Basilan Estates, Inc. vs CIR) Taxpayers using the rty, plant, and equipment revaluation model in accounting for items of prope! Under Philippine Accounting Standards (PAS) 16 are not allowed to deduct the tepreciation of the revaluation surplus on the value of property as this is not an tual cost. on items of property, plant, and equipment i 7 'nilarly, impairment losses 2 deductible. These are deductible when sustained Te peaeed under PAS 36 are not ugh disposal or retirement of the asset. ation on Passenger Vehicles ‘° with sufficient evidence such as official ing the total purchase price including mbers of the vehicles Ry ca Deductibility of Depreci evstantiation of ‘the purchase witl cits and other documents beari cific motor vehicle identification nw 505 >YY ctions Chapter 13-A - Ordinary Allowable Itemized Dedu ction or relation of the vehich 2. Substantiation of the direct connecti t et 4d lipase pe and/or conduct of the trade, business, op Profess, le : \ ass . 3. ee for land transport is allowed for an official and employ, i 3d P2,400,000. the value of which shall not excee — " 4. Nees shall be allowed for yachts, helicopters, airplanes or airy "and land vehicles which exceeded the threshold unless the main tne business is transport operation or lease of transportation equipmen amg vehicles purchased are used in said operations ing wit idered non-depreciable vehi Vehicles not conforming with these rules are consi i il for taxation purposes. Non-depreciable assets shall be considered capital assets AMORTIZATION OF INTANGIBLE ASSETS The same concepts discussed herein are also applicable to the exhaustion ¢ intangible assets with definite useful life such as patents, royalties, and franchise, The depreciation of intangible assets is referred to as “amortization expense! However, intangible assets that do not lose their value throughout time should net be amortized, Optional Expensing of Capital Expenditure Under the NIRC, private educational institutions are ranted the option to tret ‘penditure as an Outright expense or as a deduction through allowance for depreciation, DEPLETION Depletion expense is a provision for the periodic return of capital investmentsit wasting assets such as minerals, gas, and oil. Stages of wasting asset activities: Exploration perio Exploration stage involves as ration st certaining the exi deposit or mineral, The development stage gente are shown to exist in Sufficient ¢o actual extraction, Processing aj ©, location, extent or quality Lie! © commences when deposits of ore or mine, nd sale! WANtty, Commercigy Production is the stae? Common rules for both minin, 8 and oj] OPerati Taxpayers engaged in Wasting asse are aa shi ify thei tures into: 1. Costs of acquisition or improve, at Of the Soe 2. Intangible exploration, arilling, and developme, tes Nt Costs, 506chapter 13-A - Ordinary Allowable Itemized Deductions sreatment of tangible development costs ongible Ca ee include the acquisition or improvement of tangible property pues pace subject to the allowance for depreciation. This ‘ inclu le on of mine-plant Toads, buildings, processin, lants and installation of heavy equipment on-site. 7 ce Tangible exploration and development drillin costs are itali: through allowance for depreciation subject aa capitalized and deducted the following rules: . Petroleum operations Properties directly used in petroleum Operations The NIRC prescribes either the straight-line method or declining-balance method at the option of the taxpayer for properties directly related to the production of petroleum, A shift from the straight-line method to declining balance method is .,, allowed. The useful life shall be 10 years or such shorter life as may be permitted \ bythe CIR. Properties not used directly in petroleum operations The NIRC prescribed the straight-line method on the basis of an estimated useful life of S years. Mining Operations Ifthe expected life of the property used in mining is 10 years or less, the taxpayer can use the normal rate of depreciation. If the expected life is more than 10 years, the property can be depreciated over any number of years between 5 years and 10 years. (Sec. 34(E)(5), NIRC) Intangible exploration and development costs Intangible costs in petroleum operations include any incidental and necessary costs Ofdrilling wells or preparing wells for petroleum production and which have no salvage value. Intangible costs in mining operations include the costs of diamond ariling meling, and other improvements of a nature that is not subject to allowance for *preciation, Tax treatment of intangible exploration and development costs * Before commercial production - capitalized as cost of the wasting asset * Ae ial production, if incurred with: ne commercial p! 1 red with: fone or mines, deducted in the period paid or incurred i f the taxpayer, either: Produci mines, at the option o! : a ecaneereed amortized using the cost-depletion method or b. Deducted in the year paid * incurredChapter 13-A - Ordinary Allowable Itemized Deductions 2 t-Depletion Method Pane tion aera development cost of P120,000,009 ¢, el es ion in 2023. The following were the nec? Ping, oil well to commercial production in esate extraction activities until 2024: —2023__ _2024 Barrels extracted per year 4000-000 2.000.000 Estimated barrels remaining 56,000, , , Treatment of exploration and development costs ; The exploration and development costs incurred before commercial Production an capitalized as cost of the wasting asset. These will be deducted as depletion expeng using the cost-depletion formula: Units extracted Taxbasis of wastingassets x —__"S@Mtacted Total Estimated Units* "The total estimated units = units extracted for the year+ estimated remaining units The annual depletion ex; computed as follows: Depletion Dec. 31 Year. Computation —Expense _ i —Tax Basis _ P 120,000,000 2023 4M/(4M+56M) x P120M P 8,000,000 112,000,000 2024 (9M/(9M+36M) x P112M ense of the wasting asset and its adjusted tax basis shall be 22,400,000 89,600,000 Note: 1. The year-end tax basis is computed as last year’s tax basis less the annual depletice expense, 2. The P89,600, The Expense Option on Non- ‘Producing Mi; After commercial eee I production has commenced i ie beset » exploration and developm: driling expenses incurred on Ron-producing mines a be deducted outright, b# the deductible amount shall not exceed 25% of the net income from minité operations without the benefit of an ti i i de mt : laws. unclaimed balance of the expense shall be Rel se succeel . we iS until fully deducted, ‘rried forward to the succeeding ye" | Mlustration: The Expense Limit on Posts a Development Drilling Costs °st-Commercial Production Exploratio Diwalwal Mining Company started commerg. ae mm 2022 | CmowBh 2024 reported hefolowing rol uon in 2018 rom 508re ter 13-A- Ordinary Allowable Itemized Deductions chap ' — 2022 _2023 _2024 _ ising erossincome P18,000,000 P17,000,000 19,000,000 er deductible expenses 12,000,000 12,500,000 12,400,000 eration and drilling costs a ron-producing mines 2,100,000 800,000 600,000 wal Mining Company opted to deduct the exploration and development drilling pial 3 (e00) cost as outright expense. annual deductible exploration and development drilling (EDD) expenses shall be ‘The " Aoi ect to the following limits: subj A 2022 _2023__ __2024 _ Mining gross income P18,000,000 P17,000,000 P19,000,000 other deductible expenses 12,000,000 i P 6,600,000 Netincome before EDD expense P 6,000,000 P 4,500,000 Multiply by: Limit % 25% 25% 259 Deduction limi B1500.000 P1125.000 P_1.650.000 evelopment drilling expenses shall be the lower of development drilling expenses and the limit. Thus, __2022 __2023_ _ _—2024 _ EDD Carry-over, beginning P 0 P 600,000 P 275,000 Actual EDD, this year 2.100.000 ___800,000 Total accumulated EDD expense P 2,100,000 P 1,400,000 P 875,000 Less: Deductible EDD expense 1.500.000 __1.125.000 875,000 P_600,000 P__275,000 Po EDD Carry-over, ending the deductible exploration and d the accumulated exploration and fate: The annual deductible EDD expense is determined as the lower of accumulated EDD for theyear and the EDD expense limit. In 2022 and 2023, the EDD limit is lower, but in 2024, the actual accumulated EDD is lower. Note also that the option to deduct intangible exploration and development drilling costs is irrevocable and binding in succeeding taxable years. This rule is applied on a per contract area basis. ‘ons. No comparable rule exists for ploration and development drilling ercial production can be claimed The limit applies only to mining operati Peroleum operators. Hence, petroleum ex, sts on non-producing wells after comm’ Outright. ‘plication of the matching rule abayers subject to tax on world income can deduct depreciation and depletion ease on properties wherever situated. Those taxable only on Philippine ne are only allowed to claim depreciation and depletion on properties located 'n the Philippines. 509Chapter 13-A - Ordinary Allowable Itemized Deductions CHARITABLE AND OTHER CONTRIBUTIONS Contributions or gifts made to the government or non-government OTganiag, (NGOs) may be deducted against gross income. i i tributions: ) Requisites of claim for deduction on co! butions 1. The donee institution must be a domestic institution, 2. No income of the donee institution must inure to the benefit Of any Pri, stockholder or individual. | 3. The contribution must be valued at the tax basis of the property donated, 4. The taxpayer must be engaged in trade or business, 5. The donee must issue a Certificate_of Donation (BIR Form 2322) Whi | includes a donor's statement of values. = | 6. | If the amount of donation is at least PS0,000 the donor shall file a Notice y Donation to the RDO where he is registered within 30 days upon Teceipt ofthy Certificate of Donation. Donations that fail any of the requisites are non-deductible. Those that meet thy requisites are either: a. Fully deductible b. Partially deductible (deductible subject to limit) Classification of contributions A. Fully deductible contribu | tions (Mnemonics: PTA) | 1. Donations to the government or political subdivisions including fully owned | Sovernment and controlled corporations to be used exclusively in undertaking Priority activities as determined by the National Economic Development Authority (NEDA) in: a. Education 4. Human settlements b. Health &. Culture and sports & Youth and sports development Economic developments 2. Donation to foreign institution St international organization in pursuance or in compliance with ‘agreements, treaties or special laws Note that this is an exception to the rule that the donee institution must be a domesii organization, es | | | Donations to accredited domestic non-government organizations. Pursuant to EO 671, the Nco m ith A ust be an accredite, onee institution certifications issued by the following di at con “signated accrediting entities: . a Department of Social Welfare and Development - for charitable and social welfare organizations, found. ‘ations and associations > | WD SW 510chaptet 13-A - Ordinary Allowable Itemized Deductions a artment of Scien ps oe ies f Science and Technology - for research and other scientific ‘sO ¢, Philippine Sports Commission - fo) ah 4 National Council for Culture ani digo @ Commission on Higher Educatic The accreditation by the Philippine Council for N i arene il for NGO Certification, Inc. (PCNC) r Sports development d Arts - for cultural activities ion - for educational activities The accredited donee institution shall issue to the donor a certificate of donation in such form prescribed by the BIR. For donations exceeding P1,000,000 in value, the donor is required to notify the Revenue District Officer (RDO) with jurisdiction to his place of business within 30 days from the receipt of the certificate of donation. Requisites for full deductibility of contributions to accredited NGOs 1, The NGO must be organized and operated exclusively for the above purposes, and no income inures to the benefit of any private individuals. 2. The non-profit organization makes utilization of the contribution not later than the 15t day of the third month after the close of its taxable period. 3. The administrative expenses of the NGO do not exceed 30% of its total expenses. . Members of the Board of Trustees must not receive remunerations. . In the event of liquidation, the asset of the NGO will be distributed to another nonprofit domestic corporation organized for similar purpose. 6 The amount of contribution of property other than money must be valued at acquisition cost. 8. Contributions subject to limit : . Donations to the Government of the Philippines or political subdivisions exclusively for public purposes not in accordance with priority activities i 2 Donation to non-accredited non-government organizations or to domestic corporations organized exclusively for the following purposes: a Religious e. Cultural b. Charitable f, Educational G Scientific g. Rehabilitation of veterans 4. Youth and sports development h. Social welfare timit of deduction for contributions: a on the taxable income deri ibutions: come) before the deduction of any contributions: | 10% for individuals '% for corporations ssion (ie., net 511Ss Chapter 13-A - Ordinary Allowable Itemized Deductions had the following income and donations gy Mlustration 1 Mr. Joshua, a practicing accountant, the year: Professional fees P 1,100,000 Donations to government priority activities 100,000 | Donations pursuant to treaties 30,000 Donations to accredited charitable institutions 50,000 Donations to the government for public purpose 80,000 Donations to non-accredited charitable institutions 60,000 Donations to a foreign charitable institution 40,000 Donations to street beggars 50,000 Other deductible business expenses 600,000 | ‘The deductible contribution expense shall be computed as follows: | Fully deductible contributions: To government Priority activities P 100,000 | To accredited charitable institutions 50,000 To treaty-covered entities —30.000 P__180,000 Partially deductible contributions: | To sovernment non-priority activities P- 80,000 To non-accredited charitable institutions ‘Total contributions subject to limit 2_140,000 Deduction limit P__50,000 Peductible contributions with limit (LOWER) ——50,000 Total deductible contribution expense P__230,000 The deduction limit for Partially deductible Contributions is computed as follows: Professional fees Less: Other deductions before Contribution expense ‘100,000 Net income before contributions P 500,000 Multiply by: individual limit Percentage 10% Deduction limit Note P__50.000 J. The donation to a foreign Institut 3 The donation to beggars is nev made tgs auctibe 3. Contributions t es a unless in accordance wt ect a domestic fon eae tod Wualified donee incurs %€ O7Ganization; hence, itis not . cost nor's tax, stitutions are not deductible against gross in Illustration 2 Mr. John Paul, both employed and self. year:chapter 13-A - Ordinary Allowable Itemized Deductions Gross compensation income Gross income from business P 400,000 Fully deductible contributions 900,000 Contributions deductible with limit 100,000 Non-deductible contributions eee deductible busi ; Other isiness expenses 300,000 ‘the contribution deduction limit shall be computed contribution as follows: puted out of business net income before Gross income from business P 900,000 Less: Other deductible business expense __ 300.000 Net income before contribution P 600,000 Multiply by: Individual limit percentage 10% Deduction limit 260,000 The deductible contribution shall be computed as follows: Fully deductible contributions P 100,000 Partially deductible contributions P__40,000 Limit on partially deductible contributions P__60,000 Deductible contributions with limit (LOWER) 40,000 Total deductible contributions expense P_140,000 Illustration 3 . Batangas Corporation reported the following during a year: Gross income from business a Fully deductible contributions 40,000 Deductible contributions with limit 5000 Non-deductible contributions 300,000 Other deductible expenses , The deduction limit is computed as follows: P 900,000 Gross income from business “300,000 Less: Other deductible expense P 600,000 Net income before contribution Multiply by: Corporate limit percentage p__30,000 Deduction limit Th ’ “tion shall be computed as: : Seduce contribution s! p 100,000 Lully deductible contributions 40,000 Partially deductible contributions ns 230,000 bo on partially deductible contri ER) ___ 30,000 eductible contributions with limit (L p_130.000 tal deductible contributions expense a 5:Chapter 13-A - Ordinary Allowable Itemized Deductions CONTRIBUTIONS TO PENSION TRUSTS Types of Employee Pension Plans: | 1. Defined contribution plan | 2. Defined benefit plan Under defined contribution plan, the employer is merely obligated to make ceray | amounts of contribution to the pension fund on a regular basis, The employe | does not guarantee the amount of benefits to the employees, The amount | benefits to be received by the employees shall be dependent upon the investmen | Performance of the pension fund. Because the employer's liability to the Plan i | defined in terms of contributions, actuarial computation is not necessary, In a defined contribution plan, the deductible expense of the employer is simply the amount of contributions (i » funding) made by the employer to the fund, In case of Participating contribution plans where em, fund as part of their future benef deductible by the employer. Under the defined bene; the employees. The amount of funding which the em be dependent upon the investment performance of the fund. This means less funding if the fund Performs and more if it underperforms. Actuarial | computations would be necessary to determine the employer's contributions to ensure that the promised benefits to Covered employees will be met in due time. Ina defined benefit plan, the employer's contribution or funding is either or both: 1. Funding of current service cost 2. Funding of prior service cost | ployees also contribute in the fits, the portion Paid by employees is Not Current service cost refers to the term of the pension plan for servic , , | In practice, contributions to the Pension fund in excess of current service cost ® | simply presumed as funding of Past service cost without accounting for any prepaid component.chapter 13-A - Ordinary Allowable Itemized Deductions 2, The actuarial assumptions used by the fund i 3, The fund must be actually funded by the em al sound and reasonable. 4, The fund assets must be independent.from and i disposal of the employer. not subject to the control or 5, Contribution for current service cost is deductible in full. | 6, Contribution for past service cost is amortized over a period of 10 years. } Rules in computing the deductible pension expense" | 1, The contribution to the fund is first attributed to current service cost. Contributions is deductible up to the extent of current service cost. | 2, The excess funding is attributed to any unfunded past service cost. Any excess { | funding over the current service cost is presumed funding past service cost and is amortized over 10 years regardless of the actual vesting period of covered employees. Ilustration 1: Defined contribution plan In 2023, Liliwliwa Company contributed P100,000 contribution during the year to its sponsored defined contribution employee trust fund. Employees also made a PS0,000 participation in the fund. The deductible pension expense in 2023 shall be P100,000. Ilustration 2: Defined benefits plan ; _ Mindoro Corporation established a pension plan for its employees in 2023. Existing employees have average vesting period of six years. Data from the actuary together | | with Mindoro’s annual funding is as follows: i P 300,000 P 310,000 | Current i service cost 200,000 500,000 Contributions to the fund The 2023 deductible pension expense shall be: Pension contribution P SOG funding of current service cost ‘Xcess - funding of past service cost pivide by: Amortization period 10 ___80.000 *ductible pension expense B_350,000 Note: 1 P 300,000 P 500,000 it t. Hence, it must be followed The 10- eriod is a statutory requirement a a even if auiee or pee seEHIS cost is expensed outright under financial accounting. The P50,001 tion will end by 2032. ® The eis psousos eae is attributed as funding of prior service cost, The 2024 deductible pension expense shall be: 515oy Chapter 13-A - Ordinary Allowable Itemized Deductions Pension contribution P 500,000 ae Funding of current service cost . ae ote Excess - funding of past service cos! . Divide by: Amortization period at 19,000 Amortization from 2023 funding of prior service cost ____50.000 Deductible pension expense Note: The P19,000 annual amortizations will end by 2033. RESEARCH AND DEVELOPMENT (R&D) COSTS Research activities are geared towards discovery of new knowledge. Developmen activities are geared towards determining application of research knowledge which could provide income and benefits for the business. | Tax Treatment of R&D Costs 1. Research and development costs related to capital accounts such as Proper used in business are capitalized as Part of the cost of the Property and deducted through depreciation expense. Bt 2. Research and development costs not related to capital accounts are treated as j follows at the option of the taxpayer: Bal a. Outright expense or Bt b. Deferred expense amortized over a period beginning from the month the taxpayer realize benefits trons the R&D expenditures EXPENSES, IN GENERAL Other legal, ordinary, actual, and necessa by the taxpayers as long as these are sub; pertinent records. Examples of other deductible expenses: Salaries and allowances 2. Fringe benefits 3. SSS, GSIS, PhilHealth, 4. Commissions 5. Outside services 6. 7. 8 Ty expenses of business can be claimed stantiated with official receipts or other HDMF, and other contributions Advertising Rental |. Insurance 9. Royalties 10. Repairs and maintenance 11. Transportation and travel 12. Fuel and oil 516chapter 13-A - Ordinary Allowable Itemized Deductions 13. communication, light, and water 14, Supplies 15, Entertainment, amusement, and recre 16. insurance companies 17. Miscellaneous expenses Entertainment, Amusement, and Recreation (EAR) Expense EAR expense includes representation expense and/or depreciation or rental expense relating to entertainment facilities. Representation expense shall refer to expenses incurred by a taxpayer in ‘connection with the conduct of his trade, business, or exercise of profession in entertaining, providing amusement and recreation to, or meeting with, a guest or guests at a dining place, place of amusement, country club, theater, concert, play, sporting event or other similar places. Representation expense excludes fixed allowances considered as regular compensation of employees which are subject to the creditable withholding tax. Entertainment facilities refer to a yacht, vacation home or condominium, and any similar item of real property used by the taxpayer primarily for the entertainment, amusement, or recreation of guests or employees. A yacht shall be considered an entertainment facility if its use is in fact not restricted to specified officers or employee position in such manner as to make the same a fringe benefit subject to fringe benefit tax. Requisites of deductibility of EAR Expense 1. It must be paid or incurred during the taxable year. 2. Itmust be directly connected to the development, management, and operation of the trade, business, or profession of the taxpayer or directly related to orin furtherance of the conduct of his or its trade, business, or exercise of a Profession. 3. It must not be contrary to law, order, ! ‘1 id, directly or indirectly, to an official or employee of apne letequeen ars “owned and controlled corporation or of a the government or government : foreign aa private individual, corporation, general professional Partnership or similar entity if it constitutes a bribe, kickback, or other similar Payments. morals, good customs, public policy, or public 517Chapter 13-A - Ordinary Allowable Itemized Deductions ly substantiated with adequate proof. The offi, * ieee ls ae ee of accounts should be in the name of the tat claiming the deductions. ‘ayer 6. The appropriate amount of withholding tax should have been With therefrom and paid to the BIR. hely Ceiling on Deduction ; | * For taxpayers engaged in the sales of goods or properties - 0.59% OF net saley * For taxpayers engaged in the sales of services - 1% of net revenues “Net sales” is computed as gross sales less sales returns, allowances and Sales discounts. “Net revenue" is gross revenue less discounts. * For taxpayers engaged in the sales of both goods or Properties and seryig, the allowable EAR shall in all cases be determined based on following apportionment formula: x Actual EAR Total net sales and net revenue In no case shall the deductible EAR exceed the maximum percentage ceiling for the sales of goods and sales of services. “ IMustration 1 Mr. Aragon, a seller of goods, had net sales of P200,000 and expenses fr entertainment, amusement and recreation of P1,400 in 2023, The deductible EAR shall be the lower of P1,400 and P1,000, computed as (0.5% 200,000); hence, P1,000. “ Mlustration 2 Mr. Esperon is a service provider with a 0 a net revenue of P300,000. He incurred P2,500 in entertainment, amusement and recr: eation expenses during the year. phe deductible EAR shall be the lower of P2,500 and P3,000, computed as (1% * 300,000); hence, P2,500. Mlustration 3 Mrs. Beronia is engaged in both sales total of P9,000 entertainment, am Teported P300,000 in net sales and of goods and sales of services. She incurred usement, and recreation expenses in 2023. P700,000 in net revenues. The deductible EAR shall be computed as follows: 518chapter 13-A - Ordinary Allowable Itemized Deductions Deductible saesofgoods — P 300,000 pr Satan. — Collinge Sales of services z , 1500 P 1,500 700.000 roral BLono009 F——sagg $—~ 2008 —s200 Note: 4P300K/P1,000K x P9,000 = P2,700; P700K/P1,00 . +#P300,000 x 5% = P1,500; 700,000 x 1% eran Seem o te Transfer to reserve fund and payme i i insurance companies Payments to policies and annuity contracts of Under the Insurance Code, non-life insurance companies are required to maintain areserve equivalent to 40% of their gross premium, less returns and cancellations for risks expiring within one year. For marine cargo risks, the reserve is equivalent to the amount of premium on insurance during the last two months of the calendar year. The net additions, if any, required by law to be made within the year to the reserve funds and the sums, other than dividends, paid within the year on policy and annuity contracts may be deducted from the gross income of insurance companies. Even if not an actual expense, special deduction need to be included as part of ordinary allowable itemized deductions pursuant to the regulations. Under current regulations, the transfer to the reserve fund shall be deductible in the year it was actually paid and not in the year it was determined. Also in consonance with the tax benefit rule, the release of the reserve is treated as an income in the year of release. Mlustration The following relates to the performance of an insurance company: fie 272 mee 022 meee 024 we Premium revenue P 2,100,000 P 3,000,000 P2,500,000 Premiums ceded ‘420,000 600,000 500,000 Claims ex; 200,000 800,000 1,000,000 ‘pense | Commissi 100,000 300,000 250,000 mmission expense 350,000 340,000 \dministrative expenses 300,000 , ‘ pence Required legal reserves 672,000 960,00 , Required: Determine the special deductions and the net income assuming that the "equired transfers to the reserve funds were made in the same year. 519ON Chapter 13-A - Ordinary Allowable Itemized Deductions Solution: The net amount which will be paid to or released from the reserve fund is Compu as follows: —2022__2023 2024 Required reserves P 672,000 P 960,000 P800,000 Less: prior year-reserve —___ ___ 672,000 ~260,000 Amount payable (receivable) P__672,000 P__288,000 (2160,000) To simplify our illustration, let us assume that the contributions to the Teserye Were Paid in the same year they were determined, The net income of the insurance company shall be computed as follows: Premium revenue Less: premiums ceded Net premiums Release from reserve 2022 Z P 2,100,000 P 3,000, 20,000 4,000 P2,500,000 10 P 1,680,000 P 2,400,000 P 2,000,000 - = "160,000 Gross income P 1,680,000 P 2,400,000 2,160,000 Less: Ordinary allowable deductions Claims expense P 200,000 P_ g00,000 P1,000,000 Commission expense 100,000 300,000 250,000 Administrative expense Total —340,000 P 600,000 P 1,450,000 P 1,590,000 Special allowable deduction Payment to reserve 672.000 288.000 - Total deductions pl2z2000 P 738.000 Pr seaaad Taxable net income Fa0ho0a p“s62.000 p“s7ouce Note: The release of | Teserve from the reserve fund 's included in gross income. Note to readers; caansfers to reserve fund and Fements to policies and annuity contracts of insurance Soempanles is not actually an onder prenss ©*ense but a legal requisesent Its 2 SPecial deduction but the regulate expressly in itemized deductions, clude it as part of ordinary allowable 520chapter 13-A - Ordinary Allowable Itemized Deductions CHAPTER 13-A: SELF-TEST EXERCISES piscussion Questions 1, Whatare the requisites of a deductible interest? 2 Explain the arbitrage scheme and how to determine the arbitrage limit. 3 eee aeenetty of discount interest and the optional capitalization 4, Discuss the deductibility of taxes and enumerate the non-deductible taxes. 5. Discuss the computation of foreign tax credit. 6, Enumerate the requisites of deductible losses. 7. Enumerate the requisites of deduction of bad debt expense. 8. Discuss the special considerations on depreciation of properties. 9. Discuss the rules on depletion of wasting assets for petroleum and mining companies. 10. Discuss the requisites on deductibility of contributions. Enumerate those fully deductible and partially deductible contributions. 11. What is the limitation on deductibility of contribution expense for corporate taxpayers and individual taxpayers? 12, Discuss the rules on pension expense. 13. Discuss the rules on research and development expenses. True or False 1 - “1. Interest expenses are deductible in full amount if there is no interest income subject to final tax during the period. | ; f 2. Interest incurred in the financing of petroleum operations may at the option of the taxpayer be capitalized or expensed. “ 3. Income tax is not an expense. ' 4. The arbitrage limit applies only when there is an intention: “5, The arbitrage limit applies to all taxpayers including individuals. 6. Interest expenses incurred with related parties are deductible. "7. Interest ona prescribed debt is deductible. = “8. Adeductible interest must not be incurred between related parties. Fo, ‘The allowable deduction for deductible taxes includes the basic tax, surcharge and interest. : 10. Foreign taxes can be claime 11, Foreign corporations and al here is an intentional arbitrage. d as a deduction or tax credit. ; Jiens can claim deduction or tax credit for foreign +. taxes, in whi i i 12. Capital Joss is deductible to the extent of ordinary gain while ordinary loss is y,, deductible in full. ¢ BIR within 45 days from the occurrence of the ‘13. Losses must be reported to th ,, Casualty, robbery, theft, or embe; 14. Depreciation on revaluation su depreciation expense. Jement giving rise to the loss. als of Properties can be deducted as part of 521ized Deductions 7 ble Itemizet -A - Ordinary Allowa Chapter 13-A - Or ‘ne income tax return of the estate and in the State ss in the 15, The claim of the same loss tax return is not allowed. True or False 2 e property is i storation co; not determinable, res! i yf the i 1. If the fair value o! sts 4d to the extent of the basis of the original Pe The exCess over ty expensed to the exten in fair value and is capitalized. 7 asis is treated as an increase in ee only when sustaine Wandreciedt i is deduct ; a aa a aapediatiog Toss of capital can be deducted by cash bas £4, Bad debt expenses between related parties can be deducted as long as these ar i idence. tely supported with documentary evi : Fs. a al investment in a business can be claimed as bad debt expense, 6. The subsequent recovery of bad debt expense must be reverted back to gross__ income to the extent of the tax benefit of the deduction in the year the deductionis made. - 7. Theloss on insured property cannot be deducted. 8. In total destruction of properties, restoration costs are treated as new acquisition of properties. ¥ 9. Losses on wagering transactions are deductible in full. 7 10. With the exception of domestic corporations and resident citizens, expenses incurred abroad cannot be deducted unless incurred in connection with the Philippine business. 11. Contributions are valued at the fair value of the property donated. / 12. The recovery of bad debts by cash basis taxpayers must always be reverted back to gross income. 7 13. The recovery of bad debts by a i gross income. y accrual basis taxpayers may be reverted back to T 14. Capital assets can be depreciated for tax Purposes, 7 15. The depreciation expense on Properties held under is computed as é i " A d under life tenancy ' True or False 3 21 +2. Petroleum operations are ng income allowat " Te not subject allowable to each. exploration and deve Ject to the limit on i i ible ora elopment costs afer’ the deduction of intangible 2 & ae the commencement of commerti +3. Contribution expens, 74. Donations to foreign Trastttbe ithe donee isa dom ic instituti deductible. tions covered by treaty exes eee fully Fs. Contribution expenses are measur exemptions al 7 6. Private educational ing eda tthe fair value of the Owed to deduct capit 522 stitutions are all property donated. ‘al expenditures.chapter 13-A - Ordinary Allowable itemized Deductions 7. The depreciation of revaluati : | ‘No depreciation expense is allowable for henceesoe ra and land vehicles which exceeds P2,400,000 in waive uniere che way tne af ane ness of the taxpayer is eee 400.000 in value unless the main line of ; port or lease of tr i _ 4, Tangible development costs in wasting assets are onntaliced after 10. Intangible exploration and development costs neared posi venmere| bee ction in a wasting asset operation. are capitalized as cost of the wasting 711, After commencement of commercial production, intangible exploration and development costs incurred on non-producing wells or mines are deductible in the period paid or incurred. 12, After commencement of commercial production, intangible exploration and development costs incurred on producing wells or mines are-always capitalized and amortized using the cost-depletion method. . The threshold on partially deductible contributions of corporate taxpayers is 10% of the net income before the contribution. f 14. The funding of past service cost is amortized over 10 years or the actual vesting period whichever is longer. > F 15, The overfunding of defined benefit plans is treated as funding of past service cost and is amortized over 10 years. 16, The employee counterpart in a contributory pension plan is deductible by the employer. - 17, Research and development costs related to land must be capitalized. _ 18. Research and development costs not related to capital accounts are either deducted outright or deferred and amortized over a period of not less than 60 B fe months. _. 19. The EAR expense on the sale of goods is subject to a limit of 0.5% of gross sales. 20. The EAR expense on the sale of services is subject to a limit of 1% of net revenue. - 21, Purely employed individuals can claim deductions for donations made. Multiple Choice: Theory 1 1. Which i isite of a deductible loss? a requisite of a deduct” =~ Which is not a requisite o! is curreitiyeat a. Itmust be sustained by the taxpayer in b. It must be reported to the BIR within 45 days from the occurrence of the loss. i indemnity contracts. : eae mpensated nected to the trade, business or profession of d. Jt must pertain to a property con _ the taxpayer. 2 Which of the following cannot be deducted against gro incame of non-VAT : ilippine income ti a Foreign income tax b. Value added tax d. Percentage tax : 52313-A mized Deductions Chapter 13-A - Ordinary Allowable Itemized De apter 13-A - v .ductihle against gross income? i 5 pais uote i efits given to managerial employ ee @ Fringe benefits to rank and file employees in arners ©. Compensation of minimum wage e oe 4. Salaries of managerial or supervisory i income? 4. Which is deductible tax expense against gross income? (2) Documentary stamp tax B. Donor'stax Estate tax 4. Foreign income tax claimed as tax credit 5. Which is deductible in the measurement of net income from business or | profession? a. Mandatory payroll deduction b. Tuition fees of the taxpayer's brother ¢. Interest expense on borrowings from family members alaries of personal securi erial employee 6 Which ofthe following fan treat capital expenditures as gutright deduction? a. Public schools or universities 2. Non-profit schools or universities Private educational institutions 4. ‘Allof these x“ Which isa correct Statement? 2. Gains between related Parties are exem, b. Losses between Telated parties are deductible, ©) Gains between elated parties are taxable, a. Alloftheal Ove 8. Who are not related parties for. UrPOses of the NIRC? a Fiduciary of trues with he same pese He NIRC? b. The trustee and the beneficiary Ofa trust c Corporations under ‘ mmen control @ Apartner and the Partnershi pt from income tax. Which is a dedu ctible tax expense a. Surcharges and pen; n alties Stock transactioy tax ) Real proper tax on busine, I SS pro} @ Specis assessment erties 10. Which of the fol Je ded : 2 Philippine income fay es Vali eY 8 VAT taxpayers b. Donor’s tax led Tax : 7chapter 13-A - Ordinary Allowable Itemized Deductions 11, Who cannot claim foreign income tax credit? a. Resident citizens Resid i ; ; lent b. Domestic corporations d-None of ae : 42, Foreign income tax can be claimed a Deduction from gross Tax credit against the income income b. No Ye 2 es ‘e Yes N a No ° 7 No 13. Estimated quarterly income tax can be claimed as Deduction from gross Tax credit against the income income tax due z Yes Yes No Yes m Yes No d. No No 14, Fringe benefit tax can be claimed as Deduction from gross Tax credit against the income income tax due Yes Yes No _ Yes 4 Yes - No. No No 15. Which of these expenses is not part of the deductible expenses of the taxpayer? a. Expanded withholding taxes on certain expenses q i it loyee salaries b. Withholding tax on employ’ epee © Qocumentary stamp tax on the sale of-stocks directly toa buyer Real property tax on business properties Multiple Choice: Theory 2 : La taxpayer incurred research and develo} expenditures which are related to a capital account subject to depreciation. ‘The taxpayer should a. 7 ‘ction for the research and development expenses. claim outright dedu deferred expenses and amortize them over 60 b. treat the R&D expenses as 2 months. ; ditures te . ©) treat the R&D e: .es as capital expen’ useful li 525i tions Chapter 13-A - Ordinary Allowable Itemized Deduc! d. claim them as outright deductions or treat them as deferred cha . claim amortize them over 10 years. 7 2. Wagering losses are deductible Byatt b. totheextent of capital gains. ee © upto the extent of gains on wagering transactions 0 d._are treated as deferred charge subject to amortization over 60 months, 3! Securities becoming worthless is considered as an ordinary loss to |. Banks c. Security dealers . Trusts @All of these ~ 4. Bad debts include @ uncollectible debts due to the taxpayer. ~ b. securities becoming worthless. . Bothaandb d. Neither anorb 5S. Which of these is a artially deductit ibution? @) Donation to the government fc lic purpose ~ b. Donation to priority activities of the government c. Donation to foreign institutions with treaty exemption 4. Donation to accredited charitable institutions 6. Resear cost that are not chargeable to capital account can be claimed as SS a. Deductible expense b. Deferred expense subject to amortization c. Bothaandb . @ Eithera orb 7. A taxpayer pad for research and developme Yt not chargeablets cata acount The apne eSB expenses that are nach payer wished t i it ected period of benefits, ‘© amortize the same over its exp I the R&D is expected to benefit th wl . . rr Semon eiod forthe RAD expenses eet" 6 Years, what is the co @) 72 mont ©.30 months ~ mnths - b. 80 months 4.36 months 8. Which can claim a) Security dealers b. Non-security dealers eduction for ihe loss of securities becoming worthless? Both a and aecoming worth’ 4. Neither a nor ¢ 526 TBeS anyChapter 13-A - Ordinary Allowable Itemized Deductions 9, Which of the following items expenses.can be claimed as a deduction? a. Entertainment expenses b. Entertainment expenses not rece’ c, Entertainment expenses in exces, 10, Balanga Inc. owns 51% of the vi statement regarding gains and losses between a. Losses sustained by Balan; claimable as deductions, b. Losses sustained by Quezon, claimable as deductions, of entertainment, amusement and recreation Paid to officials of the government ipted in the name of the taxpayer. ti S of the limits of the law @ Entertainment expenses for potential and oxi; ing clients oting power of Quezon, Inc. Which is a correct these two entities? ga, Inc. on transactions with Quezon, Inc. are Inc. on transactions with Balanga, Inc. are c. Gains realized by either party from each other are exempt from income tax due to the underlying economic substance of their relationship. @ Gains between Balanga and Quezon are subject to income tax. Multiple-Choice: Problems 1 1. The following relates to a taxpayer: Interest expense Interest income ~ time deposit Compute the deductible interest expense. 4. P380,000 c. P333,000 P367,000 d. P300,000 2. The following relates to a taxpayer: Interest expense Interest income - promissory notes Compute the deductible interest expense @ P400,000 c. P333,000 b. P367,000 d. P300,000 3. The taxpayer has the following losses: Net Operating Loss Carry Over - last year Net capital loss - current Net capital loss - last year Ordinary loss Taxable income before losses 527 P 400,000 100,000 P 400,000 100,000 P 200,000 80,000 70,000 50,000 400,000