Module No.

12 – Regular Allowable Itemized Deductions

Learning Outcome/s:
To master the conditions of deductions, rules, and computational procedures of each item of deduction
from gross income.

Core Values/Biblical Principles:

You are my hiding place and my shield; I hope in your word. – Psalm 119:114 (ESV)

Introduction:
Regular allowable itemized deductions are those expenses that are not directly connected with the selling
of goods or rendering of services.

Body:
Itemized Deductions from Gross Income

A. Interest expense

Requisites on the deductibility of interest:

1. Must be connected with the trade or business of the taxpayer.
2. There must be a liability to pay interest and the obligation to pay the interest must be stipulated
in writing and must be legally due.
3. Must be paid or accrued within the taxable year.
4. Interest expense must be the obligation of the taxpayer.
5. Interest payment must not be between related taxpayers.

Deductible amount of interest expense:

The deductible amount of interest expense is the gross interest expense reduced by the arbitrage
limit (or arbitrage cap) amounting to 33% beginning January 1, 2009.

*CREATE Law: 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, however, that the taxpayer’s otherwise allowable deduction for interest
expense shall be reduced by 20% of the interest income subjected to final tax.

Arbitrage limit – is the percentage of interest income subject to final tax.

Optional treatment of interest incurred to acquire property used in trade or business

1. Immediately expensed; or
2. Capitalized as part of the cost of the property.

Non-deductible interest
1. Interest paid in advance (thru discount) by a cash-basis taxpayer. The interest expense is not
allowed to be deducted in the year the cash-basis taxpayer takes out the loan.
2. Interest paid between members of a family or related taxpayers defined under the NIRC.
a. Between the taxpayer and his brothers/sisters, spouse, ancestors, and lineal descendants;
b. Between a corporation and an individual who owns, directly or indirectly, more than 50% in
value of the outstanding stock of such corporation (except in cases of distributions in
corporate liquidation);
c. Between two corporations where more than 50% in value of the outstanding capital stock of
each corporation is owned, directly or indirectly, by the same individual (except in cases of
distributions in corporate liquidation);
d. Between grantor and fiduciary (trustee) of a trust;
e. Between the fiduciaries of two trusts having the same grantor;
 f. Between the fiduciaries and a beneficiary of a trust.
3. If debt is incurred to finance petroleum exploration.
4. Interest expense attributable to income without the Philippines of an alien or foreign
corporation.
5. Interest on preferred stock which is actually a dividend.
6. Interest on debt incurred to purchase a tax-exempt security.
7. Interest which is not stipulated in writing / Imputed interest.

Illustration
Assume a taxpayer paid Php 200,000 interest expense on a business loan in 2020 and received net interest
income from a deposit of Php 40,000.

Gross interest expense Php 200,000

Less: limit ((40,000/80%) x 33%) 16,500
Deductible interest expense Php 183,500

B. Taxes

Requisites:
1. Paid or incurred within the taxable year.
2. Must be connected with the profession, trade or business of the taxpayer.
3. Directly imposed on the taxpayer.

Examples of deductible taxes:

1. Percentage tax
2. Excise tax
3. Documentary stamp tax
4. Occupational tax
5. License tax
6. Fringe benefit tax
7. Local taxes except special assessment
8. Community tax
9. Municipal tax
10. Foreign income tax if not claimed as tax credit

Examples of non-deductible taxes:

1. Philippine income taxes (FIT, CGT, RIT)
2. Foreign income tax if claimed as tax credit
3. Estate tax
4. Donor’s tax
5. VAT (Exception: input VAT allocated to exempt sales)
6. Special assessment’
7. Surcharges or penalties on delinquent taxes (Exception: the interest imposed due to the same is
deductible.)

Foreign income tax (Deduction approach)

Illustration
A domestic corporation reported the following result of operations:
Taxable income from the Philippines 1,800,000
Taxable income from Japan 1,200,000
Quarterly estimated income tax paid in the PH 200,000
Income tax paid in Japan 250,000

Taxable income from the Philippines 1,800,000

 Taxable income from Japan 1,200,000
Total income 3,000,000
Less: Foreign income tax expense 250,000
Worldwide taxable income 2,750,000
Multiply: Corporate tax rate 25%
Corporate income tax due 687,500
Less: Philippine quarterly estimated tax payments 200,000
Income tax payable 487,500

Tax credit approach

Determination of foreign income tax credit
1. One foreign country – lower of the actual foreign income tax paid and the following limit:
Foreign taxable income
X Philippine income tax due
World taxable income

Illustration
Assume the same information on the previous illustration.
Taxable income from the Philippines 1,800,000
Taxable income from Japan 1,200,000
Total income 3,000,000
Multiply: Corporate tax rate 25%
Corporate income tax due 750,000
Less: Tax credits
Philippine income tax credit 200,000
Foreign tax credit [lower of 250k and 300k*]
*1,200,000 / 3,000,000 x 750,000 = 300k 250,000 450,000
Income tax payable 300,000

2. With multiple foreign countries – lower of the total of the tax credit allowable per country and
the world income tax credit limit computed as follows:
Total foreign taxable income
X Philippine income tax due
World taxable income

Illustration
A domestic corporation had the following data on its Philippine and foreign operations:
Taxable income in the Philippines 1,800,000
Taxable income from Japan 1,200,000
Taxable income from Taiwan 1,000,000
Quarterly income tax paid in the Philippines 300,000
Income tax paid in Japan 400,000
Income tax paid in Taiwan 200,000

Taxable income from the Philippines 1,800,000

Taxable income from Japan 1,200,000
Taxable income from Taiwan 1,000,000
Total income 4,000,000
Multiply: Corporate tax rate 25%
Corporate income tax due 1,000,000
Less: Tax credits
Philippine income tax credit 300,000
Foreign tax credit [lower of 500k* and 550k**]

*Japan: 400k vs. 300k [1M x 1.2M/4M] → 300k

Taiwan: 200k vs. 250k [1M x 1M/4M] → 200k

**1M x (1.2M + 1M)/4M = 550k 500,000 800,000

 Income tax payable 200,000

C. Losses

Requisites:
1. It must be incurred in trade, profession, or business of the taxpayer.
2. It must 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.
3. The loss must not be compensated by insurance or indemnity contract.
4. A declaration 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.
5. The loss must not have been claimed as deduction for estate tax purposes in the estate tax return.

Types of losses
1. Ordinary loss
2. Capital loss

D. Bad debts

Requisites:
1. There must be a valid and subsisting debt owed the taxpayer.
2. The debt must be connected with the trade, business, or profession of the taxpayer.
3. The debt must be ascertained to be worthless or uncollectible.
4. The debt must be charged off within the taxable year.

Recovery of bad debts previously allowed as a deduction is governed by the tax benefit rule. It is
included in the gross income if its deduction in a previous year resulted in an income tax benefit of
the taxpayer (i.e., a decrease in tax).

Non-deductible debts:
1. Bad debts not connected with trade, business, or profession of the taxpayer.
2. Bad debts between related parties defined under the NIRC.
3. When mortgage is foreclosed and the collateral is bought by the mortgagee in the foreclosure
sale, the difference between the amount of the loan and the purchase price of the collateral is
not allowed as a bad debt deduction. Any loss is deferred until the property is eventually sold by
the mortgagee.

E. Depreciation

Requisites:
1. Asset must be used in trade, business, or profession of the taxpayer.
2. Asset has a limited useful life.
3. Allowance for depreciation must be reasonable.
4. Allowance for depreciation must be charged off during the taxable year.

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 upon recommendation
of the CIR

Optional expensing of capital expenditure

 Private educational institutions are granted the option to treat capital expenditure as an outright
expense or as a deduction through allowance for depreciation.

F. Depletion

Stages of wasting asset activities:

1. Exploration stage – involves ascertaining the existence, location, extent or quality of any deposit
or mineral.
2. Development stage – commences when deposits of ore or minerals are shown to exist in
sufficient commercial quantity.
3. Commercial stage – stage of actual extraction, processing, and sale.

Common rules for both mining and oil operations

Taxpayers engaged in wasting assets shall classify their expenditures into:
1. Costs of acquisition or improvement of tangible properties
2. Intangible exploration, drilling, and development costs

Treatment of tangible development costs

1. Petroleum operations
a. Properties directly used in petroleum operations – either straight line method or declining
balance method at the option of the taxpayer; useful life shall be 10 years or such shorter life
as may be permitted by the CIR.
b. Properties not used directly in petroleum operations – straight line method on the basis of
an estimated useful life of 5 years.

2. Mining operations – if the expected life of the property used in mining is 10 years or less, the
taxpayer can use the normal rate of depreciation; if more than 10 years, the property can be
depreciated over any number of years between 5 years and 10 years.

Treatment of intangible exploration and development costs

1. Before commercial production – capitalized as cost of the wasting asset

2. After commencement of commercial production

a. If incurred with non-producing wells or mines – deducted in the period paid or incurred

*Deductible amount shall not exceed 25% of the net income from mining operations without
the benefit of any tax incentives under existing laws. Unclaimed balance of the expense shall
be carried forward to the succeeding years until fully deducted.

b. If incurred with producing wells or mines – either capitalized and amortized using the cost-
depletion method or deducted in the year paid or incurred

G. Charitable and other contributions

Requisites:
1. Contributions or gifts are actually paid.
2. Given to entities specified by law.
3. Net income of the recipient does not inure to the benefit of any stockholder or individual owner.
4. Taxpayer making the charitable contribution must be engaged in trade, business, or profession.

Valuation: The amount of any charitable contribution of property other than money shall be based
on the net book value of said property as reflected in the financial statements of the donor.

Classification of contributions
 1. Fully deductible contributions
a. Donations to the government or political subdivisions including fully owned government and
controlled corporations to be used exclusively in undertaking priority activities as determined
by the National Economic Development Authority (NEDA) in: education, health, youth and
sports development, human settlements, culture and sports, or economic developments.

b. Donation to foreign institution or international organization in pursuance of, or in compliance

with agreements, treaties, or special laws.

c. Donations to accredited domestic non-government organizations.

Requisites for full deductibility of contributions to accredited NGOs:

✓ NGO must be organized and operated exclusively for the scientific, research,
educational, character-building, youth and sports development, health, social
welfare, cultural, or charitable purposes.
✓ No part of the net income of such NGO inures to the benefit of any private individual.
✓ Uses the donation not later than the 15th day of the 3rd month after the close of its
taxable year.
✓ Its administrative expense is less than or equal to 30% of total expenses.
✓ Its assets, upon dissolution, shall be given or distributed to another NGO organized
for a similar purpose, or to the state for a public purpose.

2. Contributions subject to limit

a. Donations to the government of the Philippines or political subdivisions exclusively for public
purposes not in accordance with priority activities.

b. Donation to non-accredited non-government organizations or to domestic corporations

organized exclusively for the following purposes: religious, charitable, scientific, youth and
sports development, cultural, educational, rehabilitation of veterans, or social welfare.

Limit of deduction for contributions:

a. For individuals – 10% of the taxable income derived from trade, profession, or business
without the benefit of the charitable deductions
b. For corporations – 5% of the taxable income derived from trade, profession, or business
without the benefit of the charitable deductions

Illustration
Batangas Corporation reported the following during a year:
Gross income from business 900,000
Fully deductible contributions 100,000
Deductible contributions with limit 40,000
Non-deductible contributions 20,000
Other deductible expenses 300,000

Deduction limit = Net income before contribution x 5% = 600k x 5% = 30,000

Total deductible contributions = 100,000 + (lower of 40k and 30k) = 130,000

H. Contributions to pension and trusts

Requisites:
1. Employer must have established e pension or retirement fund to provide for payment of
reasonable pensions to employees.
2. The actual assumptions used by the fund must be sound and reasonable.
3. The fund must be actually funded by the employer.
 4. The fund assets must be independent from and not subject to the control or disposal of the
employer.
5. Contribution for current service cost is deductible in full.
6. Contribution for past service cost is amortized over a period of 10 years.

Illustration
Mindoro Corporation established a pension plan for its employees in 2019. Existing employees have
average vesting period of six years. Data from the actuary together with Mindoro’s annual funding is
as follows:
2019 2020
Past service cost Php 1,200,000 -
Current service cost 300,000 310,000
Contributions to the fund 800,000 500,000

2019 2020
Pension contribution 800,000 500,000
Funding of CSC 300,000 300,000 310,000 310,000
Excess – funding of PSC 500,000 190,000
Amortization period 10 50,000 10 19,000
Amortization from 2019 funding 50,000
Deductible pension expense 350,000 379,000

I. Research and development costs

May be:
1. Deducted as ordinary and necessary expenses. Taxpayer cannot use this option if the expenditure
is: a. for the acquisition of land or improvement of property which is subject to depreciation or
depletion; or b. for the purpose of ascertaining the existence of location, extent, quality of a
deposit ore or other mineral, such as oil and gas.
2. Treated as deferred expense and amortized over a period of not less than 60 months beginning
in the month that benefits are first realized from the expenditure.

J. Other ordinary and necessary trade, business or professional expenses

Requisites:
1. Ordinary and necessary for the business.
2. Incurred or paid during the taxable year.
3. Connected with the trade, business, or profession of the taxpayer.
4. Reasonable expenses of the business.
5. Substantiated by official receipts/records.
6. Withholding tax required to be withheld has been withheld and remitted to the BIR.

Examples:
1. Compensation expenses of employer for personal services actually rendered
2. Travelling expenses
3. Entertainment, amusement, and recreational expense (EAR)
✓ Includes representation expense and/or depreciation or rental expense relating to
entertainment facilities.
✓ Subject to the following ceilings:
• For taxpayers engaged in the sale of goods and properties: ½ of 1% of net sales
• Fore taxpayers engaged in the sale of services/leasing of properties: 1% of net
revenues

4. Materials and supplies actually consumed in business

 5. Maintenance and repairs which do not add to the value of the property nor appreciably prolong
its life
6. Rental expense of the lessee of property used in business
✓ Advance or prepaid rentals are not allowed to be deducted in the year of payment. It
shall be apportioned over the term of the lease.
✓ Taxes and other obligations of the lessor which are paid by the lessee are allowed as
deductions.
✓ Depreciation of leasehold improvement is allowed as deduction to the lessee.

7. Advertising and other selling expenses

8. Operating expenses of transportation equipment used in the trade, profession, or business
9. Insurance premiums against fire, storm, theft, accident, or other similar losses in the trade or
business
10. Miscellaneous expenses
✓ Amortization of pre-operating expenses, which are treated as deferred expenses, for not
more than 60 months.
✓ Costs of suits are allowed as deductions.
✓ Judgements against the taxpayer less any amount compensated for by insurance or
otherwise.
✓ Amortization of the discount upon issuance of a corporation’s bonds.
✓ Loss upon a corporation’s retirement of its own bonds.

Summary:
The above itemized deductions are not the exhaustive list of allowable deductions. Other expenses may
be allowed provided that such expenses are ordinary and necessary for the business of the taxpayer.

References:
Income Taxation, Rex Banggawan 2019 Edition