ACP FILIPINA T.

RIBAYA GERONIMO TAXATION 2

City University of Pasay, College of Law Allowable Deductions

ALLOWABLE DEDUCTIONS (SEC. 34)

DEDUCTIONS
 Deductions are amounts allowed by law to reduce the gross income to taxable income.
 These amounts are allowed to taxpayers by legislative grace and the taxpayer claiming them
must prove compliance with the provisions of the law authorizing the deductions
 Deductions and exclusion both reduce actual gross income although exclusions are not included
in the income tax return. 1

Taxpayers allowed to claim Allowable Deductions under Section 34:

1. Section 24A – RC, NRC (OFW/Seamen), RA, AEMOP (under TRAIN Law)
2. Section 25 A – NRAETB
3. Section 26 – GPP partners
4. Section 27 – Domestic Corporation, Proprietary Educational Institutions and Hospitals and GOCCs
Agencies and Instrumentalities
5. Section 28 (A) (1) – Resident Foreign Corporations

Taxpayers NOT ALLOWED to claim Allowable Deductions:

1. NRANETB
2. International Carriers
3. Offshore Banking Units
4. Branches of Foreign Corporations on the profits remitted to their head offices
5. MC/RHQs/ROHQs
6. NRFC
7. For Individuals who are Purely Compensation Income Earner:
i. No deductions allowed since Personal Exemptions and Payment on Health and/or
Hospitalization Insurance have been removed by TRAIN Law
ii. Taxable Income is the individual’s gross compensation income less non-taxable
income/benefits like 13th month pay and other benefits like de minimis benefits
and employee’s share in the SSS, GSIS, PHIC, PAG-IBIG contributions and union
dues.

General Rule for the Deductibility of Certain Transactions From Gross Income:
1. Deductions must be paid or incurred in connection with the taxpayer’s trade, business or the
exercise of profession
2. Deductions must be paid or incurred during the taxable year
3. Deductions must be supported by adequate receipts or invoices; and
4. Deductible expense must have been subjected to withholding tax.

Three Types of Deductions from Gross Income:2

1. The itemized deductions in Section 34 A-J for individuals and corporations allowed to claim
deductions;

1
Ingles, Tax Made Less Taxing p. 149
2
Mamalateo, Reviewer on Taxation p. 299
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

2. Optional Standard Deduction (OSD) of 40% on the gross sales or receipts (S34 L) for Individuals
allowed to claim deductions; OSD of 40% of its gross income as defined in S32 for DC & RFC
 A GPP and the partners comprising such partnership may only use OSD once; either by
the GPP or the partners comprising the partnership. So, if the GPP avails of OSD, then the
partners may not.3
 The share in the net income of the GPP, actually or constructively received, shall be
reported as taxable income of each partner. The partners comprising the GPP can no
longer claim further reduction from their distributive share in the net income of the GPP
and are not allowed to avail of the 8% income tax rate option since their distributive share
from the GPP is already net of cost and expenses. 4

3. The Special Deductions in Section 37 and 38 of the NIRC and in special laws like the BOI as well as
deductions allowed for private educational institutions under Section 27 B, i.e. :
a. To deduct expenditures otherwise considered as capital outlays of depreciable assets
incurred during the taxable year for the expansion of facilities.
b. To deduct allowance for depreciation thereof under Subsection 34 F.

Itemized Deduction:

 Itemized deductions are expenses and losses related to trade or business or the practice
of a profession.
 Itemized deductions are what Section 34 talks about, and these do not apply to taxpayers
earning compensation income from an employer-employee relationship or the purely
compensation income earner.

The following are the itemized deductions under Section 34 A-J:

A. Expenses
B. Interest
C. Taxes
D. Losses
E. Bad Debts
F. Depreciation
G. Depletion
H. Charitable and other contributions
I. Research and Development
J. Pension Trust

SEC. 34 (A) EXPENSES:5

Business Expenses vis-à-vis Capital Expense

3
Ingles, TRAIN Supplement, p. 2
4
Mamalateo, Reviewer on Taxation, p. 300
5
See Casasola, NIRC, Title II Chapter 7
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

“Business Expenses” are expenditures related to the conduct of the business of the TP and
deductible in the year incurred. While “Capital Expense” are expenditures that improve or add to the
value of the property or equipment of the business. They are not immediately deductible, but may be
deducted overtime in the form of Allowable Deductions.

Requisites for the deductibility of business and professional expenses:

1. The expenses must be ordinary and necessary;

An expense is “ordinary” when it connotes a payment, which is normal in relation to the business
of the TP and the surrounding circumstances.
An expense is “necessary” where the expenditures is appropriate or helpful in the development
of the TP’s business or that the same is proper for the purpose of realizing a profit or minimizing
a loss.

2. Must be paid or incurred during the taxable year;

“Paid or incurred during the taxable year” means that the deduction shall be taken for the
taxable year I which paid or accrued or paid or incurred depending upon the accounting method
in which taxable income is computed. Under the accrual method of accounting, expenses not
claimed as deduction in the current year when they are incurred cannot be claimed as deduction
from income for the succeeding year.

3. Must be paid or incurred in carrying on the trade or business, or the exercise of profession by the
TP, or attributable to the development, management or operation of the trade, business or
profession;
4. Amount must be reasonable;
5. Must be substantiated by sales invoice or OR, records, or other pertinent documents showing the
amount of expenses and the direct connection to the business;
6. If subject to withholding tax, the same should be properly withheld and remitted to the BIR
through the AABs;6
7. Must be legitimately paid (not contrary to law, morals, public policy or public order) or not in the
form of bribe, kickbacks and other similar payments.

BUSINESS EXPENSES:

1. Salaries, Wages, compensation for services rendered; pensions, compensation for injuries,
commissions;
2. Benefits to employees, including “de minimis benefits” and the grossed-up monetary value of
fringe benefits subject to FBT;
3. Travelling expenses (here and abroad) while away solely in the pursuit of a trade or business;
4. Rentals for the use of business property
5. Entertainment, amusement and recreation expenses
6. Incidental repairs;
7. Cost of materials and supplies
8. Advertising expenses and other selling expenses;
9. Professional services;

6
RR No, 17-2003. See, Mamalateo, Reviewer on Taxation, p. 305
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

10. Insurance premiums against fire; storm; theft, accident, or other similar losses in the case of a
business
11. Equipment used in the trade or business;
12. Organizational and operating expenses
13. Management expenses
14. Training expenses;
15. Other necessary expense incurred in carrying out the business;

Business Expenses; discussed:

1. Salaries and other forms of compensation for personal services actually rendered.
a. Bonuses to employees will constitute allowable deductions from gross income when
such payments are made in good faith and as additional compensation for services
actually rendered by the employee, provided such payments, when added to the
stipulated salaries, do not exceed a reasonable compensation for the services
rendered.

2. Fringe Benefit Expense

a. The grossed-up monetary value of the fringe benefit given to the managerial or
supervisory employees may be deducted provided that the said fringe benefits given
has been subjected to the FWT on the fringe benefits as required under Sec. 33.

FRINGE BENEFIT (Sec. 33)

(B) Fringe Benefit defined. - For purposes of this Section, the term 'fringe benefit' means any good,
service or other benefit furnished or granted in cash or in kind by an employer to an individual
employee (except rank and file employees as defined herein) such as, but not limited to, the following:

(1) Housing;
(2) Expense account;
(3) Vehicle of any kind;
(4) Household personnel, such as maid, driver and others;
(5) Interest on loan at less than market rate to the extent of the difference between the market
rate and actual rate granted;
(6) Membership fees, dues and other expenses borne by the employer for the employee in
social and athletic clubs or other similar organizations;
(7) Expenses for foreign travel;
(8) Holiday and vacation expenses;
(9) Educational assistance to the employee or his dependents; and
(10) Life or health insurance and other non-life insurance premiums or similar amounts in
excess of what the law allows.

NON-TAXABLE FRINGE BENEFITS

ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

(C) Fringe Benefits Not Taxable. - The following fringe benefits are not taxable under this
Section:

(1) fringe benefits which are authorized and exempted from tax under special laws;
(2) Contributions of the employer for the benefit of the employee to retirement, insurance and
hospitalization benefit plans;
(3) Benefits given to the rank and file employees, whether granted under a collective
bargaining agreement or not; and
(4) De minimis benefits as defined in the rules and regulations to be promulgated by the
Secretary of Finance, upon recommendation of the Commissioner.

DE MINIMIS BENEFITS:

De miniimis benefits are facilities and privileges of relatively small value offered by an employer
to his employees. These are not subject to income tax if such facilities are offered by the employer to
promote the goodwill, health, contentment or efficiency of the employees:

The following are considered de minimis benefits of ALL types of employees. They are
EXEMPT from tax. (R.R. 8-2000):7

a) Monetized unused vacation leave credits of private employees, not exceeding 10 days
per year.
b) Monetized value of vacation and sick leave credits paid to government officials and
employees (R.R. 5-2011)
c) Medical cash allowance to dependents of employees, not exceeding P1,500 per
employee per semester or P250/month. (R.R. 11-2018)
d) Rice subsidy of P2,000 or 1 sack of 50 kg rice per month amounting to not more than
P2,000. R.R. 11-2018)
e) Uniform and clothing allowance not exceeding P6,000.00 per month. (R.R. 11-2018)
f) Actual yearly medical benefits not exceeding P10,000/month
g) Laundry allowance not exceeding P300/month
h) Employee achievement awards for length of service or safety achievement in the form
of tangible property (other than cash or gift certificate) with value not exceeding P10,000
i) Christmas/major anniversary gifts not exceeding 5,000/year
j) Daily meal allowance for overtime work, not exceeding 25% of the basic minimum wage.
k) Benefits received by employee by virtue of a CBA and productivity incentive schemes
provided the total annual monetary value from both CBA and productivity schemes
combined do not exceed P10,000.00 (R.R. 1-2015)

 All other benefits given by employers which are not included in the enumeration shall not be
considered “de minimis” benefits, and hence shall be subject to income tax and withholding tax
on compensation (R.R. 5-2011)

 The amount of “de minimiis “ benefits is not computed in determining the P90,000 ceiling of
“other benefits” excluded from gross income under Section 32 (b)(7)(e), NIRC.

7
As amended by See RR 11-2018
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

o BUT , the excess of the de minimis benefits over their respective ceilings shall be
considered part of “other benefits” and the employee receiving it will be subject to tax
only on the excess over the P90,00 ceiling under the TRAIN law
o In other words, when a benefit is de minimis with a ceiling, the benefit is exempt from
the FBT up to the ceiling. Any excess over the ceiling shall be part of the “other benefits”
exempt up to P90,000. Anything in excess of P90,000 will be taxable.

 Any amount given by the employer as benefits, whether de minimis or not , shall be DEDUCTIBLE
as business expense (RR 10-2008.8

FRINGE BENEFIT TAX (35%)

SEC. 33 A

A final tax of thirty-five percent (35%) effective January 1, 2018; is hereby imposed on the
grossed-up monetary value of fringe benefit furnished or granted to the employee (except rank and file
employees as defined herein) by the employer, whether an individual or a corporation (unless the fringe
benefit is required by the nature of, or necessary to the trade, business or profession of the employer, or
when the fringe benefit is for the convenience or advantage of the employer). The tax herein imposed is
payable by the employer which tax shall be paid in the same manner as provided for under Section 57 (A)
of this Code. The grossed-up monetary value of the fringe benefit shall be determined by dividing the
actual monetary value of the fringe benefit by sixty-five percent (65%) effective January 1, 2018 onwards;
Provided, however, That fringe benefit furnished to employees and taxable under Subsections (B), (C), (D)
and (E) of Section 25 shall be taxed at the applicable rates imposed thereat: Provided, further, That the
grossed -Up value of the fringe benefit shall be determined by dividing the actual monetary value of the
fringe benefit by the difference between one hundred percent (100%) and the applicable rates of income
tax under Subsections (B), (C), (D), and (E) of Section 25. (As Amended by TRAIN Law)

 TRAIN Law increased the FBT to 35%.

o The grossed-up monetary value of the FB is now divided by 65%
 For NRANETB, the FBT rate is 25%
 For AEMOP, as the preferential treatment has been removed, then the FBT now seems to be the
regular rate of 35%.

NOTE:
 FB given to rank and file employees is NOT SUBJECT to the FBT
 FB given to a supervisory or managerial employee is subject to the FBT
o It is the S/M ee who is liable to the FIT of 35%, but it shall be paid and withheld by the
employer. If the FBT is not paid, it is the liability of the employer.
o The grossed-up monetary value of the FB can be DEDUCTED as business expense,
provided that the FBT has been subjected to FWT and has been paid.
 De Minimis benefit, whether given to R & F ee or to S/M ee, is NOT subject to the FBT.

8
Ingles, Tax Made Less Taxing, pp. 222-223
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

When FB given to S/M ee NOT TAXABLE

1. When the FB is required by the nature of or necessary to the T B or P of the employer
2. When the FB is for the convenience or advantage of the employer.

Sec. 34 A (1) (c) – Bribes, Kickbacks and other Similar Payments – not allowed as deductions

Q: Are contributions to a candidate in an election subject to donor’s tax? On the part of the
contributor, is it allowable as a deduction from gross income? (BAR 1998)
A: Not subject to donor’s tax, provided the recipient candidate had complied with the SOCE
requirement with the COMELEC.
The contributor is not allowed to deduct the contributions because the said expense is not directly
attributable to the development, management, operation, and/or conduct of trade, business or
profession. Furthermore, if the candidate is an incumbent government official or employee, it
may even be considered as a bribe or a kickback. (Sec. 34 [A] [l] [c], NIRC)

SEC. 34 (B) INTERESTS

Q: What is interest expense?

A: Interest expense shall refer to the payment for the use of forbearance or detention of money,
regardless of the name it is called or denominated. It includes the amount paid for the borrower’s use of
money during the term of the loan, as well as for his detention of money after the due date for its
repayment.

Requisites for deductibility of interest:

1. There must be an indebtedness
2. There should be an interest expense paid or incurred upon such indebtedness during the taxable
year.
3. The indebtedness must be of the taxpayer
4. The indebtedness must be connected with the taxpayer’s trade, business or exercise of profession
5. The interest must be stipulated in writing
6. The interest must be legally due. If there exists no obligation or where the obligation is
unenforceable, interest paid thereon is not deductible.
7. The interest payment arrangement must not be between related taxpayers as mandate in Sec.
342b, in relation to Sec. 36 B
8. The interest must not be incurred to finance petroleum operations
9. In case of interests incurred to acquire property used in trade, business or the exercise of
profession, the same was not treated as a capital expenditure.

Nos. 7,8 and 9 are exceptions to the General Rule for deductibility of interest under Sec. 34B, which states
that:

The amount of interest expense paid or incurred within a taxable year on indebtedness in
connection with the taxpayer’s trade, business or exercise of profession shall be allowed as a deduction
from the taxpayer’s gross income.
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

Take note however, the law provides that the allowable deduction shall be reduced by 33% of the interest
income which was previously subjected to a final income tax.

Illustration:

Supposing on Jan. 15, 2019, A Co., who has a deposit with BC Bank, obtained a loan from XYZ
Financing Corp. in connection with the operation of its business. Assume that A Co.’s taxable net income
for 2019 before the deduction of the interest expense amounted to 1M. For the year 2019, the interest
income it derived from the said deposit with BC Bank amounted to P180,000.00 on which a final income
tax of P36,000 had been withheld. Its interest expense on the loan obtained with XYZ Finance during the
same year amounted to P150,000.00.
How will we determine the deductible interest expense?

A Co.’s Net Income before interest expense - P1,000,000.00

Less: Interest expense (loan with XYZ) - P150,000.00
Less: 33% of interest income
from depositwith BC Bank
(33% x P180,000.00) - 59,400.00

Deductible interest expense 90,600.00

Taxable Income - P909,400.00
Income tax due for 2009 - P272,820.00

NON-DEDUCTIBLE INTERESTS (EXCEPTIONS)

1) Interests paid in advance through discount or otherwise if within the taxable year, an
individual taxpayer reporting income on the cash basis incurs indebtedness. However, such
interest shall be allowed as a deduction only in the year the indebtedness was paid.(Sec.
34B2a)

To illustrate:
A taxpayer using the cash basis method of accounting borrows money in which interest is paid
in advance through discount. He obtained a loan of P1,000,000 in October 2019 subject to a
20% interest, after deducting the advanced interest of P200,000, he received only
P800,000.00 Can the taxpayer claim the deduction in April 2020 in filing his ITR for 2009?

It depends on whether or not the principal obligation has been paid in 2019.
If the entire amount of obligation has been paid in 2019, the entire amount of interest
corresponding to the principal shall be allowed as a deduction in 2019.
If the principal obligation has not been paid entirely, say only half of it has been paid, the
interest expense to be deducted shall only be in an amount corresponding to the amount of
the principal paid. Thus, if the taxpayer paid only P100,000.00 of the P1,000,000.00 principal,
in that case, only P20,000 (10% of the advance interest) can be claimed as deduction for
interest expense.

2) Interest payments made between related taxpayers (Sec. 34B2b)

ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

No interest expense shall be allowed as deduction if both taxpayer and the person to whom
the payment has been made or is to be made are persons specified under Section 36B:
a. Between members of a family (refers to brothers or sisters, spouse, ancestors and lineal
descendants.
b. Between an individual and a corporation more than 50% in value of the outstanding stock
of which is owned directly or indirectly by or for such individual
c. Between 2 corporations more than 50% in value of the outstanding stock of each of which
is owned, directly or indirectly , by or for the same individual
d. Between the grantor and a fiduciary of any trust
e. 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. Between a fiduciary of a trust and a beneficiary of such trust.

3) If the indebtedness is incurred to finance petroleum exploration.

The non-deductible interest expense herein referred to pertains to interest or other
consideration paid or incurred by a Service Contractor engaged in the discovery and
production of indigenous petroleum in the Philippines in respect of the financing of its
petroleum operations under the Oil Exploration and Development Act of 1972.

Optional Treatment of Interest Expense (Sec. 34B3)

The interest expense may be treated as part of the value of the property acquired which property will be
treated as capital expenditure which is subject to the allowance for depreciation.

SEC. 34C TAXES

There are two ways to minimize a taxpayer’s tax liability:

1) Tax deductions – deducted from the gross income

2) Tax credits – a deduction from the income tax due.

Requisites for deductibility:

1. Taxes must be paid or incurred in connection with the taxpayers TBP

2. Tax must be imposed by law directly on the TP
3. Taxes must be paid or incurred during the taxable year.
4. Taxes must be those allowed and not disallowed to be deducted from gross income under S 34 C
5. Said taxes must be duly substantiated by Official Receipts.

Non-deductible taxes:
1. Income tax
2. Income taxes imposed by authority of any foreign country, but this deduction shall be allowed in
the case of a taxpayer who does not signify in his return his desire to have the benefits of crediting
against his taxes payable in the Philippines the taxes paid in the foreign countries
3. Estate and donor’s taxes
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

4. Taxes assessed against local benefits of a kind tending to increase the value of theproperty
assessed.
5. Tax on sale, barter or exchange of shares of stock listed and traded through the local stock
exchange or through initial public offering.
6. Taxes not connected with the TBP of taxpayer
7. Energy tax on electrical power consumption imposed by BP Blg. 36.
8. Final withholding taxes on passive income, the same being in the nature of income tax.

TAX BENEFIT RULE

The general rule is that recovery of amounts deducted in prior years would result to income.
However, where the deduction did not result in tax benefit, the subsequent recovery is not taxable
income. This is the so-called “tax benefit rule.”

Tax benefit rule also applies to taxes previously deducted from gross income but which were
subsequently refunded or credited. The taxpayer is also required to report as taxable income the
subsequent tax refund or tax credit granted to the extent of the tax benefit the taxpayer enjoyed when
such taxes were previously claimed as deduction from income. It follows that taxes paid which are not
allowed as deductions from gross income (i.e., income tax, donors or estate tax) are not taxable even
when refunded.

TAX CREDIT

a) RC and DC
They are allowed to claim as tax credits the amount of income taxes paid or claim as tax credits
the amount of income taxes paid or incurred by them during the taxable year to any foreign
country provided that they signify in their return their desire to avail of said credit.
b) Partnership and estates
For these TPs, the allowable tax credit shall the taxes paid or incurred by them during the taxable
year from any foreign country provided that the disputable share of the income of such
partnership or trust is reported for purposes of income tax

Q: What is the relation of Sec. 34C1b (tax deduction) vis-à-vis Sec. 34C3 (tax credit)?
A: Sec. 34 C1b provides that the income tax imposed by foreign country is not deductible if the TP
signifies in his return his intention to avail of the tax credit benefit under Sec34C3.However, if the TP fails
to signify in his return his desire to claim the taxes as tax credit, he may still claim the taxes as deduction.

Q: What then is the importance of signifying in his return the intention to avail of the tax credit
benefit when such failure would still warrant the deduction of the taxes under the first par of the same
section?
A: In considering the taxes as a deduction, the TP reduces only his taxable income or net income
which serves as the basis for the tax he should pay since the net income is in turn multiplied with the tax
rate to arrive at the net income tax due.
In claiming the said taxes as a form of tax credit, the taxpayer reduces not the basis of his tax
liability but more significantly the tax liability itself.
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

SEC. 34D LOSSES

Types of Losses
1. Casualty losses
2. Net Operating Loss Carry Over (NOLCO)
3. Capital losses and securities becoming worthless
4. Special losses
a. Losses from wash sales of stocks or securities
b. Wagering Losses
c. Abandonment Losses

CASUALTY LOSSES
- refers to the complete or partial destruction of property resulting from an identifiable event
of sudden, unexpected, or unusual nature, such as those arising from fire, storm, shipwreck,
or other casualty, or from theft or robbery.

Requisites for Deductibility of Losses

1. The losses are actually sustained during the taxable year.
2. Said losses are not compensated for by insurance or other forms of indemnity
3. The losses must be incurred from the exercise of TBP; or from property connected with TBP if the
losses arises from fires, storms, shipwrecks or other casualties, or from robbery, theft or
embezzlement
4. The loss shall not be allowed as a deduction if such loss has been claimed as a deduction for estate
tax purposes in the estate tax return.

NET OPERATING LOSS CARRY-OVER (NOLCO)

Q: What are the “carry-over” rules under the Code?

A: The following are the three carry-over rules:
1. Net Capital Loss Carry-over (Sec. 39D)
2. Minimum Corporate Income Tax Carry-over (Sec. 27E2)
3. Net operating Loss Carry-over (Sec. 34 D3)

Net Capital Loss Carry-over (NCaLCO) Sec. 39D

It is the remedy of a taxpayer when there is a capital loss but there is no capital gain. Normally, a capital
loss may only be deducted from a capital gain, if there is any, following the Loss Limitation Rules under
Sec. 39C, which provides that: “losses from sales or exchanges of capital assets shall be allowed only to
the extent of the capital gains from such sale or exchange.”
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

Under the NALCO, any capital loss sustained by the taxpayer during the taxable year shall be treated in
the succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than
12 months.

In other words, if a taxpayer sustains a capital loss during a taxable year where there is no capital gain or
the capital gain is not enough to offset the loss, the capital loss or the net capital loss can be carried over
to the succeeding taxable year. The carried over capital loss shall be treated as a loss from the sale or
exchange of a capital asset held for not more than 12 months or under the short-term holding period.

Requisites for application of NCaLCO

1. The amount of the loss should not exceed the net income for the taxable year when the loss
was incurred.
2. There should be a capital gain from which the carried over loss can be deducted.
3. If net capital loss is sustained in any taxable year, such loss is applied in the succeeding taxable
year as a loss from the sale or exchange of capital asset held for not more than 12 months
entitled to 100% deduction. Such net capital loss should not exceed the prior year’s taxable
income.
4. This remedy can only be availed of by individual taxpayers.

Minimum Corporate Income Tax Carry-over

Any excess of the minimum corporate income tax over the net income tax shall be carried forward
and credited against the net income tax for the three (3) immediately succeeding taxable years.

Net Operating Loss Carry over (NOLCO)

Net Operating Loss

- Shall mean the excess of allowable deduction over gross income of the business in a taxable year.

The net operating losses which have not been previously offset as deductions from gross income shall be
carried over as a deduction from gross income for the next three (3) consecutive taxable years
immediately following the year of such loss.

To illustrate

A, taxpayer, incurred a net loss of P10,000.00 in 2019, apply the net operating loss carry over rule.
Since the net loss was incurred in 2019, A can claim the carry over in 2020, 2021, 2022. In case A
has a net income in 2020, 2021, or 2022, he can deduct the net loss incurred in 2019, before arriving at
the net income subject to tax.

When NOLCO not allowed:

1. Take note however that net operating losses incurred by any person who is exempt from
income tax, or enjoying preferential tax treatment pursuant to the provisions of special laws,
shall not be allowed a NOLCO deduction, such as:
ACP FILIPINA T. RIBAYA GERONIMO TAXATION 2
City University of Pasay, College of Law Allowable Deductions

a. Any BOI-registered enterprise enjoying income tax holiday pursuant to EO 226 or OIC
of 1987
b. Any PEZA-registered enterprise enjoying preferential tax treatment or income tax
holiday pursuant to RA 7916
c. Any person enjoying preferential tax treatment pursuant to RA 7227 of BCDA Act of
1992

2. Domestic and resident foreign corporations subject to MCIT cannot enjoy the benefit of
NOLCO in any taxable year.

NALCO NOLCO
1. Can be availed of only by individual TP 1. Available to both individuals and corporate
taxpayers
2. Covers only a one (1) year period 2. May be deducted from the gross income for the
next three (3) consecutive years
3. A capital asset transaction 3. An ordinary asset transaction
4. Directly governed by the Tax Code only 4. Directly governed by the Tax Code and the
Investment Incentive Act

CAPITAL LOSSESS AND SECURITIES BECOMING WORTHLESS

“Capital Losses” are losses from sales or exchanges of capital assets.

Q: When capital losses allowed as deduction

A: Capital losses from sales or exchanges of capital assets are deductible only to the extent of the
capital gains from such sales or exchanges of capital assets of both corporations and individuals (except
for banks and trust companies). If the dealings of the taxpayer in capital assets during the year result in a
net capital loss, such loss cannot be deducted from his ordinary income, inasmuch as capital losses are
allowable only to the extent of capital gains.

“Securities considered as worthless” refers to the shares of stock when offered for sale or requested for
share redemption, no amount can be realized by the owner of the share.
Securities becoming worthless, which are capital assets, shall be considered as a loss from the sale or
exchange of capital assets on the last day of such taxable year.

SPECIAL LOSSES

A. Losses from Wash Sales of Stocks or Securities

“Wash sale of stocks or securities” is a sale or other disposition of stock or securities where the
taxpayer has acquired or has entered into a contract or option to acquire substantially identical stocks or
securities within a 61-day period, beginning 30 days before the sale and ending 30 days after the sale.

Losses from wash sale are NOT deductible from gross income, except if it is a loss incurred by a
dealer in securities in the ordinary course of business.
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Losses on was sales of stock or securities are treated in Section 38 of the Tax Code.

Purpose of “wash sales of stock or securities”

- The purpose of “wash sale provisions” is to prevent taxpayers from selling stock or securities
to establish a loss deduction and then immediately repurchasing the same or substantially
the same securities.

Requisites of wash sale:

1. The sale or other disposition of stock resulted to a loss

2. There was an acquisition or contract or option for acquisition of stock or securities within 30 days
before the sale or 30 days after the sale
3. The stock or securities sold were substantially the same as those acquired within the 61-day
period.

(see p. 422 of Casasola 2013 ed for illustration)

B. Wagering Losses

A wager is made when the outcome depends upon chance.

Losses from wagering transactions shall be allowed only to individuals to the extent of the
wagering gains or winnings from such transactions.

C. Abandonment Losses in Petroleum Operations

(a) In the event a contract area where petroleum operations are undertaken is partially or wholly
abandoned, all accumulated explorations and development expenditures pertaining thereto shall be
allowed as a deduction; Provided, that accumulated expenditures incurred in that area prior to January 1,
1979 shall be allowed as a deduction only from any income derived from the same contract area. In all
cases, notices of abandonment shall be filed with the Commissioner.

(b) In case a producing well is subsequently abandoned, the un-amortized costs thereof, as well
as the un-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 I re-entered and production is resumed, or if such equipment, or facility is restored into service, the
said costs shall be included as part of gross income in the year the resumption or restoration and shall be
amortized or depreciated, as the case may be.

Cases when no loss can be recognized:

No loss can be recognized in the following cases:

1. Loss on the sale of real property considered as capital asset.

2. Loss sustained by the transfer of property by gift
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3. Loss sustained by the transfer of property by death

4. Loss sustained in illegal transactions
5. Losses claimed as deduction from the gross estate for estate tax purposes can no longer be
claimed as deduction from gross income for income tax purposes
6. Losses in transactions between related taxpayers
7. In the case of merger, consolidation, or control of securities (where no gains are recognized
either); and
8. Losses in exchanges not solely in kind under Section 40C2 of the Tax Code

SEC. 34E BAD DEBTS

See Philex Mining Corp. vs. CIR, G.R. No. 148187, April 16, 2008

“Bad debts” shall refer to those debts resulting from the worthlessness or uncollectibility, in
whole or in part, of amounts due the taxpayer by others, arising from money lent or from uncollectible
amounts of income from goods sold or services rendered actually ascertained to be worthless and charged
off within the taxable year.

REQUISITES FOR DEDUCTIBILITY OF BAD DEBTS

(1) There must be an existing indebtedness due to the taxpayer which must be valid and legally
demandable;
(2) The same must be connected with the taxpayer’s trade, business or practice of profession;
(3) The same must not be sustained in a transaction entered into between related parties enumerated
under Section 36(B) of the Tax Code of 1997;
(4) The same must be actually charged off in the books of accounts of the taxpayer as of the end of the
taxable year; and
(5) The same must be actually ascertained to be worthless and uncollectible as of the end of the taxable
year and even in the future.

Nota bene:

Before a taxpayer may charge off and deduct a debt , he must ascertain and be able to
demonstrate with reasonable degree of certainty the uncollectibility of the debt.

Bad debts must be “charged off” during the taxable year to be allowed as deduction from gross
income.

Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that
legal action to enforce payment would in all probability not result in the satisfaction of execution on a
judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the
purpose of deduction.

Meaning of the phrase “actually charged off from the taxpayer’s books of accounts.”
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This phrase means that the amount of money lent by the taxpayer (in the course of his TBP) to his
debtor had been “recorded in his books of account as a receivable has actually become worthless as of the
end of the taxable year, that the said receivable has been cancelled and written-off from the said
taxpayer’s books of account.”

TAX BENEFIT RULE

The “Tax Benefit Rule” provides that where the creditor was allowed a deduction of bad debts
but said bad debts are subsequently recovered, the previous deduction of bad debts but said debts are
subsequently recovered, the previous deduction of bad debts will not be cancelled but the recovered
amount will be added to the computation of the gross income.

Other factors to determine whether a bad debt is already worthless:

1. The debtor has been adjudged bankrupt or insolvent

2. The debtor has no property or visible income
3. The collateral shares have already become worthless; or
4. There are many debtors with small amounts of debts and further action on the accounts would
entailexpenses exceeding the amounts sought to be collected.

When worthless securities are deductible from gross income as bad debts:

As a general rules, worthless securities, which are ordinary assets, are not allowed as deduction
from gross income because the loss is not realized.

However, if these worthless securities are capital assets and charged off within the taxable year,
the owner is considered to have incurred a capital loss from the sale or exchange of capital asset, as of
the last day of the taxable year and, therefore deductible to the extent of capital gains.

The taxpayer, however, has to prove through clear and convincing evidence that the securities
are in fact worthless.

This rule, however, is not true in the case of banks or trust companies incorporated under the
laws of the Republic of the Philippines, a substantial part of whose business is the receipt of deposits.

SEC. 34 F DEPRECIATION

This deduction serves as an exception to the rule that expenses to be deducted should have been
incurred during the taxable year. Depreciation is the expense which can be deducted by the taxpayer for
several years, as the case may be.

This expense is incurred due to the ordinary exhaustion, wear and tear, including reasonable
allowance for obsolescence, of property used in the trade or business.

Requisites for deductibility of “allowance for depreciation” from gross income

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1. The allowance for depreciation must be sustained by the person who owns or who has capital
investment in the property
2. The allowance for depreciation must be reasonable in that the amount of depreciation must be
in accordance with the depreciation method being adopted by the company
3. The property being depreciated is being used in the trade or business
4. The allowance for depreciation must be charged off during the taxable year
5. The property must have a limited useful life
6. The allowance for depreciation should not exceed the cost of the property.
7. The schedule of the allowance must be attached to the return

Methods of depreciation

1. Straight-line method
2. Declining balance method
3. Sum-of-the-years digit method
4. Any other methods as prescribed by the Secretary of Finance

Straight Line Method

The straight line method is to the effect that the rate and the base (the cost) are constant. Under
this method, the cost or other basis of the property less its estimated salvage valued is deductible in equal
annual amounts over the period of the estimated useful life of the property.

Declining Balance Method

The fixed percentage of diminishing book value method is to the effect that the rate of yearly
depreciation remains the same but the base (the book value) upon which the rate is applied diminishes
from year to year.

Sum-Of-The-Years Digit Method

The capital sum to be replaced should be charged off over the useful life of the property, either
in equal annual instalments or in accordance with any other recognized trade practice, such as an
apportionment of the capital sum over units of production. The annual allowance for depreciation is
computed by applying changing fractions to the cost or other basis of the property reduced by estimated
salvage. The numerator of the fraction changes each year to a number which corresponds to the
remaining useful life of the asset (including the year for which the allowance is being computed), and the
denominator (which remains constant) is the sum of all the year’s digits corresponding to the estimated
useful life of the asset.

SEC. 34G DEPLEITON OF OIL AND GAS WELLS AND MINES

“Depletion” refers to the exhaustion of natural resources owing to production or severance.

This expense is allowed only for oil and gas wells or mines. A reasonable allowance for depletion
or amortization shall be allowed as deduction from the gross income computed in accordance with the
cost-depletion method.

The allowance for depletion is based on the theory that the extraction of minerals gradually
exhausts the capital investment in the mineral deposit.
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SEC. 34H CHARITABLE AND OTHER CONTRIBUTION

Unlike most of the previously discussed deductions, this deduction is deducted from the net
income, not from the gross income since one of the bases of the amount to be deducted is a percentage
of the net income.

Requisites for deductibility of charitable and other contributions

1. The contribution must have been actually made to entities specified by law;
2. The contribution must have been made within the taxable year
3. It must be evidence by adequate receipts or records
4. For contributions other than money, the amount shall be based on the acquisition cost of the
property NOT the fair market value at the time of the contribution
5. For contribution subject to statutory limitations, the same must not exceed 10% in the case of
individuals (engaged in the business or in practice of profession) or 5% in the case of corporations
of the said taxpayer’s taxable income before deducting the charitable contributions.

Q: Who is entitled to claim the deduction for charitable and other contributions, the donor or the
donee?
A: It is the donor who is entitled to this deduction since, obviously, he was the one who incurred this
expense.

Take note who are allowed to receive donation for partial or full deductibility under Sec. 34 H. The
enumeration is exclusive.

Partial Deduction: Donee is

1. The Government of the Philippines or any of its political subdivision thereof – for its use
exclusively for public purpose
2. Accredited domestic corporation or associations organized and operated exclusively for religious,
charitable, scientific, youth and sports development , cultural or educational purposes or for the
rehabilitation of veterans
3. Social welfare institutions
4. Non-governmental organizations

The deduction is considered partial since the Code provides for a limitation on the amount of the donation
to be deducted. In case of individuals the amount allowed to be deducted should not exceed ten percent
(10%) of their taxable income, while in case of corporations, it should not exceed five percent (5%) of its
taxable income.

Full Deduction: Donee is

1. The Government of the Philippines or 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 education, health, youth and sports development, human
settlements, science and culture, and in economic development according to NEDA
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2. Foreign institutions or international organizations in pursuance of or in compliance with

agreements, treatises, or commitments entered into by the government and the foreign
institutions or international organization in pursuance of special laws
3. Accredited non-governmental organizations.

If the total amount of the donation can be claimed as a deduction regardless of the amount of the net
income.

Q: A businessman donated P1Million to a girl in the hospital, is the donor allowed to claim the
donation as a deduction?
A: No, he is not allowed to claim the donation as a deduction. The enumeration in Section 30H is
exclusive, if the done is not among those who are mentioned, the donation cannot be claimed as a
deduction.

Q: Is there any other instance where the donation cannot be claimed as a deduction?
A: Yes, if the taxpayer-donor is a pure compensation income earner. Even if the done is among those
mentioned in Section34H but the taxpayer is a pure compensation income earner, the donation is not
allowed to be deducted since a pure compensation earner cannot claim as such deduction.

SEC. 34 I RESEARCH AND DEVELOPMENT

“Research” is original and planned investigation undertaken by the taxpayer with the prospect of
gaining new scientific or technical knowledge and understanding.

“Development” is the application of research findings or other knowledge to a plan or desing for
the production of new or substantially improved materials, devise, products, processes, systems or
services before the start of commercial production or use.

Requisites for the charging of research and development expenditure

1. Research or development expenditures were paid or incurred in connection with the

taxpayer’s business or practice of profession
2. The same bad been paid or incurred during the taxable year as ordinary and necessary
expenses
3. The same had not been charged to the capital account

Limitations on deduction
1. This expenditure shall not apply to the acquisition or improvement of land or for the improvement
of property to be used in connection with research and development of a character which is
subject to depreciation and depletion
Except with respect to private educational institution which is allowed to claim the deduction as a
capital outlay.
2. For any expenditure paid or incurred for the purpose of ascertaining the existence, location,
extent, or quality of any deposit or ore or other mineral, including oil or gas, i.e., exploration
expenditure
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SEC. 34J PENSION TRUSTS

“Pension Trust” is a trust established or maintained by the employer to provide for the payment of
reasonable pensions to its employees.

This deduction refers to the reasonable amount transferred or paid by the employer into the pension
trusts of the employees.

Requisites for deductibility:

1. The amount must not have been previously allowed as a deduction
2. The amount must be apportioned in equal parts over a period of ten (10) consecutive years
beginning with the year in which the transfer or payment is made.