COLLEGE OF ACCOUNTANCY

C-BAC7 Taxation (Income Taxation)

Second Semester AY 2021-2022

Course : C- BAC7: Taxation (Income Taxation)

Module : Module No. 10: SPECIAL ALLOWABLE ITEMIZED DEDUCTION, NET OPERATING LOSS CARRY –
OVER & OPTIONAL STANDARD DEDUCTION

Time Frame : 3.0 hours

Time Frame : 3.0 hours

A. Overview

This learning material discusses the Special Allowable Itemized Deductions, Net Operating Loss
Carry-Over and Optional Standard Deductions. It presented the basis of its item of deductions and
a brief description the legal basis for better understanding of the students.

This is relevant to the students because this will help them fully understand the detailed
deductions allowed in the computation of the taxable income of the taxpayers.

The student will be able to achieve the desired learning outcomes by devoting time and effort in
studying this material, listening and participating actively in the online discussion, and
accomplishing the tasks assigned in the Classwork section of the Google Classroom for this course.

B. Desired Learning Outcomes

After studying this module, you should be able to:

1. Identify the special deductions that are applicable to the taxpayer in computing the taxable
income.

2. Determine the application of the rules and procedure on each item of deduction from gross
income.

3. Compute the Optional Standard Deductions applicable to the taxpayers.

C. Values Integration

In studying this module, it is hoped that you will be able to develop and manifest the following UA
Core Value/s:
✓ Servant Leadership

✓ Integrity

✓ Excellence

✓ Service Orientation

✓ Teamwork

✓ Obedience
 ✓ Open Communication

Faculty: RODELIA R. TALAVERA Page 1

COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

D. Content/Discussion

Lesson 1: SPECIAL ALLOWABLE ITEMIZED DEDUCTIONS

Special deductions are other items of deductions which may or may not partake the nature of
expense, but are allowed by the NIRC or by special laws as deductions. Special deductions include
deduction incentives to taxpayers in assisting and in complying with certain legal requirements.

A. Special Expenses under the NIRC and Special Laws

1. Income distribution from taxable estate or trust
2. Transfer to reserve fund payments to policies and annuity contracts of insurance
companies
3. Dividend distribution of a Real Estate Investment Trust (REIT) under RA 9856
4. Transfer to reserves funds of taxable cooperatives
5. Discount to senior citizens under RA9257
6. Discounts to persons with disability under RA 9442

B. Deduction Incentives under Special Laws

1. Additional compensation expense for senior citizen employees under RA 9257 2.
Additional compensation expense for person with disability under RA 7277, as amended
by RA9442
3. Cost of facilities improvements for person with disability in accordance with RA 7277,
as amended by RA 9442
4. Additional training expense under RA 8502-Jewelry Industry Development Act 1998
5. Additional labor training expense under the RA 11534 – CREATE law
6. Additional contribution expense under the Adopt-a-School program under RA 8525 7.
Additional deductions for compliance to rooming-in and breastfeeding practices under RA
7600 amended by RA 10028
8. Additional free Legal assistance expense under RA 9999
9. Additional productivity incentive bonus expense under RA 6971

A. Special Expenses under NIRC and Special Laws

1. Income Distribution made by taxable estates of trusts

Income distribution made by the administrator of a taxable estate in favor of the heirs or by a
trustee of a taxable trust in favor of the beneficiary of the trust is a special deduction against
the gross income of the estate or trust. The income distribution shall be included by the
recipient heir or beneficiary in his gross income.

2. Net transfer to reserve fund and payments to policies and annuity contracts of insurance
companies
Under the Insurance Code, non-life insurance companies are required to maintain a reserve
equivalent to 40% of their gross premium, less returns and cancellations for risks expiring
within one year. For marine cargo risk, the reserve is equivalent to the amount of premium on
insurance during the last two months of the calendar year.

3. Dividend distribution of a Real Estate Investment Trust (REIT)

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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

A REIT is a publicly listed corporation established principally for the purpose of owning
income generating real estate assets. A REIT is legally mandated to distribute 90% of its
distributable income as dividends to shareholders.

4. Transfer to Reserve Fund of Cooperative

Under RA 9520, cooperatives are required to maintain reserves for their protection and
stability, Cooperatives are exempt from income tax, but are subject to tax on their income from
unrelated activities. The amount transferred by the cooperative to the reserve fund out of the
net surplus from unrelated activities is an item of deduction in the computation of the taxable
net income of the cooperative.

5. The Expanded Senior Citizen’s Act of 2003 (RA 9257)

Senior Citizen or Elderly – refers to any resident Filipino citizen aged 60 years old and above.

Under RA 9257, A senior citizen or elderly is entitled to 20% discount in certain

establishments such as hotels and similar lodging establishments, restaurants, recreational
centers and other places of culture, leisure and amusements, hospitals, drugstores, and
services such as medical, dental, domestic air, sea and land transport, and funeral or burial
services providers.

The discount granted to senior citizens by covered establishments and service providers are
allowed as special deductions against gross income.

Conditions for deductibility of sales discounts to senior citizens

1. Only that portion of the gross sales exclusively used, consumed, or employed by the
senior citizen shall be eligible for the deductible sales discount.
2. The gross selling price and sales discount must be separately indicted in the official
receipt or sales invoice issued by the establishment for the sale of goods or services to
the senior citizen.
3. Only the actual amount of discounted granted or sales discount not exceeding 20% of
the selling price can be deducted from gross income, net of VAT, if applicable.
4. The discount can only be allowed as deduction from gross income for the same taxable
year that the discount is granted.
5. The business establishment giving sales discount to qualified senior citizen is name, TIN,
ID gross sales/receipts, discounts granted, date of transaction, and invoice number for
every sales transaction to senior citizens.

6. Discount to Disable Persons (RA7277)

Similar to senior citizens, persons with disability are entitled to a 20% discount from certain
establishments such as hotels and similar lodging establishment, restaurants, sports and
recreation centers, places of culture, leisure and amusement, drugstores on the purchase of
medicine, medical and dental services in private facilities, and domestic air sea, and land
transport.

The discounts to persons with disability shall be allowed as special deduction under the same
terms and conditions as those for senior citizens

B. DEDUCTIONS INCENTIVES UNDER SPECIAL LAWS

1. Additional claimable compensation expense for senior citizen employees.

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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

Under RA 9257, private establishments employing senior citizens shall be entitled to additional
deduction from gross income equivalent to 15% of the total amount paid as salaries and wages to
senior citizens.

Conditions for deductibility of additional compensation:

1. Employment shall have to continue for at least 6 months
2. The annual taxable income of the senior citizen does not exceed the poverty level as determined
by the NEDA

2. Additional Claimable compensation expense for persons with disability Private entities that employ
disabled persons who meet the required skills or qualifications, either as regular employees,
apprentices or learners, shall be entitled to an additional deduction, from their gross income,
equivalent to twenty-five percent (25%) of the total amount paid as salaries and wages to
disabled persons.

Requisites for deductibility:

a. The entity present proof as certified by the Department of Labor and Employment that disabled
persons are under their employ.
b. The disabled employee is accredited with the Department of Labor and Employment and the
Department of Health as to his disability, skills and qualifications.

The actual salaries shall be presented as part of regular expense while the 25% additional salaries
expense shall be presented as special itemized allowable deductions.

3. Cost of Facilities Improvement for disabled persons

Under RA 7277, private entities that improve or modify their physical facilities in order to provide
reasonable accommodation for disable persons shall also be entitle to an additional deduction from
their income equivalent to fifty percent (50%) of the direct costs of the improvements or
modifications.

4. Additional Training Expense under the Jewelry Industry Development Act of 1998 Under RA
8502 and its implementing rules and regulations, a qualified jewelry enterprise duly registered and
accredited with Board of Investments (BOI) is entitled to an additional deduction from taxable
income of 50% of the expenses incurred in training schemes approved by Technical Education
and Skills Development Authority (TESDA). The same shall be deductible during the year the
expenses were incurred.

Conditions for deductibility:

1. A qualified jewelry enterprise must submit to the BIR a certified true copy of its Certificate of
Accreditation issued by the BOI.
2. The training scheme must be approved and certified by TESDA

5. Additional Labor Training Expense under the CREATE Law.

Under RA 11534, 50% of the value of labor training expenses incurred for skills development pf
enterprise-based trainees enrolled in public senior high schools, public higher education
institutions, or public technical and vocational institutions shall be claimed as additional deduction
against gross income.
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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

Conditions of deductibility:
1. Apprenticeship agreement between the enterprise (taxpayer) and the trainees pursuant to
the Labor Code of the Philippines
2. Certification from Dep-Ed, TESDA, or CHED secured by the enterprise
3. The amount of deductions shall not exceed 10% of direct labor wage.

6. Adopt-A-School Act of 1998 (RA8525)

Under the Adopt-a-School Program, private entities are allowed to assist a public school in
particular aspects of their educational program within an agreed period of time.

Tax deduction incentive

Contributions to the government in priority activities are deductible in full while those made in
non priority activities are deductible subject to limit.

Aside from the usual regular deductible contribution expense, an adopting entity shall be allowed
an additional deduction from gross income equivalent to 50% of the contribution of the adopting
entity for the “Adopt-A-School Program.”

Conditions for deductibility:

a. The deduction shall be availed of in the taxable year in which the expense is paid or incurred.
b. The expense is substantiated with sufficient evidence such as official receipts, delivery
receipts and other adequate records which shall set forth the following:
1. The amount of expenses being claimed as deductions
2. Direct connection or relation of the expenses to the adopting private entity’s
participation in the Adopt-a-School program.
3. Proof or acknowledgement of receipt of the contributed or donated property by the
recipient public school.
c. The application together with the approved MOA endorsed by the National Secretariat shall
be filed with the RDO having jurisdiction over the place of business of the adopting private
entity, copy furnished the RDO having jurisdiction over the property, if the contribution is in
the form of real property.

Valuation of deductions (RR10-2003)

1. Cash assistance, contributions or donations shall be based on the actual amount appearing in the
official receipt issued by the donee.
2. Assistance other than money
a. Personal Property – acquisition cost of assistance or contribution
b. Consumable goods -acquisition cost or value at date of donation whichever is lower c.
Services – the value of services rendered by the donor and the service provider and the public
school as fixed in the MOA or the actual expense incurred by the donor, whichever is lower. d.
Real property – fair value (higher of zonal value or assessed value) at the time of contribution
or the depreciation cost of the property whichever is lower.

7. Expanded Breastfeeding Promotion Act of 2009 (RA 10028)

The purpose of RA 10028 is to encourage, protect and support the practice of breastfeeding which
is believed to provide distinct benefits to the mother and the infant aside from saving the country’s
valuable foreign exchange that may otherwise be used for milk importation.
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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

Tax deductions incentives

The expenses incurred by a private health institution in complying with the rooming-in and breast
feeding practices shall be deductible expenses for income tax purposes up to twice the actual
amount incurred.

Conditions for deductibility

1. The deduction shall apply for the taxable period when the expenses were incurred. 2. All health
non-health facilities, establishments and institutions shall comply with the IRR of RA 10028
within 6 months after its approval.
3. The facility, establishment or institution shall secure a “Working Mother-Baby-Friendly
Certificate” from the Department of Health to be filed with the BIR.

8. Free Legal Assistance (RA 9999)

Lawyers or professional partnerships providing pro-bono legal services are given deduction
incentives for the free legal services.

Tax Deduction Incentive

The practicing lawyer or professional partnership shall be entitled to an allowable deduction from
gross income equivalent to the amount that could have been collected for the actual
performance of the actual free services rendered or up to 10% of gross income derived from
the actual performance of the legal profession whichever is lower.

For the purpose of this incentive, the free legal services must be exclusive of the 60-hour
mandatory free legal assistance rendered to indigent clients as mandatorily required un the Rule of
Mandatory Legal Aid Services for Practicing Lawyers.

9. Additional Productivity Incentive Bonus Expense

Under the Productivity Incentive Act of 1990 (RA 6971), business enterprise which adopts a
productivity incentive program is entitled to a special additional deduction equivalent to 50% of
the total productivity bonuses given to employees under the program.

In addition, business enterprises providing manpower training and special studies to a rank-and-
file employers as accredited by the Technical Education and Skills Development Authority are also
entitled to 50% additional deduction of the total grant local trainings and special studies.

The deduction incentive will not be allowed on bonuses accruing during the pendency of a strike or
lockout arising from any violation of the productivity incentive program.

Lesson 2: NET OPERATING LOSS CARRY-OVER

Net Operating Loss (NOL) pertains to the excess of allowable deductions over the gross income
from business or exercise of a professional during a taxable year.

Net Operating Loss Carry-Over (NOLCO) pertains to the amount of net operating loss that is
allowed by the law to be carried over as deduction against the available net income in the following
three (3) years.
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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

NOL vs. NOLCO

It must be noted that a net operating loss technically different with a NOLCO. A net operating loss
may occur, but may not be carried over, hence no NOLCO. However, a NOLCO cannot exist without a
prior year net operating loss.

The Rationale of NOLCO

NOLCO is intended to allow the taxpayer to recoup his losses before taxation go full swing. Without
NOLCO, income taxation would result in taxation of recoveries of lost capital.

Who can claim NOLCO?

All taxpayers subject to tax on taxable income whether at the regular income tax or at preferential
tax rate can deduct NOLCO. Taxpayers who are exempt, enjoying a tax holiday, subject to tax on
gross income, or those subject to final income tax cannot deduct NOLCO.

How to compute NOLCO?

NOLCO is computed as follows:

Gross income subject to regular tax……………………………………….Pxxx

Less:
Total deductions excluding NOLCO from prior years
And deduction incentives under special laws………………….(xxx)

Net Operating loss carry-over (NOLCO)……………………………….(Pxxx)

To emphasize the rules in measurement of taxable net income or NOLCO:

1. Cost of sales or cost of services and regular allowable itemized deductions are fully deductible
against gross income.
2. Special incentive deductions are deductible only to the extent of net income before special
incentive deductions.
3. NOLCO prior years are deductible only to the extent of net income after special incentive
deductions but before NOLCO.

Requisites for the deductibility of NOLCO:

1. The taxpayer must not be exempt from income tax during the taxable year when the NOLCO was
incurred.
2. There has been no substantial change in the ownership of the business or enterprise.

A change of at least 75% of either the paid up capital or nominal value of the outstanding shares of
a corporation is deemed a substantial change in business ownership.

Rules in Carry-Over of NOLCO

1. NOLCO is claimable in a first-in first-out (FIFO) fashion.
2. NOLCO can be claimed only up to the extent of the business net income in the next three (3)
years. Prior year NOLCO cannot be deducted against a subsequent year net operating loss. 3. Any
NOLCO which remains unused at the end of the three (3) year prescriptive period will expire.

Faculty: RODELIA R. TALAVERA Page 7

 COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

Lesson 3: OPTIONAL STANDARD DEDUCTION (OSD)

The OSD is in lieu of the itemized deductions including NOLCO allowable under the NIRC and
special laws. Under the OSD, the allowable deduction of the taxpayer is simply presumed as a
percentage of gross sales or receipt for individuals and gross income for corporations. There is no
need to support every item expense. The OSD, however, does not relieve the taxpayer of the
responsibility to deduct withholding tax on certain income payments as required by the NIRC.

Who can claim OSD?

OSD is a proxy for itemized deductions. As a rule, all taxpayers who are subject to tax on
taxable net income can claim deductions except the following:
a. Non-resident alien engaged in trade or business (NRA-ETB)
b. Taxpayers mandated to use itemized deductions

Mandatory itemized deductions (RR2-2014)

1. Corporations mandated to use the itemized deductions:

a. Exempt GOCCs and non-stock, non-profit corporations with no taxable income
b. Those with income subject to special/preferential tax rates
c. Those with income subject to regular corporate income tax and special/preferential tax

2. Individual taxpayers mandated to use the itemized deductions:

a. Exempt individuals under the NIRC and special laws with no other taxable income
b. Those with income subject to special/preferential tax rates
c. Those with income subject to regular income tax and special/preferential income tax

Both the NIRC and its amendatory law, RA9504, excluded non-resident aliens from the option to claim
OSD Sec. 3 of RA 9504 restricted the option to claim OSD only to corporations subject to the regular
corporate income tax. Hence, special corporations subject to preferential rate on taxable income are
deemed excluded. Similarly, individuals enjoying preferential taxes under special tax incentive laws
not allowed to use OSD.

The option to claim OSD must be signified in the income tax return, otherwise, itemized deductions is
presumed. The option to elect OSD or itemized deductions must be made in the first quarter return.
Such election when made shall be irrevocable in the taxable year for which the return and made.
Shifting between OSD and itemized during the taxable quarters of the year is not allowed.

Taxpayers who opted to claim OSD are not required to submit financial statements with their income
tax return. Individual taxpayers opting to deduct OSD shall keep records pertaining to their gross sales
or gross receipts. Corporations opting to deduct OSD shall keep such records pertaining to their gross
income during the taxable year.

Percentage of Optional Standard Deductions

1. Individual taxpayers – 40% of total sales/revenues/receipts/fees

a. Those selling goods under the accrual basis – 40% of gross sales
b. Those selling services under the cash basis – 40% of gross receipts
c. Those selling services under the accrual basis – 40% of revenue

2. Corporate Taxpayers – 40% of gross income

Faculty: RODELIA R. TALAVERA Page 8

 COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

The Individual OSD

Since the OSD of individuals is based on gross receipts or gross sales, it is deemed to replace all items
of deductions against gross receipts or gross sales in computing net income. Individuals using OSD
shall use BIR Form 1701 in filing their annual return.

The Corporate OSD

Since the corporate OSD is based on gross income, it is deemed to replace all items of deductions from
gross income in computing net income.

Table of comparison on OSD

Individual Corporate
OSD replaces OSD replaces

Cost of Sales/cost of services? YES NO

Regular allowable itemized deductions? YES YES

Special allowable itemized deductions? YES YES

Net operating loss carry-over (NOLCO) YES YES

Hence, corporation can claim cost of sales or cost of services while individual taxpayers cannot claim
cost of sales or cost of services under OSD.

Corporations opting to use OSD shall use BIR Form 1702-RT for their annual income tax return.

Rules on Determination for OSD for Individual Taxpayers

Gross Sales
As classified by RR16-2008 gross sales include only sales contributory to income subject to regular tax.
Since sales returns, allowances and discounts are not contributory to income. They must be deducted
from the total recorded sales (accounting gross sales). In short, the tax concept of gross sales is the
accounting concept of net sales.

Gross Receipts

Gross receipts means amounts actually or constructively received during the taxable year. For seller of
services employing the accrual basis of accounting the term gross receipts shall mean amounts earned
as gross revenue during the taxable year.

For individual taxpayers using other methods of accounting, the gross sales or gross receipts shall be
determined in accordance with said acceptable method of accounting.

The optional standard deduction for individual taxpayers is specifically computed as:
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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

Net Sales/Revenues/Receipts/Fee .......................................................Pxxx,xxx

Add: Other taxable income from operation not
Subject to final tax.......................................................................... xxx,xxx
Total sales/revenues/receipts/fees...................................................... xxx,xxx
Multiple by: OSP percentage................................................................... 40%
Optional Standard Deduction................................................................. Pxxx,xxx

Rules on Determination of OSD for Corporate Taxpayers

Under the NIRC, gross income was restrictively defined as:

a. Gross sales less sales return, discounts and allowances and cost of services b.
Gross receipts, less sales returns, discounts and allowances and cost at services.

However, under the amendments introduced by RA 9504, gross income for purposes of the corporated
OSD pertains to all gross income subject to the regular income tax. There is no distinction between
gross income from operations and gross income from non-operating sources. Thus, the corporated
OSD is computed as follows:

Net Sales/Revenues/Receipts/Fees................................................... P xxx, xxx

Less: Cost of Saales or services............................................................. xxx,xxx
Gross income from operations.............................................................. P xxx,xxx
Add: Other taxable income, not subject to final tax...................... xxx,xxx
Total gross income...................................................................................... P xxx,xxx
Multiply by: OSD percentage................................................................... 40%
Optional Standard Deduction ................................................................ P xxx,xxx

What constitute cost of service?

Cost of service includes all direct costs and expenses necessary to provide the service required by the
customer such as:
a. Salaries and employee benefits of personel, consultants and specialists directly rendering the
service
b. Cost of facilities directly utilized in providing the service such as depreciation or rental of
equipment used and cost of supplies.

The cost of services of banks includes interest expense.

OSD for General Professional Partnerships (GPP)

A GPP can choose either the itemized deduction or the optional standard deduction in computing its
distributable net income. The allowable deduction for a GPP electing to deduct OSD shall be 40% of
gross income similar to the OSD allowed for corporations.

It must be clarified that partners may use OSD against their gross sales or receipts from business or
profession. They are only precluded from claiming OSD against their share in net income of GPP.

When to indicate the option to use OSD?

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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

For individual taxpayers, the option to use OSD can be indicated only in the annual income tax return
since quarterly income tax returns are mere estimates of gross income and deductions.

For corporate taxpayers, the option to use OSD for the taxable year must be indicated in the first
quarter return and shall be applied to all subsequent quarters and in the annual return. The option to
use either itemized deduction or OSD is irrevocable only for the current year it is made.

E. Assessment of Learning

For the self-regulated assessment of what you had learned from this module, please accomplish
the progress check/activity posted in our Google Classroom and submit it on or before due date.
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COLLEGE OF ACCOUNTANCY
C-BAC7 Taxation (Income Taxation)
Second Semester AY 2021-2022

F. References

Banggawan, R. B. (2021). Income Taxation Laws, Principles and Applications. Baguio City: Real
Excellence Publishing.

Ampongan, O. E. (2015). CPA Review in Taxation. Iriga City, Philippines: Ampongan, Omar Erasmo G.

De Leon, H. S., & De Leon, H. M. (2016). The Fundamentals of Taxation. Manila City, Philippines: REX
Book Store.

De Leon, H. S., & De Leon, H. M. (2016). The Law on Income Taxation (with Illustration, Problem and
Solution. Manila City, Philippines: REX Book Store.

Duncano, D. A. (2017). Easy Guide to Taxation for Entrepreneurs. Mandaluyong City: Anvil Publishing,
Inc.

Duncano, D. A. (2016). National Internal Revenue Code of 1997 As Amended Updated with
Annotations. Mandaluyong City, Philippines: Anvil Publishing, Inc.

Congratulations for having completed this module!

See you in the next module!

Modules prepared by : Maylene L. Evangelista

Reviewed/updated by : Rodelia R. Talavera

Faculty: RODELIA R. TALAVERA Page 12