BASIC TAXATION NOTES Professor: Atty.

Villaluz ID121 T2 AY 22-23

➢ What are the requirements for deductibility of interest Tax Arbitrage Rule
expense?
The interest expense that may be deducted shall be reduced if the
(a) There must be an indebtedness; taxpayer has derived certain interest income which had been subjected to
(b) There should be an interest expense paid or incurred upon final withholding tax.
such indebtedness;
➢ How is the EAR reported in the FS and ITR? (c) The indebtedness must be that of the taxpayer, “tax arbitrage scheme” wherein the taxpayer would simply borrow funds
(d) The indebtedness must be connected with the taxpayer's from banks in order to generate deductible interest expense and simply
SECTION 6. REPORTING – The taxpayer is hereby required to use in its trade, business or exercise of profession; deposit the borrowed funds in another bank to yield interest income. They
financial statements and income tax return the account title (e) The interest expense must have been paid or incurred during are availing two tax benefits in one.
“entertainment, amusement and recreation expense”, or in the alternative, the taxable year;
to disclose in the notes to financial statements the amount corresponding (f) The interest must have been stipulated in writing; Other cases where interest expense is not deductible from gross income. —
thereto when recording expenses paid or incurred of the nature as defined (g) The interest must be legally due; No interest expense shall be allowed as deduction from gross income in
in Section 2 of these Regulations. However, such expense should be (h) The interest payment arrangement must not be between any of the following cases:
reported in the taxpayer’s income tax return as a separate expense item. related taxpayers as mandated in Sec. 34(B)(2)(b), in relation (1) If within the taxable year, an individual taxpayer reporting
to Sec. 36(B), both of the Tax Code of 1997; income on the cash basis incurs an indebtedness on which an
➢ What are the additional expenses that may be deducted (i) The interest must not be incurred to finance petroleum interest is paid in advance through discount or otherwise:
from gross income under the CREATE Law? operations; and - Provided, That such interest shall be allowed as a
(j) In case of interest incurred to acquire property used in trade, deduction in the year the indebtedness is paid :
"(v) An additional deduction from taxable income of one-half (1/2) of the business or exercise of profession, the same was not treated as - Provided, further, That if the indebtedness is
value of labor training expenses incurred for skills development of a capital expenditure. payable in periodic amortization, the amount of
enterprise-based trainees enrolled in public senior high schools, public interest which corresponds to the amount of the
higher education institutions, or public technical and vocational institutions ➢ What are the limitations on the amount of deductible principal amortized or paid during the year shall
and duly covered by an apprenticeship agreement under Presidential interest? be allowed as deduction in such taxable year.
Decree No. 442, series of 1974, or the 'Labor Code of the Philippines', as (2) If both the taxpayer and the person to whom the payment has
amended, shall be granted to enterprises: Section 4. Rules on the Deductibility of Interest Expense been made or is to be made are persons specified under Sec.
(a) General Rule. — In general, the amount of interest expense paid 36(B) of the Tax Code of 1997, viz:
➢ What are the specific requirements for the deductibility of or incurred within a taxable year on indebtedness in (a) Between members of a family. For purposes of
the additional expense under the CREATE Law? connection with the taxpayer's trade, business or exercise of this paragraph, the family of an individual shall
profession shall be allowed as a deduction from the taxpayer's include only his brothers and sisters (whether by
Provided, further, That for the additional deduction for enterprise-based gross income. the whole or half-blood), spouse, ancestors and
training of students from public educational institutions, the enterprise lineal descendants; or
shall secure proper certification from the DepEd, TESDA, or CHED: (b) Limitation. — The amount of interest expense paid or incurred (b) Between an individual and a corporation more
Provided, finally, That such deduction shall not exceed ten percent (10%) by a taxpayer in connection with his trade, business or exercise than fifty percent (50%) in value of the
of direct labor wage.: of a profession from an existing indebtedness shall be reduced outstanding stock of which is owned, directly and
by an amount equal to the following percentages of the indirectly, by or for such individual; or
READ: interest income earned which had been subjected to final (c) Between two corporations more than fifty percent
Rev. Regs. No. 05-21 withholding tax depending on the year when the interest (50%) in value of the outstanding stock of each of
Rev. Regs. No. 10-2002 income was earned, viz: which is owned, directly or indirectly, by or for the
● Forty-one percent (41%) beginning January 1, 1998; same individual; or
2. Interest expense ● Thirty-nine percent (39%) beginning January 1, 1999; and (d) Between the grantor and a fiduciary of any trust;
Thirty-eight percent (38%) beginning January 1, 2000; and or
➢ How is the term ‘interest’ defined? ● Thirty-three percent (33%) beginning January 1, 2009 and (e) Between the fiduciary of a trust and the fiduciary
thereafter. of another trust if the same person is a grantor
Rev. Regs. 13-00 (a) Interest — shall refer to the payment for the use or with respect to each trust; or
forbearance or detention of money, regardless of the name it is called or This limitation shall apply regardless of whether or not a tax arbitrage (f) Between a fiduciary of a trust and a beneficiary of
denominated. It includes the amount paid for the borrower's use of money scheme was entered into by the taxpayer or regardless of the date when such trust.
during the term of the loan, as well as for his detention of money after the the interest bearing loan and the date when the investment was made for (3) If the indebtedness on which the interest expense is paid is
due date for its repayment. as long as, during the taxable year, there is an interest expense incurred on incurred to finance petroleum exploration in the Philippines.
one side and an interest income earned on the other side, which interest The non-deductible interest expense herein referred to
Interest is the fee paid for the use of someone else’s money. income had been subjected to final withholding tax. This rule shall be pertains to interest or other consideration paid or incurred by a
observed irrespective of the currency the loan was contracted and/or in Service Contractor engaged in the discovery and production of
whatever currency the investments or deposits were made. indigenous petroleum in the Philippines in respect of the
 BASIC TAXATION NOTES Professor: Atty. Villaluz ID121 T2 AY 22-23

financing of its petroleum operations, pursuant to Section 23 ➢ What taxes are NOT deductible? Credit Against Tax for Taxes of Foreign Countries - if the taxpayer signifies
of P.D. No. 8, as amended by P.D. No. 87, otherwise known as in his return his desire to have the benefits of tax deductions, the tax
"The Oil Exploration and Development Act of 1972." (1) Philippine income tax imposed by this Title shall be credited with citizens and domestic
(2) Income taxes imposed by authority of any foreign country; corporations which shall be the amount of income taxes paid or incurred
➢ How is the amount of deductible interest computed? - But shall be allowed in the case of a taxpayer who during the taxable year to any foreign country.
does not signify in his return his desire to have to
any extent the benefits Foreign Tax Credits ➢ Who are entitled to claim tax credits?
(3) Estate and donor’s tax
(4) Tax assessed against local benefits of a kind that tends to ○ Resident citizens
increase the value of the property assessed ○ Domestic Corporations
○ Members of GPPs
Or under the Rev. Regs. 13-00: ➢ What are the treatment taxes that are refunded? ○ Beneficiaries of estates and trusts

Taxes that are refunded or credited shall be included as part of gross ➢ What are the limitations on the availment of foreign tax
income in the year of receipt to the extent of the income tax benefit of the credits?
deduction.
The amount of the credit shall be subject to each of the following
Limitations on deductions: limitations:
● The amount of the credit in respect to the tax paid or incurred
In the case of nonresident alien individual engaged in trade or business in to any country shall not exceed the same proportion of the tax
the Philippines and a resident foreign corporation, the deductions for tax against which such credit is taken, which the taxpayer's taxable
provided shall only be allowed only if and to the extent that they are income from sources within such country under this Title bears
connected with income from sources within the Philippines to his entire taxable income for the same taxable year; and
➢ Can interest be capitalized?
➢ What option is available to the taxpayer? ● The total amount of the credit shall not exceed the same
Capitalized interest is an accounting practice required under the accrual proportion of the tax against which such credit is taken, which
basis of accounting. Capitalized interest is interest that is added to the total Domestic corporations are allowed to claim a credit for any income taxes the taxpayer's taxable income from sources without the
cost of a long-term asset or loan balance. This makes it so the interest is paid to a foreign country, provided that the taxes are not claimed as Philippines taxable under this Title bears to his entire taxable
not recognized in the current period as an interest expense. deductions. Foreign corporations are not allowed foreign tax credits. income for the same taxable year.

Sec. 4(e) of Rev. Regs 13-00 provides an optional treatment of interest Options for taxes paid in a foreign country Sec. 80 of the Income Tax Regulations provide that in the case of a
expense on capital expenditure: ● Claim as deduction from gross income of citizens and non-resident alien individual and a foreign corporation, the deduction is
domestic corporations; or allowed only if and to the extent that the taxes for which deduction is
At the option of the taxpayer, interest incurred to acquire property used in ● Claim as foreign tax credit (FTC) against Philippine income tax claimed are connected with income from sources within the Philippines.
trade, business or exercise of a profession may be: due of citizens and domestic corporations
● Allowed as a deduction (full amount in the year it is incurred); BIR Requirements
or ➢ What are foreign tax credits?
● Treated as a capital expenditure (the periodic amortization) Proof of the ff:
TAX REFUND v. TAX CREDIT v. TAX DEDUCTION (1) The total amount of income derived from foreign sources;
READ: (2) The amount of income derived from each country, the foreign
Rev. Regs. No. 13-2000 - Limitations tax paid or incurred, which is claimed as a credit; and
Refund Credit Deduction
Metro Inc. Vs. CIR, CTA Case No. 6356 dated June 9, 2009 (3) All other information necessary for the verification and
BIR Ruling DA-(C-119) 354-09 dated July 7, 2009 computation of such credit
payment is returned deductible on deductible to gross
to taxpayer; may or income tax proper; income
3. Taxes READ:
may not be income only foreign taxes
Section 80, Income Tax Regulations
subjected to tax; may be claimed
➢ What taxes are deductible?
taxable income
when the tax is an
Taxes paid or incurred within the taxable year in connection with the
allowable deduction
taxpayer’s trade or business shall be allowed as a deduction as provided for
under Sec. 34(C) of the Tax Code.
 BASIC TAXATION NOTES Professor: Atty. Villaluz ID121 T2 AY 22-23

4. Losses the close of the taxable year or property held by the taxpayer primarily for improvements, competent appraisals of the
sale to customers in the ordinary course of his trade or business, or property before and after the casualty, canceled
Losses actually sustained during the taxable year and not compensated for property used in the trade or business, of a character which is subject to checks, vouchers, receipts and other evidence of
by insurance or other forms of indemnity shall be allowed as deductions. the allowance for depreciation provided in Subsection (F) of Section 34; or cost.
real property used in trade or business of the taxpayer 3. Insurance policy for insured properties.
➢ What are the kinds of deductible losses? 4. Police report, in case of robbery/theft during the
(C) Limitation on Capital losses. – Losses from sales or exchange capital typhoon and/or as a consequence of looting.
(1) Business losses/ordinary losses assets shall be allowed only to the extent of the gains from such sales or
(2) Casualty losses exchanges. If a bank or trust company incorporated under the laws of the For purposes of pre-audit, the taxpayer claiming the loss shall attach to his
(3) Net Operating Loss Philippines, a substantial part of whose business is the receipt of deposits, return a copy of his declaration of loss showing the imprint of the date of
(4) Capital Losses sells any bond, debenture, note, or certificate or other evidence of receipt by the receiving office. Failure to attach a copy of his declaration of
(5) Losses From Wash Sales of Stock or Securities. indebtedness issued by any corporation (including one issued by a loss will result in the disallowance of loss in the pre-audit of his income tax
(6) Wagering Losses or gambling losses government or political subdivision thereof), with interest coupons or in return.
(7) Abandonment Losses in petroleum operations registered form, any loss resulting from such sale shall not be subject to
(8) Losses due to voluntary removal of buildings, machinery the foregoing limitation and shall not be included in determining the Requisites for Deductibility
(9) Losses of the useful capital assets due to some change in applicability of such limitation to other losses.
business conditions (1) Declaration filed with the BIR;
If the sale results in a capital loss, such a loss shall be deductible only to the (2) Casualty losses must have been properly reported as part of
➢ What is an ordinary business loss? Other losses? extent of capital gains from the same type of transaction during the same the taxpayer’s assets in the taxpayer’s accounting records and
period. financial statements in the year immediately preceding the
occurrence of the loss with the costs of acquisition clearly
Ordinary losses Casualty losses
➢ What are the requirements for the deductibility of casualty established and recorded;
loss? (3) The amount of loss that shall be compensated by insurance
Sec. 34(D)(1)(a) Sec. 34(D)(1)(b) coverage should NOT be claimed as a deductible loss
A. Declaration of loss. Taxpayers who intend to claim their losses - If the insurance proceeds exceed the net book
Normally Arising from fires, storms, shipwreck, or other as a deduction should file within 45 days after the event, a value of the damaged assets, such excess shall be
incurred in the casualties, or from robbery, theft or embezzlement. sworn declaration of loss with the Revenue District Officer subject to the the regular income tax
trade, profession (RDO) which has jurisdiction over the taxpayer’s place of (4) Deduction of assets as capital losses must be properly
or business business. The sworn declaration of loss shall contain, among recorded in the accounting reports, with the adjustment of the
complete or partial destruction of property resulting other things, the following information: applicable accounts
from an identifiable event of a sudden, unexpected or 1. Nature of the event that gave rise to the loss and (5) The restoration of the damaged property or the acquisition of
unusual nature. It denotes accident, some sudden time of its occurrence new property to replace it must be properly recorded and
invasion by hostile agency, and excludes progressive 2. Description and location of the damaged recognized as either repairs expense or capitalized asset
deterioration through steadily operating cause properties.
3. Items needed to compute the losses such as: (a) ➢ What are the requirements for the destruction of inventory?
cost or other basis of the properties; (b)
➢ What are the allowable capital losses?
depreciation, if any; (c) value of the properties Revenue Memorandum Order No. 21-20 provides for the policies, guidelines
before and after the event; and (d) cost of repair; and procedures for the inspection or supervision of the
- Losses from (allowable only to the extent of capital gains)
and destruction/disposal and determination of deductible expenses of
sales or exchanges of capital assets
4. Amount of insurance or other compensation inventory which have been declared as waste or obsolete.
- Losses resulting from securities becoming worthless and which
received or receivable.
are capital assets (considered loss from sale or exchange) on
(1) An “Application for Destruction/Disposal of Goods/Assets”
last day of the taxable year
B. Proof of loss. The declaration of loss should be substantiated shall be filed with the Large Taxpayers’ Office or Revenue
- Losses from short sales of property
with evidence which the taxpayer should gather immediately District Office where the principal place of the business is
- Losses due to failure to exercise privileges or options to buy or
after the occurrence of the casualty or event causing the loss. registered.
sell property
These include the following documents which should be kept (a) Must be filed at least 7 days before the proposed
by the taxpayer for BIR verification. scheduled date of destruction/disposal of the
The allowable capital losses are those incurred from sales or exchanges of
1. Photographs of the property taken before and inventories/equipment
capital assets but only to the extent of capital gains.
after the monsoon rains showing the extent of the (b) Must include the following documents:
damage sustained. (i) Sworn Declaration of Goods/Assets as
(1) Capital Assets. – The term ‘capital assets’ means property held by the
2. Documentary evidence for determining the cost Waste or Obsolete;
taxpayer (whether or not connected with his trade or business), but does
of valuation of the damaged properties such as (ii) a List of Goods/Assets for
not include stock in trade of the taxpayer or other property of a kind which
purchase contracts and deeds, receipt bills for Destruction/Disposal
would properly be included in the inventory of the taxpayer if on hand at
 BASIC TAXATION NOTES Professor: Atty. Villaluz ID121 T2 AY 22-23

Machineries/Equipment for ➢ Who are entitled to claim NOLCO?

Destruction/Disposal;
(iii) Letter of intent that he is considering In general, all taxpayers subject to normal/net income tax or regular
to avail the services of a third party as corporate income tax can avail or claim NOLCO as a deduction.
witness in the process of
destruction/disposal and providing a. Any individual engaged in trade or business
the name thereof; b. Domestic and resident foreign corporations subject to normal
(iv) Inventory List of Goods duly received income tax
by the BIR; c. Corporations subject to preferential tax rates under the Code
(v) Supporting documents to prove the (private educ institutions, hospitals, regional operating
reasons stated in this application as headquarters)
the cause for the destruction/disposal;
(vi) Other documents to prove the ➢ What are the reporting requirements for the NOLCO?
correctness of the value of the
goods/assets to be The NOLCO shall be separately shown in the taxpayer’s income tax return
destroyed/disposed while the Unused NOLCO shall be presented in the Notes to the Financial
(2) BIR shall conduct a witnessing Statements showing, in detail, the taxable year in which the net operating
(3) BIR shall then issue a “Certificate of Deductibility of loss was sustained or incurred.
Goods/Assets Destructed/ Disposed”
Failure to comply with this requirement will disqualify the taxpayer from
➢ What is NOLCO? claiming the NOLCO.

Net Operating Loss Carry-Over arises when there is net operating loss, READ:
which is the excess of allowable deduction over gross income of the Casualty Losses- RMC31-2009;
business in a taxable year. Rev. Regs. No. 12-77
NOLCO- Rev. Regs. No. 14-2001
When the taxpayer incurred net operating loss, it still derives benefit from RMO NO. 21-20
it because the Tax Code allows the carry-over of the operating loss as a BIR RULING [DA-745-06], December 29,2006
deduction from gross income for the next 3 consecutive taxable years BIR RULING [DA-300-06], May 8, 2006
immediately following such loss. COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. NIDEC COPAL
PHILIPPINES CORPORATION, respondent. C.T.A. EB CASE NO. 250.
This means for the next 3 years, an additional deduction called NOLCO October 1, 2007.] (C.T.A. Case No. 6577)
may be claimed in the computation of taxable income.

NOLCO shall only be allowed if there has been NO substantial change in

the ownership of the business or enterprise.

➢ What is the substantial change in ownership that would not

affect the availment of the NOLCO?

If, as a result of a merger, consolidation or combination, the shareholders

of the transferor/assignor gains control of at least 75% or more in nominal
value of the outstanding issued shares or paid up capital, or at least 75% or
more interest in the business, of the transferee/ assignee.

➢ In what instances will there be NO substantial change in

ownership?

If more than 75% in nominal value of outstanding issued shares or more

than 75% of the paid up capital of the corporation is held by or on behalf
of the same persons even after the merger or consolidation or
combination.