TAXATION

TOPIC 7.1: ITEMIZED DEDUCTIONS

ITEMIZED DEDUCTIONS FROM GROSS INCOME

1. Interest Expense 6. Depletion
2. Taxes 7. Charitable and Other Contributions
3. Losses 8. Contributions to Pension and Trusts
4. Bad Debts 9. Research and Development Costs
5. Depreciation 10. Other Ordinary and Necessary T,B, or Prof. Exp.

INTEREST EXPENSE

Requisites:
1. Must be a valid indebtedness
2. Legal liability to pay interest
3. Indebtedness incurred in connection with the taxpayer’s trade, profession or business
4. For interest incurred abroad by taxpayers who are subject to income tax only on income earned within the Philippines,
the indebtedness must be incurred
5. Deductible Amount of Interest Expense
Effectivity % Note:
January 1, 2019 33% - This arbitrage limit does not apply to MSME domestic corporations qualified to the 20%
January 1, 2022 20% corporate income tax.
- This arbitrage always applies to individual taxpayers regardless of the level of income.
Non-deductible Interest
1. Interest paid in advance through discount on indebtedness incurred by an individual taxpayer
2. Interest payments with related parties
3. If the indebtedness to finance petroleum operations
Capitalization of Interest
Interest incurred to acquire property used in trade, business, or profession – ALLOWED as capital expenditure

Special Cases
a. Interest on Preferred Stock – dividends; NOT DEDUCTIBLE to interest
b. Interest on Scrip Dividends – DEDUCTIBLE interest

TAXES

Requisites:
1. Must be paid or accrued within the taxable year
2. Must be incurred in connection with the taxpayer’s trade, profession or business

Non-deductible Taxes Tax Credit for Foreign Income Tax Paid

1. PH income tax, except fringe benefit tax Can be claimed only by those taxable on world income – RC
2. Estate or Donor’s Tax and DC.
3. Special Assessment
4. Income Tax imposed by a foreign country Taxpayer option to claim the foreign income tax EITHER as:
5. Stock Transaction Tax 1. Tax credit OR
6. VAT on business 2. Deduction from income

Limit of Tax Credit

1. 1st Limitation: Per Country Evaluation – whichever is lower of the actual amount of foreign tax paid and the
amount which reflects the ratio with gross income from foreign country
𝐶𝑜𝑢𝑛𝑡𝑟𝑦 𝑥 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒
𝑥 𝑃ℎ𝑖𝑙𝑖𝑝𝑝𝑖𝑛𝑒 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑎𝑥
𝑇𝑜𝑡𝑎𝑙 𝑊𝑜𝑟𝑙𝑑 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒

2. 2nd Limitation: Total Foreign Country Evaluation – whichever is lower of the aggregate lower values of the per-
country evaluation and the amount which reflects the ratio of the taxable income from all foreign countries
𝑇𝑜𝑡𝑎𝑙 𝐹𝑜𝑟𝑒𝑖𝑔𝑛 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒
𝑥 𝑃ℎ𝑖𝑙𝑖𝑝𝑝𝑖𝑛𝑒 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑎𝑥
𝑇𝑜𝑡𝑎𝑙 𝑊𝑜𝑟𝑙𝑑 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒

Rules on Income Tax Paid

Taxpayers who are TAXABLE on: Note:
World Income Philippine Income ONLY *Other than the non-deductible
Foreign Taxes Paid* Deductible Qualified** taxes above
**Deductible to the extent they
Foreign Income Tax Paid Deductible/Creditable Non-deductible/Non-creditable
are connected with income from
Philippine Taxes Paid* Deductible Deductible the sources in the PH only.
Philippine Income Tax Paid Non-Deductible Non-deductible

Refund Taxes: The refund of a deductible tax is TAXABLE if it created a tax benefit in the year is deducted.

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LOSSES
1. Ordinary Losses

Requisites:
1. Must be sustained during the taxable year
2. Not compensated for by insurance or other forms for indemnity
3. Sustained in a close and completed transaction
4. Loss must be that of the taxpayer
5. Loss must be reported to BIR with 45 days from the date loss or discovery
6. Not claimed as a deduction in the estate tax return (for individual taxpayers ONLY)

Deductible Losses Measure of the Loss

1. Loss incurred in trade, profession or business 1. Total Loss – book value of the property
2. Loss due to fire, storm, shipwreck or other casualty 2. Partial Loss – replacement cost of the damaged portion
3. Loss due to theft, robbery, or embezzlement or the book value at the time of loss, whichever is LOWER

Abandonment Losses Special Cases

1. Petroleum Operation – all accumulated exploration and 1. Pending proceeding in which the loss
development expenditures (partially or wholly abandoned of contract can be recovered – DEDUCTION for the
area) shall be allowed as a deduction, provided notice of loss is delayed until recovery becomes
abandonment shall be filed with the Commissioner of Internal impossible
Revenue. 2. Loss of Income – cannot be deducted
2. Producing Wells – the unamortized cost as well as the unless related income has already been
undepreciated costs of equipment directly used shall be allowed as included in gross income.
a deduction in the year such well, equipment or facility is 3. Losses on sale or exchanges of property
abandoned by the contractor with related parties – NOT DEDUCTIBLE

2. Capital Losses – DEDUCTIBLE only to the extent of capital gains

BAD DEBTS
Requisites:
1. Must be valid and subsisting debt to the taxpayer
2. Must be connected with taxpayer’s trade, profession or business
3. Debt is ascertained to be worthless
4. Charged-off within taxable years

Recovery of Bad Debts Non-Deductible Bad Debts

1. Taxpayers under cash basis – TAXABLE but 1. Those incurred under cash basis of reporting gross income
subject to Income Tax Benefit Rule 2. Those sustained in a transaction entered into by related parties
2. Taxpayers under accrual basis – ALWAYS 3. For taxpayers not taxable on world income, those that
TAXABLE represents loss of foreign income.

Special Cases with Bad Debts:

Receivables assigned without recourse – only the difference of amount paid and amount recovered is allowed as deduction.

DEPRECIATION
Requisites: Methods of Depreciation:
1. The property must be used in trade, profession or business 1. Straight line
2. The property must have a limited useful life 2. Declining balance
3. The provision must be charged off during the taxable year 3. Sum of years
4. The provision must be reasonable 4. Other methods prescribed by Secretary of
Finance upon recommendation of CIR.
Special Option with depreciation:
1. For a proprietary or private educational institution only
2. May either choose to:
a. Charged off as capital outlays of depreciable asset in the year of acquisition; or
b. Deduct allowance for depreciation

Petroleum Operation Mining Operations

The taxpayer may choose either declining- balance method or straight line For all properties used in mining operations
method at the option of the contractor. 1. 10 year useful life or less - At
normal rate of depreciation
Useful life of depreciable asset: 2. More than 10 years useful life
1. Used in or related to the production of petroleum - 10 years or shorter depreciated over any number of
2. Not used in or not related to the production of petroleum - 5 years years between 5 and the
under straight line method expected life.

DEPLETION (Cost Depletion)

- Available only for oil and gas wells and mines.
Exploration Expenditure Development Expenditure
Expenditures paid or incurred in ascertaining the existence, Paid or incurred during the development stage of the mine.
location and extent, or quality of any deposit or ore or other The development stage begins when ore or other minerals
minerals before the beginning of the development stage of are shown to exist in commercial quality and quantity and
the mine or deposit. end upon commencement of actual commercial extraction.

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Method to Use: Cost-Depletion Method
Depletion should be provided only up to the extent of capital investment in the mine only.
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛 𝑡ℎ𝑒 𝑚𝑖𝑛𝑒
𝑁𝑜. 𝑜𝑓 𝑈𝑛𝑖𝑡𝑠 𝑅𝑒𝑐𝑜𝑣𝑒𝑟𝑎𝑏𝑙𝑒
𝑈𝑛𝑖𝑡 𝐷𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 𝑜𝑓 =
𝑈𝑛𝑖𝑡𝑠 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑒𝑐𝑜𝑣𝑒𝑟𝑎𝑏𝑙𝑒

Oil and Gas Wells or Mines: Treatment of Intangible Exploration and Development Drilling Costs
If intangible development drilling cost are incurred for:
1. Non-producing wells and or mines deductible in the year incurred
2. Producing wells and or mines at the option of the taxpayer, deduction in full in the year paid or incurred, or capitalized
and amortized

Irrevocable Alternative Deduction: Applicable to Mining Operation only

Limit: Shall not exceed 25% of taxable income, without the benefit of any tax incentive under existing laws.

Deductibility of Depreciation or Depletion on Mining Properties:

Taxpayers who are TAXABLE on:
World Income Philippine Income ONLY
Located abroad Deductible Non-deductible
Located in Philippines Deductible Deductible

CHARITABLE AND OTHER CONTRIBUTIONS

Requisites: Note: If the taxpayer is not engaged in
1. The contribution or gift must be actually paid trade, business or profession, the rules on
Donor's taxation applies. Similar gifts are
2. The contribution of property must be measured based on acquisition cost usually exempt under donor's taxation
3. It must be given to an organization specified by law provided that not more than 30% of the
4. Net income of the specified institution donation is used for administrative purposes
5. Must not inure to the benefit of any private stockholder or individual by such done non-profit entity.
6. The person making the contribution must be engaged in trade, business or profession

Classifications of Contributions:
A. Fully Deductible Contributions
1. Donation to the government or political subdivisions including fully owned government and controlled
corporations to be used exclusively in undertaking priority activities in:
1. Education 4. Human settlements
2. Health 5. Culture and Sports
3. Youth and Sport Development 6. Economic Developments

NOTE: Donation to the government that are not in accordance with priority activities are subject to limit.

2. Donation to foreign institution or international organization in compliance with agreement or treaties.

3. Donations to accredited domestic non - government organizations. These includes organizations
exclusively for:
1. Scientific 6. Health
2. Research 7. Social Welfare
3. Educational 8. Cultural
4. Character Building 9. Charitable
5. Youth and Sports Development 10. Any combination of the listed above

Requisites:
a. Must be utilized by the donee institution not later than the 15th day of the third month following the close of the
taxable year
b. Administrative expense must not exceed 30% of the total expenses
c. Upon dissolution, assets must be distributed to another non-profit domestic corporation of to the government
d. If these conditions are not complied with, the donation is subject to limit

B. Contributions Subject to Limits

1. Donations to the Government of the Philippines or political subdivisions exclusively for public purposes
2. Donation to non-government organization or to domestic corporations organized exclusively for the
following purposes:
1. Religious 5. Cultural
2. Charitable 6. Educational
3. Scientific 7. Rehabilitation of Veterans
4. Youth and Sports Development 8. Social Welfare

Limit of Deductions (either fully deductible or subject to limit)

1. 10% for Individual
2. 5% for Corporations

Deductible Contribution Subject to Limit: Whichever is lower of the actual contribution with the limit as set forth

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CONTRIBUTIONS TO PENSION AND TRUSTS
Current Service Cost – computed value of services rendered by a plan employee during the year
Past Service Cost – value of services rendered by employees in the past that partially satisfy vesting conditions

Rules for Pension Expense:

1. Payments to the trust to cover pension liability accruing during the year are FULLY DEDUCTIBLE expense for the
taxable year.
2. Funding of past service cost is amortized over a period of 10 years starting from the year in which the contribution
was made.

RESEARCH AND DEVELOPMENT COSTS

Requisites:
1. Must be paid or incurred during the taxable year
2. Must be connected with the trade, profession or business of the taxpayer
3. Not chargeable to capital accounts (capitalizable expenditure)

Amortization of Capitalizable Research and Development Costs that are not chargeable to a property of a kind that is subject
to depreciation or depletion:
1. The taxpayer should treat the expenditure as a deferred charge
2. Amortized over a period of not less than 60 months starting from the month in which the taxpayer first derived
benefits from such deferred expense

Non-deductible research and development costs

1. Expenditure for the acquisition of improvement of a land (in connection with research projects)
2. Any expenditure for the improvement of property to be used in connection with research and development of a kind
which is subject to depreciation and depletion; and (these items are capitalized then charged off to depreciation)
3. Any expenditure paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of any
deposit of ore or other mineral, including oil and gas. (exploration costs are non- deductible, only development costs)

OTHER ORDINARY AND NECESSARY TRADE, BUSINESS OR PROFESSIONAL EXPENSES

Requisites:
1. Ordinary and necessary
2. Paid or incurred during the taxable year
3. Directly attributable to the development, operation, management and or conduct of the trade, profession or business
4. Reasonable
5. The amount paid shall be allowed as deduction only if it is shown that the tax required to be deducted and withheld
therefrom has been paid to the BIR
6. Must be supported by official receipts or adequate records

A. COMPENSATION B. TRAVEL EXPENSES

Requisites: Requisites:
1. Personal services must have been actually rendered 1. Must be incurred while away from home
2. The compensation for such services must be reasonable, including 2. In pursuant of a trade, profession or
the grossed-up monetary value of fringe benefit furnished to the business
employee and the applicable final tax remitted to the BIR

C. ENTERTAINMENT, AMUSEMENT OR RECREATION EXPENSES (EAR)

Requisites:
1. Directly related to the furtherance of the conduct of trade, profession or business
2. Not be contrary to law, morals, good customs, public policy or public order
3. Not have been paid directly or indirectly to an official or employee of the Government (local or national, including
government-owned and controlled corporations) or of a foreign government, or to a private individual, corporation,
General Professional Partnership or a similar entity, if it constitute bribe, kickback or other similar payments
4. The official receipts, invoices, bills or statement of accounts should be in the name of the taxpayer claiming the
deduction.

Limit of deductible amount for EAR:

A. Taxpayers deriving income from either sale of properties or sale of services:
Whichever is LOWER of the following and the actual EAR expense
a. Taxpayers engaged in sale of goods or properties - 12 of 1% (or.5%) of net sales
b. Taxpayers engaged in sale of services (profession, lessors) - 1% of net revenue
B. Taxpayers deriving income from both sales of properties and sales of services, the deductible amount shall be
whichever is LOWER between the two tests below: tests below: a

1st Limit Test: The final deductible amounts shall be WHICHEVER IS LOWER of the respective tentative deductible amount
and the respective amounts which the total sales or revenue bears to the total sales and revenue bears to the actual
entertainment, amusement or recreation expenses.

2nd Limit Test: 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

x Actual Total EAR for Sales and Revenue
𝑇𝑜𝑡𝑎𝑙 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 𝑎𝑛𝑑 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑁𝑒𝑡 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
x Actual Total EAR for Sales and Revenue
𝑇𝑜𝑡𝑎𝑙 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 𝑎𝑛𝑑 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

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MAJOR CLASSIFICATION OF ITEMS DEDUCTIONS
1. Cost of sales / cost of services 3. Special Allowable Itemized Deductions (SAID)
2. Ordinary allowable itemized deductions 4. Net Operating Loss Carry Over (NOLCO)

COST OF SERVICES – Covers all direct costs and expenses necessary to provide the service required by customers such as:
a. Salaries and employee benefits of personnel, 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.

SPECIAL ALLOWABLE DEDUCTIONS

SPECIAL ALLOWABLE ITEMIZED DEDUCTIONS
There are two types of special allowable itemized deductions:
1. Special expense under the NIRC and special laws with outflows
2. Deduction incentives under special laws no outflows

SPECIAL EXPENSE DEDUCTION EXPENSE

1. Income distribution of taxable estate and trust 1. Additional compensation expense for SCs and PWDs
to reserve fund and payment trust 2. Cost of facility improvements for PWDs
2. Transfers to reserve fund and payments to 3. Additional training expense on jewelry industry
policies and annuity contracts of insurance 4. Additional contribution expense on Adopt- a-School program
companies 5. Additional deductions on rooming-in and breastfeeding
3. Dividend distribution of REITs program
4. Transfers to reserve funds of cooperatives 6. Additional free legal assistance expense
5. Discounts to senior citizens and PWDs 7. Additional productivity incentive bonus expense
8. Additional apprenticeship expense (CREATE)

Required disclosures:
1. Description of the special deduction
2. Legal basis
3. Amount

NET OPERATING LOSS CARRY OVER

Measurement: Exclude NOLCO prior year and deduction incentives in the current year

Requisites:
1. Taxpayer must not be exempt from income tax during the taxable year the NOL was incurred.
2. There must be no substantial change in ownership of the business enterprise

NOTE:
 NOLCO is deductible over 3 years except taxpayers in the extractive industries such as mining or oil companies
where the carry over period is 5 years.
 For taxpayers under the fiscal year basis, this shall apply for those fiscal years ending on or before June 30, 2021
and June 30, 2022.