LOSS

A loss incurred in a transaction in trade or business is deductible from gross income.

For example; a loss of a business asset is deductible.

A CASUALTY LOSS
A loss can be deducted from gross income even if not from transaction.
If;
(1) In the course of business
(2) Involving property used in business, and
(3) The loss was the result of a casualty

What is casualty? It is an accident, a mishap or a sudden invasion by a hostile agency, and excludes the
gradual deterioration of property arising from a steadily operating cause.
Examples are; fire, storm and lightning.

In order that a casualty loss can be deducted, there must be a declaration of loss filed with the Bureau of
Internal Revenue within 45 days from the date of discovery of the loss.

So, the actual loss will be reduced by insurance recovery or any other form of informality.

Illustration;
A factory building was destroyed by fire. It had a book value (Depreciated value) of P2, 000,000 at the
time of loss. The building was insured, and the insurance company paid P1, 800,000 under the property
insurance policy. The deduction for loss is P2, 000,000 (less) P1, 800,000 or P800, 000.

Illustration;
A company car with a book value of P1, 400,000 was involved in an accident. The person responsible for
the accident paid P800, 000 as his contribution for the repair of the car, and the company absolved him
from further liability. The deduction loss is P600, 000

CHARITABLE AND OTHER CONTRIBUTIONS

Charitable and other contribution can be deducted from gross income:
(1) If it is an expense in other conduct of trade or business.
(2) If it was given to associations with purposes mentioned in the law.
(3) There are contributions deductible
(a) In full.
(Example; a contribution to the government, for a priority activity in health)
(b) Subject to limitation and amount.
(Example; A contribution to a church in the Philippines)

For individual;
The amount must not exceed ten percent (10%) of the taxable income from business practice or
profession before deduction contributions;

For Corporation;
The amount must not exceed five percent (5%) of the taxable income before deduction for
contributions;
Illustration;
From assumed data:

Corporation;

Gross income P900, 000

All deductions, not including contributions 300,000
Net income before contributions P600, 000
Less; Contributions -
Deductible in full P20, 000
Deductible, subject to limitation –
Contribution 1 P15, 000
Contribution 2 P16, 000
Total P 31,000 (a)
5% of P600, 000 P30, 000 (b)
Allowed ([a] or [b], whichever is lower) P30, 000
Total deduction from contributions P50, 000
Taxable income P550, 000

Illustration;
From assumed data:

Individual;

Gross income P900, 000

All deductions, not including contributions 300,000
Net income before contributions P600, 000
Less; Contributions -
Deductible in full P20, 000
Deductible, subject to limitation –
Contribution 1 P15, 000
Contribution 2 P16, 000
Total P 31,000 (a)
10% of P600, 000 P60, 000 (b)
Allowed ([a] or [b], whichever is lower) P31, 000
Total deduction from contributions P51, 000
Net income P549, 000
PENSION PAYMENTS TO EMPLOYEES
The pension plan considers the number of years of service of the employee. The payment may be lump
sum payment or payments over a certain period.
Pension payments may be;
(a) Without a funded plan;
(b) With a funded plan set up by the employer, called by the law “pension trust”

Illustration;
In 2018, an employee retired after ten years of service. For his part services, the employer computed a
retirement and paid him cash of P50, 000 out of the general fund of the employer. The deduction for the
employer is in 2018, in the amount of P50, 000.

There is no pension trust.

Illustration;
For the past five years by 2018, Mr. A had five employees. He expanded his operations and took in
twenty new employees is that he is to receive a pension after ten years of service. Mr. A decided to set
up a pension plan for employees, and the plan called for a payment for past service and for payment for
services after the establishment of the plan for new twenty five employees and other employees who
may come after them. The pension of the old five employees for their services before the plan was
established is called “Past service cost”. The pension for the now twenty five employees (five old and
twenty new), beginning 2018 is called “Present service cost”.

Illustration;
A fund was established in 2018, for
Past service cost of original five (5) employees of P50, 000
Present service cost of the new twenty five (25) employees of P250, 000 a year.
The deduction will be;

Past service cost Present service cost Total deduction

2018 P5,000 P25,000 P30,000

2019 5,000 25,000 30,000
2020 5,000 25,000 30,000
2021 5,000 25,000 30,000
2022 5,000 25,000 30,000
2023 5,000 25,000 30,000
2024 5,000 25,000 30,000
2025 5,000 25,000 30,000
2026 5,000 25,000 30,000
2027 5,000 25,000 30,000
2028 25,000 25,000
2029 25,000 25,000
2030 25,000 25,000

Rule; if fund is funded, past service cost must be amortized over ten years (2018-2017) Present service
cost is a deduction for the year.
RESEARCH AND DEVELOPMENT COST
Are expenses towards improvement of processes and formulas or the development of new products?
Research and development cost must be categorized as follows;

KINDS OF EXPENDITURE TREATMENT

On acquisition or improvement of property Capitalize to the asset account and deduction will be
subject to depreciation or amortization by depreciation or amortization.

Other research and development costs (a) Full deduction in the year the cost is paid or
incurred; or
(b) Amortize over a period of not less than sixty (60)
months from the date of acquisition of benefit.

Illustration;

Research and development costs on January 2, 2018 were as follows;

Research building with a useful life of twenty (20) years,

Cost of P5, 000,000
Laboratory supplies and other research costs P1, 200,000

Benefits were expected to give benefits beginning December 1, 2018

and for 4 years
How much is the deduction for 2018?

Solution:
Depreciation of research building
(P5, 000,000/20years) – January 2 to December 31 P250, 000

Laboratory supplies and other research costs-

Lump sum P1, 200,000

Deduction in 2018 (P250, 000 + P1, 200,000) P1, 450,000

TAXES
All taxes paid or incurred, whether national or local, are deductible from gross income.
Except;

(a) Philippine income tax;

(b) Income tax paid into foreign country, if such tax is claimed as a credit against the Philippine income
tax (reduction of the Philippine income tax under a special formula in the law)
(c) Estate tax (a tax on the properties of one who died)
(d) Donor’s tax (a tax on a gift made)
(e) Special assessment tax (a tax assessed against real property benefitted by a public improvement.
(f) The tax paid will be a deduction for the person whom the tax is imposed. So that, a tax which is an
indirect tax, passed on by a seller of property or services upon whom imposed to the buyer of his
property or services cannot be deducted by the actual pay or (the buyer)
(g) The stock transaction tax, imposed on the seller of shares of stock who is not a dealer in securities, of
his securities sold thru a tax exchange.
(h) Interest and penalty for late payment of taxes cannot be deducted from gross income as taxes. But
interest can be deducted as interest expense. But on the penalty, the absolute rule is, it cannot be
deducted, because that is against public policy.
(i) Taxes deductible from gross income will include national and local taxes.

Illustration;
Payments of the following taxes:
Income tax of 2018 P100, 000
Real property tax for the first two quarters of the year
(Paid to the city) 18, 000
Value added tax on purchases 40, 000
Value added tax on sales 80, 000
Interest of late payment of tax 20, 000
Surcharge (a penalty) on late payment of income tax 50, 000
Excise tax on alcoholic beverages manufactured and sold 120, 000

The deduction for tax follows:

Real property tax P18, 000
Excise tax 120,000
Total P138, 000

Income tax is not deductible. Value added tax on purchases (input taxes) and value-added tax on sales
(output taxes) are offset against each other and do not bring about an expense. Interest for late
payment of taxes is not deductible as tax, but as interest expense. Surcharge, a penalty is not
deductible.
INTEREST EXPENSE
Is an amount paid for the use of money on indebtedness. It may be payable at the maturity of the
indebtedness, or it may be paid in advance when the indebtedness was incurred.

Illustration;
On an indebtedness money received of P100,000 on January 1, 2018 payable on December 31, 2018 at
P100,000 plus P12,000 interest, or total of P112,000.
(The interest here is payable upon maturity of the indebtedness)

Illustration;
On an indebtedness of P100, 000 with interest on it of P12, 000, money received on January 1, 2018 was
P88, 000 and to be paid on December 31, 2018 is P100, 000.
(Interest paid in advance called prepaid interest)

Illustration;
Interest paid upon maturity of indebtedness
For the indebtedness the tax payer paid interest due to maturity in 2018 at P10, 000.
How much the deduction for 2018?
(a) If the taxpayer is an individual – P10, 000;
(b) If the taxpayer is a corporation- P10, 000;
Prepaid interests (advance payment of interest)

Illustration;
Interest paid in 2018 – P20, 000
Period covered by the payment – 2018 and 2019 (2 years);
Principal due and paid, 2019 – P200, 000;
(The interest was prepaid in 2018)

1. If the taxpayer is on the CASH BASIS of accounting,

Deduction in 2019;
(a) If the tax payer is an individual
Deduction will be in the year that the principal was paid (2019);
(b) If the tax payer is a corporation
Deduction will be in the year that the interest was prepaid (2018);

2. If the taxpayer is on the accrual basis of accounting,

(a) If the tax payer is an individual:
Deduction in 2018- P10, 000
Deduction in 2019- P10, 000
(b) If the tax payer is a corporation:
Deduction in 2018- P10, 000
Deduction in 2019- P10, 000
DEPRECIATION
The loss of useful life of an asset used in business with a useful life of more than one year (fixed asset) is
called depreciation. The usual method of depreciation is (other methods are for higher studies in
accounting)

Straight line method of depreciation

Cost of the asset (less) scrap value

Formula: = Depreciation per year
Number in years of useful life

The books of accounts will record the expense, and deduction, as follows;
Debit- Depreciation expense
Credit- Allowance for depreciation

Illustration;
Cost of the fixed asset – P1, 100,000
Scrap value – P100, 000
Useful life – P10years

Annual depreciation; P100, 000, computed as follows

P1, 100,000 less P100, 000 divided by 10years

DEPLETION
Is the loss of the mineral deposit of a mine. The formula is:

Cost
= Depletion rate per ton
Estimated mineral deposit in tons

(Assumed in tons)
Minerals extracted during the year in tons x depletion rate = Depletion for the year

ENTERTAINMENT EXPENSE
When a business expense, is deductible from gross income as follows:
(a) At not exceeding one half percent (½%) of net sales in the case of sale of goods; and
(b) At not exceeding one percent (1%) of net revenue, in case of sale of service.
DISCOUNT TO SENIOR CITIZEN OR PERSON WITH DISABILITY
A senior citizen (sixty 60 years old and above) and a person with disability is exempt from the value-
added tax and is entitled to a discount of 20% on his purchases from a value-added tax registered seller.
The discount to the senior citizen of person with disability is a deduction from gross income of the seller.

Illustration
The tag price of an article being sold by a VAT taxpayer showed P1, 120, VAT included.
The computations involved are:

Tag price P 1, 120

Less: VAT 12/112 x P1, 120 120
Selling price, VAT not included P 1,000
Less: Discount (20% of P1, 000) 200
Selling price, net of VAT and discount to senior citizen P 800

Journal entries: Debit Credit

If the sale was recorded Cash P800

Net of discount Sales P800

There is no deduction, because the sale was recorded net of discount.

If the sale was recorded Cash P800

With the discount also Sales discount to senior citizen 200
recorded Sales P1,000

There is a deduction from gross income of P200

OTHER EXPENSES
Other business expenses, as itemized deductions, for which there are no specific provisions of the law,
are deductible from gross income. If satisfying the following requirements:
(a) Ordinary;
(b) Necessary
(c) Paid or incurred during the year; and
(d) Supported by vouchers or receipts

Examples of deduction under the category are:

(a) Advertising expense;
(b) Utilities expense (water, electricity)
(c) Rent expense;
(d) Salary expense;
(e) SSS distribution of employer.
SPECIAL DEDUCTION OF BONUS TO A PARTNER
Bonus may be given to the managing partner in a partnership. It is recognition of his expertise that
brings about profitable operations. But bonus is given only if the operations for the year resulted in net
income, and is at a certain percent of the net income of the year. The partners have to agree on the
meaning of “net income” base for bonus.

The net income base for bonus may be;

(a) Net income before bonus (bonus is not treated as an expense of operation)
(b) Net income after bonus (bonus is treated as an expense of operation)

An algebraic computation is required.

Illustration
Messrs. S, T and U have capital balances of P100, 000, P200, 000 and P300, 000. They have agreed to
provide bonus of 10% to Mr. U, the managing partner. At year-end, the partnership had a net income of
P80, 000 before providing for the bonus.

(a) If bonus is treated as expense;

Bonus B= .10 (80,000)
= 8,000

(b) If bonus is treated as expense;

Bonus B= .10 (80,000 – B)
= 8,000 - .10B
1.10B= 8,000
B= 8,000/1.10
B=7,272.73

Illustration
A VARIATION
Partners A and B are sharing equally in the partnership net income loss. In addition, Partner A is entitled
to a bonus at 10% if affordable, from net income after all expenses, including bonus and tax expenses.

Situation:
Bonus can be determined only after deducting all expenses, including the income tax expense:
But income tax can be computed only after the bonus expense is deducted.

So that, an algebraic computation is required:

Let B = Bonus is 10%

T= Income tax at corporate rate of 30%

B= .10(100,000 – B - .30 [100,000 – B])

=.10(100,000 – B - .30, 000 + .3B)
= .10(70,000- .7B)
=7,000- .07B
1.07B= 7,000
B= 7,000/1.07
B= 6,542.06