Income taxation

Allowable Deduction

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Deduction from Gross Income 1. Itemized Deduction a. Expenses

Ordinary and necessary trade, business or professional expenses

Expenses allowable to private educational institutions b. Interest c. Taxes d. Losses

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e. Bad debts f. Depreciation g. Depletion of oil and Gas Wells and Mines h. Charitable and other Contributions i. Research and Development j. Pension Trusts k. Premium Payments on health and/or Hospitalization Insurance. (available for individual taxpayer only) 2. Optional Standard Deduction (OSD) In place of items a to j above, resident citizens, non-resident citizens and resident aliens may deduct from their gross income from trade, business or profession, an optional standard deduction equivalent to 10% of gross income.

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A. Business Expense

Deduction include the following:

Compensation Payment Fringe Benefit Travel Expenses Rentals Entertainment, Amusement and Recreation

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Coverage (EAR) individuals engaged in trade/business, including estate and trusts Individuals engaged in the practice of profession Domestic Corporation Resident Foreign corporations General professional partnership, including its members

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Exclusion The following expenses are not considered (EAR) a) Expenses which are treated as compensation or fringe benefits for service rendered under the employer-employee relationship. b) Expenses for charitable or fund raising events; c) Expenses bonafide business meeting of stockholders, partners or directors; d) Expenses for attending or sponsoring an employee to a business league or professional organization meeting; e) Expenses for events organized for promotion, marketing and advertising including concerts, conferences, seminars, workshops, convention, an other similar events; f) Other expenses of a similar nature

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Requisites of deductibility a. It must be paid or incurred during the taxable year: b. It must be 1. directly connected to the development, management and operation of the trade, business or profession of the taxpayer; or 2. directly related to or in furtherance of the conduct of his or its trade, business or exercise of a profession; c. It must not contrary to law, morals, good customs, public policy or public order; d. It must not be paid, directly or indirectly, to an official or employee of the national government, or any local government unit, or of any government owned or controlled corporation (GOCC), or of foreign government, or to a private individual, or corporation, or general professional partnership (GPP), or a similar entity, if it constitute a bribe, kickback or other similar payment. E. It must be duly sustained by adequate proof. The official receipts, or invoices, or bills or statements of accounts should be in the name of the taxpayer claiming the deduction; and f. The appropriate amount of withholding tax, if applicable, should have been withheld there from and paid to the Bureau of Internal Revenue.

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Ceiling on entertainment, amusement and recreation expense -There shall be allowed as deduction from gross income for EAR Apportionment Formula:
Net Sales / Net Revenue Total Net Sales and net revenue x Actual Expense

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Repairs are expenditures to restore assets to good operating
condition upon breakdown by replacing broken parts.

Cost of Materials and Supplies

Methods used in deducting cost of materials and supplies:
1. Actual consumption this method the taxpayer maintains a record of consumption of materials and supplies or takes physical inventories at the end of the year. Beginning inventory Add: Purchases during the year xxx Materials and supplies available during the year Less: Ending inventory xxx Materials and supplies expense xxx xxx xxx

2. Total Purchases if a taxpayer carries incidental materials or supplies on hand for which no record of consumption is kept or of which no physical inventories are taken

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Additional Deduction to a Private Educational Institution Deduction from Gross Income of a Corporation Engaged in Farming Entitled to deduct from gross income: 1. Cost of ordinary tools of short life or small cost such as hand tools, including shovels, rakes etc. 2. Cost of feeding and raising livestock representing actual outlay but not including the value of farm products grown upon the farm. 3. Cost of gasoline or fuel, repairs and upkeep of the transportation equipment.

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Expenses Not Deductible from gross Income of Farmers The following are not deductible from gross income: 1. Cost of farm machinery, equipment, and farm buildings. 2. Amounts expended in the development of farm, orchards, and ranches, prior to the time when the productive state is reached. 3. Amounts expended in purchasing work, breeding or dairy animals unless such animals are included in an inventory. 4. Cost of gasoline or fuel, repairs and upkeep of transportation equipment, used for pleasure or convenience of the farmer or his family. B. INTEREST Interest shall refer to the payment for the use or forbearance or detention of money, regardless of the name or denominated.

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Requisites for Deductibility 1. There must be an indebtedness; 2. There should be an interest expense paid or incurred upon such indebtedness; 3. The indebtedness must that of the taxpayer; 4. The indebtedness must be connected with taxpayers trade, business or exercise profession; 5. The interest expense must have been paid or incurred during the taxable year; 6. The interest must have been stipulated in writing; 7. The interest must be legally due; 8. The interest payment arrangement must not be between related taxpayers; 9. The interest must not be incurred to finance petroleum operation; and 10. In case must not be incurred to acquire property used n trade, business or exercise of profession, the same was not treated as a capital expenditure.

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Non-deductible Interest Expense No interest expense shall be allowed as deduction from gross income in any of the following cases: 1. If within the taxable year, an individual taxpayer reporting income on the cash basis incurs indebtedness on which an interest is paid in advance through discount or otherwise. Such interest shall be allowed as a deduction in the year the indebtedness is paid. But if the indebtedness is payable in the periodic amortization, the amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as deduction in such taxable year;

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2. If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under sec. 36(B) of the tax code of 1997; and 3. If the indebtedness on which the interest expense is paid is incurred to finance petroleum operations in the Philippine Interest Expense on Capital Expenditure At the option of taxpayer, interest expense on a capital expenditure incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction in full in the year when incurred.

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C. Taxes
Exceptions The following are taxes not deductible from gross income: 1. Philippine Income Tax. 2. Income Taxes imposed by authority of any foreign country. 3. Estate and donors taxes. 4. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

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D. Losses Losses of property arising from fire, storm, shipwreck, other casualties, robbery, theft or embezzlement; and other losses, if occurred in connection with trade, business or profession actually sustained during the taxable year and not compensated for by insurance shall allow as deductions.
Fire Loss Net Operating Loss Carry-Over (NOLCO) The net operating loss (excess of allowable deductions over gross income) of business or enterprise for any taxable year immediately preceding the current taxable year, which had not been previously offset as deduction from gross income shall be carried over as a deduction from gross income from next three consecutive taxable years immediately following the year

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Taxpayer Entitled to Deduct NOLCO
1. Any individual (including estates and trusts) engaged in trade or business or in the exercise of his profession. An individual who claims the 10% optional standard deduction shall not simultaneously claim deduction of the NOLCON. 2. Domestic and resident foreign corporations subject to the normal income tax (e.g., manufacturers and traders.) 3. Domestic and resident foreign corporations subject to the preferential tax rates under the Code (e.g., private educational institutions, hospitals, and regional operating headquarters.)

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Taxpayer Not Entitled to Deduct NOLCO *Offshore Banking Unit (OBU) *Philippine Economic Zone Authority (PEZA) *Foreign Currency Deposit Unit (FCDU) *Board of Investment (BOI) Loss from Shrinkage in the Value of Stock Loss from Stocks Becoming Worthless Loss of Useful Value Loss from Wash Sales Wagering Loss Abandonment loss Loss from Farming

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E. Bad Debts
Bad debts shall refer to those debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayers by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered. Revenue Regulations No. 25-2002 dated November 19, 2002 further implements Section 34(E) of Tax Code of 1997 on the requirements for the deductibility of bad debts from gross income of the following: *Individuals engaged in trade/business, including estates and trusts *Individuals engaged in the practice of profession *Corporations *Banks and Insurance Companies

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

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F. Depreciation
Depreciation is that portion of the cost of the property allocated or charge as expense for a specific period.

Methods of Depreciation
1. straight-line method 2. Declining the balance method 3. Sum-off the years digit method

Agreement to Useful Life and Rate

When the tax payer and the Commissioner have entered into an agreement in writing specifically dealing with he useful life and rate of the depreciation any property, the rate so agreed upon shall be binding on both the tax payer and National Government in the absence of facts ad circumstances not taken into consideration during the adoption of such agreement.

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Depreciation of properties used in petroleum Operations An allowance for depreciation is respect of all properties directly related to the production of petroleum initially placed in service In a taxable year shall be allowed under the straight-line or declining balance method of depreciation at the point service contractor. Depreciation of properties used in Mining Operations An allowance for depreciation in respect n all properties used in mining operations other than petroleum operations shall be computed as follows; 1. At the normal rate of depreciation if the expected life is ten(10) years or less; or 2.Depreciated over any number of years between (5) years and the expected life if the latter is more than ten(10) years, and the depreciation thereon allowed as deduction from taxable income, provided that the contactor notifies the commissioner at the beginning of the depreciation period which depreciation rate allowed will be used.

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Depreciation by Non-resident aliens in Business or Resident Foreign Corporation

In the case of a non-resident alien engaged in trade or business, or resident foreign corporation, a reasonable allowance for the deterioration of property arising out of its use or employment or its non use in business, trade or professional shall be permitted only when such property is located in the Philippines. G. Depletion Wasting assets or natural resources usually include coal, oil, ore, precious metals like gold, silver and timber. Wasting assets are physically consumable and irreplaceable. Only Nature may be able to replace the same. The location of the cost or the other basis of wasting assets over the periods the natural resource is extracted or produced is called depletion. Depletion allowance enables the taxpayers to recover that capital interest-free from income tax, at its cost or some other basis.

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Cost Depletion Method In general, incase of oil and as walls or mines, reasonable allowances for depletion or amortization computed in accordance with the cost-depletion method shall be granted under rules and regulations to be prescribed by the secretary of Finance, upon recommendation by the commissioner. 1. When the allowance for depletion shall equal the capital invested, no further allowance shall be granted. 2. After production in commercial quantities has commenced, certain intangible exploration and development drilling cost shall be deductible. a. In the year incurred if such expenditures are incurred for nonproducing wells and /or mines ; or b. In full in the year paid or incurred; or c. At the election of the taxpayers, may be capitalized and amortized of such expenditures incurred are for producing wells and/or mines in the same contract area.

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Election to Deduct Exploration and Development Expenditures The total amount deductible for exploration and development expenditures shall not exceed 25% of the net income from mining operations computed without the benefit of any tax incentives under existing laws. The actual exploration and development expenditures minus 25% of the net income from mining shall be carried forward to the succeeding years until fully deducted. The election by the taxpayers to deduct the exploration and development expenditures is irrevocable and shall be binding in succeeding taxable years. Depletion by Non-Resident Alien Individual or Foreign Corporation In the case of Non-Resident Alien Individual engaged in trade or business in the Philippines or a resident foreign corporation, allowance from depletion of oil and gas wells or mines shall be authorized only in respect to oil and gas or mines located within the Philippines.

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H. Charitable and Other Contribution
Definition of terms 1. Non-stock, non-profit corporation or organization shall be refer to a corporation or association/organization created or organized under Philippines laws exclusively for one or more of the following purposes; a. religious b. charitable c. Scientific d. Athletic e. Cultural f. Rehabilitation of veterans g. Social welfare No part of the net income or assets of such corporation or organization shall belong to or inure to the benefit of any member, organizer, officer or any specific person.

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2.Non Government Organization (NGO) shall refer to a non-tock, non-profit domestic corporation or organization organized and operate exclusively for scientific, research, educational, character building, and youth ad sports development, health, social welfare, cultural or charitable purposes, or a combination thereof, no part of the net income which inures to the benefit of any private individual, 3. Accrediting entity shall be refer to a non-stock, non-profit organization composed of NGO networks, duly designated by the Secretary of Finance to Establish and operationalize a system of accreditation to determine the qualification of non-stock, non- profit corporations or organization ad NGOs for qualification as qualified done institutions. Donation to Accredited Non- Stock, Non-Profit Corporation/NGOs Certificate of Donation Notice of Donation Date and Place of Filling

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I. Research and Development
Research and development cost are cost of materials, equipment, facilities, personnel, purchased intangibles, contract services and a reasonable allocation of indirect cost that are specifically related to research and development activities and that have no alternative future uses. Research activities are those undertaken to discover new knowledge that we be useful in developing new product service or process. Development activities involve the application of research findings to develop product, service or process

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Amortization of Certain Research and Development Expenditures
At the election of the taxpayer and in accordance with the rules and the regulations to be prescribed by the Secretary of Finance, upon recommendation of the Commissioner the following research and development expenditures may be treated as deferred expenses. a. Paid or incurred by the taxpayer in connection with his trade, business or profession. b. Not treated as expense. c. Chargeable to capital account but not chargeable ton property of a character which is subject to depreciation or depletion.

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Limitation on Deduction 1. Any expenditure for 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 or depletion. 2. 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 or gas.

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J. Pension Trust
An employer establishing or maintaining a pension trust to provide for the payment of reasonable pensions to his employees shall be allowed as a deduction a reasonable amount transferred or paid into such trust during the taxable year in excess of such contribution, but only if such amount. 1.has not been allowed as deduction; and 2. is apportioned in equal parts over a period of ten (10) consecutive years beginning with the year in which the transfer or payment is made.

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ITEMS NOT DEDUCTIBLE 1. Personal, living or family expenses 2. Any amount paid out for new buildings or for permanent improvements, or betterment made to increase the value of any property or estate, except that intangible drilling and development cost incurred in petroleum operations are deductible. This is a capital expenditure. 3. Any amount expended I restoring property or in making goods the exhaustion thereof for which an allowance is or has been made. This is a capital expenditure. 4. Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such policy. 5. Loses from sales or exchange of property between related taxpayers.

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K. Premium Payments on Health and/or Hospitalization Insurance
The following condition must be met: 1. The insurance shall be taken by the individual taxpayer himself for his family; 2. The amount being claimed shall not exceed P2,400a year or P200 a month per family; 3. The family has gross income of P250, 000 or less for the taxable year. Premium payments on health and/or hospitalization insurance may be deducted from the gross business/professional income or from the gross compensation income of a resident citizen, non resident citizen, and resident alien.