Allowable deductions from gross income include optional standard deductions, itemized deductions, and net operating loss carryovers. Optional standard deductions allow taxpayers to deduct 40% of gross income in lieu of itemizing expenses. Itemized deductions must be ordinary and necessary expenses incurred for business purposes and substantiated. Major categories of itemized deductions include salaries and wages, travel expenses, rental expenses, interest expenses, taxes, losses, bad debts, and depreciation.

1. Allowable Deductions from Gross Income (Courtesy: www.philtaxation.blogspot.com )

2. Where in Formula Gross sales/receipts Pxxx Less: Returns, discounts & allow. Xxx Net sales Pxxx Less: Cost of sales xxx Gross income/gross profit Pxxx Less: ALLOWABLE DEDUCTIONS XXX TNI before PE & HHIP – individual Pxxx Taxable net income - corp Pxxx (Courtesy: www.philtaxation.blogspot.com )

3. Characteristics Provide taxpayer a more equitable taxable base and true measure of income; Business related expenses/losses – gen.; Similar to operating expenses in GAAP; Matters of legislative wisdom; Construed against taxpayer, thus, burden of proof lies upon taxpayer (Courtesy: www.philtaxation.blogspot.com )

4. Major Classification of Expenditures (Courtesy: www.philtaxation.blogspot.com ) CAPITAL REVENUE Material in amounts Small amounts, individually Increase useful life, capacity & efficiency Helps current operations Non-recurring Ordinary recurring Benefits future periods (current & long-term) Benefits current period only (short-term) Allocated throughout the periods benefited Charged to operations

5. Classifications of Allowable Deductions 40% Optional standard deductions (OSD) (introduced to Corp. by RA 9337) ; Itemized deductions (Courtesy: www.philtaxation.blogspot.com )

6. Optional Standard Deduction (OSD) At the option of the taxpayer; In lieu of itemized deductions Irrevocable for the taxable year; 40% flat rate; No substantiation requirement; Trade/business/profession (Courtesy: www.philtaxation.blogspot.com )

7. OSD Formulas (Courtesy: www.philtaxation.blogspot.com ) Individual Corporate Gross sales Pxxx Gross sales Pxxx Less: Returns, discounts & allowances xxx Less: Returns, discounts & allowances xxx Net sales xxx Net sales xxx Less: Cost of sales xxx Gross income/profit xxx Multiplied by OSD % 40% Multiplied by OSD% 40% OSD Pxxx OSD Pxxx

8. Itemized Deductions Applicable, in general Trade/business/profession related On a per item of expense basis Incurred or paid during the year Generally no limit as to amount Substantiation requirement, in general; (Courtesy: www.philtaxation.blogspot.com )

9. Itemized Deductions Ordinary & necessary expenses (Sec. 34(A)) Interest (Sec. 34(B)) Taxes (Sec. 34(C)) Losses (Sec. 34(D)) Bad debts (Sec. 34(E)) Depreciation/depletion (Sec. 34(F)/(G) ) Charitable contribution (Sec. 34(H)) Research & development (Sec. 34(I)) Pension trusts (Sec. 34(J)) (Courtesy: www.philtaxation.blogspot.com )

10. General business expenses Ordinary & necessary to trade, business, or profession; Reasonable in amount; Must be substantiated, in general; Not contrary to public policy, morals, or order; Incurred or paid during the taxable year; Properly withheld, if required (Courtesy: www.philtaxation.blogspot.com )

11. General business expenses Necessary Appropriate & helpful in the development of taxpayer’s business and are intended to minimize losses or to increase profits. Day to day expenses Ordinary Normal or usual in relation to the taxpayer’s business and the surrounding circumstances. (See: Atlas vs. CIR. 102 SCRA 246) (Courtesy: www.philtaxation.blogspot.com )

12. General business expenses Examples: Salaries & wages; Travel expenses; Rentals; Entertainment, amusement, & recreation expenses; Supplies, repairs & maintenance & other incidental expenses; Advertising; Insurance premiums (Courtesy: www.philtaxation.blogspot.com )

13. Requisite of deductibility-ID Ordinary & necessary to trade, business, or profession; Reasonable in amount; Must be substantiated, in general; Not contrary to public policy, morals, or order; Incurred or paid during the taxable year; Properly withheld, if required (Courtesy: www.philtaxation.blogspot.com )

14. Salaries & wages Compensation for personal services actually rendered Includes allowances , no matter how called, provided to employees under employee-employer relationship; Must have been subjected to w/holding tax on compensation, unless, exempted thereof Fringe benefit to managerial & supervisory employees on a separate account Employer’s share on SSS, PHIC, HDMF maybe added (Courtesy: www.philtaxation.blogspot.com )

15. Salaries & wages Salaries exempted from withholding on compensation De minimis benefits (RR 8-00, as amended) Minimum wage income earners: B-H(2)ON (RA 9504/RR 10-08) Fringe benefits subject to FBT (RR 3-98) ; Separation pay for causes beyond control of employee (e.g. retrenchment, etc.) Retirement pay under RA 9417 (Courtesy: www.philtaxation.blogspot.com )

16. Travel expenses Incurred w/in & w/out the country while away from home in pursuit of trade, business or profession (Sec. 34(A)(ii)) Includes transportation expenses, meals and lodging, as long as incurred solely for carrying trade, business, or profession (Sec. 66, RR No. 2) Not included: Personal foreign travels sponsored by employer subject to FBT (Courtesy: www.philtaxation.blogspot.com )

17. Rental expenses Incurred for the continued use or possession of property to w/c taxpayer is not taking title or in which he has no equity other than that of a lessee, user or possessor (Sec. 34(A)(1)(iii)) Property maybe real or personal property under operating lease Must have been subjected to EWT of 5% (RR No. 2-98) Finance lease treated differently (Courtesy: www.philtaxation.blogspot.com )

18. Other deductions on rentals Advance payment of lease – deductible upon lapse of the period applicable Leasehold improvements An improvement constructed on a leased property; Depreciation of such improvement is allowed as a deduction Lease bonus paid to secure lease is deductible on pro-rata basis (Courtesy: www.philtaxation.blogspot.com )

19. Entertainment, amusement & recreation (Sec. 34(A)(1)(iv)/RR No. 10-02) Inclusions: Representation expenses –entertaining, providing amusement and recreation to, or meeting with, a guests at a dining place, place of amusement, country club, theater, concert, play, sporting event, & similar establishments (Sec. 2, RR 10-02) Depreciation or rental expense relating to entertainment facilities (e.g. yacht, vacation club, or any similar item or real or personal property for entertainment, amusement or recreation of guests or employees (Sec. 2, RR 10-02); (Courtesy: www.philtaxation.blogspot.com )

20. Entertainment, amusement & recreation (Sec. 34(A)(1)(iv)/RR No. 10-02) Requisites: Paid or incurred during the taxable year; Directly connected w/ dev’t., mgt., & operation; or furtherance of the conduct of trade, business, or profession Not contrary to law, morals, good customs, public policy Substantiated by adequate proof; Subjected to w/holding tax, if applicable; Limitation: (a) 0.5% of net sales (goods); (b) 1% of net revenue (services) (Courtesy: www.philtaxation.blogspot.com )

21. Entertainment, amusement & recreation (Sec. 34(A)(1)(iv)/RR No. 10-02) Exclusions: (Sec. 3, RR 10-02) Compensation or expenses subjected to FBT under RRs 2-98 & 3-98; For charitable or fund raising event; For bona fide business meetings of stockholders, partners or directors; For attending or sponsoring an employee to a league or professional organization meeting; For events for promotion, mktg., and advertising like concerts, seminars, workshops, conventions, etc.; Expenses of similar nature (Courtesy: www.philtaxation.blogspot.com )

22. Interest expense (Sec. 34(B)/RR No. 13-00) Cost of money incurred w/n a taxable year on indebtedness in connection with trade, business, or profession; Requisites: There must be indebtedness stipulated in writing; Indebtedness connected with trade/bus./profession; There must be an interest paid or incurred during the year (CIR vs. Prieto GR l-13912/Sept. 30, 1960) ; Interest must be legally due & demandable; (Courtesy: www.philtaxation.blogspot.com )

23. Interest expense (Sec. 34(B)/RR No. 13-00) Exceptions: Loans between related parties under Sec. 36(B); Limitation on income subject to final tax to counter tax arbitrage Optional treatment, if incurred on property acquisition (Sec. 34(B)(3), NIRC) Indebtedness to finance petroleum exploration; Interest on cash basis accounting (Courtesy: www.philtaxation.blogspot.com )

24. Interest expense (Sec. 34(B)/RR No. 13-00) Related parties (Sec. 3(B), NIRC) Between members of the family (wife bothers sisters ancestors & lineal descendants or ascendants; Individual & corp. where individual owns more that 50% interest, directly or indirectly; Same individual owns more than 50% interest on both parties to loan; Loan between fiduciaries of two trusts owned by same grantor (Courtesy: www.philtaxation.blogspot.com )

25. Interest expense (Sec. 34(B)/RR No. 13-00) Limitation on interest income subjected to FWT Interest income, net of FWT Pxxx Divided by FWT 20/7.5/5/12% Gross interest income Pxxx Multiply by rate 42% or 33% from 1/1/’09 Reduction of interest exp Pxxx (Courtesy: www.philtaxation.blogspot.com )

26. Interest expense (Sec. 34(B)/RR No. 13-00) Optional treatment of interest on acquisition of property Outright expense - full amount deductible Capitalized - as depreciation Interest to finance petroleum operations Exempt from income tax under special law; Capitalized as deferred exploration cost (Courtesy: www.philtaxation.blogspot.com )

27. Interest expense (Sec. 34(B)/RR No. 13-00) Interest under cash basis Deductible upon actual payment of interest on amortization; If interest is paid in advance, interest is deductible only upon full payment of the principal If service enterprise, prepaid interest is deductible in year interest is paid (Courtesy: www.philtaxation.blogspot.com )

28. Interest expense (Sec. 34(B)/RR No. 13-00) Is interest from delinquent payment of taxes deductible? Yes. Taxes constitutes an indebtedness for purposes of income tax, thus, interest on delinquent payments of tax is allowed as deduction. However, surcharge and compromise penalties for late payment, not allowable deduction. (CIR vs. Palanca GR#l-166266.10-29-66) (Courtesy: www.philtaxation.blogspot.com )

29. Taxes (Sec. 34(C), NIRC) Requisites: Paid or incurred w/in the taxable year; Incurred in connection w/ taxpayer’s trade business, or profession; Imposed directly upon taxpayer (Courtesy: www.philtaxation.blogspot.com )

30. Taxes (Sec. 34(C), NIRC) Deductible (Sec. 80, RR No. 2) : Documentary stamp tax; Occupation tax; Privilege & license fees; Excise taxes; Import duties; Local business tax; Automobile registration fees; Community tax; Municipal tax (Courtesy: www.philtaxation.blogspot.com )

31. Taxes (Sec. 34(C), NIRC) Non-deductible (Sec. 81, RR No. 2) : Philippine income tax; Estate & donor’s tax; Stock transaction tax (1/2 of 1%); Value-added tax; Foreign income tax, if used as tax credit; Non-business/trade/profession taxes; Special assessments/levy for increase in property values; Interest on delinquent taxes – as interest expense; Additions to tax: surcharge and compromise penalties (Courtesy: www.philtaxation.blogspot.com )

32. Taxes (Sec. 34(C), NIRC) Foreign tax credits To minimize impact of double taxation on income of RC/DC taxes in Phils. & abroad; For non-residents, allowed if related to business in Phils.; Apply limitation A, if one country only; Apply limitation A & B, if more than one foreign country (Courtesy: www.philtaxation.blogspot.com )

33. Taxes (Sec. 34(C), NIRC) Limitations on foreign tax credits: Limitation A : TNI, Country A x Phil. Tax due TNI, world (Lower: Actually paid in Country A vs. Lim. A) - Limitation B : TNI, Abroad x Phil. Tax due TNI, world (Lower: Actually paid in Countries abroad vs. aggregate of Lim. A applications) (Courtesy: www.philtaxation.blogspot.com )

34. Losses (Sec. 34(D), NIRC) Actually sustained during the taxable year relative to the property used in the conduct of trade, business, or profession and not compensated for by insurance or other form of indemnity Kinds: Transaction losses; Casualty losses; Capital losses Special losses; or, NOLCO (Courtesy: www.philtaxation.blogspot.com )

35. Losses (Sec. 34(D), NIRC) Transaction loss – losses arising from closed and completed transactions in the conduct of trade or business Example: Loss on sale of ordinary assets; Foreign exchange losses; (Courtesy: www.philtaxation.blogspot.com )

36. Losses (Sec. 34(D), NIRC) Casualty losses Requisites: Loss of properties used in trade. Business or practice of profession Arising from fires, storms, shipwreck or other casualties or robbery, theft, or embezzlement; Not compensated by insurance or other indemnity; Reported to the BIR w/n 30 to 90 days from date of discovery (Courtesy: www.philtaxation.blogspot.com )

37. Losses (Sec. 34(D), NIRC) Capital losses – losses from capital assets other than those subjected to CGT Deductible only to the extent of capital gains Examples: Sales or exchanges of capital assets; Short sales of property; Securities becoming worthless; Loss for failure to exercise option to buy capital asset; Wagering/gambling losses; (Courtesy: www.philtaxation.blogspot.com )

38. Losses (Sec. 34(D), NIRC) Special losses – with specific or special rules based on its nature Loss on voluntary removal of buildings – n/a because cost added to cost of new building; Losses from illegal transactions – n/a; Loss on exchange between related parties-n/a; Shrinkage of value of shares – n/a; Write-off of inventories – allowed in certain instances; Abandonment of petroleum operations - deductible (Courtesy: www.philtaxation.blogspot.com )

39. Losses (Sec. 34(D), NIRC) Net-operating loss carry over (NOLCO) – arises when Allowable deductions exceeds Gross income; Carried over for the next 3 immediately succeeding years; Forms part of deductions as a special allowable deduction upon application; Applied on first-in first-out basis (FIFO); Not applicable under OSD; Not applicable against MCIT; Not transferable except in merger and consolidation where NOLCO of absorbed is transferred to the surviving corporation (Courtesy: www.philtaxation.blogspot.com )

40. Bad Debts (Sec. 34(E), NIRC/ RR No. 25-2002) Business, trade or profession related debts due to taxpayer actually ascertained to become worthless and actually charged off during the taxable year Under direct write-off method for BIR purposes (Courtesy: www.philtaxation.blogspot.com )

41. Bad Debts (Sec. 34(E), NIRC/ RR No. 25-2002) Requisites: Valid and subsisting claim connected with trade business o profession; Not between related parties under Sec. 36(B), NIRC; Actually ascertained to be worthless and uncollectible at the end of the taxable year; Written-of during the taxable year Recovery of written-of : tax benefit doctrine Bad debts of cash basis: non-deductible (Courtesy: www.philtaxation.blogspot.com )

42. Depreciation (Sec. 34(F), NIRC/ RR No. 25-2002) allowance to reduce value of tangible fixed assets resulting from wear and tear and normal obsolescence for the taxpayer to recover cost of the asset; Requisites: Must be reasonable ; Charged off during the year; Asset must be used in trade/bus./profession; Asset must have limited useful life; and, Must be located in the Phils. for NRA & foreign corp. (Courtesy: www.philtaxation.blogspot.com )

43. Factors affecting depreciation Cost of the property – acquisition cost plus incidental costs in bringing property to intended use. Useful life – estimated service life of the property. Scrap value – value at the end of useful life. Depreciation method (Courtesy: www.philtaxation.blogspot.com )

44. Depreciation, special rules Properties used Petroleum operations Option Methods: Straight-line or declining balance Option to change any of the two methods; Useful life is 10 years or shorter period permitted by BIR; Properties not directly used – straight-line for five (5) years (Courtesy: www.philtaxation.blogspot.com )

45. Depreciation, special rules Properties used in Mining operations At the normal rate of depreciation, if the expected life is ten (10) years or less; Depreciation over any number of years between 5 years and the normal expected life of ten (10) years; (Courtesy: www.philtaxation.blogspot.com )

46. Depreciation (Sec. 34(F), NIRC/ RR No. 25-2002) Depreciation methods: Straight-line method; Declining balance method; Sum of years digit method; Any other method prescribed Change in accounting method Approved by the BIR (Courtesy: www.philtaxation.blogspot.com )

47. Depletion ( Sec. 34(G)/RR 5-76 dated Apr. 2, 1976 ) Exhaustion of natural resources due to production that is allowed as deduction to recover cost of the property or wasting assets. Exploration expenditures – expenses paid or incurred before the development stage to ascertain the existence, location, extent o quality of any deposit o ore or other mineral. Development expenditures – expenses incurred or paid from the time when deposits or minerals are shown to exist in sufficient commercial quantity and quality until actual commencement of commercial operations. (Courtesy: www.philtaxation.blogspot.com )

48. Depletion Optional treatment: Part of cost of the property; or Allowable deduction Limitation on allowable deduction Exploration and development not to exceed 25% of net income from mining operations; Excess exploration and development shall be carried over o the succeeding years until fully consumed w/ no expiry (Courtesy: www.philtaxation.blogspot.com )

49. Charitable & other contribution (Sec. 34(H)/RR No. 13-98) Contributions or gifts actually paid or made within the taxable year to the government or any of its agencies or political subdivisions, NGO, or non-stock and non-profit organizations under certain conditions Not necessarily business/trade/profession expenses Subject to substantiation requirements Valuation – based on cost of property (Sec.34(H)(3)) (Courtesy: www.philtaxation.blogspot.com )

50. Charitable & other contribution (Sec. 34(H)/RR No. 13-98) Deductible in full Donations to NEDA priority projects; Donations to certain foreign institutions based on international agreements, treaties, or commitments entered into by Phils.; Donations to accredited NGOs Non-stock and non-profit; Utilization of donation not later than the 15 th day o the 3d month after the close of the taxable year; Not more than 30% is used for administrative purposes; In event of dissolution, assets of the NGO would be distributed to an NGO of similar purpose or in accordance with Court’s judgment (Courtesy: www.philtaxation.blogspot.com )

51. Charitable & other contribution (Sec. 34(H)/RR No. 13-98) Deductible with limitations Donations to similar entities other than those entitled full deductibility or those not complying the requirements for full deductibility; Limitations: Individual- not exceeding 10% of taxable income from trade/business or profession before considering the donation Corporation- not exceeding 5% of taxable income from trade/business or profession before considering the donation (Courtesy: www.philtaxation.blogspot.com )

52. Research and Development (Sec. 34(I)) Research – original & planned investigation undertaken by the taxpayer with the prospect of gaining new scientific or technical knowledge and understanding; Development – application of the research findings or other knowledge to a plan or design for production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. (Courtesy: www.philtaxation.blogspot.com )

53. Research and Development (Sec. 34(I)) Optional treatment: Ordinary & necessary expense in the year incurred or paid; Deferred expenses charged to a capital account but not to property subject to depreciation or development and amortized over 60 months from the month first benefits were realized from such expenditures (Courtesy: www.philtaxation.blogspot.com )

54. Pension trusts (Sec. 34(J), NIRC/RA 4917) A pension plan intended to provide retirement benefits to covered employees at a certain period of time under the circumstances and amounts provided for. Types of pensions Defined benefit plan – handled and managed by employer with benefits normally based on certain percentage of salary Defined contribution plan – handled by 3 rd parties, bank or trust or others called “administrator” who manage the fund and pay employee upon retirement. Employer contribute defined or contracted periodic contribution based agreement. (Courtesy: www.philtaxation.blogspot.com )

55. “ Taxes affects lives, care for taxes and save lives” (Courtesy:philtaxation.blogspot.com) End of slides Thank you!