Taxation Reviewer 5

Part V

A. Interest

1. Interest Deductible From Gross Income

(1) In General. — The amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income: Provided, however, That the taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax:
Forty-one percent (41%) beginning January 1, 1998;
Thirty-nine percent (39%) beginning January 1, 1999; and
Thirty-eight percent (38%) beginning January 1, 2000.
(2) Exceptions. — No deduction shall be allowed in respect of interest under the succeeding subparagraphs:
(a) If within the taxable year an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise: Provided, That such interest shall be allowed as a deduction in the year the indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic amortizations, 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;
(b) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Section 36(B); or
(c) If the indebtedness is incurred to finance petroleum exploration.
(3) Optional Treatment of Interest Expense. — At the option of the taxpayer, interest incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure.


2. Interest Not Deductible

§ No deduction is allowed in respect of interest under the following:

a. ADVANCE INTEREST - if within the taxable year an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise
Provided, that such interest shall be allowed as a deduction in the year the indebtedness is paid.
Provided further, that if the indebtedness is payable in periodic amortizations the amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as a deduction in such taxable year.

**under this provision, the phrase "within the taxable year" assumes a modified meaning. For example, a taxpayer using the cash basis method of accounting borrows money in which interest is paid in advance through discount. He obtains a loan of P1,000,000 in October 1998 subject to 20% interest; hence, after paying the advance interest of P200,000 he receives only P 800,000.00 Can the borrower/taxpayer claim the deduction when he files his ITR in April 1999?
It depends on w/n the principal obligation had been paid.
i. if the entire principal obligation had been paid, then the entire amount of interest can be claimed as itemized deduction
ii. if only 1/2 of the obligation has been paid, only 1/2 interest can be claimed as itemized deduction;
iii. if no payment had been paid on the principal obligation, the advance interest paid cannot be claimed as deduction on the year that it was paid.

b. PERSONS UNDER 36b - if both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under section 36B, namely:
i. between members of a family
ii. between an individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; and
iii. between two corporations more than 50% in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual;
iv. between the grantor and a fiduciary of any trust; or
v. between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust
vi. between a fiduciary or a trust and a beneficiary

c. PETROLEUM OPERATION - if the indebtedness is incurred to finance petroleum operation.



3. Prepaid Interest Of Individual On Cash Method Of Accounting

Comm. V. Vda De Prieto (109 Phil 592)

Facts: Vda. de Prieto conveyed by way of gifts to her 4 children real property with a total assessed value of P892,497.50. After the filing of the gift tax returns, CIR appraised the real property donated for gift tax purposes at P1,231,268.00 and assessed the total sum of P117,706.50 as donor's gift tax, interests and compromises due thereon. Of the total sum of P117,706.50 paid by respondent the sum of P55,978.65 represents the total interest on account of delinquency. This sum of P55,978.65 was claimed as deduction. Petitioner, however, disallowed the claim and as a consequence of such disallowance assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the aforesaid P55,978.65, including interest, surcharge and compromise for the late payment.

Issue: w/n the interest paid by respondent for the late payment of her donor's tax is deductible from her gross income

Held: YES.
1) Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should be interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within the year. It is here conceded that the interest paid by respondent was in consequence of the late payment of her donor's tax, and the same was paid within the year it is sought to be deducted.
2) The term "indebtedness" has been defined as an unconditional and legally enforceable obligation for the payment of money. Within the meaning of that definition, it is apparent that a tax may be considered an indebtedness. "Although taxes already due have not, strictly speaking, the same concept as debts, they are, however, obligations that may be considered as such. Where statute imposes a personal liability for a tax, the tax becomes, at least in a board sense, a debt. It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her gross income under section 30 (b) of the Tax Code above quoted.
3) The uniform ruling is that interest on taxes is interest on indebtedness and is deductible.
4) In conclusion, we are of the opinion and so hold that although interest payment for delinquent taxes is not deductible as tax under Section 30(c) of the Tax Code and section 80 of the Income Tax Regulations, the taxpayer is not precluded thereby from claiming said interest payment as deduction under section 30(b) of the same Code.


4. Reduction Of Interest Expense On Interest Income Subjected To Final Tax Under TRA of 1997


5. RR 13-2000 (Nov. 20, 2000)

Requirement for deductibility of Interest Expense

SEC. 3. TAX INCENTIVES ACCRUING TO THE ADOPTING PRIVATE ENTITY. – A pre-qualified adopting private entity, which enters into an Agreement with a public school, shall be entitled to the following tax incentives:
(a) Deduction from the gross income of the amount of contribution/donation that were actually, directly and exclusively incurred for the Program, subject to limitations, conditions and rules set forth in Section 34(H) of the Tax Code, plus an additional amount equivalent to fifty percent (50%) of such contribution/donation subject to the following conditions:
(1) That the deduction shall be availed of in the taxable year in which the expenses have been paid or incurred;
(2) That the taxpayer can substantiate the deduction with sufficient evidence, such as official receipts or delivery receipt and other adequate records –
(2.1) The amount of expenses being claimed as deduction;
(2.2) The direct connection or relation of the expenses to the adopting private entity’s participation in the Adopt-a-School Program. The adopting private entity shall also provide a list of projects and/or activities undertaken and the cost of each undertaking, indicating in particular where and how the assistance has been utilized as supported by the Agreement; and
(2.3) Proof or acknowledgment of receipt of the contributed/donated property by the recipient public school.
(3) That the application, together with the approved Agreement endorsed by the National Secretariat, shall be filed with the Revenue District Office (RDO) having jurisdiction over the place of business of the donor/adopting private entity, copy furnished the RDO having jurisdiction over the property, if the contribution/donation is in the form of real property.
(b) Exemption of the Assistance made by the donor from payment of donor’s tax pursuant to Sections 101 (A)(2) and (B)(1) of the Tax Code of 1997.


B. Taxes

Sec. 34, C, NIRC
(1) In General. - Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business, shall be allowed as deduction, except
(a) The income tax provided for under this Title;
(b) Income taxes imposed by authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credits for taxes of foreign countries);
(c) Estate and donor's taxes; and
(d) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.
Provided, That taxes allowed under this Subsection, when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in trade or business in the Philippines and a resident foreign corporation, the deductions for taxes provided in paragraph (1) of this Subsection (C) shall be allowed only if and to the extent that they are connected with income from sources within the Philippines.
(3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his return his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited with:
(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a domestic corporation, the amount of income taxes paid or incurred during the taxable year to any foreign country; and
(b) Partnerships and Estates. - In the case of any such individual who is a member of a general professional partnership or a beneficiary of an estate or trust, his proportionate share of such taxes of the general professional partnership or the estate or trust paid or incurred during the taxable year to a foreign country, if his distributive share of the income of such partnership or trust is reported for taxation under this Title.
An alien individual and a foreign corporation shall not be allowed the credits against the tax for the taxes of foreign countries allowed under this paragraph.
(4) Limitations on Credit. - The amount of the credit taken under this Section shall be subject to each of the following limitations:
(a) The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources within such country under this Title bears to his entire taxable income for the same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources without the Philippines taxable under this Title bears to his entire taxable income for the same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Commissioner; who shall redetermine the amount of the tax for the year or years affected, and the amount of tax due upon such redetermination, if any, shall be paid by the taxpayer upon notice and demand by the Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition precedent to the allowance of this credit may require the taxpayer to give a bond with sureties satisfactory to and to be approved by the Commissioner in such sum as he may require, conditioned upon the payment by the taxpayer of any amount of tax found due upon any such redetermination. The bond herein prescribed shall contain such further conditions as the Commissioner may require.
(6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this Section may, at the option of the taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year which the taxes of the foreign country were incurred, subject, however, to the conditions prescribed in Subsection (C)(5) of this Section. If the taxpayer elects to take such credits in the year in which the taxes of the foreign country accrued, the credits for all subsequent years shall be taken upon the same basis and no portion of any such taxes shall be allowed as a deduction in the same or any succeeding year.
(7) Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following:
(a) The total amount of income derived from sources without the Philippines;
(b) The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit under said paragraph, such amount to be determined under rules and regulations prescribed by the Secretary of Finance; and
(c) All other information necessary for the verification and computation of such credits.

Sec. 80-82, RR-2
Sec. 80. Taxes in general.—As a general rule, taxes are deductible with the exception of those with respect to which the law does not permit deduction. However, in the case of a nonresident alien individual and a foreign corporation, deduction is allowed only if and to the ex that the taxes for which deduction is claimed are connected with income from sources within the Philippines.
Import duties paid to the proper customs officers, and business, occupation, license, privilege, excise and stamp taxes and any other taxes of every name or nature paid directly to the Government of the Philippines or to any political subdivision thereof, are deductible. The word “taxes” means taxes, proper and no deduction should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes. Taxes are deductible at most only by the person upon whom they are imposed. Thus the merchants sales tax imposed by law upon sales is not deductible by the individual purchaser even though the tax may be billed to him as a separate item.
In computing the net income of an individual no deduction is allowed for the tax is imposed upon his interest as shareholder of a bank or other corporation, which are paid by the corporation without reimbursements from the taxpayer. The amount so paid should not be included in the income of the shareholder.
In the case of corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to deduct such payment from gross income on any ground.

Sec. 81. Income tax imposed by the government of the Philippines. – The law does not permit the deduction of the income tax paid to or accrued in favor of the Government of the Philippines, and in no case may the taxpayer avail of such deduction.

Sec. 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country. – Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country (including the United States and possessions thereof) are allowed as deductions only if the taxpayer does not signify in his return his desire to have to any extent the benefits of the provisions of law allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction.


1. Deductible From Gross Income

GENERAL RULE: Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business, shall be allowed as deduction.

** Import duties paid to the proper customs officers and business, occupation, license, privilege, excise and stamp taxes and any other taxes of every name or nature paid directly to the Government of the Philippines or to any political subdivision thereof, are deductible. The word "taxes" means taxes proper and no deduction shall be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes. Taxes are deductible as such only by the person upon whom they are imposed. Thus the merchants sales tax imposed by law upon sales is not deductible by the individual purchasers even though the tax may be billed to him as a separate item.

EXCEPTIONS:
a. Income tax
b. Income taxes imposed by authority of any foreign country (but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of tax credits paid to foreign countries)
c. Estate and donor's taxes
d. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

Provided, that the taxes allowed under this subsection, when refunded or credited shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction.

Others (under Sec 80-82, RR2):
a. Taxes paid by a nonresident alien individual and a foreign corporation - taxes are deductible only if and to the extent that the taxes for which deduction is claimed are connected with income from sources within the Philippines;
b. Income tax imposed by the Philippine government - the law does not allow the deduction of the income tax paid to or accrued in favor of the government and in no case may the taxpayer avail of such deduction;
c. income, war profits, and excess profits taxes imposed by the authority of a foreign country - allowed as deductions only if the taxpayer does not signify in his return his desire to have to any extent the benefits of the provisions of law allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction.


** In computing the net income of an individual, no deduction is allowed for the tax is imposed upon his interest as shareholder of a bank or other corporation, which are paid by the corps w/o reimbursements from the taxpayer. The amount so paid should not be included in the income of the shareholder.
** In case of corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to deduct such payment from gross income on any ground.


2. Not deductible from Gross Income

Sec. 82-83, RR-2
Sec. 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country. – Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country (including the United States and possessions thereof) are allowed as deductions only if the taxpayer does not signify in his return his desire to have to any extent the benefits of the provisions of law allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction.

Sec. 83. Estate, inheritance, and gift taxes; taxes assessed against local benefits. – Estates, inheritance, and gist taxes are not deductible.
So-called taxes, more properly assessments, paid for local benefits, such as street, sidewalk, and other like improvements, imposed because of and measured by some benefit inuring directly to the property against which the assessment is levied, do not constitute an allowable deduction from gross income. A tax is considered assessed against local benefits when the property subject to the tax is limited to the property benefited. Special assessments are not deductible, even though an incidental benefit may inure to the public welfare. The taxes deductible are those levied for the general public welfare, by the proper taxing authorities at a like rate against all property in the territory over which such authorities have jurisdiction. When assessments are made for the purpose of maintenance or repair of local benefits, the taxpayer may deduct assessments paid as an expense incurred in business, if the payment of such assessments is necessary to the conduct of his business. When the assessments are made for the purpose of constructing local benefits, the payments by the taxpayer are in the nature of capital expenditures and are not deductible. Where assessments are made for the purpose of both construction and maintenance or repairs, the burden is on the taxpayer to show the allocation of the amounts assessed to the different purposes. If the allocation can not be made, none of the amounts so paid is deductible.


3. Meaning of the term “taxes”

Sec. 80, RR-2
The word “taxes” means taxes, proper and no deduction should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes.


4. Tax Credits vs. Tax Deduction

CIR v. Lednicky, et al. (11 SCRA 609)

Facts: The respondents, V.E. Lednicky and Maria Valero Lednicky, are husband and wife, both American citizens residing in the Philippines, and have derived all their income from Philippine sources for the taxable years in question. In compliance with Phil tax law, they filed their income tax return for 1955 and 1956. In 1956, they filed an amended income tax return claiming a tax deduction for federal income taxes which they paid to the United States in the year 1955. In 1959, they likewise claimed a similar tax deduction for the 1956 return. Comm of IR failed to answer the claim for refund, thus they filed a petition with the Tax Court.

Issue: whether a US citizen residing in the Philippines who derives income wholly from sources within the Republic of the Philippines, may deduct from his gross income the income taxes he has paid to the US government for the taxable year on the strength of sec 30 (c-1) of the Phil Internal Revenue Code?[1]

Held:
1. The wording of Sec 30 shows the code's intent that the right to deduct income taxes paid to foreign government from the taxpayer's gross income is given only as an ALTERNATIVE to his right to claim a tax credit for such foreign income taxes under Sec 30 so that unless the alien resident has a right to claim such tax credit if he so chooses, he is precluded from deducting the foreign income taxes from his gross income. The law provides that the deduction shall be allowed if the taxpayer in his return does not signify his desire to have the benefits of tax credits for taxes paid to foreign countries. Thus, the statutes assumes that the taxpayer in question may also signify his desire to claim a tax credit and waive the deduction.
2. No double credit (i.e, for claiming twice the benefits of his payment of foreign taxes, by deduction from gross income and by tax credit) exists here. This danger cannot exist if the taxpayer cannot claim benefit under either of these headings at his option, so that he must be entitled to a tax credit (respondent here are NOT entitled to tax credit because all their income is derived from Phil sources), or the option to deduct from gross income disappears altogether.
3. No double taxation exists. Double taxation becomes obnoxious only when the taxpayer is taxed twice for the benefit of the same governmental entity. In the present case, although the taxpayer would have to pay two taxes on the same income but the Philippine government only receives the proceeds of one tax, there is no obnoxious double taxation.


5. Fines and Penalties

Guttierez v. Collector (14 SCRA 33)

Fines and penalties paid for late payment of taxes are not deductible.

Gutierrez also claimed for deduction the fines and penalties which he paid for late payment of taxes. While Section 30 allows taxes to be deducted from gross income, it does not specifically allow fines and penalties to be so deducted. Deductions from gross income are matters of legislative grace; what is not expressly granted by Congress is withheld. Moreover, when acts are condemned by law and their commission is made punishable by fines or forfeitures, to allow them to be deducted from the wrongdoer's gross income, reduces, and so in part defeats, the prescribed punishment.


E. LOSSES

Sec. 93-101, RR-2

1. Kinds of Taxpayers and their losses

Individuals
To be fully deductible:
it must not be compensated by insurance and
incurred in a taxpayer’s trade or
incurred in any transaction entered into for profit or
of property connected with the trade or business if arising from fires, storm, shipwreck, or other casualty, or from robbery, theft or embezzlement. No loss shall be allowed as deduction if at the time of filing of the return, such loss has been claimed as deduction for estate or inheritance tax purposes in the estate or inheritance tax return.
Corporations
Can deduct losses actually sustained and charged off within the year and not compensated for by insurance or otherwise.
Nonresident alien and foreign corporations
Can deduct losses sustained in business or trade conducted within the Philippines, losses of property within the Philippines arising from fires, storms, shipwreck or other casualty and from robbery, theft or embezzlement, and losses actually sustained in transactions entered into for profit in the Philippines, although not connected with their trade or business, not compensated by insurance or otherwise.

Summary: Requisites for deductibility of losses
Must be incurred in trade, business or profession of the taxpayer, or of property connected with the trade, business or profession, arising from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement;
Must be actually sustained and not merely anticipated, and must be charged off within the taxable year;
Must be evidenced by closed and completed transaction;
Must not be compensated for by insurance or other form of indemnity
A sworn declaration of loss sustained from casualty or robbery, theft or embezzlement during the taxable year must be filed with the Bureau of Internal Revenue within a period of not less than 30 days nor more than 90 days from the date of discovery of the casualty;
Must not have been claimed as deduction in the estate tax return.

2. Completed Transactions

Fernandez Hermanoz v. CIR, 29 SCRA 552

Facts: Fernandez Hermanos Inc. is a domestic corporation organized for the principal purpose of engaging in business as an “investment company.” The CIR disallowed the following deductions:
1. losses in Mati Lumber Co in 1950
2. losses or bad debts in Palawan Manganese Mines Inc in 1951
3. losses in Balamban Coal Mines in 1950 and 1951
4. losses in Hacienda Dalupiri and Hacienda Samal from 1950-1954

Held: The Supreme Court discussed the allowance or disallowance of each in the following manner:
1. Allowed. These losses represent the shares of stock (worth P8,050) petitioner acquired from Mati in Jan. 1, 1948. The petitioner was correct in writing off and claiming as a deduction in 1950 the amount on the ground that the lumber company had ceased operations and became insolvent in that year. The CIR was incorrect in arguing that since the company still owned a sawmill and some equipment, the shares of stock still had value. The proper assessment would be to treat as income for the year in which petitioner gets the proceeds from the liquidation of those assets.
2. Disallowed. These losses represent part of the loans extended by the petitioner to its 100% owned subsidiary. Petitioner advanced financial assistance to Palawan from 1945 to 1952. By way of payment, Palawan was to give petitioner 15% of net profits. Whether Palawan was able to pay the loans or not because it continued to operate at a loss is immaterial. Petitioner cannot properly claim as a loss the advances given to Palawan in 1951 for that year. There can be no partial writing off as a loss or bad debt under the Tax Code. Those losses or bad debts ascertained within the taxable year are deductible in full or not at all. Petitioner continued to give Palawan advances even beyond 1951. It was only in 1956 when Palawan decided to cease operations.
3. Disallowed. These losses represent sums spent by the petitioner for the operation of its Balamban coal mines in 1950 and 1951. The petitioner should have treated them as losses in 1952 when the mines were abandoned and not in 1950 and 1951 on the ground that the mines made no sales of coal during those years.
4. Allowed. These losses represent sums spent by petitioner for the operation of the 2 haciendas. The amounts were properly reported as deductions for the correct years. The only reason why the CIR disallowed them was on the ground that the farms were operated solely for pleasure or as a hobby and not for profit. But the Supreme Court is not convinced, and being for business, the petitioner may properly deduct the same.

3. Special Rules on losses

a) Voluntary Removal of Buildings
If the building is demolished by the owner for some practical reasons, say the building is no longer safe, then the loss which was sustained in a closed and completed transaction is deductible from gross income.

If the taxpayer buys real estate with an existing old building with the intention of demolishing it and constructing a new one, then the loss sustained in demolishing the old building is not deductible from gross income, the value of the real estate, exclusive of old improvements, being presumably equal to the purchase price of the land and building plus the cost of removing the useless building.

Sec. 97, RR-2

b) Loss of Useful Value of Assets

When, through some change in business conditions, the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use in such business, he may claim as deduction the actual loss sustained.
In determining the amount of the loss, adjustment must be made for improvements, depreciation, the salvage value of the property. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property has been prematurely discarded, as for example:
1. where any increase in the cost or change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or
2. where legislation directly or indirectly makes the continued profitable use of the property impossible.
This exception DOES NOT APPLY
1. to a case where the useful life of property terminates solely as a result of those gradual process for which depreciation allowance are authorized.
2. to inventories other than capital assets
This exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned.

Sec. 98, RR-2

c) Shrinkage in value of Stocks

A person possessing stock of a corporation cannot subtract from gross income any amount claimed as a loss merely on account of shrinkage in value of a stock through fluctuation of the market or otherwise. The loss allowable in such case is that wholly suffered when the stock is disposed of. If stock of a corporation becomes worthless, its cost or other basis determined in accordance with these regulations may be deducted by the owner in the taxable year in which the stock became worthless, provided a satisfactory showing of its worthlessness is made, as in the case of bad debts.

Sec. 99, RR-2


4. Wagering Losses

Deductible only to the extent of gains from such transactions. Example, if winnings amounted to 10,000 and the losses amounted to 6,000, only 4,000 of the net winnings is taxable. However, if the winnings are 5,000 and losses are 6,000, the 1,000 net losses cannot be claimed as a deduction from gross income.


5. Substantation of Losses

RR 12-77
In general – the amount of casualty loss deductible is the difference between the FMV of the property immediately before and the FMV after the casualty, but not exceeding the cost or book value of the property, reduced by any insurance or other compensation received.
In case of total destruction of property used in business, the net book value of the property immediately before the loss should be used as the basis of claiming the loss, reduced by any amount of insurance or compensation received.
In case of partial destruction of property used in business, the replacement cost to restore the property to its normal operating condition should be used in computing deductible loss, but in no case should it be more than the net book value immediately before the casualty. Depreciation over the remaining useful life is computed by dividing the replacement cost by the remaining useful life of the property.


6. Foreign Exchange Losses

Bir Ruling 144-85
Issue: Whether foreign exchange losses, which have accrued by reason of devaluation, are deductible for income tax purposes?

Held: Foreign exchange losses which have accrued by reason of devaluation but where remittances have not yet been made are not deductible for income tax purposes.
- the annual decrease in the value of property is not normally allowable as a loss. To be allowable, the loss must be realized.
- When foreign currency acquired in connection with a transaction in the regular course of business is disposed of, ordinary gain or loss results from the fluctuations. The loss is deductible only for the year it is actually sustained. It is sustained during the year in which the loss occurs as evidenced by closed and completed transaction and as fixed by identifiable events occurring in that year. A closed transaction is a taxable event which has been consummated. No taxable event has as yet been consummated prior to the remittance of the scheduled amortization. Accordingly, foreign exchange losses sustained as a result of devaluation of the peso vis-à-vis the foreign currency, but which remittance of scheduled amortization consisting of principal and interest payments on a foreign loan has not actually been made are not deductible from gross income for income tax purposes.

Interbank Guiding Rate
RMC No. 26-85
· Beginning Jan. 1, 1985, the conversion rate to be applied shall be the prevailing interbank reference rate for the day of the transaction.
· In the event that the foreign exchange rate as stated in the above paragraph (a) is impractical or not feasible, the average interbank reference during the year shall apply.
· For the purpose of converting the tax liability in US dollar to Philippine peso, the prevailing interbank rate at the time of payment shall be applied when paid before the due date of the tax or the prevailing interbank reference rate at the due date of tax when paid on or after the due date of the tax.
· When currency involved is other than US dollar, the foreign currency shall first be converted to US dollar at the prevailing exchange rates between the two currencies.
· This circular does not apply to transaction covered by RMC 30-84 regarding the imposition of additional 1% gross receipt tax on buying and selling of foreign exchange of peso by bank, non-bank financial intermediaries and other authorized foreign exchange dealers or agents and RMC 32-84 in determining the cost basis of certain commodities imported beginning Jan. 1, 1984, the value and prices thereof are quoted in foreign currency.


7. Abandonment of Losses

In case a contract area where petroleum operations are undertaken is partially or fully abandoned, all accumulated exploration and development expenditures pertaining thereto shall be allowed as deduction; however, those incurred before Jan. 1, 1979 can be deducted only from income derived from the same contract area. In all cases, notice of abandonment shall be filed with the Commissioner.
The unamortized cost of a producing well subsequently abandoned, and the undepreciated cost of equipment directly used therein are also deductible in the year such well, equipment or facility is abandoned by the contractor. If such abandoned well is recentered and production is resumed, or if such equipment or facility is restored into service, the said costs shall be included as part of gross income in the year of resumption or restoration and shall be amortized or depreciated.


8. Net Operating Loss Carry-Over (NOLCO)

The net operating loss of the 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 for the next 3 consecutive taxable years immediately following the year of such loss, provided that any net loss incurred in a taxable year during which the taxpayer is exempt from income tax shall not be allowed as a deduction.
The deduction is allowed only if there has been no substantial change in the ownership of the business or enterprise in that—
a. Not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or
b. Not less than 75% of the paid up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons.

For mines other than oil and gas wells, a net operating loss without the benefit of incentives provided under EO No. 226,as amended, incurred in any of the first 10 years of operation may be carried over as a deduction, from taxable income for the next 5 years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the 5 taxable years following the loss, and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining 4 years.

Net operating loss = excess of allowable deductions over gross income.


RR 14-2001

a) Three Year Period

b) No substantial Change in Ownership (75% Rule)

F. BAD DEBTS

1. Requirements for Deductibility

I. there must be an existing indebtedness due to the taxpayer which must be valid and legally demandable
II. it must be connected with the taxpayer’s trade, business, or practice of profession
III. it must not be sustained in a transaction entered into between related parties enumerated under Sec. 36 (b)
IV. it must be actually charged off the books of accounts of the taxpayer as of the end of the taxable year.
V. It must be actually ascertained to be worthless and uncollectible as of the end of the taxable year.
*Before a debt can be ascertained to be worthless, the creditor must have taken all reasonable steps to collect within the period of prescription, and in the light of the following circumstances, acting in good faith, he may justify an ascertainment of worthlessness of a debt:
i. insufficiency of collateral
ii. bankruptcy or insolvency
iii. loss of evidence of indebtedness
iv. disappearance of debtor, who fled leaving no properties
v. death of debtor leaving no properties
vi. injury to debtor incapacitating him from work
vii. fruitless efforts to collect small amounts from debtors scattered all over the country.

Collector v. Goodrich, 21 SCRA 1336

CRITERIA FOR ASCERTAINING WORTHLESSNESS OF DEBTS.- The statute permits the deduction of debts "actually ascertained to be worthless within the taxable year" obviously to prevent arbitrary action by the taxpayer to unduly avoid tax liability. The ascertainment of worthlessness of bad debts requires proof of two facts: (1) that the taxpayer did in fact ascertain the debt to be worthless in the year the deduction is sought; and (2) in so doing, he acted in good faith. Good faith is not enough. The taxpayer must show that he had reasonably investigated the relevant facts and had drawn a reasonable inference from the information thus obtained by him.

WHERE SMALL AMOUNTS ARE INVOLVED, WRITING THEM OFF, WHEN JUSTIFIED.- Considering the small amounts involved, the taxpayer may be justified in feeling that the unsuccessful efforts therefore exerted to collect the same would suffice to warrant their being written off. "It is foolish to spend good money after bad."


2. Tax Benefit Rule

RR 5-99
· The recovery of bad debts previously claimed as deduction shall be included as part of gross income in the year of recovery to the extent of the income tax benefit of said deduction.
· Under the tax benefit rule, the recovery of amounts deducted in previous years from gross income become taxable income unless to the extent thereof, the deduction did not result in any tax benefit to the taxpayer.
Example: If in the year the taxpayer claimed deduction of bad debts written-off, he realized a reduction of the income tax due from him on account of the said deduction, his subsequent recovery thereof from his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said taxpayer did not benefit from the deduction of the said bad debt written-off because it did not result to any reduction of his income tax in the year of such deduction (i.e. where the result of his business operation was a net loss even without deduction of the bad debts written-off), then his subsequent recovery thereof shall be treated as a mere recovery or return of capital, hence, not treated as receipt of realized taxable income.
- not deductible.
- Refer to E10 above on who are related taxpayers.



3. Bad Debts between Related Parties

Losses from sale or exchange of property that are not deductible
- those made between related taxpayers.

Who are related taxpayers?
members of a family (brothers/sisters of the whole or half blood, spouse, ancestors and lineal descendants
an individual and corporation, if the individual owns, directly or indirectly, more than 50% in value of the outstanding stock
two corporations, if more than 50% in value of the outstanding stock in both is owned, directly or indirectly, by the same individual, if either one of such corporations was a personal holding company or a foreign personal holding company
the grantor and a fiduciary of any trust
fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust
fiduciary of a trust and a beneficiary of such trust.

Sec. 30 [b], NIRC)
(B) Mutual savings bank not having a capital stock represented by shares, and cooperative bank without capital stock organized and operated for mutual purposes and without profit;

4. Requirements for Deductibility of Bad Debts including banks

RR 5-99
· See F1 on requirements
· In the case of banks, in lieu of requisite no. 5 above, the BSP, thru its Monetary board, shall ascertain the worthlessness and uncollectibility of the bad debts and it shall approve the writing off of the said indebtedness from the bank’s books of accounts at the end of the taxable year. The bank though should still comply with requisites nos. 1-4 as enumerated above before it can avail of the benefit of deduction.

Amount not deductible
i. if partially secured by a mortgage, the portion not covered by the mortgage is deductible.
ii. In case of insolvency of the debtor, the difference between the amount of the claim and the amount received in distribution of assets of the bankrupt.
iii. The difference between the amount received by a creditor of a decedent in distribution of the assets of the decedent’s estate and the amount of the claim.
iv. The purchase price paid by a purchaser of accounts receivable which cannot be collected and charged off as bad debts in his books.
v. The amount absolved if the debt is compromised and the debtor is insolvent.


G. DEPRECIATION

Depreciation – reasonable allowance for the exhaustion, wear and tear, obsolescence and inadequacy of a property used in trade, business or profession of the taxpayer.

Requisites for deduction as depreciation expense:
1. asset must be used in connection with the taxpayer’s trade, business or profession
2. asset must have a limited useful life.

Sec. 105-115, RR-2

1. Depreciation Base

- the capital sum to be replaced by depreciation allowances is the cost or other basis of the property, to which should be added from time to time the cost of improvements, additions and betterments, and from which should be deducted from time to time the amount of any definite loss or damage sustained by the property through casualty.
- In case of patent or copyright, the capital sum to be replaced is the cost or other basis of the intangible, which allowance should be computed by an apportionment of the cost or other basis of the intangible over its life since its acquisition or grant.
- No depreciation is allowed where the property has been amortized to its scrap value and is no longer in use.
- Nonresident aliens and foreign corporations engaged in business in the Philippines may deduct depreciation only on properties located in the Philippines.
- if property is held by one person for life transferable to another person upon death, the deduction shall be computed as if the life tenant were the absolute owner of the property and depreciation shall be allowed to the life tenant.
- If property is held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income allowable to each.
- Farmers may deduct depreciation on farm buildings, farm machinery and other tangible properties used in the farm, livestock acquired for work, or for breeding or dairy purposes, unless included in an inventory to determine profits.
- For properties used in petroleum operations, an allowance for depreciation is allowed on all properties directly related to production of petroleum initially placed in service in a taxable year under the straight line method or declining balance method at the option of the service contractor over an estimated useful life of 10 years or such shorter life as may be permitted by the CIR. Properties not used directly in production of petroleum shall be depreciated under the straight line method over an estimated useful life of 5 years.
- For properties used in mining operations, an allowance for depreciation is computed as follows:
- at the normal rate of depreciation if the expected life is 10 years of less; or
- depreciated over any number of years between 5 years and the expected life if the latter is more than 10 years, and the depreciation thereon allowed as deduction from taxable income, provided that the contractor notifies the CIR at the beginning of the depreciation period which depreciation rate will be used.
- for non-resident aliens engaged in trade or business in the Philippines or resident foreign corporation, a reasonable allowance for the deterioration of property arising out of its use or employment or its non-use in the business, trade or profession shall be permitted only when such property is located in the Philippines.
- Where the taxpayer and the CIR have agreed in writing about the useful life and rate of depreciation of any property, the same shall be binding on both, under the regulations of the Secretary of Finance. Any change in the agreed rate and useful life shall not be effective for the taxable years before the taxable year in which notice in writing by certified mail or registered mail is served by the party initiating the change.
- In addition to depreciation, a reasonable allowance for obsolescence may be allowed if the taxpayer clearly shows that the whole or any portion of physical property is being affected by economic conditions that will result in its being abandoned before the end of its natural life, so that depreciation deduction alone is insufficient to return the cost at the end of its economic term of usefulness.


Zamora v. Collector, 8 SCRA 163


2. Methods of Depreciation

a. Straight line- provides for a uniform periodic diminution of the property.
Formula:
Cost – Estimated Scrap Value
Annual Depreciation = Estimated Useful Life

b. Declining balance- provides decreasing charges by applying a constant percentage rate to a declining asset book value. The most popular rates are 1.5 times the straight-line rate often referred to as “150% declining balance” and 2 times the straight line rate, often referred to as double-declining balance depreciation. Residual value is not used in the computations under this method; however, it is generally recognized that depreciation should not continue once the book value is equal to residual value.

c. Sum of the years digit – this method of decreasing charges is based on applying a decreasing rate of depreciation of a constant depreciable cost. The denominator of the rate fraction is equal to the sum of the digits in reverse order. For example if an asset had an estimated service life of 5 years, the denominator would be 15. In the first year, the rate fraction would be 5/15, second year 4/15 and so on. The rate fraction is multiplied by the depreciable cost (cost less salvage) to obtain each year’s charge to expense.

d. Depreciation rates – there is a table provided for in RR 19-86, Annex A.


3. Depreciation Rates

a) Bulletin “F”

b) RR 19-86, Annex “A”


H. DEPLETION

Wasting assets – refers to natural resources, which are physically consumed and once consumed, are irreplaceable. Examples include coal, oil, ore, precious metals like gold and silver and timber.

*Depletion is the exhaustion of natural resources such as mines, oil and gas wells due to production or severance from such mines or wells. Depletion enables the taxpayer to recover his capital interest in the property free of income tax, at its cost or on some other basis. Only mining entities owning economic interest in mineral deposits are allowed depletion deduction. Economic interest means interest in minerals in place acquired by investment therein or secured by operating or contract agreement for which income is derived, and return of capital expected, from the extraction of the mineral.
The adjusted cost basis of the property is the accumulated exploration and development expenses incurred on the mining property as of Dec. 31, 1974 for those on a calendar year basis, and June 30, 1975 for those on the fiscal year basis beginning July 1, 1975 minus accumulated cost of depletion that should have been deducted as of the same date on the same property.
Exploration expenses are those incurred or paid for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore, or other mineral before the beginning of the development stage of the mine or deposit.
Development expenses are those paid or incurred during the development stage of the mine or other natural deposit, or when deposits of ore or other mineral are shown to exist in sufficient commercial quantity and quality.

Allowable cost depletion allowance
1) In the case of oil and gas wells and mines, a reasonable allowance for depletion or amortization computed in accordance with the cost depletion method shall be granted under the rules and regulations prescribed by the Secretary of Finance.
2) When the allowance shall equal the capital invested no further allowances shall be granted.
3) After production in commercial quantities has commenced, certain intangible exploration and development drilling costs (a) shall be deductible in the year incurred if such expenditures are incurred for non-producing wells and/or mines, or (b) shall be deductible in full in the year paid or incurred, or at the election of the taxpayer, may be capitalized and amortized if such expenditures incurred are for producing wells and/or mines in the same contract are.
4) Any intangible exploration, drilling and development expenses allowed as a deduction in computing taxable income during the year shall not be taken into consideration in computing the adjusted cost basis or the purpose of computing allowable cost depletion.

Limitation of cost depletion

The basis for cost depletion of mineral deposits does not include amount recoverable through depreciation, through deferred expenses and through deductions other than depletion and the residual value of improvements at the end of operation.
The annual allowable cost of depletion shall not exceed the market value as used for purposes of imposing the mining ad valorem taxes in the mine of the product thereof which has been mined and sold during the year for which the return and computation are made. The allowable cost depletion deduction shall be limited only to the extent of the capital invested in the particular mining property.
No further deduction for cost shall be allowed when the sum of the cost depletion equals the cost or adjusted basis of the property plus allowable capital additions.
In computing taxable income from mining operations, the taxpayer may, at his option, deduct exploration and development expenditures accumulated as cost or adjusted basis for cost depletion as of date of prospecting, as well as exploration and development expenditures paid or incurred during the taxable year; provided that 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 taxpayer to deduct exploration and development expenditures is irrevocable and binding in succeeding taxable years.

Computation of cost depletion

In general:
Adjusted cost Basis
Mineral units remaining = Depletion per mineral unit
As of the taxable year

No. of mineral units sold X depletion per mineral unit for the year = cost depletion within the taxable year

In the case of natural gas and oil wells:

No. of cu. Ft. of gas or barrels of
Oil recovered during the year Adjusted cost Cost depletion
Expected reasonable no. of cu.ft. of X basis of property = for the year
Gas or barrels of oil at the end
Of the year, plus No. of cu.ft. of
Gas or barrels of oil recovered
During the year.

In the case of non-resident alien individual engaged in trade or business in the Philippines or a resident foreign corporation, allowance for depletion of oil and gas wells or mines shall be authorized only in respect to oil and gas wells or mines located within the Philippines.

RR 5-76


I. PENSION TRUST

An employer establishing or maintaining a pension trust for the payment of reasonable pensions to his employees, may deduct from his gross income:
Contributions to such trust during the taxable year representing the liability accruing during the year; and
One tenth (1/10) of a reasonable amount paid to the trust during the taxable year covering the pension liability applicable to the years prior to the taxable year (if not theretofore allowed as deduction) in excess of such contributions.

Requisites for deductibility:
Employer must have established a pension plan.
Pension plan must be reasonable and actuarially sound.
It must be funded by the employer.
Amount contributed by employer must no longer be subject to his control.
Payment has not been allowable as a deduction.

Sec. 118, RR-2


J. CHARITABLE AND OTHER CONTRIBUTIONS

Kinds of Charitable contributions:
Ordinary – those that are subject to the following limitations:
Individuals – 10% of net income before charitable contribution
Corporation – 5% of net income before charitable contribution
c. Donations to or for the use of the Government of the Philippines or any of its agencies or political subdivision for exclusively public purposes.
d. Donations to accredited domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes or for the rehabilitation of veterans.
e. Social welfare institutions or non-governmental organizations, provided no part of the net income of which inures to the benefit of any private stockholder or individual.
2. Special – those that are deductible in full
a. Donations to the Government of the Philippines or to any of its agencies or political subdivisions, including fully-owned government corporations, exclusively to finance, to provide for, or to be used in undertaking priority activities in education, health, youth and sports development, human settlements, science and culture, and in economic development according to a National Priority Plan determined by NEDA, in consultation with appropriate government agencies, including its regional development councils and private philanthropic persons and institutions.
b. Donations to foreign institutions or international organizations, which are fully deductible in pursuance of or in compliance with agreements, treaties, or commitments, entered into by the Government of the Philippines and the foreign institutions or international organizations or in pursuance of special laws.
c. Donations to accredited non-government organizations:
i. organized and operated exclusively for scientific, research, educational, character building, youth and sports development, health, social welfare, cultural, charitable purposes, no part of the net income of which inures to the benefit of any private individuals;
ii. which not later than the 15th day of the third month after the close of the taxable year in which contributions are received, makes utilization directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated, unless an extended period is granted by the Secretary of Finance.
iii. with administrative expenses not exceeding 30% of the total expenses
iv. upon dissolution, the assets would be distributed to another non-profit domestic corporation organized for similar purposes, or to the state for public purpose, or would be distributed by a court to another organization to be used in such manner as in the judgment of said court shall best accomplish the general purpose for which the dissolved organization was organized.

By virtue of PD 507 contributions, donations, gifts and bequests to social welfare, cultural and charitable institutions, no part of the net income of which inures to the benefit of any individual, are deductible in full in computing the donor’s taxable net income.
Under special laws, donations to the following, among others, are deductible in full:
a. The Artesian Well Fund
b. The IRRI
c. The National Science Development Board and its agencies and to public or recognized private educational institutions, and scientific and research foundations
d. The University of the Philippines and other state colleges and universities.
e. The Philippine Rural Reconstruction Movement
f. The Cultural Center of the Philippines
g. The Trustees of the Press Foundation of Asia, Inc.
h. The National Commission on Culture
i. The Humanitarian Science Foundation
j. The Integrated Bar of the Philippines
k. Development Academy of the Philippines
l. Agriculture Department of the Southeast Asian Fisheries Development Center
m. National Social Action Council
n. Task Force on Human Settlement
o. Donations to the National Museum, Library and Archives

Valuation – acquisition cost of property contributed other than money.

BIR-NEDA Regs. No. 1-81

BIR-NEDA Regs. No. 1-82

1. Fully deductible

2. Deductible, subject to limitations

a) Corporation

b) Individuals

3. Deductibility by Actually paid or made to accredited donee institution

RR 13-98


RA 8424



K. RESEARCH AND DEVELOPMENT EXPENSES

1. When paid or incurred; or

Sec. 34 (I), NIRC 1. In general- a taxpayer may treat research or development expenditures which are paid or incurred by him during the taxable year in connection with his trade, business or profession as ordinary and necessary expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as deduction during the taxable year when paid or incurred.

2. Amortized for 60 months

Sec. 34 (I), NIRC 2. Amortization of Certain Research and Development Expenditures- at the election of the taxpayer and in accordance with the rules and 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:
(1) paid or incurred by the taxpayer in connection with his trade, business or profession
(2) not treated as expenses under paragraph 1 hereof
(3) chargeable to capital account but not chargeable to property of a character which is subject to depreciation or depletion
In computing taxable income, such deferred expenses shall be allowed as deduction ratably distributed over a period of not less than sixty (60) months as may be elected by the taxpayer (beginning with the month in which the taxpayer first realizes benefits from such expenditures).


L. IMPOSITION OF CEILINGS ON DEDUCTIONS BY THE SECRETARY OF FINANCE

Sec. 34, NIRC: last par.: Notwithstanding the provisions of the preceding subsections, the Secretary of Finance, upon recommendation of the Commissioner, after public hearing shall have been held for this purpose, may prescribe by rules and regulations, limitations or ceilings for any of the itemized deductions under Subsections (A) to (J) of this section: Provided, that for purposes of determining such ceilings or limitations, the Secretary of Finance shall consider the following factors:
i) adequacy of the prescribed limits on the actual expenditure requirements of each particular industry;
ii) effects of inflation o expenditure levels
Provided, further, That no ceilings shall further be imposed on items of expense already subject to ceilings under present law.



M. ADDITIONAL REQUIREMENT FOR DEDUCTIBILITY

Sec. 34 (K), NIRC: Additional Requirements for Deductibility of Certain Payments- any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income or for which depreciation or amortization may be allowed under this section, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance with this section, sections 58 and 81 of this Code.

RMO No. 38-83 on Deficiency Withholding
Guidelines for Allowance of Deductions for Certain Income Payments Under Section 30 (1) of the Tax Code.
Section 30 (1) of the National Internal Revenue Code, as amended by Batas Pambansa Blg. 1 25, provides:
“Additional requirement for deductibility of certain payments. - Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income for which depreciation or amortization may be allowed under this section and Section 29, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance with this section, Sections 54 and 93 of this Code.”
The above-quoted provisions of the Tax Code is frequently cited by Revenue Examiners in their reports of investigation to justify disallowances of certain expense and other itemized deductions for which the taxpayer is obliged to make a withholding under Sections 54 and 93 of the Code and implementing regulations. Since the amounts otherwise deductible are substantial, some taxpayers have vigorously protested the literal application of the said provision in the audit and investigation of their income tax liabilities.
In order to minimize audit controversies and to achieve uniformity in implementing the aforequoted provision of Section 30(1), this Revenue Memorandum Order is hereby issued to prescribe guidelines that shall be observed by revenue officers for allowing or disallowing items of deductions referred to in the said Section.
Considering that the existing ad valorem (surcharges and interests), as well as the specific penalties (fine and imprisonment), are adequate to compel taxpayers/withholding agents to comply with the requirements of the withholding tax law and regulations, outright disallowance of deductions representing income payment for mere failure to withhold and remit will in effect, in case of corporations, be tantamount to the imposition of additional 25% or 35% “surcharge” (equivalent to the normal corporate tax rates).
In order to minimize the onerous effect of literal application of Section 30(1), allowance or disallowance of a deduction falling under the said paragraph of Section 30 shall be determined in accordance with the following guidelines.
Guidelines For Applying Section 30(1):
An amount claimed as deduction on which a tax is supposed to have been withheld under Sections 54 and 93 shall be allowed if in the course of his audit and/or investigation, the examiner discovers that:
v No withholding of creditable or final tax was made but the payee reported the income and the withholding agent/taxpayer pays during the original audit and investigation the surcharges, interest and penalties incident to the failure to withhold the tax.
v No withholding of creditable or final tax was made and the recipient-payee failed to report the income on due date thereof, but the withholding agent pays during the original audit and investigation the amount supposed to have been withheld, inclusive of surcharges, interest and penalties incident to his failure to withhold.
v The withholding agent erroneously underwithheld the tax but pays during the original audit and investigation the difference in the amount supposed to have been withheld, inclusive of surcharges, interest and penalties incident to such error.


N. ITEMS NOT DEDUCTIBLE

Sec. 36, NIRC: Items not Deductible-
(A) General Rule - in computing net income, no deduction shall in any case be allowed in respect to:
1. personal, living or family expenses
2. any amount paid out for new buildings or for permanent improvements, or betterments made to increase the value of any property or estate
This subsection shall not apply to intangible drilling and development costs incurred in petroleum operations which are deductible under subsection G(1) of sec 34 of this Code.
3. any amount expended in restoring property or in making food the exhaustion thereof for which an allowance is or has been made
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.
(B) Losses from Sales or Exchanges of Property- in computing net income, no deduction shall in any case be allowed in respect of losses from sales or exchanges of property directly or indirectly:
1. between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether whole or half-blood), spouse, ancestors, and lineal descendants
2. except in the case of distributions in liquidation, between an individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual
3. except in the case of distributions in liquidation, between two corporations more than 50% in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign personal holding company
4. between a grantor and a fiduciary of any trust
5. between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust
6. between a fiduciary of a trust and a beneficiary of such trust

Secs. 119-122, RR-2
Sec.119, RR-2: Personal, living and family expenses- personal, living and family expenses are not deductible
1) insurance paid on a dwelling owned and occupied by a taxpayer is a personal expense and not deductible
2) premiums paid for life insurance by the insured are not deductible. In the case of a professional man who rents a property for residential purposes, but incidentally receives his clients, patients or callers in connection with his professional work, no part of the rent is deductible as a business expense. If, however, he uses part of the house for his office, such portion of the rent is deductible.
3) Alimony and an allowance unpaid under a separation agreement are not deductible from gross income.

Sec. 120, RR-2: Capital Expense: No deduction from gross income may be made for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of the taxpayer’s property, or for the amount expended for restoring property or in making good the exhaustion thereof for which an allowance for depreciation expended for securing copyright and plates, which remain the property of the person making the payments, are investments of capital. The cost of defending or perfecting title to property constitutes part of the cost of the property and is not a deductible expense. The amount expended for architect’s services is part if the cost of the building. Commissions paid in purchasing securities are on offset against the selling price. Expenses of the administration of an estate, such as court costs, attorney’s fees and executor’s commissions, are chargeable against the “corpus” of the estate and are not allowable deductions.
In the case of the corporation, expenses for organization, such as incorporation fees, attorney’s fees and accountants’ charges, are ordinarily capital expenditures, but where such expenditures are limited to purely incidental expenses, a taxpayer may charge such items against income in the year for which they are incurred. A holding company which guarantees dividends at a specified rate on the stock of a subsidiary may not deduct amounts paid in carrying this guaranty in computing its net income, but such payments may be added to the cost of its stock to the subsidiary.

Sec. 121, RR-2: Premiums on Life Insurance of Employees- any amounts paid for premium on any life insurance policy covering the life of an officer or employee or of any person financially interested in the business of the taxpayer which the taxpayer is directly a beneficiary under such policy are not deductible.

Sec. 122, RR-2: Losses from Sales or Exchanges of Property- No deduction is allowed in respect of losses from sales or exchanges of property, directly or indirectly:
a. between members of a family. The family of an individual shall include only his brothers and sisters (whether whole or half-blood), spouse, ancestors, and lineal descendants
b. except in the case of distributions in liquidation, between an individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual
c. except in the case of distributions in liquidation, between two corporations more than 50% in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign personal holding company
d. between a grantor and a fiduciary of any trust
e. between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust
f. between a fiduciary of a trust and a beneficiary of such trust

Atlas Consolidated v. CIR, GR. L-26911

Facts: Atlas is being assessed of deficiency income tax. Atlas protested the assessment asking for its reconsideration and cancellation. It is the contention of Atlas that the amount paid for as annual public relations expenses is a deductible expense from gross income under sec 30 of the NIRC. Atlas claimed that it was paid for services of a public relations firm, P.K. Macker, a reputable public relations consultant in New York, hence an ordinary and necessary business expense.

ISSUE: Whether or not the expenses paid to create a favorable image of the corporation is a deductible expense?
HELD: No, efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures. To be deductible as business expense, the following requisites are imposed: 1. the expense must be ordinary and necessary, 2. paid and incurred within the taxable year, 3. paid or incurred in carrying in a trade or business.
[1] Sec. 30. Deductions from gross income- In computing net income there shall be allowed as deductions -
© Taxes - taxes paid or accrued within the taxable year, except -
B. income, war-profits, and excess profit taxes imposed by the authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph 3 of this subsection (relating to credit for foreign countries)