Taxation One: Outline with Codals
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and (C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
• Deductions are amounts allowed by law to reduce the gross income to taxable income.
• These amounts are allowed to taxpayers by legislative grace and the taxpayer claiming them must prove compliance with the provisions of the law authorizing the deductions.
• The following are the deductions from gross income:
o For individuals with gross compensation income (from employer-employee relationship) only:
i. Premium payments on health and/or hospitalization insurance (PHHI) (provided family gross income is not more than 250,000).
ii. Personal exemptions
o For individuals with gross income from business or practice of profession:
i. Optional standard deduction (OSD), or ii. Itemized deductions,
iii. PHHI,
iv. Personal exemptions.
o For corporations:
i. Optional standard deduction (OSD), or ii. Itemized deductions
• Itemized deductions are expenses and losses related to trade or business or the practice of a profession.
o Itemized deductions are what Sec. 34 talks about, and these do not apply to taxpayers earning compensation income from an employer-employee relationship.
• The following are the itemized deductions:
1. Expenses 2. Interest 3. Taxes 4. Losses 5. Bad debts 6. Depreciation 7. Depletion
8. Charitable and other contributions 9. Research and development
10. Pension trusts
Expenses, in general
(A) Expenses. -
(1) Ordinary and Necessary Trade, Business or Professional Expenses.-
(a) In General. - There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession, including:
(i) A reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered, including the grossed-up monetary value of fringe benefit furnished or granted by the employer to the employee: Provided, That the final tax imposed under Section 33 hereof has been paid;
(ii) A reasonable allowance for travel expenses, here and abroad, while away from home in the pursuit of trade, business or profession;
(iii) A reasonable allowance for rentals and/or other payments which are required as a condition for the continued use or possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor;
(iv) A reasonable allowance for entertainment, amusement and recreation expenses during the taxable year, that are directly connected to the development, management and operation of the trade, business or profession of the taxpayer, or that are directly related to or in furtherance of the conduct of his or its trade,
Taxation One: Outline with Codals
business or exercise of a profession not to exceed such ceilings as the Secretary of Finance may, by rules and regulations prescribe, upon recommendation of the Commissioner, taking into account the needs as well as the special circumstances, nature and character of the industry, trade, business, or profession of the taxpayer:
Provided, That any expense incurred for entertainment, amusement or recreation that is contrary to law, morals public policy or public order shall in no case be allowed as a deduction.
(b) Substantiation Requirements. - No deduction from gross income shall be allowed under Subsection (A) hereof unless the taxpayer shall substantiate with sufficient evidence, such as official receipts or other adequate records:
(i) the amount of the expense being deducted, and
(ii) the direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business or profession of the taxpayer.
(c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross income shall be allowed under Subsection (A) hereof for any payment made, directly or indirectly, to an official or employee of the national government, or to an official or employee of any local government unit, or to an official or employee of a government-owned or -controlled corporation, or to an official or employee or representative of a foreign government, or to a private corporation, general professional partnership, or a similar entity, if the payment constitutes a bribe or kickback.
(2) Expenses Allowable to Private Educational Institutions. - In addition to the expenses allowable as deductions under this Chapter, a private educational institution, referred to under Section 27 (B) of this Code, may at its option elect either: (a) to deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the expansion of school facilities or (b) to deduct allowance for depreciation thereof under Subsection (F) hereof.
• The codal considers as deductions all ordinary and necessary expenses in carrying on the development, management, and operation of a trade, business or profession, including a reasonable allowance for:
1. Salaries, wages, and other forms of compensation including fringe benefits 2. Travel expenses, here and abroad, in pursuit of trade and business
3. Rentals and others which are required for the continued use of property
4. Entertainment, amusement and recreation expenses that are directly connected to the trade, business, or profession (but should not be contrary to law, morals, etc)
• According to the codal, these are the requirements for deductible claims:
1. Sufficient evidence (like official receipts)
2. A direct connection of the expense to the development, management, operation, and/or conduct of the trade, business or profession
• Payments of bribes & kickbacks are not deductible.
• Jurisprudence expounded on the requirements with the following requisites for the deductibility of ordinary and necessary trade, business, or professional expenses (CIR v Isabela):
1. Expense must be ordinary and necessary
2. Must have been paid or incurred during the taxable year
3. Must have been paid or incurred in carrying on the trade/business 4. Must be supported by receipts, records or other pertinent papers
• A taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year.
• It is ordinary when it is normal in relation to the business of the taxpayer. It need not be recurring.
• It is necessary when it is appropriate and helpful in the development of the taxpayer’s business. See if it is intended to minimize losses, or to maximize profits.
• Regarding advertising expenses (CIR v General Foods):
o Advertising is generally of two kinds:
i. To stimulate the current sale of merchandise or use of services ii. To stimulate the future sale of merchandise or use of services
o The second type involves expenditures incurred, in whole or in part, to create or
maintain some form of goodwill for the taxpayer’s trade or business or for the
industry or profession of which the taxpayer is a member.
Taxation One: Outline with Codals o If it’s the first kind, it’s definitely deductible as a business expense, the only
question to be answered is if it’s reasonable or not.
o If it’s the second kind, normally they should be spread out over a reasonable time.
o In the case, the amount was not only huge (ie unreasonable), but was also used to protect the brand franchise. The Supreme Court said that it was analogous to the maintenance of goodwill or title to one’s property. Thus, it was a capital expenditure which should have been spread out over a reasonable period of time.
It was akin to the acquisition of capital assets and therefore expenses related thereto were not to be considered as business expenses but as capital expenditures.
• Expenses paid to advertising firms to promote sale of capital stock for acquisition of additional capital is not deductible from taxable income. Efforts to establish reputation are akin to acquisition of capital assets, and therefore, expenses related thereto are not business expense but capital expenditures. (Atlas Consolidated v CIR)
• Litigation expenses incurred in defense of title to property is capital in nature and not deductible. (Atlas)
• Bonuses to employees made in good faith and as additional compensation for the services actually rendered by the employees are deductible, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered. (Kuenzle v CIR)
o Bonus given to corporate officers out of sale of corporate land not deductible as an ordinary business expenses in the absence of showing what role said officers performed to effectuate said sale. The taxpayer must show that personal services had been rendered and that the amount was reasonable. (Aguinaldo Industries v CIR)
o For income tax purposes, the employer cannot legally claim such bonuses as deductible expenses unless they are shown to be reasonable. The conditions precedent to the deduction of bonuses are:
1. The payment of the bonuses is in fact compensation 2. It must be for personal services actually rendered, and
3. The bonuses, when added to the salaries, are reasonable when measured by the amount and quality of the services performed with relation the business of the taxpayer. (CM Hoskins v CIR)
• Contributions to a private entity that gives dividends to stockholders not deductible because the net income of the recipient inures to the benefit of its stockholders.
o Contributions to a government entity is deductible when used exclusively for public purposes (Roxas v CTA)
• Payment for police protection is illegal as it is a compensation given by the petitioner to the police for the performance by the latter of the functions required of them to be rendered by law. (Calanoc v CIR)
• For cost of materials, taxpayers carrying materials and supplies on hand should include in expenses the charges of materials and supplies only to the amount that they are actually consumed and used in operation during the year for which the return is made, provided that the cost of such materials and supplies has not been deducted in determining the net income for any previous year.
o If a taxpayer carries incidental materials or supplies on hand for which no record
of consumption is kept or of which physical inventories at the beginning and end
of the year are not taken, it will be permissible for the taxpayer to include in his
expenses and deduct from gross income the total cost of such supplies and
materials as were purchased during the year for which the return is made,
provided the net income is clearly reflected by this method. (Sec 67, RR 2)
Taxation One: Outline with Codals
• For repairs, the cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditure.
o Repairs in the nature of replacement, to the extent that they arrest deterioration and appreciably prolong the life of the property should be charged against the depreciation reserves if such account is kept. (Sec 68, RR 2)
• For lease agreement expenses, the following are allowed deductions (Sec 74, RR 2):
o Where a leasehold is acquired for business purposes for a specified sum, the purchaser may take deduction in his return for an aliquot part of such sum each year, based on the number of years the lease will run;
o Taxes paid by a tenant to or for a landlord for business property are additional rent and constitute a deductible item to the tenant and taxable income to the landlord; the amount of the tax being deductible by the latter.
o The cost of leasehold improvements are NOT considered business expenses since they are capital investments.
i. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the cost of such improvements divided by the number of years remaining of the term of the lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the building erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation.
• For professional expenses, the following are allowed deductions (Sec 69, RR 2):
o Cost of supplies
o Expenses paid in the operation and repair of transportation equipment used in making professional class
o Due to professional societies and subscriptions to professional journals
i. So bar review tuition fees and bar examination fees paid are not deductible
o Rent paid for offices
o Expenses for utilities on offices
o Expenses for hiring of office assistants
o Books, furniture and professional instruments and equipment with a SHORT useful life
i. Those with a permanent character are NOT allowable
• Professional expenses are deductible in the year the professional services are rendered, not in the year they are billed. (Mamalateo)
• For farmer who operates for a profit, they can deduct necessary expenses all amounts actually expended in the carryon on of the business of farming.
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11 The cost of ordinary tools of short life or small cost, such as hand tools, including shovels, rakes, etc., may be included. The cost of feeding and raising livestock may be treated as an expense deduction, in so far as such cost represents actual outlay, but not including the value of farm produce grown upon the far, or the laborer of the taxpayer. Where a farmer is engaged in producing crops which take more than a year from the time of planting to the process of gathering and disposal, expenses deducted may be determined upon the crop basis, and such deductions must be taken in the year in which the gross income from the crop has been realized. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches, prior to the time when the productive state is reached may be regarded as investments of capital. Amounts expended in purchasing work, breeding or dairy animals are regarded as investments of capital, and may be depreciated unless such animals are included in an inventory in accordance with section 149 of these regulations. The purchase price of transportation equipment if used wholly used in carrying on farm operations, is not deductible but is regarded as an investment of capital. The cost of gasoline or fuel, repairs, and upkeep of the transportation equipment if used wholly in the business of farming is deductible as an expense; if used partly for business purposes and partly for the pleasure or convenience of the taxpayer or his family, such cost may be apportioned according to the extent of the use for
Taxation One: Outline with Codals
• Private educational institutions have special deductibles.:
1. They are allowed to deduct expenditures otherwise considered as capital outlays of depreciable assets incurred for the expansion of school facilities, or
2. They are allowed to capitalize the expenditure, and claim deduction by way of depreciation.
Representation, amusement, recreation expenses and entertainment facilities (RR 10-02)
• Representation expenses are expenses incurred in connection with the conduct of one’s trade, business or profession in:
o Entertaining, providing amusement & recreation to, or meeting with guests
o At a dining place, place of amusement, country club, theater, concert, play, sporting event & similar places
i. If the taxpayer is the registered member of a country, golf, or sports club, the presumption is that the expenses are fringe benefits subject to the FBT unless the taxpayer can prove that these are actually representation expenses.
• Entertainment facilities refer to a yacht, vacation home or condominium & similar items of real or personal property used by the taxpayer primarily for entertainment, amusement, or recreation of guests or employees.
o It must be owned or form part of the taxpayer’s trade, biz, or profession for which he claims a rental expense.
o A yacht is considered an entertainment facility if its use is not restricted to specified officers or employees. If it was restricted to them, it would be a fringe benefit, subject to the FBT.
• The following are not considered entertainment, amusement & recreation expenses:
1. Those that are treated as compensation for fringe benefits 2. Expenses for charitable & fund-raising events
3. Expenses for bona fide meeting of stockholders, partners or directors
4. Expenses for attending or sponsoring an employee to a business league or professional org meeting
5. Expenses for events organized for promotion, marketing & advertising including concerts, conferences, seminars, workshops, conventions, etc
6. Other expenses of a similar nature
o BUT! These may still be qualified as deductions under other provisions of Section 34.
o Possible legal implication? They won’t be subject to the ceiling of representation expenses (my opinion lang ah!)
• Requisites of deductibility for entertainment, amusement, and recreational expense:
1. Paid or incurred during the taxable year
2. Must be directly connected to the development, management & operation of the trade, biz or profession of the taxpayer; or directly related to or in furtherance of, his or its trade, biz or exercise of profession
3. Not be contrary to blah blah blah
4. Not been paid to an official of the government as a bribe or kickback 5. Must be substantiated by adequate proof
6. Must been withheld, if applicable, and paid to the BIR, if subject to final tax Ceiling for Representation, Entertainment and Amusement Expenses
purposes of business and pleasure or convenience, and only the proportion of such cost justly attributable to business purposes is deductible as a necessary expense. If a farm is operated for recreation or pleasure and not on a commercial basis, and if the expenses incurred in connection with the farm are in excess of the receipt
therefrom, the entire receipts from the sale of products may be ignored in rendering a return of income, and the expenses incurred, being regarded as personal expenses, will not constitute allowable deduction.
Taxation One: Outline with Codals Taxpayers engaged in sale of goods or properties 0.5% of net sales Taxpayers engaged in sale of services, including exercise of
profession and use or lease of properties 1% of net revenue
• For constructive dividends, see footnote.
12o Sorry, pagod na!
Interests
(B) Interest.-
(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 42% of the interest income subject to final tax: Provided, that effective January 1, 2009, the percentage shall be 33%.
(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 a 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;
(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 a 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;