CHAPTER 8
DEDUCTIONS FROM GROSS INCOME
Problem 8 – 1 DEDUCTIBLE OR NONDEDUCTIBLE FROM GROSS INCOME
1. Nondeductible 2. Deductible 3. Deductible 4. Deductible 5. Nondeductible 6. Nondeductible 7. Nondeductible 8. Deductible 9. Deductible 10. Deductible 11. Nondeductible 12. Nondeductible
13. Deductible, in lieu of tax credit (Sec. 34C3, NIRC) 14. Deductible 15. Deductible 16. Nondeductible 17. Nondeductible 18. Deductible 19. Deductible 20. Nondeductible
Problem 8 – 2 TRUE OR FALSE
1. False – Some business expenses are nondeductible; some are subject to limit. 2. True
3. False – Compensation income is not subject to OSD. 4. False – NOLCO is not an itemized deduction.
5. True – Amortized over the term of the lease 6. False – ½ of 1%
7. False – 33%
8. False – Double –declining method 9. True
10. True
11. False – Income outside the Philippines by a NRC is not taxable in the Philippines, hence, no allowable deduction is allowed.
12. True 13. True 14. True
15. False – Business expenses related to business income outside the Philippines is deductible also by domestic corporations and resident Filipino.
16. False – Business expense is deductible from gross income. 17. True
Problem 8 – 3 Problem 8 – 4 Problem 8 – 5 Problem 8 – 6 1. C 1. D 1. A 1. C 2. C 2. B 2. C 2. C 3. A 3. B 3. C 3. B 4. D 4. C 4. A 4. C 5. A 5. A 5. D 5. C 6. B 6. D 6. C 6. D 7. A 7. C 7. A 7. D 8. C 8. C 8. B 8. A 9. C 9. A 9. A 9. C 10. D 10. A 10. C 10. C Problem 8 – 7 C Expensed Capitalized
Change of motor of air condition P60,000
Expansion of store 50,000
Damages paid due to workers’ injury P20,000
Repainting of building 10,000
Cleaning of computers 9,000
Repair of furniture 1,000 .
Totals P40,000 P110,000
Problem 8 – 8 C
Identifiable operating expenses – Philippines P400,000
Add: Allocated operating expenses within
(P200,000 x P1M/P5M) 40,000
Operating expenses – Philippines P440,000
Problem 8 – 9 D
Police protection P20,000
Interest expense paid to his father 10,000
Gifts made to employees during birthday 5,000
Capital loss 4,000
Amount of nondeductible expenses and losses P39,000
Problem 8 – 10 D
Depreciation expense (P1,000,000 x 40%)/25 P16,000
Loss of business equipment 38,000
Deductible expense P54,000
Problem 8 – 11 D
No personal or business expense is deductible. 2. Letter B Depreciation (P20,000 x 10%) P 2,000 Repair (P100,000 x 10%) 10,000 Office supplies 6,000 Total deduction P18,000 Problem 8 – 12 B
Tax laws GAAP
Salary expense (P180,000 + P20,000) P200,000 P200,000
Estimated uncollectible accounts 10,000
Compromise penalty 50,000
Depreciation expense 30,000 30,000
Miscellaneous expense . 5,000
Deductible from earnings P230,000 P295,000
Note: For tax purposes, the miscellaneous expense is not deductible because it was not reported last year. For accounting purposes, the miscellaneous expense can be deducted as prior period adjustment from retained earnings.
Problem 8 – 13 A
Sales
P300,000
Multiplied by OSD rate
40%
Optional standard deduction
P120,000
The compensation income is not included in determining OSD. The OSD (40% of gross
sales or gross receipts) is only allowed as deduction from income derived from
business. If an individual opted to use OSD, he is no longer allowed to deduct cost of
sales. [Sec. 34(L), NIRC; Sec. 3, Rev. Regs. No. 16-2008]
Problem 8 – 14 B
Gross receipts from profession P100,000
Rent income (P475,000/95%) 500,000
Total gross income P600,000
Multiplied by percent of OSD 40%
Optional standard deduction P240,000
Problem 8 – 15 D
Since there are no official receipts and documents to support the operating expenses,
the reported operating expenses are not deductible (Sec. 34(A)(b), NIRC). The OSD is
not allowed for nonresident aliens (Sec. 34(L), NIRC). No personal exemption will be
granted to a nonresident alien with business in the Philippines if his country does not
have an exemption reciprocity law favoring a Filipino citizen. (Sec. 9, Rev. Regs. No. 2)
Problem 8 – 16 A
Sole Proprietor Corporatio
n
Sales
P1,000,00
0
P1,000,000
Less: Cost of sales
.
300,000
Basis of OSD
P1,000,00
0
P 700,000
Multiplied by OSD rate
40%
40%
Optional standard deduction
P
400,000
P 280,000
RA 9504 is specific as to the basis of OSD. For individuals, the basis of the 40% OSD
shall be the “gross sales” or “gross receipts.” In the case of corporate taxpayers subject
to tax under Sections 27(A) and 28(A)(1) of the Tax Code, as amended, the basis of the
40% OSD shall be the “gross income.”
Problem 8 – 17 B
Operating expense before representation expense
(P2,000,000 – P300,000) P1,700,000
Representation expense – Actual P300,000
- Limit (P20,000,000 x 0.005) 100,000
- Lower 100,000
Allowable itemized deductions P1,800,000
Problem 8 – 18 B Salary expense P120,000 Rent expense 24,000 Advertising expense 6,000 Depreciation expense 5,000 Interest expense 60,000
Tax differential on interest income (P30,000 x 33%) ( 9,900)
Total itemized deductions P205,100
NOLCO is not an itemized deduction.
Problem 8 – 19 D
Using OSD Using Itemized
Sales
P1,200,000
P1,200,000
Cost of sales
- 0 -
700,000
Gross income
P1,200,000
P 500,000
(P1,200,000 x 40%)
480,000
0
-Net income before personal exemption
P 720,000
P 500,000
Allowed deduction using OSD (P1,200,000 x 40%)
P 480,000
Less: Cost of sales
700,000
Net disadvantage using OSD
(P220,000)
No itemized deduction is allowed if no official receipts, records or other pertinent
papers can be used to support it (CIR vs. Isabela Cultural Corporation, G.R. No.
172231, Feb. 12, 2007).
In case of individual taxpayer, the “cost of sales” or the “cost of services” are not allowed
to be deducted for purposes of determining the basis of OSD inasmuch as the law (RA
9504) is specific as to the basis thereof which states that for individuals, the basis of
the 40% shall be the “gross sales” or “gross receipts” and not the “gross income.” (Sec.
3, Rev. Regs. No. 16-2008)
Problem 8 – 20 A
Gross salaries of employees P6,000,000
Grossed-up monetary value of fringe benefits 1,000,000
Deductible salaries and fringe benefits expenses P7,000,000
Problem 8 – 21 C
Assume bonus is computed after tax but before bonus. The answer is letter D = P8,143, computed as follows:
Net income before charitable contribution (P75,000 + P5,000) P 80,000 Less: Deductible contribution (P80,000 x 5%) – lower of actual 4,000
Net income before income tax and bonus P 76,000
B = 15% (76,000 – T) T = 30% (76,000 – B) B = 15% [76,000 – 30% (76,000 – B)] B = 15% (76,000 – 24,320 + 30%B) B = 11,400 – 3,420 +0.045B B – 0.045B = 7,980 0.955B = 7,980/0.955 B = 8,356 Proof:
Income before bonus and tax P76,000
Income after tax but before bonus P55,715
Multiplied by rate of bonus 15%
Bonus P 8,356
Problem 8 – 22 B
Monthly salary P 5,000
Death benefits 50,000
Terminal pay 25,000
Continuous compensation after the burial for three months 15,000
Total deductible expenses P95,000
Note: Donation for coffin and other wake expenses is not business or compensation related and, hence, not deductible. (Sec. 72, Rev. Regs. 2)
Problem 8 – 23 C
Inventoriable cost Supplies expense
Purchases P300,000 P40,000 Decreased in inventory 20,000 Increased in inventory . ( 3,000) P320,000 P37,000 Problem 8 – 24 D Traveling expenses (P50,000 + P200,000) P250,000
Fringe benefit expense (P68,000/68%) 100,000
Transportation expense – messenger 40,000
Total allowable expense P390,000
Problem 8 – 25 B
Monthly rent (P20,000 x 60%) x 2 mos from Oct. 31 to Dec. 31 P24,000
Insurance premium (P3,000 x 60%) x 2/12 300
Real property tax (P1,500 x 60%) x 2/12 150
Deductible rent expense P24,450
Note: The city services is not a rent expense.
Problem 8 – 26
1. Letter B
Rent for 6 months based on usage (P20,000 x 6) x 80% P96,000
2. Letter D
Actual cash collection for rent P150,000
Problem 8 – 27 D
Monthly rental expense P2,000
Monthly depreciation (P600,000/8)/ 12 6,250
Problem 8 – 28 C
Rent expense (P5,000 x 12) P 60,000
Add: Depreciation expense [(P950,000/9.5) x 11/12] 91,667
Deductible expense in 200y P151,667
At the start of the used of the building, the remaining period for the contract of lease is
9.5 years. The salvage value is ignored in the computation of the depreciation because
T Foods could no longer benefit on it since the improvement on the land will be owned
by the lessor at the end of the 10-year contract of lease.
Problem 8 – 29
1. Letter B
Trading - Limit lower (P5,000,000 x .005) P25,000
2. Letter C
Servicing – actual lower P30,000
Problem 8 – 30 B
Actual representation expense
P10,000
Multiplied by percent of representation expense
for sales [P700,000/(P700,000 + P300,000)]
70%
Apportioned representation expense for sales
P 7,000
Limit (P700,000 x 0.005), lower
P3,500
Actual representation expense
P10,000
Multiplied by percent of representation expense
for revenue [P300,000/(P700,000 + P300,000)]
30%
Apportioned representation expense for sales
P 3,000
Limit (P300,000 x 0.01)
3,000
Deductible representation expense
P6,500
Problem 8 – 31 A
Interest expense P40,000
Tax differential (P50,000 x 33%) (16,500)
Deductible interest expense P23,500
Problem 8 – 32 B
Breast-feeding assistance to the needy – additional
P200,000
Salary of senior citizens – additional (P100,000 x 15%)
15,000
Senior’s citizen discount (P300,000 x 20%)
60,000
Problem 8 – 33 B
Deductible Nondeductible
Interest paid in advanced P 20,000
Interest paid to a brother 12,000
Interest paid on delinquency taxes P 8,000
Interest on borrowings to finance his family home 30,000
Interest paid to finance petroleum exploration . 100,000
Total P 8,000 P162,000
Problem 8 – 34 B
Interest expense on unpaid salaries
P 60,000
Add: Nondeductible tax differential (P40,000/80%) x 33%
16,500
Nondeductible interest expense
P 76,500
Salary expense
P600,000
Rent expense
200,000
Deductible interest expense bank loan (P40,000 – P16,500)
23,500
Total itemized deductions
P823,500
The salaries of direct workers should be classified as deductible cost of service and not
to be classified as part of itemized deductions (Rev. Regs. No.16-2008). Interest expense
on unpaid salaries is not deductible. (Kuenzel & Streiff, Inc. vs. Collector of Internal
Revenue, 106 Phil. 355)
Problem 8 – 35 D
Tax savings from interest expense (P100,000 x 30%) P30,000
Final tax on interest income (P1,000,000 x 12%) x 20% (24,000)
Actual net tax savings P 6,000
Problem 8 – 36 A
Documentary stamp taxes P 1,000
Local tax (P6,000 – P800 – P200) 5,000
Municipal tax 2,000
Community tax 1,500
Deductible taxes P9,500
Note: The fringe benefit income taxes to key officers and rank-in-file employees are to be classified as deductible fringe benefit expense and not tax expense.
Problem 8 – 37 C
Business taxes
P 20,000
Documentary stamp taxes
1,000
Automobile registration fees
3,000
Import duty taxes
50,000
Total deductible taxes
P 74,500
Problem 8 – 38 D
Unadjusted net income (P520,000 – P200,000) P320,000
Add back: Income tax foreign country 10,000
Adjusted net income P330,000
Personal exemption (50,000)
Net taxable income P280,000
Note: The P10,000 income tax paid to foreign country is better to be treated as tax credit rather than as operating expense.
Problem 8 – 39 A
Asset of Oliva P 60,000
Payment to government (P200,000 x 50%) (100,000)
Balance (P40,000)
Deductible bad debts is the entire amount of collectibles P100,000
Problem 8 – 40 B
Bad debts from business actual written off (P100,000 x
40%) P40,000
Bad debts from profession actual written off 50,000
Deductible bad debts expense P90,000
Problem 8 – 41 D
Annual depreciation expense (P50,000 – P5,000)/5 P9,000
Multiplied by ratio of months used during the year (from June 30 to Dec. 31) 6/12
Depreciation expense 200B P4,500
Problem 8 – 42 A
Annual depreciation (P2,300,000/11.5 years) P200,000
Multiplied by ratio of months used in 200B (July 1 to Dec.) 6/12
Depreciation expense P100,000
Problem 8 – 43 D
Oil drilling machine (P800,000 x 90%)/8 years P 90,000
Oil extracting machine (P900,000 x 90%)/10 years – limit 81,000
Computers (P100,000 x 90%)/4 years 22,500
Delivery truck (P200,000 x 90%)/5 years – limit 36,000
Annual depreciation expense P229,500
The useful life of properties used in or related to production of petroleum shall be ten
(10) years or such shorter life as may be permitted by the BIR Commissioner. Properties
not used directly in the production of petroleum shall be depreciated under the
straight-line method on the basis of an estimated useful life of five (5) years. (Sec. 34(F)
(4), NIRC)
Problem 8 – 44 C
Depletion base (P6,000,000 – P1,000,000 + P300,000) P5,300,000
Divided by number of extractible estimated tons 5,000,000
Depletion per ton P 1.06
Multiplied by number of tons extracted during the year 800,000
Depletion expense P 848,000
Problem 8 – 45
1
. Letter D
Depletable costs, January 1, 200x P12,500,000
Exploration costs 1,000,000
Intangible development costs 1,500,000
Total P15,000,000
Less: Depletion expense (P15,000,000/7,500,000) x 1,200,000 2,400,000
Adjusted basis P 1,260,000
Divided by remaining reserves
(5,000,000 + 2,500,000 – 1,200,000) 6,300,000
New depletion rate/ unit P 2.00
2
. Letter A
Depletion cost 2007 (P2 x 1,200,000 units) P2,400,000
3
. Letter B
Value of production (P12 x 1,200,000 units) P14,400,000
Less: Production and selling costs:
Mining costs P2,000,00 0 Milling costs 3,000,000 Marketing expenses 1,500,000 Depreciation expense 1,000,00 0 7,500,000
Net income from operation P 6,900,000
Multiplied by limit percentage 25%
Deductible amount fro exploration and development cost P 1,725,000 4
. Letter B
Current exploration and development cost (P1,500,000 + P1,000,000) P2,500,000 Less: Deductible amount of exploration and development cost (see 3) 1,725,000 Exploration and development cost chargeable to succeeding years P 775,000
Problem 8 – 46 B
Deductible expense: Capitalized Outright expense
Depreciation expense (P10,000,000 x 90%)/50 P180,000
Capital outlay P10,000,000
Problem 8 – 47
1 Letter B 200A 200B 200C Lower of actual contribution or normal valuation 800,000 800,000 500,000 Add: Amortization of excess
200A (P200,000/10) 20,000 20,000 20,000
200B (P100,000/10) . 10,000 10,000
Deductible retirement expense 820,000 830,000 530,000
2. Letter A 200A 200B 200C
Actual retirement payments 0 400,000 300,000
Problem 8 – 48 A
Year X Year Y
Actual contribution or normal valuation, lower 700,000 600,000
Add: Amortization (P100,000/10) 10,000 10,000
Deductible retirement expense 710,000 610,000
Note: Only the excess of the actual contribution over the normal valuation is to be amortized
over 10 years.
Problem 8 – 48 B
Allowed deductible contribution (P200,000 x 5%) P10,000
Problem 8 – 49 B
Allowed deductible contribution (P200,000 x 5%) P10,000
Problem 8 – 50 D
Allowed deductible contribution [(P60,000 + P5,000) x 10%] P6,500
Problem 8 – 51 B
Income before charitable contribution (P500,000 – P130,000) P370,000
Multiplied by percent of limit 5%
Allowed deductible contribution - lower P 18,500
Problem 8 – 52 A
PPHHI per month P200
Problem 8 – 53 D
Problem 8 – 54 C
Actual value of donation – priority program P1,000,000
Adopt a school program – incentive (P1,000,000 x 50%) 500,000
Deductible donation P1,500,000
Problem 8 – 55
1. Operating expenses (1,000,000 x 30%) – P50,000 P250,000
Interest expense (P50,000 – (P40,000/80%) x 33%] 33,500
Total itemized deductions P283,500
Add: NOLCO 500,000
Total deductible expenses P783,500
Note: NOLCO is not an itemized deduction but part of deductible expenses.
2. Gross income (P5,000,000 – P2,000,000) P3,000,000
Multiplied by OSD rate 40%
OSD P1,200,000
Note: NOLCO is not allowed to be deducted if the taxpayer uses OSD.
3. Gross income P3,000,000
Less: OSD 1,200,000
Net taxable income P1,800,000
Problem 8 – 56
Salaries of assistants P 96,000
Traveling expenses 11,000
Light and water – office 7,890
Stationeries and supplies 1,960
Office rent 60,000
Total operating expenses before contribution P176,850
Add: Contribution subject to limit (P500,000 – P176,850) x 10%) 32,315
Allowable itemized deductions P209,165
Problem 8 – 57
Sole
Proprietorship Corporation Partnership Bad debts written-off (P35,000 – P30,000)
Donation to the government – priority program Donations subject to limit:
Lower of actual, P170,000 or (P2,500,000 x 10%) (P2,500,000 x 5%) Total allowable deductions
50,000 170,000 . P 265,000 50,000 125,000 P 220,000 50,000 125,000 P 220,000 The research and development cost is to be treated as a deferred expense, hence, its
amortization shall be made in the succeeding five years when the taxpayer realizes benefits from such expenditures (Sec. 341, NIRC).
Problem 8 – 58
1. 200A 200B
Actual contribution or normal valuation, lower 1,000,000 900,000
Add: Amortization - 200A (P250,000/10) 25,000 25,000
Deductible retirement expense 1,025,000 925,000
2. Financial net income 50,000,000 60,000,000
Add: Retirement benefit expense – accounting 1,100,000 1,200,000
Total 51,100,000 61,200,000
Less: Deductible retirement expense – taxation 1,025,000 925,000
Net income for tax purposes 50,075,000 60,275,000
Problem 8 – 59
Corporation Individual
Salary expenses 500,000 500,000
Retirement (P250,000 + P50,000/10) 255,000 255,000
Representation expense (P10,000,000 x .005) 50,000 50,000
Interest expense paid to the BIR - full 20,000 20,000
Interest expense – limit:
(P100,000 – (P96,000/80%) x 33%) 60,400 60,400
Depreciation expense 40,000 40,000
Rent expense 250,000 250,000
Group insurance expense 50,000 50,000
Bad debts expense (P100,000 x 20%) 20,000 20,000
Contribution expenses:
TESDA priority project (500,000 x 1.5) 750,000 750,000
Local government – limit (lower is actual) 100,000 100,000
Total itemized deductions 2,095,400 2,095,400
Note: NOLCO is an allowable special deduction but not an itemized deduction. Problem 8 – 60
1. Individual Corporation
Salaries expense (P680,000 – P100,000) 580,000 580,000
Bad debts expense (P370,000 – P270,000) 100,000 100,000
Representation expense (P39,000,000 x 0.005) 195,000 195,000
Rent expenses (P200,000 – P20,000) 180,000 180,000
Taxes expense (P300,000 – P270,000) 30,000 30,000
Life insurance expense (P150,000 – P100,000) 50,000 50,000 Interest expense [(P200,000 – (50,000 x 33%) + P20,000] 203,500 203,500 Total itemized deduction before contributions 1,958,500 1,958,500 Contribution expenses:
Donation to TESDA priority project (P500,000 x 150%) 750,000 750,000 Donations for Rooming-in and Breast-feeding (200k x 2) 400,000 400,000
Donations NGO’s (35% for admin.) 100,000 100,000
Ind: (P39,460,000 – P30,000,000 – P1,958,500) x 10%=750,150
Corp: (P39,460,000 – P30,000,000 – P1,958,500) x 5%=375,075 . .
Total allowable deductions 3,208,500 3,208,500
Computation of sales:
Financial income P 5,000,000
Cost of sales 30,000,000
Operating expenses deducted
(P680,000 + P370,000 + P1,000,000 + P800,000 + P200,000
+ P300,000 + P150,000 + P160,000 + P800,000) 4,460,000
Total sales P39,460,000
2. Individual Corporation
Gross income (P39,460,000 – P30,000,000) P9,460,000 P9,460,000
Less: Total allowable deductions 3,208,500 3,208,500
