PHILIPPINE TAX SYSTEM AND INCOME TAXATION

1
MODULE 7: ALLOWABLE DEDUCTIONS-PART 1

Allowable Deductions-Part 1

LEARNING OBJECTIVES
At the end of this module you are
expected to:
1. What are the Allowable Deductions both for the individual and corporate
taxpayers?
2. What is the difference between itemized deductions and optional
standard deduction?
3. Are all expenses incurred by a taxpayer deductible?
4. What expenses are fully and partly deductible?

Allowable Deductions

for

Individual and Corporate Taxpayers

- These are the amounts that are deducted from the gross income to arrive at the taxable income.
- These groups of expenses are deductible if allowed by NIRC or by Revenue Regulations issued by
Secretary of Finance, otherwise those expenses will not be allowed as deductions.

DEDUCTIONS FROM GROSS INCOME

Ordinary Deduction Special Deduction

1. Health/Hospitalization insurance premium
Choose between:
2. Special deductions allowed to:
Itemized Deduction Optional Standard Deduction insurance companies
1. Business Expenses 1. Individual Taxpayers - 40% of Gross Sales Receipts mutual insurance companies
2. Interest Expenses 2. Corporation - 40% of Gross Income mutual marine companies
3. Taxes
4. Losses
5. Bad Debts Expense
6. Depreciation and Depletion
7. Charibtable Contributions
8. Research and Development Costs
9. Pension Trust

Course Module
 ILLUSTRATION
Mr. Juan Dela Cruz, a mixed income earner, married with three qualified dependents, has the
following data for the current taxable year:
Annual salary 1,225,000
Allowances received from the employer 144,000
Gross sales from business 3,125,000
Cost of sales 1,275,000
Itemized business allowable expenses – total 435,000
Required: Determine the net taxable income using the optional standard deduction
Answer:
Annual salary P 1,225,000
Allowances received from the employer 144,000
Gross Compensation Income P 1,369,000
Business Income 1,850,000
Total Income P 3,219,000
Less: Allowable Deductions
Optional Standard Deduction (P3,125,000*40%) (1,250,000)
Personal Exemptions
Basic Personal Exemptions (BPE) (50,000)
Additional Personal Exemptions (APE) (75,000)
Health and/or hospitalization insurance premium (HHIP) -
Net Taxable Income P 1,844,000

Gross sales from business P 3,125,000

Cost of sales 1,275,000
Gross Profit P 1,850,000

Itemized Deductions
- These are the lists of specific expenses allowed by the Tax Code and tax regulations to be deducted
from gross taxable income to arrive at the taxable net income
 PHILIPPINE TAX SYSTEM AND INCOME TAXATION
3
MODULE 7: ALLOWABLE DEDUCTIONS-PART 1

- Ordinarily, these specific expenses allowed in the itemized deductions are the items that appear in
the income statement of a business.

1. Business Expenses
- Ordinary, necessary and reasonable expenses incurred in running the operations of the
business entity during the taxable year
a. Salaries, wages and other forms of compensation
b. Grossed-up monetary value of fringe benefits granted by the employer to the
employee
c. Travel allowance and expenses in the pursuit of trade, business or profession
d. Representation, entertainment, amusement and recreation expenses that are
directly related to the development of the taxpayer’s trade, business or
profession
e. Rental expenses
f. Commissions paid
g. Supplies used
h. Advertising and other selling expenses
i. Other similar business expenses

ILLUSTRATION 1
During 20xx, the total net amount paid for salaries and wages amounted to P5,000,000
after the following deductions:
SSS employees contribution 425,500
Pag-Ibig employees contribution 130,300
PhilHealth employees contribution 73,400
Withholding tax 1,270,000
In addition, the company provided its manager P255,000 cash as fringe benefits
Required: Compute the allowable deduction for salary disbursements
Answer:
Salaries and wages P 5,000,000
SSS employees contribution 425,500
Pag-Ibig employees contribution 130,300
PhilHealth employees contribution 73,400
Fringe Benefits 255,000
Allowable deductions for salary disbursements P 5,884,200

Course Module
 ILLUSTRATION 2
During 20xx, ABC Company incurred the following expenses related to the travel of its officers and
employees:
Foreign travel of officers and employees (plane ticket, meals and 1,800,000
lodging) for attending business seminars
Domestic travel of officers and employees related to business 900,000
Travel expenses of the spouse of the vice president for administration 272,000
Required: Compute the allowable deduction for travel expenses
Answer:
Foreign travel of officers and employees P 1,800,000
Domestic travel of officers and employees related to business 900,000
Allowable deductions for travel expenses P 2,700,000
 PHILIPPINE TAX SYSTEM AND INCOME TAXATION
5
MODULE 7: ALLOWABLE DEDUCTIONS-PART 1

2. Interest Expenses
- Arises and incurred when the company:
1) borrows money from a bank or
2) has a penalty, in view of delinquent payment of financial obligations

- Requisites to be deductible:
1) There is indebtedness must be in writing.
2) The indebtedness must be that of the taxpayer.
3) The indebtedness must be connected with the taxpayer’s trade, business
or profession.
4) The interest must have been paid or accrued during the taxable year

- Deductibility of interest expense:

 Deductible interest expense subject to limitation
- As a general rule, the amount of interest expense incurred or paid is
deductible in full, except:
 if the taxpayer, at the same time, earns interest income
subject to 20% final tax,
the allowable interest expense shall be reduced by an
amount equivalent to the interest income multiplied by
33%

sf
Interest Expense Pxxx
Less: Applicable amount of
interest income (xxx)
Allowable Deduction for
Interest Expense Pxxx

Interest Income, GROSS

x
33%
Applicable amount of interest income

Course Module
 Deductible interest expense in full amount
a) Interest for tax delinquency
b) Interest payment on scrip dividends
o Scrip dividends – is a promissory note issued by a corporation
for payment of cash dividends in future date
c) Interest payment on deposits
d) Interest payment on bonds

 Non-deductible interest expense

a) Interest paid in advance by a taxpayer using cash basis method of
accounting
b) Interest expense arising between related taxpayers
c) Interest expense if the indebtedness is incurred to finance petroleum
exploration
d) Interest on preferred stock
e) Interest agreed orally
f) Interest on indebtedness that has been prescribed
 PHILIPPINE TAX SYSTEM AND INCOME TAXATION
7
MODULE 7: ALLOWABLE DEDUCTIONS-PART 1

3. Taxes
- Requisites for taxes to be deductible
1) It must be paid or incurred during the taxable year
2) It must be connected with the taxpayer’s trade, business or profession
3) It must be directly imposed upon the taxpayer

- Deductibility of Taxes:

Taxes

Not Deductible Deductible

 Philippine income tax  Import duties

 Estate tax  Excise taxes
 Donor’s tax  Occupation taxes
 VAT  Documentary stamp taxes
 Special assessment  Privilege and license taxes
 Stock transaction tax  Business taxes except taxes on
 Income taxes paid in foreign sale of shares of stock through
country which were treated as the local stock exchange and VAT
tax credit  Local business and municipal
taxes
 Automobile registration fee

- Limitation on Taxes as Deduction

1. For Non-resident alien engaged in trade and business (NRAETB) and a Resident
Foreign Corporation
 Deductible amount is limited to the extent of income derived within
the Philippines
2. For Resident Alien (RA)

Deductible Net Income within the Philippines Taxes paid to

Foreign taxes Net Income – World foreign country

Course Module
 ILLUSTRATION
The resident alien has the following income information:
Gross income – Philippines P10,000,000
Gross income – Germany 4,000,000
Business expenses – Philippines 4,000,000
Business expenses – Germany 2,000,000
Income tax paid in the Philippines 1,818,000
Income tax paid in the Germany 900,000
Required: Compute the allowable tax deduction
Answer:

Philippines Germany Total

Gross income P 10,000,000 P 4,000,000 P 14,000,000
Business expenses 4,000,000 2,000,000 6,000,000
Net Income P 6,000,000 P 2,000,000 P 8,000,000

Allowable Foreign Tax Deduction 6,000,000 x 900,000 675,000

8,000,000

4. Losses
- Arise from fire, storm, shipwreck, casualties, robbery, theft or embezzlement
- Requisites to be deductible:
a. The loss must be actually sustained in a closed and completed transaction
b. The loss must be that of a taxpayer and incurred in connection with trade, business or
profession
c. The loss must not be compensated by insurance or other forms of indemnity
d. The loss must be reported to the BIR within the period of 30 days up to 90 daysfrom
the date of discovery of loss
 PHILIPPINE TAX SYSTEM AND INCOME TAXATION
9
MODULE 7: ALLOWABLE DEDUCTIONS-PART 1

- Classification:
Book Value of Lost Assets
Total Loss Less: Insurance (if any)
Deductible Loss
Classification of Losses
How much Book Value of Lost Assets
Nondeductible Losses Deductible Losses or
to deduct?
Replacement Cost
Business Losses (whichever is HIGHER)
All losses which
do not meet the
Partial Loss
requisites and Less:Less: Insurance (if any)
not expressly
stated as Deductible Loss
Casualty Losses
deductible

Net Operating
Loss Carry-Over
(NOLCO)

Losses from
theft, robbery or
embezzlement

Others

i. Business Losses
- arises from unpaid debts extended to customers
- sum of the following:
Unpaid Debts
Plus: Interest
Total Business Losses

- Additional requisites to be deductible:

a. If the taxpayer reports income using accrual basis Business Losses = DEDUCTIBLE
b. If the taxpayer reports income using cash basis Business Losses = NOT DEDUCTIBLE

Course Module
 ILLUSTRATION
Mr. Juan Dela Cruz owns a 15-door, 5-storey commercial building with a monthly rental of
P10,000. At the end of the current taxable year, the tenant occupying the fifth door has not
paid its rental fee for six months.
Required: Compute the deductible loss if:
1. The taxpayer is using the accrual basis method of accounting
2. The taxpayer is using the cash basis method of accounting
Answer:
Accrual Basis Cash Basis

P10,000 x 6 month = P 60,000 None

ii. Casualty Losses

- Arise from accidents, natural calamities or man-made events resulting in
destruction, deprivation or deterioration of the value of the property
- Additional requisites to be deductible:
 Casualty losses should be on account of:
a. fire
b. storms
c. flood
d. earthquakes
e. shipwreck
f. car accidents
 PHILIPPINE TAX SYSTEM AND INCOME TAXATION
11
MODULE 7: ALLOWABLE DEDUCTIONS-PART 1

ILLUSTRATION
Mr. Juancho Cruz owns and operates a printing business. During the taxable year, the
business building and all its equipment were destroyed completely by fire. The following
are the relevant data:
Cost of the building P1,250,000
Accumulated depreciation – building 350,000
Cost of the equipment 250,000
Accumulated depreciation – equipment 70,000
Fire insurance – building 100,000
Required: Compute the deductible loss
Answer:
Cost of the building P 1,250,000
Accumulated depreciation – building 350,000
Book Value P 900,000
Fire insurance – building 100,000
Deductible Loss P 800,000

Cost of the equipment P 250,000

Accumulated depreciation – equipment 70,000
Book Value P 180,000
Insurance -
Deductible Loss P 180,000

Total Deductible Loss P 980,000

Course Module
 ILLUSTRATION
The following data were taken from the records of Mr. Ramil Santiago whose business
assets was partly destroyed by fire
Cost of the machinery with estimated useful life of 20 years P3,000,000
Accumulated depreciation as of the date of fire (10 years) 2,000,000
Estimated cost to replace the damage portion (70% damage) 1,800,000
Required: Compute the deductible loss
Answer:
Cost of the machinery P 3,000,000
Accumulated depreciation – machinery 2,000,000
Book Value P 1,000,000
vs.
Estimated cost to replace 1,800,000

Estimated cost to replace 1,800,000

Insurance -
Deductible Loss P 1,800,000

iii. Net Operating Loss Carry-Over (NOLCO)

- Excess of allowable deductions over gross taxable income in a particular taxable
year
- Shall be carried over as deduction from gross income for the next three
consecutive taxable years immediately following the year of such loss

TAXPAYERS ENTITLED TO DEDUCT NOLCO TAXPAYERS NOT ENTITLED TO DEDUCT NOLCO

1. Self-employed individual taxpayers 1. Individual taxpayers earning purely
2. Estates and trusts compensation income
3. Domestic and resident foreign corporations 2. Offshore banking units
covered by the NCIT Foreign currency deposit units of both
4. Domestic and resident foreign corporations domestic and foreign banks
subject to preferential rate like 3. Taxpayers who are exempt by law from
 Hospitals income taxation
 Private educational institutions

ILLUSTRATION
The records for the past five years of XYZ Manufacturing Company show the following data:
2013 2014 2015 2016 2017
Gross taxable income 750,000 900,000 1,000,000 1,200,000 1,400,000
Allowable deductions 1,100,000 800,000 800,000 1,050,000 1,100,000
Required: Determine how to charge properly the operating loss of prior years to the
succeeding years and the amount
Answer:
 PHILIPPINE TAX SYSTEM AND INCOME TAXATION
13
MODULE 7: ALLOWABLE DEDUCTIONS-PART 1

2013 2014 2015 2016 2017

Gross taxable income 750,000 900,000 1,000,000 1,200,000 1,400,000
Allowable deductions 1,100,000 800,000 800,000 1,050,000 1,100,000
Net taxable income (350,000) 100,000 200,000 150,000 300,000
NOLCO (350,000) (250,000) (50,000) -
Net Income (Loss) (350,000) (250,000) (50,000) 100,000 300,000

iv. Lossess from theft, robbery or embezzlement

- Actual amount of losses are fully deductible
v. Others
- Pertains to capital losses and loss from sale of shares of stock
5. Bad Debt Expense
- Refers to worthless or uncollectible amounts
- Requisites to be deductible:
a. There must be an existing debt, which is valid, subsisting and demandable
b. The existing debts must be ascertained to be worthless
c. The debts must be charged off within the taxable year
d. The existing indebtedness must be connected with trade, business or exercise of
profession
e. The debts must not be sustained or incurred between related parties

Course Module
 ILLUSTRATION
Mr. Juan Dela Cruz, married, a sole proprietorwas granted the following loans:
To the customers of the business P 5,000,000
To his father 735,500
During the year, estimates revealed that 20% of the amounts lent to
customers could no longer be collected. However, customers with a debt
amounting to P250,000 had been declared by the appropriate court bankrupt
and such account to be worthless.

Similarly, Mr. Dela Cruz also had fully ascertained that the loan extended to his
father would never be collected.
Required: Compute the deductible bad debts of the taxpayer
Answer:
P250,000

End of Module 7

Links to Supplemental Readings

1. http://www.chanrobles.com/legal6nircmain.htm#.WW14qRUrLIU
2. https://www.bir.gov.ph/index.php/tax-code.html#title1
3. https://www.bir.gov.ph/index.php/tax-code.html#title2

Links to Other Video Lectures

1. https://www.youtube.com/watch?v=mjvKbx8HBcA
2. https://www.youtube.com/watch?v=nEkSZtKuRjQ
3. https://www.youtube.com/watch?v=6ORA5dIdhlQ

References
National Internal Revenue Code of 1997 . (n.d.). Retrieved from https://www.bir.gov.ph/index.php/tax-
code.html.
Aduana, N. L. (2012). Simplified and procedural handbook on income taxation (2nd Edition ed.). Quezon
City: C & E Publishing Inc.
Garcia, E. R., & Tabag, E. D. (2014). Income Taxation (3rd Edition ed.). Quezon City: Good Dreams
Publishing .
Valencia, E. G. (2016). Income Taxation (7th Edition ed.). Baguio City: Valencia Educational Supply .