BUSINESS AND PROFESSIONAL INCOME- TAX 2 LAW

2/15/2023/ W

BUSINESS AND PROFESSIONAL INCOME- These refers to income earned from business or the exercise
of a profession.

Basic formula: GROSS INCOME (from business or profession) – allowable deductions = NET INCOME
(from business or profession)

NET INCOME x applicable TAX RATE = TAX DUE TAX DUE – TAX CREDIT (if applicable) = TAX PAYABLE
(on business or profession) Where; gross income refers to ALL earnings from business or exercise of
profession

Note: Insurance companies (Sec.37) estate and trust (Secs. 61-64) – Items included a spart of gross
income.

Allowable deductions
3 Kinds:

1) itemized deductions under Section 34 (A)

2) optional standard deduction under Section 34 (L)

3) extraordinary deductions under Section 37 (insurance companies), Section 61 (A) and (B) (to estates
and trusts)

4) special allowable deductions for Insurance companies and Estate and Trust (Sec. 61) under Section
34 (A) 2 (private educational institutions)

ITEMIZED DEDUCTIONS: specified by the law.

Bussiness or prof expenses- expenses incurred by TP in exercise of its profession

A) EXPENSES

1. Ordinary and necessary trade, business or professional 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, Example: employee salaries, utility
expenses, cost of products bought for sale

REQUIREMENTS for DEDUCTIBILITY (must concur so expense must be allowed as deduction)

a. the expense must be ordinary and necessary

b. paid or incurred during the taxable year

c. incurred in connection with taxpayer’s trade or business

d. must be reasonable in amount

e. substantiated by adequate proof f. not contrary to law, moral, public policy or order

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1.EXPENSE MUST BE ORDINARY AND NECESSARY

Ordinary - if customarily incurred in the course of the taxpayer’s trade or business which is relevant.
Necessary - if it is useful in the course of the taxpayer’s trade or business.

SECTION 36 CAPITAL EXPENDITURES (CANNOT BE DEDUCTED FROM THE BUSS. PROF INCOME)

- list the items which are not allowed as deductions - capital expenditures refer to expenses of large
amounts the benefits from which can be derived by the taxpayer over a period of time.

- capital expenditures are not allowed as deductions from business or professional income because
there is only a change of taxpayer’s assets from one form to another. When you buy a machinery for
1M, you return an item worth 1M.

Thus, the value of assets stays the same. -capital expenditures are considered ordinary expenses when
assets depreciated. Depreciation is an allowable deduction under Section 34A

Gradual diminution in process of using the machine, its value reduces b/c of wear and tear

Examples: Bldg is a fixed asset can be use by the TP in a period of time.

TP cannot deduct the entire value of bldg. during one whole year but only the portion of the entire value

FORMULA IN DETERMINING THE DEPRECIATION VALUE:

STRAIGHTLINE METHOD IN DETERMINING THE DEPRECIATION VALUE: (ACQUISITION COST - SCRAP

VALUE) / ESTIMATED USEFUL LIFE

ACQUISITION COST

NOTE: All other expenses necessary to make ready the asset for use is considered to be a part of
Acquisition Cost.

Not only the value upon which the purchase is acquired.

SCRAP COST- the estimated cost that a fixed asset can be sold for after factoring in full depreciation.

USEFUL LIFE

– no. of years that the machine is expected to work Example: Machine- 10 yrs.

The whole price cannot be entirely deducted, the full price must be amortized.

NOTE: The cost of the construction of the bldg. which includes a fixed asset, the bldg. itself. All expenses
acquired from the beginning not only the labor, materials as well as the services of the architect, etc.
become part of the value of expenses/ the new bldg.. NOT only the actual value of the bldg. (start to end
will form part for its cost)

NOTE: CAPITAL expenses must be divided over the no of years that the bldg. would bec. Useful and will
be considered as a depreciation and not as an ordinary expenses.

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Types of expenses

1.Rental expenses is deductible provided that the property TP is NOT the owner of the property leased,
the money incurred cannot be claimed by him as deductions. Allowed to be deducted as the ordinary
expenses prov that he has no title over the leased property and only act as lessee.

2.Repair expense becomes part of the cost of the machinery and must be amortised during the
remaining years of the machinery. It becomes capital expense and cannot be deducted under Ordinary
buss expense, what can be educted is the depreciation but not the capital expenses.

3.Advertising expense- can be capital expenditures(if long term)/ ordinary buss expense (advertisement
for short time)

In CIR vs. General Foods, advertising expense could be an ordinary expense or a capital expense
depending on the purpose of the advertisement. If the purpose of the advertisement is to boost current
sales which will benefit the current year, then it is an ordinary business expense. If it expected effect is
longterm, then it is a capital expense.

4.Litigation expenses- can be capital expenditures /ordinary buss expense.

If litigation expense is incurred to defend title to property, it becomes part of the cost of the
assets(capital expenditures). If it is for other purposes, then it is an ordinary business expense.

What is the nature of litigation expenses?

Look on the nature of the suit filed. Example: ejectment suit- involves possession issue and NOT
ownership. Hence, there’s no ownership business and considered to be an ordinary business expense.

Amended by NIRC

5.Training expenses for skills devt.- TP is allowed to deduct ½ training expenses provided that the
enterprise w/c empliy students must procure proper cert from deped and ched and must not exceed
10% to direct labor wage.

Limits: ½ is only deducted; 10% to direct labor wage

6. SEC. 36 (no.3 to enumeration) INSURANCE POLICY

Section 36: No. 3 of the enumeration provides that the amounts of premiums paid by the taxpayer on
the life of the employee, official or any person directly or indirectly connected to his business are non-
deductible if the taxpayer is indirectly or directly a beneficiary of the insurance policy.

 How is it treated? Not deductible if the TP is a beneficiary whether direct/indirect under the
Insurance policy

7. Section 34A2: = Optional Treatment on Capital Outlays or Depreciable Assets applying to Private
Educ. Inst. ONLY

- This is the option granted to private educational institutions and it has something to do with
capital expenditures. Private educational institutions are given option to treat this capital
expenditures as ordinary expenses.

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2.EXPENSE incurred in connection with taxpayer’s trade or business

This is a common requirement for all the allowable deductions under Section 34 except charitable
contributions.

It is a common requirement because the expense incurred must be in connection with earning of the
business income or professional income.

NOTE: Expense is deductible from buss./profession only if it is incurred from the earning of the
income.

TP to be entitled to claim from expenses MUST be engaged in business and not as a passive earner.

See: San Juan Hospital De dios Hospital

NOTE: Sec. 36 : Personal/family and living expenses is NOT deductible

3.MUST BE PAID PAID OR INCURRED DURING THE TAXABLE YEAR

- If the expense incurred in 2017, it must be claimed as a deduction in 2017.

4.MUST BE SUBSTANTIATED WITH ADEQUATE PROOF

- Receipts constitutes adequate proof. If the expense has really been incurred but the receipts
were lost, secondary evidence may be allowed to be used provided that the primary evidence
has been proved that it is no longer to be found.

5.MUST NOT BE CONTRARY TO LAW, ET. AL.

Section 36: No. 4 of the enumeration provides bribes, kickbacks, and similar payments. These
are contrary to law, et. al. that is why they are non-deductible.
Section 36: No. 3 of the enumeration provides that the amounts of premiums paid by the
taxpayer on the life of the employee, official or any person directly or indirectly connected to his
business are non-deductible if the taxpayer is indirectly or directly a beneficiary of the insurance
policy.
Sec31A(6) Paragraph A 1A: Entertainment, recreation and amusement expenses which are
contrary to law, public policy, morals and public order are non-deductible. Example: You bring
clients to a pub house

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6. MUST BE REASONABLE IN AMOUNT

In the case of CM Hoskins vs. CIR (disallowed the bonus since no service rendered to be
qualified of bonus), the SC provided the test of reasonableness. The test of reasonableness is
the degree of service rendered by the employee who is granted the bonus taking into account
the efforts exerted by him.

#Sec. 34 A- BONUSES

Requirements:

In granting bonuses, the ff. must be complied:

1. Must be made in good faith

2. Compensation of services actually rendered
3. If added to stipulated salary it will not exceed the amount

In CIR vs Smith Klein, this covers an expense incurred by a multinational company which benefited its
branches worldwide. A part of that expense can be deductible in the Philippines because it benefited the
Philippine operation by using this formula:

Branch Gross Income / World Gross Income x Amount Expense = Part Deductible

ISSUE: Is Smith Kline’s share of the head office overhead expenses incurred outside the Philippines
deductible?
HELD: YES. Smith Kline’s share of the head officer overhead expenses incurred outside the Philippines is
deductible. Section 37 of the old NIRC. Net Income from sources in the Philippines.
“From the items of gross income specified in subsection (a) of this section, there shall be
deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a
ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some
item or class of gross income. The remained, if any, shall be included in full as net income from sources
within the Philippines.”

In Zamora vs Collector, expense was incurred for personal and for business purposes.
SC ruled that only the expenses incurred in the exercise of profession is deductible.
If you can segregate what is for business and what is for personal purposes, then segregate.
If not, an equal division (50-50)will be reasonable. ½ considered to be deductible and other ½ not
deductible.

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#2 Section 34B: INTEREST EXPENSE Interest expense refers to interest on indebtedness incurred by the
taxpayer in connection with his trade or business

Requirement for Deductibility:

1. Indebtedness must be incurred in connection with his business or trade
Indebtedness- obligation for the payment of money
Commisioner vs. Prieto Case: Is the interest payment made by TP deductible or is it covered by
this provision? Yes, interest paid by the TP or non-payment or late payment of TP
Interest incurred upon such indebtedness.
2. Interest must be paid or approved during the taxable year
3. Interest must be legally due It is legally due when it is stipulated in writing. NOTE: Limited only
to 33% interest income.
Q: When is interest legally due?
A: Art. 1956 of NCC, Interest is not legally due unless stipulated in writing.
4. Interest between related parties
Section 36B - family members, lineal ascendants
Interest (Sec. 32 B2 in rel. Sec. 36 B) Enumeration of those considered to be related parties
If indebtedness exist b/n the parties mentioned, then it is not deductible expense.
5. To finance petroleum corporations
Q: Is the entire amount of interest expense deductible?
- To be deductible interest expense must be reduced by an amount equiv. to 20% of an interest
income related to deductible tax
- The amount to claim must be reduced by at least 20% of the interest income earned by TP
during that year.
Interest income-120K, interest expense- 400k 375 k is the deductible interest expense.

NOTE: Why is it necessary to reduce the amount?

Tax Arbitrage Scheme- A scheme resorted to TP to reduce their tax liability by taking advantage
by diff. ways using various tax methods.

Example: Gross Income-1M ;800k -allowed deductions= 200k (net income)

Interest income-100k (passive income)

Regular income-25%; Passive income (20% tax rate applicable) on the income earned during the same
year period

NET TAX BENEFIT

Regular inc- 25k

Passive income-20k

Does he profited where he supposedly pay 50k

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SECTION 34C: TAXES IN CONNECTION WITH TRADE OR BUSINESS

Examples: Business permits, real property tax, custom duties Requirements:
1. Must be incurred in connection with trade or business
2. Must be incurred or paid during the taxable period

Forms of Non-deductible Taxes:

Income tax under Title 2 of the NIRC. Fringe benefit is not covered under Title 2 of the NIRC
1. Income taxes paid by foreign country except when the taxpayer does not avail the tax credit
It can be claimed by taxpayer either as a deduction or as a tax credit. One option only.
Income tax paid on Foreign country: can be treated either as a deduction/ tax credit (can
be treated in either way).
2. Estate and Donor’s Tax
3. Special Assessment/Levy Imposition made by LGU to lands that benefitted the public.
TAX BENEFIT RULE
- In 2017, you are allowed to deduct a particular tax from your professional or
business income. Several years later, you are able to claim a refund. The effect of
which is that the tax refund will be considered as income during the year when the
tax is returned subject to the Tax Benefit Rule.

Under this rule, you cannot deduct the entire amount of the tax refunded. What you can deduct
only is the amount by which you have been benefitted because of the previous deduction from his
business or professional income. HOW TO DETERMINE THE EXTENT OF LIABILITY?

- Compute tax liability Gross Income - Allowable Deductions (including and excluding
tax)

WHO ARE ENTITLED TO TAX CREDIT? Citizens Domestic Corporation Members of Professional
Partnership Estates and Trusts

WHO ARE NOT ENTITLED TO TAX CREDIT? - Aliens Foreign Corporations

Due to tax deduction, your tax liability decreased also

Lesser N.I.= Lesser Tax due

NOTE: How will you treat the refunded tax? -Part of the fross income subj. to tax
application of Tax Benefit rule
- The amount of income that must be included w/ respect to refunded tax must be
only to the extent of the benefit derived by the tax payer.
- Not the whole amount of refunded tax, only the portion which recently benefited
the TP.

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SECTION 34D: LOSSES INCURRED IN CONNECTION WITH HIS TRADE OR BUSINESS

*LOSSES- connotes abrupt parting of the value b/c of man-made/natural causes

- It can be an abrupt loss of a property because of fire, earthquake, or other natural calamities.
- It can also be because of theft, embezzlement, carnapping.
- It can also be losses during the operation of the business like net loss.
- It could also be a loss because of foreign currency adjustments.

Requirements:

- Must be incurred in connection with trade or business;

- Capital loss is not covered under this provision because it is not related to taxpayer’s trade or
business. We are talking here about ordinary income.

LOSS LIMITATION RULE - Capital losses cannot be deducted from ordinary gains.

- Must be actually sustained during the taxable period

- Must be evident by closed and completed transactions
- Must be compensated for by the insurance or other forms of indemnity such as stipulations of
contracts, insurance, et. Al.
- Must not be claimed as deductions for estate tax purposes

NOTE: What are other forms of indemnity aside from insurance?- Contract with stipulation of
indemnification

Capital expenditures: The value of the abolished bldg. will form part of the value of the new building.

Exception:

In Commisioner vs. Priscilla estate case,

Issue: Must the value of the barong-barong form part the value of new building? – No, b/c the
demolition is involuntary thru LGU’s order and not on owner’s initiative. PROVIDED that such barong-
barong is used by Tax payer in line with his business/trade.

NET OPERATING LOSS

Net loss due to operation of business. It is treated as an ordinary loss because it involve income in
connection with his trade or business. If during this year you incurred a net loss, the law says you can
deduct this the following year and two years after.

RULE ON CARRY OVER OF NET OPERATING LOSS

You can carry over the net operating loss as a deduction from your income during the three succeeding
taxable years. It is also an allowable deduction from business or professional income.

NOTE: NOL can be carried over by the TP as a deduction on the gross income on the next taxable income
year. (3 years carry over but during the Bayanihan One Act Ra 11914, for yrs. 2020-2021, the carry over
period is w/n 5 years, only applies for 2020-2021)

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CAPITAL LOSS

NOTE: CAPITAL LOSS is deductible from CAPITAL GAINS not from ORDINARY GAINS.

It is not allowed as a deduction because we are talking here about ordinary income.

SECTION 34E: BAD DEBTS These are the uncollectible debts. Unpaid compensation for services rendered.

REQUIREMENTS

1. Must be valid and subsisting debt

2. Connected with trade or business

3. Debt is actually ascertained to be worthless

4. Charged off during the taxable year It must be removed from the records.

NOTE: There must be an effort to collect the debt. If efforts fail, then it is considered as deductible from
business or professional income.

In Phil. Refining Company, a case that deals the requisites of bad debt. You must file collection letters.
Without effort exerted to collect the debt, it is still considered as a good debt.

TYPES OF LOSSES

1.Losses from Wash sale of stock or securities

Wash sale of stock/securities- The wash-sale rule is a regulation that prohibits a taxpayer from

claiming a loss on the sale of stock while essentially maintaining a position in it.

How do you treat Wash sale of stock/securities?

NOTE: Check the Transaction =loss but why before he sell, he bought again same shares of stocks

If its loss then why he bought shares again, evil intent of lowering tax liability

However, if TP is a dealer of stocks securities, then it is allowed to deduct from tax

2. Wagering losses- applicable on gamble

3. Abandonment losses- abandonment of petroleum corporations, all accumulated explorations
and development expenditures is considered to be a deduction or the producing well (amortized
cost of producing well/ undepreciated equipment used in a well is con. To be a deduction in a
form of abandonment losses)
What if it is restore? – the cost will form part of the gross income during the year during the
resumption at the time it amortized/depreciated.

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* SEC 34 E. BAD DEBTS/ UNCOLLECTIBLE RECEIVABLES

- not deductible not related to TP buss/ profession
NOTE: If the indebtedness is b/n related parties- cannot be a deduction = If the indebtedness is
a BAD DEBT= cannot be a deduction
Recovered debt must be a part of Gross income subj. to application of Tax Benefit Rule in
relation to Refunded Tax
SECTION 34E: BAD DEBTS These are the uncollectible debts.
Unpaid compensation for services rendered.
REQUIREMENTS
1. Must be valid and subsisting debt
2. Connected with trade or business
3. Debt is actually ascertained to be worthless
4. Charged off during the taxable year It must be removed from the records.
NOTE: There must be an effort to collect the debt. If efforts fail, then it is considered as
deductible from business or professional income. In Phil. Refining Company, a case that deals
the requisites of bad debt. You must file collection letters. Without effort exerted to collect the
debt, it is still considered as a good debt.

*SECTION 34F: DEPRECIATION

This is the diminution of value because of wear and tear. It is gradual unlike loss which is abrupt.
REQUIREMENTS:
 Property subject of depreciation must be used in connection with business or profession
Diminution of the value of the property must be because of wear and tear.
 Depreciation must be gradual
 Depreciation amount must be reasonable

*SECTION 34G: CHARITABLE CONTRIBUTIONS

 It is one allowable deduction which need not be connected with the taxpayer’s trade or
business.
 It is the donations made by the taxpayers to certain entities mentioned in Section 34H.
 If Coca Cola company donates drinks to typhoon victims, they cannot deduct the value as
charitable contribution because Section 34H makes specific mention of recipients of the
contributions.
 It speaks of two kinds of donations: deductible in full and deductible subject to 5 to 10%
limitation. If the contribution is covered under Section 34H1, it is subject to 5%-10%
limitation.
 But if the contribution is covered by 34H2, it is deductible in full. 10% - if individual; 5% - if
corporation. This imitation is based on taxable income exclusive of contribution.

REQUIREMENTS:

1. Recipient is one of those specified under Section 34H of the NIRC

2. Must be made within the taxable year

3. Must be supported by adequate proof The contributions made to employees are deductible.

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Know who is the recipient and the purpose of donation

Recipient: Govt and other political subdivisions
NOTE: SEE: Sec. 34 H1 – exclusive for public purposes and
Sec. 34 H2- for priority activities for education
WON the expenses is deductible in full or in limitation? 10%- TP is indiv; 5% if TP is corp
of Taxable income exclusive of a Contribution
NOTE: You MUST exclude from allowed deductions the donation made= bigger amount.
How do you determine this? G.I. 1M; allowable deduction- 900K Net income=100k
200 K X TAX RATE = ______ the product is what can only be deducted
*SECTION 34L: RESEARCH AND DEVELOPMENT
These are the expenses incurred for improvement of the goods and services offered by the
taxpayer for research and development of the product.
If it is used to acquire a capital asset, you cannot deduct the whole amount. It should be
amortized with the useful life of the asset.
REQUIREMENTS:
 Must be paid or incurred during the taxable year.
 Must be incurred in connection with taxpayer’s trade or business.

*SECTION 34J: CONTRIBUTION TO PENSION TRUST

REQUIREMENTS:

Contribution is not under the control of the employee.

DEPLETION

It is similar to depreciation but what is involved is natural resources. E.g. gold mines, et. al. WHO CAN
CLAIM THESE DEDUCTIONS?

Those covered by section 24A: Citizens & Resident aliens

Those covered by section 25A: Non-resident aliens engaged in trade or business

Those covered by section 26C: General Professional Partnership GPP is taxed same as corporation.
Section 27A: Domestic corporation

5. 27B: Proprietary non-profit educational institutions

6. 27C: Government owned or controlled corporations

7. 28A1: Resident foreign corporation except those earning purely compensation income

UNDER THE TRAIN LAW, there are only two deductions allowed from gross income to arrive at a taxable
income: First 250K because that is exempt Second 90K 13th month pay and benefits

*SECTION 34L: OPTIONAL STANDARD DEDUCTIONS

It is 40% gross income then you have the allowable deduction. Take 40% of the gross income.

WHO ARE ENTITLED TO AVAIL OPTIONAL STANDARD DEDUCTIONS?

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Resident and non resident citizens

Resident alien 32. Domestic corporation

Resident foreign corporation - GPP is treated like a corporation.

In case of GPP, the OSD can be availed by the GPP itself or by the partners. If the GPP makes use OSD,
the partners cannot avail OSD.*amendment under the TRAIN Law SECTION 27A & 28A1: The option to
be taxed at 15% of their gross income subject to existence of the requirement provided by law

*SECTION 27AE & 28A2: MINIMUM CORPORATE INCOME TAX - 2% of the gross income with respect to
domestic and resident foreign corporation, they are required under the law to pay minimum amount of
income tax every year even they incurred loss. This only applies with respect to operations subject to
30% Instances made to be paid:

1. When the tax due is below the minimum tax liability ; 2. Incurred loss/net loss

Excess payments can be carried over against the normal income for the succeeding three years as
deduction. Payment of MCIT starts on the fourth year from the time it registers in the BIR or when the
corporation commences its business operation This is only applicable to corporations subject to regular
income tax. Non-stock non-profit institutions are considered special income taxpayers. It cannot be
deducted from tax since it is treated as income tax. The Secretary of Finance can suspend MCIT with the
recommendation from the BIR.

GROUNDS FOR SUSPENSION OF MCIT :

Sustained losses from prolong labor dispute; Force majeure; Legitimate business reverses(losses
incurred by the corp as determined by Sec of finance with a prior recommendation of Comm of Internal
revenue).

SECTION 29: TAX ON IMPROPERLY ACCUMULATED EARNINGS Taxpayer retained earnings beyond its
reasonable means. The determinative factor is if there is a need for him which justifies his failure to
distribute his earnings to the stockholders. REASONABLE MEANS

In Basilan State vs CIR, reasonable means refers to immediate needs of business including reasonably
anticipated means. 10% of the accumulated means.

NO DISTRIBUTION OF DIVIDENDS == GOVERNMENT CANNOT COLLECT TAX If there will be a

distribution of earnings to stockholders, they will still be liable to tax because it is a different kind of tax.
The collection of one does not bar the collection of another. Section 29 applies to a domestic
corporation which is considered as a closely held corporation. A closely held corporation if at least 50%
of the total combined power of all classes of stock is owned directly or indirectly by not more than 20
individuals. Case: Chamber real estate and builders assoc vs. Hon Romulo (Gr no 160716, march 9,
2010) MCIT is constitutional as held by the Court.

1% or 2% (depends on the date)

MCIT was proposed to counteract the fraudulent practices on operating pay minimum amount of
income tax every year even they incurred loss

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When is MCIT applies?- on the 4th yr from the period that corp started to SECTION 28A4: BRANCH
PROFIT REMITTANCE TAX - Covers resident foreign corporation. - Branch of a multinational company
remits profit/earnings to the mother company. - Amount remitted is subject to 15% of the profit.

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