Chapter 13

Chapter 13 - Principles of Deductions h pter 13 ..
Prin iples of Deductions

Th 5 paratf on of the busines
CHAPTER 13 tndjvidual income taxpayer is i~ expenses and the personal expenses of an
PRINCIPLES OF DEDUCTIONS d ductf b]e. The P250,000 annual in portant beca~se only business expenses are
I •
( l is deemed in lieu of all personal ex c;~e exe?1p~1~n in the tax table for individuals
expenses are non-deductible. p es of md1v1dual taxpayers. Hence, personal
Chapter Overview and Objectives
------------------------------------------------------------------------·-------------------~----------- Allocadon of common expenses
This chapter provides a detailed discussion on the concept of business expense Expenses that are intended for both h .
and the different accounting procedures used to account for expenses. It also taxpayer are allocated between th t e busmess and . for personal use of the
discusses the general principles of deductions from gross incomeJ are deductible. e two. Only those that pertain to the business
After this chapter, readers are expected to demonstrate mastery ·o f the: Illustration 1
1. Distinction of business expense.from a personal expense · A taxpaycte_r borfroh~ehd money from a bank and used 60% of the proceeds to finance the
2. Concept of an expense and a capital expenditure constru 10n o 1s ouse and the rem · · 400
He later paid Pl0,000 in interest. ammg ¾, as working capital for his business.
3. Accounting rules of deduction of capital expepqitures, ,. , 1
,
4. Mastery of the different depreciati~n methods and t~e sp,e:c!ffl-co~~.i.derations

Only 60°!1 of t~e interest _expense [P6,000) shall be considered personal expense while the
on deductions , . r-- l 1 P4,000 1s considered busmess expense.
5. Allocation of common expenses between taxable and non-iax~ple op~rations
I c ., -~ ) '~ __,
6. General principles of deductions · Illustration 2

7. Tax reporting of deductions A taxpayer engaged in trading business is renting a two-storey warehouse for P40,000
I
8. Modes of claiming deductions from gross income 7 . " ' ,.J

a month. He used the lower floor to store merchandise and the upper floor as his
residence.
f' I ._
' .
- ! •
DEDUCTIONS FROM GROSS INCOME In this case, half of the rent pertaining to the lower floor is a business expense while the
other half of the rent is a personal expense.
Deductions from gross income pertain to busines~ expenses incurred by a
taJfpayer engaged in business or engaged in the practice of prof~ssion. ( . Business Expense vs. Business Capital Expenditure
Business expenses benefit only the current accounting period. These are costs of
What is a business? generating income or gains for the current period. Hence, these are deductible
Business means habitual engagement in a commercial actiVityJ involving the against gross income in the current period.
regular sale of goods and services to cu~tomers or clients. In taxation, th~ term Examples of expenses:
business is generally used to include the exercise of a profession. Self-employment 1. Salaries and wages expense
is a business but employment is not a busin~ss. · ' 2. Utilities expense such as electricity, telephone, internet, gas, and water
3. Selling expenses such as delivery and commission expense
Business Expense vs. Personal Expense 4. Rent
5. Local taxes and permits
c:•· ijusine~s e¥penses.are costs of doing trade, business or pracQce of,profession such
1
.t • as employee salaries,. office utilities, supplies and , rent, taxes, losses,·tbad debts, Capital expenditures are expenses that be~~fit future accounting peri?ds. These
depreciation on business properties, research and developm-e nt,and the like. are initially recorded as assets upon acquisition then later _deducted agamst future
' l gross income when used in the trade, business or profess10n of ~he taxpa~er. The
Personal expenses include the living and family expenses of individual taxpayers • o f cap 1·tal expenditures is not warranted as 1t contradicts the
advance d d e d uctton
, sue~ _as family food, personal recreation and transportation, medicati9n, home Lifeblood Doctrine.
. rentals and utilities, tuition fees of dependents, and other similar expeoses.
' . Examples of capital expenditures:
1· Items of property, plant, an d eqmpm
· ent
2· Inventory
3· Investments
451
450
Chapter 13 - Principles of Dedu tions
Chapter 13 - Principles of Deductions
These expenditures ar expect d t O
4. Prepayments amortized over the period of y dbe~ fit futur p riods; hence, th ey should be
s. Acquisition of intangible assets such as patent or franchise, including costs of are realized. rs urmg whkh th e benefits of the expenditures
defending the same in court
6. Expenses to promote business goodwill
Rental payments on finance lease th
7. Rentals on capital lease or finance lease that transfers ownership Rentals on a finan ce lease or . at transfers ownership
the lease term common) ckapital lease that transfers own r hip at the end of
Property, plant, and equipment pertain to all types of properties used or reserved '
considered expense The r Yt nown as "rent-t 0 ·own " arrang ments are not
for use in the business of the taxpayer, such as: 1
that should be initially en _a sl _constitute acquisition cost of the leased property
1. Land used currently or intended to be used in the business capita ized The c ·t I' d h JI b .
throughout the useful life of th · api a ize cost s a e depreciated
2. Depreciable properties GAAP, the rental payments c : prop~rty. For all other finance leases under the
a. Land improvements such as fences, benches and roads an e considered as expenses for tax purposes.
b. Building
Rules on Deducting Capital Expenditures
c. Building improvements such as installed escalator or elevator
d. Machineries and equipment 1. Non-depreciable asset
e. Furniture and fixtures The cos_t of assets that _do not depreciate by usage or by passage of time such
f. Leasehold improvements as land 1s deducted agamst the selling price when sold.
2. Depreciable properties
Depreciable properties pertain to those that decrease in value through normal : The "depreciable co~t'' or the acquisition cost, net of expected salvage value, is
wear and tear by usage or through obsolescence by the passage of time. allocated as deduction over the useful life the property. The useful life of the
property is the length of time it is expected to be serviceable or its Iegal life, if
Inventory includes merchandise intended for sale. It may also include tools and
applicable, whichever is lower. ·
supplies used by the taxpayer in his business.
Note that the law requires maximum usage life on certain items of properties
Investments are assets purchased which are intended to earn from appreciation in such as vessels or aircrafts after which they must be de-commissioned from
value or for accrual of income such as dividends and interest. use.
Examples of investments:
a. Lands held for appreciation in val~e Useful Life and Depreciation Rate
b. Stocks, bonds, and other securities of another corporation Under Sec. 34(F)(3) of the NIRC, the taxpayer and the CIR may enter into a
written agreement on the estimated useful life and rate of depreciation of any
Acquisition of intangible properties property. Such agreement shall be binding on both the taxpayer and the
The acquisition of intangible assets such as patents and franchises constitutes Government in the absence of facts and circumstances not taken into
capital expenditure that must be amortized (deducted) over the period they are consideration during the adoption of the agreement.
expected to be used.
Any change in the agreed rate and use_ful life sh~ll be a~plied p~ospectivel~
Expenses to promote business goodwill starting on the taxable period when notice by certified mail or registered mall
is rendered by the initiating party to the other party.
Expenses incurred 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 Depreciation methods .
member are non-deductible. The term goodwill is used generally to denote ~e The taxpayer may choose from the followmg methods:
benefit arising from connection and reputation in business. Efforts to estabhsh a. Straight line method
reputation are akin to acquisition of capital assets and, therefore, expenses related b. Sum-of-the-years-digit me th0 d )
thereto are not business expenses but capital expenditures. (Atlas Mining and D r .balance method (150% or 20 001/o
Development Corp. vs. Commissioner of Internal Revenue) e. Oehc ining h d whi'ch may be prescribed by the Secretary of Finance upon
d. t er met o s . .
. n of the Comm1ss10ner of Internal Revenue
recommen d a t 10
453
452
Chapter 13 - Principles of Deductions ,,apter 13 - Principles of Deductions
Straight line method Declining balance method
The de~r~ciable cost ~s simply spread equally over the useful life. The annlial A declining rate not exceeding double of the straight line rate Is applied to the
deprec1at1on expense 1s computed as: book value of the property. For every period depreciation expense is
computed by multiplying the depreciation rate to the declining book value of
(Acquisition cost - salvage value)/ useful life in years
the property._ The s~lvage ~alue Is initially Ignored In computing depreciation
Alte~natively, the straight Une depreciation rate may be computed as a expense, but is considered m the terminal year of the property,
fraction of one over the useful life in years. The depreciation rate is multiplied
The 150% declining balance and the double declining balance are more
to the depreciable cost of the property to arrive at the depreciation expense.
common in practice. Under the 150% declining rate and double declining rate,
Illustration the depreciation rate is determined by multiplying the strafght line rate by
On January t, 2021, a taxpayer acquired a P6,000,000 building with P1,000,000 150% and 200% respectively.
salvage value at the end of its 5-year expected useful life. Illustration
The annual straight line rate is 1/5 or _20%. The annual depreciation expense shall In January 2, 2017, a taxpayer purchased an equipment for PS00,000 which is
be .Pl,000,000, computed as PS,000,000 x 20% or PS,000,000/S. estimated to last 5 years with PS0,000 salvage value. The taxpayer uses the
double declining balance method of depreciation.
Sum-of-.t he -years-digit method
The depreciation charge is computed as a fraction of the remaining useful life The depreciation rate is computed by multiplying the straight line rate 1/5: ~y
200%; hence, 40%. The periodic depreciation expense and adjusted tax basis 1s
over the total of the annual remaining useful life of ~h asset. computed as follows:
Illustration .
I
Depreciation Year-end
A taxpayer bought a machine for P120,000. The machine is expeeted to be sold
expense adjusted tax basis
P20,000 net of selling expense. after its 4-year estimated useful life. The
2017:
depreciable cost is Pl00,000, computed as (P120,000 - P20,000)"'
40% x PS00,000 P 200,000 P 300,000
The divisor is first determined as the sum of the annual remaining 1llseful life. 2018: I
Hence, 4 + 3 + 2 + 1 = 10. 40% x P300,000 P 120,000 P 180,000

2019:
For simplicity, this arithmetic series is computed using the following formula:· I,
40% x P180,000 P 72,000 P 108,000

n x (n + 1)/2, where "n" is the useful life of the asset. 2020: I
Hence, 4 x (4+1)/2 equals 10. 40% x P108,000 p 43,200 P 64,800

2021:
The depreciation expense for each period is computed based on the depreciable (P64,800 - PS0,000) p 14,800 P 50,000
amount as follows:
· f exp~nse in the terminal year shall not result in a tax
Depreciation Book value at Note: The provision for deprecia ~n the depreciation expense is merely an adjustment
basis less than the residual value. ence,
expense year-end l
of the remaining book va ue o t the salvage value.
First year:
4/10 x P100,000 P 40,000 P 80,000 . , . b fore full depreciation '
Second year: Disposal ofpr~pe~es e of before it gets fully depreciated, its book value is
3/10 x P100,000 P 30,000 P 50,000 If the property 1s dispose? . The difference is either a gain or a loss. If
Third year: deducted against the selh~g ~~~:-value is recognized as an ordinary loss.
the property is destroyed, its
2/10 x P100,000 -
'- -- -
P 20,000 !
--
P 30,000
Fourth year: 3
1/10 x P100,000 P 10,000 P 20,000 , Intangible assets those that Jose their value over time should
Amortizable intangibll~ asse:~ 1:;e or expected usage life whichever is lower.
The "book value" 9r carrying value.is the acquisition cost less periodic depreciation. Book I, be expensed over their leg
value is referred to as adju$ted tax.basis in taxation .. The same shall equal the salvage
value at the end of the useful life of the machine. 455
454
. . I of Deductions h" f chapter 13 - Principles of Deductions
Chapter 13 - Pnnc1p es . lue such as franc 1se o public Ut'l·
t lose their va 1 ty
d
Intangible assets that o n~ . . 5, prepaid expenses
vehicles shall not be amortized. . . prepayments are deducted in th f
used in the business or rofi . e uture period as they expire or as th~y are
I t 'f .P ession of the taxpayer The advanced deduction of
4 • Inventory . h ·r costs are deducted when sold or'" ,
d supphes, t e1 . .d . ~ect prepaymhen s, 1.tr_naterial in amount, will cause ~ignificant distortion in net
For goods inventory an . method or the spec1 6c 1 entificaij income; ence, 1 1s not allowed.
. • the mventory . on
in the busmess usmg . . f S le (POS) machine.
method with the aid of a Pomt-o - a · ·· , Illustration
In 2? 1 ~, Zefra, Inc. paid P300,000 as a three-year advanced rental for the lease of
Illustration: The Inventory me~od_ g data pertaining to its inventory: ·I a bmldmg to commence 2 019 through 2021. To close the lease cohtract Zefra also
New York Corporation had the fo owm paid the lessor a lease bonus of P30,000. ,
PZ,500,000
Gross purchases 50,000 The P!O,OOO lease b?nus is not an expense, but a prepayment that should be
In-transit freight and insurance 100,000 amortized together with the P300,000 prepaid rentals. These should be amortized as
Purchase returns and discounts
Pll0,000 annual rent expense from 2019 to 2021.
during the year were P250,000 and
The beginning and ending inventories 11
P340,000 respective~y. 11 Immaterial capital expenditures

The acquisition of items of property, plant and equipment, inventories or
The cost ofgoods sold shall be computed as follows:
prepayments of expenses which are relatively immaterial in amount may be
P 250,000 deducted outright as expense upon acquisition as this will not materially distort
Beginning inventory
net income. Moreover, the inventory method may likewise be impractical to use
Add: Net purchases
P2,500,000 for such items.
Gross purchases
Add: Freight-in an~ insurance 50,000 ~I
Less: Purchase returns and discounts 100.000 2.450.000 SPECIAL CONSIDERATIONS WITH DEDUCTIONS
1,
Total goods available for sale PZ,700,000 1. Property repairs and improvements
1,
Less: Ending inv~ntory 340.000 l. 2. Property acquisition-related costs
Cost of goods sold/ c?st of sales P2.360.000 3. Securities issue costs
i,
4. Manufacturing expenses
Cost of goods sold shall include the purchase price or cost to produce the ~ 5. Effects of accounting methods
merchandise and all expenses directly incurred in taking them to their present ~ 6. Effects of value added tax
location and use.
~- PROPERTY REPAIRS AND IMPROVEMENTS
The same compu~tional procedure is employed with supplies and tools, but tbe i Repairs that significantly increase the value or prolong the useful life of properties
resultant figure is referred to as "supplies expen.se." are capital expenditures. These are capitalized to the adjusted tax basis of the
property and are included in the s4bsequent annual provision for depreciation.
The inventory method is applic~ble to taxpayers using either cash basis or accrual Repairs that merely restore the value or functionality of the property without
basis. Note that the expensing of purchase cost of inventory or supplies noi:malli causing increase in fair value or useful life of the property shall be deducted as
~oes not proper!y_ reflect ~e income of the taxpayer unless the fluctuat!O\. outright expense.
mventory_ levels 1s immaterial. This may expose the taxpayer to risk of income
computation and assessment by the CIR. If the fair value of the property increases due to repairs, improvements or
additions, the actual cost of the repairs, improvements or additions should be
Presentation in the Income Tax Return t capitalized not to exceed the appreciation in fair value.
The cost of ?oods sold is deducted outright from gross sales in the rneasurernent If the fair v l f the property is not determinable, the excess of the actual repair
of the gross mcome from operations. a ue o . d . 1· bl . . .
cost over the tax basis of the property 1s presume · a capita 1za e mcrease m fair
Value.
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457
456
chapter 13 - Principles of Deductions
Improvements and additions to prop~rti_es normally lnc~ease the value or 118 61 cost of demolishing old buildings
life of properties; hence, these are cap1tahzed and depreciated. When la nd was acqu!red with an old building in it but was not int nded to b u d
by the buyer, th e entire amount paid is assigned only to the land.
lllustration . .
The building of B Corp with a carrying value of Pt,000,000 was partially dilapidated The co sts of demolishing the old building, net of any salvage scrap ar treat d as
through Jong usage. A repair of PS00,000 was made on the property. additional cost of acquisition of the land. '
Case t : No increase i,n property value or useful life The cost_ 0 ~ razing ?r removing an old building to give way for the erection of
The PS00,000 repair is , deductible as repair. expense. The tax basis of the property another m Its place Is _n~t a deductible expense, but capitalized as part of the cost
remains at Pl,000,000. of the replacement budding. (Priscilla Estate vs. CTA)
Case 2: Property fair va.lue increased to P1,800,000 after the repair Illustration
The en.tire PSOO,(i}OO :repair is capitalizable since it is less than the P800,000 appreciation Determined to be insufficient for business use, the two-storey building of Benguet
in fair value. The a,djusted tax basis of the property.for purposes of future provision of Corporation was decided to be replaced by a nine-storey building. The two-storey
depreciation expense shall be Pl,500,000. building with a Pl,500,000 carrying value was razed at a cost of P600,000. A nine-
storey building was constructed in its place for P12,000,000.
Case 3.: PrQperlJ' fair value i'!-creased to Pl,.4 00,000 after the repair .
The PS00, 000 repair cos.t shall be capitalize.d only tothe, extent of the P400,000 increase The Pl,500,000 carrying value of the old building shall be deducted as a loss. The cost of
in fair value. The excess Pl 00,000 •repair cost is expensed. The ,a.djusted ~asis af the the nine-storey building shall be P12,600,000, inclusive of the demolition cost of the old
pr~pert;y for future depreciation shall.be Pl,40.Q,~OO. building.
,t_, • •
Case 4: P1,2ifJO,OOO repair cost was made to restore the property; fair value after ASSET ACQUISITION-RELATED COSTS
repair is unknown
All costs directly related to the acquisition of an item of property, plant and
Pl,000,000 is -deductible as repairs expense while the excess P200,000 is a capftalizable equipment such as in-transit insurance, title guarantee insurance, freight, finder's
improvement The adjusted tax basis of the property shall be Pl,200,000. fee or commissions, import duties, and other taxes (excluding VAT for a VAT
The same principles apply in case of repairs of properties due to partial destruction taxpayer) are capitalized as part of the cost of the property subject to
by fire, storm and other calamities except that the de1u~tible repair cost is_ presented depreciation.
as a "toss..,, . ·
Expenses incurred which are directly related to the acquisition of goods such as
Case 5.: No increase in fair value but with increase in useful life transportation, broker's commissions, and insurance in-transit including those
The PS00,000 will be capitalized. The adjusted basis for future depreciation shall be incurred in bringing the goods for sale such as consignment freight-out are
Pl,500,000. . capitalized to the cost of the goods and are expensed through cost of goods sold
when sold.
Replacements of old or destroyed properties
· The tax basis of the aid property is •deductible as a loss, but the cost of the Cost of financing asset acquisition (i.e., interest expense) may, at the option of the
repl~cement prop~rty is ~apitalized subject to future provisions for
depreciation. taxpayer, be expensed outright or capitalized and depreciated.
Illustration
SECURITY ISSUE COSTS
The of~ce building of Andri~ ~orporation with q carrying value of P4,000,000 was
Expenses of issuing equity or debt securities (i.e., stock or bond~) ~uch as cost of
totall¥, de 5troyed by an earthquake, The same was replaced with a new building at a
total cost of PB,000,000. · registering shares of stock to the Securities and ~xchan~e ~omm1ss10~ (SEC), cost
of printing bond or stock certificates, or brokers comm1ss10n on selhng stocks or
The P4,ooo~o~o is de~uctib/e as loss while the PB,()00,000 is capitalized as,the tax basis of bonds, are not deductible expense against gross income. They are deducted
the new ~wldmg sub1ect to future provision fpr depreciation. . against the proceeds of such securities.
458 459
Ch ter 13 - Principles f Deductions Chapter 13 - Principles of Deductions
MANUFACTURING EXPENSES Non-manufacturing cost:s - adrntnistrattve and elllng expenses

Pl nt r fi tory xpen such as cost of raw materials and supplies used, lab Non .. manufacturing expenses commonly classifled as administrative expen es and
nd oth r v 1h -ad like plant utilities, maintenance and security, supplies aor, ·selling expenses in financial accounting should be expensed as incurred or paid
d pr i tion ar capitalized as part of the cost of the goods being processed /d
nd
depending on the accounting method adopted by the taxpayer:
r p n d through cost of sales when sold. Administrative expenses:
office utilities P H0,000
Th Id of a manufacturing firm is coJ;t1puted as follows:
office building depreciation 50,000
p xxx,xxx Administrative salaries
Raw m t ri ls, beginning 120,000
Add: N t purch se xxx.xxx Total deductible administrative expenses P 250.000
Raw materials available for use p xxx,xxx
Less: Raw materials, ending xxx.xxx Selling expenses:
Raw materials used p xxx,xxx Sales salaries P 50,000
Direct labor (direct workers' salaries) (
xxx,xxx Commission expenses 20,000
Factory overhead (all other plant costs) xxx.xxx Total deductible selling expepses P 70.000
Total manufacturing costs p xxx,xxx
Add: Cost of work in-process, beginning xxx.xxx Manufacturing costs
Total cost of goods placed into process
I~ I
p xxx,xxx Manufacturing expenses should not be expensed outright but are capitalized to
1 .
Less: Costs of work in-process, ending xxx.xxx inventory then expens_e d through cost of goods sold.
Cost of goods manufactured (finished) p xxx,xxx
Add: Cost of finished goods, beginning xxx.xxx Cost ofgoods sold:
Total cost of goods available for sale p xxx,xxx
Raw materials, beginning P 30,000
Less: Cost of finished goods, end xxx.xxx 140,000
p Ra~ materials purchased
Cost of goods sold xxx.xxx 45.000
Less: raw materials, ending
Raw materials used P 125,000
Illustration
A manufacturing firm had the following data in March: ·Conversion costs:
Factory labor P 600,000
March 1 March 31 Factory supplies 30,000
Finished goods ( undelivered work orders) P 150,000 P 110,000 Factory utilities expense 70,000
Work-in-process (unfinished work orders) 380,000 250,000 Machinery repair & maintenance 20,000
Raw materials 30,000 45,000 Plant depreciation expense 100.000 fll0.000
p 94 ,000
The following costs and expenses were incurred in March: Total manufacturing costs
Add: In-process work, beginning
380.000
, . costs pace1 d to process Pl,325,000
Total raw materials purchases 140,000 Total manufacturmg
Factory supplies used Less: In-process work, ending .
250.000
30,000 Pl,075,000
Factory salaries and wages 600,000 Cost of goods finished, this pertod
15Q,OOO
Factory utilities expenses (gas, water, and electricity) 70,000 Add: Finished g0,ods, beginning p 1,225,000
Machinery repair and maintenance 20,000 Total goods available for sale 110,000
Plant depreciation 100,000 Less: Finished goods, ending El,1!2,000
Office utilities 80,000 Cost of goods sold
Office building depreciation 50,000
S. .
· . h ost of goo ds so Id of manufacturing firms. is deducted
Administrative salaries 120,000 nniiar to trading firms, t e c . bl gross income from operations.
Sales salaries 50,000
· sales in determmmg
against · · the reporta e
Commission expenses 20,000
461
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Chapter 13 - Principles of Deductions Chapter 13 - Principles of Deductions
EFFECT OF ACCOUNTING METHODS ON DEDUCTIONS Accrual Basis Deductions
The methods adopted by the taxpayer in accounting for expense have a significan
Salaries expense (cash expense)
bearing on the deductible expense. It must be recalled that under the cash basi t P 50,000
supplies expense
expenses are deductible when paid regardless of when they accrue while undes, 8,000
Depreciation expense
the accrual basis, expenses are deductible when they accrue regardless of Whe r 24,000
they are paid. However, prepayments and capital expenditures cannot b~
Accrued expense
Total deductible expenses 12.000
deducted outright. P 94.000
No~: . .
Under the cash basis, deductions include the following: 1. Note that the accrued expenses are also ded tfbl
1
f. , 1
1
Cash expenses [paid) P xxx,xxx 2. Prepayments and capital expenditure 1•t u e. . ...
related freight costs and the p 'd .ems such as the cost of equipment, the acqu1s1tion
Amortization of prepayments xxx,xxx ' rep~i expense are exclud~c;l. , .
Depreciation of properties xxx,xxx
Cash basis deductions P xxx.xxx EFFECT OF VALUE ADDED TAX ON DEDUCTIONS '''
When purchases
VAT of goods or services
· are made from .VAT su pp 1·1ers, tax payers WI·11
Under the accrual basis, deductions include the following: pay t he passed-on by the supplier. To the seller's perspective this is called
output VAT. But to the buyer, this is called input VAT. '
Accrued expenses (paid or unpaid) p xxx,xxx
Amortization of prepayments xxx,xxx
Treatment of Input VAT ,
Depreciation of properties xxx.xxx
Accrual basis deductions p xxx.xxx a. For VA! ~axpayer~ the in put VAT is claimable as tax credit against output VAT;
hence, 1t 1s not cla1mable as deduction. , .· ·
Illustration b. For non-VAT taxpayer, the input VAT is part of costs of the purchase or
Xhelsy Corporation had the following items of expense and expenditures in 2021: expense of the taxpayer; hence, it is claimable as deduction. .
t. j
Purchase of equipment (paid in cash) P 200,000

Freight on purchase of equipment (paid in cash) 20,000 GENERAL PRINCIPLES OF DEDUCTIONS FROM GROSS INCOME
2021 salaries expenses paid this period (cash expense) 50,000 1. Expenses must be legitimate, ordinary, actual and necessary (LOAN)
Supplies bought in 2020, half\Vas used in 2021 16,000
Depreciation expense on property 24,000 2. The Matching Principle
2021 expenses, not paid this period (accrued expense) 12,000 Only business expenses which contribute to, ot are incurred in connection
2022 expenses, paid this period [prepaid expense) 18,000 with the generation of income, gain, or profits -subject to regular income tax
Required: Determine the total deductions under: are deductible.
' I• 1\ ' J
1. Cash basis of accounting 3. The Related Party Rule . . ·, ·

1
•
2. Accrual basis of accounting In case of transactions between related parties, gains are taxable but losses
are not deductible. Also, pursuant to the transfer pricing rule, non-arms'
Solution:
length expenses incurred between associated enterpri~es may be restated to
Cash Basis Deductions their arm's length fair values to reflect the correct mcome of each of the
Salaries expense (cash expense) P 50,000 associated enterprises. . . · ~·, 1
Supplies expense (P16,000 x 1/2) 8,000 4· The Withholding Rule ' v •
Depreciation expense 24,000 No ded t· . • )lowed unless the withholding .tax required by the law or
Total deductible expenses uc 10n 1s a (. ) · · hh Id
P 82,000 regulations to be withheld on the income payment 1.e., expense 1s wit e
Note: and remitted by the taxpayer to the govern.ment , i • .
1. Accrued expenses are not deductible under cash basis. . · .
2· 10
Capital expenditures and prepaid expenses cannot be deducted in the current period but
the future period they relate to.
462
463
t, pt r 1 - Principles of Dedu tions
THE #LOAN" PRINCIPLE
F cto~ in assessing reasonablene
A deductible business expense is legitimate, 11.rdlna,y, actual and aecessary. fhere 1s no fi ·ed test or clear-cut cri .
pense. In CIR vs. General Foods P . tena In d t rmlntng r onableness of an
Chara_ct~ristics of a legitimate business expense: b judged on the interplay f C hils), Inc., It w held that rea onableness wiU
0
1. It ~s incurred in and for the current taxable period. ~lowing: many fa or uch , bu no limited to, the
2· It IS not a capital expenditure.
1· type and size of business in which th t
3. It pertains to the business or profession of the taxpayer. 1 d . e axpayer is engaged
4. It is not contrary to Jaw, public policy or morals. 2. vo ume an amount of its net earnings
3. nature of the expenditure itself
Examples: Bribes, kickbacks to government officials, payment to police officers for 4. intention of the taxpayer
protection (Calanoc vs. CIR), and revolutionary taxes to rebels are held non- s. general economic conditions
deductible illegal payments.
The burden of proof of establishing the validity and reasonableness of an expense
5. It is adequately substantiated with receipts or other documents. rests upon the taxpayer and not upon the taxing authority.
Illustration What is meant by actual expense?
A taxpayer compiled the following payments:
An expense is actual if it is paid or resulted to an incurrence of an obligation to
Salaries of employees P 400,000 the taxpayer. In case of a loss, it must be sustained or realized by the taxpayer in a
Maintenance repair of offic_e building 100,000 closed and completed transaction.
Renovation cost of an old building 200,000
Purchase of new equipment 150,000 Meaning of"closed and completed transaction"
Bribes to government officials to win business deals 200,000 A transaction is said to be closed and completed when no further transaction
Dividend distributions to shareholders 400,000 emanates from its occurrence. In other words, no right of recourse for
Only salaries and maintenance are deductible. The renovation cost and purchase of equipment are indemnification or reimbursement from other parties exists.
capital expenditures claimable through depreciation. Bribe is a non-deductible illegal payment
The dividend is not an expense, but a distribution of corporate profit. For example, a fire loss on insured property cannot be said to have been sustained
in a closed and completed transaction because its occurrence gives rise to another
What is an ordinary and necessary expense? transaction, the claim for reimbursement. The loss is considered incurred in a
An expense is necessary if reasonable and essential to the development, closed and completed transaction only when final reimbursement is received from
management, operation, or conduct of the trade, business or exercise of profession the insurer.
of the taxpayer. It is "ordinary" when it is normal in relation to the business of the
taxpayer and the surrounding circumstances. (Atlas vs. CIR) An expense is also Furthermore, a loss on lawsuit cannot be said to have been sustained in a dosed
said to be ordinary if it is normally incurred by other taxpayers under the same and completed transaction until final judgment is rendered. without expectation of
line of business. further appeal.
A deductible expense must be both ordinary and necessary. An ordinary business Examples of non-deductible expense under this rule:
expense may still be disallowed by the BIR if unnecessary or unnecessarily l 1. Decrease in value of properties or invesbnents such as:
extravagant or unreasonable taking into consideration the context of the expense a. Decrease in value of securities such as stocks or bonds
and the nature of the taxpayer's business. b. Decrease in value of foreigp currencies or foreign currency-denominated
receivables . •
An extraordinary expense is presumed incurred outside the business of the c· Decrease m· va Iue of machi'neries' equipment and butldmg brought by
taxpayer; hence, it is non-deductible. However, extraordinary expense may be obsolescence and impairment
allowed if its connection and necessity to the business can be demonstrated by the
taxpayer.
. 464 465
Ch pter 13 - Prin iples of Deductions
2. Estlm ted future losses such as:
b. Expens~s of enterprises registered with the Philippine Economic Zone
a. tim t d loss on bad debts or uncollectibl e receivables Authority
b. stjm ted loss on lawsuit not yet confirmed by a final judgment Under RA 7916 ' registered en t erprises
· . special
. economic
. zones (ECO ZONES) are
c. Estimated warranty expense • m
sub_Ject to a 5 ¾> gross income tax on their registered operations in lieu of all taxes,
0
3. Loss on properties covered by Insurance or indemnity contracts nat10nal or local, except real property taxes on land. · · ·
The expenses. of th ese businesses in connection with their operations subject to

Thes~ losses ar 1nerely temporary and may rever e until they become actually the 5% ?ross mcome tax are non-deductible against their gross income subject to
sustained upon final settlement by the insurer. regular mcome tax. .
THE MATCHING PRINCIPLE 3. Business expenses of taxpayers subject to final inc~~~ tax such a~:
a. Non-resident alien, not engaged in trade or business ·
It is a ell-established rule in income taxation that only business expenses that b. Non-resident foreign corporations
are in curred for the generation of items of gross income subject to regular tax are
de ductible. This is a pervasive criterion that is consistently observed by the NIRC, These taxpayers are not subject to regular income true;- he1n:e, they cannot claim
deductions of whatever nature. . · ·
re enue regulations, and BIR rulings. Let us refer to this rule as the "Matching
Principle." 4. Expenses and taxes on income subject to final tax ·or capital gaiits tax
B ·ness expenses incurred to generate items of gross income that are either ~- Selling expenses of ~omestic stocks directly to a_buyer . , .
b. Selling expenses of real properties classified as capital assets , - ·.
e empt or excluded from taxation, subject to final tax or capital gains tax or to a
c. Expenses of petroleum service subcontractors in.supplying good·s and services
special tax regime, must not be matched or deducted against gross income subject
to petroleum service operators · ,
to regular tax. -
Pursuant to PD 1354, the gross income derived by subcontractors with petroleum
Examples of non-deductible expenses under this rule: service contractors is subject to 8% final tax in lieu o~ any and all taxes; national or
local. · ,. ·· ·
1. Expenses on exempt income l,
a. Expenses incurred to finance the acquisition of a tax-exempt security 5. Foreign business expenses of taxpayers taxable only on Philippine income,
such as:
b. Premiums paid for the life insurance of an officer where- the taxpayer-
business itself is the beneficiary
a. Resident aliens and non-resident aliens engaged in trade or businesi hi the
Philippines
The proceeds from such insurance arrangement is tax-exempt; hence, the premium
b. Resident foreign corporations
expense is not deductible. However, if the beneficiary is other than the employer, the
same shall be deductible as fringe benefit expense. The foreign income of these taxpayers is not included in their gross income for Philippine
c. Expense on FCDU or EFCDU from foreign currency operation taxation purposes. Hence, their foreign expenses shall not be deductible, unless jhe same
are incurred in connection with their Philippine business.
Foreign currency deposit units (FCDUs) and EFCDUs are exempt from regular income
tax on their income from foreign currency·transactions in the Philippines. Hence, FCDU ~. 6. Loss of income not yet recognized in gross income · ·
and EFCDU expenses from exempt operations cannot be deducted against their items a. Write-off of receivable under the cash basis of accounting
of gross income subject to regular income tax. b. Destruction of unharvested farm fruits or vegetables .,·
d. Expenses of non,.profit organizations, government agencies, and cooperatives c. Death of animal offspring 'I '
from their exempt operations cannot be ded\lcted from their gross income ' j (
subject to regular tax, ~ THE RELATED PARTY RULE . ) '
2. Expenses on income subject to a special tax regime , ~ Gains realized between related parties are taxable, but losses are non-
a. Expenses of new enterp~ises registered with the Tourism Infrastructure and ~ deductible.
Enterprise Zone Authority (TIEZA) ~ The rule · · t d d as a control measure due to the fact that related party
~nder RA 9~93,_ newly registered enterprises of the TIEZA are subject to a 5% gross ~ 1s 1n en e d Th• • · I I
transactions can be easily tailored in a way to eva e taxes. . 1s ru 1e 1s part1cu ar y
mcome tax m heu of all other national and local taxes, license fees imposts, and ~ relevant in the claim of losses, bad debts, and interest expenses.
assessments except real estate taxes and such fees as may be imposed by the TIEZA, \
466 467
Who are related parties?

1. Members of a family . . . Trust 1
Agus
2. Except in cases of distribution in liquidation, the dtrect or 1nd1rect controlling
individual of a corporation · .
3. Except in cases of distribution in liquidation, corporations under direct or Trust2
indirect com.m on control by or for the same individual
4. Grantor and fiduciary of any trust
Trust3
5. Fiduciaries of trusts with the same grantor
6. Fid11ciary of a trust and the.beneficiary of such trust Note:
1. The fiduci_ar~es of all the trusts are related to Mr. Sarangani.
Members of a family includes brothers and sisters (whether half-blood or full-blood), 2. The fiduciaries of Trust 2 and Trust 3 are related because the trusts they manage are for
spouse, lineal ascendants and descendants. the same beneficiary.
3. Agus is related to the fiduciary of Trust 1, but not to, the fiduciaries of Trust 2 and Trust 3.
Control means ownership of more than ½ of the voting stocks of a corporation. · 4. Cami is related to the fiduciaries of Trust 2 ·and Trust 3, but is not related to the fiduciary of
Trust 1.
Illustration 1: Corporations
5. Agus, Cami, and Mr. Sarangani are not necessarily related to each other unless they qualify
Mr. Lanao owns 60% of Misamis Corporation and 30% of Basilan Company. Misamis as such as members of a family. .
owns 70% of Compostela Company and 80% of Surigao Company. Compostela owns
55% of Cotabato, Inc. Surigao Company also owns 40°/4 of Davao Company.
Transfer Pricing Regulation .
·-·-·-·-·-·-·- ·- ·-·-·- ·- ·-·-·-·-·-·- ·- ·- ·- ·-·-·- Transactions between associated enterprises must be maoe at arm's length.
70%
Pursuant to RR2-2013, the BIR may restate the price of a non-arm's length
Mlsamis Compostela expense between associated or related enterprises to their arm's length fair value
comparable to those entered into by independent enterprises. The amount
80% 55%
determined as arm's length value shall be the deductible amount for purposes of
r 30% Surigao [ Cotabato )
I I
income tax.
40% THE WITHHOLDING RULE

Payors of income are required to withhold income taxes on their payments. The
( Basilan ) Davao failure to comply with this requirement shall result in the disallowance of the
expense as deduction. The rule is "no withholding, no deduction."
Note:
1. The related parties are indicated in bold font Transactions between any of these taxpayers, Types of Withholding Taxes:
either inter-company or involving Mr. Lanao, the ultimate controlling individual, are
transactions between related parties. T es Ex ense e BIR Form Deadline
2. There being absence of control, Basilan and Davao are neither related between themselves a. Withholding tax Compensation 1601-C On or before the
nor to the group of affiliated corporations. on com ensation ex ense · 10th day of the
3. ~n liquidation, all shareholders, related or unrelated, may realize actual losses on their Certain passive month following the
investments. Hence, liquidation losses incurred from a related party are deductible. b, Final withholding . 0619-F month in which
income and fringe
tax benefits withholding was
Illustration 2: Trusts made. For EFPS
Other income
~- Sarangani designated three trusts under management of different trustees. Trust 1 C, payments which are filers, their
15 m favor of Agus as beneficiary while Trust 2 and Trust 3 are in favor of Cami as Expanded
subject to regular tax 0619-E respective group
beneficiary. The trusts are irrevocably designated except Trust·No. 3. Withholding tax deadlines apply.
to the reci ient
468 469
The guidelines on withholding tax on compensation and final withholding taxes a ChaP r 13 - Principl f u ions
discussed in Chapter 10 and 5, respectively. You may refer to RRl 1-2018 from the Bte rs. Aria hall withhold P2,000 ompu d O ( % x p4o,OOO) from the rent, pay P38,O00
website for the specific details of withholding taxes. l~ th le or 0nd furnf h him O copy of BIR Form 2307. Mrs. Arla hall file BIR Form
th 2
0 19-E and remit e P ,000 wt hheld tax to the gov rnment through an authorized
Summary of Expanded withholding tax rates: government depositary bank.
A. Payments to suppliers of goods, in general - 1%
1,frs. Arias shall use the Bl R Form 0619- as support for her claim of itemized deductions,
B. Payments to suppliers of services, in general - 2°/4, except:
The lessor shall also u e the BIR Form 2307 a tax credit agafnst his tax due,
1. Rentals of properties or films and toll fees to refineries - 5%
2. Professional services to: mustrad on 2: Expanded withholding tax - VAT mppller
1. individual professionals, brokers, agents, entertainers - 5% or 10% In March 2021, Genesis Realty Corporation (GRC), a VAT taxpayet, is about to pay
2. corporations - 10% or 15% P896,000 commi sion to Mr. Galante, a VAT-regl tered realty broker.
3. general professional partnerships - 0%
3. Embalmers by funeral companies - 1 % GRC shall deduct 10% withholding tax on the gross Income of Mr. Galante, The
4. Additional payments to gov~rnment personn~l from !mporters, shipping withholding tax and VAT of the payment shall be computed as follows:
and airline companies or the1r agents for overtime services - 15% Gross amount due P 896,000
C. Income distribution by Less: Ou,r:put VAT (P896,000 x 12/112) 96.000
1. Estates and trusts to heirs or beneficiaries - 15% Commission income P 800,000
2. General p_rofessional partnerships to partners - 10% Multiply by: Withholding rate 10%
D. Payments made by credit card companies - ½ of 1% Withholding tax P BO.ODO
GRC shall claim the PB00,000 as commissions expense and record the P96,000 as input
For purposes of the withholding tax on professional fees, professionals must submit a VAT. The input VAT is a tax credit and is not an expense.
sworn declaration that his gross receipts do not exceed P3,000,000 in a year. The
same shall be the basis for the withholding agent to deduct 5% instead of the 10%. If The cash payments to Mr. Galante shall be:
the professional is a VAT taxpayer or if he fails to submit this sworn declaration, he
shall be deducted the 10% withholding tax. Commission income P 800,000
Plus: VAT 96,000
For corporate payees of professional services, the corporate taxpayer must submit a Less: Withholding tax 80.000
sworn declaration that their gross incomes do not exceed P720,000 in a year. The Net cash due to Mr. Galante P 816.000
same shall be the basis for the withholding agent to deduct 10% instead of the 15%. If
the corporation failed to submit such sworn declaration, the withholding agent shall In accounting, this is recorded in the books as:
deduct the 15% withholding tax. PB00,000
Commission expense
Input VAT 96,000
The withholding agent-payor must release to the recipient or payee of the income P 816,000
Cash
payments copies of evidence of the withholding: Withholding tax payable 80,000
a. BIR Form 2306 (Certificate offinal tax withheld at source)
b. BIR Form 2307 (Certificate of creditable tax withheld at source) If GRC is a non-VAT taxpayer, it can claim the commission and the VAT or P896,000 as
deductible expense.
For income not subject to withholding tax, the withholding agent-payor shall
~elease to the recipient of income exempt a copy of BIR Form 2304 (Certificate of GRC h 1 . 0.F BIR Form 2307. Since this is the third month of
s a I furnzsh Mr. Galante a copy 1 . .
th e quarter GRC shall include the commission expense
on its 1601-EQ (Quarterly
mcome payment not subject to withholding tax). .
Rem·tta ' d' bl
• 1 nee Return of Cre 1ta e rr
u,ithholding
1
Taxes), and remit the PB0,0000
Illustration 1: Expanded withholding tax- non-VAT supplier . withholding tax to the BIR.
In January 2021, Mrs. Arias is due to pay P40,000 monthly rental expense to a non 11
VAT lessor. \ Usttatton 2: Final withholdln_g tax royalty expenses to author Atty.
200 000
Pn0iune 2021, Dell Publishing mcurreddPd ; Pl0 000 (10% final tax] on the royalzy
icarpio Galemo. Dell Publishing shall e uc '
470 471
Chapter 13 - Principles of Deductions chapter 13 - Principles of Deductions
payments to Galemo pau h PlBO Note:

Since this is the th. 'd ~ er ,000, and furnish h r a opy of the BlR Form 230 The deadline for the withholdin t
1. of withholding). . g ax was April 10, 2021 (i.e., 10th day following the month
payments . I·ts 8m month oF ' Iude the royal6·
'1 the quarter, DeII publIs hi ng h aII ,n
governmen~n JR Form 1601-FQ and remit the P20,000 withheld tax to th~ 2_ April 10, 2021 _to June 28, 2021 ts 79 days.
The comprom1se penalty is taken fr 0 h .
3· withhold or remit withheld tax at h .m t e ~able of compromise penalties for failure to
t e time or times required by law, as follows: *
Dell Publishing shall keep the BIR Form 1601-FQ to support its deduction fo r roya/
expense but Galemo cannot use the BIR Form 2306 fu rnished her as her tax cret If the amount not Withheld or remitted
Exceeds But not exceed . 1s
Comprom,se
because the royalty is not part of his gross income subject to regular Income tax. It
..... ....
Timing of withholding p 15,000 p
....
20,000 p 5,000
:er RR12-2001, the obligation of the payor to deduct and withhold tax from the 20,000 50,000 10,000
income payment arises upon the occurrence of any of the following, whichever 50,000 500,000 15,000
comes first:
a. Payment PERIOD FOR WHICH DEDUCTIONS AND CREDITS ARE TAKEN
b. when the income payment becomes due or payable The deductions shall be taken for the taxable year paid or accrued depending
c. recording of the income payment as expense or asset in the books upon the method. of accounting employed by the taxpayer, unless in order to
clearly reflect the income, the deductions should be taken as of a different period.
To avoid penalty, the withholding agent must remit the withheld tax before the
[Sec. 45, NIRC) ·
deadline.
Late payment of withholding taxes NON-DEDUCTIBLE EXPENSES
Under the new rule established by RR6-2018, the BIR held that expenses will still The NIRC lists the following non-deductible expenses:
be deductible even if the withholding tax, surcharge including interest of such late 1. Personal, living, or family expenses
withholding is paid at the time of audit investigation or reinvestigation. This is a 2. Amount paid out for new buildings or for permanent, or betterments made to
reversal of the previous rule that no deduction is allowed even if the withholding increase the value of any property or estate
tax and penalties is subsequent paid. .3. Any amount expended in restoring property or in making good the exhaustion
For income payments exempt from withholding tax such as salary payments to thereof
minimum wage earners, the taxpayer must comply with certain documentary 4. Premiums paid on any life insurance policy covering the life of any officer or
requirements of the BIR. employee, or any person financially interested in any trade or business
carried on by the taxpayer, individually or corporate, when the taxpayer is
PENALTIES FOR NON-WITHHOLDING OR LATE REMITTANCE OF
directly or indirectly a beneficiary under·such policy
WITHHOLDING TAX I
Non-withholding or late remittance of withholding tax is subject to the same
penalties for late filing or late payments of tax discussed under Chapter 4. TAX REPORTING CLASSIFICA1'ION OF DEDUCTIONS
1. Cost of sales or cost of services
Integrated Illustration 2. Regular allowable itemized deductions
On March 15, 2021, the taxpayer paid P475,000 net rental to a lessor but failed to 3. Sp.ecial allowable itemized deductions
remit the P25,000 withholding tax to the government. The taxpayer filed BIR Form
4. Net Operating Loss Carry Over (NOLCO)
0619-E on June 28, 2021.
The total amount to be paid by the taxpayer on June 28, 2021 shall be: Cost of sales or cost of services is deducted outright against sal~s, revenues,
Withholding tax due P 25,000 receipts or fees of individual taxpayers in the measurement of gross mcome from
Plus: Penalties operations. ·
Surcharge (P25,000 x 25%) 6,250
Interest (P25,000 x 12% x 79 /365) 649 Regular allowable itemized deductions pertain ~o all ~eces_sary and ~rdinary
Compromise* 10,000 expenses paid or incurred during the taxable year mdudm~ directly attributable
Total tax due p 41.899 costs in carrying on the development, management, operation and/ or conduct of
th e trade, business or exercise of profession.
472
473
It must be noted that e The raxpayer has to point to the provision of the law authorizing the deduction,
services or in the ac . _xpenses that are directly related to the renderin substantiate his claim by supporting the deduction with official receipts, payment
itemized deducti qu~sitio~ of goods are excluded from the regular allow\ 01 vouchers, cancelled checks or other adequate records and documentations, a nd
case may be. ons an are included in "cost of sales" or "cost of services" a a~ comply with any withholding tax requirements on expenses. Deductions claimed
must also comply with any applicable deduction ceilings set by law.
Expenses which · d'
serv· . are no~ 1rectly related to the acquisition of goods or provision f Optional Standard Deductions
ad ~c:s ar: included m regular allowable itemized deductions. These inclu:, The optional standard deduction is in lieu of the itemized deductions, regular or
ministrative expenses and selling expenses. special, including NOLCO. The deduction is merely presumed as a fixed percentage
of gross income for corporations and gross sales or gross receipts for individuals.
Regular allowable itemized deductions are discussed in Chapter 13-A. The rules of OSD will be discussed in detail in Chapter 13-C.
Special allowable itemized deductions are additional deductions as proVided

~nder the NIRC or special laws. Sp~cial allowable deductions can be categorized
into two types:
1. Actual compliance expense ,
2. Deduction incentives
Compliance expenses are actual payments or transfers of funds. Deduction

incentives are not actual expenses, but are merely allowed by law to encourage
taxpayers to support government programs.
Net Operating Loss Carry-Over (NOLCO) pertains to the excess of expense

deduction over gross income during a taxable year which is allowed by the law to
be· deducted against the net income of the following three years.
Technically, NOLCO is not an expense. it is a special deduction incentive allowed

by law. Technically, deduction in.centives are deductible only in the year they are
availed of but NOLCO is exceptionally allowed to be carried over three years.
Special allowable itemized deductions and NOLCO will be discussed in detail in

Chapter 13-8.
MODE OF CLAIMING DEDUCTIONS FROM GROSS INCOME

1. Itemized deductions
2. Optional standard deductions
Itemized Deductions
Under the itemized deductions, taxpayers list every item of business expense theY
claim as deductions. Deductions are strictly construed against the taxpayer.
475
474
.::.:.:.:;..;..=:..;.;;..:.;~~.;.;;.;.._ _ _ ____________________~ Chapter 13 - Principles of Deductions
CHAPTER 13: SELF-TEST EXERCISES
Business Pe·r onal
Discussion Questions e ense e ense
1. Distinguish a business expense from a personal expense.
2. Distinguish an expense from a capital expenditure.
3. Discuss how depreciable and non-depreciable assets are expensed.
4. Explain the inventory method for inventories ahd supplies. t 4. Travel ex ense to attend seminar
5. Enumerate the common depreciation methods used in practice. Distinguish how
depreciation is computed under each method.
Exercise Drill No. 2
6. Discuss how intangible assets are expensed.
7. Illustrate the computation of the cost of goods manufactured and sold. On Jul 1, 2021, a taxpayer paid for a P200,000 business expenditure.
8. Discuss how repairs and asset-related acquisition costs are accounted for.
Required:
9. How do accrual expense and cash basis expense differ?
10. Enumerate and discuss the four general principles of deductions. Compute the deduction from 2021 through 2023 assuming the expenditure was for:
11. How do the terms "ordinary" and "necessary" differ? ~
2021 - 2022 2023

12. When do we say an expense is actual? 1. land which was sold in 2023
13. What does "close and completed transaction" mean?
14. Explain the matching rule. 2. Equipment with 4-year
15. Who are related parties? Enumerate. estimated useful life
16. What are the classifications of deductions in tax reporting? 3. Inventory which was sold in
' .
,... J
17. How are deductions claimed? Discuss the two modes of deductions. 2022 . '
4. Salaries of administrative and

Exercise Drill No. 1 sales personnel in 2022
Identify whether the following is a business expense or a personal expense by 5. Rental of a facility for the
checking the appropriate box corresponding to the item: years 2021 and 2022
Business Personal
expense expense Exercise Drill No. 3 . .
A taxpayer engaged in trading two types of precious merchandise had the- followmg
1. Medical expense of the proprietor [business owner)
summaries of inventories:
2. Tuition fees of an employee to acquire expertise for
future use of the business Zircon Ruby
3. Transportation expense from office to client p 200,000 P 320,000 P 520,000
January 1 inventory
establishments
Purchases:
4. Cost of entertaining family members of the proprietor 1,000 units p 800,000 - P 800,000
5. Cost of entertaining clients receipted under the name of - p 1,200,000 P ,200,060
4,000 units
the taxpayer's spouse January 31 inventory 400 units 800 unit
-
6. Interest expense to finance the construction of the
office building - Required:
7. Loss on destruction of taxpayer's residence ~
Compute the cost of goods sold.
8. Office utilities expense
9. Repairs. that restore the value of destroyed business
----
Exercise Drill No. 4 h d equipment for P2,000,000 with an estimated
er pure ase .
10.
properties
Tuition fee of the taxpayer's dependents
- 0
n July 1, 2021, a taKpay : four-year estimated useful hfe.
scrap value of P200,000 after its
477
476
Chapter 13 - Principles of Deductions Chapter 13 - Principles of Deductions
True or False 1
Compute the depreciation expense an d the adjusted tax basis of the property as of
Required:
December 31 of 2021 throu_gh 2026. 1. Losses on properties not u d . b . .
SLM SYD 150%D8 200%D8 - of capital gains. se m usmess may be deducted but only to the extent
E~ense Tax basis Exoense Tax basis Expense Taxbasfs ENJ_ense Tax basts~
2021 - 2. The cost of investments and I d . ·
2022 -
of sale. an are deductible against their proc~eds in the year
2023 -
2024 - 3. Tthhe entiref co st of depreciable properties is deductible against their proceeds in
2025 - e year o sa1e.
2026 .
-
4. Prepaid e~penses are deductible upon payment consistent with the rule that
adv~nced mco~es are taxable upo~ receipt.
Exercise Drill No. S . . d. CE if the item is a capital expenditure. If it is an 5. Capital expenditures are deductible against future income.
For each indicate
of the following, m . icate 6. Personal ~xpenses are deductible from gross income.
expense, DE if deductible expense an d NDE if non-deductible expense.
7. Expenses mtended for the business and the personal use of the taxpayer must be
1. Loss on destruction of uninsured personal car of the taxpayer allocated between the two. Only the portion pertaining to the business is
2. Employee performance bonus for the current year deductible. , I •
1
3. Acquisition cost of equipment ..
8. The expense of defending a patent is a business expense deductible in the current
4. Decline in market value of investment securities period. , .,
5. Advanced rent for the next two years ..
9. The depreciation of the property revaluation gain is deQuctible~ , r •
6. Interest expense in acquiring tax-exempt securities
10. Supplies and inventories are expensed using the inven~ory method.
7. Expenses to create business goodwill .2
8. Loss on decline in the value of securities
True or False 2 1. ~
9. Fire loss on uninsured building
1. Repairs that increase property fair value are capitalized. w 1
10. Factory salaries, utilities and ren t expense

11. Entertainment expenses for governm en offici 2. So long as the expense relates to the generation 6f an in1come 'subject to any
income tax, the same is deductible against gross income subject to regular tax.
12. Revaluation loss on decline in value of building and equipment
13. Loss on sale of properties to an unaffiliated com pany 3. The amount of expense between affiliated companies may be a.djust.edI by the• BIR
I ,,
14. Decline ·in value of foreign currency denominated receivables to reflect their arm's length value. , 1 .• ,. .• • 111
l ·
15. Facilitation fees to government agencies 4. The failure to deduct creditable withholding tax on income pafPl~~ts will render
16. Freight costs of selling goods the expense non-deductible.
17. Freight and insurance cost of buying goods or equipment 5. Immaterial expenditures must always be capitalized.· r · ,. ( _, r
18. Raw materials used in production 6. Repairs that increase property useful life are capitalized. · ' · ,.
19. Cost of goods manufactured 7. An unpaid expense may be deducted under the accrual, basis. of acc.0unting.
20. Accrued salaries expense of an accrual basis taxpayer 8. The government should not enrich itself at the e:,_cpense of the taxpayers. Losses
21. Cost of goods finished and sold between related parties are deductible in the same w~y gains between related
22. Expired portion of business property insurance parties are taxable. ·, · l.
23. Interest expense on borrowings from family members 9. Taxpayers opting to use the optional standard -deduction ,must also maintain
24. Accrued but unpaid rent expense of a cash basis taxpayer records of their expenses.
25. Value of unharvested fruits destroyed by a storm 10. Deduction incentives are dedu~ble b_ecause they are actual expense.
26. Receivables proven to be uncollectible under the cash basis
Multiple Choice - Theory: Part 1 . . . . • .
27. Insurance expense on the life of the company president where the beneficiary is 1. A repair expense is deductibl~ in the penod paid or mcurred unless tt
the spouse of the president
a. merely maintain the value of tbe property. ·
28. Ex~enses on bu~iness operation which are exempt from regular income tax or b. increases the value of the property.
subJect to a special tax regimes
29. Bad debt expense with non-paying family members c. constitutes a major repair.
30. Dividend to preferred or common stocks d. constitutes a minor expense.
478 479
2. Losses on capital assets are
a. deductible against gross income to the extent not compensated by insurance. b. Prepai~ expense is deductible in __ . . . _
b. deductible against capital gain to the extent compensated by insurance. the basis of accounting emplo ed ~he future period 1t relate without regard to
c. not deductible against gross income whether or not compensated for by c. Accrued expenses are deductiil by the taxp~yer.
insurance. d. Depreciation expense can be cla~mYe_dcashl bbas1s taxpayers
d. not deductible against capital gains unless not compensated by insurance. . on Y y accrual basis taxpayers.
1o. cash basis and accrual basis taxpayers diff . .
3. Which is a deductible expense? a. Prepaid expense ers m the treatment of
a. Marketing and advertising expense b. Current period cash expense
b. Insurance on factory building c. Current period accrued expense
c. Salaries of security guards in the factory d. Depreciation expei:ise
d. Cost of registering stocks
l 1. Which may not be related?
4. The transactions involving an insured property is said to be closed and completed a. The controlling individual and the controlled · t·
Th t . . d. . _ corpora 10n.
when b. econ ro 11 ing m 1v1dual and a subsidiary of a controlled corporation.
a. final settlement by the insurer is made. c. The grantor and fiduciary of a trust
b. the report of the insurance adjuster indicates a loss. . J d. The .g rantor and the beneficianr of a trust
c. final settlement confirms an unrecoverable cost. ·' ,
d. no proceedings in court is expected to be made by the insured. 12. Which of the following is an extraordinary non-deductible expense against regular
gross income of a merchandiser? ., •-- ' . , , I
5. Which is a dedµctible expense? a. Loss on sale of obsolete merchandise , · · · · ,, ·

a. Acquisition cost of a business franchise b. Store supplies and utilities ··. · : ..
b. Repayment of debt ' •' '.. I
c. Local business permit , ···:i 1
'. • .
c. Cost of registering a business d. Loss on sale of investment in stocks

d. Cost of issuing securities . t ' 1· .; ,c,
13. Which is a deductible expense against business gross income? ~. . 1
6. Which is a deductible business expense? · a. Commission expense on sale of investment in stocks ·

a. Interest on personal borrowings b. Salaries of marketing personnel of a manufacturing business -
b. Rental of taxpayer's domicile c. Quarterly estimated income tax · - • · .·
c. Selling commission to agents d. Final tax on interest income on bank savings deposit .
d. Wages of kasambahays
14. Which is not a general principle of deduction?
7. Losses on property are not deductible unless
a. The matching principle c_.The withholding rule
a. sustained with a related party. b. The related party rule d. The transfer pricing rule
b. sustained in an actual or completed transaction.
c. temporary in nature. • I
15. Which is an actual deductible expense?"
d. covered by insurance or indemnity contracts. a. Provision for an estimated bad debt expense
b. Loss arising from liability on a contested lawsuit confirmed by a final
8. Losses on insured properties are not deductible
a. to the extent not compensated by insurance. judgment ~ - • . t d d bt
c. Increase in value of foreign currency-deoomma e e
b. to the e~ent compensated by insurance.
c. as a rule, except'when allowed·by the BIR examiner. d. Death of animal offspring
d. in all circumstances. 16- Which is deductible against gross income? .'
9. Which statement is the most accurate? . a. Imputed interest expense · of a partner in a . general professional
b. Advances to the profit sharing
a. Prepaid expense is deductible in the · period paid by taxpayers using cash .)
basis. . partnership
c. Repayment of business debts
d. Local taxes
480 481
1 ·. hich of the folio ing is deductible?

a. Rent of office space
b. Tuition fees of the siblings of the taxpayer lU itt f th t In
c. Selling expense of domestic stocks directly to a buyer
d. Estimated los es on l suit t.
t.
18. ich is non--deductible against gross income?
a Loss on sale of stocks through the PSE
b. rite-off of bad debts
C. Loss on destruction of office building by an earthquake
d. Amortization of patent or franchise used in business
19. ·ch is an incorrect statement? .

a. The straight line method provides for an equal periodic deduction against
gross income. "pie Choice - Theory: Part 2
b. The sum-of-the-years digit method provides for an increasing deduction
hich is a deductible expense?
against gross income.
a. Regular repair of office equipment ,
C. The double declining balance method provides for a declining deduction at a
rate twice the deduction of the straight line method. b. Refurbishing of an old building to prepare it for use
Both straight line method and sum-of-the-years-digit method consider the c. Addition of a wing to an existing building
d
residual value of the property. d. Overhaul of machineries to extend their useful life
20. Which of the following ordinary assets cannot be depreciated? . Which of the following cannot claim deductions from gross income despite actual
a Office equipment c. Building and its improvements engagement in business?
b. Machineries d. Land a Resident citizen
21. Statement 1: Only taxpayers under the accrual basis shall use the inventory b. Resident alien
method in deducting inventories. c. Non-resident citizen
Statement 2: Only taxpayers under the accrual basis can claim deduction for d. Non-resident alien not engaged in trade or business
depreciation and losses. 3. Which of the following taxpayers cannot claim deductions from gross income?
a Statement 1 is correct. c. Both statements are correct.
a General professional partnership
b. Statement 2 is correct. d. Neither statement is correct.
b. Domestic corporation
22. Statement 1: The cost of goods sold is directly deducted upon sales in the c. Resident foreign corporation
measurement of the gross income from the sales of goods. cl Non-resident foreign corporation
Statement 2: The cost of services is directly deducted from gross receipts in the
measurement of the gross income from the sales of services.
4. Which of the following can be claimed as deduction?
a Transportation allowance of employees of the taxpayer
aA Statement 1 is correct. c. Both statements are correct. b. Transportation allowance of the taxpay~r's d~pendents
b. Statement 2 is correct. d. Neither statement is correct. c. Losses from destruction of the taxpayer s residence
cl Depreciation of the residence of the taxpayer
23. Which is not a capital expenditure?
S. Which expense is deductible despite the fact_that it is not an actual expense?
a. Payments to create a good image of the business of the taxpayer
b. Prepaid expenses a Compliance expense on regulatory reqmrements .
c. Accrued expenses b. Deduction incentives for compliance to regulatory reqmrements
d. Advances to contractors c. Uncollectible debts ascertained to be worthless
dJ None of these
482
483
Chapter 13 - Principles of Deductions chapter 13 - Principles of Deductions
6 · Which is not a characteristic of deductions from gross income? b. Tuition fees of dependents of the taxpayer
a. Legitimate business expense c. Interest expense on a business loan
b. Capital expenditure d. Representation expenses booked in the name of the taxpayer's wife
c. Ordinary and necessary business expense
d. Actual and necessary business expense 14. Which 0 ~ th e f~llowing qualifies for deduction for an individual income taxpayer
engaged m busmess?
7 • Which of the following taxpayers cah claim deduction against gross income? a. Salaries of household maid
a. A resident citizen taxpayer earning purely compensation income b. Ga_soline expenses of the taxpayer's ·p ersonal car
b. Non-resident foreign corporation c. Office Internet expense ·
c. Non-resident alien not engaged in trade or business
d. Taxpayer's transportation expense to and from his residence
d. Resident citizen earning a mix of passive and business income
8. Which is not a separate classification of deduction from gross income? 15. Which of the following can be deducted by an individual taxpayer not engaged in
business? . ,
a. Net operating loss carry over
b. Regular allowable itemized deductions a. Transportation expenses c. Internet expense
c. Special allowable itemized deductions b. Communication expenses d. Norie of these
d. Net capital loss carry over 16. Which of the following can be claimed by a resident foreign corporation?
9. Which statement is incorrect regarding deductions? a. Depreciation expense on properties located abroad
a. The claim of deduction, similar to exemption, is construed against the b. Income tax paid in a foreign country
taxpayer. c. Income tax paid in the Philippines
b. The use of optional standard deduction always results in reported taxable d. Interest expense on foreign borrowings used to finance its Philippine
income. business
c. The unreasonableness of deduction is up to the BIR to prove.
d. The incurrence of an operating loss is an indication of an unreasonable 17. Which can be treated as a capital expenditure deductible through depreciation
expense. expense?
a. Interest expense incurred to purchase office equipment
10. The following cannot claim deduction from gross income except b. Losses sustained in an uninsured office building
a. A self-employed individual taxpayer c. Acquisition of land
b. A corporation earning purely passive income d. Acquisition of personal computers
c. An individual earning purely passive income
d. An individual taxpayer earning purely compensation and passive income 18. Which of the following items can be deducted in full in the year sustained?
a. Write-off of bad debts by a taxpayer under the cash basis
11. Which is not deductible against gross income? b. Loss on market decline in the value of gold inventories
a. Interest expense incurred to purchase tax-exempt securities c. Loss on the destruction of the taxpayer's personal car
b. Net capital loss
d. Uninsured fire loss sustained by the business of the taxpayer
c. Personalexpenses
d. All of these 19. Deductions can be claimed against
a. talent fees. c. fringe benefits.
12. Which is a deductible business expense?
b. fixed allowances. d. salaries.
a. Loss on decline in value of securities
b. Estimated losses on expropriation 20. Which is deductible in full by a taxpayer engaged in the merchandising business?
c. Fire loss on an insured property a. Value of inventories taken home by the business owner
d. Loss on theft of company assets b. Loss on unrecoverable debts from a non-paying family member
13. Which of the following constitutes a deductible business expense? c. Imputed interest on the capital investment of the owner
a. Purchase of office equipment invoiced under the trade name of the taxpayer's d. Value of inventories destroyed by rodents
business
484
485
Chapter 13 - Principles of Deductions Ch pt r 13 - Principles of Deductions
21. Which is not a dedu~tible loss by a security dealer? comput the deductible interest expense in 20 21 .
a. Wash sales loss . a. P O c. PS0,000
b. Loss on the sale of bonds with more than five years maturity b. P25,000 d. P75,000
c. Loss on the sale of stocks through the PSE
d. Loss on ·the sale of short-term bonds through the Philippine 3. CHS Corporation had office supplies valued at P40,000 on January 1, 2021. At the
Exchange Dealings end of the fir st calendar quarter, it had P80,000 worth of oftlce supplies. Total
supplies purchased were P250,000 during the period.
22. Determine the deductible loss. '
Compute the supplies expense to be deducted during the first quarter.
a. Loss incurred in exchanging property to obtain control of a corporation
a. P210,000 c. P280,000
b. Loss incurred in exchanging p.r operties with a corporation after obtainin b. P250,000 d. P290;000
control over said corporatiqn g
c. Calamity loss on uninsured property 4. A non-resident alien not engaged in business incurred business expenses of
d. Bad debts from a sister company Pl00,000 and personal expenses of P20,000. How much is deductible from hi.s
,gross income?
23. Which of the following js non-d~ductible by the fact t~at it violates the Matching
Principle? · · a. PO C. p 100,000
a. Expense of a tax-exempt operation b. P 20,000 d. P 120,000

'\·
' ·,1
b. Payment for police protection 5 5. A taxpayer paid the following salaries during the year: r ,
c. Payment of revolutionary taxes _ . .f
d. Expenses not receipted in the name of the taxpayer Salaries of administrative employees P 80,000
Salaries of sales and marketing employees ,... 70,000 ,,
24. Which is incorrect with regard to expenses incurred between associated Salaries of factory production workers 120,000
enterprises?
. a. J The pricing of the transaction must not be controlled. .. Compute the deductible salaries expense.
b. The pricing method to be adopted shall be based on free market factors or a. P270,000 c. PlS0,000
those made between two indepen<;lent parties. b. P200,000 d. P120,000
11
c. In case of a controlled transaction, the deductible . expense to the paying 6.
1 1
I ,:· ' :•
enterprise shall be the arm's length value of the tran~acti9n. i _ 6. On July 1, 2021, a taxpayer purchased equipment for PS00,000 which was
d. · No deduction shall be allowed on expens_e s. incurred beho/~en ~ssociated estimated to be useful until July 1, 2026, with an expected Pl00,,000 residual
enterprises. value. Compute the 2021 depreciation expense using the straight line method.
a. PO c. PS0,000
2 5. Which is not a business expense? b. P 40,000 d. PB0,000 . ,. .. j
1
,
a. Fringe benefit tax expense 7.

b. De minimis benefits granted to .e mployees 7. A storm resulted in the loss of the following livestock:
' -.1,
c. Salaries of personal driver of the_company president which was subjected to Value of two heifers (purchased at PlS,000 each) P 40.000
fringe benefit tax . Value of a bull (purchased for P18,000) , , 24,000 .)
d. Depreciation value of properties designated for the 1,1se of company managers Value of twelve calves worth P6,0~0 each , . 7~.QOO .
and supervisors which are subjected to fringe benefits tax Total value of lost livestock P 136.000
Multiple Choice - Problems: Part 1 De~ermine the decfµctible Ios, for taxatiQn ,purposes~
a. pO c. P64,000 ,,
1. A taxpayer paid P45,000 property insurance having a 12-month coverage starting
b. P48,000 d. P120,000
March 1, 2.018. Compute the deductible in~urance expense in 2018.
a. po c. P37,S00 ij. 8· Mr. Gan, a pro,ess1ona
i- · •
· · ·the following
I practitioner' incurred . expenses, ·during
. the
b. P7,500 d. P45,000 period: ·
, 1 •]
I intere st '1 I I
01. .P so,ooo
2. On September 30, 2021, a taxpayer borrowed Pl,000,000 at 10 ,-o annua Salaries of household maids
30,000
to finance his acquisition of a luxury car. Salaries of office staff
486
(. 487
f ducti n h pter 13 - Principles of Deductions
12,000 0 mpute the total deductible e
iIiti 8,000 a po xpense from the abov it m :
15,000 . p 20 000 c. PS0,000
f p r onal car b. ' d. P60,000
f offi equipment 20,000
Bermuda Inc. insured two of 1•t k
13 · annually:
Jd - uctible expen s. s ey employees paying the fo llowing premiums
ompu th t
. P 50,0 0 . Pl00,000
d. P135,000 Mr. Croco, the president
b. P 70,000 P 40,000
Mr. Genero, the vice president "or
11 op erat·ions 34,000
9. Th follo ing relate to the building of a taxpayer: In Mr. Croco's policy, Bermud I •
'" - the benefi . f th a,. nc. is the beneficiary. In Mr. Genero's policy, his
P 6,000,000 wi,e 15 c1ary o e pohcy.
Fair market value
5,000,000
ur ha e rice Compute the total deductible expense.
Car ·ng amount 4,500,000
a. P34,000 c. PS0,000
Remaining useful life 9 years
b. P40,000 d. P7 4,000
Depreciation method straight line
14. Ca?anatua~ City C_orp~ration is a resident foreign corporation established in
What is the deductible amount of depreciation expense?
Chma but IS operating m the Philippines. During the year it paid for P300 000 for
a. P666,66 7 c. PS00,000 salaries of Philippine employees and Pl,200,000 for Chin~se employees. '
b. PSSS,555 d. P 0
Compute the deductible compensation expense.
1o. The personal car of the taxpayer had the following data: ., a. PO c. Pl,200,000
Fair market value P 6,000,000 b. P300,000 d. Pl,500,000
Purchase price 5,000,000
15. Using the same choices in Number 14, compute the deduction assuming that
Estimated useful life 10 years Dragon City is a domestic corporation.
What is the deductible annual depreciation expense? 16. Using the same choices in Number 14, compute the deduction assuming that
a. PO c. PS00,000 Dragon City is a non-resident foreign corporation.
b. P250,000 d. P600,000
Multiple Choice - Problems: Part 2
11. The following relate to-the inventory of tools held by the taxpayer:
1. The accountant of TRIBOA Corporation provides for an allowance ag~inst
Inventory of tools, January 1, 2 0 21 P 120,000 unrecoverable accounts equivalent to 3% of TRIBOA's total receivables. The
Purchases of tools 300.000 allowance for bad debts had a balance of P45,000 and PS0,000 at the start and end
Inventory of tools, December 31, 2021 140,000 of the year, respectively, while P30,000 of previous accounts were actually found
What is the amount of deductible tools expense? to be worthless and were written-off. What is the deduction against gross income
a. PO c. P280,000 · for purposes of taxation? ,,
b. P 120,000 d. P300,000 a. PO c. P30,000
b. P25,000 d. PS0,000
12. A taxpayer paid the following disbursements and expenses for the current year:
2. Boracay Company had the following summaries of expenses:
Tuition fees of children P 50,000 P 200,000
Donation to friends Expenses without supporting documentation
20,000 Expenses with supporting documentations. . .
Purchase of office equipment at start of the year Income payments subject to creditable w1thholdmg tax:
(equipment expected to last for five years) 100,000 600,000
with withheld CWf . 400,000
Office rent (for three years including the current year) 90,000 without withheld CWf
Office supplies.(~/2 used) 20,000 200,000
Payments not subject to creditable withholding tax
489
488
Chapter 13 ~ Prin ; 1 of du tions
D t rmin th amoun of d du fons.
a. P800,000
c. Pl,200,000 8. A taxpayer had the following losses d urmg. th e year:
b· · Pl,000,000 d . Pl,400,000 Estimated bad debt expense p 300,000
Write-off of uncollectible accounts 150,000
3. Palawan Corporation bought qufpm nt costing PS00,000. The equipment w, carrying value ?f property destroyed by fire
expected to hav PS0,000 r siduaJ valu at the end of its 5-yea~ expected lit: (The P _ropdelrty is covered by insurance.) 1,200,000
Palawan Corporation fail d to withhold the creditable w1thholdmg tax on ·· Unrea1ize oss on foreign currency receivables 12,000
equipm nt Assuming the taxpayer is under the accrual basis, compute the total deduction.
a. PO c. P162,000
Compute the depreciation expense In th e first year.
b. P 150,000 d. Pl,315,000
a. PO c. P90,000
b. P45,000 d. P180,000 9. In the immediately preceding problem, compute the deduction assuming. the
taXpayer is under the cash basis.
4. Tri- Peak Semiconductor is an exporter of transi st0 rs to th e United States. On
a. PO c. P162,000
December 15, 2021, it made a single shipment worth $l,000,000 payable January
b. P 150,000 d. Pl,315,000
21, 2022. The value of the sales in peso equivalent was as foJJows:
P42,000,000 10. Cavite Innovations Company incurred and paid the following expenses in 2021;
December 15, 2021
December 31, 2021 41,800,000
Salaries (1/8 unpaid) p 400,000
January 21, 2022 (Converted value to peso) 41,700,000
Prepaid rent (2021 to 2023) 150,000
Compute the deductible foreign currency loss. Depreciation expense 80,000
a. P200,000 in 2021 c. P300,000 in 2021 Purchase of supplies 60,000
b. P300,000 in 2021 d. P200,000 in 2021
Supplies used 25,00ID
5. The taxpayer incurred the following in 2021:
Compute the total deductions under the cash basis for the year 2021.
Loss on sale of equipment to a subsidiary compai:iy P 400,000
a. P690,000 c. PSSS,000
Loss on sale of equipment to a sister company 100,000
b. P655,000 d. PSOS,000
Loss on liquidation of an affiliate company 200,000
' .
What is the deductible amount ofloss to a related party? 11. Compute the total deductions under the accrual basis for the year 2022.
a. PO c. P300,000 a. P655,000 c. PSSS,000
b. P200,000 d. P600,000 b. P605,000 d. PSOS,000
12. An equipment was purchased on January 1, 2020 for P4,000.000. The equipment
6. Th~ following relate to a transaction between associated enterprises which was
sub1ected to transfer pricing restatement by the BIR. has an estimated residual value of P400,000 at the end of its five ..year useful life.
Amount of expense claimed Compute the depreciation expense assuming the use of the straight line method:
P 800,000 a. P 720,000 c. Pl,440,000
Arm's length value in a comparable transaction 500,000 b. P 1,200,000 d. Pl,600,000
What is the deductible amount of expense?
a. PB00,000 c. P300,000 13. Under the sum-of-the-years digit method, compute the 2020 depr~ciation expense
b. PS00,000 d. p O in the first year.
a. P 720,000 C. Pl,333,333
7 b. P 1,200,000 d. Pl,440,000
· lntt~e immediately preceding problem, what is the required ad1·ustment to taxable
ne mcome?
14. Using a 1500/4 declining balance method, compute the 2020 depreciation expense.
a. P300,000 increase c. PS00,000 increase a. P 720 000 c. Pl,440,000
b. P300,000 decrease I '
d. PB00,000 decrease b. P 1,200,000 d. Pl,600,000
490
491
15. U in 200% d lining balan e m hod, ompu h 2020 d pr · i . on pn
a. P 72 ,000 c. Pl,440,000 6. In the immediately preceding problem, what is the amount of surcharge due from
b. P 1,200,000 d. Pl,600,000 the taxpayer?
a. p O C. p 2,000
Multiple Choice - Probl m : Part 3 b. P 1,874 d. P 2,500
1. The taxpayer withheld 5% er dit bl withholding tax on rental payrnen
various VAT-regi ter d I ssors. Th total tax s withheld wer P 5,600. What is t~ 7. The following case is applicable for Nos. 7 through 10:
deductible amount of rental expense? Nueva Ecija Company received a bill for P27,440 from a non-VAT service provider.
a. p O C. p 100,000 The payment for the service is subject to 2% creditable withholding tax.
b. P 56,000 d. P 112,000 What is the deductible expense if Nueva Ecija is a non-VAT taxpayer?
a. PO c. P 27,440
2. A certain taxpayer paid the following bill from a VAT-registered supplier of offic b. P26,891 d. P 28,000
suppHes. The office supplies were all used in operation during the period: e
Selling price P 400,000
s. If Nueva Ecija is a non-VAT taxpayer, what respectively is the withholding tax and
the amount of cash to be paid by Nueva Ecija to the service provider?
Plus: Output VAT 48,000 a. P 0; P 27,440 c. P 560; P27,440
Less: Withholding tax (1 %) 4,000 b. P 548.80; P 26,891.20 d. P 537.82; P26,353.18
Net cash due P 444,000
9. If Nueva Ecija is a VAT taxpayer, what is the deductible expense?
What is the deductible supplies expense assuming the taxpayer is a VAT-taxpayer?
a. p O C. p 27,440
a. P 396,000 c. P 444,000
b. P26,891 d. P 28,000
b. P 400,000 d. P 448,000
10. If Nueva Ecija is a VAT taxpayer, what respectively is the withholding tax and the
3. What is the deductible supplies expense assuming the taxpayer is a non-VAT· amount of cash to be paid by Nueva Ecija to the service provider?
taxpayer?
a. PO; P 27,440 c. P 560; P27,440
a. P 396,000 c. P 444,000 b. P 548.80; P 26,891.20 d. P 537.82; P26,353.18
b. P 400,000 d. P 448,000
4. On January 2, 2021, a non-VAT taxpayer purchased an equipment with estimated

useful life of 5 years
Selling prke , P 150,000
Plus: Output VAT 18,000
Less: Withholding tax (1 %) 1,500
Net amount due P 166,500
What is the claimable depreciation expense for the year?
a. PO c. P 33,300
b. P 30,000 d. P 33,600
5. Until the time of the examination of its book, the taxpayer failed to withhold 10%
withholding tax amounting to Pt0,000 from the payments of professional fees to a
consultant who is a VAT taxpayer. What is the deductible amount for professional
services paid?
a. PO c. P100,000
b. P 89,286 d. P112,000
493
492

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Chapter 13 - Principles of Deductions h pter 13 ..

Prin iples of Deductions

4. Mastery of the different depreciati~n methods and t~e sp,e:c!ffl-co~~.i.derations

6. General principles of deductions · Illustration 2

8. Modes of claiming deductions from gross income 7 . " ' ,.J

Hence, 4 + 3 + 2 + 1 = 10. 40% x P300,000 P 120,000 P 180,000

40% x P180,000 P 72,000 P 108,000

Hence, 4 x (4+1)/2 equals 10. 40% x P108,000 p 43,200 P 64,800

P340,000 respective~y. 11 Immaterial capital expenditures

MANUFACTURING EXPENSES Non-manufacturing cost:s - adrntnistrattve and elllng expenses

Purchase of equipment (paid in cash) P 200,000

1. Cash basis of accounting 3. The Related Party Rule . . ·, ·

The expenses. of th ese businesses in connection with their operations subject to

subject to regular tax, ~ THE RELATED PARTY RULE . ) '

Who are related parties?

40% THE WITHHOLDING RULE

payments to Galemo pau h PlBO Note:

Special allowable itemized deductions are additional deductions as proVided

Compliance expenses are actual payments or transfers of funds. Deduction

Net Operating Loss Carry-Over (NOLCO) pertains to the excess of expense

Technically, NOLCO is not an expense. it is a special deduction incentive allowed

Special allowable itemized deductions and NOLCO will be discussed in detail in

MODE OF CLAIMING DEDUCTIONS FROM GROSS INCOME

2021 - 2022 2023

4. Salaries of administrative and

10. Factory salaries, utilities and ren t expense

5. Which is a dedµctible expense? a. Loss on sale of obsolete merchandise , · · · · ,, ·

c. Cost of registering a business d. Loss on sale of investment in stocks

6. Which is a deductible business expense? · a. Commission expense on sale of investment in stocks ·

1 ·. hich of the folio ing is deductible?

19. ·ch is an incorrect statement? .

a. Expense of a tax-exempt operation b. P 20,000 d. P 120,000

c. Payment of revolutionary taxes _ . .f

a. Fringe benefit tax expense 7.

4. On January 2, 2021, a non-VAT taxpayer purchased an equipment with estimated

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