Lecture 8 Allowable Deductions

ALLOWABLE DEDUCTIONS FROM GROSS INCOME
Allowable deductions are items or charges against the gross income, as claimed by the taxpayer arising from the conduct
of business or from the practice of profession such as expenses, whether incurred or paid, which are allowed by the law
to be deducted from his gross income before imposing the corresponding income tax. Only those self-employed
taxpayers or those having business may deduct pertinent items from their gross income to arrive at net taxable income.
Compensation income earners and passive income earners cannot deduct their expenses, unless they have business
income from which business expenses may be charged against.
General Rule: Deductions from gross income can only be allowed if it is necessary, ordinary, and substantiated (strictissimi
juris). Deductions depends upon the taxpayer residence and citizenship, and his source of income. A taxpayer seeking a
deduction must:
o Ascertain his entitlement to such deduction by pointing specific provisions of the statute authorizing the deduction;
and
o Prove that he is entitled to the deduction authorized or allowed, especially in cases under dispute.
In the absence of a law authorizing or granting such deduction or exemption, taxpayer cannot deduct such amount of
charges claimed against his income.
Exemption: In the case of claiming Optional Standard Deduction (OSD), the taxpayer may not need to substantiate the
deductions.
A taxpayer, whether individual or corporate, during any taxable year, may claim either of the following deduction:
1. Optional Standard Deduction
2. Itemized Deductions
OPTIONAL STANDARD DEDUCTION (OSD)

At the option of the taxpayer, he may choose to select Optional Standard Deduction or OSD to be claimed against his
gross income. The OSD shall be computed as forty percent (40%) of the gross income in lieu of the itemized deductions.
A taxpayer who opts to avail of this deduction need not submit the Account Information Form (AIF)/ Financial
Statements, but he may be required to do so when the BIR needed it.
Individual taxpayers such as resident citizen, non-resident citizen, resident alien, taxable estates and trusts who are
engaged in business or selling of services may claim OSD. Non-resident alient engaged in trade or business and non-
resident alien not engaged in trade of business cannot elect OSD.
For individual taxpayers, the forty percent (40%) OSD is multiplied at his gross sales or gross receipts. For purposes of
computing OSD for individuals, gross sales or receipts shall mean after deducting sales discounts actually taken, sales
returns and sales allowances. In this case, the OSD replaces the cost of goods sold or the cost of service and the related
business expenses. Typically, individuals who chose OSD are those who cannot substantiate their expenses and OSD
becomes the better option for them, or those who think that claiming OSD results to a lower income tax than claiming
the itemized deduction.
However, the intention to claim OSD is not presumed as it is only optional; the taxpayer should signify his intention to
claim OSD during the filing of the first quarterly return by marking [x] the box indicating OSD, and such election would
be irrevocable for the taxable year in which the return is made. Thus, in the next taxable year, the taxpayer shall select
again whether to choose OSD or the itemized deduction.
Example of Erroneous Election of Deductions:

1st Quarter 2nd Quarter 3rd Quarter Annual
OSD Itemized Deduction OSD Itemized Deduction
Itemized Deduction OSD OSD Itemized Deduction
Example of Correct Election of Deductions:

1st Quarter 2nd Quarter 3rd Quarter Annual
OSD OSD OSD OSD
Itemized Deduction Itemized Deduction Itemized Deduction Itemized Deduction
The failure to indicate the election to avail the OSD shall be considered as having availed of the itemized deductions.
OSD or itemized deductions should be consistently applied each quarter for the entire taxable year.
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On the other hand, corporate taxpayers particularly the domestic corporations and resident foreign corporations may
claim 40% OSD of its gross income as shown below. Non-resident foreign corporation cannot elect OSD as they are
deemed to be not engaged in business, and are taxed at 30% of their gross income from sources within the Philippines.
Individual Taxpayers Corporate Taxpayers

(RC, NRC, RA, Estates and Trusts) (Domestic and Resident Foreign Corporations)
Gross Sales or Receipts, net of VAT xxx Gross Sales or Receipts, net of VAT xxx
Less: Discounts actually taken Less: Discounts actually taken by customers (xxx)
by customers (xxx) Sales Returns and Allowances credited (xxx)
Sales Returns and Allowances (xxx) Net Sales or Receipts xxx
Net Sales or Receipts xxx Less: Cost of Goods Sold or Cost of Service (xxx)
Multiplied by: 40% Gross Income from Business xxx
Optional Standard Deduction xxx Multiplied by: 40%
Optional Standard Deduction xxx
Net Sales or Receipts xxx
Add: Other Non-Operating Income xxx Gross Income from Business xxx
Total Gross Income xxx Add: Other Non-Operating Income xxx
Less: Optional Standard Deduction (xxx) Total Gross Income xxx
Taxable Income xxx Less: Optional Standard Deduction (xxx)
Taxable Income xxx
The OSD substitutes the cost of goods sold or cost of The OSD substitutes all business expenses only.
service, and all business expenses. No other
deductions may be claimed. Also, in computing OSD,
do not include non-operating income such as those
passive incomes not subjected to final tax (if there is)
as it will only bloat the allowable deduction.
Example 1:
A taxpayer had the following non-cumulative data for the year 2018:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Gross Sales from Business P 3,700,000 P 3,200,000 P 4,000,000 P 3,900,000
Other Incomes:
Interest in Bank Deposits, Philippines 20,000 20,000 22,000 25,000
Cash Dividends from a Domestic Corp. 13,000 None 30,000 10,000
Interest in Bank Deposit, Abroad 20,000 30,000 25,000 33,000
Other non-operating income 150,000 170,000 145,000 210,000
Discounts Availed by Customers 10,000 7,000 20,000 30,000
Cost of Sales 2,100,000 2,150,000 2,460,000 2,320,000
General and Administrative Expenses 300,000 200,000 250,000 260,000
Finance Cost 10,000 15,000 27,000 23,000
Depreciation 30,000 44,000 35,000 38,000
Compute the net taxable income each quarter of the taxpayer under the following assumptions:
Assumption 1: Individual Taxpayer (RC, NRC and RA) – OSD versus Itemized Deductions
It is resolved that the interest in bank deposits in the Philippines and the dividends received from a domestic corporation
are no longer added to the gross income because they are already subjected to final tax of 20% and 10%, respectively.
Itemized Deductions:
Less: Discounts Availed by Customers ( 10,000) ( 7,000) ( 20,000) ( 30,000)
Net Sales from Business 3,690,000 3,193,000 3,980,000 3,870,000
Less: Cost of Sales ( 2,100,000) ( 1,750,000) ( 2,460,000) ( 2,320,000)
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Gross Income from Business 1,590,000 1,443,000 1,520,000 1,550,000

Add: Other Incomes
Total Gross Income Subject to Tax 1,760,000 1,643,000 1,690,000 1,793,000
Less: Itemized Deductions
General and Administrative Expenses ( 970,000) ( 940,000) ( 750,000) ( 860,000)
Finance Cost ( 150,000) ( 128,000) ( 27,000) ( 23,000)
Depreciation ( 130,000) ( 44,000) ( 35,000) ( 38,000)
Net Taxable Income per Quarter 510,000 531,000 878,000 872,000
Optional Standard Deduction:

Multiplied by OSD Rate 40% 40% 40% 40%
Optional Standard Standard 1,476,000 1,277,200 1,592,000 1,548,000
Taxable Business Income (Net Sales less OSD) 2,214,000 1,915,800 2,388,000 2,322,000
Add: Other Incomes
Net Taxable Income per Quarter 2,384,000 2,115,800 2,558,000 2,565,000
Noted from the above computations that it is better for the individual taxpayer to claim the itemized deductions than
the Optional Standard deduction because the income tax is higher under the OSD. Also, it is observed that the 40% OSD
is based on the gross sales from business (net of the discounts validly taken by the customers) because the taxpayer is
an individual taxpayer. Again, the choice must be selected when filing the first quarterly income tax return.
Assumption 2: Corporate Taxpayer (DC and RFC) – OSD versus Itemized Deductions
Under this assumption, the net taxable income under the itemized deduction will be the same as that of the individual
taxpayer. So, we will use the same figures for comparison.

Less: Cost of Sales ( 2,100,000) ( 1,750,000) ( 2,460,000) ( 2,320,000)
Gross Income from Business 1,590,000 1,443,000 1,520,000 1,550,000
Multiplied by OSD Rate 40% 40% 40% 40%
Optional Standard Standard 636,000 577,200 608,000 620,000
Taxable Business Income (Net Sales less OSD) 954,000 865,800 912,000 930,000
Add: Other Incomes
Net Taxable Income per Quarter 1,124,000 1,065,800 1,082,000 1,173,000
As presented in the preceding page, the corporate taxpayer will still have a higher net taxable income under when
claiming optional standard deduction, compared to the itemized deduction. Thus, it will pay more tax when it opts to
claim OSD than the itemized.
However, there are some cases when the taxpayer can benefit OSD: (1) when it has no expense, (2) when its expenses
are not duly substantiated or receipted, or (3) when claiming OSD results to a lower income than claiming itemized
deduction. For whatever reason, still the taxpayer has to decide during the filing of the first quarter return. Such decision
will be irrecovable during such taxable year.
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ITEMIZED DEDUCTIONS (EX IN TALOBA DEPDEP CHARD PET)

Itemized deductions are the pertinent items allowed by law to be charged as deductions against the gross income,
provided they are necessary, ordinary and substantiated. Under the new Tax Code, individual and corporate taxpayers
may deduct the following items:
EXPENSES, IN GENERAL
1. A reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered,
including grossed up monetary value of the fringe benefits granted by the taxpayer-employer to the employee,
Provided, however, that the corresponding withholding tax is properly withheld and remitted to the BIR for such
compensation.
Example 2:
The following payroll expenses are claimed by a taxpayer as charges against his gross income:
Gross Salaries and wages, withholding tax was properly remitted P 550,000
13th Month Pay and Other bonuses 210,000
De Minimis Benefits granted by the company to its employees 65,000
Fringe Benefits to Managerial Employees, no fringe benefit tax remitted 125,000
Professional fees paid to its consultants, no withholding tax remitted 170,000
Dividends distributed to its manager-stockholders, final tax remitted 150,000
Commissions paid to agents, withholding tax remitted 50,000
How much is the total deductible salaries and wages?
Solution:
Gross Salaries and wages, withholding tax was properly remitted P 550,000
13th Month Pay and Other bonuses 210,000
De Minimis Benefits granted by the company to its employees 65,000
Commissions paid to agents, withholding tax remitted 50,000
Total Salaries and Wages P 875,000
The fringe benefits and professional fees paid cannot be allowed to be deducted because the final tax of 35% on
fringe benefits and the 5% or 10% creditable withholding tax on professional fees were not withheld and remitted.
Those may be deducted only if the company pays the correct withholding tax plus the penalties and interests due
thereon.
The dividends, on the other hand, cannot be allowed as salaries expense because they are a distribution of profit of
the company. Allowing the dividends to be deducted from the gross income would only diminish the income, and
thus the income tax, where the stockholders have interests on the profits of the company.
2. A reasonable allowance for travel expenses, here and abroad, while away from home in the pursuit of trade, business
or practice of profession.
Example 3:
The company paid the following expenses on behalf of its manager in 2018:
Airfare to Manila for a seminar where the company is benefited P 20,000
Travel Allowance for meals and accommodation 30,000
Travel to Singapore, a treat to the manager for a job well-done 50,000
How much is the total deductible travel expense?
Solution: Only P 50,000 (airfare and travel allowance for meals and accommodation). The travel to Singapore is
actually a fringe benefit to the manager subject to a final tax of 35%. The grossed-up monetary value of such benefit
may be deducted as part of the salaries and wages, but not as travel expense.
3. A reasonable allowance for rentals and other payments which are required as a condition for the continued use or
possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is
not taking the title or in which he has no equity other than that of a lessee, user or possessor. Provided, that for the
use or lease of real properties, the lessee shall withhold a 5% creditable tax from the gross payment to the lessor,
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and shall remit the same to the BIR before such rent expense may be deducted. Provided further that, rent expense
is deductible only when the lessee is using:
o Accrual basis – when the rent is incurred regardless when paid.
o Cash basis – when the rent is incurred and paid
Example 4:
Patricia leased some properties from Don Company, and made the following payments during the year 2018:
Commercial space for office use: (5% CWT was remitted to BIR)
For the year 2018 P 250,000
For the year 2019 250,000
For security deposit 100,000
Warehouse, for the year 2018 – no CWT was remitted to BIR 100,000
Automobile 50,000
How much is the total rent expense for the year 2018?
Solution:
The lessee has the obligation to withhold 5% creditable withholding tax in favor of the lessor of a real property prior
to making such payment. Failure to withhold and remit such 5% CWT will disallow the lessee from claiming such rent
as an expense, unless the withholding tax plus the penalties and interests due thereon is paid by either the lessee
or the lessor.
Commercial space for office use for the year 2018 P 250,000
Automobile 50,000
Total rent expense deductible P 300,000
The lessee shall be allowed the rent expense only if: (1) using accrual basis – the rent is incurred, or (2) using cash
basis – the rent is incurred and paid. The following shall be the correct entry in the books of Patricia:
Rent Expense – Commercial Space P 250,000

Rent Expense – Automobile P 50,000
Advance Rent – Commercial Space P 250,000
Receivable – Security Deposit, Long-Term P 100,000
Withholding Tax Payable P 25,000*
Cash P 575,000
*(P 250,000 + P 250,000) x 5% = P 25,000
The security deposit is not an income to the lessor, nor an expense to the lessee because such deposit is returnable
and just a form security in case of breach of contract. Such security deposit shall not be subject to the 5% withholding
tax. However, in case of breach of contract and such security deposit is appropriated as payment for any rent
payable, such deposit shall be reclassified as expense from being an asset. Also, the 5% creditable withholding tax
shall be paid accordingly.
The advance rent is subject to 5% CWT in the year such amount is paid to the lessor, regardless of when incurred.
However, it can only be deducted as expense by the lessee in the year such rent is actually incurred (2019). On the
part of the lessor, however, such advance collection of rent is taxable in the year of receipt regardless when it is
actually earned, because lessors are seller of service, thus cash basis is more appropriate.
The rent expense on warehouse cannot be deducted as expense due to failure of withholing the 5% CWT.
4. A reasonable allowance for Entertainment, Amusement and Recreation (EAR) expense during the taxable year, that
are directly connected to the development, management and operation of the trade, business or exercise of
profession of the taxpayer, but the allowable amount cannot exceed the limit: (Revenue Regulation 10 -2002)
o Seller of Goods – ½% (0.005) of the net sales
o Seller of Services – 1% (0.01) of the net receipts
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Example 5:
Crabby Company is engaged in the sale of goods and services with net sales and net revenue of P 2 million and P 1
million, respectively. The actual, amusement and recreation expense amounted to P 21,000. How much is the
deductible EAR?
Solution:
Threshold for:
Sale of Goods: P 2,000,000 x P 21,000 = P 14,000
P 3,000,000
P 2,000,000 x ½% = P 10,000, lower amount – deductible
Sale of Service: P 1,000,000 x P 21,000 = P 7,000, lower amount – deductible

P 3,000,000
P 1,000,000 x 1% = P 10,000
Thus, the total deductible EAR is only P 17,000.
5. Cost of materials and supplies when actually consumed, and other necessary business expenses incurred in connection
to the business or trade or profession.
Bribes, Kickbacks, Facilitation Fees and Other Similar Payments

These payments, whether directly or indirectly, cannot be deducted from the gross income because, apart from they
encourage the illegal or wrongdoing, they are not normally reported to the BIR by the receiver of such payment for
income tax purposes.
Expenses Allowable to Private Educational Institutions

In addition to the expenses above, a private educational institution may, at its option, elect either:
o To deduct the expenditures or the entire cost arising from capital outlays or acquisition or construction as of
depreciable assets incurred during the taxable year; or
o Capitalize the costs or capital outlays thereon, and deduct an allowance for depreciation using an appropriate
method for depreciation, discussed in the succeeding topics.
INTERESTS
General Rule: The amount of interest paid or incurred within a taxable year on indebtedness in connection with the
taxpayer's profession, trade or business shall be allowed as deduction from gross income. Provided, however, that the
taxpayer's allowable deduction for interest expense shall be reduced by thirty-three percent (33%) of the interest income
subjected to final tax.
The following requirements must be present before a deduction for interest may be claimed:
o There must be an indebtedness which pertains to the taxpayer.
o The indebtedness must be connected to the business, trade or profession of the taxpayer.
o There must be a legal (enforceable by law) liability to pay interest.
o It must be paid or incurred during the taxable year.
o Interest paid in advance through discount or otherwise shall be claimed as deduction in the year the
indebtedness is paid.
Exception to the Rule: No deduction shall be allowed in respect of interest:

1. If such interest is paid in advance during the taxable year and the taxpayer is using cash basis of accouting. Such
interest shall be allowed for deduction in the year the indebtedness is paid. If the indebtedness is payable in periodic
amortizations, only the amount of interest which corresponds to the amortized principal shall be allowed as
deduction in such taxable year;
2. If both the taxpayer and the person to whom the payment has been made or is to be made are related. The following
persons are considered related:
a. Between members of a family – the family of an individual shall include only his brothers and sisters (whether
by the whole or half-blood), spouse, ancestors, and lineal descendants; or
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b. Except in the case of distributions in liquidation, between the taxpayer and corporation more than fifty
percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for such
individual; or
c. Between the grantor and a fiduciary of any trust; or

Ilustration:
A is a wealthy man. He appoints B to manage his wealth for the benefit of C, his son. Here, A is the grantor,
B is the fiduciary, while C is the beneficiary. A and B are considered related for this purpose, hence, interest
accruing to either A or B is non-deductible.
d. Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect
to each trust; or
Illustration:
Assume that A also appoints D (trustee) to manage the properties of A for the benefit of C, his son. Here, B
(first trustee or fiduciary) and D (second trustee or fiduciary) are also considered related because they have
the same grantor, A. Any interest accruing between themselves are also non-deductible.
e. Between a fiduciary of a trust and beneficiary of such trust.

Illustration:
In the same illustrations above, interest accruing between B or D and C, the beneficiary, is also non-
deductible.
3. If the indebtedness is incurred to finance petroleum exploration.
Optional Treatment of Interest Expense

At the option of the taxpayer, interest incurred to acquire property used in trade business or exercise of a profession
may be allowed as a deduction or treated as a capital expenditure, subject to depreciation. In the latter case, the interest
expense will essentially become part of the depreciation expense.
Summary of Rules on Deductible Interest:
Items Rules
Interest expense on tax delinquency or
deficiency, provided the tax is related to trade or
business or practice of profession Deductible in full amount
Keyword: interest owing to the government
Subject to Limit (Partial Deduction):
Interest expense xxx
Interest incurred for liabilities contracted in Less: Interest income subjected to FT xxx
connect to the conduct of trade, business or Multiplied 33% (xxx)
practice of profession Deductible interest expense xxx
If there is no interest income subjected to final tax,
such interest expense becomes deductible in full.
Interest related to acquisition of property used 1. Outright expense or
in trade or practice of profession may, at the 2. Capitalized and claimed as depreciation as part of
option of the taxpayer the cost of the asset
Interest incurred or paid:
a. To persons classified as related taxpayers
b. To finance petroleum exploration Non-Deductible
c. To preferred stockholders (treated as
dividends)
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Example 6:
Apple Corporation is engaged in trading business. The reported income and expenses for taxable year 2014 are as
follows:
Sales P 10,000,000
Cost of Sales 6,000,000
General Business Expenses 1,000,000
Interest on Peso Time Deposit, gross amount 100,000
Interest earned under foreign currency deposit system, gross amount 20,000
Interest from Installment Receivables 120,000
Interest Expenses Claimed:
On loans payable 180,000
On Deficiency Taxes 30,000
On a loan from B Corp., a parent company 10,000
How much is the total deductible interest expense?
Solution:
Interest on deficiency tax (deductible in full) P 30,000
Interest on loan (partial deduction):
Interest claimed P 180,000
Interest on Peso Deposit P 100,000
Interest on Foreign Currency 20,000
Total Interest subjected to FT P 120,000
Multiplied 33%
Threshold (Limit) P 39,600 ( 39,600)
Deductible Amount 140,400
Total Deductible Interest P 170,400
TAXES
General Rule: Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or
business, shall be allowed as deduction, except:
a. Income tax
b. Income taxes imposed by and paid to authority of any foreign country (they are claimed as tax credits subject to
limitation); however, when the taxpayer does not signify the same as tax credits, deduction for taxes paid to
foreign country shall be allowed;
c. Estate and donor's taxes; and
d. Special Asessment – taxes assessed against local benefits of a kind tending to increase the value of the property
assessed.
Taxes allowed to be deducted from gross income, when refunded or credited, shall be included as part of gross income in
the year of receipt to the extent of the income tax benefit of said deduction.
Limitations on Deductions
In the case of a nonresident alien individual engaged in trade or business in the Philippines and a resident foreign
corporation, the deductions for taxes shall be allowed only if and to the extent that they are connected with income from
sources within the Philippines.
Credit Against Tax for Taxes of Foreign Countries
If the taxpayer signifies in his return his desire to credit the tax paid in foreign countries, the income tax due thereon
shall be credited with:
a. Citizen and Domestic Corporation. In the case of a citizen of the Philippines and of a domestic corporation, the
amount of income taxes paid or incurred during the taxable year to any foreign country (only RC and DC may
claim tax credits as they are taxed globally – meaning, regardless of the source of income); and
b. Partnerships and Estates. In the case of any such individual who is a partner of a general professional partnership
or a beneficiary of an estate or trust, his proportionate share of such taxes of the general professional partnership
or the estate or trust paid or incurred during the taxable year to a foreign country, if his distributive share of the
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income of such partnership or trust is reported for taxation purposes. A partner may claim a proportionate share
of tax credit paid to foreign country only if he is a resident citizen.
An alien individual and a foreign corporation shall not be allowed the credits against the tax for the taxes of foreign
countries allowed for tax credits because they are only taxed for their income in the Philippines, without regard to their
income outside the Philippines.
Limitations on Credit
The amount of the credit allowed to be charged against the income tax due shall be subject to each of the following
limitations:
a. The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same
proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources within
such country bears to his entire taxable income for the same taxable year; and
b. The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken,
which the taxpayer's taxable income from sources outside the Philippines taxable to his entire taxable income
for the same taxable year.
Formula:
If the source outside comes only from one country,
Tax Limit = Taxable Income Outside the Philippines x Total Tax Due in the Philippines
Total Taxable Income (within and outside)
Compare the tax limit computed with the actual tax paid in such foreign country. The lower amount is the creditable
amount.
If the sources outside comes from two or more countries,
Tax Limit 1, Per Country = ____Taxable Income in Country A______ x Total Tax Due in the Philippines
= ____Taxable Income in Country B______ x Total Tax Due in the Philippines

Tax Limit 2, All Countries = Total Taxable Income Outside __ x Total Tax Due in the Philippines
Compare the tax limit 1 computed per country with the actual tax paid in each country. Choose the lower amounts.
Compare the tax limit 2 computed for all countries with the actual tax paid in all countries. Choose the lower amount.
Compare the Tax Limit 1 and Tax Limit 2. Choose the lower amount.
Example 7:
A domestic company has the following income and expenses during the year 2018:
Philippines China New Zealand
Sales P 4,000,000 P 2,000,000 P 3,000,000
Cost of Sales 2,300,000 1,000,000 1,400,000
Expenses 700,000 600,000 1,000,000
Income Tax Paid to Foreign Country 200,000 150,000
Assuming the corporate tax rate is 30%, how much is the tax due and payable?
Solution:
Philippines China New Zealand
Sales P 4,000,000 P 2,000,000 P 3,000,000
Cost of Sales ( 2,300,000) ( 1,000,000) ( 1,400,000)
Gross Income P 1,700,000 P 1,000,000 P 1,600,000
Expenses ( 700,000) ( 600,000) ( 1,000,000)
Net Taxable Income P 1,000,000 P 400,000 P 600,000
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Consolidated Income (within and outside) P 2,000,000

Tax Rate 30%
Income Tax Due P 600,000
Computing Tax Credit:
Limit 1: Per Country Basis
China = P 400,000 x P 600,000

P 2,000,000
China = P 120,000, lower amount
Actual Tax Paid = P 200,000
New Zealand = P 600,000 x P 600,000 Combine the two

P 2,000,000 lower amounts.
New Zealand = P 180,000
Actual Tax Paid = P 150,000, lower amount
Total Tax Credit under Limit 1 is P 270,000.
Limit 2: All countries

All Countries = (P 400,000 + P 600,000) x P 600,000
P 2,000,000
All Countries = P 300,000
Actual Tax Paid = P 350,000 (such as P 200,000 plus P 150,000)
Tax Credit under Limit 2 is P 300,000 – the lower amount.
Therefore, the allowable tax credit in this case is only P 270,000 since it is still lower than limit 2. Thus,
Tax Due in the Philippines P 600,000

Less: Tax Credit ( 270,000)
Tax Due and Payable P 330,000
Remember that as a rule, the resident citizen and domestic corporation must signify that they are claiming tax credits
for the taxes they paid in foreign countries. Otherwise, the taxes paid thereon shall be allowed as tax deduction against
the gross income.
Adjustments on Payment of Incurred Taxes
If accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in
whole or in part, the taxpayer shall notify the Commissioner; who shall re-determine the amount of the tax for the year
or years affected, and the amount of tax due upon such re-determination, if any, shall be paid by the taxpayer upon
notice and demand by the Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to the
taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition precedent to the allowance
of this credit may require the taxpayer to give a bond with sureties satisfactory to and to be approved by the
Commissioner in such sum as he may require, conditioned upon the payment by the taxpayer of any amount of tax found
due upon any such redetermination. The bond herein prescribed shall contain such further conditions as the
Commissioner may require.
Year in Which Credit Taken
The tax credits allowed may, at the option of the taxpayer and irrespective of the method of accounting employed in
keeping his books, be taken in the year which the taxes of the foreign country were incurred, subject, however, to the
conditions of adjustments, when applicable. If the taxpayer elects to take such credits in the year in which the taxes of
the foreign country accrued, the credits for all subsequent years shall be taken upon the same basis and no portion of any
such taxes shall be allowed as a deduction in the same or any succeeding year.
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Proof of Credits
The tax credits shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following:
a. The total amount of income derived from sources without the Philippines;
b. The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit, such
amount to be determined under rules and regulations prescribed by the Secretary of Finance; and
c. All other information necessary for the verification and computation of such credits.
Example 8:
Taxes paid by a corporation within a year were:

Normal Income tax P 500,000
Improperly Accumulated Profit Tax 300,000
Capital Gain Tax 740,000
Final tax 50,000
Community Tax 10,500
Value-Added Tax 89,000
Local taxes and licenses 10,000
Interest for late payment of national and local taxes 40,000
Surcharges for late payment of national and local taxes 60,000
The deduction for taxes is:
Solution: Only P 20,500 – that is, Community Tax P 10,500 and local taxes and licenses P 10,000. The income tax,
improperly accumulated profit tax, capital gains tax, and final tax are all income taxes. The value-added tax cannot be
deducted from gross income because they are treated differently, against the Output VAT. The interest for late payment
may be deducted but as interest, not as taxes. The surcharges cannot be deduct at all because such arise from non-
compliance of the law and thus, must not be tolerated.
LOSSES
General Rule: Losses actually sustained during the taxable year, and not compensated for by insurance or other forms of
indemnity shall be allowed as deductions:
a. If incurred in trade, profession or business;

b. Of property connected with the trade, business or profession, if the loss arises from fires, storms, shipwreck, or
other casualties, or from robbery, theft or embezzlement.
c. No loss shall be allowed as a deduction under this Subsection if at the time of the filing of the return, such loss
has been claimed as a deduction for estate tax purposes in the estate tax return.
Requisites: A taxpayer claiming losses as a deduction from its gross income must concur the following requirements:
a. The loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement;
b. The property lost is connected with the trade, business or practice of profession;
c. Actually sustained and the loss thereof is ascertain during the taxable year;
d. Not compensated for by insurance or other forms of idemnity, if compensated with insurance, only that portion
which is not covered by insurance may be deducted;
e. Reported with the BIR within forty-five (45) days from the time of loss; and
f. Not claimed as deduction for estate tax purposes.
Casualty Losses
These are losses arising from casualty such as floods, typhoons, shipwreck, theft and other forms of casualties.
Example 9: The asset lost was a capital asset
Cost or adjusted basis (depreciated value) P 18,000

Value of property before casualty 15,000
Value of property after casualty 10,000
Insurance recovered 3,000
How much is the deductible loss?
Page 11 of 23
Solution:
We already know the concept of capital loss. It arises when the asset sold is a capital asset. Real properties classified as
capital asset that is not used in business are subject to 6% capital gains tax. Personal properties classified as capital asset
such as personal car, jewelries and others are subject to normal tax; capital gains are added to the gross income, while
capital loss is deducted only from the capital gains. If the person selling such capital assets is an individual taxpayer,
holding period applies, and net capital loss shall be carried over for one year.
However in this case, the capital asset was not sold, but destroyed by a casualty. In this case, we shall account the loss
based on the difference between the value of the property before the casualty and the value of the property after the
casualty. The cost or the adjust basis (depreciated value) will not matter because the property is not used in business,
thus allowance for depreciation does not actually applies. Hence,
Value of property before casualty P 15,000

Less: Value of property after casualty ( 10,000)
Actual Loss Sustained on Capital Asset P 5,000
Less: Insurance or Indemnification Received ( 3,000)
Deductible Loss on Capital Asset P 2,000
Take note that holding period still applies in this case, which means there is a need to ascertain the period that the
taxpayer held such property, if the taxpayer is an individual taxpayer. This loss computed can be deducted only if there
is a capital gains. See the rules on Net Capital Loss Carry-Over for review.
Example 10: The asset lost was an ordinary asset, and there is a total destruction.
Acquisition Cost P 10,000
Accumulated Depreciation 4,000
Insurance Recovered 2,500
Solution:
Here, the computation of the loss is illustrated as follows:

Less: Accumulated Depreciation ( 4,000)
Book Value of the Asset Lost P 6,000
Less: Insurance Recovered ( 2,500)
Deductible Loss on Ordinary Asset – Total Loss P 3,500
When there is no indemnity or insurance for the asset lost, the entire book value is deductible.
Example 11: The asset lost was an ordinary asset, but there is only a partial destruction.

Accumulated Depreciation 90,000
Replacement Cost to restore the property back to its
normal operating condition 20,000
Insurance Recovered 5,000
Estimated remaining useful life after the repairs 5 years
Solution:
In this case, there is only a partial destruction which means that the property can still be repaired back to its normal
condition. The computation of deductible loss is as follows:

Less: Accumulated Depreciation ( 90,000) Replacement Cost is
Book Value of the Asset 10,000 higher than the
Compare with the Replacement Cost to restore the asset 20,000 book value!
When the replacement cost is higher than the actual book value, the lower amount (book value) may be claimed as the
deductible loss because the deductible loss cannot exceed the book value of the asset. So in this case, the deductible
Page 12 of 23
loss is only P 10,000. However, since the company spent P 20,000 to restore the property, it means to say that it only
benefited P 10,000 (as a loss) out from the total expenditure of P 20,000. Thus:
The Replacement Cost to restore the asset P 20,000

Less: Deductible Loss – Tax Benefit ( 10,000)
Money Spent but not claimed as deduction P 10,000
Less: Insurance Recovery ( 5,000)
Net Money Spent and not allowed for deduction P 5,000
As observed, there is a net amount of P 5,000 which is not allowed by law for deduction. However, this amount may be
capitalized! Treated as asset since it is capitalized on the account of the property, the P 5,000 shall be depreciated over
the remaining useful life of the asset.
Special Rules on Net Operating Loss Carry-Over (NOLCO)
Net operating loss means the excess of allowable deductions over gross income of the business in a taxable year. When
a taxpayer’s allowable deduction (those items allowed by the Tax Code to be deducted from gross income) exceeds the
gross income for any given taxable year, such taxpayer is said to have a net operating loss. This condition is almost similar
to that net loss in accounting, but different in that, the amounts used to compute the allowable deduction is in
accordance with the provisions of the law, subject to limitations. Nevertheless, the idea is the same; the taxpayer has a
net operating loss.
The net operating loss of the year may be carried forward in the next three years or until such loss is totally eliminated,
whichever is shorter. This is called NOLCO or net operating loss carry-over. If after the three-year period, the loss was
not entirely deducted from the gross income, such loss can no longer be carried over.
The following rules shall apply when forwarding the net operating loss:
1. The net operating loss of the business or enterprise for any taxable year shall be carried over as a deduction from
gross income for the next three (3) consecutive years immediately following the year of such loss.
2. Provided that, at the time of incurring net loss, the taxpayer must not be exempted from income tax. Exempted
taxpayers do not benefit from NOLCO because they do not pay income taxes.
3. Provided further, that there is no substantial change in the ownership of the business or enterprise in that, not less
than seventy-five percent (75%) in the par value (nominal value) or paid-up capital (in case of no par value) of
outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons.
4. For mines other than oil and gas wells, net operating loss incurred in any of the first ten (10) years of operation may
be carried over for the next five (5) years after the incurrence of such loss.
5. The following taxpayers are permitted to deduct NOLCO from their gross income:
 Individual taxpayers engaged in trade or business or in the exercise of profession;
 Domestic and resident foreign corporation subject to normal income tax (30%).
 Special corporation subject to preferential tax rates such as private educational institutions, hospitals, and
regional area headquarters
Any persons, natural or juridical, enjoying exemptions from income tax pursuant to the provisions of the Tax Code and
any special law shall not be entitled to deduct NOLCO from gross income. Also, corporate taxpayers who are subject to
gross income tax, rather than the income tax imposed on the net taxable income, such as those registered with PEZA
cannot enjoy the benefit of NOLCO because they are taxed at their gross income, not on their net income.
Example 12:
Star Excellence Corporation, a domestic taxpayer, began its operation in 2001. It had the following data:
2015 2016 2017 2018 2019

Gross Sales P 1,500,000 P 1,900,000 P 1,880,000 P 1,840,000 P 1,980,000
Cost of Sales 700,000 1,000,000 1,030,000 970,000 1,010,000
Allowable Deductions 980,000 880,000 900,000 930,000 820,000
Compute the income to be recognized in every year.
Page 13 of 23
Solutions:
The net income (loss) of Star Excellence each shall be computed as follow:
2015 2016 2017 2018 2019

Gross Sales P 1,500,000 P 1,900,000 P 1,950,000 P 1,840,000 P 1,980,000
Less: Cost of Sales ( 700,000) ( 1,000,000) ( 1,000,000) ( 970,000) ( 1,010,000)
Gross Income P 800,000 P 900,000 P 950,000 P 870,000 P 970,000
Less: Deductions ( 980,000) ( 880,000) ( 900,000) ( 930,000) ( 820,000)
Net Income (Loss) (P 180,000) P 20,000 P 50,000 (P 60,000) P 150,000
NOLCO from:
2015 ( 20,000) ( 50,000) 0
2016 0 0 0
2017 0
2018 ( 60,000)
Net of NOLCO (P 180,000) 0 0 (P 60,000) P 90,000
Observations:
1. The net operating loss in 2015 of P 180,000 may be carried forward and charged against the income in the next
three years (2016, 2017 and 2018). However, in 2016, there is only a net income before NOLCO of P 20,000, which
means only P 20,000 of the net operating loss from 2015 may be carried forward in 2016. Thus, there is a remaining
P 160,000 loss balance in 2015, which can still be carried forward in 2017 and 2018.
2. In 2017, there is only a net income before NOLCO of P 50,000. This means that from the remaining loss of P 160,000
in 2015, only P 50,000 may be charged against the income of 2017. The remaining P 110,000 loss in 2015 can still
be forwarded in 2018 – the last and final year for forwarding of NOLCO.
3. In 2018 however, there is a net loss of P 60,000, which means no loss from 2015 may be forwarded in 2018 because
it will only bloat the loss.
4. But since 2018 is the final year for the forwarding of loss, the remaining P 110,000 net operating loss in 2015 can no
longer be forwarded in 2019 and so on. The remaining loss balance in 2015 is deemed to expire after 2018.
5. The P 60,000 loss in 2018, however, may be carried forward in the next three years (2019, 2020, and 2021).
6. In 2019, there is a net income of P 150,000, and such amount is more than enough to absorb the loss in 2018. Thus,
the net operating loss of P 60,000 in 2018 can be fully credited against the income in 2019.
NOLCO versus NCLCO

o Net operating loss occurs when the allowable deductions claimed exceeds the gross business income, while net
capital loss occurs when, in case of individual taxpayers, the capital loss exceeds capital gains.
o Net operating loss of any given year may be forwarded and charged against the net income before NOLCO of the 3
succeeding years, while net capital loss may be forwarded only in the immediate succeeding year after such capital
loss was sustained, and may be charged only against capital gains.
o NOLCO is available to both individual and corporate taxpayers doing business, whereas, NCLCO is available only to
individual taxpayers.
Special Rules on Losses arising from Wash Sales of Stocks or Securities
A wash sale is a situation whereby a non-dealer of stocks or securities, or simply an investor, sells identical stocks or
securities of the same issuing corporation resulting to a loss, thereby ‘washing’ out or eliminating the taxable income,
thus, avoiding the payment of tax. Identical stocks are those shares of stocks or securities of any registered corporation
having the same rights and features.
When a dealer of stocks incurs a loss, it is actually normal because it is part of his business. But, losses incurred by non-
dealers of stocks becomes questionable especially if he did so with the intention of reducing the tax. In such case, any
loss claimed to have been sustained from any sale or other disposition of shares of stocks or securities shall not be
deductible if the following conditions are present:
a. The seller is not a dealer in securities

b. The loss sustained is actual, and does not merely arise from shrinkage of stock prices.
c. Within a period of 30 days before the sale or 30 days after the sale, the seller either:
o Acquired (by purchase or exchange) stocks or securities which are identical to the stock or securities sold;
or
o Has entered into a contract or option to acquire stock or securities identical to the stock or securities sold.
Page 14 of 23
Example 13:
A sold, not a dealer in securities, has the following transactions during the year:
1/15/2018 Purchased 5,000 shares at P 12.00 each from ABC Corp.

2/1/2018 Purchased 1,000 shares at P 13.00 each month from ABC Corp. (identical stocks).
2/28/2018 Sold 1,800 shares from the first purchase at P 10.00 each.
3/5/2018 Purchased 800 stocks from XYZ Company at P 11.00 each
3/17/2018 Purchased 500 identical shares from ABC Corp. at P 11.00 each.
How much is the deductible loss arising from the sale of stocks in February 28, 2018?
Solution:
The first thing to do is to compute the loss. The problem is silent as to what method is used, thus the First-In-First-Out
Method shall be used by default.
Sale of 1,800 Stocks at P 10.00 each P 18,000

Less: Cost of each stock at P 12.00 (1/15/2018) ( 21,600)
Loss on Sale P 3,600
If the seller above is a dealer, the loss on sale will be automatically deductible. But since he is not, the loss shall be further
investigated to determine how much is deductible and how much is not. In doing so, it is important to identify whether
there are acquisitions of identical stocks during the 30-day period prior to the date of sale, and during the 30-day period
after the date of sale.
1/15/2018 2/1/2018 2/28/2018 3/5/2018 3/17/2018

5,000 stocks 1,000 stocks Sale of 1,800 stocks 800 Stocks 500 stocks
ABC Corp. ABC Corp. XYZ Co. ABC Corp.
30 days prior 30 days after
From the above, let us eliminate the purchase from XYZ Company since the stocks purchased were not identical or similar
to that sold in February 28, 2018. So, there were only two purchases which fall during the 60-day period: the purchase
of 1,000 stocks in February 1 and the purchase of 500 stocks in March 17. From there, we get a total acquisitions of
identical stocks of 1,500 (1,000 plus 500). After which, the computation of non-deductible loss is shown below:
Non-Deductible Loss = Total Identical Stocks Acquired x Loss

Total Shares Sold
Non-Deductible Loss = 1,500 shares x P 3,600
1,800 shares
Non-Deductible Loss = P 3,000, thus the only deductible loss is P 600
The P 3,000 non-deductible loss is capitalized and added to the cost per share of the shares acquired, while the P 600
may be deducted from the gross income. The reason for such allocation is that taxpayers especially non-dealers are
discouraged to intentionally sell their investments at a lower price to incur loss, so as to decrease their taxable income,
but intends to recoup the loss by purchasing an identical stocks within the 60-day period. Such practice is not illegal, but
rather prohibited.
The non-deductible loss shall be allocated and capitalized as follows:
Capitalizable Loss = Acquisition 1 x Non-deductible loss
Total Shares
Capitalized (1,000) = 1,000 shares x P 3,000
1,500 shares
Capitalized (1,000) = P 2,000
The P 2,000 allocable amount shall be capitalized to the original cost. Thus the new cost per share shall be computed as
follows:
Page 15 of 23
New Cost per Share = (Old Cost per Share x # of Shares Acquired) + Capitalizable Loss
Number of Shares Acquired
New Cost per Share = (P 13.00 x 1,000 shares) + P 2,000
1000 shares
New Cost per Share = P 15.00
When these shares are sold, the new cost per share shall be reflected. Remember that, this procedure is not accounted
in books of the taxpayer which normally follows the PFRS or IFRS. This difference is called permanent difference, because
the tax base is different from the book value. For the 500 stock acquisition, the same formula and process above will
apply.
What will happen if the number of identical shares acquired is greater than the number of shares sold?
In such case, the numerator will be greater than the denominator, thus it will be illogical to use the formula since it will
only bloat the non-deductible loss:
Non-Deductible Loss = Total Identical Stocks Acquired x Loss

Total Shares Sold
If such condition happen, the entire loss becomes non-deductible and there is no need to allocate the amount of loss
using the above formula.
Summary:
Dealer of Stocks or Securities Non-Dealers, Investors or Speculators
6/10 of 1% percentage tax based on

Sales of stocks which are
selling price
traded in the stock market or
local stock exchange (e.g. 6/10 of 1% percentage tax based on
Gains or losses (Selling Price less
stocks of publicly-listed selling price
Costs) will always be included in
companies)
computing the gross income.
Situation 1: With capital gain

15% CGT of the capital gains
(selling price less cost of stocks) – See
discussions on Dealings in Properties.
No tax applicable since he is a
Situation 2: With capital loss
dealer in stocks and securities,
Sale of stocks which are not o If wash sale, either non-deductible or
unless he has his own investment in
traded in the stock market or partially deductible against capital
stocks which are not traded in the
local stock exchange gains.
stockmarket. If so, the rules on non-
o If not wash sale, deductible in full.
dealers will apply.
In both cases in Situation 2, rules on net
capital loss carry-over will apply, subject to
holding period (if individual taxpayer) and
only to the extent of capital gains.
Special rules on Abandonment losses
In the event a contract area where petroleum operations are taken is partially or wholly abandoned, all accumulated
exploration and development expenditures pertaining thereto shall be allowed as deduction. In case a producing well is
subsequently abandoned, the unamortized costs thereof, as well as the undepreciated costs of equipment directly used
therein, shall be allowed as deduction.
If the abandoned well is re-entered and production is resumed or equipment is restored into service, the effects are:
 The amount previously claimed as deduction shall be recognized as income; and
 Such amount shall also be capitalized and amortized or depreciated, as the case may be.
Page 16 of 23
BAD DEBTS
A bad debt is an amount of receivable which subsequently becomes worthless or uncollectible. Accounting standards
and the Tax Code differs in recognizing bad debts as an expense. For taxation purposes, a bad debt is expensed or allowed
for deduction if and only if it is ascertained to be worthless and has been actually written off.
Requisites for deductibility:
1. There is an existing debt due to the taxpayer which must be valid and legally demandable.
2. The debt is connected with the taxpayer’s trade, business or practice of profession.
3. The debt is not transacted between related taxpayers. (See discussions on interest.)
4. The debt must be actually written off, not just merely estimated, in the books of accounts of the taxpayer as of the
end of the taxable year.
5. The debt must be actually ascertained to be worthless and uncollectible.
Accounts previously written off which are later recovered shall be taxable to the extent of the amount which benefited
the taxpayer (tax benefit rule), meaning the tax shield which was availed and for which had benefited the taxpayer
Example 14:
As the new accountant of Zeemar Company, Bea suggested to her boss that there is a need to recognize a provision on
accounts which are deemed to be doubtful as regards to its collectibility. She suggested that PAS 39 requires financial
asset to be measured at fair value, and for receivables, subsequent measurement must be the net realizable value. Her
boss agreed and asked her to investigate the account receivables. She prepared the following schedule for 2017:
Debtor Amount Involved Days Over Due Percentage of Collection

ABC Company P 500,000 45 days 98%
DEF Company P 1,300,000 57 days 97%
GHI Company P 800,000 95 days 95%
JKL Company P 210,000 135 days 92%
In 2018, JKL Company declared itself bankrupt and can no longer pay any of its debt. How should this be accounted both
under PFRS and Tax Code?
Solution:
The PFRS provides accounting for doubtful accounts, while the Tax Code does not account for expense unless such
account becomes worthless. Thus, the comparative solution below is presented:
Treatment Under PAS/PFRS

Treatment Under Tax Code
Amount % of Uncollectibility Doubtful Accounts
P 500,000 2% P 10,000
P 1,300,000 3% P 39,000
P 800,000 5% P 40,000
P 210,000 8% P 16,800
Total Expense in 2017 P 105,800 No Expense deductible in 2017
The entry in the books in 2017 shall be:
Doubtful Accounts P 105,800

Allowance for Doubtful Accounts P 105,800
In 2018, when the receivable from JKL Company is ascredtained to be worthless, the books will simply write it off. But
for income taxation purposes, such amount actually written off shall be considered as an expense and may be allowed
for deduction against the gross income.
Assuming the amount previously written off is recovered in 2020, such amount is recognized as an income in the books
and is taxable for income taxation purposes. The reason is that, such amount previously deducted when written off
benefited the taxable year it was written off by reducing the income, thus the tax. To recover such loss of income due
to the government, the law imposes a tax on such amount recovered.
Page 17 of 23
DEPRECIATION
Depreciation is the “systematic allocation of the depreciable amount of an asset over its useful life.” It is the decrease of
the value of any property used in the trade, business or the practice or profession of the taxpayer.
Requisites for deductibility:
1. The property subject to depreciation is used in the trade, business or practice or profession.
2. The allowance for depreciation must be sustained by the person who owns or who has a capital investment in the
property.
3. The allowance for depreciation must be reasonable.
4. The allowance for depreciation should not exceed the cost of the property.
5. The schedule of the allowance must be attached to the return.
Depreciation Methods
Depreciation methods were already taught in basic accounting subjects. But for taxation purposes, the following
methods may be used in allocating the cost of the property:
1. Straight-line method. This is the most common depreciation method used in taxation. Under this method, the cost
of the property is reduced by the salvage value at the end of its useful, and then divided by the useful life usually
expressed in years.
Formula:
Depreciation = Cost of the Property – Salvage Value
Useful Life
Example 15:
RB Pawnshop brought three computer set with a total cost of P 30,000 each for the use in its business. The
computers were estimated to be useful for 5 years. At the end of the five-year period, the computers may be sold
for a salvage value of P 2,000 each. Compute the depreciation that may be deducted from the gross income.
Solution:
Depreciation = (P 30,000 x 3 units) – (P 2,000 x 3 units)
5 years
Depreciation = P 16,800 per year
At the end of the five-year period, when the computers are sold for P 3,000 each, the gain of P 1,000 each (P 3,000
less the book value of P 2,000) shall treated as taxable income.
2. Declining-Balance Method. This method is applicable when the property is essentially used in its earlier years.
Formula:
Rate = 1 – n √𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 ÷ 𝐶𝑜𝑠𝑡
Where n represents the useful year.
Example 16:
Assume the same given in Example 15, but the company used the declining-balance method, compute the annual
depreciation.
Solution:
Rate = 1 – 5 √𝑃 6,000 ÷ P 90,000

Rate = 41.82%
The rate computed will be used in calculating the annual depreciation.

Years Rate Depreciation per Year Balance___
0 None None P 90,000.00
1 41.82% P 37,638.00 52,362.00
2 41.82% 21,897.79 30,464.21
3 41.82% 12,401.13 17,724.08
4 41.82% 7,412.21 10,311.87
5 41.82% 3,311.87 6,000.00
Page 18 of 23
3. Sum of the Years Digit (SYD) Method. This method is almost the same as the declining balance method in that the
depreciation per year gradually decreases. However, the main difference of this method from the declining balance
method is that it allocates the depreciation based on the sum of the years.
Sum of Years = Life ( Life + 1 )

2
Example 17:
Assume the same example in Example 15 but the company uses the Sum-of-the-Years Digit Method, compute the
annual depreciation.
Solution:
Sum of Years = Life ( Life + 1 )

2
Sum of Years = 5 (5 + 1 )
2
Sum of Years = 15
The sum computed will be used in allocating depreciation using the fractional share per year.
Years Fraction Depreciation per Year

0 None None
1 5/15 P 28,000*
2 4/15 22,400**
3 3/15 16,800
4 2/15 11,200
5 1/15 5,600
*5/15 x (P 90,000 – P 6,000)
**4/15 x (P 90,000 – P 6,000) and so on
4. Any other method which may be prescribed by the Secretary of Finance upon recommendation of the
Commissioner.
Special Rules on Properties Used in Petroleum Operations

For properties directly related to production, the following rules on depreciation shall apply:
1. Straight-line method; OR
2. Declining balance method
Useful life to be used in either of the above methods, should be the property’s useful life or 10 years, whichever is shorter.
For properties not directly related to production, the following rules shall apply:
1. Only straight-line method is used.
2. Useful life is always presumed to be 5 years.
Special Rules on Properties Used in Mining Operations

For properties used in mining operations, the following rules shall apply:
1. If expected life of the property is 10 years or less, use the normal rate of depreciation, which means depreciate over
the actual useful life.
2. If expected life is more than 10 years, depreciate over any number of years between 5 and expected life.
3. In the case of a nonresident aliens engaged in trade or business (NRAETB) or a resident foreign corporation (RFC),
depreciation shall be allowed only if the property is located in the Philippines.
4. Allowance for obsolescence may be deducted in addition to the reasonable allowance for the exhaustion, wear and
tear.
DEPLETION
Depletion is similar to depreciation. It is a periodic charge to expense for the extraction or exhaustion of natural
resources. Depletion is very common to mining and timber business.These natural resources exhausted and exhausted
by those businesses are called wasting assets. As the physical units representing such resources are extracted and sold,
such assets move towards exhaustion.
Page 19 of 23
In case of oil and gas wells or mines, capital invested may be amortized using the cost-depletion method, provided:
1. When allowance for depletion shall equal to capital invested, and no further allowance shall be granted.
2. After production in commercial quantities has commenced, intangible exploration and development drilling costs shall
be treated as:
a. If incurred for non-producing wells and/or mines, deductible entirely in the year incurred.
b. If incurred for producing wells and/or mines:
o Deductible in full in the year paid or incurred; or
o Capitalized and amortized at the election of the taxpayer.
Intangible costs in petroleum operations refers to any cost incurred in petroleum operations which in itself has no salvage
value and which is incidental to and necessary for the drilling of wells and preparation of wells for the production of
petroleum, provided that, said costs shall not pertain to the acquisition or improvement of property of a character subject
to the allowance for depreciation except that the allowances for depreciation on such property shall be deductible. Any
intangible exploration, drilling and development expenses allowed as a deduction in computing taxable income during
the year shall not be taken into consideration in computing the adjusted cost basis for the purpose of computing
allowable cost depletion.
In the case NRAETB or resident foreign corporation, depletion shall be allowed only if the oil and gas wells or mines are
located in the Philippines.
Example 18:
Land containing natural resource was purchased for P 110,950,000. It was estimated that the land, after exploration and
exhaustion of its natural resurce resource, will have a value of P 950,000. It was estimated that the natural resources
available for exhaustion was 5,000,000 tons. During 2018, 500,000 tons were extracted. How much is the deduction for
depletion for the year?
Solution:
Depletion for 2018 is computed as follows:
Purchase Price of the Property P 110,950,000
Less: Residual Value of the Land after Exhaustion ( 950,000)
Depletable Amount P 110,000,000
Divided by: Available Resource as estimated (in tons) 5,000,000
Depletion Rate per Ton P 22.00
Multiplied: Resource Extracted during the year 500,000
Depletion for 2018 P 11,000,000
Example 19:
Assuming the same example above, but the estimated total available remaining resource is 4,200,000 tons. Compute
the depletion for 2019 if 450,000 tons were exhausted.
Solution:
Depletion for 2019 is computed as follows:
Purchase Price of the Property P 110,950,000

Less: Residual Value of the Land after Exhaustion ( 950,000)
Depletable Amount P 110,000,000
Less: Depletion recognized in 2018 ( 11,000,000)
Remaining Depletable Amount P 99,000,000
Divided by: Remaining Available Resource as estimated (in tons) 4,200,000
Depletion Rate per Ton P 23.57
Multiplied: Resource Extracted during the year 450,000
Depletion for 2019 P 10,606,500
Page 20 of 23
CHARITABLE CONTRIBUTION
Charitable and other contributions and donations may be deductible fromm gross income in full, or subject to limitation.
Fully Deductible Contributions

Contributions are deductible in full under the following conditions:
1. Donations to the Government of the Philippines or any of its agencies or political subdivisions including fully owned
government corporations, exlusively to be used in undertaking priority activities in:
a. Culture e. Economic Development
b. Health f. Sports Development
c. Human Settlements g. Science
d. Education h. Youth
2. Donations to foreign institutions or international organizations which are fully deductible.
3. Donations to Accredited Non-Government organizations organized and operated exclusively for Scientific, Research,
Educational, Character Building; Youth and Sports Development, Health, Social Welfare; Cultural, Charitable purposes
and a combination thereof, PROVIDED, that no part of NET INCOME of which inures to the benefit of any private
individual and not more than 30% of such contributions are utilized for administrative purposes.
Contributions subject to Limit
Contributions are deductible subject to limitations under the following conditions:

1. Donations to the Government of the Philippines or any of its agencies or political subdivisions including fully owned
government corporations, to be used in a non-priority activities, but exclusively for public purpose.
2. For corporations, the limit is 5% of the taxable income from trade or practice of profession before the deduction for
charitable contributions.
3. For individuals, the limit is 10% of the taxable income from trade or practice of profession before the deduction for
charitable contributions.
Comparative Formula:
Individual Taxpayer Corporate Taxpayer
Gross Income P xxx Gross Income P xxx

Less: Itemized Deductions before Contributions ( xxx) Less: Itemized Deductions before Contributions ( xxx)
Net Taxable Income before Contributions xxx Net Taxable Income before Contributions xxx
Multiplied: Limit 5%_ Multiplied: Limit 10%
Threshold xxx Threshold xxx
Compare with Actual Amount xxx Compare with Actual Amount xxx
(Choose whichever is lower.) (Choose whichever is lower.)
Example 20:
JJ Co.had a gross income from business of P 1,000,000, business expenses of P 400,000, and contributions deductible
but subject to limitation to KK Association of P 10,000 and LL Association of P 40,000. Compute the taxable income of
JJ Co.
Solution:
Gross Income P 1,000,000
Less: Business Expenses excluding Contributions ( 400,000)
Net Taxable Income Before Contributions 600,000
Less: Contributions
ACTUAL AMOUNT:
To KK Association P 10,000
To LL Association 40,000
Total P 50,000
LIMIT (P 600,000 x 5%) 30,000 ( 30,000)
Net Taxable Income P 570,000
Page 21 of 23
Example 21:
Mr. Lloyd, married, had a gross income from business of P 800,000 and business expenses of P 600,000. He made
contributions deductible in full of P 12,000, and contributions subject to limit of P 25,000. Compute the taxable income
of Mr. Lloyd.
Solution:
Gross Income P 800,000
Less: Business Expenses excluding Contributions ( 600,000)
Net Taxable Income Before Contributions 200,000
Less: Contributions
Deductible in full P 12,000
Subject to Limit (Actual) P 25,000
LIMIT (P 200,000 x 10%) 20,000 20,000 ( 32,000)
Net Taxable Income P 168,000
Contributions which are deductible in full are not included in determining the lower between the actual amount of
contributions subject to limit, and the 5% or 10% limit.
RESEARCH AND DEVELOPMENT
Research and development costs are for improvements of processes and formulas as well as the development of
improved or new products. Research and development costs may either be:
1. For acquisiton or improvements of property subject to depreciation or depletion used in research and development
2. Other research and development costs
The following rules will apply.
Acquisition or Improvements of Property Other Research and Development Costs
If chargeable to property, capitalize the cost, and At the option of the taxpayer:
include the cost in computing depreciation or OPTION 1 – Claim as outright expense; full expenditure
depletion. in the year of incurrence or payment
OPTION 2 – Amortize over 60 months from the date of
acquisition.
The following Research and Development expenditures are not deductible:
1. Any expenditure for the acquisition or improvement of land, or the improvement of property to be used in
connection with research and development of a character which is subject to depreciation and depletion; and
2. Any expenditure paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of any
deposit of ore or other mineral, including oil or gas.
Example 22:
A manufacturer of food seasoning is continuously conducting research and development on its product lines.
In 2018, it extended its research and development building at a cost of P 1,000,000, and incurred an aggregate
amount of P 1,800,000 for other research and development costs that will immediately benefit the company.
How are these costs treated for income tax purposes?
Solution:
The P 1,000,000 shall be capitalized and be depreciated since such costs were incurred for building the expansion. While,
the P 1,800,000, at the option of the taxpayer, may be deducted in full in the year 2018, or amortized over 60 months
beginning the date where the taxpayer benefits from such research and development expenditures.
PENSION TRUST
General Rule: An employer establishing or maintaining a pension trust to provide for the payment of reasonable pensions
to his employees shall be allowed as a deduction a reasonable amount transferred or paid into such trust during the
taxable year in excess of such contributions.
Exceptions: Such amounts are deductible only if:

1. It has not been allowed as a deduction before (past service cost), and
Page 22 of 23
2. It has been apportioned in equal parts over a period of ten (10) consecutive years beginning with the year in which
the transfer or payment is made.
Formula:
Actual contribution to the extent of pension (current service cost) xxx
Amortization of Past Service Cost xxx
Total xxx
Past Service Cost is the excess of actual contributions over the normal service cost. It shall be amortized over ten (10)
years.
Example 23:
ABC put up a qualified retirement plan approved by the BIR. It appointed B Corporation to administer the plan which
called for the payment of P200,000 to cover for the retirement of employees for past services rendered and a yearly
contribution. The following amounts were paid for the first three years of the plan’s operation:
Contribution for Services

Past Years Current Years
First Year P 100,000 P 50,000
Second Year 60,000 50,000
Third Year 40,000 50,000
Compute the pension expense each year.
Solution:
Current Years Past Years Divided by 10 Years Total Expense
First Year P 50,000 P 100,000 P 10,000 P 60,000*
Second Year P 50,000 P 60,000 P 6,000 P 66,000**
Third Year P 50,000 P 40,000 P 4,000 P 70,000***
TOTAL P 196,000
*P 50,000 + P 10,000 = P 60,000
**P 50,000 + P 10,000 + P 6,000 = P 66,000
*** P 50,000 + P 10,000 + P 6,000 + P 4,000 = P 70,000
ITEMS NOT DEDUCTIBLE

General Rule: In computing net income, no deduction shall in any case be allowed in respect to:
1. Personal, living or family expenses;
2. Any amount paid out for new buildings or for permanent improvements, or betterments made to increase the value
of any property or estate, except, intangible drilling and development costs incurred in petroleum operations which
are deductible under Depletion.
3. Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or
has been made; or
4. Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially
interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly
or indirectly a beneficiary under such policy.
Losses from Sales or Exchanges of Property

In computing net income, no deductions shall in any case be allowed in respect of losses from sales or exchanges of
property directly or indirectly.
1. Between members of a family. For purposes of this paragraph, the family of an individual shall include only his
brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants; or
2. Except in the case of distributions in liquidation, between an individual and corporation more than fifty percent
(50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; or
3. Except in the case of distributions in liquidation, between two corporations more than fifty percent (50%) in value
of the outstanding stock of which is owned, directly or indirectly, by or for the same individual if either one of such
corporations, with respect to the taxable year of the corporation preceding the date of the sale of exchange was
under the law applicable to such taxable year, a personal holding company or a foreign personal holding company;
4. Between the grantor and a fiduciary of any trust; or
5. Between the fiduciary of and the fiduciary of a trust and the fiduciary of another trust if the same person is a
grantor with respect to each trust; or
6. Between a fiduciary of a trust and beneficiary of such trust.
Page 23 of 23

Lecture 8 Allowable Deductions

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Lecture 8 Allowable Deductions

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ALLOWABLE DEDUCTIONS FROM GROSS INCOME

OPTIONAL STANDARD DEDUCTION (OSD)

Example of Erroneous Election of Deductions:

Example of Correct Election of Deductions:

Individual Taxpayers Corporate Taxpayers

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Gross Income from Business 1,590,000 1,443,000 1,520,000 1,550,000

Optional Standard Deduction:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

ITEMIZED DEDUCTIONS (EX IN TALOBA DEPDEP CHARD PET)

How much is the total deductible salaries and wages?

Rent Expense – Commercial Space P 250,000

P 2,000,000 x ½% = P 10,000, lower amount – deductible

Sale of Service: P 1,000,000 x P 21,000 = P 7,000, lower amount – deductible

Thus, the total deductible EAR is only P 17,000.

Bribes, Kickbacks, Facilitation Fees and Other Similar Payments

Expenses Allowable to Private Educational Institutions

Exception to the Rule: No deduction shall be allowed in respect of interest:

c. Between the grantor and a fiduciary of any trust; or

e. Between a fiduciary of a trust and beneficiary of such trust.

3. If the indebtedness is incurred to finance petroleum exploration.

Optional Treatment of Interest Expense

Summary of Rules on Deductible Interest:

Credit Against Tax for Taxes of Foreign Countries

If the source outside comes only from one country,

If the sources outside comes from two or more countries,

= ____Taxable Income in Country B______ x Total Tax Due in the Philippines

Consolidated Income (within and outside) P 2,000,000

Computing Tax Credit:

Limit 1: Per Country Basis

China = P 400,000 x P 600,000

New Zealand = P 600,000 x P 600,000 Combine the two

Total Tax Credit under Limit 1 is P 270,000.

Limit 2: All countries

Tax Credit under Limit 2 is P 300,000 – the lower amount.

Tax Due in the Philippines P 600,000

Adjustments on Payment of Incurred Taxes

Year in Which Credit Taken

Taxes paid by a corporation within a year were:

a. If incurred in trade, profession or business;

Cost or adjusted basis (depreciated value) P 18,000

How much is the deductible loss?

Value of property before casualty P 15,000

Acquisition Cost P 10,000

Acquisition Cost P 100,000

Acquisition Cost P 100,000

The Replacement Cost to restore the asset P 20,000

Special Rules on Net Operating Loss Carry-Over (NOLCO)

2015 2016 2017 2018 2019

Compute the income to be recognized in every year.

2015 2016 2017 2018 2019

NOLCO versus NCLCO

Special Rules on Losses arising from Wash Sales of Stocks or Securities

a. The seller is not a dealer in securities

1/15/2018 Purchased 5,000 shares at P 12.00 each from ABC Corp.

Sale of 1,800 Stocks at P 10.00 each P 18,000

1/15/2018 2/1/2018 2/28/2018 3/5/2018 3/17/2018

30 days prior 30 days after

Non-Deductible Loss = Total Identical Stocks Acquired x Loss

Non-Deductible Loss = Total Identical Stocks Acquired x Loss

Dealer of Stocks or Securities Non-Dealers, Investors or Speculators

6/10 of 1% percentage tax based on

Situation 1: With capital gain

= Taxable Income in Country B__ x Total Tax Due in the Philippines