INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

51

Chapter 8: Deductions from Gross Income

CHAPTER 8

DEDUCTIONS FROM GROSS INCOME

Problem 8 1 DEDUCTIBLE OR NONDEDUCTIBLE FROM GROSS INCOME 1. Deductible 2. Nondeductible 3. Nondeductible 4. Deductible, in lieu of tax credit (Sec. 34C3, NIRC) 5. Deductible 6. Nondeductible 7. Nondeductible 8. Deductible 9. Deductible 10. Nondeductible 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. Nondeductible Deductible Deductible Deductible Nondeductible Nondeductible Nondeductible Deductible Deductible Deductible

Problem 8 2 TRUE OR FALSE 1. True 2. True 3. False Business expenses related to business income outside the Philippines is deductible also. 4. False Business expense is deductible from gross income. 5. True 6. True 7. True Once OSD is opted, no capital loss could be deducted from capital gain. 8. False Some business expenses are nondeductible or subject to limit. 9. False Income outside the Philippines by a NRC is not taxable in the Philippines, hence, no allowable deduction is allowed. 10. True 11. False Compensation income is not subject to OSD. 12. False NOLCO is not an itemized deduction. 13. True Amortized over the term of the lease 14. False of 1% 15. False 33% 16. False Double declining method 17. True 18. True Problem 8 3 1. B 2. No choice, OSD=40% 3. D 4. D 5. D 6. C 7. B 8. D 9. B 10. C 11. C 12. D 13. C Problem 8 7 Problem 8 4 1. C 2. A 3. D 4. A 5. B 6. B 7. A 8. A 9. D 10. A Problem 8 5 1. A 2. A 3. C 4. C 5. A 6. D 7. C 8. A 9. B 10. C Problem 8 6 1. A 2. C 3. A 4. C 5. C 6. C 7. B 8. C 9. C 10. C 11. D 12. B Expensed Capitalized

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS
Change of motor of air condition Repainting of building Expansion of store Cleaning of computers Repair of furniture Problem 8 8 Salaries net of tax Withholding tax Deductible business expense A

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Chapter 8: Deductions from Gross Income

P60,000 P10,000 50,000 9,000 1,000 P20,000 . P110,000 P100,000 5,000 P105,000

Problem 8 9 A General rule: No personal or business expense is deductible from compensation income. Problem 8 10 D Depreciation expense (P1,000,000 x 40%)/25 Loss of business equipment Deductible expense Problem 8 11 D 1. A No personal or business expense is deductible. 2. B Depreciation (P20,000 x 10%) Repair (P100,000 x 10%) Office supplies Total deduction B P 2,000 10,000 6,000 P18,000 P16,000 38,000 P54,000

Problem 8 12

Tax laws GAAP Salary expense (P180,000 + P20,000) P200,000 P200,000 Estimated uncollectible accounts 10,000 Compromise penalty 50,000 Depreciation expense 30,000 30,000 Miscellaneous expense . 5,000 Deductible from earnings P230,000 P295,000 Note: For tax purposes, the miscellaneous expense is not deductible because it was not reported last year. For accounting purposes, the miscellaneous expense can be deducted as prior period adjustment from retained earnings. Problem 8 13 C Gross income (P300,000 + P20,000 + P180,000) Multiplied by OSD rate Optional standard deduction Problem 8 14 1. B Gross income (P870,000 P10,000 P380,000)) Add: Gains from sale of capital asset Total Multiplied by OSD rate Optional standard deduction 2. B OSD Less: Operating expense P500,000 40% P200,000

P480,000 40,000 P520,000 40% P208,000 P208,000 20,000

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS
Amount of income enjoying tax savings Problem 8 15 D Gross receipts from profession Rent income Total gross income Multiplied by percent of OSD Optional standard deduction Problem 8 16 C Operating expense before representation expense (P2,000,000 P300,000) Representation expense Actual - Limit (P20,000,000 x 0.005) - Lower Allowable itemized deductions Problem 8 17 B Salary expense Rent expense Advertising expense Depreciation expense Interest expense Tax differential on interest income (P30,000 x 33%) Total itemized deductions Problem 8 18 A Gross salaries of employees Grossed-up monetary value of fringe benefits Deductible salaries and fringe benefits expenses Problem 8 19 D Allowable deduction fringe benefit expense (P102,000/68%)

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Chapter 8: Deductions from Gross Income

P188,000 P100,000 450,000 P550,000 40% P220,000

P1,700,000 P300,000 100,000 100,000 P1,800,000 P120,000 24,000 6,000 5,000 60,000 ( 9,900) P205,100 P6,000,000 1,000,000 P7,000,000 P150,000

Problem 8 20 D Assume bonus is computed after tax but before bonus. The answer is letter D = P8,143, computed as follows: Net income before charitable contribution (P75,000 + P5,000) Less: Deductible contribution (P80,000 x 5%) lower of actual Net income before income tax and bonus B T B B B B 0.045B 0.952B B = = = = = = = = 15% (76,000 T) 30% (76,000 B) 15% [76,000 30% (76,000 B)] 15% (76,000 24,320 + 30%B) 11,400 3,420 +0.045B 7,980 7,980/0.955 8,356 P 80,000 4,000 P 76,000

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS
Proof: Income before bonus and tax Less: Income tax (P76,000 P8,356) x 30% Income after tax but before bonus Multiplied by rate of bonus Bonus Problem 8 21 B Monthly salary Death benefits Terminal pay Continuous compensation after the burial for three months Total deductible expenses

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Chapter 8: Deductions from Gross Income

P76,000 20,293 P55,707 15% P 8,356 P 5,000 50,000 25,000 15,000 P95,000

Note: Donation for coffin and other wake expenses is not business or compensation related and, hence, not deductible. (Sec. 72, Rev. Regs. 2) Problem 8 22 Purchases Decreased in inventory Increased in inventory Problem 8 23 D Traveling expenses (P50,000 + P200,000) Fringe benefit expense (P68,000/68%) Transportation expense messenger Total allowable expense Problem 8 24 D Total rent expenses paid Rent last year Prepaid rent Deductible rent expense Problem 8 25 C Monthly rent (P20,000 x 60%) x 2 mos from Oct. 31 to Dec. 31 Insurance premium (P3,000 x 60%) x 2/12 Real property tax (P1,500 x 60%) x 2/12 Deductible rent expense Note: The city services is not a rent expense. Problem 8 26 B 1. B Rent for 6 months based on usage (P20,000 x 6) x 80% Rent based on usage and payments (P80,000 x 80%) 2. A Actual cash collection for rent Problem 8 27 D Monthly rental expense Monthly depreciation (P600,000/8)/ 12 Monthly deductible expense Accrual P96,000 Cash P64,000 P150,000 P150,000 P2,000 6,250 P8,250 C Inventoriable cost P300,000 20,000 . P320,000 Supplies expense P40,000 ( 3,000) P37,000 P250,000 100,000 40,000 P390,000 P150,000 (10,000) (20,000) P120,000 P24,000 300 150 P24,450

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

55

Chapter 8: Deductions from Gross Income

Problem 8 28 1. B Trading - Limit lower (P5,000,000 x .005) 2. C Servicing actual lower Problem 8 29 B Operating Expense before representation Representation expense (P300,000 x .01) Deductible operating expense Problem 8 30 C Interest expense Tax differential (P50,000 x 33%) Deductible interest expense Problem 8 31 D Sole proprietor P50,000 (11,400) . P38,600

P25,000 P30,000 P80,000 3,000 P83,000 P40,000 (16,500) P23,500 Corporation P50,000 (9,900) P40,100

Interest expense Tax differential (P30,000 x 38%) (P30,000 x 33%) Deductible interest expense Problem 8 32 Interest Interest Interest Interest Interest Total B

Deductible paid in advanced paid to a brother paid on deliquency taxes on borrowings to finance his family home paid to finance petroleum exploration P 8,000 . P 8,000

Nondeductible P 20,000 12,000 30,000 100,000 P162,000 P30,000 24,000 P 6,000 P 1,000 5,000 2,000 1,500 P9,500

Problem 8 33 A Tax savings from interest expense (P100,000 x 30%) Final tax on interest income (P1,000,000 x 12%) x 20% Actual tax savings Problem 8 34 A Documentary stamp taxes Local tax (P6,000 P800 P200) Municipal tax Community tax Deductible taxes

Note: The fringe benefit income taxes to key officers and rank-in-file employees are to be classified as deductible fringe benefit expense and not tax expense. Problem 8 35 D Unadjusted net income (P520,000 P200,000) Add back: Income tax foreign country Adjusted net income Personal exemption Net taxable income P320,000 10,000 P330,000 (50,000) P280,000

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

56

Chapter 8: Deductions from Gross Income

Note: The P10,000 income tax paid to foreign country is better to be treated as tax credit rather than as operating expense. Problem 8 36 A Asset of Oliva Payment to government (P200,000 x 50%) Balance Deductible bad debts is the entire amount of collectibles Problem 8 37 B Bad debts from business actual written off (P100,000 x 40%) Bad debts from profession actual written off Deductible bad debts expense Problem 8 38 D Annual depreciation expense (P50,000 P5,000)/5 Multiplied by ratio of months used during the year Depreciation expense 200B Problem 8 39 A Annual depreciation (P2,300,000/11.5 years) Multiplied by ratio of months used in 2007 (July 1 to Dec.) Depreciation expense Problem 8 40 D Oil drilling machine (P800,000 x 90%) / 8 years Oil extracting machine (P900,000 x 90% / 10 years limit Computers (P100,000 x 90%)/4 years Delivery truck (P200,000 x 90%)/ 5 years limit Annual depreciation expense Problem 8 41 C Depletion base (P6,000,000 P1,000,000 + P300,000) Divided by number of extractible estimated tons Depletion per ton Multiplied by number of tons extracted during the year Depletion expense Problem 8 42 1 D . Depletable costs, January 1, 200x Exploration costs Intangible development costs Total Less: Depletion expense (P15,000,000/7,500,000) x 1,200,000 Adjusted basis Divided by remaining reserves (5,000,000 + 2,500,000 1,200,000) New depletion rate/ unit 2 . A P 60,000 (100,000) (P40,000) P100,000

P40,000 50,000 P90,000 P9,000 1/2 P4,500 P200,000 6/12 P100,000 P 90,000 81,000 22,500 36,000 P229,500 P5,300,000 5,000,000 P 1.06 800,000 P 848,000

P12,500,000 1,000,000 1,500,000 P15,000,000 2,400,000 P 1,260,000 6,300,000 P 2.00

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS
Depletion cost 2007 (P2 x 1,200,000 units) 3 . B Value of production (P12 x 1,200,000 units) Less: Production and selling costs: Mining costs Milling costs Marketing expenses Depreciation expense Net income from operation Multiplied by limit percentage Deductible amount fro exploration and development cost 4 . B Current exploration and development cost (P1,500,000 + P1,000,000) Less: Deductible amount of exploration and development cost (see 3) Exploration and development cost chargeable to succeeding years Problem 8 43 B Deductible expense: Depreciation expense (P10,000,000 x 90%)/50 Capital outlay Problem 8 44 1 B Lower of actual contribution or normal valuation Add: Amortization of excess 200A (P200,000/10) 200B (P100,000/10) Deductible retirement expense 2. A Actual retirement payments Capitalized P180,000

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Chapter 8: Deductions from Gross Income

P2,400,000

P14,400,000 P2,000,00 0 3,000,000 1,500,000 1,000,00 0

7,500,000 P 6,900,000 25% P 1,725,000

P2,500,000 1,725,000 P 775,000 Outright expense P10,000,000

200A 800,000 20,000 . 820,000 200A 0

200B 800,000 20,000 10,000 830,000 200B 400,000 Year X 700,000 10,000 710,000

200C 500,000 20,000 10,000 530,000 200C 300,000 Year Y 600,000 10,000 610,000

Problem 8 45

P610,000 = Not in the choices

Actual contribution or normal valuation, lower Add: Amortization (P100,000/10) Deductible retirement expense

Note: Only the excess of the actual contribution over the normal valuation is to be amortized over 10 years. Problem 8 46 B Allowed deductible contribution (P200,000 x 5%) Problem 8 47 C Allowed deductible contribution actual P10,000 P5,000

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS
Problem 8 48 B Income before charitable contribution (P500,000 P130,000) Multiplied by percent of limit Allowed deductible contribution - lower Problem 8 49 C Actual value of donation priority program Adopt a school program incentive (P1,000,000 x 50%) Deductible donation Problem 8 50 Net sales Less: Cost of goods manufactured and sold: Raw materials used: Raw materials, beginning P 200,000 Net purchases of raw materials 2,000,000 Raw materials, ending ( 400,000) Direct labor Factory overhead: Indirect labor factory supervisor P 120,000 Depreciation (P100,000 x 90%) 90,000 Light and water (P150,000 x 80%) 120,000 Miscellaneous factory expenses 20,000 Cost of goods manufactured Finished goods, ending Gross income Less: Optional standard deduction (P3,000,000 x 40%) Income from operations Problem 8 51 1. Salaries of barbers Depreciation of barbershop equipment Cost of service 2. Rent expense Utility expense Janitorial expense Bookkeeping expense Itemized deductions

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Chapter 8: Deductions from Gross Income

P370,000 5% P 18,500 P1,000,000 500,000 P1,500,000

P5,000,000

P1,800,000 600,000

350,000 P2,750,000 ( 750,000)

2,000,000 P3,000,000 1,200,000 P1,800,000

P200,000 50,000 P250,000 P 20,000 30,000 15,000 10,000 P 75,000 P 96,000 11,000 7,890 1,960 60,000 P176,850 32,315 P209,165

Problem 8 52 Salaries of assistants Traveling expenses Light and water office Stationeries and supplies Office rent Total operating expenses before contribution Add: Contribution subject to limit (P500,000 P176,850) x 10%) Allowable itemized deductions Problem 8 53 Sole Proprietorship Corporation

Partnership

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS
Bad debts written-off (P35,000 P30,000) Depreciation expense (P140,000 P100,000) Donation to the government priority program Donations subject to limit: Lower of actual, P170,000 or (P2,500,000 x 10%) (P2,500,000 x 5%) Total allowable deductions P 5,000 40,000 50,000 P 5,000 40,000 50,000 P 5,000 40,000 50,000

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Chapter 8: Deductions from Gross Income

170,000 . P 265,000

125,000 P 220,000

125,000 P 220,000

The research and development cost is to be treated as a deferred expense, hence, its amortization shall be made in the succeeding five years when the taxpayer realizes benefits from such expenditures (Sec. 341, NIRC). Problem 8 54 1. Operating expenses (1,000,000 x 30%) P50,000 Interest expense (P50,000 (P40,000/80%) x 33%] Total itemized deductions Add: NOLCO Total deductible expenses Note: NOLCO is not an itemized deduction but part of deductible expenses. 2. Gross income (P5,000,000 P2,000,000) Multiplied by OSD rate OSD Note: NOLCO is not allowed to be deducted if the taxpayer uses OSD. 3. Gross income Less: OSD Net taxable income 200A 1,000,000 25,000 1,025,000 50,000,000 1,100,000 51,100,000 1,025,000 50,075,000 Corporation 500,000 255,000 50,000 20,000 60,400 40,000 250,000 54,400 40,000 250,000 P3,000,000 1,200,000 P1,800,000 200B 900,000 25,000 925,000 60,000,000 1,200,000 61,200,000 925,000 60,275,000 Individual 500,000 255,000 50,000 20,000 P3,000,000 40% P1,200,000 P250,000 33,500 P283,500 500,000 P783,500

Problem 8 55 1. Actual contribution or normal valuation, lower Add: Amortization - 200A (P250,000/10) Deductible retirement expense 2. Financial net income Add: Retirement benefit expense accounting Total Less: Deductible retirement expense taxation Net income for tax purposes

Problem 8 56 Salary expenses Retirement (P250,000 + P50,000/10) Representation expense (P10,000,000 x .005) Interest expense paid to the BIR - full Interest expense limit: Corporation (P100,000 (P96,000/80%) x 33%) Individuals (P100,000 (P96,000/80%) x 38% Depreciation expense Rent expense

INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS
Group insurance expense Bad debts expense (P100,000 x 20%) Contribution expenses: TESDA priority project (500,000 x 1.5) Local government limit (lower is actual) Total itemized deductions 50,000 20,000 750,000 100,000 2,095,400

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Chapter 8: Deductions from Gross Income

50,000 20,000 750,000 100,000 2,089,400

Note: NOLCO is an allowable special deduction but not an itemized deduction. Problem 8 57 1. Salaries expense (P680,000 P100,000) Bad debts expense (P370,000 P270,000) Retirement expense (P1,000,000 P380,000) Representation expense (P39,000,000 x 0.005) Rent expenses (P200,000 P20,000) Taxes expense (P300,000 P270,000) Life insurance expense (P150,000 P100,000) Total itemized deduction before contributions Contribution expenses: Donation to TESDA priority project (P500,000 x 150%) Donations to CHED not priority project (P200,000 actual is lower + 50% of actual) Donations to government (P100,000 actual is lower) Ind: (P39,000,000 P30,000,000 P1,752,500) x
10%=724,500 Corp: (P39,000,000 P30,000,000 P1,752,500) x 5%=362,250

Individual 580,000 100,000 620,000 195,000 180,000 30,000 50,000 1,755,000 750,000 300,000 100,000 . 2,905,000

Corporation 580,000 100,000 620,000 195,000 180,000 30,000 50,000 1,755,000 750,000 300,000 100,000 . 2,905,000 P 5,000,000 30,000,000 4,000,000 P39,000,000 Corporation P9,000,000 2,905,000 P6,095,000

Total allowable deductions Computation of sales: Financial income Cost of sales Operating expenses deducted (P680,000 + P370,000 + P1,000,000 + P800,000 + P500,000 + P200,000 + P300,000 + P150,000) Total sales 2. Gross income (P39,000,000 P30,000,000) Less: Total allowable deductions Net taxable income

Individual P9,000,000 2,905,000 P6,095,000