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Deductible Expenses (Allowable Deductions) in the Philippines

April 15 is fast approaching, and if you have taxable income, you need to file
and pay your income tax before that due date. In computing your income tax,
you need to determine your deductible costs and expenses to arrive at your
net taxable income. In doing the computation, we should be careful to claim
only those expenses that are considered as allowable deductions. We should
also remember that there are differences between the treatment of expenses
in conformity with the Philippine Accounting Standards (PAS) and the
National Internal Revenue Code (NIRC). In financial accounting, expenses
are recognized as they accrue, while in taxation they can be recognized
when actually paid. Thus you cannot just deduct to your gross taxable
income all the expenses you incur within the taxable year. The following are
tips and things you should consider when claiming expenses as deductions
against your taxable income.
1. Personal, living or family expenses. As a general rule, expenses can
only be claimed if they are paid or incurred as part of the profession, trade or
business operations of the taxpayer. Hence, personal expenses, living or
family expenses are not deductible.
3. Substantiation Requirements. No expenses shall be allowed unless the
taxpayer shall substantiate with sufficient evidence, such as official receipts
or other adequate records: (a) the amount of the expense being deducted,
and (b) the direct connection or relation of the expense being deducted to the
development, management, operation and/or conduct of the trade, business
or profession of the taxpayer.
4. Bribes, Kickbacks and Other Similar Payments. No deduction from
gross income shall be allowed for any payment made to an official or
employee of the national, local or foreign government or similar entities if the
payment constitutes a bribe or kickback. In other words, expenses done
illegally are not allowed as deductions to your taxable income.
5. Losses and interest incurred/paid to related parties. Losses from
Sales or Exchanges of Property and interest paid or incurred on transaction
between the following are not allowed to be claimed as deductions to
income.

a) 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
b) 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
c) 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;
d) Between the grantor and a fiduciary of any trust; or
e) 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
f) Between a fiduciary of a trust and beneficiary of such trust.
6. Interest expense (tax arbitrage). There are exception and limitations on
the amount of interest expense that can be deducted from income. The
taxpayers allowable deduction for interest expense shall be reduced by an
amount equal to the 33% of the interest income subjected to final tax.
Moreover, all interest incurred or paid to related parties cannot be claimed as
deductions to income (please read no 5 above).
7. Bad debts expense. Bad debts expense are only deductible when
actually ascertained to be worthless and charged off within the taxable year.
Recovery of bad debts previously allowed as deduction in the preceding
years shall be included as part of the gross income in the year of recovery to
the extent of the income tax benefit of said deduction.
8. Taxes. The following taxes are not deductible to your income for the
purpose of computing income tax:
a) The Philippines income tax
b) Income taxes imposed by authority of any foreign country; but this
deduction shall be allowed in the case of a taxpayer who does not signify in
his return his desire to have to any extent the benefits of credit against tax for
taxes of foreign countries
c) Estate and donors taxes; and

d) Taxes assessed against local benefits of a kind tending to increase the


value of the property assessed.
9. Entertainment, amusement and recreation expenses. There is a limit in
claiming expenses on Entertainment, amusement and recreation (EAR). EAR
expenses are limited to 0.5% of net sales for sellers of goods or 1% of net
revenue for seller/provider of services. For sellers of both goods or properties
and services an apportionment formula is used in determining the ceiling on
such expenses.
To learn more about allowable deductions and personal / additional
exemptions in computing for your income tax, please read our follow-up
article What are Deductions and Exemptions to Income Tax in the
Philippines.
Disclaimer: The above list of tips is for informational use only. To learn more
about allowable deductions, you may read Chapter VII (Allowable
Deductions) of the NIRC, as amended. There may also other things that
should be considered when claiming deductions to your taxable income.
Furthermore, this article is intended for taxpayers who are claiming itemized
deductions instead of the optional standard deductions in computing for
income tax. New laws, BIR issuances, regulations and rulings may render
this post obsolete or incorrect. For more information, please visit the BIR
website or office for updated information.

What are allowable deductions from gross income?


1. Optional Standard Deductions. Both individual taxpayers and
corporations have the option to claim optional standard deductions (OSD in
lieu of itemized deductions. The following are OSD for individuals and
corporations:
a. OSD for individual
For individual taxpayers, a maximum of 40% of their gross sales or gross
receipts shall be allowed as deduction instead of the itemized deduction. This
type of deduction shall not be allowed for non-resident aliens engaged in
trade or business.
b. OSD for corporations
RA 9504, which was approved effective July 2008, gives corporate taxpayers
an option to claim optional standard deduction (OSD) instead of itemized
deductions. OSD is equivalent to 40% of gross income. Once the option to

use OSD is made, it shall be irrevocable for the taxable year for which the
option was made. A corporation who availed and claimed this deduction is
still required to submit its financial statements when it files its annual tax
return and to keep such records pertaining to its gross income.
2. Itemized deductions. These deductions from gross income include all
ordinary and necessary trade and business expenses paid or incurred during
the taxable year in carrying on or which are directly attributable to the
development, management, operation and/or conduct of the trade and
business. Itemized deductions include the following:
a)
Expenses
b)
Salaries
c)
Interest *
d)
Travel
e)
Rental expenses
f)
Entertainment expenses *
g)
Taxes *
h)
Losses
i)
Bad Debts *
j)
Depreciation
k)
Depletion of Oil and Gas Wells and Mines
l)
Charitable Contributions and Other Contributions *
m) Research and Development
n)
Pension Trusts
o)
Premium payments on health/ or hospitalization insurance *
p)
and other expenses that may be allowed as itemized deductions by the
NIRC
Important Note: Certain expenses, such as interest, bad debts, taxes,
entertainment and other expenses have been set with limitations and
exemptions in claiming as deductions against the taxable income. To learn
more on the limitations, tax arbitrage and exemptions on those expenses,
please read our article allowable deductions in the Philippines. Premium
payment on health and/or hospitalization insurance of an individual taxpayer,
including his family, in the amount of P= 2,400 per year, per family, may be
deducted from his gross income: Provided, that said taxpayer, including his
family, has a yearly gross income of not more than P= 250,000. In case of
married taxpayers, only the spouse claiming the additional exemption for
dependents shall be entitled to this deduction.
Personal and Additional Exemptions

As discussed earlier, individual taxpayers may claim personal and addition


exemptions as follows:
1. Personal exemption
For single individual or married individual judicially decreed as legally
separated with no qualified dependentsP
50,000.00
For head of familyP 50,000.00
For each married individual *P 50,000.00
Note: In case of married individuals where only one of the spouses is
deriving gross income, only such spouse will be allowed to claim the
personal exemption.
2. Additional exemption.
For each qualified dependent, a P25,000 additional exemption can be
claimed but only up to 4 qualified dependents. The additional exemption can
be claimed by the following:
The husband who is deemed the head of the family unless he explicitly
waives his right in favor of his wife
The spouse who has custody of the child or children in case of legally
separated spouses. Provided, that the total amount of additional
exemptions that may be claimed by both shall not exceed the maximum
additional exemptions allowed by the Tax Code.
The individuals considered as Head of the Family supporting a qualified
dependent
Note: Dependent Child means a legitimate, illegitimate or legally adopted
child chiefly dependent upon and living with the taxpayer if such dependent is
not more than twenty-one (21) years of age, unmarried and not gainfully
employed or if such dependent, regardless of age, is incapable of selfsupport because of mental or physical defect.