BDB Laws Tax Law For Business appears in the opinion section of BusinessMirror every

Thursday. BDB Law is an affiliate of Punongbayan & Araullo (P&A).

Rules on deductibility of expenses

During any BIR examination, the issue of the deductibility of a certain expense from
gross income often arises. Considering that valid business expenses have the effect of
reducing a taxpayers taxable income, it is highly appropriate for finance managers and
chief financial officers to get acquainted with the rules on the deductibility of expenses. A
lot of headaches can be avoided with a working knowledge of the rules on the
deductibility of expenses.
As a general rule, the requisites for the deductibility of an expense are: (a) the expense
must be ordinary and necessary; (b) it must have been paid or incurred during the
taxable year; (c) it must have been paid or incurred during the conduct of the trade or
business of the taxpayer; and (d) it must be supported by receipts, records or other
pertinent papers. An additional requirement is that the withholding tax on the amount
paid as expense must have been withheld and remitted to the Bureau of Internal
Revenue.
For the accrual of expenses, a deduction can be made when the liability of the expense
becomes fixed, rather than contingent or estimated, and the amount of the liability can
be determined with reasonable accuracy. The propriety of an accrual must be judged by
the fact that a taxpayer knew, or can reasonably be expected to have known, at the
closing of its books for the taxable year, the amount of expenses to be accrued. The
accrual method of accounting largely presents a question of fact such that the taxpayer
bears the burden of proof of establishing the accrual of an item of income or deduction.
(Commissioner of Internal Revenue v. Isabela Cultural Corp., G.R. No. 172231.
February 12, 2007)

Of particular concern to many taxpayers is the deductibility of representation expenses.

The term representation expenses refers to expenses incurred by a taxpayer in
connection with the conduct of his trade, business or exercise of profession in
entertaining, providing amusement and recreation to or meeting with a guest or guests at
a dining place, place of amusement, country club, theater, concert, play, sporting event
and similar events or places.
Although the following expenses are not considered representation expenses, these
may qualify as items for deduction under Section 34 of the Tax Code of 1997, subject to
conditions for deductibility stated therein:
a. Expenses which are treated as compensation (like fixed representation allowances) or
fringe benefits for services rendered under an employer-employee relationship, pursuant
to Revenue Regulations 2-98, 3-98 and amendments thereto;
b. Expenses for charitable or fund raising events;
c. Expenses for a bonafide business meeting of stockholders, partners or directors;
d. Expenses for attending or sponsoring an employee to a business league or
professional organization meeting; and
e. Expenses for events organized for promotion, marketing and advertising, including
concerts, conferences, seminars, workshops, conventions and other similar events.
To prevent its abuse, the law has imposed a ceiling on representation expenses (for
sellers of goods or properties, it should not exceed 50 percent of net sales, while for
sellers of services, the ceiling is 1 percent of net revenue). An apportionment formula
taking into consideration the percentage of the net sales/net revenue to the total net
sales/net revenue should be applied in case a taxpayer sells both goods and services.
For rental expenses, the lessee may deduct the amount of rent paid or legally payable
during the year.
Operating costs are incurred by employers in supporting workplace-based and related
early childhood care and development programs as long as the employer does not
charge employees user fees, whether monetary or nonmonetary.
For interest expenses, among the other requisites, the interest must have been
stipulated in writing. Otherwise, the taxpayers allowable deduction for interest expense
is reduced by an amount equal to 42 percent of the interest income subject to final tax.
Taxes such as percentage taxes (except VAT), excise taxes, documentary stamp taxes,
local taxes and import dues are also deductible. However, taxes previously claimed as
deductions, when refunded or credited, must be included as part of the taxpayers gross
income in the year of receipt (but only to the extent of the income-tax benefit of such
deduction).

Input VAT applied for refund can also be claimed as deduction from gross income as
loss of property in the year such loss was sustained (i.e., year when claim was denied).
To be deductible as a loss, the claim for refund must have been denied based on the
following grounds: a) deficient invoices/ORs; b) out-of-period claims; or c) violation of
invoicing requirements for export sales.
Foreign-currency loss is deductible only if the loss was actually sustained in a closed
and completed transaction. The mere recognition of loss that has not been realized is
not deductible.
For inventory losses, a certification from the BIR of the actual destruction of the obsolete
inventories is not necessary, but there must be competent documentary evidence to
substantiate the inventory that was written off.
These are just some of the rules on the deductibility of expenses. Is it still a surprise why
taxpayers are having a difficult time complying with the rules on the deductibility of
expenses? Taxpayers must keep these rules in mind for them to steer clear of a
potentially huge deficiency assessment on income tax.