Chapter 13-A Regular Allowable Itemized Deductions

Question: Discuss the deductibility of taxes and enumerate the non-deductible taxes.
Taxes paid or incurred within the taxable year in connection with the taxpayer’s trade, business or
exercise of a profession shall be alowed as deduction except:
1. Philippine income taxes except fringe benefit tax
a) Final income tax
b) Capital gains tax

c) Regular income tax

2. Foreign income tax, if claimed as tax credit
3. Estate or donor’s tax
4. Special assessment

Income taxes are not costs of earning income but are impositions on net income accruing only
after income is earned; they are non-deductible. Foreign income tax is not a cost of earning
income. However, it is allowed to be claimed as a deduction under the NIRC if not claimed as tax
credit. Special assessment is not a tax expense but is a capitalized to the cost of the land.

Other non-deductible taxes

1. Business taxes, in particular the Value added tax (VAT)

2. Surcharges or penalties on deliquent taxes

Business tax includes VAT, percentage tax and excise tax. Businesses pay VAT or percentage tax
on their sales or receipts. Manufacturers of excisable articles such as sin products and
non-essential commodities pay the excise tax.

In principle, business taxes are consumption taxes required by the government to be collected
from consumers through the businesses. Hence, they should be recognized by businesses as
liability upon making the sales. This principle is well applied under the VAT; hence is not a
deductible expense. However, this is not the case with percentage tax.

Contrary to the principle, current regulatory developments treated percentage tax as a deductible
expense. This might be due to the fact that this treatment yields the government higher tax
collections.

Businesses subject to excise ax normally include the tax on their selling price. Hence, excise taxes
are deductible as tax expenses.
Only the basic tax is deductible
Only the basic tax of a deductible tax is allowable as deduction. Tax surcharges for late payments
are avoidable and unnecessary expenses; hence, they are non-deductible. Moreover, allowing
these as deductions will relax policy on tax collections. Nevertheless, interest for late payment of
tax was held deductible by the Supreme Court but as interest expense rather than as tax expense.

Question: Discuss the computation of foreign tax credit.

Under the tax credit approach, the foreign taxes paid are not deducted against the gross income but
are credited against the income tax due on world taxable income.

Determination of Foreign Tax credit: One foreign country

The foreign tax credit shall be lower of the actual foreign income tax paid and the following limit:

Foreign taxable income X Philippine income tax due

World taxable income

Determination of Foreign Tax credit: With multiple foreign countries

The final foreign tax credit shall be the lower of the total of the tax credit allowable per country
and the world income tax credit limit computed as follows:
Total foreign taxable income Philippine income tax due
X
World taxable income

Question: Enumerate the requisites of deductible losses.

 It must be incurred in trade, profession or business of the taxpayer. (The loss must be a
business loss not a personal loss.)
 It must pertain to property connected with the trade, business or profession, if the loss arises
from fires, storms, shipwrecks, or other casualities, or from robbery, theft, or embezzlement.
(the loss must be an ordinary loss.)
 The loss must not be compensated by insurance or indemnity contract. (The loss must be
actually sustained, not temporary.)
 A declaration of loss must have been filed by the taxpayer within 45 days from the date of
discovery of the casualty or robbery, theft or embezzlement giving rise to the loss.
 The loss must not have been claimed as a deduction for estate tax purposes in the estate tax
return. (Double deduction is not allowed.)
Question: Discuss the rules on depletion of wasting assets for petroleum and mining companies.

Common rules for both mining ang oil operations

1. Costs of acquisition or improvement of tangible properties.
2. Intangible expplorations, drilling and development costs.

Treatment of tangible development costs

Tangible development costs include the acquisition or improvement of tangible property
which are of character subject to the allowance for depreciation. This may include construction of
mine-plant roads, buildings, processing plants and installation of heavy equipment on-site.
Tangible exploration and development drilling costs are capitalized and deducted through
allowance for depreciation subject to the following rules:

1. Petroleum Operations
Properties directly used in petroleum operations
The NIRC prescribes either the straight line method or declining-balance method at the
option of the taxpayer for properties directly related to the production of petroleum. A shift from
the straight line method to declining balance method is allowed. The useful life shall be 10 years
or such shorter life as may be permitted by the CIR.
Properties not used directly in petroleu operations

The NIRC prescribed the straight line method on the basis of an estimated useful life of 5
years.

2. Mining Operations
If the expected life of the property used in mining is 10 years or less, the taxpayer can use the
normal rate of depreciation. If the expected life is more than 10 years, the property can be
depreciated over any number of years between 5 years an 10 years.

Intangible exploration and developent costs

Intangible costs in petroleum operations include any incidental and necessary costs of drilling
wells or preparing wells for petroleum production and which have no salvage value.

Intangible costs in mining operations include the costs of diamond driling, tunneling and
other improvements of a nature that is not subject to allowance for depreciation.

Question: What is the limitation on deductibility of contribution expense for corporate

taxpayers and individual taxpayers?

Based on the taxable income derived from trade, business or profession (I.e., net income) before
the deductions of any contributions
 10% for individuals
 5% for corporations

Question: Discuss the rules on pension expense.

 The contribution to the fund is first attributed to current service cost. The fundng of current
service cost is deductible in full.
 The excess funding is attributed to any unfunded past service cost. The funding of past
service cost is amortized over 10 years regardless of the actual vesting period of covered
employees.
 Overfunding of the fund is a prepaid pension expense deductible in the future as funding of
future current serice cost.

Chapter 13-B Special Allowable Itemized Deductions and NOLCO

Question: Distinguish an actual expense from a deduction incentive.

Actual expense is the cost incurred by a business through its operations to earn a revenue. It is
deducted from the gross income to determine the taxable income. Deduction incentive, on the
other hand, is a kind of special deduction which reduces the taxpayers’ taxable income.

Question: Enumerate the special expenses allowed by the NIRC and special laws.
 Income distribution from a taxable estate or trust
 Transfer to reserve fund and payments to policies and annuity contracts of insurance
companies
 Dividend distribution of a Real Estate Investent Trust (REIT) under RA 9856
 Transfer to reserves funds of taxable cooperatives
 Discounts to senior citizens under RA 9257
 Discounts to persons with disability under RA 9442

Question: Enumerate the deduction incentives allowed by special laws.

 Additional compensation expense for senior citizen employees under RA 9257

 Additional compensation expense for persons with disability under RA 7277, as amended by
RA 9442

 Cost of facilities improvements for persons with disability in accordance with RA 7277, as
amended by RA 9442
 Additional training expense under RA 8502- Jewerly Industry Development Act of 1998
 Additional contribution expense under the Adopt-a-School program under RA 8525
 Additional deductions for compliance to rooming-in and breast-feeding practices under RA
7600, as amended by RA 10028
 Additional free legal assistance expense under RA 9999
 Additional productivity incentive bonus expense under RA 6971

Question: Demonstrate how NOLCO is measured.

Net Operating Loss Carry-Over (NOLCO) pertains to the amount of net operating loss that is
allowed by the law to be carried over as deduction against available net income in the following
three years.

NOLCO is computed as follows:

Gross income subject to regular tax P xxx, xxx

Less:
Total deductions excluding NOLCO from prior years
and deduction incentives under special laws xxx, xxx

Net operating loss carry-over P xxx, xxx

Question: What are the conditions for the deductibility of NOLCO?

 The taxpayer must not be exempt from income tax during the taxable year when the NOLCO
was incurred.
 There has been no substantial change in the ownership of the business or enterprise.

Note: A change of at least 75% of either the paid up capital or nominal value of the outstanding
shares of a corporation is deemed a substantial change in business ownership.

Question: Explain the rules in the carry-over of NOLCO.

 NOLCO is claimable in a first-in first-out (FIFO) fashion
 NOLCO can be claimed only up to the extent of the business net income in the next three
years. Prior year NOLCO cannot be deducted against a subsequent year net operating loss.
 Any NOLCO which remains unused at the end of the three-year prescriptive period will
expire.

Question: Is NOLCO transferrable? Explain.

NOLCO is indeed not a transferrable right, privilege or interest.

Under Sec 34(D)(3) of the NIRC, NOLCO is not allowed as deduction when there is a
substantial change in the ownership of the business. It is clear that the privilege for NOLCO
deduction is reserved by the law only to the group oog owners when the loss was incurred while
denying it to the new group of owners who subsequently acquired substantial interest in the
business.

Chapter 13-C Optional Standard Deduction

Question: What is optional standard deduction?

The OSD is in lieu of the itemized deductions including NOLCO allowable under the NIRC and
special laws. Under the OSD, the allowable deduction of the taxpayer is simply presumed as a
percentage of gross sales or receipt for individuals and gross income for corporations. There is no
need to support every item of expense. The OSD, however, does not relieve the taxpayer of the
responsibility to deduct withholding tax on certain income payments as required by the NIRC.

Question: Who can claim OSD? Who cannot claim OSD?

OSD is a proxy for itemized deductions . As a rule, all taxpayers who are subject to tax on taxable
net income can claim deductions except the following:

a. Non-resident alien engaged in trade or business (NRA-ETB)

b. Taxpayers mandated to use itemized deductions

Mandatory itemized deductions (RR2-2014)

1. Corporations mandated to use the itemized deductions:

a) Exempt GOCCs and non-stock, non-profit corporations with no taxable income
b) Those with income subject to special/preferential tax rates
c) Those with income subject to regular corporate income tax and special/preferential tax

2. Individual taxpayers mandated to use the itemized deductions:

a) Exempt individuals under the NIRC and special laws with no other taxable income
b) Those with income subject to special/preferential tax rates
c) Those with income subject to regular income tax and special/preferential income tax

3. Non-resident alien not engaged in trade or business

Question: Explain the distinction between an operating income and a non-operating income.

Operating income is operating revenues less operating expenses and depreciation. A company
generates operating revenues from the goods and services it provides to its customers. Operating
expenses are tied to the production, sale and delivery of these goods and services and include
associated overhead and administrative expenses. Operating income excludes interest payments
and income taxes. Operating income is also called operating profit. It is sometimes referred to as
EBIT.
Non-operating income is revenues and expenses generated by a business that does not derive
from ordinary business operations. Non-operating income includes regularly occurring items such
as interest expense and income taxes. Interest expense shows the impact of a company's debt
structure on the income statement, and income taxes can vary if the company has tax credits or
prior net operating losses. Non-operating income also includes nonrecurring items such as the gain
or loss from selling a large asset or subsidiary.

Question: Discuss the OSD base for an individual taxpayer and the OSD base for a corporate
taxpayer.

Rules on determination of OSD for individual taxpayers

Gross Sales
As clarified by RR16-2008, gross sales include only sales contributory to income subject to
regular tax. Since sales returns, allowances and discounts are not contributory to income, they
must be deducted from the total recorded sales (accounting gross sales). In short, the tax concept
of “gross sales” is the accounting concept of “net sales.”

Gross Receipts
Gross Receipts means amounts actually or constructively received during the taxable year. For
sellers of services employing the accrual basis of accounting, the term gross receipts shall mean
amounts earned as gross revenue during the taxable year.
For individual taxpayers using other methods of accounting, the gross sales or gross receipts shall
be determined in accordance with said acceptable method of accounting.

The OSD for individual taxpayers is specifically computed as:

Net Sales/Revenues/Receipts/Fees P xxx,xxx
Add: Other taxable income from operation not subject to final tax xxx,xxx

Total sales/revenues/receipts/fees xxx,xxx

Multiply by: OSD percentage 40%
OSD P xxx,xxx

Rules on determination of OSD for corporate taxpayers

Gross Income
Under the NIRC, gross income was restrictively defined as:

a. Gross sales less sales return, discounts, allowances and cost of sales, or
b. Gross receipts less sales returns, discounts, allowances and cost of services
However, under the amendments introduced by RA 9504, gross income for purposes of the
corporate OSD pertains to all gross income subject to regular income tax. There is no distinction
between gross income from operations and gross income from non-operating sources.

Thus, the corporate OSD is computed as follows:

Net Sales/Revenues/Receipts/Fees P xxx,xxx
Less: Cost of sales or services xxx,xxx
Gross income from operations xxx,xxx

Add: Other taxable income not subject to final tax xxx,xxx

Total gross income xxx,xxx
Multiply by: OSD percentage 40%
OSD P xxx,xxx

Question: Discuss the rules of OSD for a general professional partnership and the partners.
A partner can claim only itemized deductions from his share in the net income of a GPP, provided
that the GPP also uses itemized deductions in computing its distributive net income.

A partner cannot claim OSD against his share in the net income because the same is an item of
gross income, not a revenue, sale, fee or receipt. Note that for individual taxpayers, OSD is
deductible only against gross sales, gross receipts or revenue but not against gross income.

Also, the partner cannot use itemized deduction when the GPP uses OSD since OSD is a proxy for
all claimable deductions. The OSD of the partnership is presumed to cover the deductible
expenses of the GPP including those of the partners because the GPP is merely a pass-through
entity.