DEDUCTIONS FROM GROSS INCOME:

A: CONCEPT OF ALLOWABLE DEDUCTIONS a) Deductions, Defined DEDUCTIONS items or amounts which the law allows to be deducted from gross income in order to arrive at the taxable income (2010 Beda Notes, page 66) Nature of Deductions (Valencia, Roxas, page 365) In general, deductions or allowable deductions are business expenses and losses incurred which the law allows to reduce gross business income to arrive at net income subject to tax. They are kind of legislative grace. They are not presumed but allowable only by specific provisions of law. They are construed strictly against the taxpayer.

b) Deductions vs. Exclusions DEDUCTIONS EXCLUSIONS 1. Amount which the law 1. Flow of wealth not allows to be subtracted treated as part of gross from the gross income in income because order to arrive at a net exempted by tax treaty, taxable income statute or the Constitution (in the 2. Allowed only to nature of tax exemptions) businesses, corporations 2. Can be availed by all kinds of taxpayer c) Deductions vs. Cost DEDUCTIONS 1. ____________ 2. ______________ d) Deductions, When Allowed INSTANCES WHEN DEDUCTIONS ARE ALLOWED: 1. Existence of a law authorizing the deductions 2. Tax payer must be able to prove that he is entitled to such deductions COST 1. ________________ 2. ______________

3.

e) Deductions vs. Tax Credit DEDUCTIONS TAX CREDIT 1. Subtracted from the gross 1. Deducted from income tax income to arrive at net income payable to arrive at income tax payable due 2. Diminishes income tax payable 2. Diminishes tax liability

i)

CIR vs. Central Luzon Drug Corp, GR No. 159647, 15 April 2005

PANGANIBAN, J.: The 20 percent discount required by the law to be given to senior citizens is a tax credit, not merely a tax deduction from the gross income or gross sale of the establishment concerned. A tax credit is used by a private establishment only after the tax has been computed; a tax deduction, before the tax is computed. RA 7432 unconditionally grants a tax credit to all covered entities. Thus, the provisions of the revenue regulation that withdraw or modify such grant are void. Basic is the rule that administrative regulations cannot amend or revoke the law. Facts: Respondent is a domestic corporation primarily engaged in retailing of medicines and other pharmaceutical products. In 1996, it operated six (6) drugstores under the business name and style Mercury Drug. From January to December 1996, respondent granted twenty (20%) percent sales discount to qualified senior citizens on their purchases of medicines pursuant to Republic Act No. [R.A.] 7432 and its Implementing Rules and Regulations. For the said period, the amount totalled P904,769.00. On April 15, 1997, respondent filed its Annual Income Tax Return 1996 declaring that it incurred net losses from its operations. On January 16, 1998, respondent filed with petitioner a claim for tax refund/credit in the amount of P904,769.00 allegedly arising from the 20% sales discount granted by respondent to qualified senior citizens in compliance with [R.A.] 7432. Unable to obtain affirmative response from petitioner, respondent

elevated its claim to the Court of Tax Appeals [(CTA or Tax Court)] via a Petition for Review. The Tax Court dismissed respondents Petition for lack of merit. CTA said: x x x, if no tax has been paid to the government, erroneously or illegally, or if no amount is due and collectible from the taxpayer, tax refund or tax credit is unavailing. Moreover, whether the recovery of the tax is made by means of a claim for refund or tax credit, before recovery is allowed[,] it must be first established that there was an actual collection and receipt by the government of the tax sought to be recovered. x x x. Prescinding from the above, it could logically be deduced that tax credit is premised on the existence of tax liability on the part of taxpayer. In other words, if there is no tax liability, tax credit is not available. The MR filed by the respondent was granted by the CTA. It then ordered petitioner to issue a Tax Credit Certificate in favor of Central Luzon Drug.

The CA affirmed in toto the Resolution of the Court of Tax Appeals (CTA) in the reduced amount of P903,038.39. It reasoned that Republic Act No. (RA) 7432 required neither a tax liability nor a payment of taxes by private establishments prior to the availment of a tax credit. Moreover, such credit is not tantamount to an unintended benefit from the law, but rather a just compensation for the taking of private property for public use. Issue : Is the 20% sales discount a tax credit or a deduction from gross income or gross sales?

Ruling: The 20% sales discount is a tax credit as expressly provided for by RA 7432. Tax Credit versus Tax Deduction

Tax credit generally refers to an amount that is subtracted directly from ones total tax liability. It is an allowance against the tax itself or a deduction from what is owed by a taxpayer to the government. Examples of tax credits are withheld taxes, payments of estimated tax, and investment tax credits.

Tax deduction -- defined as a subtraction from income for tax purposes, or an amount that is allowed by law to reduce income prior to *the+ application of the tax rate to compute the amount of tax which is due. An example of a tax deduction is any of the allowable deductions enumerated in Section 34[20] of the Tax Code.

A tax credit differs from a tax deduction. On the one hand, a tax credit reduces the tax due, including -- whenever applicable -- the income tax that is determined after applying the corresponding tax rates to taxable income.

A tax deduction, on the other, reduces the income that is subject to tax in order to arrive at taxable income. To think of the former as the latter is to avoid, if not entirely confuse, the issue. A tax credit is used only after the tax has been computed; a tax deduction, before.

By ordinary acceptation, a discount is an abatement or reduction made from the gross amount or value of anything. To be more precise, it is in business parlance a deduction or lowering of an amount of money; or a reduction from the full amount or value of something, especially a price. In business there are many kinds of discount, the most common of which is that affecting the income statement or financial report upon which the income tax is based.

To stress, the effect of a sales discount on the income statement and income tax return of an establishment covered by RA 7432 is different from that resulting from the availment or use of its tax credit benefit. While the former is a deduction before, the latter is a deduction after, the income tax is computed.

As mentioned earlier, a discount is not necessarily a sales discount, and a tax credit for a simple discount privilege should not be automatically treated like a sales discount. Where the law does not distinguish, we ought not to distinguish.

When the law says that the cost of the discount may be claimed as a tax credit, it means that the amount -- when claimed -- shall be treated as a reduction from any tax liability, plain and simple

Granting that there is a tax liability and respondent claims such cost as a tax credit, then the tax credit can easily be applied. If there is none, the credit cannot be used and will just have to be carried over and revalidated accordingly. If, however, the business continues to operate at a loss and no other taxes are due, thus compelling it to close shop, the credit can never be applied and will be lost altogether.

Tax Credit Benefit Deemed Just Compensation Sections 2.i and 4 of RR 2-94 deny the exercise by the State of its power of eminent domain. Be it stressed that the privilege enjoyed by senior citizens does not come directly from the State, but rather from the private establishments concerned. Accordingly, the tax credit benefit granted to these establishments can be deemed as their just compensation for private property taken by the State for public use.

SC affirmed Decision and Resolution of the Court of Appeals.

ii)

CIR vs. Central Luzon Drug Corp, GR No. 148512, 26 June 2006

AZCUNA, J.: FACTS: Central Luzon Drug Corporation has been a retailer of medicines and other Pharmaceutical products since December 19, 1994. In 1995, it opened

three (3) drugstores as a franchisee under the business name and style of Mercury Drug.

For the period January 1995 to December 1995, in conformity to the mandate of Sec. 4(a) of R.A. No. 7432 (Senior Citizens Act), petitioner granted a 20% discount on the sale of medicines to qualified senior citizens amounting to P219,778.

Pursuant to Revenue Regulations No. 2-94[1] implementing R.A. No. 7432, which states that the discount given to senior citizens shall be deducted by the establishment from its gross sales for value-added tax and other percentage tax purposes, respondent deducted the total amount of P219,778 from its gross income for the taxable year 1995. For said taxable period, respondent reported a net loss of P20,963 in its corporate income tax return. As a consequence, respondent did not pay income tax for 1995.

Subsequently, on December 27, 1996, claiming that according to Sec. 4(a) of R.A. No. 7432, the amount of P219,778 should be applied as a tax credit, respondent filed a claim for refund in the amount of P150,193, thus:

Since the Commissioner of Internal Revenue was not able to decide the claim for refund on time,*2+ respondent filed a Petition for Review with the Court of Tax Appeals (CTA) on March 18, 1998.

The CTA dismissed the petition, declaring that even if the law treats the 20% sales discounts granted to senior citizens as a tax credit, the same cannot apply when there is no tax liability or the amount of the tax credit is greater than the tax due. In the latter case, the tax credit will only be to the extent of the tax liability. Also, no refund can be granted as no tax was erroneously, illegally and actually collected based on the provisions of Section 230, now Section 229, of the Tax Code. Furthermore, the law does not state that a refund can be claimed by the private establishment concerned as an alternative to the tax credit.

Thus, respondent filed with the CA a Petition for Review.

CA concluded that the 20% discount given to senior citizens which is treated as a tax credit pursuant to Sec. 4(a) of R.A. No. 7432 is considered just compensation and, as such, may be carried over to the next taxable period if there is no current tax liability.

ISSUE: whether the 20% sales discount granted by respondent to qualified senior citizens may be claimed as a tax credit or as a deduction from gross sales.

RULING: The CA and the CTA correctly ruled that based on the plain wording of the law discounts given under R.A. No. 7432 should be treated as tax credits, not deductions from income. The provision of RA 7432 explicitly employed the word tax credit. Nothing in the provision suggests for it to mean a deduction from gross sales. To construe it otherwise would be a departure from the clear mandate of the law.

Accordingly, when the law says that the cost of the discount may be claimed as a tax credit, it means that the amount -- when claimed shall be treated as a reduction from any tax liability.

The tax credit that is contemplated under the Act is a form of just compensation, not a remedy for taxes that were erroneously or illegally assessed and collected. In the same vein, prior payment of any tax liability is not a precondition before a taxable entity can benefit from the tax credit. The credit may be availed of upon payment of the tax due, if any. Where there is no tax liability or where a private establishment reports a net loss for the period, the tax credit can be availed of and carried over to the next taxable year.

It must also be stressed that unlike in Sec. 229 of the Tax Code wherein the remedy of refund is available to the taxpayer, Sec. 4 of the law speaks only of a tax credit, not a refund.

The tax credit benefit granted to the establishments can be deemed as their just compensation for private property taken by the State for public use. The privilege enjoyed by the senior citizens does not come directly from the State, but rather from the private establishments concerned.

SC affirmed Decision of the Court of Appeals.

iii)

Bicolandia Drug Corp vs. CIR GR No. 142299, 22 June 2006

AZCUNA, J.:

FACTS: Petitioner Bicolandia Drug Corporation is a domestic corporation principally engaged in the retail of pharmaceutical products. Petitioner has a drugstore located in Naga City under the name and business style of Mercury Drug.

Pursuant to the provisions of R.A. No. 7432 (Senior Citizens Act), and Revenue Regulations No. 2-94, petitioner granted to qualified senior citizens a 20% sales discount on their purchase of medicines covering the period from July 19, 1993 to December 31, 1994.

When petitioner filed its ITR 1993 and 1994, it claimed as a deduction from its gross income the respective amounts of P80,330 and P515,000 representing the 20% sales discount it granted to senior citizens.

However, alleging error in the computation and claiming that the aforementioned 20% sales discount should have been treated as a tax credit pursuant to R.A. No. 7432 instead of a deduction from gross income, petitioner filed a claim for refund or credit of overpaid income tax for 1993 and 1994.

Petitioner contended that Section 4 of R.A. No. 7432 provides in clear and unequivocal language that discounts granted to senior citizens may be claimed as a tax credit. Revenue Regulations No. 2-94, therefore, which is merely an implementing regulation cannot modify, alter or depart from the clear mandate of Section 4 of R.A. No. 7432, and, thus, is null and void for being inconsistent with the very statute it seeks to implement.

The CIR, on the other hand, maintained that the aforesaid section providing for a 20% sales discount to senior citizens is a misnomer as it runs counter to the solemn duty of the government to collect taxes. The Commissioner likewise pointed out that the provision in question employs the word may, thereby implying that the availability of the remedy of tax credit is not absolute and mandatory and it does not confer an absolute right on the taxpayer to avail of the tax credit scheme if he so chooses. The Commissioner further stated that in statutory construction, the contemporaneous construction of a statute by executive officers of the government whose duty is to execute it is entitled to great respect and should ordinarily control in its interpretation.

The CTA ruled that: Revenue Regulations No. 2-94 gave a new meaning to the phrase tax credit, interpreting it to mean that the 20% discount granted to qualified senior citizens is an amount deductible from the establishments gross sales, which is completely contradictory to the literal or widely accepted meaning of the said phrase, as an amount subtracted from an individuals or entitys tax liability to arrive at the total tax liability (Blacks Law Dictionary). In view of such apparent discrepancy in the interpretation of the term tax credit, the provisions of the law under R.A. 7432 should prevail over the

subordinate regulation issued by the respondent under Revenue Regulation No. 2-94. x x x

On the issue of whether or not petitioner is entitled to the claim for refund of its overpaid income taxes for the years 1993 and 1994 based on the evidence at hand, the CTA ordered CIR to ISSUE tax credit certificates in favor of petitioner [in] the amounts representing overpaid income tax for the years 1993 and 1994. On the other hand, the CIRs Motion for Reconsideration is DENIED for lack of merit. Consequently, the Commissioner filed a petition for review with the CA asking for the reversal of the CTA Decision and Resolution. However, CA denied such petition. Issue: The matter to be determined is the amount of tax credit that may be claimed by a taxable entity which grants a 20% sales discount to qualified senior citizens on their purchase of medicines. Is it the acquisition cost or the actual amount of discount? Ruling: Section 4(a) of R.A. No. 7432 states that: Sec. 4. Privileges for the Senior citizens. The senior citizens shall be entitled to the following: a) the grant of twenty percent (20%) discount from all establishments relative to utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost as tax credit.

The term "cost" in the above provision refers to the amount of the 20% discount extended by a private establishment to senior citizens in their purchase of medicines. This amount shall be applied as a tax credit, and may be deducted from the tax liability of the entity concerned. If there is no current tax due or the establishment reports a net loss for the period, the credit may be carried over to the succeeding taxable year. This is in line with the interpretation of this Court in

Commissioner of Internal Revenue v. Central Luzon Drug Corporation9 wherein it affirmed that R.A. No. 7432 allows private establishments to claim as tax credit the amount of discounts they grant to senior citizens. Accordingly, petitioners claim for refund must be denied. The law expressly provides that the discount given to senior citizens may be claimed as a tax credit, and not a refund. iv) CIR vs. Central Luzon Drug Corp, GR No. 159610, 12 June 2008 (in relation to RA 9257) CARPIO, J.:

Facts: Respondent is a domestic corporation engaged in the retail of medicines and other pharmaceutical products. In 1997, it operated eight drugstores under the business name and style "Mercury Drug."6 Pursuant to the provisions of RA 7432 and Revenue Regulations No. (RR) 2-94 issued by the BIR, respondent granted 20% sales discount to qualified senior citizens on their purchases of medicines covering 1997 which totalled P2,798,508.00. Respondent filed its 1997 Corporate Annual ITR reflecting a nil income tax liability due to net loss incurred from business operations of P2,405,140.00. Respondent filed its 1997 ITR under protest. In March 1999, respondent filed with the petitioner a claim for refund or credit of overpaid income tax for the taxable year 1997 in the amount of P2,660,829.00. Respondent alleged that the overpaid tax was the result of the wrongful implementation of RA 7432. Respondent treated the 20% sales discount as a deduction from gross sales in compliance with RR 2-94 instead of treating it as a tax credit as provided under Section 4(a) of RA 7432. Petitioner contended that the construction given to a statute by a specialized administrative agency like the BIR is entitled to great respect and should be accorded great weight. When RA 7432 allowed senior citizens' discounts to be claimed as tax credit, it was silent as to the mechanics of availing the same. For clarification, the BIR issued RR 2-94 and defined the term "tax credit" as a deduction from the establishment's gross income and not from its tax liability in order to avoid an absurdity that is not intended by the law. 12 The Ruling of the Court of Tax Appeals The CTA rendered ordered petitioner to issue a tax credit certificate in the amount of P2,376,805.63 in favor of respondent. In a number of analogous cases, CTA has consistently ruled that the 20% senior citizens' discount should be

treated as tax credit instead of a mere deduction from gross income. In quoting its previous decisions, the CTA ruled that RR 2-94 engraved a new meaning to the phrase "tax credit" as deductible from gross income which is a deviation from the plain intendment of the law. An administrative regulation must not contravene but should conform to the standards that the law prescribes. The CTA also ruled that respondent has properly substantiated its claim for tax credit by documentary evidence. However, based on the examination, the CTA deemed it proper to consider the lesser of two amounts. Aggrieved by the CTA's decision, petitioner elevated the case before the Court of Appeals. The Ruling of the Appellate Court The CA affirmed the CTA's decision in toto. The CA distinguished "tax credit" as an amount subtracted from a taxpayer's total tax liability to arrive at the tax due while a "tax deduction" reduces the taxpayer's taxable income upon which the tax liability is computed. "A credit differs from deduction in that the former is subtracted from tax while the latter is subtracted from income before the tax is computed."19 Hence, this petition. Issue: Whether the respondent may claim the 20% senior citizens' sales discount as a tax credit deductible from future income tax liabilities instead of a mere deduction from gross income or gross sales The Ruling of the Court The petition lacks merit. In two similar cases involving the same parties on the same issues, the Court has squarely ruled that the 20% senior citizens' discount required by RA 7432 may be claimed as a tax credit and not merely a tax deduction from gross sales or gross income. Under RA 7432, Congress granted the tax credit benefit to all covered establishments without conditions. The net loss incurred in a taxable year does not preclude the grant of tax credit because by its nature, the tax credit may still be deducted from a future, not a present, tax liability. However, the senior citizens' discount granted as a tax credit cannot be refunded.

RA 7432 expressly allows private establishments to claim the amount of discounts they grant to senior citizens as tax credit. Section 4(a) of RA 7432 states: SECTION 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following: a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost as tax credit; (Emphasis supplied)

However, RR 2-94 interpreted the tax credit provision of RA 7432 in this wise: Sec. 2. DEFINITIONS. - For purposes of these regulations: xxx i. Tax Credit - refers to the amount representing 20% discount granted to a qualified senior citizen by all establishments relative to their utilization of transportation services, hotels and similar lodging establishments, restaurants, drugstores, recreation centers, theaters, cinema houses, concert halls, circuses, carnivals and other similar places of culture, leisure and amusement, which discount shall be deducted by the said establishments from their gross income for income tax purposes and from their gross sales for value-added tax or other percentage tax purposes. (Emphasis supplied). xxx Sec. 4. Recording/Bookkeeping Requirement for Private Establishments xxx The amount of 20% discount shall be deducted from the gross income for income tax purposes and from gross sales of the business enterprise concerned for purposes of the VAT and other percentage taxes. (Emphasis supplied)

Tax credit is defined as a peso-for-peso reduction from a taxpayer's tax liability. It is a direct subtraction from the tax payable to the government. On the other hand, RR 2-94 treated the amount of senior citizens' discount as a tax deduction which is only a subtraction from gross income resulting to a lower taxable income. RR 2-94 treats the senior citizens' discount in the same manner as the allowable deductions provided in Section 34, Chapter VII of the National Internal Revenue Code. RR 2-94 affords merely a fractional reduction in the taxes payable to the government depending on the applicable tax rate. In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court ruled that petitioner's definition in RR 2-94 of a tax credit is clearly erroneous. To deny the tax credit, despite the plain mandate of the law, is indefensible. In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court declared, "When the law says that the cost of the discount may be claimed as a tax credit, it means that the amount- when claimed shall be treated as a reduction from any tax liability, plain and simple."

The tax credit may still be deducted from a future, not a present, tax liability. Petitioner-CIR alleged that respondent incurred a net loss from its business operations in 1997; hence, it did not pay any income tax. Since no tax payment was made, it follows that no tax credit can also be claimed because tax credits are usually applied against a tax liability. In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court stressed that prior payment of tax liability is not a pre-condition before a taxable entity can avail of the tax credit. The Court declared, "Where there is no tax liability or where a private establishment reports a net loss for the period, the tax credit can be availed of and carried over to the next taxable year." It is irrefutable that under RA 7432, Congress has granted the tax credit benefit to all covered establishments without conditions. Therefore, neither a tax liability nor a prior tax payment is required for the existence or grant of a tax credit. Hence, respondent is entitled to claim the amount of P2,376,805.63 as tax credit despite incurring net loss from business operations for the taxable year 1997.

The senior citizens' discount may be claimed as a tax credit and not a refund. Section 4(a) of RA 7432 expressly provides that private establishments may claim the cost as a tax credit. A tax credit can only be utilized as payment for future internal revenue tax liabilities of the taxpayer while a tax refund, issued as a check or a warrant, can be encashed. A tax refund can be availed of immediately while a tax credit can only be utilized if the taxpayer has existing or future tax liabilities. Hence, the senior citizens' discount may be claimed as a tax credit and not as a refund.

RA 9257 now specifically provides that all covered establishments may claim the senior citizens' discount as tax deduction. On 26 February 2004, RA 9257, otherwise known as the "Expanded Senior Citizens Act of 2003," was signed into law and became effective on 21 March 2004.31 RA 9257 has amended RA 7432. Section 4(a) of RA 9257 reads: "Sec. 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following: (a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of services in hotels and similar lodging establishments, restaurants and recreation centers, and purchase of medicines in all establishments for the exclusive use or enjoyment of senior citizens, including funeral and burial services for the death of senior citizens; xxx The establishment may claim the discounts granted under (a), (f), (g) and (h) as tax deduction based on the net cost of the goods sold or services rendered: Provided, That the cost of the discount shall be allowed as deduction from gross income for the same taxable year that the discount is granted. Provided, further, That the total amount of the claimed tax deduction net of value added

tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as amended." (Emphasis supplied)

Contrary to the provision in RA 7432 where the senior citizens' discount granted by all covered establishments can be claimed as tax credit, RA 9257 now specifically provides that this discount should be treated as tax deduction.

With the effectivity of RA 9257 on 21 March 2004, there is now a new tax treatment for senior citizens' discount granted by all covered establishments. This discount should be considered as a deductible expense from gross income and no longer as tax credit. The present case, however, covers the taxable year 1997 and is thus governed by the old law, RA 7432. The Decision of the CA was AFFIRMED.

B. KINDS OF ALLOWABLE DEDUCTIONS a) Optional Standard Deductions (OSD) b) Itemized Deductions (ID)

C. THE OPTIONAL STANDARD DEDUCTION (RA 9054, June 17, 2008) Earlier, only individual subject to tax under Section 24 of the NIRC (other than a non resident alien) may elect a standard deduction. However, the new RA 9504 (Act Amending among others Section 34 of the NIRC) allows OSD not only to individual taxpayer (other than a non-resident alien) but also to corporation subject to tax under Section 27(A) and 28 (A)(1) of the Tax Code.

In lieu of the itemized allowable deductions, the OSD may be deducted from the gross income as follows:

a) An individual other than a non resident alien OSD must not exceed 40% of his gross sales or gross receipts b) A corporation OSD is not exceeding 40% of its gross income

From its name itself, standard deduction is optional (Mamalateo, page 213). The taxpayer must signify in his return that he elects the OSD, otherwise he shall be considered as having availed of the itemized deductions. The Tax Code provides that once a taxpayer elected a deduction (either OSD or itemized) in his ITR, such election is irrevocable for the taxable year which the return is made [Section 34(L), NIRC]. Hence, the taxpayer can change to itemized deductions in succeeding years. (Mamalateo, page 213).

Requites for the exercise of OSD: 1) Available to both corporations and individuals other than non-resident aliens 2) OSD is optional - taxpayer signifies in his return his intention to elect OSD otherwise he is considered as having availed of ID 3) Election is irrevocable for the year in which it is made 4) Amount is limited to 40% of taxpayers gross income or gross receipts 5) Proof of actual expenses is not required.

Illustration 1 (Individual Taxpayer): Mr. X, a practicing lawyer, received a total professional fee amounting to P600K during the taxable year. His related itemized deduction allowed amounted to P100K. Mr. X opted to deduct OSD in lieu of itemized deductions (ID). The net income of Atty. X before personal exemption would be: Gross Receipts professional fee Less: OSD (P600K x 40%) Net Income before Personal Exemption P600,000.00 240,000.00 P360,000.00

NOTES: a) The following individuals may claim OSD in lieu of ID: 1. Resident Citizen 2. Non-resident Citizen 3. Resident Alien 4. Taxable Estates and Trusts b) Submission of supporting financial statements to tax return shall not be required if a qualified individual claims OSD (Valencia, Roxas, page 371, 2010). Simply stated, proof of actual expenses is not required to support claim of OSD (Mamalateo, page 213). c) OSD is based on gross sales during the taxable year if an individual employs the accrual basis of accounting of his income and deductions d) Sales discounts, sales returns and sales allowances should reduce the gross sales in computing OSD (based on the tax principle that lower amount of deduction will be allowed for income tax purposes) (Valencia, Roxas, page 371, 2010)

Illustration 2 (Corporate Taxpayer): X Corportion reported a gross sales of P5M, cost of sales of P3M and itemized deductions of P500K. The Company opted to deduct OSD in lieu of itemized deductions.

The net income of X Corporation would be: Sales Less: Cost of Sales Gross Income Less: OSD (P2M x 40%) Net Income P5,000,000.00 3,000,000.00 2,000,000.00 800,000.00 P1,200,000.00

NOTES: a) The following corporations may claim OSD in lieu of ID: 1. Domestic Corporations 2. Resident Foreign Corporations b) Components of GROSS INCOME FOR OSD

Gross Income includes other income not subjected to final tax. Other income includes interest income earned from outside source as well as gain from sale of capital assets. The other should have been reported in the ITR and not subjected to final tax or CGT. Hence, the basis of the 40% OSD should include other taxable income not subjected to final tax. c) If taxpayer elects to offset his losses against his profit from capital asset transaction, he may no longer claim OSD because OSD shall be in lieu of the itemized allowed deductions which evidently includes losses from sales or exchanges of capital assets (Valencia, Roxas, Income Taxation, page 372, 2010)

OSD or ID of HUSBAND and WIFE For married individuals, the husband may choose OSD and the wife ID (or vice versa) to minimize their individual income tax.

ILLUSTRATION: The husband and wife may compute separately their individual income tax based on their respective taxable income as follows:

Gross receipts from business service Less: OSD (P400K x 40%) ID Income from business Add: Compensation Income Income before personal exemption NOTES:

Mr. X P 400,000.00 160,000.00 P 240,000.00 300,000.00 P 540,000.00

Mrs. X P 600,000.00 400,000.00 P 200,00.00 P 200,00.00

a) Compensation Income is not allowed to be reduced by OSD

b) If any income of the husband and wife cannot be definitely identified as income exclusively earned or realized by either of the spouses the same shall be divided equally between them in order to determine their respective taxable income. c) In the case of individual entitled to claim OSD, allowable deductions shall mean aforesaid OSD plus deductions of premium payments (if applicable) on: 1) Health insurance, and/or 2) Hospitalization Insurance,