Lecture: Deductions from Gross Income and Losses Deductions from gross income depends upon the taxpayer and his source of income. GENERAL RULE: A taxpayer seeking a deduction
Must point to point to some specific provisions of the statute authorizing the deduction Must be able to prove that prove that he is entitled to the deduction authorized or allowed
Optional Standard Deduction 1. 2. 3.
4.
5.
Optional standard deduction of 40% may be claimed in lieu of the itemized deductions. A taxpayer who opts to avail of this deduction need not submit the Account Information Informa tion Form (AIF)/ Financial Statements. Individual taxpayers (RC, NRC, RA, taxable taxable estates and trusts) who are engaged in business or selling of service may claim OSD, OSD, except NRAETB and NRANETB. For individual taxpayers, the 40% OSD is multiplied at his gross sales or gross receipts. receipts . For purposes of computing OSD for individuals, gross sales/receipts shall mean after deducting sales discounts actually taken, sales returns and sales allowances. Corporate taxpayers (domestic and resident foreign), except non-resident foreign corporation, may claim 40% OSD of OSD of its gross income (sales/receipts income (sales/receipts less cost of sales/service plus other income not subjected to final tax). The selection is not presumed; the taxpayer should signify his election to claim OSD and such would be irrevocable for the taxable year in which the return is made . Example of Erroneous Computation: 1st Quarter OSD Itemized Deduction
2nd Quarter Itemized Deduction OSD
3rd Quarter OSD OSD
Annual Itemized Deduction Itemized Deduction
3rd Quarter OSD Itemized Deduction
Annual OSD Itemized Deduction
Example of Correct Computation: 1st Quarter OSD Itemized Deduction 6.
2nd Quarter OSD Itemized Deduction
The failure to indicate the election to avail avail the OSD shall be considered as having availed of the itemized deductions.
Itemized Deductions (Ex InTaLoBa DepDep ChaRD PeT) 1.
Ordinary and necessary business expenses, expenses, in general (STERO): a. Salaries, wages, and other forms of compensation for personal services actually rendered, including grossed up monetary value of the fringe benefits granted by the taxpayer-employer to the employee, Provided, however, that such compensation is reasonable reasonable and the corresponding withholding tax is properly withheld and remitted to the BIR for such compensation. b. Travel expenses incurred in connection to a business pursuit. c. Entertainment, Amusement and Recreation (EAR) expense directly connected to the development, management and operation of the trade or business or profession of the taxpayer, subject to the following limit: i. ½ % (0.005) of the net sales ifif the taxpayer is engaged in selling of goods; and ii. 1% (0.01) of the net receipts if the taxpayer is engaged in selling of services. d. Rent expense is deductible only when: i. Accrual basis – basis – incurred incurred regardless regardless when paid. ii. Cash basis – basis – incurred and paid e. Other necessary business expenses incurred in connection to the business or trade or profession.
2.
Interests Interests a. There must be an indebtedness indebtedness which pertains to the taxpayer. b. The indebtedness must be connected to the business, trade or profession of the taxpayer. c. There must be a legal (enforceable by law) liability to pay interest. d. It must be paid or incurred during the taxable year. e. It must be subjected to the following limit: Interest expense, incurred or paid (depending whether accrual or cash basis) xx Less: total interest income subjected to final tax times 33% (xx) Deductible interest expense xx
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Lecture: Deductions from Gross Income and Losses
f. g. h.
Exception: Interest expense on tax delinquency or deficiency, provided the tax is related to trade or business or practice of profession, shall be 100% deductible. Interest related to acquisition of property used in trade or practice of profession may, at the option of the taxpayer, be claimed as (1) outright expense or (2) capitalized and claimed as depreciation. Interest paid in advance through discount or otherwise shall be claimed as deduction in the year the indebtedness is paid. The following interests are non-deductible: 1. Interests paid to persons classified as related taxpayers 2. If the indebtedness is incurred to finance petroleum exploration 3. Interest on preferred stocks.
3.
Taxes a. Taxes paid or incurred within taxable year in connection with the taxpayer’s business, trade or profession, shall be allowed as deduction. b. The following taxes are not deductible: 1. Income tax 2. Income tax paid abroad, IF claimed as tax credit 3. Estate tax 4. Donor’s tax 5. Value-added tax 6. Special assessment
4.
Losses a. The following losses may be claimed as deduction: 1. Casualty losses 2. Net Operating Loss Carry-Over (NOLCO) 3. Capital losses – see discussions on Dealings in Property 4. Special losses i. Losses from wash sales of stock or securities ii. Wagering losses iii. Abandonment losses iv. Securities becoming worthless b.
Requisites: 1. The loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement; 2. The property lost is connected with the trade business or practice of profession; 3. Actually sustained during the taxable year; 4. Not compensated for by insurance or other forms of idemnity; 5. Incurred in trade, profession or business; 6. Reported with the BIR within forty-five days from the time of loss; and 7. Not claimed as deduction for estate tax purposes.
c.
Net Operating Loss Carry-Over 1. Net operating loss means the excess of allowable deductions over gross income of the business in a taxable year. 2. The net operating loss of the business or enterprise for any taxable year shall be carried over as a deduction from gross income for the next three (3) consecutive years immediately following the year of such loss. 3. Provided, that at the time of incurring net loss, the taxpayer must not be exempted from income tax. 4. Provided further, that there is no substantial change in the ownership of the business or enterprise in that – Not less than seventy-five percent (75%) in the par value (nominal value) or paid-up capital of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or 5. For mines other than oil and gas wells, net operating loss incurred in any of the first ten (10) years of operation may be carried over for the next five (5) years after the incurrence of such loss.
Notes to remember: a.
The i. ii. iii.
following taxpayers are permitted to deduct NOLCO from their gross income: Individual taxpayers engaged in trade or business or in the exercise of profession; Domestic and resident foreign corporation subject to normal income tax (30%). Special corporation subject to preferential tax rates such as private educational institutions, hospitals, and regional area headquarters
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Lecture: Deductions from Gross Income and Losses b.
d.
Any persons, natural or juridical, enjoying exemptions from income tax pursuant to the provisions of the Tax Code and any special law shall not be entitled to deduct NOLCO from gross income.
Losses from wash sales of stocks or securities 1. In case of any loss claimed to have been sustained from any sale or other disposition of shares of stocks or securities shall not be deductible if: The seller is not a dealer in securities (shrinkage) – the loss should be ACTUAL. Within a period of 30 days before the sale or 30 days after the sale, the seller either: 1. Acquired (by purchase or exchange) stock or securities identical to the stock or securities sold; or 2. Has entered into a contract or option to acquire stock or securities identical to the stock or securities sold. 3. In case of wagering transactions, the loss shall be allowed only to the extent of the gains from such transactions.
e.
Abandonment losses 1. In the event a contract area where petroleum operations are taken is partially or wholly abandoned, all accumulated exploration and development expenditures pertaining thereto shall be allowed as deduction. 2. In case a producing well is subsequently abandoned, the unamortized costs thereif, as well as the undepreciated costs of equipment directly used therein, shall be allowed as deduction. 3. If the abandoned well is re-entered and production is resumed or equipment is restored into service, the effects are: The amount previously claimed as deduction shall be recognized as income; and Such amount shall also be capitalized and amortized or depreciated, as the case may be. Bad Debts a. Requisites: 1. There must be an existing debt due to the taxpayer which must be valid and legally demandable. 2. The same must be connected with the taxpayer’s trade, business or practice of profession. 3. The same must not be sustained in a transaction between related taxpayers. 4. The same must be actually written off in the books of accounts of the taxpayer as of the end of the taxable year. 5. The same must be actually ascertained to be worthless and uncollectible. 6. Accounts previously written off which are later recovered shall be taxable to the extent of the amount which benefited the taxpayer, meaning the tax shield which was availed and for which had benefited the taxpayer
5.
b.
6.
Securities becoming worthless: 1. Securities are ascertained to be worthless; 2. The same is charged off within the taxable year; 3. It must be a capital asset.
Depreciation a. Requisites: 1. The property subject to depreciation is used in the trade, business or practice or profession. 2. The allowance for depreciation must be sustained by the person who owns or who has a capital investment in the property. 3. The allowance for depreciation must be reasonable. 4. The allowance for depreciation should not exceed the cost of the property. 5. The schedule of the allowance must be attached to the return. b.
Depreciation Methods in General 1. Straight-line method 2. Declining-balance method – rate should not exceed twice the rate in the straightline method 3. Sum-of-the-years digit method 4. Any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner.
c.
Properties used in PETROLEUM OPERATIONS 1. Properties directly related to production: i. Straight-line method ii. Declining balance method*
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Lecture: Deductions from Gross Income and Losses *Useful life to be used in either of the above m ethods, should be the shorter of the property’s useful life or 10 years. 2.
d.
Properties used in MINING OPERATIONS 1. If expected life of the property is 10 years or less , normal rate of depreciation (depreciate over the actual useful life). 2. If expected life is more than 10 years, depreciate over any number of years between 5 and expected life.
e.
In the case of a nonresident aliens engaged in trade or business or a resident foreign corporation, depreciation shall be allowed only if the property is located in the Philippines. Allowance for obsolescence may be deducted in addition to the reasonable allowance for the exhaustion, wear and tear.
f.
7.
Properties not directly related to production i. ONLY straight-line method is used. ii. Useful life is always presumed to be 5 years.
Depletion a. In case of oil and gas wells or mines, capital invested may be amortized using the cost-depletion method, provided: 1. When allowance for depletion shall equal to capital invested, and no further allowance shall be granted. 2. Afte production in commercial quantities has commenced, intangible exploration and development drilling costs shall be treated as i. If incurred for non-producing wells and/or mines, deductible in the year incurred. ii. If incurred for producing wells and/or mines: Deductible in full in the year paid or incurred; or Capitalized and amortized b. In the case NRAETB or resident foreign corporation, depletion shall be allowed only if the oil and gas wells or mines are located in the Philippines.
8.
Charitable Contribution 1. Fully deductible contributions: a. Donations to the Government of the Philippines or any of its agencies or political subdivisions including fully owned government corporations, exlusively to be used in undertaking priority activities in Education, Health, Youth, Sports Development, Human Settlements, Science and Culture, and Economic Development.
2.
9.
b.
Donations to foreign institutions or international organizations which are fully deductible.
c.
Donations to Accredited Non-Government organizations organized and operated exclusively for Scientific, Research, Educational, Character Building; Youth and Sports Development, Health, Social Welfare; Cultural, Charitable purposes and a combination thereof , PROVIDED, that no part of NET INCOME of which inures to the benefit of any private individual and not more than 30% of such contributions are utilized for administrative purposes.
Contributions subject to Limit a. Donations to the Government of the Philippines or any of its agencies or political subdivisions including fully owned government corporations, to be used in a non-priority activities. b.
For corporations, the limit is 5% of the taxable income from trade or practice of profession before the deduction for charitable contributions.
c.
For individuals, the limit is 10% of the taxable income from trade or practice of profession before the deduction for charitable contributions.
Research and Development If not chargeable to capital account. Outright Expense If chargeable to capital account but not At the option of the taxpayer : chargeable to property subject to depreciation OPTION 1 – Claim as outright expense or depletion OPTION 2 – Amortize over 60 months
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Lecture: Deductions from Gross Income and Losses If chargeable to property subject to depreciation or depletion. a.
Capitalize
The following R&D expenditures are not deductible: i. Any expenditure for the acquisition or improvement of land, or the improvement of property to be used in connection with research and development of a character which is subject to depreciation and depletion; and ii. Any expenditure paid or incurred for the purpose of ascertaining of any deposit of ore or other mineral including oil or gas.
10. Pension Trust Actual contribution to the extent of pension Amortization of Past Service Cost * Total
xx xx xx
Past Service Cost is the excess of actual contributions over the Normal Cost. It shall be amortized over ten (10) years.
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