1

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS)

SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

CHAPTER 8

DEDUCTIONS FROM GROSS INCOME

Problem 8 1 DEDUCTIBLE OR NONDEDUCTIBLE FROM GROSS INCOME
1. Nondeductible
2. Deductible
3. Deductible
4. Deductible
5. Nondeductible
6. Nondeductible
7. Nondeductible
8. Deductible
9. Deductible
10. Deductible
11. Nondeductible
12. Nondeductible
13. Deductible, in lieu of tax credit (Sec. 34C3, NIRC)
14. Deductible
15. Deductible
16. Nondeductible
17. Nondeductible
18. Deductible
19. Deductible
20. Nondeductible
Problem 8 2
TRUE OR FALSE
1. False Some business expenses are nondeductible; some are subject to limit.
2. True
3. False Compensation income is not subject to OSD.
4. False NOLCO is not an itemized deduction.
5. True Amortized over the term of the lease
6. False of 1%
7. False 33%
8. False Double declining method
9. True
10. True
11. False Income outside the Philippines by a NRC is not taxable in the Philippines,
hence, no allowable deduction is allowed.
12. True
13. True
14. True
15. False Business expenses related to business income outside the Philippines is
deductible also by domestic corporations and resident Filipino.
16. False Business expense is deductible from gross income.
17. True
18. False 40% based on sales or gross receipts.

Problem 8 3
1. C

Problem 8 4
1. D

Problem 8 5
1. A

Problem 8 6
1. C

2. C
3. A
4. D
5. A
6. B
7. A
8. C
9. C
10. D
Problem 8 7

2. B
3. B
4. C
5. A
6. D
7. C
8. C
9. A
10. A

2. C
3. C
4. A
5. D
6. C
7. A
8. B
9. A
10. C
C

Change of motor of air condition

Expansion of store
Damages paid due to workers injury
Repainting of building
Cleaning of computers
Repair of furniture
Totals
Problem 8 8
C
Identifiable operating expenses Philippines
Add: Allocated operating expenses within
(P200,000 x P1M/P5M)
Operating expenses Philippines
Problem 8 9
D
Police protection
Interest expense paid to his father
Gifts made to employees during birthday
Capital loss
Amount of nondeductible expenses and losses

2. C
3. B
4. C
5. C
6. D
7. D
8. A
9. C
10. C

Expensed

Capitalized
P60,000
50,000

P20,000
10,000
9,000
1,000
P40,000

.
P110,000
P400,000
40,000
P440,000
P20,000
10,000
5,000
4,000
P39,000

Problem 8 10
D
Depreciation expense (P1,000,000 x 40%)/25
Loss of business equipment
Deductible expense

P16,000
38,000
P54,000

Problem 8 11
D
1.
Letter A
No personal or business expense is deductible.
2.

Letter B
Depreciation (P20,000 x 10%)
Repair (P100,000 x 10%)
Office supplies
Total deduction

Problem 8 12

Salary expense (P180,000 + P20,000)

Estimated uncollectible accounts
Compromise penalty
Depreciation expense
Miscellaneous expense

P 2,000
10,000
6,000
P18,000
Tax laws
P200,000
30,000
.

GAAP
P200,000
10,000
50,000
30,000
5,000

Deductible from earnings

P230,000

P295,000

Note: For tax purposes, the miscellaneous expense is not deductible because it was not
reported last year. For accounting purposes, the miscellaneous expense can be deducted as
prior period adjustment from retained earnings.
Problem 8 13

Sales

P300,00
0
40 %
P120,00
0

Multiplied by OSD rate

Optional standard deduction

The compensation income is not included in determining OSD. The OSD (40% of
gross sales or gross receipts) is only allowed as deduction from income derived from
business. If an individual opted to use OSD, he is no longer allowed to deduct cost of
sales. [Sec. 34(L), NIRC; Sec. 3, Rev. Regs. No. 16-2008]
Problem 8 14
B
Gross receipts from profession
Rent income (P475,000/95%)
Total gross income
Multiplied by percent of OSD
Optional standard deduction
Problem 8 15

P100,000
500,000
P600,000
40%
P240,000

Since there are no official receipts and documents to support the operating
expenses, the reported operating expenses are not deductible (Sec. 34(A)(b), NIRC).
The OSD is not allowed for nonresident aliens (Sec. 34(L), NIRC). No personal
exemption will be granted to a nonresident alien with business in the Philippines if
his country does not have an exemption reciprocity law favoring a Filipino citizen.
(Sec. 9, Rev. Regs. No. 2)
Problem 8 16

Sales
Less: Cost of sales
Basis of OSD
Multiplied by OSD rate
Optional standard deduction

Sole Proprietor

Corporatio
n
P1,000,00 P1,000,000
0
.
300,000
P1,000,00 P 700,000
0
40 %
40 %
P P 280,000
400,000

RA 9504 is specific as to the basis of OSD. For individuals, the basis of the 40% OSD
shall be the gross sales or gross receipts. In the case of corporate taxpayers
subject to tax under Sections 27(A) and 28(A)(1) of the Tax Code, as amended, the
basis of the 40% OSD shall be the gross income.

Problem 8 17
B
Operating expense before representation expense
(P2,000,000 P300,000)
Representation expense Actual
- Limit (P20,000,000 x 0.005)
- Lower
Allowable itemized deductions

P1,700,000
P300,000
100,000
10 0, 000
P1,800,000

Problem 8 18
B
Salary expense
Rent expense
Advertising expense
Depreciation expense
Interest expense
Tax differential on interest income (P30,000 x 33%)
Total itemized deductions

P120,000
24,000
6,000
5,000
60,000
( 9,900)
P205,100

NOLCO is not an itemized deduction.

Problem 8 19

Sales

Using OSD
P1,200,00
0
- 0P1,200,00
0

Cost of sales
Gross income
Less: OSD or Itemized deductions
(P1,200,000 x 40%)
Net income before personal exemption

Using
Itemized
P1,200,000
700,000
P 500,000
- 0-P

480,00
0
P
720,000

Allowed deduction using OSD (P1,200,000 x 40%)

Less: Cost of sales
Net disadvantage using OSD

500,000

P 480,000
700,000
(P220,000)

No itemized deduction is allowed if no official receipts, records or other pertinent

papers can be used to support it (CIR vs. Isabela Cultural Corporation, G.R. No.
172231, Feb. 12, 2007).
In case of individual taxpayer, the cost of sales or the cost of services are not
allowed to be deducted for purposes of determining the basis of OSD inasmuch as
the law (RA 9504) is specific as to the basis thereof which states that for individuals,
the basis of the 40% shall be the gross sales or gross receipts and not the
gross income. (Sec. 3, Rev. Regs. No. 16-2008)
Problem 8 20
Gross salaries of employees

A
P6,000,000

Grossed-up monetary value of fringe benefits

Deductible salaries and fringe benefits expenses

1,000,000
P7,000,000

Problem 8 21
C
Assume bonus is computed after tax but before bonus. The answer is letter D = P8,143,
computed as follows:
Net income before charitable contribution (P75,000 +
P5,000)
Less: Deductible contribution (P80,000 x 5%) lower of
actual
Net income before income tax and bonus
B
T

=
=

15% (76,000 T)
30% (76,000 B)

B
B
B

=
=
=

15% [76,000 30% (76,000 B)]

15% (76,000 24,320 + 30%B)
11,400 3,420 +0.045B

B 0.045B
0.955B
B

=
=
=

7,980
7,980/0.955
8, 35 6

P 80,000
4,000
P 76,000

Proof:
Income before bonus and tax
Less: Income tax (P76,000 P8,382) x 30%
Income after tax but before bonus
Multiplied by rate of bonus
Bonus

P76,000
20,285
P55,715
15%
P 8,356

Problem 8 22
B
Monthly salary
Death benefits
Terminal pay
Continuous compensation after the burial for three months
Total deductible expenses

P 5,000
50,000
25,000
15,000
P95,000

Note: Donation for coffin and other wake expenses is not business or compensation related
and, hence, not deductible. (Sec. 72, Rev. Regs. 2)
Problem 8 23

Purchases
Decreased in inventory
Increased in inventory
Problem 8 24
D
Traveling expenses (P50,000 + P200,000)

Inventoriable
co s t

Supplies expense

P300,000
20,000
.

P40,000
( 3,000) P320,000
P37,000
P250,000

Fringe benefit expense (P68,000/68%)

Transportation expense messenger
Total allowable expense

100,000
40,000
P390,000

Problem 8 25
B
Monthly rent (P20,000 x 60%) x 2 mos from Oct. 31 to Dec. 31
Insurance premium (P3,000 x 60%) x 2/12
Real property tax (P1,500 x 60%) x 2/12
Deductible rent expense

P24,000
300
150
P24,450

Note: The city services is not a rent expense.

Problem 8 26
1. Letter B
Rent for 6 months based on usage (P20,000 x 6) x 80%

P96,000

2. Letter D
Actual cash collection for rent

P150,000

Problem 8 27
D
Monthly rental expense
Monthly depreciation (P600,000/8)/ 12
Monthly deductible expense
Problem 8 28
C
Rent expense (P5,000 x 12)
Add: Depreciation expense [(P950,000/9.5) x 11/12]
Deductible expense in 200y

P2,000
6, 250
P 8, 25 0
P 60,000
91,667
P151,667

At the start of the used of the building, the remaining period for the contract of lease
is 9.5 years. The salvage value is ignored in the computation of the depreciation
because T Foods could no longer benefit on it since the improvement on the land
will be owned by the lessor at the end of the 10-year contract of lease.
Problem 8 29
1. Letter B
Trading - Limit lower (P5,000,000 x .005)

P25,000

2. Letter C
Servicing actual lower
Problem 8 30

P30,000
B

Actual representation expense

Multiplied by percent of representation expense
for sales [P700,000/(P700,000 + P300,000)]
Apportioned representation expense for sales
Limit (P700,000 x 0.005), lower

P10,000

Actual representation expense

Multiplied by percent of representation expense
for revenue [P300,000/(P700,000 + P300,000)]
Apportioned representation expense for sales
Limit (P300,000 x 0.01)
Deductible representation expense

P10,000

70 %
P 7,000
P3,500

30 %
P 3,000
3,000
P6,500

Problem 8 31
A
Interest expense
Tax differential (P50,000 x 33%)
Deductible interest expense

Problem 8 32

P40,000
(16,500)
P23,500

Breast-feeding assistance to the needy additional

Salary of senior citizens additional (P100,000 x 15%)
Seniors citizen discount (P300,000 x 20%)
Total special itemized deduction
Problem 8 33
Interest
Interest
Interest
Interest
Interest
Total

P200,000
15,000
60,000
P275,000
Deductible

paid in advanced
paid to a brother
paid on delinquency taxes
on borrowings to finance his family home
paid to finance petroleum exploration

Problem 8 34

Nondeductible
P 20,000
12,000

P 8,000
.
P 8,000

30,000
100,000
P162,000

Interest expense on unpaid salaries

Add: Nondeductible tax differential (P40,000/80%) x 33%
Nondeductible interest expense

P 60,000
16,500
P 76,500

Salary expense
Rent expense
Deductible interest expense bank loan (P40,000 P16,500)
Total itemized deductions

P600,000
200,000
23,500
P823,500

The salaries of direct workers should be classified as deductible cost of service and
not to be classified as part of itemized deductions (Rev. Regs. No.16-2008). Interest
expense on unpaid salaries is not deductible. (Kuenzel & Streiff, Inc. vs. Collector of
Internal Revenue, 106 Phil. 355)
Problem 8 35
D
Tax savings from interest expense (P100,000 x 30%)
Final tax on interest income (P1,000,000 x 12%) x
20%
Actual net tax savings
Problem 8 36
A
Documentary stamp taxes
Local tax (P6,000 P800 P200)
Municipal tax
Community tax
Deductible taxes

P30,000
(24,000)
P 6,000
P 1,000
5,000
2,000
1,500
P 9, 500

Note: The fringe benefit income taxes to key officers and rank-in-file employees are to be
classified as deductible fringe benefit expense and not tax expense.

Problem 8 37

Business taxes
Documentary stamp taxes
Automobile registration fees
Postage stamp taxes
Import duty taxes
Total deductible taxes

P 20,000
1,000
3,000
500
50,000
P 74,500

Problem 8 38
D
Unadjusted net income (P520,000 P200,000)
Add back: Income tax foreign country
Adjusted net income
Personal exemption
Net taxable income

P320,000
10,000
P330,000
(50,000)
P280,000

Note: The P10,000 income tax paid to foreign country is better to be treated as tax credit
rather than as operating expense.
Problem 8 39
A
Asset of Oliva
Payment to government (P200,000 x 50%)
Balance

P 60,000
(100,000)
(P40,000)

Deductible bad debts is the entire amount of

collectibles

P100,000

Problem 8 40
B
Bad debts from business actual written off (P100,000 x
40%)

P40,000

Bad debts from profession actual written off

Deductible bad debts expense

50,000
P90,000

Problem 8 41
D
Annual depreciation expense (P50,000 P5,000)/5
Multiplied by ratio of months used during the year (from June 30 to Dec. 31)
Depreciation expense 200B
Problem 8 42
A
Annual depreciation (P2,300,000/11.5 years)
Multiplied by ratio of months used in 200B (July 1 to Dec.)
Depreciation expense
Problem 8 43
D
Oil drilling machine (P800,000 x 90%)/8 years
Oil extracting machine (P900,000 x 90%)/10 years limit
Computers (P100,000 x 90%)/4 years
Delivery truck (P200,000 x 90%)/5 years limit
Annual depreciation expense

P9,000
6/12
P 4, 500
P200,000
6/ 12
P100,000

P 90,000
81,000
22,500
36,000
P229,500

The useful life of properties used in or related to production of petroleum

shall be ten (10) years or such shorter life as may be permitted by the BIR
Commissioner. Properties not used directly in the production of petroleum
shall be depreciated under the straight-line method on the basis of an

estimated useful life of five (5) years. (Sec. 34(F)(4), NIRC)

Problem 8 44
C
Depletion base (P6,000,000 P1,000,000 + P300,000)
Divided by number of extractible estimated tons
Depletion per ton
Multiplied by number of tons extracted during the year
Depletion expense

P5,300,000
5,000,000
P
1.06
80 0, 000
P 848,000

Problem 8 45
1
Letter D
.
Depletable costs, January 1, 200x
Exploration costs
Intangible development costs
Total
Less: Depletion expense (P15,000,000/7,500,000) x 1,200,000
Adjusted basis
Divided by remaining reserves
(5,000,000 + 2,500,000 1,200,000)
New depletion rate/ unit
2
.

P12,500,000
1,000,000
1,500,000
P15,000,000
2,400,000
P 1,260,000
6,300,000
P 2. 00

Letter A
Depletion cost 2007 (P2 x 1,200,000 units)

3
.

P2,400,000

Letter B
Value of production (P12 x 1,200,000 units)
Less: Production and selling costs:
Mining costs

P14,400,000
P2,000,00
0
3,000,000
1,500,000
1,000,00
0

Milling costs
Marketing expenses
Depreciation expense

7,500,000

Net income from operation

Multiplied by limit percentage
Deductible amount fro exploration and development cost
4
.

P 6,900,000
25%
P 1,725,000

Letter B
P2,500,000

Current exploration and

development cost (P1,500,000 +
P1,000,000)
Less: Deductible amount of exploration and development cost (see
3)

1,725,000

Exploration and development cost chargeable to succeeding years

Problem 8 46
B
Deductible expense:
Depreciation expense (P10,000,000 x 90%)/50
Capital outlay
Problem 8 47
1
Letter B
Lower of actual contribution or normal

P 775,000

Capitalized
P180,000

Outright expense
P10,000,000

200A
800,000

200B
800,000

200C
500,000

valuation
Add: Amortization of excess
200A (P200,000/10)
200B (P100,000/10)
Deductible retirement expense
2.

20,000
.
820, 00 0

20,000
10,000
830, 00 0

20,000
10,000
530, 00 0

200A
0

200B
400, 00 0

200C
300, 00 0

Year X

Year Y

700,000
10,000
71 0, 000

600,000
10,000
61 0, 000

Letter A
Actual retirement payments

Problem 8 48

Actual contribution or normal valuation, lower

Add: Amortization (P100,000/10)
Deductible retirement expense

Note: Only the excess of the actual contribution over the normal valuation is to be amortized
over 10 years.
Problem 8 48
B
Allowed deductible contribution (P200,000 x 5%)

P10,000

Problem 8 49
B
Allowed deductible contribution (P200,000 x 5%)

P10,000

Problem 8 50
D
Allowed deductible contribution [(P60,000 + P5,000) x 10%]
Problem 8 51
B
Income before charitable contribution (P500,000 P130,000)
Multiplied by percent of limit
Allowed deductible contribution - lower
Problem 8 52
PPHHI per month

P 6, 500

P370,000
5%
P 18,500

A
P 2 00

Problem 8 53
D
Not allowed to deduct PPHHI because family income exceeded P250,000 per year.
Problem 8 54
C
Actual value of donation priority program
Adopt a school program incentive (P1,000,000 x 50%)
Deductible donation
Problem 8 55
1. Operating expenses (1,000,000 x 30%) P50,000
Interest expense (P50,000 (P40,000/80%) x 33%]
Total itemized deductions
Add: NOLCO
Total deductible expenses

P1,000,000
50 0, 000
P1,500,000

P250,000
33,500
P283,500
500,000
P783,500

Note: NOLCO is not an itemized deduction but part of deductible

expenses.
2.

Gross income (P5,000,000 P2,000,000)

Multiplied by OSD rate

P3,000,000
40%

OSD

P1,200,000

Note: NOLCO is not allowed to be deducted if the taxpayer uses OSD.

3.

Gross income
Less: OSD
Net taxable income

P3,000,000
1,200,000
P1,800,000

Problem 8 56
Salaries of assistants
Traveling expenses
Light and water office
Stationeries and supplies
Office rent
Total operating expenses before contribution
Add: Contribution subject to limit (P500,000 P176,850) x 10%)
Allowable itemized deductions

P 96,000
11,000
7,890
1,960
60,000
P176,850
32,315
P209,165

Problem 8 57
Bad debts written-off (P35,000 P30,000)
Depreciation expense (P140,000 P100,000)
Donation to the government priority
program
Donations subject to limit:
Lower of actual, P170,000 or
(P2,500,000 x 10%)
(P2,500,000 x 5%)
Total allowable deductions

Sole
Proprietorship
P 5,000
40,000
50,000
170,000
.
P 26 5, 000

Corporation
P 5,000
40,000
50,000

125,000
P 22 0, 000

Partnership
P 5,000
40,000
50,000

125,000
P 220,000

The research and development cost is to be treated as a deferred expense, hence, its
amortization shall be made in the succeeding five years when the taxpayer realizes
benefits from such expenditures (Sec. 341, NIRC).
Problem 8 58
1.
Actual contribution or normal valuation, lower
Add: Amortization - 200A (P250,000/10)
Deductible retirement expense
2.

Financial net income

Add: Retirement benefit expense accounting
Total
Less: Deductible retirement expense taxation
Net income for tax purposes

Problem 8 59
Salary expenses
Retirement (P250,000 + P50,000/10)
Representation expense (P10,000,000 x .005)
Interest expense paid to the BIR - full
Interest expense limit:

200A
1,000,000
25,000
1,025,000

200B
900,000
25,000
925, 00 0

50,000,000
1,100,000
51,100,000
1,025,000
50,075,000

60,000,000
1,200,000
61,200,000
925, 00 0
60,275,000

Corporation
500,000
255,000
50,000
20,000

Individual
500,000
255,000
50,000
20,000

(P100,000 (P96,000/80%) x 33%)

Depreciation expense
Rent expense
Group insurance expense
Bad debts expense (P100,000 x 20%)
Contribution expenses:
TESDA priority project (500,000 x 1.5)
Local government limit (lower is actual)
Total itemized deductions

60,400
40,000
250,000
50,000
20,000

60,400
40,000
250,000
50,000
20,000

750,000
100,000
2,095,400

750,000
100,000
2,095,400

Note: NOLCO is an allowable special deduction but not an itemized deduction.

Problem 8 60
1.
Salaries expense (P680,000 P100,000)
Bad debts expense (P370,000 P270,000)
Retirement expense (P1,000,000 P380,000)
Representation expense (P39,000,000 x 0.005)
Rent expenses (P200,000 P20,000)
Taxes expense (P300,000 P270,000)
Life insurance expense (P150,000 P100,000)
Interest expense [(P200,000 (50,000 x 33%) + P20,000]
Total itemized deduction before contributions
Contribution expenses:
Donation to TESDA priority project (P500,000 x 150%)
Donations for Rooming-in and Breast-feeding (200k x 2)
Donations NGOs (35% for admin.)
Ind: (P39,460,000 P30,000,000 P1,958,500) x
10%=750,150
Corp: (P39,460,000 P30,000,000 P1,958,500) x 5%=375,075

Total allowable deductions

Individual
580,000
100,000
620,000
195,000
180,000
30,000
50,000
203,500
1,958,500

Corporation
580,000
100,000
620,000
195,000
180,000
30,000
50,000
203,500
1,958,500

750,000
400,000
100,000

750,000
400,000
100,000

.
3,208,500

.
3,208,500

Computation of sales:
Financial income
Cost of sales
Operating expenses deducted
(P680,000 + P370,000 + P1,000,000 + P800,000 + P200,000
+ P300,000 + P150,000 + P160,000 + P800,000)
Total sales
2.
Gross income (P39,460,000 P30,000,000)
Less: Total allowable deductions
Net taxable income

Individual
P9,460,000
3,208,500
P6,251,500

P 5,000,000
30,000,000
4,460,000
P39,460,000
Corporation
P9,460,000
3,208,500
P6,251,500