DEDUCTIONS ON GROSS

INCOME
Deductions
• Deductions are amounts allowed to be substracted from Gross
Income to arrive at taxable income in the ITR. Taxpayers may choose
not to avail of the deduction.
• If deductions are claimed, the burden of providing the legality and
correctness of the deductions rests upon the taxpayer. The taxpayer
has the obligation to substantiate with receipts and other evidences
every item of deduction is required.
Kinds of Deductions
• 1. Itemized Deductions (ID) or Optional Standard Deduction (OSD);
and
• 2. Income distributed to heirs/beneficiaries for estate tax.
Optional Standard Deduction
• OSD is the deduction which can be taken in lieu of Itemized Deductions
• Who may claim OSD?
• 1. For individuals – citizens, resident aliens, estate and trusts (graduated
rates)
• Amount of OSD = 40% of Gross sales, net of returns, allowances, and
discounts (accrual basis) + other taxable income from operations not
subject to FTs
• Amount of OSD = 40% of Gross receipts, net of returns, allowances, and
discounts (cash basis) + other taxable income from operations not subject
to FTs
• *OSD is in lieu of COGS (COS) and Itemized Deductions
• 2. Corporations: Domestic Corporations (including OP) and Resident
Foreign Corporations
• Amount of OSD = 40% of Gross Income and Other taxable income not
subject to FTs
• *OSD is in lieu of the Itemized Deduction only.
• Election of OSD is made in the 1st Quarter Return. Failure by taxpayer
to indicate OSD election in 1st Q Return means that taxpayer is
claiming IDs. When election is made, it is irrevocable for the entire
year.
Itemized Deductions
A. Business Expenses
• Requisites:
• 1. Ordinary and necessary for the business
• 2. Incurred or paid during the taxable year
• 3. Connected with the trade, profession, or business of the taxpayer
• 4. Reasonable expenses of the business
• 5. Substantiated by official receipts/records
• 6. The withholding tax required to be withheld has been withheld and
remitted to the BIR
A. Business Expenses
• 1. Compensation expenses for personal services actually rendered:
• a. Includes salaries and other forms of compensation, including bonuses,
and the Grossed-up Monetary Value of fringe benefits subject to FT
• b. Includes management and labor expenses, commissions, and pension
payments.
• c. Includes compensation for injuries paid by the employer less any
insurance proceeds
• d. Includes premiums of life insurance of the employee where the
beneficiary is not the employer but the employee
• e. Includes salaries paid after death of the employee, but does not include
donations for coffin and wake expenses.
• 2. Travelling Expenses includes transportation expenses, meals and lodging
• 3. Entertainment, Amusement, and Recreational Expense (EAR)
• Expenses in entertaining or meeting with guests, or clients (representation
expenses) including
• depreciation expenses relating to entertainment facilities.
• Subject to the following ceilings:
• 1. For taxpayers engaged in the sale of goods and properties: ½ of 1% of
net sales
• 2. For taxpayers engaged in the sale of service/leasing of properties: 1% of
net revenues
• 4. Materials and supplies actually consumed in business
• 5. Maintenance and repairs which do not add to the value of the property
nor appreciably prolong its life
• 6. Rental expense of the lessee of property used in business including
taxes and other obligations of the lessor which are paid by the lessee and
deprecation of leasehold improvement.
• 7. Advertising and other selling expenses
• 8. Operating expenses of transportation equipment used in trade,
profession, or business
• 9. Insurance premiums against fire, storm, theft, accident, or other
similar losses in the trade or business
• 10. Miscellaneous expenses including the following:
• a. Amortization of pre-operating expenses, which are treated as deferred
expenses, for not more than 60 months.
• b. Cost of suits are allowed as deductions
• c. Judgement against the taxpayer less any amount compensated for by
insurance
• d. Loss upon a corporation’s retirement of its own bonds.
• 11. Special Expense Allowed to private educational institution under Sec.
27(B)
• Capital outlays for expansion of school facilities can either be expensed
immediately or capitalized and depreciated
Interest Expense
• 1. Requisites
• a. Must be connected with the trade or business of the taxpayer
• b. There must be a liability to pay interest. The obligation to pay
interest must be stipulated in writing and must be legally due.
• c. Must be paid or accrued within the taxable year.
• d. Interest expense must be the obligation of the taxpayer
• e. Interest payment must not be between related taxpayers in Section
36(B) of NIRC
• 2. Reduction of Allowable deduction for interest expense by 33%
interest income subject to FT beginning January 1, 2009
• Exceptions: Where interest expense is deductible in full:
• a. IF taxpayer has no interest income subject to FT;
• b. Interest on all unpaid business-related taxes (RR 13-200); and
• c. Interest payments of an occupant of a socialized housing project
incurred for the construction or purchase of the house
C. Deductible Taxes
• Requisites:
• 1. Paid or incurred within the taxable year;
• 2. Must be connected with the profession, trade or business of the
taxpayer; and
• 3. Is directly imposed on the taxpayer.
• Examples of deductible taxes: import duties; business taxes (like
percentage taxes); local business taxes; community tax; occupation tax;
privilege and license taxes; excise taxes; DST; automobile registration fees;
real property tax; fringe benefits tax (FBT)
• Examples of non-deductible taxes: Income tax, foreign income tax if
claimed as a tax credit; estate tax; donor’s tax; special assessments; VAT;
final taxes; stock transaction tax under Sec. 127; capital gains tax
D. Losses
• Ordinary Losses
• 1. Casualty losses due to mishap, accident, fortuitous event, robbery, theft,
embezzlement of property used in trade, profession or business of the
taxpayer
• Requisites:
• 1. Must involve ordinary properties
• 2. Actually sustained
• 3. Not claimed as a deduction for estate tax purposes
• 4. Not compensated for by insurance or by other forms of indemnity
• 5. Must be reported to the BIR within 45 days from the date of loss
• 2. Business Losses
• a. Losses from sale of ordinary assets
• b. Partner’s share in the losses of a GPP

• 3. Net Operation Loss Carry-Over (NOLCO) – excess of allowable deductions

over gross income in a taxable year.
• a. Can be availed of by individual taxpayers engaged in trade, business, or a
profession, estate and trust, domestic and resident foreign corporations
subject to normal income tax, and special corporations subject to
preferential tax rates (hospital corporation, proprietary educational
corporations, and regional operating headquarters of MNCs)
• Taxpayers not entitled to NOLCO;
• 1. OBUs and FCDUs of domestic or foreign banking corporations;
• 2. PEZA, SBMA, CDA etc. registered enterprises with respect to their registered business
• 3. Foreign corporations engaged in international shipping or air carriage business

• b. No NOLCO if net operating loss was incurred in a year during which taxpayer was
exempt from income tax.
• Ex. Corporations enjoying income tax holiday incentives from the BOI or PEZA are not
entitled to NOLCOs.

• c. Net operating loss can be carried over and deducted from gross income for the next 3
consecutive taxable years
• d. NOLCO shall be allowed only if there has been no substantial
change in the ownership of the business. “No substantial change”
means ≥ 75% in value of the outstanding shares or ≥ 75% of the paid-
up capital of a corporation, is held or on behalf of the same person.
E. Bad Debts
• Requisites:
• a. There must be a valid and subsisting debt owed the taxpayer;
• b. The debt must be connected with the trade, business or profession
of the taxpayer;
• c. The debt must be ascertained to be worthless or uncollectible;
• d. The debt must be charged off within the taxable year.
Recovery of bad debt previously allowed as deduction is governed by
the Tax Benefit Rule. The recovery of a bad debt is included in gross
income if its deduction in a previous year resulted in an income tax
benefit to the taxpayer.
F. Depreciation/Depletion
• Also includes amortization of intangible assets (patents, copyrights,
etc.)

• Requisites:
• 1. Asset must be used in trade, business, or profession of the
taxpayer;
• 2. Asset has a limited useful life;
• 3. Allowance for depreciation must be reasonable;
• 4. Allowance for depreciation must be charged off during the taxable
year.
• Methods of Depreciation Allowed under Section 34(F)(1)
• 1. Straight-line method
• 2. Declining balance method
• 3. Sum of the years digits method
• 4. Units of production/hours of use method
• 5. Any reasonable method of measuring obsolescence approved by
the Secretary of Finance
G. Pension Trust Contributions
• Present service cost contribution – paid to cover current pension
liabilities accruing during the taxable year. – Deducted in full

• Past service cost contributions – contributions in excess of the

present service cost contribution in a taxable year – Prorated over 10
year beginning with the year in which the payment is made.
H. Charitable Contributions
• Requisites:
• 1. Contributions or gifts are actually paid
• 2. Given to entities specified by law
• 3. Net income of the recipient does not inure to the benefit of any
stockholder or individual owner
• 4. Taxpayer making the charitable contribution must be engaged in
trade, business or profession.
The amount of any charitable contributions of property other than
money shall be based on the net book value of said property as
reflected in the FS of the donor.
• Limit of Contributions
• Corporation: 5% of taxable income derived from trade, profession, or
business without the benefit of the charitable deductions (both
subject and not subject to limit)
• Individual: 10% of taxable income derived from trade, profession, or
business without the benefit of the charitable deductions (both
subject and not subject to limit)
• Not subject to limit – deductible in full
• 1. Donation to the government or to GOCCs for priority activities in
education, health, youth and sports development, human settlements,
science and culture, or economic development as determined by the
NEDA;
• 2. Donations to foreign institutions and organizations pursuant to treaties
or agreements entered into by the Philippine Government;
• 3. Donations to entities pursuant to special law
• Examples: State colleges and universities; National Commission for Culture
and Arts; Integrated Bar of the Philippines; Philippine Red Cross
• 4. Donations to accredited NGOs
• NGO refers to a non-profit corporation:
• a. Organized and operated exclusively for scientific, research, educational,
character-building, youth and sports development, health, social welfare,
cultural, or charitable purposes;
• b. No part of the net income of such NGO inures to the benefit of any
private individual;
• c. Uses the donation not later than the 15th day of the 3rd month after the
close of its taxable year;
• d. Its administrative expenses ≤30% of total expenses; and
• e. Its assets, upon dissolution, shall be given or distributed to another NGO
organized for a similar purpose, or to the state for a public purpose
• Subject to Limit
• 1. Donation to the government or GOCCs exclusively for public
purposes, but not for priority activities;
• 2. Donations to accredited domestic corporations or associations
organized and operated exclusively for religious, charitable, scientific,
youth and sports development, cultural, educational, or the
rehabilitation of veterans;
• 3. Donations to social welfare institutions;
• 4. Donations to NGOs
I. Research and development expenditures
• Options:
• 1. Deduct as ordinary and necessary expenses. However, the taxpayer
cannot use this option if the expenditure is:
• a. for the acquisition of land or improvement of property which is not
subject to depreciation or depletion; or
• b. for the purpose of ascertaining the existence of location, extent, quality
of a deposit ore or other mineral such as oil and gas.

• 2. Treat as deferred expense and amortize over a period ≥ 60 months

beginning in the month that benefits are first realized from the
expenditure.
• A domestic corporation organized in 2006 provided the following
information:
2014 2015 2016 2017 2018
Net Sales 4,000,000 5,000,000 6,000,000 7,000,000 9,000,000
Cost of 2,000,000 3,500,000 4,200,000 5,000,000 5,200,000
Sales
Business 1,900,000 1,550,000 1,820,000 2,100,000 2,300,000
Exp

• Income tax still due on 2014, 2015, 2016, 2017 and 2018?
• Ginebra Corp. had net sales of ₱1,000,000. The actual entertainment,
amusement, and recreation expense amounted to ₱20,000. The
deductible EAR expense is
• Spa Corp. had net revenues of ₱1,000,000. The actual entertainment,
amusement, and recreation expense amounted to ₱20,000. The
deductible EAR expense is
• CPA Corp. is engaged in the sale of goods and services with net sales
and net revenue of ₱2,000,000 and ₱1,000,000, respectively. The
actual entertainment, amusement and recreation expense amount to
₱18,000. The deductible EAR expense is
• Mr. Popo, a retailer of goods, uses the accrual method in reporting his
income and expenses. His transactions show:
Jan 1 to June 30 July 1 to Sept 30 Oct 1 to Dec 31

Gross Sales 1,000,000 700,000 900,000

Cost of Sales 600,000 200,000 300,000
Business Expense 100,000 50,000 70,000

Non-operating 50,000 40,000 10,000

income in the ITR

• If the calendar year is 2018, and he avails of the OSD, his taxable net
income under the graduated rate is:
• Mr. Popo, a retailer of goods, uses the accrual method in reporting his
income and expenses. His transactions show:
Jan 1 to June 30 July 1 to Sept 30 Oct 1 to Dec 31

Gross Sales 1,000,000 700,000 900,000

Cost of Sales 600,000 200,000 300,000
Business Expense 100,000 50,000 70,000

Non-operating 50,000 40,000 10,000

income in the ITR

• If the calendar year is 2018, and he avails of the itemized deduction,

his net taxable income?
• ABC Corporation, a retailer of goods, uses the accrual method in
reporting his income and expenses under the calendar year basis. Its
transactions show:
Jan 1 to June 30 July 1 to Sept 30 Oct 1 to Dec 31
Gross Sales 1,000,000 700,000 900,000
Cost of Sales 600,000 300,000 600,000
Itemized deduction 100,000 50,000 150,000
Other income in the 70,000 20,000 10,000
ITR

• If the calendar year is 2015, the net taxable income using the OSD is