INCOME TAX DEDUCTIONS What are Deductions Items or

INCOME TAX DEDUCTIONS

What are Deductions? Items or amounts which the law allows to be deducted from gross income in order to arrive at the taxable income.

Governing Principles: • The basic principle governing deductions from gross income apply to all taxpayers. • Deductions are strictly construed against the taxpayer. • Adequate records should be kept. • The deduction claimed must have been subjected to withholding tax, if required. • Taxpayer must be able to prove he is entitled to the deduction authorized or allowed.

Who may avail of deductions? INDIVIDUALS § Citizen § Resident alien § NRA-ETB § Member of GPP CORPORATIONS § Domestic corp. § Resident foreign corp. § Proprietary educational institutions and hospitals § GOCCs

Who CANNOT avail of deductions from GI? § Non-resident alien NETB § Non-resident foreign corporation § Citizens and resident aliens whose income is purely compensation income (except for health and/or hospitalization insurance premium payments)

Kinds of Deductions: 1. Optional standard deductions – 10% of the GI. 2. Itemized deductions • ordinary AND necessary expenses, losses, interests, taxes • bad debts • depreciation of property; • depletion of oil and gas wells and mines; • charitable and other contributions; • research and development; • pension trust contributions of employees; and • premium payments on health and/or hospitalization insurance 3. Personal and additional exemptions 4. Special deductions – applicable only to Insurance companies, whether domestic or foreign. (Sec. 37, CTRP).

Itemized Deductions

NECESSARY and ORDINARY EXPENSES Necessary Expense - appropriate and helpful in the development of taxpayer's business. Ordinary Expense - normal or usual in the /line of business. Bribes, kickbacks and other similar payments are NOT deductible. Requisites of Business Expense to be Deductible: § ordinary and necessary; § paid or incurred w/in the taxable year; § paid or incurred in carrying on a trade or business; § substantiated with official receipts or other adequate records.

What is Capital Expenditure? An expenditure that benefits not only the current period but also future periods. It is not deductible but depreciable, EXCEPT, if the taxpayer is a non-profit proprietary educational institution which may elect either to deduct the capital expense or depreciate it.

INTEREST Requisites to be deductible: (Rev. Reg. No. 13 -2000) § There must be indebtedness; § There should be interest expense paid/incurred; § Indebtedness must be that of the taxpayer; § Connected with the taxpayer’s trade/business/profession; § interest expense must have been paid/incurred during the taxable year; § Interest must be legally due and stipulated in writing; § not be incurred to finance petroleum operation; § Payment must not be arranged between related taxpayers; § Interest was not treated as capital expenditure; and § Not expressly disallowed by law.

INTEREST DEDUCTIBLE NON-DEDUCTIBLE § Interest on taxes paid for § Payments made delinquency/deficiency between related § Interest paid on scrip parties dividends § Interest paid in § Interest on deposits advance thru § Interest paid by corporate discount taxpayer § Indebtedness is incurred by a service contractor to finance petroleum corp.

INTEREST GENERAL RULE ON DEDUCTION: The amount paid/incurred within the taxable year of indebtedness in connection with taxpayers trade/business/profession shall be allowed as deduction. LIMITATION: 1/1/00 - 38%; 1/1/06 - 42%; 1/1/09 - 33% OPTIONAL TREATMENT: a. As expense b. As capital expenditure

TAXES Requisites to be deductible: must be in connection with taxpayer’s business; tax must be imposed by law on , and payable by, taxpayer; and paid or incurred during the taxable year. (Tax Benefit Rule)

TAXES DEDUCTIBLE NON-DEDUCTIBLE • Philippine income tax, except All taxes, national/local, paid or incurred during the FBT taxable year in connection • Income tax imposed by foreign authority, except with the taxpayer’s when taxpayer signifies profession/trade/business, desire to avail of tax credit are deductible from GI. • Estate and donor’s taxes • Tax assessed against local benefits of kind tending to increase the value of property assessed. • Final taxes (income tax) • Special assessments

TAXES LIMITATIONS: In case of NRAETB and RFC, taxes deducted shall only be allowed only to the extent they are connected with income from sources in the Philippines. Exception that deduction is personal: § Taxes of shareholder can be claimed by corporation. § If a tax free covenant , even if paid no deduction.

LOSSES Requisites to be deductible: actually sustained by the taxpayer during the taxable year; connected with the business, trade or profession; Evidenced by completed transaction; not compensated by insurance or otherwise; Not claimed as deduction for estate tax purposes; Notice of loss must be filed with the BIR within 45 days from date of discovery of casualty, robbery, theft or embezzlement.

LOSSES TYPES OF LOSSES: Ordinary Losses (deductible) Special Losses (Non-deductible) • Incurred in • Capital losses trade/business/profession • Loss from wash sale • Of property connected with • Wagering losses trade/business/profession, if • Abandonment losses loss arises from fires, • Loss from illegal shipwreck or other transactions casualties, or from robbery, • Loss from theft or embezzlement sale/exchange between related parties

What are BAD DEBTS? Are debts due to the taxpayer actually ascertained to be worthless and charged off during the year.

BAD DEBTS Requisites to be deductible: Valid and subsisting debt; Debt must be actually ascertained to be worthless and uncollectible; Obligation is not between related parties (Sec. 36 b CTRP); Debt is expensed within the year; and Debt is connected with profession, trade or business.

What is Equitable Doctrine of Tax Benefit? A recovery of bad debts previously deducted from gross income constitutes taxable income if in the year the account was written off, the deduction resulted in a tax benefit.

What is DEPRECIATION? Is the gradual diminution in the service or useful value of tangible property due from exhaustion, wear and tear, and normal obsolescence.

DEPRECIATION Requisites to be deductible: Must be reasonable; Must be on property used in the conduct of the business; Must be expensed during the taxable year;

Method of Depreciation: Straight line Method

Special Type of Depreciation q. Petroleum operations: Depreciation of directly related to production – SLM Useful Life – 10 yrs. or shorter Depreciation of not directly related to production - SLM q. Mining operations: If expected life is 10 yrs. or less – normal rate If 10 yrs. Above – depreciate between 5 yrs. and above.

The Depreciation charged if taxpayer is NRAETB and NRC? Depreciation is deductible only when property is located in the Philippines.

DEPLETION Is the reduction of cost or value of natural resources such as oil and gas wells, and mines as resources are converted into inventories.

Allowable Deductions from GI based on classes of taxpayer: Individuals Corporations Estates/Trusts Er-Ee relationship Business/Professional Itemized only deductions • health and/or • OSD or itemized hospitalization deduction insurance • health and/or premium hospitalization payments insurance premium • Personal and payments additional • Personal and exemptions additional exemptions Section 62 of the NIRC

CHARITABLE & OTHER CONTRIBUTIONS REQUISITES FOR DEDUCTIBILITY: § gift must be actually paid. § must be given to the organization. § net income of the institution must not inure to the benefit of any private stockholder or individual. VALUATION of property donated other than money: Acquisition Cost

CHARITABLE & OTHER CONTRIBUTIONS Deductible in Full: Donations to the govt. - in accordance with National Priority Plan determined by NEDA Donations to foreign institutions/organizations - in compliance with agreements, treaties, etc. or Donations to accredited NGOs: Ø Organized/operated exclusively for scientific, educational, character-building & youth & sports development, health, social welfare, cultural or charitable purposes Ø Administrative expense < 30% of total expenses Ø Upon dissolution, assets distributed to another nonprofit domestic corp. /state/another org. to be used in same purpose as the dissolved corp.

CHARITABLE & OTHER CONTRIBUTIONS Limitations: § Paid or made w/in the taxable yr. : § For use of the govt. , exclusively for public purpose or, to accredited domestic corps. /associations organized & operated exclusively for: religious, charitable, scientific, youth & sports development, cultural or educational purposes, for the rehabilitation of veterans, social welfare institutions, NGOs § no part of NI inures to the benefit of any private stockholder or individual

CHARITABLE & OTHER CONTRIBUTIONS Limitations for: § individuals: not > 10% of taxable income before deducting the charitable contributions § corporation: not > 5 % of taxable income before deducting the charitable contributions

RESEARCH AND DEVELOPMENT § RESEARCH is the original and planned investigation undertaken with the prospect of gaining scientific/technical knowledge and understanding. It is undertaken to discover new knowledge useful in developing a new product or will result in significant improvements of an existing product. § DEVELOPMENT is the application of research findings or other knowledge to a plan/design for the production of a new/substantially improved material, device, product, process, system or service prior to commencement of commercial production.

RESEARCH AND DEVELOPMENT REQUISITES FOR DEDUCTIBILITY AS : EXPENSE AMORTIZATION § paid/incurred during the taxable year § Ordinary/necessary expenses in connection with trade/business/profession § not chargeable to capital account • • paid/incurred by the taxpayer in connection w/ his trade/business not treated as expense chargeable to capital acct. not chargeable to property subject to depreciation/depletion amortized not over 60 months

RESEARCH AND DEVELOPMENT LIMITATIONS ON DEDUCTIONS - not applicable to EXCLUSIONS: • Any expenditure for the acquisition or improvement of land, or for the important of prop. to be used in connection w/ R&D of a character subject to depreciation & depletion • Any expenditure paid/ incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, including oil or gas (exploration exp. )

PENSION TRUSTS (past service cost) Pension Trust Contributions - a deduction applicable only to the employer on account of its contribution to a private pension plan for the benefit of its employee. This deduction is purely business in character. Established or maintained by employer to provide for the payment of reasonable pensions to his employees. • Normal Cost - the contributions during the taxable year to cover the pension liability accruing during the taxable year. (EXPENSE) • Past Service Cost – amount in excess of the above contribution (covering pension liability pertaining to old employees which accrued during the years previous to the establishment of the pension trust); allowed as deduction only if: (a) such amount not been allowed as a deduction (b) apportioned in equal parts over 10 consecutive years beginning w/ the yr. in w/c the transfer/payment is made (Sec. 34[J])

PENSION TRUSTS (past service cost) REQUISITES FOR DEDUCTIBILITY: Øemployer must have established a pension or retirement plan; Øpension plan is reasonable and actuarially sound; Ømust be funded by the employer; Øamount contributed must be no longer subject to the control and disposition of the employer; Øpayment has not yet been a deduction; and Ødeduction is apportioned in equal parts over a period of 10 consecutive years beginning with the year in which the transfer of payment is made.

PENSION TRUSTS (past service cost) Summary Rules: ü EXEMPT FROM INCOME TAX - employees’ trust under Sec. 60(B) ü EXCLUSION FROM GROSS INCOME - amount received by the employee from the fund upon compliance of certain conditions under Sec. 32(B)(6) ü DEDUCTION FROM GROSS INCOME – a. amounts contributed by the employer during the taxable year - considered as ordinary and necessary expenses under Sec. 34(A)(1). b. 1/10 of the reasonable amount paid by the employer to cover pension liability applicable to the years prior to the taxable year, or so paid to place the trust in a sound financial basis -deductible under Sec. 34 (J).

PREMIUM PAYMENTS ON HEALTH AND/OR HOSPITALIZATION INSURANCE- an amount of premium on health and/or hospitalization paid by an individual taxpayer (head of family or married), for himself and members of his family during the taxable year.

PREMIUM PAYMENTS ON HEALTH AND/OR HOSPITALIZATION INSURANCEWho may Avail of this deduction? i. Individual taxpayers earning purely compensation income during the year. ii. Individual taxpayers earning business income or in practice of his profession whether availing of itemized or OSD during the year.

PREMIUM PAYMENTS ON HEALTH AND/OR HOSPITALIZATION INSURANCEREQUISITES FOR DEDUCTIBILITY: Ø Insurance must actually be taken; Ø The amount deductible must not exceed P 2400 per family or P 200 per month during the taxable year; Ø The family had GI of not more than P 250, 000 for the taxable year; Ø In case of married individuals, only the spouse claiming additional exemption shall be entitled to this deduction.

What is the nature of Optional Standard Deduction or OSD? A Taxpayer may elect to pay a standard deduction in an amount not exceeding 10% of GI. Such election should be signified in his return & shall be irrevocable for the taxable year for which the return was made.

Who may avail of Optional Standard Deduction or OSD? OSD may be applicable to any individual, except to an NRA.

Are there deductions for Estates and Trusts? Yes. They are allowed a deduction of P 20, 000.

NON-DEDUCTIBLE ITEMS: (Section 36) § Personal, living or family expenses § Amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate § Amounts expended in restoring property or in making good the exhaustion thereof for w/c an allowance is or has been made § Premiums on life insurance policy when the taxpayer is directly/indirectly a beneficiary under such policy

NON-DEDUCTIBLE ITEMS: (Section 36) § No deduction shall be allowed in Losses from Sales or Exchanges of Property directly/indirectly: ü between members of a family (consanguinity) ü between an individual & a corp. more than 50% of OS owned by such individual (except in case of distributions in liquidation) ü between 2 corps. more than 50% in value of OS stock owned by same individual, if either one is a personal holding co. or a foreign holding co. during the taxable yr. preceding the date of sale/exchange ü between grantor & fiduciary of any trust ü between Fiduciary of a trust & the fiduciary of another if same person is a grantor to each trust ü between Fiduciary & a beneficiary of a trust