3/2/2018

Deductions vs. Exclusions from Gross Income

 Deductions create tax shields while exclusions are items
exempt from taxation.

 Deductions reduce taxable income while exclusions are

not at all included in the computation of taxable income.

Philippine Income Taxation  Both deductions and exclusions are good news to
taxpayers.

Deductions and Exclusions from Gross Income

Itemized Deductions: General Rule Rules on specific itemized deductions

 Allowable deductions [Ch. VII, Title II, NIRC] – to qualify as a  Entertainment, amusement and recreation expenses
deductible, an expense should be:  Expenses incurred by a taxpayer in connection with the
 Ordinary, necessary and reasonable expenses in the conduct of conduct of trade, business or exercise of profession, in
business or exercise of profession entertaining, providing amusement or recreation to, or meeting
 Properly substantiated with, guests at a dining place, place of amusement, country club,
theater, concert, play, sporting event and similar events or
 Within the limits set by law – certain expenses have limits
places.
provided by law; Examples are:
 Interest expenses on indebtedness in connection with the taxpayer's
 “Guests” shall mean persons or entities with which the
profession, trade or business taxpayer has direct business relations including a potential
 Taxes client.
 Losses  Limit: 0.5% of net sale of goods and/or 1% of net revenue from
sale of services
Remember: this does not apply to purely-compensation income earners.

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Rules on specific itemized deductions
 Interest
 Interest expense paid or incurred within a taxable year on indebtedness
in connection with the taxpayer's profession, trade or business
 Not treated as a capital expenditure
 Not incurred to finance petroleum operations
 Interest expense to be deducted shall be reduced by 33% of interest
income subjected to final tax
 No deductions allowed for interest expense incurred in a transaction
between:
 members of a family (brothers, sisters, spouse, and lineal descendants only)
 an individual and corporation where majority of its stocks are owned by the
former
 two corporations, majority of both’s stocks are owned by the same individual
 grantor and fiduciary of a trust
 fiduciaries of different trusts of the same grantor
 fiduciary and beneficiary of a trust
Rules on specific itemized deductions
 Losses
 Losses actually sustained in connection to trade, business or
exercise of profession during the taxable year and not
indemnified are deductible
 Casualty losses
 Sworn Declaration of Loss filed with BIR w/in 45 days from the event
causing the loss
 Documentary evidence supporting the actual incurrence of loss and the
value of losses incurred
 Operating Losses/Net Operating Loss Carryover (NOLCO)
 Deductible within the three consecutive years immediately following the
year of loss
 NOLCO incurred during a year where taxpayer is tax-exempt shall not be
carried over
3/2/2018
Rules on specific itemized deductions
 Taxes
 Taxes paid or incurred within the taxable year in connection
with the taxpayer's profession, trade or business, shall be
allowed as deduction except the ff:
 Income taxes
 Foreign income taxes UNLESS not claimed as tax credit
 Estate and donor’s taxes
 Special assessment taxes
 Taxes allowed, if refunded, shall be taxable income to the
extent of income tax benefit derived
Rules on specific itemized deductions
 Losses
 Losses actually sustained in connection to trade, business or
exercise of profession during the taxable year and not
indemnified are deductible
 Capital losses – losses on sale/disposal of capital assets
 Limitation on individual taxpayers: if capital asset sold was held for more
than a year, only 50% of the loss shall be deductible
 Securities classified as capital assets that have become worthless qualify as
capital loss
 Losses from wash sales of stock or securities are DISALLOWED
 A wash sale is a transaction where an investor sells a losing security to
claim a capital loss, only to repurchase it again for a bargain.
 Unless executed by a stock dealer, presumption of a wash sale if the sale at
a loss was preceded or followed (within a 30-day period) by a purchase or
an agreement to purchase substantially identical stocks.
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Rules on specific itemized deductions
 Losses
 Losses actually sustained in connection to trade, business or
exercise of profession during the taxable year and not
indemnified are deductible
 Wagering losses – losses incurred in gambling activities
 Allowable to the extent of gambling gains
 Abandonment losses – abandoned petroleum operations / producing
well
 all accumulated exploration and development expenditures
 book value of drilling equipment
Rules on specific itemized deductions
 Bad debts – tax benefit rule
In 2015, Companies A & B both wrote off a customer account in
the amount of ₱10,000 each. Company A took this amount as a
deduction from its taxable income in the same year while Company
B didn’t as it had enough deductions to zero out its taxable income
for that year. This year, both were able to recover ₱4,000 each.
In accordance with the tax benefit rule…
 Company A should report ₱4,000 as part of its gross income for
the current year;
 Company B need not to as it did not benefit from it in the prior
years.
3/2/2018
Rules on specific itemized deductions
 Bad debts – to be deductible, the debt must be:
 Existing, valid and legally demandable
 connected with the taxpayer’s trade, business or practice
of profession
 a non-related party transaction
As of the end of the taxable year, must have been…
 actually charged off from the taxpayer’s book of accounts
 actually ascertained to be worthless and uncollectible
Recovery of bad debts previously allowed as deduction shall be
included as part of the gross income in the year of recovery to
the extent of the income tax benefit of said deduction (Tax
Benefit Rule)
Rules on specific itemized deductions
 Depreciation
 reasonable allowance for the exhaustion, wear and tear
(including reasonable allowance for obsolescence) of property
used in the trade or business
 Acceptable methods of depreciation:
 Straight-line method (SLM)
 Declining-balance method (DDB)
 Sum-of-the-years-digit method
 Other methods w/c the Secretary may prescribe
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Rules on specific itemized deductions
 Depreciation
 Taxpayer initially determines useful life and depreciation
method (for tax purposes) of the properties and any change
must be approved by the BIR.
 Increase in the value of properties due to appraisal is not
deductible for income tax purposes.
 NRAETB & RFC may only deduct depreciation expense related
to properties in the Philippines used in trade or business.
Rules on specific itemized deductions
 Depletion of oil and gas wells and mines
 Using up of a natural resource by mining, quarrying, or drilling
 Systematic allocation of the cost of extracting natural resources
other than properties subject to depreciation
 Exploration costs – ascertaining the existence, location, extent or quality
of any deposit of resource, incurred prior to development stage
 Development costs – upon establishment of commercial feasibility before
start of actual commercial extraction
 Restoration cost
 After production in commercial quantities has commenced, depletion
incurred shall be:
 If the well/mine dug is non-producing, deductible in the year incurred;
 If the well/mine dug is producing, taxpayer may have the option to:
o Deduct in full as paid/incurred
o Capitalized and amortized using the cost-depletion method
3/2/2018
Rules on specific itemized deductions
 Depreciation
Specific tax treatment on depreciation expense related to…
 All properties used in mining operations (except petroleum
operations) –
• if useful life is 10 years or less, at the normal rate
• if useful life is more than 10 years, may be depreciated over any number
of years between 5 and the useful life.
 All properties related to production of petroleum
 Directly used in the production – either DDB or SLM over 10 years or
shorter as may be allowed by the Commissioner
 Not used directly in the production – SLM over 5 years
 Properties constructed by private educational institutions may either
be (a) deducted outright as incurred or (b) claim depreciation
expense over the useful life
Rules on specific itemized deductions
 Depletion of oil and gas wells and mines
 Cap on claims of outright deduction of mining companies for a
taxable year: amount deductible for exploration and
development expenditures not to exceed 25% of net income
from mining operations computed without the benefit of any
tax incentives under existing laws
 Total deduction for depletion cannot exceed the capital
invested
 NRAETB or RFC are allowed only to deduct depletion on
expenditures related to wells/mines located within the
Philippines
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Rules on specific itemized deductions
 Charitable and other contributions
 Fully-deductible donations
 To Philippine government or its agencies or political subdivisions
including fully-owned government corporations for priority
activities/projects (included in the National Priority Plan) certified by
the National Economic and Development Authority (NEDA)
 To foreign institutions or international organizations if covered by a
treaty with the Philippine government which states full deductibility
Rules on specific itemized deductions
 Charitable and other contributions
 Partially-deductible contributions
 To Philippine government or its agencies or political subdivisions
including fully-owned government corporations for non-priority
activities/projects
 To other accredited domestic corporation or associations organized
and operated exclusively for religious, charitable, scientific, youth and
sports development, cultural or educational purposes or for the
rehabilitation of veterans, or to social welfare institutions, or to non-
government organizations no part of the net income of which inures
to the benefit of any private stockholder or individual not meeting all
the criteria for full deduction
Limitation on Deduction – allowable deduction should not exceed:
10% of taxable income of an individual taxpayer
5% of taxable income of a corporate taxpayer
3/2/2018
Rules on specific itemized deductions
 Charitable and other contributions
 Fully-deductible donations
 To accredited Nongovernment Organizations (NGOs) – nonprofit
domestic corporation
 For exclusively for scientific, research, educational, character-building and
youth and sports development, health, social welfare, cultural or charitable
purposes no part of the net income of which inures to the benefit of any
private individual
 Which should utilize the contribution for its direct purpose not later than
the 15th day of the 3rd month following the close of the taxable year in
which the contribution was received
 Whose annual administrative expenses should not exceed 30% of total
expenses
 Which, upon dissolution, assets are to be distributed to another nonprofit
organization for similar purposes or to the State for public purpose
Rules on specific itemized deductions
 Research and Development
 Research or development expenditures which are paid or
incurred by him during the taxable year in connection with his
trade, business or profession as ordinary and necessary
expenses
 Does not include expenditures subject to depletion or
depreciation
 At the taxpayer’s election, may be:
 expensed outright (as incurred) or
 deferred and amortized over a period not shorter than 60 months
beginning in the month the taxpayer receives benefit from such
expenditures
 Pension trusts
 In excess of contributions for current pension liabilities
amortized over 10 years
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Items not deductible
 Personal, living or family expenses
 Amounts paid out for permanent improvements or
betterments to properties
 Restoration costs for which allowance has been made
 Premiums paid on any life insurance policy covering the
life of any officer or employee when the taxpayer is
directly or indirectly a beneficiary under such policy
Exclusions from Gross Income
 Life insurance proceeds
 paid to the heirs or beneficiaries upon death of the insured
 interest, if any, shall be included in gross income
 Return of premium
 amount received by the insured as a return of premiums
 Gifts, Bequests, and Devises
 received gifts (subject to Donor’s tax)
 income from gifts, shall be included in gross income
 Compensation for Injuries or Sickness
 compensation for personal injuries or sickness, plus the
amounts of any damages received, whether by suit or
agreement, on account of such injuries or sickness
3/2/2018
Optional Standard Deduction (OSD)
 In lieu of itemized deductions, the taxpayer may elect
OSD which is equal to:
 40% of an individual taxpayer’s gross sales/receipts
 40% of a corporate taxpayer’s gross income
 irrevocable for the taxable year for which the return is
made
 an individual who is entitled to and claimed for the
optional standard deduction shall not be required to
submit with his tax return such financial statements
Exclusions from Gross Income
 Income exempt under treaty
 Retirement Benefits, Pensions, Gratuities, etc.
 Retiring employee must:
 have received it in accordance with a reasonable private benefit plan
 have been employed by the company for atleast 10 years
 be at least 50 years old
 be availing of this retirement benefit exemption only once
 Separation pay – separation must be for any cause beyond the
employee’s control
 social security benefits, retirement gratuities, pensions and
other similar benefits received by citizens or residents from
foreign government agencies and other institutions
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Exclusions from Gross Income Exclusions from Gross Income

 Retirement Benefits, Pensions, Gratuities, etc.
 Benefits due to any Philippine residents under the laws of the
United States administered by the United States Veterans
Administration
 Social Security System (SSS) benefits
 Government Service Insurance System (GSIS) benefits
 Income Derived by Foreign Government
 Income Derived by the Government or its Political
Subdivisions
 Prizes and awards – if…
 made primarily in recognition of religious, charitable, scientific,
educational, artistic, literary, or civic achievement
 recipient was selected without any action on his part to enter
the contest or proceeding
 recipient is not required to render substantial future services
as a condition to receiving the prize or award
 Prizes and Awards in sports Competition
 Local or international sports competitions and tournaments
 Sanctioned by their national sports association

Exclusions from Gross Income

 13th month pay and other benefits
 Not exceeding ₱90,000

 GSIS, SSS, Medicare and Other Contributions

 Gains from the Sale of Bonds, Debentures or other

Certificate of Indebted
 With a maturity of more than 5 years

 Gains from Redemption of Shares in Mutual Fund