Ch.13-A: Ordinary Allowable Itemized Deductions Flashcards
1
Q
items of expenses are classified as “Ordinary allowable itemized deductions” when?
A
they are not directly connected with the selling of goods or rendering of services
2
Q
What are the requisites on the deductibility of interest expense?
A
- There must be a valid indebtedness
- The indebtedness must be that of the taxpayer
- The indebtedness must be connected with the taxpayer’s trade, business, or exercise of profession
- Interest expense must have been paid or incurred during the taxable year
- Interest must have been stipulated in writing
- Interest must be legally due
- Interest payments must not be made between related taxpayers
- Interest must not be incurred to finance petroleum operations
- In case of interest incurred in the acquisition of property, used in trade, business or profession, the same is not treated as a capital expenditure
- The interest is not expressly disallowed by law to be deducted from gross income
3
Q
How much is the deductible amount of interest expense
A
The deduction amount of interest expense is the gross interest expense reduced by 20% of the interest income subject to final tax.
4
Q
The 20% of the interest income subject to final income tax that is deductible to the interest expense is referred to as
A
Arbitrage limit or the arbitrage cap
5
Q
How was the arbitrage limit computed
A
(Corporate income tax rate - final tax on interest income) / Corporate income tax rate
(25-20)/25 or 5/25, which is basically 20%
6
Q
Is there an arbitrage to MSMEs subject to 20% corporate tax?
A
There is no arbitrage for qualified MSME’s subject to 20% corporate tax. The arbitrage limit would be computed as (20-20)/20 = 0%. As such, qualified MSMEs can deduct the full amount of interest expense without the arbitrage limit.
7
Q
Is the arbitrage applicable to any taxpayer subject to regular tax?
A
The arbitrage limit is apparently set in the context of corporate taxpayers. However, the NIRC did not distinguish between individuals and corporations in the application of the rule. The revenue regulations did not separate a limit for individual taxpayers. The rule shall be applied to individuals and corporations alike. Since the law did not distinguish, neither should we.
8
Q
Are discount or pre-deducted interest deductible>
A
Discount or pre-deducted interest is a prepayment. Hence, it is not deductible upon release of the loan but upon payment of the same as it accrues as expense. If the loan is due on installments, the interest pertaining to each installment shall be deductible
9
Q
What are the other optional treatment of interest expense?
A
Interest incurred in financing the acquisition of property used in trade or business may, at the option of the taxpayer, be claimed as:
1. an outright deduction from gross income or
2. a capital expenditure claimable through depreciation
10
Q
What are other deductible interest expenses?
A
- Interest from tax delinquency
- A capital expenditure claimable through depreciation
11
Q
Taxes paid or incurred within the taxable year in connection with the taxpayer’s trade, business, or exercise of profession shall be allowed as deduction except:
A
- Philippine income taxes except fringe benefit tax
- Foreign income tax, if claimed as tax credit
- Estate tax and donor’s tax
- Special assessment
12
Q
What is the rationale behind the non-deductibility of taxes?
A
Income taxes are not costs of earning income but impositions on net income accruing only after income is earned; hence, they are non-deductible. Foreign income tax is not a cost of earning income. However, it is allowed to be claimed as a deduction under the NIRC if not claimed as tax credit. Special assessment is not a tax expense, but is capitalized to the cost of land.
13
Q
Other non-deductible taxes
A
- Business taxes, in particular the Value Added Tax (VAT)
- Surcharges or penalties on delinquent taxes
14
Q
Why is VAT treated a non-deductible expense, but other percentage taxes are not?
A
Contrary to the principle, current regulatory developments treated percentage tax as a deductible expense. This might be due to the fact that this treatment yields the government higher tax collections.
15
Q
What part of a deductible tax is allowable as a deduction?
A
Only the basic tax of a deductible tax is allowable as a deduction. Tax surcharges for late payments are avoidable and unnecessary expenses; hence, they are non-deductible. Moreover, allowing these as deduction will relax policy on tax collection. Nevertheless, interest for late payment of tax was held deductible by the Supreme Court but as interest expense rather than tax expense.
16
Q
How are unused input VAT treated?
A
Historically, unused input VAT on zero-rated sales of services after the expiration of the two-year prescriptive period is allowed as an item of deduction against gross income. However, the BIR reversed the rule by disallowing the deduction for lack of legal basis
17
Q
Income taxes paid in a foreign country can either be claimed as
A
- Deduction
- Tax credit
18
Q
How to determine the foreign tax credit: One foreign country
A
The foreign tax credit shall be the lower of the actual foreign income tax paid and the following limit:
(Foreign taxable income / World taxable income) x Philippine income tax due
19
Q
How to determine the foreign tax credit: With multiple foreign countries
A
The final foreign tax credit shall be the lower of the total of the tax credit allowable per country and the world income tax credit limit computed as follows:
(Total foreign taxable income/World taxable income) x Philippine income tax due
20
Q
Who can claim tax credit or deduction for foreign taxes paid?
A
Consistent with the matching rule, only taxpayers taxable on world income such as domestic corporations and resident citizens can claim deduction or tax credit for foreign income taxes paid.
21
Q
What is the tax treatment of refunds or credit of taxes?
A
The refund or credit of deductible taxes must be reverted back to gross income to the extent of their tax benefit. Incidentally, the refund of non-deductible taxes is exempt from income tax.
22
Q
What are the requisites for deduction of losses?
A
- It must be incurred in trade, profession or business of the taxpayer (The loss must be a business loss, not a personal loss)
- It must pertain to property connected with the trade, business or profession, if the loss arises from fires, storms, shipwrecks, or other casualties, or from robbery, theft, or embezzlement (The loss must be an ordinary loss)
- The loss must not be compensated by insurance or indemnity contract. (The loss must actually be sustained, not temporary)
- A declaration of loss must have been filed by the taxpayer within 45 days from the date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss
- The loss must not have been claimed as a deduction for estate tax purposes in the estate tax return (Double deduction is not allowed.)
23
Q
Types of losses
A
- Ordinary losses
- Capital loss
24
Q
How are losses from ordinary assets treated?
A
Losses from ordinary assets are deemed normal to the taxpayer’s trade, business or profession; hence, these are deductible in full
25
How are losses on capital assets treated?
Losses on capital assets are deemed by law unnecessary expenses not connected with business; hence, these are deductible only to the extent of capital gains
26
Rules on restoration or replacement of a property that is totally destroyed
If the restoration involves total replacement of the previous property, the tax basis of the old property shall be claimed as a loss while the entire replacement cost is capitalized as cost of the replacement property subject to allowance for depreciation
27
Rules on restoration or replacement of partially destroyed properties
If the restoration involves partial replacement of the previous property, the restoration cost shall be expensed up to the extent of the tax basis of the property immediately before the casualty. Any excess is capitalized subject to allowance for depreciation.
28
How is loss of value of assets treated?
The loss of value of assets, as a rule, is not deductible due to their temporary and reversible nature. However, impairment losses that became actually sustained can be deducted.
29
How is loss on insured property treated?
The excess of the tax basis of the property over the insurance reimbursement is a deductible loss in the year of insurance settlement
30
How are abandonment losses treated?
In the event a contract area where petroleum operations are undertaken is abandoned, the accumulated exploration and development expenditures pertaining thereto, including the adjusted tax basis of equipment directly used in the abandoned contract area, shall be allowed as a deduction. Notice of abandonment must be filed with the CIR.
31
What happens if the abandoned well is restored or resumed or reentered?
When the abandoned well is reentered and production is resumed or if such equipment or facility is restored into service, the amount of abandonment loss previously claimed shall be reversed and incurred in gross income in the year of resumption or restoration and shall also be amortized or depreciated as the case may be.
32
How are losses from wagering transactions or passive activities treated?
Losses from wagering transactions such as gambling and other passive activities shall be allowed only up to the extent of the gains from the same transaction
33
Application of the matching rule on losses?
Taxpayers taxable on global income can deduct losses on properties wherever situated, but taxpayers taxable only in Philippine income can only deduct losses on properties situated in the Philippines.
34
Requisites of claim for deduction of bad debt
1. The debt must have been ascertained to be worthless
2. It must be charged off within the taxable year
3. It must be connected with the taxpayer's profession, trade or business
4. The taxpayer must be under the accrual basis of accounting
5. It must not be incurred from a related party
35
The deductible bad debt expense pertains to
the write-off of uncollectible receivables after having been actually ascertained to be worthless
36
When is the requirement that the taxpayer must be under accrual basis be applied?
It should be applied only to bad debts representing loss of income and not to bad debts representing loss of capital. Bad debts representing loss of capital can be deducted by both accrual basis and cash basis taxpayers.
37
Application of the matching principle in bad debts
In case of receivables representing loss of income only write-off or receivables which have been previously recognized in gross income can be claimed as bad debt expense. Since accrued income is not reported in gross income under the cash basis of accounting, cash basis taxpayers cannot claim bad debt expense.
38
How do we treat securities becoming worthless?
For domestic banks and trust companies a substantial part of whose business is the receipts of deposits, securities becoming worthless are bad debt expense and not capital loss. However, the term securities specifically covers only bonds, debentures, notes, certificates, or other evidence of indebtedness with interest coupons or in registered form.
39
How is subsequent recovery of bad debts treated?
Under the NIRC, the recovery of bad debts previously allowed as a deduction in the preceding years 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.
40
How is subsequent change in accounting methods affect bad debts?
Bad debts expense sustained by the taxpayers under the cash basis of accounting should not be deducted even if the taxpayer subsequently changed its accounting method to the accrual basis of accounting. What cannot be done directly cannot be done indirectly.
41
How is depreciation treated?
There shall be allowed as a depreciation deduction as a reasonable allowance for the exhaustion, and wear and tear (including reasonable allowance for obsolescence) of property used in business
42
What are the special rules on depreciation
1. Life tenancy to a property
2. Properties held in a trust
3. Reevaluation on properties
4. Rules on depreciation of passenger vehicles
43
Explain the special rule: Life tenancy to a property
In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant was the absolute owner of the property and shall be allowed to the life tenant
44
Explain the special rule: Properties held in trust
In the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income allowable to each.
45
Explain the rule: Depreciation on revalued property (On reevalution surplus)
The depreciation of an asset must be premised on its acquisition cost and not on its reappraised value. Taxpayers using the revaluation model in accounting for PPE under PAS 16 are not allowed to deduct the depreciation of the reevaluation surplus of the property as this is not an actual cost.
46
Explain the rule: Depreciation on revalued property (On impairment)
Impairment losses on items of PPE recognized under PAS 36 are not deductible. These are deductible when sustained through disposal or retirement of the asset.
47
What are the rules on deductibility of depreciation on passenger vehicles
1. Substantiation of purchase with sufficient evidence such as official receipts and other documents bearing the total purchase price including specific motor vehicle ID numbers of the vehicles.
2. Substantiation of the direct connection or relation of the vehicle to the development, operation, and/or conduct of trade, business, or profession of the taxpayer.
3. Only one vehicle for land transport is allowed for an official and employee, and the value of which shall not exceed P2,400,000
4. No depreciation shall be allowed for yachts, helicopters, airplanes, or aircrafts, and land vehicles which exceeded the threshold unless the main line of business is transport operation or lease of transportation equipment and the vehicles purchased are used in said operations.
48
Vehicles not conforming with the rules are considered?
Non-depreciable vehicles for taxation purposes. Non-depreciable assets shall be considered capital assets
49
How are amortization of intangible assets treated?
The depreciation of intangible assets is referred to as "Amortization expense" The same concepts discussed herein are applicable to the exhaustion of intangible assets with definite useful life. However, intangible assets that do not lose value throughout time should not be amortized
50
Under the NIRC who are allowed for optional expensing of capital expenditure?
Under the NIRC, private educational institutions are granted the option to treat the capital expenditures as an outright expense or as a deduction through allowance for depreciation.
51
Explain depletion and its difference to depreciation?
Depletion expense is a provision for the periodic return of capital investments in wasting assets such as minerals, gas, and oil
52
What are the stages of wasting asset activities?
1. Exploration period
2. Development period
3. Commercial production
53
Exploration stages involves
ascertaining the existence, location, extent or quality of any deposit or mineral
54
Development stage commences when?
deposits of ore or minerals are shown to exist in sufficient commercial quantity
55
Commercial production is the stage when
there is actual extraction, processing and sale
56
What are the common rules for both mining and oil operations
Taxpayers engaged in wasting assets shall classify their expenditures into:
1. Costs of acquisition or improvement of tangible properties
2. Intangible exploration, drilling, and development costs
57
Treatment of tangible development costs
Tangible development costs include the acquisition or improvement of tangible property which are of a character subject to the allowance of depreciation. This may include construction of mine-plant roads, buildings, processing plants, and installation of heavy equipment on-site
58
Treatment of tangible exploration and development costs that are capitalized and deducted through allowance for depreciation subject to the rules of properties directly used in petroleum operations
The NIRC prescribes either the straight-line method or declining-balance method at the option of the taxpayer for properties directly related to the production of petroleum. A shift from the straight-line method to declining balance method is allowed. The useful life shall be 10 years or such shorter life as may be permitted by the CIR
59
Treatment of tangible exploration and development costs that are capitalized and deducted through allowance for depreciation subject to the rules of properties not used directly in petroleum operations
The NIRC prescribed the straight-line method on the basis of an estimated useful life of 5 years
60
Treatment of tangible exploration and development costs that are capitalized and deducted through allowance for depreciation subject to the rules of mining operations
If the expected life of the property used in mining is 10 years or less, the taxpayer can use the normal rate of depreciation. If the expected life is more than 10 years, the property can be depreciated over any number of years between 5 and 10 years
61
Intangible exploration and development costs in petroleum operations
Intangible costs in petroleum operations include any incidental and necessary costs of drilling wells or preparing wells for petroleum and which have no salvage value
62
Intangible exploration and development costs in mining operations
Intangible costs in mining operations include the costs of diamond drilling, tunneling, and other improvements of a nature that is not subject to allowance for depreciation
63
Tax treatment of intangible exploration and development costs before commercial production
Capitalized as cost of the wasting asset
64
Tax treatment of intangible exploration and development costs after commercial production, if incurred with non-producing wells or mines
deducted in the period paid or incurred
65
Tax treatment of intangible exploration and development costs after commercial production, if incurred with producing wells or mines
at the option of the taxpayer, either:
a. Capitalized and amortized using the cost-depletion method or
b. Deducted in the year paid or incurred
66
Treatment of exploration and development costs
The exploration and development costs incurred before commercial production are capitalized as cost of the wasting asset These will be deducted as depletion expense using the cost-depletion formula
67
What is the cost depletion formula?
Tax basis of the assets X (Units extracted / Total Estimated Units)
68
How do you calculate for total estimated units
Units extracted for the year + Estimated remaining units
69
Explain the expense option on non-producing mines?
After commercial production has commenced, exploration and development drilling expenses incurred on non-producing mines may be deducted outright, but the deductible amount shall not exceed 25% of the net income from mining operations without the benefit of any tax incentives under existing laws. The unclaimed balance of the expense shall be carried forward to the succeeding years until fully deducted
70
Note that the option to deduct intangible exploration and development drilling costs is
irrevocable and binding in succeeding taxable years. This rule is applied on a per contract area basis
71
The limit only applies to?
Mining operations. No comparable rule exists for petroleum operators. Hence, petroleum exploration and development drilling costs on non-producing wells after commercial production can be claimed outright
72
Application of the matching rule in Depletion
Taxpayers subject to tax on world income can deduct depletion on expense on properties wherever situated. IF taxable only on Philippine income, deductions can only be claimed on properties located in Philippines.
73
Requisites of claim for deduction on contributions
1. The donee institution must be a domestic institution
2. No income of the donee institution must inure to the benefit of any private stockholder or individual
3. The contribution must be valued at the tax basis of the property donated
4. The taxpayer must be engaged in trade or business
5. The donee must issue a Certificate of Donation which includes a donor's statement of values
6. If the amount of the donation is at least P50,000 the donor shall file a Notice of Donation to the RDO where he is registered within 30 days upon receipt of the certificate of donation
74
Donations that fail any of the requisites are non-deductible. Those that meet the requisites are either:
a. Fully Deductible
b. Partially deductible (deductible subject to limit)
75
What are fully deductible contributions
(PTA)
1. Donations to be used exclusively in undertaking Priority activities as determined by NEDA
2. Donation to foreign institution or international orgs in compliance of agreements, Treaties, or special laws
3. Donations to Accredited domestic non-government organizations
76
Requisites for full deductibility of contributions to accredited NGO's
1. The NGO must be organized and operated exclusively for the above purposes, and no income inures to the benefit of any private individuals
2. The non-profit organization makes utilization of the contribution not later than the 15th day of the third month after the close of its taxable period
3. The administrative expenses of the NGO do not exceed 30% of its total expenses
4. Members of the Board of Trustees must not receive remunerations
5. In the event of liquidation, the asset of the NGO will be distributed to another nonprofit domestic corporation organized for similar purpose
6. The amount of contribution of property other than money must be valued at acquisition cost
77
Contributions subject to limit
1. Donations to Philippine government that is not a priority activity
2. Donations to non-accredited non-government organizations or to domestic corporations organized exclusively for the following purposes:
a. Religious
b. Charitable
c. Scientific
d. Youth and sports development
e. Cultural
f. Educational
g. Rehabilitation of veterans
h. Social welfare
78
What is the limit of deduction for contributions?
Based on the taxable income derived from trade, business, or profession (i.e. net income) before the deduction of any contributions:
1. 10% for individuals
2. 5% for corporations
79
What are the type of employee pension plans
1. Defined contribution plan
2. Defined benefit plan
80
Explain what is a defined contribution plan
The employer is merely obligated to make a distribution on a regular basis. Employer has no guarantee on the benefit received and the benefit will be dependent upon the performance of the pension fund.
81
What is the deductible expense of the employer in a defined contribution plan?
The deductible expense of the employer is simply the amount of contributions (i.e. funding) made by the employer to the fund. In case of participating contributions, contributions made by employee is not deductible by the employer.
82
Explain the defined benefit plan
The employer guarantees the benefit that will be received by the employee. So the amount of funding will be dependent upon the performance of the fund (Less if overperforms, more if underperforms). Actuarial computations is necessary to determine the employer's contribution to ensure that the promised benefits to covered employees will be met in due time.
83
In a defined benefit plan, the employer's contribution or funding is either or both?
1. Funding of current service cost
2. Funding of prior service cost
84
Requisites of deductibility of pension expense
1. The employer must have established a pension or retirement fund to provide for payment of reasonable pensions to employees
2. The actuarial assumptions used by the fund must be sound and reasonable
3. The fund must be actually funded by the employer
4. The fund assets must be independent from and not subject to the control or disposal of the employer
5. Contribution for current service cost is deductible in full
6. Contribution for past service cost is amortized over period of 10 years
85
Rules in computing the deductible pension expense
1. The contribution of the fund is first attributed to current service cost. Contributions is deductible up to the extent of current service cost.
2. The excess funding is attributed to any unfunded past service cost. Any excess funding over the current service cost is presumed funding past service cost and is amortized over 10 years regardless of the actual vesting period of covered employees
86
Tax treatment of R&D Costs
1. R&D costs related to capital accounts such as property used in business are capitalized as part of the cost of the property and deducted through depreciation expense
2. R&D costs not related to capital accounts are treated as follows at the option of the taxpayer:
a. Outright expense or
b. Deferred expense amortized over a period not less than 60 months beginning from the month the taxpayer realize benefits from the R&D expenditures
87
Requisites of deductibility of EAR expense
1. It must be paid or incurred during the taxable year
2. It must be directly connected to the development, management, and operation of the trade, business, or profession of the taxpayer or directly related to or in furtherance of the conduct of his or its trade, business, or exercise of a profession
3. It must not be contrary to law, morals, good customs, public policy, or public order
4. It must not have been paid, directly or indirectly, to an official or employee of the government or GOCCs or of a foreign gov't, private individual, Corp, GPP, or similar entity if it constitutes a bribe, kickback, or other similar payments
5. It must have been duly substantiated with adequate proof. The official receipt, invoices, bills, or statements of accounts should be in the name of the taxpayer claiming the deductions
6. The appropriate amount of withholding tax should have been withheld therefrom and paid to the BIR.
88
Ceiling on deduction on EAR
For taxpayers engaged in the sales of goods or properties - 0.5% of net sales
For taxpayers engaged in the sales of services - 1% of net revenues
89
For taxpayers engaged in both sales of goods or properties and services the ceiling on deduction for EAR is computed by
((Net sales/Net revenue) / Total net sales and revenue) x Actual EAR
90
Under the insurance code, non-life insurance companies are required to maintain a reserve equivalent to
40% of their gross premium, less returns and cancellations for risks expiring within one year. For marine cargo risks, the reserve is equivalent to the amount of premium on insurance during the last two months of the calendar year.
