Itemized Deductions Flashcards
Itemized Deductions
- Interest
- Taxes
- Losses
- Bad debts
- Depreciation
- Depletion
- Charitable contributions
- Pension trust
- Research & Development cost
- Expenses
Interest
Interest
Requisites:
- there should be a valid indebtedness
- there must be legal liability to pay interest
- the indebtedness must have been incurred in connection with the taxpayer’s trade, profession or business
- for interest incurred abroad by taxpayers who are subject to income tax only on income earned within the Philippines, the indebtedness must have been actually incurred to provide funds for use in connection with the conduct or operation of trade or business in the Philippines
- the deductible amount of interest shall be reduced by an amount equal to 20% of interest income subject to final tax.
- This arbitrage limit does not apply to MSME domestic corporations qualified to the 20% corporate income tax
- This arbitrage always applies to individual taxpayers regardless of the level of their income.
Non-deductible interest:
- Interest paid in advance through discount on indebtedness incurred by an individual taxpayer reporting income under the cash basis. If the discounted liability is payable in installment, the amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as deduction in such taxable year
Note: If the borrower is a corporation, pro-deducted interest could be claimed as deduction in the year of granting of the loan
- Interest payments with related parties
- If the indebtedness is incurred to finance petroleum operations
Capitalization of interest- At the option of the taxpayer, interest incurred to acquire property used in trade, business or profession may be allowed as a capital expenditure
Note: the capitalization of borrowing cost under PAS 23 is not followed for taxation purposes. The interest expense up to repayment of the debt may be capitalized
Special Cases:
- Interest on preferred stock- these are dividends; hence, not deductible on interest
- Interest on scrip dividends-since there is evidence of indebtedness, these are deductible interest
Taxes
Generally, taxes paid or accrued within the taxable year in connection with the taxpayer’s trade or business or exercise of a profession, are deductible from gross income. The deductible tax includes local taxes and some national taxes, however, the deductible tax component is the proper tax. Interest on delinquent taxes are deductible from gross income but as “interest expense” not taxes.
Note: no deduction is allowed for surcharges or penalties on delinquent taxes. Interest on tax delinquency is deductible as interest expense
Requisites:
- must be paid or accrued within the taxable year
- must be incurred in connection with the taxpayer’s trade, professional or business
Non-deductible Taxes:
- Philippine income tax, except fringe benefit tax
- Estate or donor’s tax
- Special assessment
- Income tax imposed by a foreign country if the taxpayer opted to claim them as deduction rather than as tax credit
- Stock transaction tax
- Value-added tax on business
Tax Credit for Foreign Income Tax Paid
Can be claimed only by those taxable on world income such as resident citizen and domestic corporations
Taxpayers have the option to claim the foreign income tax either as:
- tax credit or
- deduction from income
Limit of Tax Credit:
1st Limitation: Per Country Evaluation - whichever is lower of the actual amount of foreign tax paid and the amount which reflects the ratio which the gross income from the foreign country bears with the total world taxable income to the Philippine income tax
For instance, the amount creditable or deductible for tax paid per foreign country is:
Country x taxable income
/ Total world taxable Income
X Philippine Income Tax
= 1st Limit
2nd Limitation: Total Foreign Country Evaluation - whichever is lower of the aggregate lower values of the per-country evaluation and the amount which reflects the ratio of the taxable income from all foreign countries bears with the total world taxable income to the Philippine tax
Total foreign taxable income
/ Total world taxable income
X Philippine Income Tax
= 2nd Limit
Rules on Income Taxes Paid:
1. Foreign taxes paid
- RC/Domestic- Deductible
- NRC/NRA/RFC/NRFC- Qualified**
- Foreign income tax paid
- RC/Domestic- Deductible/Creditable
- NRC/NRA/RFC/NRFC- Non-deductible/Non-creditable
- Philippine taxes paid*
- RC/Domestic- Deductible
- NRC/NRA/RFC/NRFC- Deductible
- Philippine income tax paid
- RC/Domestic- Non-deductible
- NRC/NRA/RFC/NRFC- Non-deductible
*other than the non-deductible taxes above
**deductible to the extent they are connected with income from sources in the Philippines only (Sec. 34 C (2), NIRC)
Refund of taxes: The refund of a deductible tax is taxable if it created a tax benefit in the year it is deducted
Losses
A. Ordinary Loss
Requisites:
- loss must be actually sustained during the taxable year
- not compensated for by insurance or other forms of indemnity
- it must be sustained in a close and completed transaction
- the loss must be that of the taxpayer - the loss must be reported to the BIR within 45 days from the date of loss or discovery
- not claimed as a deduction in the estate tax return for individual income tax payer only
Note: In estate taxation, losses incurred during the settlement of the estate such as theft of property or results of calamity may be claimed as deduction in determining the net taxable estate.
Deductible losses:
- loss incurred in trade, profession or business
- loss due to fire, storm, shipwreck or other casualty of property connected with trade, profession or business 3. loss due to theft, robbery, or embezzlement if the property is connected with trade, profession or business
Measure of the loss:
- Total Loss-book value of the property
- Partial Loss-replacement cost of the damaged portion of the asset or the book value thereof at the time of loss, whichever is lower.
Note: The asset must be written-off before a loss can be claimed as a deduction
Abandonment Losses
- Petroleum operation - all accumulated exploration and development expenditures pertaining to partially or wholly abandoned of contract area shall be allowed as a deduction, provided notice of abandonment shall be filed with the Commissioner of Internal Revenue
- Producing wells - the unamortized costs thereof, as well as the undepreciated costs of equipment directly used therein, shall be allowed as a deduction in the year such well, equipment or facility is abandoned by the contractor
Note: if the abandoned well is re-entered and production is resumed, or if such equipment is restored into use, the same cost claimed as deduction shall be reverted back into gross income subject to the income tax benefit rule.
Special Cases:
- If there is a pending proceeding in which the loss can be recovered, deduction for the loss is delayed until recovery becomes impossible. Pending the resolution of the proceeding, the transaction is not yet complete, hence, the loss is not yet actually sustained.
- Loss of income- cannot be deducted unless the related income has already been included in gross income (For
example: worthless receivable is not deductible under cash basis of reporting income). - Losses on sale or exchanges of property with related parties - not deductible.
Net Operating Loss Carry Over (NOLCO)
Any excess of allowable deductions over gross income of a business in a taxable year immediately preceding the current taxable year shall be carried over as a deduction from gross income for the next three consecutive taxable years.
B. Capital Loss- are deductible only to the extent of capital gains. But a net capital loss carry-over can be deducted in the following year it arose for non-corporate taxpayers. (Please check handouts in Dealings in Properties.)
Bad Debts
Bad Debts
Requisites:
- There must be valid and subsisting debt due to the taxpayer.
- it must be connected with the taxpayer’s trade, profession or business
- the debt is actually ascertained to be worthless
- it must be charged-off within the taxable years
Recovery of bad debts
- Taxpayers under cash basis-Taxable but subject to Income Tax Benefit Rule
- Taxpayers under accrual basis-Always taxable
Non-deductible bad debts:
- Those incurred under cash basis of reporting gross income
- Those sustained in a transaction entered into by related parties
- For taxpayers not taxable on world income, those that represent loss of foreign income.
The rules on bad debts may be applicable to debt securities becoming worthless for dealers in securities only such as domestic banks and trusts companies whose major part of business are dealing with securities For other taxpayers where such security is a capital asset, the rules on capital loss apply and are deductible subject to limit.
Special Cases with Bad Debts:
Receivables assigned without recourse only the difference of amount paid and amount recovered is allowed as deduction
Depreciation
Depreciation
Requisites:
- the property must be used in trade, profession or business
- the property must have a limited useful life
- the provision must be charged off during the taxable year
- the provision must be reasonable
Special Option with depreciation:
- For a proprietary or private educational institution only
- May either choose to:
- charged off as capital outlays of depreciable assets in the year of acquisition; or
- deduct allowance for depreciation
Basis of Depreciation
The fair market value at the time of acquisition
- The taxpayer and the Commissioner of Internal Revenue shall agree in writing about the useful life and rate of depreciation. Such agreement shall be binding upon the taxpayer and the National Government in the absence of circumstances not taken into consideration during the adoption of the agreement.
- Any change in the agreed rate and useful life shall operate prospectively. 3. In default of such agreement, the adoption of the taxpayer of useful life and depreciation rate for depreciable assets without the objection of the Commissioner or his duly authorized representative shall be considered binding.
Methods of Depreciation
- Straight line
- Declining balance
- Sum of the years
- Other methods which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner of Internal Revenue
Petroleum Operation:
The taxpayer may choose either declining-balance method or straight line method at the option of the contractor
Useful life of depreciable asset:
- used in or related to the production of petroleum- 10 years or shorter as may be permitted by the Commissioner of Internal Revenue
- not used in or not related to the production of petroleum-5 years under straight line method
Mining Operations:
For all properties used in mining operations, other than petroleum operation:
- 10 year useful life or less- At normal rate of depreciation
- More than 10 years of useful life depreciated over any number of years between 5 and the expected life Provided the taxpayer notifies the CIR at the beginning of the deprecation period of the rate to be used.
Depletion
Depletion (Cost Depletion)- available only for oil and gas wells and mines
Exploration Expenditure- expenditures paid or incurred in ascertaining the existence, location and extent, or quality of any deposit or ore or other minerals before the beginning of the development stage of the mine or deposit
Development Expenditure- paid or incurred during the development stage of the mine. The development stage begins when ore or other minerals are shown to exist in commercial quality and quantity and end upon commencement of actual commercial extraction.
Method to Use: Cost-Depletion Method
Depletion should be provided only up to the extent of capital investment in the mine only.
Unit depletion =
Capital investment in the mine / Units expected recoverable
Oil and Gas Wells or Mines: Treatment of Intangible Exploration and Development Drilling Costs
Provided that production in commercial quantities has commenced, if intangible development drilling costs are incurred for:
- Non-producing wells and or mines-deductible in the year incurred 2. Producing wells and or mines- at the option of the taxpayer, deduction in full in the year paid or incurred, or capitalized and amortized
Note: tangible development costs are capitalized and are subject to depreciation
If intangible exploration, drilling and development expenses are claimed as deductions, they should not be added to the adjusted cost basis of the mining property for purposes of computing the cost depletion.
Irrevocable Alternative Deduction: Applicable to Mining Operation only
The taxpayer may, at his option, deduct exploration and development expenditures accumulated as cost or adjusted basis for cost depletion as of date of prospecting, as well as exploration and development expenditures paid or incurred during the taxable year.
Limit: the amount of deductible exploration and development cost shall not exceed 25% of taxable income, without the benefit of any tax incentive under existing laws
Once elected, the scheme shall be binding and irrevocable in succeeding taxable years.
Deductibility of Depreciation or Depletion on Mining Properties:
- Located Abroad
- RC/Domestic- Deductible
- NRC/NRA/RFC/NRFC- Non-deductible
- Located in the Philippines
- RC/Domestic- Deductible
- NRC/NRA/RFC/NRFC- Deductible
Charitable and other contributions
Charitable and Other Contributions
Requisites:
- the contribution or gift must be actually paid
- the contribution of property must be measured based on acquisition cost
- it must be given to an organization specified by law
- net income of the specified institution must not inure to the benefit of any private stockholder or individual
- the person making the contribution must be engaged in trade, business or profession
Note: if the taxpayer is not engaged in trade, business or profession, the rules on Donor’s taxation applies. Similar gifts are usually exempt under donor’s taxation provided that not more than 30% of the donation is used for administrative
purposes by such non-profit entity
Classification of contributions
A. Fully deductible contributions
- Donation to the government or political subdivisions including fully owned government and controlled
corporations to be used exclusively in undertaking priority activities in:
- Education
- Health
- Human settlements
- Culture and sports
- Youth and sport development
- Economic developments
Provided, donations to the government that are not in accordance with priority activities are subject to limit.
- Donation to foreign institutions or international organizations in compliance with agreement or treaties
- Donations to accredited domestic non-government organizations. These include organizations exclusively for:
- Scientific
- Research
- Health
- Educational
- Social welfare
- Cultural
- Charitable
- Character building
- Youth and sports development
- Any combination of the listed purposes
Requisites:
- the donation must be utilized by the donee institution not later than the 15 day of the third month following the
close of the taxable year - the administrative expense must not exceed 30% of the total expenses 3. Upon dissolution, assets must be distributed to another non-profit domestic corporation of to the Government
- if these conditions are not complied with, the donation is subject to limit
B. Contributions subject to limit
- Donations to the Government of the Philippines or political subdivisions exclusively for public purposes (non-priority activities)
- Donation to non-government organizations or to domestic corporations organized exclusively for the following purposes:
- Religious
- Charitable
- Scientific
- Cultural
- Educational
- Rehabilitation of veterans
- Youth and sports development
- Social welfare
Limit of deduction:
Based on the taxable income derived from business or profession prior to the deduction of contributions (either fully deductible or subject to limit)
- 10% for Individual
- 5% for Corporations
Deductible Contribution subject to limit
The deductible contribution subject to limit shall be whichever is lower of the actual contribution with the limit as set forth herein.
Contribution to Pension Trust
Current Service Cost- actually computed value of services rendered by a plan employee during the year
Past Service Cost- value of services rendered by employees in the past that partially satisfy vesting conditions
Rules for Pension Expense:
- Payments to the trust to cover pension liability accruing during the year (current service cost) are fully deductible expenses for the taxable year.
- Payment to the trust in excess of the current period costs is attributed to past service cost up to unfunded past service cost. Funding of past service cost is amortized over a period of 10 years starting from the year in which the contribution was made.
Actually, costs that accrue during the current year include the value of services rendered currently (current service cost and interest cost).
Note: Deductions claimed for non-vesting employees should be reversed to gross income
Research & Development cost
Research and Development Cost
Requisites:
- It must be paid or incurred during the taxable year
- it must be connected with the trade, profession or business of the taxpayer
- it is not chargeable to capital accounts (capitalizable expenditure)
Amortization of Capitalizable Research and Development costs that are not chargeable to a property of a kind that is subject to depreciation or depletion:
- the taxpayer should treat the expenditure as a deferred charge
- amortized over a period of not less than 60 months starting from the month in which the taxpayer first derived benefits from such deferred expense.
Non-deductible research and development expenditures:
- expenditure for the acquisition of improvement of a land (in connection with research projects)
- any expenditure for the improvement of property to be used in connection with research and development of a kind which is subject to depreciation and depletion; and (these items are capitalized then charged off to depreciation)
- any expenditure paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, including oil and gas (exploration costs are non-deductible, only development costs)
Expenses in general
Expenses, in general
Requisites:
- It must be ordinary and necessary
- it must be paid or incurred during the taxable year
- it must be directly attributable to the development, operation, management and or conduct of the trade, profession or business
- it must be reasonable
- the amount paid shall be allowed as deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR
- it must be supported by official receipts or adequate records
A. Compensation
- personal services must have been actually rendered
- the compensation for such services must be reasonable, including the grossed-up monetary value of fringe
benefit furnished to the employee and the applicable final tax remitted to the BIR
B. Traveling Expenses
Requisites:
- must be incurred while away from home
- in pursuant of a trade, profession or business
C. Entertainment, Amusement or Recreation Expenses (EAR)
Requisites:
- it must be directly related to the furtherance of the conduct of trade, profession or business
- it must not be contrary to law, morals, good customs, public policy or public order
- it must not have been paid directly or indirectly to an official or employee of the Government (local or national,
including government-owned and controlled corporations) or of a foreign government, or to a private individual, corporation, General Professional Partnership or a similar entity, if it constitutes bribe, kickback or other similar payments - the official receipts, invoices, bills or statement of accounts should be in the name of the taxpayer claiming the deduction
Limit of deductible amount for EAR:
A. Taxpayers deriving income from either sale of properties or sale of services:
Whichever is lower of the following and the actual EAR expense
- Taxpayers engaged in sale of goods or properties of 1% (or 5%) of net sales (ie. sales less sales returns, allowances and discounts)
- Taxpayers engaged in sale of services (profession, lessons) - 1% of net revenue (ie. gross revenues less discounts)
B. Taxpayers deriving income from both sales of properties and sales of services, the deductible amount shall be whichever is lower between the two tests below:
1st Limit Test:
Note: The tentative deductible amounts are first determined using rules above for each respective class of business (service or sales).
The final deductible amounts shall be whichever is lower of the respective tentative deductible amount and the respective amounts which the total sales or revenue bears to the total sales and revenue bears to the actual entertainment, amusement or recreation expenses.
2nd Limit Test:
- Net Sales
/ Total Net Sales & Revenue
X Actual total EAR for sales and service - Net Revenue
/ Total Net Sales & Revenue
X Actual total EAR for sales and service
Major Classifications of Items Deductions
- Cost of sales/cost of services
- Ordinary allowable itemized deductions
- Special allowable itemized deductions
- Net operating loss carry over
Cost of services
Cost of services -covers all direct costs and expenses necessary to provide the service required by customers such as:
- Salaries and employee benefits of personnel, consultants and specialists directly rendering the service
- Cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used and cost of supplies
Note: The cost of services of banks includes interest expense
Special Allowable Itemized Deductions (SAID)
There are two types of special allowable itemized deductions:
- Special expense under the NIRC and special laws - with outflows
- Deduction incentives under special laws no outflows
Special Expenses
- Income distribution of taxable estate and trust
- Transfers to reserve fund and payments to policies
- Dividend distribution of REITS
- Transfers to reserve funds of cooperatives
- Discounts to senior citizens and PWDs
