April 15 is fast approaching, and if you have taxable income, you need to file and pay your income tax before that due date. In computing your income tax, you need to determine your deductible costs and expenses to arrive at your net taxable income. In doing the computation, we should be careful to claim only those expenses that are considered as allowable deductions. We should also remember that there are differences between the treatment of expenses in conformity with the Philippine Accounting Standards (PAS) and the National Internal Revenue Code (NIRC). In financial accounting, expenses are recognized as they accrue, while in taxation they can be recognized when actually paid. Thus you cannot just deduct to your gross taxable income all the expenses you incur within the taxable year. The following are tips and things you should consider when claiming expenses as deductions against your taxable income.
1. Personal, living or family expenses. As a general rule, expenses can only be claimed if they are paid or incurred as part of the profession, trade or business operations of the taxpayer. Hence, personal expenses, living or family expenses are not deductible.
3. Substantiation Requirements. No expenses shall be allowed unless the taxpayer shall substantiate with sufficient evidence, such as official receipts or other adequate records: (a) the amount of the expense being deducted, and (b) the direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business or profession of the taxpayer.
4. Bribes, Kickbacks and Other Similar Payments. No deduction from gross income shall be allowed for any payment made to an official or employee of the national, local or foreign government or similar entities if the payment constitutes a bribe or kickback. In other words, expenses done illegally are not allowed as deductions to your taxable income.
5. Losses and interest incurred/paid to related parties. Losses from Sales or Exchanges of Property and interest paid or incurred on transaction between the following are not allowed to be claimed as deductions to income.
a) Between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants; or
b) Except in the case of distributions in liquidation, between an individual and corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; or
c) Except in the case of distributions in liquidation, between two corporations more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for the same individual if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale of exchange was under the law applicable to such taxable year, a personal holding company or a foreign personal holding company;
d) Between the grantor and a fiduciary of any trust; or
e) Between the fiduciary of and the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or
f) Between a fiduciary of a trust and beneficiary of such trust.
6. Interest expense (tax arbitrage). There are exception and limitations on the amount of interest expense that can be deducted from income. The taxpayer’s allowable deduction for interest expense shall be reduced by an amount equal to the 33% of the interest income subjected to final tax. Moreover, all interest incurred or paid to related parties cannot be claimed as deductions to income (please read no 5 above).
7. Bad debts expense. Bad debts expense are only deductible when actually ascertained to be worthless and charged off within the taxable year. Recovery of bad debts previously allowed as 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.
8. Taxes. The following taxes are not deductible to your income for the purpose of computing income tax:
a) The Philippines income tax
b) Income taxes imposed by authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of credit against tax for taxes of foreign countries
c) Estate and donor’s taxes; and
d) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.
9. Entertainment, amusement and recreation expenses. There is a limit in claiming expenses on Entertainment, amusement and recreation (EAR). EAR expenses are limited to 0.5% of net sales for sellers of goods or 1% of net revenue for seller/provider of services. For sellers of both goods or properties and services an apportionment formula is used in determining the ceiling on such expenses.
To learn more about allowable deductions and personal / additional exemptions in computing for your income tax, please read our follow-up article “What are Deductions and Exemptions to Income Tax in the Philippines“.
Disclaimer: The above list of tips is for informational use only. To learn more about allowable deductions, you may read “Chapter VII (Allowable Deductions) of the NIRC, as amended”. There may also other things that should be considered when claiming deductions to your taxable income. Furthermore, this article is intended for taxpayers who are claiming itemized deductions instead of the optional standard deductions in computing for income tax. New laws, BIR issuances, regulations and rulings may render this post obsolete or incorrect. For more information, please visit the BIR website or office for updated information.