Law on Income

Taxation
CHAPTER IV - Special Treatment of Fringe
Benefits
 CHAPTER IV -
SPECIAL
TREATMENT OF
FRINGE BENEFITS
CHAPTER V -
DEDUCTIONS
FROM GROSS
INCOME
 Definition of
Deductions are deductions
items or amounts that the law allows to be deducted
from a taxpayer's gross income to arrive at taxable income and
determine the tax due.

Taxpayer means any person subject to income tax and a person

may be an individual, state, trust, or corporation

A taxpayer can deduct all authorized allowances for the taxable year. If
he does not within any year, deduct certain of his expenses, losses,
interest, taxes, or other charges, he cannot deduct them from the
income of the next or succeeding year.
 Two principles governing
deductions from gross income
apply to all taxpayers
• The taxpayer seeking a deduction must point to some specific
provisions of the statute authorizing the deduction
• He must be able to prove that he is entitled to the deduction
authorized or allowed

Deductions are deemed to be a matter of legislative grace.

They are allowed only where there is a clear provision in the
statute for the deduction claimed and where particular
deductions are authorized by the statute no others may be
made to taxpayer has the burden of proof to establish the
validity of claim deductions.
 Taxpayers may claim lesser
deduction than that allowed by
law
For income tax purposes, a taxpayer is free to deduct from
his gross income a lesser amount or not to claim any
deduction. What is prohibited by the income tax is to claim a
deduction beyond the amount authorized by the law.
Kinds of Deduction
• Deductions from business and/or professional income of
individual taxpayer
• Deductions from corporate income
• Special deductions
Category or types of
deduction
• Deductions must be claimed under the particular category to
which they belong. Thus, taxes should not be claimed by a
corporation as losses an item of deduction that does not satisfy
the requisites for deductibility under the category
• It may, however, be claimed as a valid deduction from a
taxpayer's gross income if it meets the requirements of another
type of deduction under a different subsection of the tax code
 Ceilings on itemized
deductions
• No maximum limit to ceilings - Snow maximum limit to the itemized
deduction but they must be duly paid or incurred in connection with the
taxpayer's trade or business and proven by receipts invoices or other
pertinent documents. Charitable and other contributions are deductible
whether business-connected or not.
• Factors to be considered in setting ceilings
• Adequacy of the prescribed limits on the actual expenditure
requirements of each industry
• Effects of inflation on expenditure levels

No ceilings shall further be imposed on items of expense already

subject to ceilings under present law
Taxpayers entitled or not
entitled to avail of deductions
1) The taxpayer entitled to deductions are
• Citizens of the Philippines
• resident aliens
• Non-resident aliens engage in trade or business in the Philippines
• Domestic corporations
• Resident foreign corporations are those engaged in trade or business
within the Philippines
• Taxable co-partnerships which are treated by law as corporations and
general professional partnerships
• Estates and trusts
• No deductions from gross income are allowed under section 34 of the
tax code for taxpayers earning compensation income arising under an
employer-employee relationship. Similarly, no deduction is allowed for
self-employed individuals or professionals who avail of the 8% tax on
gross sales are receipts under section 24 of the tax code
• Resident aliens not engaging in trade or business within the Philippines
and non-resident foreign corporations or those not engaging in trade or
business within the Philippines or not having an office or place of
business therein our tax based on their gross income received from
within the Philippines
• Recipients of passive income mentioned by law are subject to final tax
on the total amount thereof
Additional requirements for
deductibility of certain
payments
• Withholding of tax income payment
• Person required to withhold
⚬ In general, any juridical person, whether or not engaged in business or
trade
⚬ An individual with respect to payments made in connection with trade or
business
⚬ All government offices including government-owned or controlled
corporations and provincial city and municipal governments and
barangays
⚬ All individuals juridical persons and political parties with respect to their
income payments made as campaign contributions and/or purchase of
goods and resources intended as campaign contributions
Business Expenses
 Business expenses deductible from gross
income are the ordinary and necessary
expenses paid or incurred during the taxable
year in carrying on, or which are directly
attributable to the development, management,
operation, and/or conduct of the taxpayer’s
trade, business, or exercise of a profession.
In general, business expenses include:

• Salaries, wages, and other forms of compensation. – A

reasonable allowance for salaries, wages, and other forms of compensation
for personal services actually rendered, including the grossed-up monetary
value of fringe benefits furnished or granted by the employer to the employee,
provided the final fringe benefit tax imposed under Section 33 (Chap. IV.) has
been paid.
• Travel expenses. – A reasonable allowance for travel expenses, here and
abroad, while away from home in pursuing the taxpayer’s trade, business, or
profession.
• Rentals and similar payments. – A reasonable allowance for rentals
and/or other payments required as a condition for the continued use or
possession of property for purposes of the trade, business, or profession.
• EAR expenses – A reasonable allowance for entertainment, amusement,
and recreation expenses that are directly connected to the development,
management, and operation of the trade, business, or profession. However,
such expenses shall not be allowed if they are contrary to law, morals, public
policy, or public order

• Labor training expenses. – An additional deduction from taxable income

of one-half (½) of the value of labor training expenses incurred for skills
development of enterprise-based trainees enrolled in public senior high schools,
public higher education institutions, or public technical and vocational institutions
under an apprenticeship agreement. The deduction shall not exceed 10% of
direct labor wage
The expenses must be:
• Ordinary and necessary.
• Paid or incurred during the taxable year.
• Paid or incurred in carrying on any trade, business, or profession.
• Reasonable in amount.
• Substantiated by adequate proof.
• Not against law, morals, public policy, or public order.
• The tax required to be withheld therefrom (if applicable) has been withheld and
remitted to the BIR (Sec. 34 [K]).

The term "paid or incurred" and "paid or accrued," as used in the Tax Code, shall
be construed according to the method of accounting (see Chap. XI-A) upon which
the taxable income is computed. (Sec. 22[RI], ibid.)
When an expense is ordinary and necessary.
• An expense is considered ordinary when it is commonly incurred in the trade
or business of the taxpayer. (1955 CCH Fed. Tax Course, par. 403.) An
ordinary expense connotes a payment that is normal in relation to the
taxpayer’s business.
• An expense is considered necessary if it is appropriate and helpful to the
taxpayer’s business (1955 CCH Fed. Tax Course, par. 403) or if it is intended
to realize a profit or to minimize a loss.

For a business expense to be deductible, it must be both an ordinary expense and

a necessary expense since the terms are used in the law conjunctively.
(Parkersburg Iron & Steel Co. v. Burnet, 1931; Welch v. Helvering, 1933.)
2) An expense is considered necessary if it is appropriate and helpful to the taxpayer’s business (1955
CCH Fed. Tax Course, par. 403.) or if it is intended to realize a profit or to minimize a loss. (Visayan Cebu
Terminal Co., Inc. vs. Coll., supra.) Thus, ransom money paid by a corporation to secure the release of a
corporate officer who was kidnapped is not deductible as it has nothing to do with profit-making. But the
expense need not be essential or indispensable to the business to be considered necessary.

(3) For a business expense to be deductible, it must be both an “ordinary” expense and a “necessary”
expense since the terms “ordinary” and “necessary” are used in the law conjunctively. The two (2) words
must be given their rational, practical meaning. (Parkersburg Iron & Steel Co. v. Burnet, 1931; CCA 40th
48 F[2d] 163.)

While it is difficult to establish any fixed standard for determining what expenses are “ordinary” and
“necessary” (Welch v. Helvering [1933], 290 U.S. 111.), it has been said that to be deductible, expenses
"must be incurred by a taxpayer in doing the ordinary and necessary things his business requires to be
done to make it function as such” and must be necessary in the ordinary course of its conduct. (Motion
Picture Capital Corp. v. Comm. of Internal Revenue, [1936; CCA 2d] 80 F[2d] 872.)
Interest Expenses
Interest is the compensation allowed by
law or fixed by the parties for the loan or
forbearance of money, goods, or credits.
Generally, any amount of interest paid or
incurred within the taxable year on
indebtedness in connection with the
taxpayer’s trade, business, or profession may
be deducted from gross income. (Sec. 34[B,
1], NIRC).
 Requisites for Deductibility of
For interest to be deductible: Interest
• The taxpayer must have an indebtedness (i.e. the debt must be that of the
taxpayer).
• The indebtedness must be connected with the trade, business, or exercise
of a profession.
• The interest must have been paid or incurred during the taxable year.
• The interest must be legally due.
• The interest must have been stipulated in writing.
• The interest must not be between related taxpayers as mandated in Section
34(B)(2)(b) in relation to Section 36(B) of the Tax Code.
• The interest must not be incurred to finance petroleum operations.
• The interest was not treated as a “capital expenditure” if such interest was
incurred in acquiring property used in trade. (Sec. 7, Rev. Regs. No. 5-21).
Expenses allowable to private
educational institutions.
In addition to the expenses allowable as deductions
under the Tax Code, property educational expenditures
otherwise considered as capital outlays or depreciable
assets incurred for the expansion of school facilities
may be deducted in the taxable year for the expansion
thereof. (Sec. 34[A, 2], NIRC). If no further claims for
yearly depreciation expense have been claimed as a
deduction, it is allowed. (BIR Ruling No. 046, February
28, 1984).
 Requisites for Deductibility of
Expenses
• Entertainment, amusement, and recreation expenses to be deductible must meet the
requirements laid down by the law for the allowance of ordinary and necessary
expenses (supra). These are the requisites for deductibility of entertainment,
amusement, and recreation expenses as defined above subject to the ceiling
prescribed:
• It must be paid or incurred during the taxable year.
• It must be:
a) Directly connected to the development, management, and operation of the trade,
business, or profession of the taxpayer; or
b) Directly related to or in furtherance of the conduct of his or its trade, business, or exercise
of a profession.
In other words, they were made to promote the business of the taxpayer. Thus,
entertainment expenses to obtain contracts with private firms or individuals are deductible;
but those spent for government officials to procure government contracts are not deductible
for being contrary to public policy. (Nava vs. Coll., CTA Case No. 568, September 30, 1969).
 Existence of indebtedness
Indebtedness is habitually defined as something owed by one who is unconditionally
obligated or bound to pay. (Comm. v. Prieto, L-1292, September 30, 1960). If there is no
valid obligation, no indebtedness, and interest paid thereon is not deductible. (Page Oil
Co. v. Breen, 1951, And. 129 F.2d 420).

It has been held that interest paid by corporations on undrawn salaries and bonuses of
its nonresident officers was not deductible from gross income since it does not appear
that the corporations had contracted the interest in question. It rather appears that the
unpaid salaries and bonuses for which interest was paid were merely withheld at the
disposal of their recipients. (Kienzle & expectation of repayment do not give rise to a
valid and subsisting debt. (Fernandez Hermanos, Inc. v. Comm., L-21551 and 21557,
September 30, 1969).
Tax Credit
Tax Credit
Tax credit refers to the taxpayer’s right to
deduct from the income tax due, the amount
of tax he has paid to a foreign country. This
method is provided by law to lessen the rigor
of international double or multiple income
taxation. It may also refer to the amount
allowed as a reduction of Philippine income
tax.
Persons entitled to tax credit
These persons are allowed by law to claim a tax credit:
[Link] of the Philippines
[Link] corporations
[Link], except general professional partnerships
[Link] of general professional partnerships
[Link] of estates and trusts (See Sec. 34[C, 3], ibid.)

Persons not entitled to tax credit

These taxpayers are not entitled to tax credit:
[Link], whether resident or nonresident
[Link] corporations, whether resident or nonresident

Tax credits for foreign taxes are allowed only for income derived from sources outside the
Philippines. These taxpayers may not deduct tax credit; they are taxable only on income derived
from Philippine sources. (See Sec. 23[B, F], ibid.)
Basis of credit for foreign taxes
The taxpayer signifies in his return his desire to claim a credit
for taxes.
• If the basis of the taxpayer is a citizen of the Philippines, the
amount of any income taxes paid or incurred during the
taxable year to any foreign country.
• In case of partnership, individual, or trust—The proportionate
share of taxes of the estate, professional partnership, or trust
attributable to the taxpayer’s income from foreign sources.
• Domestic corporation—The amount of any income taxes
paid or incurred during the taxable year to any foreign
country. (See Sec. 34[C, 3, a], ibid.)
Distinction between tax
deduction and tax credit
• In tax deduction, the taxes are deducted
from gross income to determine the taxable
income.
• In tax credit, the taxes are deducted from
the Philippine tax itself.
• In tax deduction, all taxes are allowed
except those expressly excluded.
• In tax credit, only foreign income taxes may
be credited against Philippine income tax.
(Ibid.)
Losses
 Definition of Losses
The term losses implies an unintentional parting
with something of value. It is used in the income
tax law in a very broad sense to comprehend all
losses that are not general or natural to the
ordinary course of business which are not covered
under some other heading such as bad debts,
inventory losses, depreciation, etc.
(See 1955 CCH Fed. Tax Course, par. 598.)
 Classification of Losses
For purposes of deducting losses from gross income,
losses may be classified into:
1. Ordinary Losses
• (a) Losses incurred in trade, business, or profession.
• (b) Losses incurred in property connected with the
trade, business, or profession, if due to casualty or
from robbery, theft, or embezzlement. (Sec. 34(D,
4a), Sec. 39, NIRC.)
2. Capital Losses
• (a) Losses from sales or exchanges of capital assets.
(See Sec. 34(D, 4a), Sec. 39, NIRC.)
 Losses deductible
A taxpayer shall be allowed to deduct all losses actually
sustained and charged off within the taxable year and
not compensated by insurance or other forms of
indemnity.
• (1) Losses incurred in trade, business, or profession.
• (2) Loss of property connected with the trade,
business, or profession, if such losses arise from
casualties, robbery, theft, or embezzlement. (Sec.
34(D, 1a), NIRC.)
In the case of a nonresident alien individual and a
resident foreign corporation, the losses deductible shall
be those actually charged off within the taxable year.
 Special Rules on Losses
(a) Net Operating Loss Carry-Over (NOLCO)
• The net operating loss of the business or enterprise for any taxable year immediately preceding
the current taxable year, which had not been previously offset as a deduction from gross income,
may be carried over as a deduction for the next three (3) immediate years following the year of
such loss. (Sec. 34(D,3), NOLCO is also a special kind of loss.)

(b) Abandonment Losses

• Petroleum operations (See Sec. 34(D, 4a), ibid.)
• (c) Losses due to change in business conditions
• (See Sec. 98, ibid.)
• (d) Special kinds of losses
• (i) Losses from sales of stock or securities that become worthless. (Sec. 34(D, 4b), ibid.)
• (ii) Losses from short sales of property. (Sec. 39(F, 1), ibid.)
• (iii) Losses due to failure to exercise privileges or options to buy or sell property. (See Sec. 39(F, 2),
ibid.)
Bad Debts
Definition of Bad Debts
Bad debts are debts due to the taxpayer, when
actually ascertained to be worthless and
charged-off within the taxable year. (See Sec. 3
[E], NIRC.) They refer to those debts resulting
from uncollectible amounts, in whole or in part, of
income from goods sold or services rendered.
(Sec. 2[a], Rev. Regs. No. 5-1999)
Requisites for Deductibility of Bad
Debts
• There must be a valid and subsisting
indebtedness due to the taxpayer which must be
legally demandable.
• The same must be connected with the taxpayer’s
trade, business, or profession.
• The debt must have been sustained in a
transaction entered into between related parties
enumerated under Section 36(B) of the Tax
Code.
Existence of Valid and Subsisting
Debt
A valid and subsisting debt is one the collection of which
may be enforced in court. A debt which had prescribed is
no longer valid and subsisting. Hence, it is not deductible
even if written-off as a bad debt.
Ascertainment of Worthlessness
A debt is not worthless simply because it is of doubtful value or difficult to
collect. Worthlessness should be determined by an inflexible formula or a
slide rule, but upon the exercise of sound judgment. The determination of
worthlessness in given cases will depend upon the particular facts and
the circumstances. (Sec. 21[c], Rev. Regs. No. 5-1999)
Examples
• F.L. Inc. gave advances to a subsidiary
mining company which the latter could not
repay due to its difficulties. F.L. Inc. wrote off
the advance which were disallowed by the
Commissioner and sustained by the court
because the debt is not in the nature of a
valid and subsisting debt.
• Unpaid advances which are, in fact, in the
nature of investments in a contract of loan
cannot be deducted from gross income or
bad debts in a business.