tax chapter 5 finals.docx

8/14/2019 tax chapter 5 finals.docx

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Taxation Reviewer 5

Part V

A. Interest

1. Interest Deductible From Gross Income

(1) In General. The amount of interest paid or incurred within

a taxable year on indebtedness in connection with the

taxpayer's profession, trade or business shall be allowed as

deduction from gross income: Provided, however, That the

taxpayer's otherwise allowable deduction for interest expense

shall be reduced by an amount equal to the following

percentages of the interest income subjected to final tax:

Forty-one percent (41%) beginning January 1, 1998;

Thirty-nine percent (39%) beginning January 1, 1999; and

Thirty-eight percent (38%) beginning January 1, 2000.

(2) Exceptions. No deduction shall be allowed in respect of

interest under the succeeding subparagraphs:

(a) If within the taxable year an individual taxpayer reporting

income on the cash basis incurs an indebtedness on which an

interest is paid in advance through discount or otherwise:

Provided, That such interest shall be allowed as a deduction in

the year the indebtedness is paid: Provided, further, That if the

indebtedness is payable in periodic amortizations, 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;

(b) If both the taxpayer and the person to whom the payment

has been made or is to be made are persons specified under

Section 36(B); or

(c) If the indebtedness is incurred to finance petroleum

exploration.

(3) Optional Treatment of Interest Expense. At the option of

the taxpayer, interest incurred to acquire property used in

trade, business or exercise of a profession may be allowed as a

deduction or treated as a capital expenditure.

2. Interest Not Deductible

No deduction is allowed in respect of interest under the

following:

a. ADVANCE INTEREST- if within the taxable year an individual

taxpayer reporting income on the cash basis incurs anindebtedness on which an interest is paid in advance through

discount or otherwise

Provided, that such interest shall be allowed as a deduction in

the year the indebtedness is paid.

Provided further, that if the indebtedness is payable in periodic

amortizations the amount of interest which corresponds to the

amount of the principal amortized or paid during the year shall

be allowed as a deduction in such taxable year.

**under this provision, the phrase "within the taxable year"

assumes a modified meaning. For example, a taxpayer using the

cash basis method of accounting borrows money in which

interest is paid in advance through discount. He obtains a loan

of P1,000,000 in October 1998 subject to 20% interest; hence,

after paying the advance interest of P200,000 he receives only P800,000.00 Can the borrower/taxpayer claim the deduction

when he files his ITR in April 1999?

It depends on w/n the principal obligation had been paid.

i. if the entire principal obligation had been paid, then the entire

amount of interest can be claimed as itemized deduction

ii. if only 1/2 of the obligation has been paid, only 1/2 interest

can be claimed as itemized deduction;

iii. if no payment had been paid on the principal obligation, theadvance interest paid cannot be claimed as deduction on the

year that it was paid.

b. PERSONS UNDER 36b- if both the taxpayer and the person to

whom the payment has been made or is to be made are persons

specified under section 36B, namely:

i. between members of a family

ii. between an individual and a corporation more than 50% in

value of the outstanding stock of which is owned, directly or

indirectly, by or for such individual; and

iii. between two corporations more than 50% in value of the

outstanding stock of each of which is owned, directly or

indirectly, by or for the same individual;

iv. between the grantor and a fiduciary of any trust; or

v. between the fiduciary of a trust and the fiduciary of another

trust if the same person is a grantor with respect to each trust

vi. between a fiduciary or a trust and a beneficiary

c. PETROLEUM OPERATION- if the indebtedness is incurred to

finance petroleum operation.

3. Prepaid Interest Of Individual On Cash Method Of

Accounting

Comm. V. Vda De Prieto (109 Phil 592)

Facts: Vda. de Prieto conveyed by way of gifts to her 4 children

real property with a total assessed value of P892,497.50. After

the filing of the gift tax returns, CIR appraised the real property

donated for gift tax purposes at P1,231,268.00 and assessed thetotal sum of P117,706.50 as donor's gift tax, interests and

compromises due thereon. Of the total sum of P117,706.50 paid

by respondent the sum of P55,978.65 represents the total

interest on account of delinquency. This sum of P55,978.65 was

claimed as deduction. Petitioner, however, disallowed the claim

and as a consequence of such disallowance assessed respondent

for 1954 the total sum of P21,410.38 as deficiency income tax

due on the aforesaid P55,978.65, including interest, surcharge

and compromise for the late payment.


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Issue: w/n the interest paid by respondent for the late payment

of her donor's tax is deductible from her gross income

Held: YES.

1) Under the law, for interest to be deductible, it must be shown

that there be an indebtedness, that there should be interest

upon it, and that what is claimed as an interest deduction

should have been paid or accrued within the year. It is here

conceded that the interest paid by respondent was in

consequence of the late payment of her donor's tax, and the

same was paid within the year it is sought to be deducted.

2) The term "indebtedness" has been defined as an

unconditional and legally enforceable obligation for the

payment of money. Within the meaning of that definition, it is

apparent that a tax may be considered an indebtedness.

"Although taxes already due have not, strictly speaking, thesame concept as debts, they are, however, obligations that may

be considered as such. Where statute imposes a personal

liability for a tax, the tax becomes, at least in a board sense, a

debt. It follows that the interest paid by herein respondent for

the late payment of her donor's tax is deductible from her gross

income under section 30 (b) of the Tax Code above quoted.

3) The uniform ruling is that interest on taxes is interest on

indebtedness and is deductible.

4) In conclusion, we are of the opinion and so hold that although

interest payment for delinquent taxes is not deductible as tax

under Section 30(c) of the Tax Code and section 80 of the

Income Tax Regulations, the taxpayer is not precluded thereby

from claiming said interest payment as deduction under section

30(b) of the same Code.

4. Reduction Of Interest Expense On Interest Income Subjected

To Final Tax Under TRA of 1997

5. RR 13-2000 (Nov. 20, 2000)

Requirement for deductibility of Interest Expense

SEC. 3. TAX INCENTIVES ACCRUING TO THE ADOPTING PRIVATE

ENTITY. A pre-qualified adopting private entity, which enters

into an Agreement with a public school, shall be entitled to the

following tax incentives:

(a) Deduction from the gross income of the amount of

contribution/donation that were actually, directly and

exclusively incurred for the Program, subject to limitations,

conditions and rules set forth in Section 34(H) of the Tax Code,

plus an additional amount equivalent to fifty percent (50%) of

such contribution/donation subject to the following conditions:

(1) That the deduction shall be availed of in the taxable year in

which the expenses have been paid or incurred;

(2) That the taxpayer can substantiate the deduction with

sufficient evidence, such as official receipts or delivery receipt

and other adequate records

(2.1) The amount of expenses being claimed as deduction;

(2.2) The direct connection or relation of the expenses to the

adopting private entitys participation in the Adopt-a-School

Program. The adopting private entity shall also provide a list of

projects and/or activities undertaken and the cost of each

undertaking, indicating in particular where and how the

assistance has been utilized as supported by the Agreement;and

(2.3) Proof or acknowledgment of receipt of the

contributed/donated property by the recipient public school.

(3) That the application, together with the approved Agreement

endorsed by the National Secretariat, shall be filed with the

Revenue District Office (RDO) having jurisdiction over the place

of business of the donor/adopting private entity, copy furnished

the RDO having jurisdiction over the property, if the

contribution/donation is in the form of real property.

(b) Exemption of the Assistance made by the donor from

payment of donors tax pursuant to Sections 101 (A)(2) and

(B)(1) of the Tax Code of 1997.

B. Taxes

Sec. 34, C, NIRC

(1) In General. - Taxes paid or incurred within the taxable year in

connection with the taxpayer's profession, trade or business,

shall be allowed as deduction, except

(a) The income tax provided for under this Title;

(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 paragraph (3) of this subsection (relating

to credits 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.

Provided, That taxes allowed under this Subsection, when

refunded or credited, shall be included as part of gross income

in the year of receipt to the extent of the income tax benefit of

said deduction.

(2) Limitations on Deductions. - In the case of a nonresident

alien individual engaged in trade or business in the Philippines

and a resident foreign corporation, the deductions for taxes

provided in paragraph (1) of this Subsection (C) shall be allowed

only if and to the extent that they are connected with incomefrom sources within the Philippines.

(3) Credit Against Tax for Taxes of Foreign Countries. - If the

taxpayer signifies in his return his desire to have the benefits of

this paragraph, the tax imposed by this Title shall be credited

with:

(a) Citizen and Domestic Corporation. - In the case of a citizen of

the Philippines and of a domestic corporation, the amount of


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income taxes paid or incurred during the taxable year to any

foreign country; and

(b) Partnerships and Estates. - In the case of any such individual

who is a member of a general professional partnership or a

beneficiary of an estate or trust, his proportionate share of such

taxes of the general professional partnership or the estate or

trust paid or incurred during the taxable year to a foreign

country, if his distributive share of the income of such

partnership or trust is reported for taxation under this Title.

An alien individual and a foreign corporation shall not be

allowed the credits against the tax for the taxes of foreign

countries allowed under this paragraph.

(4) Limitations on Credit. - The amount of the credit taken under

this Section shall be subject to each of the following limitations:

(a) The amount of the credit in respect to the tax paid or

incurred to any country shall not exceed the same proportion of

the tax against which such credit is taken, which the taxpayer's

taxable income from sources within such country under this

Title bears to his entire taxable income for the same taxable

year; and

(b) The total amount of the credit shall not exceed the same

proportion of the tax against which such credit is taken, which

the taxpayer's taxable income from sources without the

Philippines taxable under this Title bears to his entire taxable

income for the same taxable year.

(5) Adjustments on Payment of Incurred Taxes. - I f accrued taxes

when paid differ from the amounts claimed as credits by the

taxpayer, or if any tax paid is refunded in whole or in part, the

taxpayer shall notify the Commissioner; who shall redetermine

the amount of the tax for the year or years affected, and the

amount of tax due upon such redetermination, if any, shall be

paid by the taxpayer upon notice and demand by the

Commissioner, or the amount of tax overpaid, if any, shall be

credited or refunded to the taxpayer. In the case of such a tax

incurred but not paid, the Commissioner as a condition

precedent to the allowance of this credit may require the

taxpayer to give a bond with sureties satisfactory to and to be

approved by the Commissioner in such sum as he may require,

conditioned upon the payment by the taxpayer of any amount

of tax found due upon any such redetermination. The bond

herein prescribed shall contain such further conditions as the

Commissioner may require.

(6) Year in Which Credit Taken. - The credits provided for in

Subsection (C)(3) of this Section may, at the option of the

taxpayer and irrespective of the method of accounting

employed in keeping his books, be taken in the year which the

taxes of the foreign country were incurred, subject, however, to

the conditions prescribed in Subsection (C)(5) of this Section. If

the taxpayer elects to take such credits in the year in which the

taxes of the foreign country accrued, the credits for all

subsequent years shall be taken upon the same basis and no

portion of any such taxes shall be allowed as a deduction in the

same or any succeeding year.

(7) Proof of Credits. - The credits provided in Subsection (C)(3)

hereof shall be allowed only if the taxpayer establishes to the

satisfaction of the Commissioner the following:

(a) The total amount of income derived from sources without

the Philippines;

(b) The amount of income derived from each country, the tax

paid or incurred to which is claimed as a credit under said

paragraph, such amount to be determined under rules and

regulations prescribed by the Secretary of Finance; and

(c) All other information necessary for the verification and

computation of such credits.

Sec. 80-82, RR-2

Sec. 80. Taxes in general.As a general rule, taxes are

deductible with the exception of those with respect to which

the law does not permit deduction. However, in the case of a

nonresident alien individual and a foreign corporation,

deduction is allowed only if and to the ex that the taxes for

which deduction is claimed are connected with income from

sources within the Philippines.

Import duties paid to the proper customs officers, and business,

occupation, license, privilege, excise and stamp taxes and any

other taxes of every name or nature paid directly to the

Government of the Philippines or to any political subdivision

thereof, are deductible. The word taxes means taxes, proper

and no deduction should be allowed for amounts representing

interest, surcharge, or penalties incident to delinquency.

Postage is not a tax. Automobile registration fees are considered

taxes. Taxes are deductible at most only by the person upon

whom they are imposed. Thus the merchants sales tax imposed

by law upon sales is not deductible by the individual purchaser

even though the tax may be billed to him as a separate item.

In computing the net income of an individual no deduction is

allowed for the tax is imposed upon his interest as shareholder

of a bank or other corporation, which are paid by thecorporation without reimbursements from the taxpayer. The

amount so paid should not be included in the income of the

shareholder.

In the case of corporate bonds or other obligations containing a

tax-free covenant clause, the corporation paying a tax or any

part of it for someone else pursuant to its agreement is not

entitled to deduct such payment from gross income on any

ground.

Sec. 81. Income tax imposed by the government of the

Philippines. The law does not permit the deduction of the

income tax paid to or accrued in favor of the Government of the

Philippines, and in no case may the taxpayer avail of such

deduction.

Sec. 82. Income, war-profits, and excess-profits taxes imposed

by the authority of a foreign country. Income, war-profits, and

excess-profits taxes imposed by the authority of a foreign

country (including the United States and possessions thereof)


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are allowed as deductions only if the taxpayer does not signify in

his return his desire to have to any extent the benefits of the

provisions of law allowing credits against the tax for taxes of

foreign countries. In the case of a citizen of a foreign country

residing in the Philippines whose income from sources within

such foreign country is not subject to income tax, only thatportion of the taxes paid to such foreign country which

corresponds to his net income subject to the Philippine income

tax shall be allowed as deduction.

1. Deductible From Gross Income

GENERAL RULE:Taxes paid or incurred within the taxable year

in connection with the taxpayer's profession, trade or business,

shall be allowed as deduction.

** Import duties paid to the proper customs officers and

business, occupation, license, privilege, excise and stamp taxesand any other taxes of every name or nature paid directly to the

Government of the Philippines or to any political subdivision

thereof, are deductible. The word "taxes" means taxes proper

and no deduction shall be allowed for amounts representing

interest, surcharge, or penalties incident to delinquency.

Postage is not a tax. Automobile registration fees are considered

taxes. Taxes are deductible as such only by the person upon

whom they are imposed. Thus the merchants sales tax imposed

by law upon sales is not deductible by the individual purchasers

even though the tax may be billed to him as a separate item.

EXCEPTIONS:

a. 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 tax credits paid to foreign countries)

c. Estate and donor's taxes

d. Taxes assessed against local benefits of a kind tending toincrease the value of the property assessed.

Provided, that the taxes allowed under this subsection, when

refunded or credited shall be included as part of gross income in

the year of receipt to the extent of the income tax benefit of

said deduction.

Others (under Sec 80-82, RR2):

a. Taxes paid by a nonresident alien individual and a foreign

corporation - taxes are deductible only if and to the extent that

the taxes for which deduction is claimed are connected withincome from sources within the Philippines;

b. Income tax imposed by the Philippine government - the law

does not allow the deduction of the income tax paid to or

accrued in favor of the government and in no case may the

taxpayer avail of such deduction;

c. income, war profits, and excess profits taxes imposed by the

authority of a foreign country - allowed as deductions only if the

taxpayer does not signify in his return his desire to have to any

extent the benefits of the provisions of law allowing credits

against the tax for taxes of foreign countries. In the case of a

citizen of a foreign country residing in the Philippines whose

income from sources within such foreign country is not subject

to income tax, only that portion of the taxes paid to such foreigncountry which corresponds to his net income subject to the

Philippine income tax shall be allowed as deduction.

** In computing the net income of an individual, no deduction is

allowed for the tax is imposed upon his interest as shareholder

of a bank or other corporation, which are paid by the corps w/o

reimbursements from the taxpayer. The amount so paid should

not be included in the income of the shareholder.

** In case of corporate bonds or other obligations containing a

tax-free covenant clause, the corporation paying a tax or any

part of it for someone else pursuant to its agreement is not

entitled to deduct such payment from gross income on any

ground.

2. Not deductible from Gross Income

Sec. 82-83, RR-2

Sec. 82. Income, war-profits, and excess-profits taxes imposed

by the authority of a foreign country. Income, war-profits, and

excess-profits taxes imposed by the authority of a foreign

country (including the United States and possessions thereof)

are allowed as deductions only if the taxpayer does not signify in

his return his desire to have to any extent the benefits of the

provisions of law allowing credits against the tax for taxes of

foreign countries. In the case of a citizen of a foreign country

residing in the Philippines whose income from sources within

such foreign country is not subject to income tax, only that

portion of the taxes paid to such foreign country which

corresponds to his net income subject to the Philippine income

tax shall be allowed as deduction.

Sec. 83. Estate, inheritance, and gift taxes; taxes assessed

against local benefits. Estates, inheritance, and gist taxes are

not deductible.

So-called taxes, more properly assessments, paid for local

benefits, such as street, sidewalk, and other like improvements,

imposed because of and measured by some benefit inuring

directly to the property against which the assessment is levied,

do not constitute an allowable deduction from gross income. A

tax is considered assessed against local benefits when the

property subject to the tax is limited to the property benefited.

Special assessments are not deductible, even though an

incidental benefit may inure to the public welfare. The taxes

deductible are those levied for the general public welfare, by

the proper taxing authorities at a like rate against all property in

the territory over which such authorities have jurisdiction.

When assessments are made for the purpose of maintenance or

repair of local benefits, the taxpayer may deduct assessments

paid as an expense incurred in business, if the payment of such

assessments is necessary to the conduct of his business. When

the assessments are made for the purpose of constructing local

benefits, the payments by the taxpayer are in the nature of


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capital expenditures and are not deductible. Where assessments

are made for the purpose of both construction and maintenance

or repairs, the burden is on the taxpayer to show the allocation

of the amounts assessed to the different purposes. If the

allocation can not be made, none of the amounts so paid is

deductible.

3. Meaning of the term taxes

Sec. 80, RR-2

The word taxes means taxes, proper and no deduction should

be allowed for amounts representing interest, surcharge, or

penalties incident to delinquency. Postage is not a tax.

Automobile registration fees are considered taxes.

4. Tax Credits vs. Tax Deduction

CIR v. Lednicky, et al. (11 SCRA 609)

Facts: The respondents, V.E. Lednicky and Maria Valero

Lednicky, are husband and wife, both American citizens residing

in the Philippines, and have derived all their income from

Philippine sources for the taxable years in question. In

compliance with Phil tax law, they filed their income tax return

for 1955 and 1956. In 1956, they filed an amended income tax

return claiming a tax deduction for federal income taxes which

they paid to the United States in the year 1955. In 1959, they

likewise claimed a similar tax deduction for the 1956 return.

Comm of IR failed to answer the claim for refund, thus they filed

a petition with the Tax Court.

Issue: whether a US citizen residing in the Philippines who

derives income wholly from sources within the Republic of the

Philippines, may deduct from his gross income the income taxes

he has paid to the US government for the taxable year on the

strength of sec 30 (c-1) of the Phil Internal Revenue Code?[1]

Held:

1. The wording of Sec 30 shows the code's intent that the right

to deduct income taxes paid to foreign government from the

taxpayer's gross income is given only as an ALTERNATIVE to his

right to claim a tax credit for such foreign income taxes under

Sec 30 so that unless the alien resident has a right to claim such

tax credit if he so chooses, he is precluded from deducting the

foreign income taxes from his gross income. The law provides

that the deduction shall be allowed if the taxpayer in his return

does not signify his desire to have the benefits of tax credits for

taxes paid to foreign countries. Thus, the statutes assumes that

the taxpayer in question may also signify his desire to claim a tax

credit and waive the deduction.

2. No double credit (i.e, for claiming twice the benefits of his

payment of foreign taxes, by deduction from gross income and

by tax credit) exists here. This danger cannot exist if the

taxpayer cannot claim benefit under either of these headings at

his option, so that he must be entitled to a tax credit

(respondent here are NOT entitled to tax credit because al l their

income is derived from Phil sources), or the option to deduct

from gross income disappears altogether.

3. No double taxation exists. Double taxation becomes

obnoxious only when the taxpayer is taxed twice for the benefit

of the same governmental entity. In the present case, although

the taxpayer would have to pay two taxes on the same income

but the Philippine government only receives the proceeds of

one tax, there is no obnoxious double taxation.

5. Fines and Penalties

Guttierez v. Collector (14 SCRA 33)

Fines and penalties paid for late payment of taxes are not

deductible.

Gutierrez also claimed for deduction the fines and penalties

which he paid for late payment of taxes. While Section 30 allows

taxes to be deducted from gross income, it does not specifically

allow fines and penalties to be so deducted. Deductions fromgross income are matters of legislative grace; what is not

expressly granted by Congress is withheld. Moreover, when acts

are condemned by law and their commission is made

punishable by fines or forfeitures, to allow them to be deducted

from the wrongdoer's gross income, reduces, and so in part

defeats, the prescribed punishment.

E. LOSSES

Sec. 93-101, RR-2

1. Kinds of Taxpayers and their losses

Individuals

To be fully deductible:

it must not be compensated by insurance and

incurred in a taxpayers trade or

incurred in any transaction entered into for profit or

of property connected with the trade or business if arising from

fires, storm, shipwreck, or other casualty, or from robbery, theft

or embezzlement. No loss shall be allowed as deduction if at the

time of filing of the return, such loss has been claimed as

deduction for estate or inheritance tax purposes in the estate or

inheritance tax return.

Corporations

Can deduct losses actually sustained and charged off within the

year and not compensated for by insurance or otherwise.

Nonresident alien and foreign corporations

Can deduct losses sustained in business or trade conducted

within the Philippines, losses of property within the Philippines

arising from fires, storms, shipwreck or other casualty and from

robbery, theft or embezzlement, and losses actually sustained in

transactions entered into for profit in the Philippines, although

not connected with their trade or business, not compensated by

insurance or otherwise.

Summary: Requisites for deductibility of losses


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Must be incurred in trade, business or profession of the

taxpayer, or of property connected with the trade, business or

profession, arising from fires, storms, shipwreck, or other

casualties, or from robbery, theft or embezzlement;

Must be actually sustained and not merely anticipated, and

must be charged off within the taxable year;

Must be evidenced by closed and completed transaction;

Must not be compensated for by insurance or other form of

indemnity

A sworn declaration of loss sustained from casualty or robbery,

theft or embezzlement during the taxable year must be filed

with the Bureau of Internal Revenue within a period of not less

than 30 days nor more than 90 days from the date of discovery

of the casualty;

Must not have been claimed as deduction in the estate tax

return.

2. Completed Transactions

Fernandez Hermanoz v. CIR, 29 SCRA 552

Facts: Fernandez Hermanos Inc. is a domestic corporation

organized for the principal purpose of engaging in business as an

investment company. The CIR disallowed the following

deductions:

1. losses in Mati Lumber Co in 1950

2. losses or bad debts in Palawan Manganese Mines Inc in 1951

3. losses in Balamban Coal Mines in 1950 and 1951

4. losses in Hacienda Dalupiri and Hacienda Samal from 1950-

1954

Held: The Supreme Court discussed the allowance or

disallowance of each in the following manner:

1. Allowed. These losses represent the shares of stock (worth

P8,050) petitioner acquired from Mati in Jan. 1, 1948. The

petitioner was correct in writing off and claiming as a deduction

in 1950 the amount on the ground that the lumber company

had ceased operations and became insolvent in that year. The

CIR was incorrect in arguing that since the company still owned

a sawmill and some equipment, the shares of stock still had

value. The proper assessment would be to treat as income for

the year in which petitioner gets the proceeds from the

liquidation of those assets.

2. Disallowed. These losses represent part of the loans extended

by the petitioner to its 100% owned subsidiary. Petitioner

advanced financial assistance to Palawan from 1945 to 1952. By

way of payment, Palawan was to give petitioner 15% of net

profits. Whether Palawan was able to pay the loans or not

because it continued to operate at a loss is immaterial.

Petitioner cannot properly claim as a loss the advances given to

Palawan in 1951 for that year. There can be no partial writing

off as a loss or bad debt under the Tax Code. Those losses or bad

debts ascertained within the taxable year are deductible in full

or not at all. Petitioner continued to give Palawan advances

even beyond 1951. It was only in 1956 when Palawan decided to

cease operations.

3. Disallowed. These losses represent sums spent by the

petitioner for the operation of its Balamban coal mines in 1950

and 1951. The petitioner should have treated them as losses in

1952 when the mines were abandoned and not in 1950 and

1951 on the ground that the mines made no sales of coal during

those years.

4. Allowed. These losses represent sums spent by petitioner for

the operation of the 2 haciendas. The amounts were properly

reported as deductions for the correct years. The only reason

why the CIR disallowed them was on the ground that the farms

were operated solely for pleasure or as a hobby and not for

profit. But the Supreme Court is not convinced, and being for

business, the petitioner may properly deduct the same.

3. Special Rules on losses

a) Voluntary Removal of Buildings

If the building is demolished by the owner for some practical

reasons, say the building is no longer safe, then the loss which

was sustained in a closed and completed transaction is

deductible from gross income.

If the taxpayer buys real estate with an existing old building with

the intention of demolishing it and constructing a new one, then

the loss sustained in demolishing the old building is not

deductible from gross income, the value of the real estate,

exclusive of old improvements, being presumably equal to the

purchase price of the land and building plus the cost of

removing the useless building.

Sec. 97, RR-2

b) Loss of Useful Value of Assets

When, through some change in business conditions, the

usefulness in the business of some or all of the capital assets is

suddenly terminated, so that the taxpayer discontinues the

business or discards such assets permanently from use in such

business, he may claim as deduction the actual loss sustained.

In determining the amount of the loss, adjustment must be

made for improvements, depreciation, the salvage value of the

property. This exception to the rule requiring a sale or other

disposition of property in order to establish a loss requires proof

of some unforeseen cause by reason of which the property has

been prematurely discarded, as for example:

1. where any increase in the cost or change in the manufacture

of any product makes it necessary to abandon such

manufacture, to which special machinery is exclusively devoted,

or

2. where legislation directly or indirectly makes the continued

profitable use of the property impossible.


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This exception DOES NOT APPLY

1. to a case where the useful life of property terminates solely

as a result of those gradual process for which depreciation

allowance are authorized.

2. to inventories other than capital assets

This exception applies to buildings only when they are

permanently abandoned or permanently devoted to a radically

different use, and to machinery only when its use as such is

permanently abandoned.

Sec. 98, RR-2

c) Shrinkage in value of Stocks

A person possessing stock of a corporation cannot subtract from

gross income any amount claimed as a loss merely on account

of shrinkage in value of a stock through fluctuation of the

market or otherwise. The loss allowable in such case is that

wholly suffered when the stock is disposed of. If stock of a

corporation becomes worthless, its cost or other basis

determined in accordance with these regulations may be

deducted by the owner in the taxable year in which the stock

became worthless, provided a satisfactory showing of its

worthlessness is made, as in the case of bad debts.

Sec. 99, RR-2

4. Wagering Losses

Deductible only to the extent of gains from such transactions.

Example, if winnings amounted to 10,000 and the losses

amounted to 6,000, only 4,000 of the net winnings is taxable.

However, if the winnings are 5,000 and losses are 6,000, the

1,000 net losses cannot be claimed as a deduction from gross

income.

5. Substantation of Losses

RR 12-77

In general the amount of casualty loss deductible is the

difference between the FMV of the property immediately

before and the FMV after the casualty, but not exceeding the

cost or book value of the property, reduced by any insurance or

other compensation received.

In case of total destruction of property used in business, the net

book value of the property immediately before the loss should

be used as the basis of claiming the loss, reduced by any amount

of insurance or compensation received.

In case of partial destruction of property used in business, the

replacement cost to restore the property to its normal operating

condition should be used in computing deductible loss, but in no

case should it be more than the net book value immediately

before the casualty. Depreciation over the remaining useful life

is computed by dividing the replacement cost by the remaining

useful life of the property.

6. Foreign Exchange Losses

Bir Ruling 144-85

Issue: Whether foreign exchange losses, which have accrued by

reason of devaluation, are deductible for income tax purposes?

Held: Foreign exchange losses which have accrued by reason of

devaluation but where remittances have not yet been made are

not deductible for income tax purposes.

- the annual decrease in the value of property is not normally

allowable as a loss. To be allowable, the loss must be realized.

- When foreign currency acquired in connection with a

transaction in the regular course of business is disposed of,

ordinary gain or loss results from the fluctuations. The loss is

deductible only for the year it is actually sustained. It is

sustained during the year in which the loss occurs as evidenced

by closed and completed transaction and as fixed by identifiableevents occurring in that year. A closed transaction is a taxable

event which has been consummated. No taxable event has as

yet been consummated prior to the remittance of the scheduled

amortization. Accordingly, foreign exchange losses sustained as

a result of devaluation of the peso vis--vis the foreign currency,

but which remittance of scheduled amortization consisting of

principal and interest payments on a foreign loan has not

actually been made are not deductible from gross income for

income tax purposes.

Interbank Guiding Rate

RMC No. 26-85

Beginning Jan. 1, 1985, the conversion rate to be applied shall

be the prevailing interbank reference rate for the day of the

transaction.

In the event that the foreign exchange rate as stated in the

above paragraph (a) is impractical or not feasible, the average

interbank reference during the year shall apply.

For the purpose of converting the tax liability in US dollar to

Philippine peso, the prevailing interbank rate at the time of

payment shall be applied when paid before the due date of the

tax or the prevailing interbank reference rate at the due date of

tax when paid on or after the due date of the tax.

When currency involved is other than US dollar, the foreign

currency shall first be converted to US dollar at the prevailing

exchange rates between the two currencies.

This circular does not apply to transaction covered by RMC 30-

84 regarding the imposition of additional 1% gross receipt tax on

buying and selling of foreign exchange of peso by bank, non-bank financial intermediaries and other authorized foreign

exchange dealers or agents and RMC 32-84 in determining the

cost basis of certain commodities imported beginning Jan. 1,

1984, the value and prices thereof are quoted in foreign

currency.

7. Abandonment of Losses


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8

In case a contract area where petroleum operations are

undertaken is partially or fully abandoned, all accumulated

exploration and development expenditures pertaining thereto

shall be allowed as deduction; however, those incurred before

Jan. 1, 1979 can be deducted only from income derived from

the same contract area. In all cases, notice of abandonmentshall be filed with the Commissioner.

The unamortized cost of a producing well subsequently

abandoned, and the undepreciated cost of equipment directly

used therein are also deductible in the year such well,

equipment or facility is abandoned by the contractor. If such

abandoned well is recentered and production is resumed, or if

such equipment or facility is restored into service, the said costs

shall be included as part of gross income in the year of

resumption or restoration and shall be amortized or

depreciated.

8. 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 deduction from gross

income shall be carried over as a deduction from gross income

for the next 3 consecutive taxable years immediately following

the year of such loss, provided that any net loss incurred in a

taxable year during which the taxpayer is exempt from income

tax shall not be allowed as a deduction.

The deduction is allowed only if there has been no substantial

change in the ownership of the business or enterprise in that

a. Not less than 75% in nominal value of outstanding issued

shares, if the business is in the name of a corporation, is held by

or on behalf of the same persons; or

b. Not less than 75% of the paid up capital of the corporation, if

the business is in the name of a corporation, is held by or on

behalf of the same persons.

For mines other than oil and gas wells, a net operating losswithout the benefit of incentives provided under EO No. 226,as

amended, incurred in any of the first 10 years of operation may

be carried over as a deduction, from taxable income for the next

5 years immediately following the year of such loss. The entire

amount of the loss shall be carried over to the first of the 5

taxable years following the loss, and any portion of such loss

which exceeds the taxable income of such first year shall be

deducted in like manner from the taxable income of the next

remaining 4 years.

Net operating loss = excess of allowable deductions over grossincome.

RR 14-2001

a) Three Year Period

b) No substantial Change in Ownership (75% Rule)

F. BAD DEBTS

1. Requirements for Deductibility

I. there must be an existing indebtedness due to the taxpayer

which must be valid and legally demandable

II. it must be connected with the taxpayers trade, business, or

practice of profession

III. it must not be sustained in a transaction entered into

between related parties enumerated under Sec. 36 (b)

IV. it must be actually charged off the books of accounts of the

taxpayer as of the end of the taxable year.

V. It must be actually ascertained to be worthless and

uncollectible as of the end of the taxable year.

*Before a debt can be ascertained to be worthless, the creditor

must have taken all reasonable steps to collect within the period

of prescription, and in the light of the following circumstances,

acting in good faith, he may justify an ascertainment of

worthlessness of a debt:

i. insufficiency of collateral

ii. bankruptcy or insolvency

iii. loss of evidence of indebtedness

iv. disappearance of debtor, who fled leaving no properties

v. death of debtor leaving no properties

vi. injury to debtor incapacitating him from work

vii. fruitless efforts to collect small amounts from debtors

scattered all over the country.

Collector v. Goodrich, 21 SCRA 1336

CRITERIA FOR ASCERTAINING WORTHLESSNESS OF DEBTS.- The

statute permits the deduction of debts "actually ascertained to

be worthless within the taxable year" obviously to preventarbitrary action by the taxpayer to unduly avoid tax liability. The

ascertainment of worthlessness of bad debts requires proof of

two facts: (1) that the taxpayer did in fact ascertain the debt to

be worthless in the year the deduction is sought; and (2) in so

doing, he acted in good faith. Good faith is not enough. The

taxpayer must show that he had reasonably investigated the

relevant facts and had drawn a reasonable inference from the

information thus obtained by him.

WHERE SMALL AMOUNTS ARE INVOLVED, WRITING THEM OFF,

WHEN JUSTIFIED.- Considering the small amounts involved, the

taxpayer may be justified in feeling that the unsuccessful efforts

therefore exerted to collect the same would suffice to warrant

their being written off. "It is foolish to spend good money after

bad."

2. Tax Benefit Rule

RR 5-99


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The recovery of bad debts previously claimed as deduction

shall be included as part of gross income in the year of recovery

to the extent of the income tax benefit of said deduction.

Under the tax benefit rule, the recovery of amounts deducted

in previous years from gross income become taxable income

unless to the extent thereof, the deduction did not result in any

tax benefit to the taxpayer.

Example: If in the year the taxpayer claimed deduction of bad

debts written-off, he realized a reduction of the income tax due

from him on account of the said deduction, his subsequent

recovery thereof from his debtor shall be treated as a receipt of

realized taxable income. Conversely, if the said taxpayer did not

benefit from the deduction of the said bad debt written-off

because it did not result to any reduction of his income tax in

the year of such deduction (i.e. where the result of his business

operation was a net loss even without deduction of the bad

debts written-off), then his subsequent recovery thereof shall

be treated as a mere recovery or return of capital, hence, not

treated as receipt of realized taxable income.

- not deductible.

- Refer to E10 above on who are related taxpayers.

3. Bad Debts between Related Parties

Losses from sale or exchange of property that are not deductible

- those made between related taxpayers.

Who are related taxpayers?

members of a family (brothers/sisters of the whole or half

blood, spouse, ancestors and lineal descendants

an individual and corporation, if the individual owns, directly or

indirectly, more than 50% in value of the outstanding stock

two corporations, if more than 50% in value of the outstanding

stock in both is owned, directly or indirectly, by the sameindividual, if either one of such corporations was a personal

holding company or a foreign personal holding company

the grantor and a fiduciary of any trust

fiduciary of a trust and the fiduciary of another trust if the same

person is a grantor with respect to each trust

fiduciary of a trust and a beneficiary of such trust.

Sec. 30 [b], NIRC)

(B) Mutual savings bank not having a capital stock represented

by shares, and cooperative bank without capital stock organized

and operated for mutual purposes and without profit;

4. Requirements for Deductibility of Bad Debts including banks

RR 5-99

See F1 on requirements

In the case of banks, in lieu of requisite no. 5 above, the BSP,

thru its Monetary board, shall ascertain the worthlessness and

uncollectibility of the bad debts and it shall approve the writing

off of the said indebtedness from the banks books of accounts

at the end of the taxable year. The bank though should still

comply with requisites nos. 1-4 as enumerated above before itcan avail of the benefit of deduction.

Amount not deductible

i. if partially secured by a mortgage, the portion not covered by

the mortgage is deductible.

ii. In case of insolvency of the debtor, the difference between

the amount of the claim and the amount received in distribution

of assets of the bankrupt.

iii. The difference between the amount received by a creditor ofa decedent in distribution of the assets of the decedents estate

and the amount of the claim.

iv. The purchase price paid by a purchaser of accounts

receivable which cannot be collected and charged off as bad

debts in his books.

v. The amount absolved if the debt is compromised and the

debtor is insolvent.

G. DEPRECIATION

Depreciation reasonable allowance for the exhaustion, wear

and tear, obsolescence and inadequacy of a property used in

trade, business or profession of the taxpayer.

Requisites for deduction as depreciation expense:

1. asset must be used in connection with the taxpayers trade,

business or profession

2. asset must have a limited useful life.

Sec. 105-115, RR-2

1. Depreciation Base

- the capital sum to be replaced by depreciation allowances is

the cost or other basis of the property, to which should be

added from time to time the cost of improvements, additions

and betterments, and from which should be deducted from time

to time the amount of any definite loss or damage sustained by

the property through casualty.

- In case of patent or copyright, the capital sum to be replaced is

the cost or other basis of the intangible, which allowance shouldbe computed by an apportionment of the cost or other basis of

the intangible over its life since its acquisition or grant.

- No depreciation is allowed where the property has been

amortized to its scrap value and is no longer in use.

- Nonresident aliens and foreign corporations engaged in

business in the Philippines may deduct depreciation only on

properties located in the Philippines.


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- if property is held by one person for life transferable to

another person upon death, the deduction shall be computed as

if the life tenant were the absolute owner of the property and

depreciation shall be allowed to the life tenant.

- If property is 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.

- Farmers may deduct depreciation on farm buildings, farm

machinery and other tangible properties used in the farm,

livestock acquired for work, or for breeding or dairy purposes,

unless included in an inventory to determine profits.

- For properties used in petroleum operations, an allowance for

depreciation is allowed on all properties directly related toproduction of petroleum initially placed in service in a taxable

year under the straight line method or declining balance

method at the option of the service contractor over an

estimated useful life of 10 years or such shorter life as may be

permitted by the CIR. Properties not used directly in production

of petroleum shall be depreciated under the straight line

method over an estimated useful life of 5 years.

- For properties used in mining operations, an allowance for

depreciation is computed as follows:

- at the normal rate of depreciation if the expected life is 10

years of less; or

- depreciated over any number of years between 5 years and

the expected life if the latter is more than 10 years, and the

depreciation thereon allowed as deduction from taxable

income, provided that the contractor notifies the CIR at the

beginning of the depreciation period which depreciation rate

will be used.

- for non-resident aliens engaged in trade or business in the

Philippines or resident foreign corporation, a reasonableallowance for the deterioration of property arising out of its use

or employment or its non-use in the business, trade or

profession shall be permitted only when such property is

located in the Philippines.

- Where the taxpayer and the CIR have agreed in writing about

the useful life and rate of depreciation of any property, the

same shall be binding on both, under the regulations of the

Secretary of Finance. Any change in the agreed rate and useful

life shall not be effective for the taxable years before the

taxable year in which notice in writing by certified mail orregistered mail is served by the party initiating the change.

- In addition to depreciation, a reasonable allowance for

obsolescence may be allowed if the taxpayer clearly shows that

the whole or any portion of physical property is being affected

by economic conditions that will result in its being abandoned

before the end of its natural life, so that depreciation deduction

alone is insufficient to return the cost at the end of its economic

term of usefulness.

Zamora v. Collector, 8 SCRA 163

2. Methods of Depreciation

a. Straight line- provides for a uniform periodic diminution of

the property.

Formula:

CostEstimated Scrap Value

Annual Depreciation = Estimated Useful Life

b. Declining balance- provides decreasing charges by applying a

constant percentage rate to a declining asset book value. The

most popular rates are 1.5 times the straight-line rate often

referred to as 150% declining balance and 2 times the straight

line rate, often referred to as double-declining balance

depreciation. Residual value is not used in the computations

under this method; however, it is generally recognized that

depreciation should not continue once the book value is equal

to residual value.

c. Sum of the years digit this method of decreasing charges is

based on applying a decreasing rate of depreciation of a

constant depreciable cost. The denominator of the rate fraction

is equal to the sum of the digits in reverse order. For example if

an asset had an estimated service life of 5 years, the

denominator would be 15. In the first year, the rate fraction

would be 5/15, second year 4/15 and so on. The rate fraction is

multiplied by the depreciable cost (cost less salvage) to obtain

each years charge to expense.

d. Depreciation ratesthere is a table provided for in RR 19-86,

Annex A.

3. Depreciation Rates

a) Bulletin F

b) RR 19-86, Annex A

H. DEPLETION

Wasting assets refers to natural resources, which are

physically consumed and once consumed, are irreplaceable.

Examples include coal, oil, ore, precious metals like gold and

silver and timber.

*Depletion is the exhaustion of natural resources such as mines,

oil and gas wells due to production or severance from such

mines or wells. Depletion enables the taxpayer to recover his

capital interest in the property free of income tax, at its cost or

on some other basis. Only mining entities owning economic

interest in mineral deposits are allowed depletion deduction.

Economic interest means interest in minerals in place acquired

by investment therein or secured by operating or contract

agreement for which income is derived, and return of capital

expected, from the extraction of the mineral.

The adjusted cost basis of the property is the accumulated

exploration and development expenses incurred on the mining

property as of Dec. 31, 1974 for those on a calendar year basis,

and June 30, 1975 for those on the fiscal year basis beginning


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July 1, 1975 minus accumulated cost of depletion that should

have been deducted as of the same date on the same property.

Exploration expenses are those incurred or paid for the purpose

of ascertaining the existence, location, extent, or quality of any

deposit of ore, or other mineral before the beginning of the

development stage of the mine or deposit.

Development expenses are those paid or incurred during the

development stage of the mine or other natural deposit, or

when deposits of ore or other mineral are shown to exist in

sufficient commercial quantity and quality.

Allowable cost depletion allowance

1) In the case of oil and gas wells and mines, a reasonable

allowance for depletion or amortization computed in

accordance with the cost depletion method shall be grantedunder the rules and regulations prescribed by the Secretary of

Finance.

2) When the allowance shall equal the capital invested no

further allowances shall be granted.

3) After production in commercial quantities has commenced,

certain intangible exploration and development drilling costs (a)

shall be deductible in the year incurred if such expenditures are

incurred for non-producing wells and/or mines, or (b) shall be

deductible in full in the year paid or incurred, or at the election

of the taxpayer, may be capitalized and amortized if such

expenditures incurred are for producing wells and/or mines in

the same contract are.

4) Any intangible exploration, drilling and development

expenses allowed as a deduction in computing taxable income

during the year shall not be taken into consideration in

computing the adjusted cost basis or the purpose of computing

allowable cost depletion.

Limitation of cost depletion

The basis for cost depletion of mineral deposits does not include

amount recoverable through depreciation, through deferred

expenses and through deductions other than depletion and the

residual value of improvements at the end of operation.

The annual allowable cost of depletion shall not exceed the

market value as used for purposes of imposing the mining ad

valorem taxes in the mine of the product thereof which has

been mined and sold during the year for which the return and

computation are made. The allowable cost depletion deduction

shall be limited only to the extent of the capital invested in the

particular mining property.

No further deduction for cost shall be allowed when the sum of

the cost depletion equals the cost or adjusted basis of the

property plus allowable capital additions.

In computing taxable income from mining operations, 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; provided that the total amount

deductible for exploration and development expenditures shall

not exceed 25% of the net income from mining operations

computed without the benefit of any tax incentives under

existing laws. The actual exploration and developmentexpenditures minus 25% of the net income from mining shall be

carried forward to the succeeding years until fully deducted. The

election by the taxpayer to deduct exploration and development

expenditures is irrevocable and binding in succeeding taxable

years.

Computation of cost depletion

In general:

Adjusted cost Basis

Mineral units remaining = Depletion per mineral unit

As of the taxable year

No. of mineral units sold X depletion per mineral unit for the

year = cost depletion within the taxable year

In the case of natural gas and oil wells:

No. of cu. Ft. of gas or barrels of

Oil recovered during the year Adjusted cost Cost depletion

Expected reasonable no. of cu.ft. of X basis of property = for the

year

Gas or barrels of oil at the end

Of the year, plus No. of cu.ft. of

Gas or barrels of oil recovered

During the year.

In the case of non-resident alien individual engaged in trade or

business in the Philippines or a resident foreign corporation,

allowance for depletion of oil and gas wells or mines shall be

authorized only in respect to oil and gas wells or mines located

within the Philippines.

RR 5-76

I. PENSION TRUST

An employer establishing or maintaining a pension trust for thepayment of reasonable pensions to his employees, may deduct

from his gross income:

Contributions to such trust during the taxable year representing

the liability accruing during the year; and

One tenth (1/10) of a reasonable amount paid to the trust

during the taxable year covering the pension liability applicable

to the years prior to the taxable year (if not theretofore allowed

as deduction) in excess of such contributions.


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Requisites for deductibility:

Employer must have established a pension plan.

Pension plan must be reasonable and actuarially sound.

It must be funded by the employer.

Amount contributed by employer must no longer be subject to

his control.

Payment has not been allowable as a deduction.

Sec. 118, RR-2

J. CHARITABLE AND OTHER CONTRIBUTIONS

Kinds of Charitable contributions:

Ordinarythose that are subject to the following limitations:

Individuals10% of net income before charitable contribution

Corporation5% of net income before charitable contribution

c. Donations to or for the use of the Government of the

Philippines or any of its agencies or political subdivision for

exclusively public purposes.

d. Donations to accredited domestic corporations or

associations organized and operated exclusively for religious,

charitable, scientific, youth and sports development, cultural or

educational purposes or for the rehabilitation of veterans.

e. Social welfare institutions or non-governmental organizations,

provided no part of the net income of which inures to the

benefit of any private stockholder or individual.

2. Specialthose that are deductible in full

a. Donations to the Government of the Philippines or to any of

its agencies or political subdivisions, including fully-owned

government corporations, exclusively to finance, to provide for,

or to be used in undertaking priority activities in education,

health, youth and sports development, human settlements,

science and culture, and in economic development according to

a National Priority Plan determined by NEDA, in consultation

with appropriate government agencies, including its regional

development councils and private philanthropic persons and

institutions.

b. Donations to foreign institutions or international

organizations, which are fully deductible in pursuance of or in

compliance with agreements, treaties, or commitments,

entered into by the Government of the Philippines and the

foreign institutions or international organizations or in

pursuance of special laws.

c. Donations to accredited non-government organizations:

i. organized and operated exclusively for scientific, research,

educational, character building, youth and sports development,

health, social welfare, cultural, charitable purposes, no part of

the net income of which inures to the benefit of any private

individuals;

ii. which not later than the 15th day of the third month after the

close of the taxable year in which contributions are received,

makes utilization directly for the active conduct of the activities

constituting the purpose or function for which it is organized

and operated, unless an extended period is granted by the

Secretary of Finance.

iii. with administrative expenses not exceeding 30% of the total

expenses

iv. upon dissolution, the assets would be distributed to another

non-profit domestic corporation organized for similar purposes,

or to the state for public purpose, or would be distributed by a

court to another organization to be used in such manner as in

the judgment of said court shall best accomplish the generalpurpose for which the dissolved organization was organized.

By virtue of PD 507 contributions, donations, gifts and bequests

to social welfare, cultural and charitable institutions, no part of

the net income of which inures to the benefit of any individual,

are deductible in full in computing the donors taxable net

income.

Under special laws, donations to the following, among others,

are deductible in full:

a. The Artesian Well Fund

b. The IRRI

c. The National Science Development Board and its agencies and

to public or recognized private educational institutions, and

scientific and research foundations

d. The University of the Philippines and other state colleges and

universities.

e. The Philippine Rural Reconstruction Movement

f. The Cultural Center of the Philippines

g. The Trustees of the Press Foundation of Asia, Inc.

h. The National Commission on Culture

i. The Humanitarian Science Foundation

j. The Integrated Bar of the Philippines

k. Development Academy of the Philippines

l. Agriculture Department of the Southeast Asian Fisheries

Development Center

m. National Social Action Council

n. Task Force on Human Settlement

o. Donations to the National Museum, Library and Archives

Valuation acquisition cost of property contributed other than

money.


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BIR-NEDA Regs. No. 1-81

BIR-NEDA Regs. No. 1-82

1. Fully deductible

2. Deductible, subject to limitations

a) Corporation

b) Individuals

3. Deductibility by Actually paid or made to accredited donee

institution

RR 13-98

RA 8424

K. RESEARCH AND DEVELOPMENT EXPENSES

1. When paid or incurred; or

Sec. 34 (I), NIRC 1. In general- a taxpayer may treat 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 which are not

chargeable to capital account. The expenditures so treated shall

be allowed as deduction during the taxable year when paid or

incurred.

2. Amortized for 60 months

Sec. 34 (I), NIRC 2. Amortization of Certain Research and

Development Expenditures- at the election of the taxpayer and

in accordance with the rules and regulations to be prescribed by

the Secretary of Finance, upon recommendation of the

Commissioner, the following research and development

expenditures may be treated as deferred expenses:

(1) paid or incurred by the taxpayer in connection with his trade,

business or profession

(2) not treated as expenses under paragraph 1 hereof

(3) chargeable to capital account but not chargeable to property

of a character which is subject to depreciation or depletion

In computing taxable income, such deferred expenses shall be

allowed as deduction ratably distributed over a period of not

less than sixty (60) months as may be elected by the taxpayer

(beginning with the month in which the taxpayer first realizes

benefits from such expenditures).

L. IMPOSITION OF CEILINGS ON DEDUCTIONS BY THESECRETARY OF FINANCE

Sec. 34, NIRC: last par.: Notwithstanding the provisions of the

preceding subsections, the Secretary of Finance, upon

recommendation of the Commissioner, after public hearing shall

have been held for this purpose, may prescribe by rules and

regulations, limitations or ceilings for any of the itemized

deductions under Subsections (A) to (J) of this section: Provided,

that for purposes of determining such ceilings or limitations, the

Secretary of Finance shall consider the following factors:

i) adequacy of the prescribed limits on the actual expenditure

requirements of each particular industry;

ii) effects of inflation o expenditure levels

Provided, further, That no ceilings shall further be imposed on

items of expense already subject to ceilings under present law.

M. ADDITIONAL REQUIREMENT FOR DEDUCTIBILITY

Sec. 34 (K), NIRC: Additional Requirements for Deductibility of

Certain Payments- any amount paid or payable which is

otherwise deductible from, or taken into account in computing

gross income or for which depreciation or amortization may be

allowed under this section, shall be allowed as a deduction only

if it is shown that the tax required to be deducted and withheld

therefrom has been paid to the Bureau of Internal Revenue in

accordance with this section, sections 58 and 81 of this Code.

RMO No. 38-83 on Deficiency Withholding

Guidelines for Allowance of Deductions for Certain Income

Payments Under Section 30 (1) of the Tax Code.

Section 30 (1) of the National Internal Revenue Code, as

amended by Batas Pambansa Blg. 1 25, provides:

Additional requirement for deductibility of certain payments. -

Any amount paid or payable which is otherwise deductible from,

or taken into account in computing gross income for which

depreciation or amortization may be allowed under this section

and Section 29, shall be allowed as a deduction only if it is

shown that the tax required to be deducted and withheld

therefrom has been paid to the Bureau of Internal Revenue in

accordance with this section, Sections 54 and 93 of this Code.

The above-quoted provisions of the Tax Code is frequently cited

by Revenue Examiners in their reports of investigation to justify

disallowances of certain expense and other itemized deductions

for which the taxpayer is obliged to make a withholding under

Sections 54 and 93 of the Code and implementing regulations.

Since the amounts otherwise deductible are substantial, some

taxpayers have vigorously protested the literal application of the

said provision in the audit and investigation of their income tax

liabilities.

In order to minimize audit controversies and to achieve

uniformity in implementing the aforequoted provision of

Section 30(1), this Revenue Memorandum Order is hereby

issued to prescribe guidelines that shall be observed by revenueofficers for allowing or disallowing items of deductions referred

to in the said Section.

Considering that the existing ad valorem (surcharges and

interests), as well as the specific penalties (fine and

imprisonment), are adequate to compel taxpayers/withholding

agents to comply with the requirements of the withholding tax

law and regulations, outright disallowance of deductions

representing income payment for mere failure to withhold and


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attorneys fees and executors commissions, are chargeable

against the corpus of the estate and are not allowable

deductions.

In the case of the corporation, expenses for organization, such

as incorporation fees, attorneys fees and accountants charges,

are ordinarily capital expenditures, but where such expenditures

are limited to purely incidental expenses, a taxpayer may charge

such items against income in the year for which they are

incurred. A holding company which guarantees dividends at a

specified rate on the stock of a subsidiary may not deduct

amounts paid in carrying this guaranty in computing its net

income, but such payments may be added to the cost of its

stock to the subsidiary.

Sec. 121, RR-2: Premiums on Life Insurance of Employees- any

amounts paid for premium on any life insurance policy covering

the life of an officer or employee or of any person financially

interested in the business of the taxpayer which the taxpayer is

directly a beneficiary under such policy are not deductible.

Sec. 122, RR-2: Losses from Sales or Exchanges of Property- No

deduction is allowed in respect of losses from sales or

exchanges of property, directly or indirectly:

a. between members of a family. The family of an individual

shall include only his brothers and sisters (whether whole or

half-blood), spouse, ancestors, and lineal descendants

b. except in the case of distributions in liquidation, between an

individual and a corporation more than 50% in value of the

outstanding stock of which is owned, directly or indirectly, by or

for such individual

c. except in the case of distributions in liquidation, between two

corporations more than 50% in value of the outstanding stock of

each 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 or

exchange was, under the law applicable to such taxable year, a

personal holding company or a foreign personal holding

company

d. between a grantor and a fiduciary of any trust

e. between the fiduciary of a trust and the fiduciary of another

trust if the same person is a grantor with respect to each trust

f. between a fiduciary of a trust and a beneficiary of such trust

Atlas Consolidated v. CIR, GR. L-26911

Facts: Atlas is being assessed of deficiency income tax. Atlasprotested the assessment asking for its reconsideration and

cancellation. It is the contention of Atlas that the amount paid

for as annual public relations expenses is a deductible expense

from gross income under sec 30 of the NIRC. Atlas claimed that

it was paid for services of a public relations firm, P.K. Macker, a

reputable public relations consultant in New York, hence an

ordinary and necessary business expense.

ISSUE: Whether or not the expenses paid to create a favorable

image of the corporation is a deductible expense?

HELD: No, efforts to establish reputation are akin to acquisition

of capital assets and, therefore, expenses related thereto are

not business expense but capital expenditures. To be deductible

as business expense, the following requisites are imposed: 1.

the expense must be ordinary and necessary, 2. paid and

incurred within the taxable year, 3. paid or incurred in carrying

in a trade or business.

[1] Sec. 30. Deductions from gross income- In computing net

income there shall be allowed as deductions -

Taxes - taxes paid or accrued within the taxable year, except -

B. income, war-profits, and excess profit taxes imposed by the

authority of any foreign country; but this deduction shall beallowed in the case of a taxpayer who does not signify in his

return his desire to have to any extent the benefits of paragraph

3 of this subsection (relating to credit for foreign countries)

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