DEDUCTIONS FROM GROSS INCOME:

- business expenses and losses incurred which the law allows to reduce gross business income to arrive at
net income subject to tax.

Classification of Deductions from Gross Income:

A. Regular itemized deductions – are allowed deductible ordinary and necessary business expenses paid or
incurred during the taxable year. As a rule, these deductions require supporting documents to justify
reduction from gross income.

Composition of Regular Allowable Itemized Deductions:

1. General business expenses – such as salaries, advertising, travel expense, repair and maintenance etc.
Requisite:
- Ordinary and necessary for the conduct of business or exercise of profession;
- With official receipts or any adequate records;
- Reasonable in amount;
- Withheld with tax and paid to the BIR, if required such as salary expense or income payments;
- Incurred or paid and deducted within the taxable year;
- Not contrary to law, morals, public policy, or public order.
2. Rent expense – deductible only if the 5% creditable withholding tax on rental payment has been made.
Deductible?
Payments given by the lessee: Accrual basis Cash basis
Prepaid expense Prorate Prorate
Incurred and paid Yes Yes
Incurred but not paid Yes No

3. Representation expenses – these are entertainment, amusement and recreation (EAR) incurred or paid
during the year that are directly connected to the development, management and operation of the business or
profession of the taxpayer.
Subject to ceiling:
 ½% of net sales for taxpayers engaged in sale of goods/properties, or
 1% of net revenue for taxpayers engaged in sale of services.

Illustration:
Mr. Sacarias, a manager of Mayaman Corporation with total net sales of goods amounting to P10,000,0000 in
2018, incurred total entertainment and recreation expenses amounting to P60,000 with adequate records. It was
incurred to conduct special meeting with major customers at Supreme Hotel. Compute the deductible
representation expense in 2018.

Solution:
Actual entertainment and recreation expenses P60,000
Total net sales during the year P10,000,000 x ½% = 50,000 lower

4. Interest expense – the cost of money incurred within a taxable year on indebtedness in connection with the
taxpayer’s profession or business.
Rules for deductibility:
 Interest expense will be reduced by 33% if the taxpayer has interest income subject to 20% final tax.
 If there is no interest income subject to 20% final tax, interest expense is deductible in full.
 Interest to finance petroleum exploration is non-deductible because this is exempt from income tax.
 In the case of an individual reporting income on a cash basis of accounting:
o Interest paid in advance shall be allowed only as deduction in the year that the principal
indebtedness is fully paid. However, if the indebtedness is payable in periodic amortization, 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.

Example: On January 2, 2018, Al borrowed P900,000 from PNB payable in equal periodic amortization within
three years starting December 31, 2018. The bank deducted an interest expense in advance amounting to
P162,000. The deductible interest expenses for 2018, 2019 and 2020 are computed as follows:
Year Amortization Principal Fraction Deductible interest expense
 2018 P300,000 P900,000 9/18 81,000
2019 300,000 600,000 6/18 54,000
2020 300,000 300,000 3/18 27,000
P1,800,000 162,000

Note: At the option of the taxpayer, interest incurred to acquire property used in trade in business or exercise of
profession may be allowed as either an outright deduction from business gross income, or treated as a capital
expenditure.

Example:
Assume that the taxpayer engaged in business incurring an interest expense of P400,000. In the same year, the
business also earned P300,000 interest income from time deposit in the bank.

Solution: the deductible interest expense would be

Actual interest expense P400,000
Less: Tax differential on interest income
(300,000 x 33%) (99,000)
Deductible interest expense P301,000

5. Taxes – in general, taxes are allowed as deduction when paid or incurred within the taxable year in
connection with the taxpayer’s profession, trade or business.
Rules for deductibility:
 In the case of income tax paid to any foreign country by a resident citizen or domestic corporation,
the taxpayer has the option to treat it as an item of deduction from gross income or tax credit.
 The following taxes are not allowed as deduction from gross income:
a. Philippine income tax;
b. Estate and Donor’s taxes;
c. Foreign income tax, if claimed as tax credit (see above)
d. Percentage tax on stock transaction tax
e. Taxes not related to business, trade, or profession; and
f. Other items related to tax such as:
 Special assessment;
 Surcharges; and
 Compromise penalty.
6. Bad debt expense (Doubtful account expense) - is a claim that becomes worthless or uncollectible arising
from money lent or from goods sold or services rendered.
Rules for deductibility:
 To be deductible, the claim must be ascertained worthless and the corresponding receivable should
have written off within the taxable year.
 It should be connected to trade or exercise of a profession.
7. Pension trust – it comprises a fund intended to provide retirement benefits to the employees. It composed of:
a. Past service cost – contributions paid to employees already employed prior to provision of reasonable
benefit plan. This is normally paid in a lump sum amount.
b. Current service cost – contributions paid to services provided by employees during the current year.
Rules for deduction:
 The plan must be reasonable and actuarially sound (actuarial valuation)
 The plan must be approved by the BIR or if not approved, the deduction will only be allowed if there is
an actual retirement payment. No deduction is allowed for the retirement contribution.
 The deduction is lower of the normal or actuarial valuation or the actual contribution. The excess of
actual contribution over the normal valuation is to be amortized over the period of 10 years.

Example:
A Co. maintains BIR-registered defined benefit retirement plan. The company’s normal cost per actuarial
valuation for funding is P900,000 and P950,000 for years 2018 and 2019, respectively. The actual
contributions of A Co. to the retirement plan were P1,100,000 and P800,000 for years 2018 and 2019,
respectively. The deductible retirement expense for 2018 and 2019 would be
2018
2019
 Normal or actual contribution (lower) P900,000
P800,000
Add: 2018 amortization of excess contribution over normal cost (200k/10) 20,000
20,000
Retirement expense P920,000
P820,000

8. Research and development cost

Option of the taxpayer in deducting the R & D:
a. Ordinary and necessary expense deductible from gross income in the year the expenses are paid or
incurred.
b. Deferred expenses chargeable to the capital account but not chargeable to property subject to
depreciation or depletion. Such expenses will be allowed as deduction ratably distributed over a period
of not less than 60 months beginning with the month in which the taxpayer first realizes benefits from
such expenditure.
9. Depreciation
Requisites for deductibility:
a. It must be reasonable.
b. It must be charged off during the year.
c. The asset must be used in business or profession.
d. The asset must have a limited useful life.
e. The depreciable asset must be located in the Philippines if the taxpayer is a nonresident alien or a
foreign corporation.

Methods of depreciation:
a. Straight-line method
b. Declining balance method
c. Sum of the years digit method

Depreciation of Properties used in Petroleum Operations:

- Properties directly used in petroleum operations - useful life is 10 years or such shorter life if permitted
by the BIR.
- Properties not directly used in petroleum operations – useful life is 5 years using straight line method.

Depreciation of Properties used in Mining Operations:

- At the normal rate of depreciation if the expected life is 10 years or less;
- Depreciated over any number of years between 5 years and the expected life if the latter is more than 10
years.
10. Depletion – exhaustion of natural resources like mines, oil and gas wells due to production.
Exploration and Development Expenditures:
Exploration expenditures - means expenses paid/incurred before the development stage of the mine intended
to ascertain the existence, location, extent, or quality of any deposit of ore or other mineral.
Development expenditures – means expenditures paid or incurred during the development stage of the mine
or other natural deposits.

Tax treatment:
- At the option of the taxpayer, the exploration and development expenditures paid or incurred during the
taxable year may be treated as:
a. Part or adjusted bases for depletion cost (capitalized), or
b. Deduction to compute the taxable income from mining operations subject to limitation:
o The total deduction shall not exceed 25% of the net income from mining operations;
o The actual exploration and development expenditures minus 25% of the net income from mining
operations shall be carried forward to the succeeding years until fully depreciated.
 Net income from mining operations – shall mean gross income from operations less “allowable
deductions” which are necessary to mining operations. “Allowable deductions” shall include mining,
milling and marketing expenses, and depreciation of properties directly used in the mining operations.

11. Charitable and other contributions – is a non-operating expense, but the law allows some contributions or
gifts given within the taxable year as deductions from gross income.
Requisites for deductibility:
 The donor must be engaged in business or profession;
 There must be actual payment of contribution or gift;
 The recipient must be entity or institution specified by law;
 The net income of the institution must not inure to the benefit of any individual or private
stockholder.
a. Contributions deductible in full
- Donations to the Philippine Government 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 the National Economic Development Authority (NEDA).
- Donations to international organizations 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.
- Donations to Accredited Non-Government Organizations (non-profit domestic corporation) subject to
the following requisites:
o Not more than 30% of which should be used for administration purposes;
o The contribution received must be utilized not later than 15 day of the third month after the close
of its taxable quarter;
o Upon dissolution, a court shall distributed the assets of the said NGO to another nonprofit
domestic corporation or similar organization.

Note: if the abovementioned requisites are not met, the donation shall be subject to limit.

b. Contributions subject to Limit

o The donor is an individual taxpayer with business – the limit is 10% of the taxable income
derived from business or profession before contribution or the actual contribution, whichever is
lower.
o The donor is a corporation – the limit is 5% of the taxable income derived from business or
profession before contribution or the actual contribution, whichever is lower.

Example: Individual Taxpayer - Donor

AB revealed the following data regarding his income and expenses for the taxable year 2018:
Gross income from business P800,000
Business expenses allowed as deduction (except contributions) 600,000

Charitable contributions:
To the government:
- For specific priority activities in education 50,000
- For public purposes 60,000
To church 15,000

Total deductible charitable contributions of AB would be:

Contributions deductible in full P50,000
Contributions subject to limit:
To government – public purposes P60,000
To the church 15,000
Total actual contributions P75,000
Limit: {(P800,000 – P600,000) x 10%} 20,000 20,000
Total deductible charitable contributions P70,000
12. Losses – represents reductions of resources due to unintended destruction or deprivation of things. As a rule,
losses are deductible from gross income if related to business, actually sustained during the taxable year and
not compensated for by insurance or other forms of indemnity.

 In case of total loss – the amount of loss is deductible from gross income.
 In case of partial loss – the amount of loss is measured at lower of cost to restore the property back
to its normal state or book value of the property damaged portion.

Classification of Losses:
a. Ordinary losses
b. Capital losses

B. Optional Standard Deduction – In lieu of itemized deduction, OSD may be deducted from gross income.
For individual taxpayer other than non-resident alien – 40% of his gross sales or gross receipts.
For corporation – 40% of its gross income

Example: Assume the following data of a taxpayer:

Gross sales P1,000,000
Cost of goods sold 800,000

OSD if the taxpayer is (a) individual, or (b) corporation?

Individual Corporation
Gross sales 1,000,000 1,000,000
Cost of goods sold 800,000
Basis of OSD 1,000,000 200,000
OSD rate 40% 40%
OSD amount 400,000 80,000

C. Special Allowable Itemized Deductions – additional incentives allowed to be deducted from gross income.
1. Senior Citizen discounts (R.A 9257) and PWD discounts (R.A 9442)
2. Net Operating Loss Carry-Over – excess of allowable deductions from gross income of the business in a
taxable year. It can be carried forward for the next three consecutive years.

Note: If the taxpayer claims the 40% OSD or if the corporation is taxed with MCIT, it shall not simultaneously
claim deduction of the NOLCO.