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TAXATION

SEPT. 7, 2010 Tuesday


DISGUISED DIVIDENDS
- Disguised dividends may be considered as distributed to an individual who is not a
stockholder. gree or disagree!
o Disagree. Dividends are only given to stockholders o" a cor#oration.
o $hus% whenever an e&cessive #ayment o" honorarium '() a month* is given to a
+resident o" the ,om#any% who is not a stockholder% it will not be treated as
disguised dividends. -ut what will ha##en to the #ayment! $a&able still!
It will be ta&able on the #art o" the +resident but not as dividends.
.hatever income will be derived by an individual% it will be ta&able. In
what way! It de#ends on what is the treatment given by the $a& ,ode. In
case e&cessive #ayment is made to an individual who is a stockholder% it
will be treated as disguised dividends and sub/ect to the usual rates o"
(01 "or 2,% N2, and 2% 301 "or N2-E$-% and 341 "or N2-NE$-. -ut i"
it so ha##ens that the individual who received e&cessive #ayouts or
#ayments is not a stockholder% it will not be considered as disguised
dividends. No dividends shall be given to a non-stockholder. -ut still% being
an income or an in5ow o" wealth in the hands o" such individual% it will be
ta&able sub/ect to the ordinary rates to be withheld% i" he6s an em#loyee%
o" the 4-731 income ta& according to the withholding ta& on wages table.
8I9UID$ING DIVIDENDS
- .henever a cor#oration dissolves% li:uidates and winds u# its business o#erations% it
may ha##en that assets will be le"t a"ter #aying all the creditors and these assets will be
distributed to the stockholders in accordance with the #ro#ortion o" ownershi# that they
have in the business and it6s called li:uidating dividends. It6s ta&able.
o 8i:uidating dividends given% like cash% #ro#erties or other remaining assets a"ter
#aying out all the creditors o" the cor#oration% i" distributed to the stockholders%
will it be sub/ect to ;.$ (01% 301 or 341 de#ending on the classi<cation o" the
ta&#ayer or the cor#oration!
N=.
Do you think a stockholder will e&#erience loss in receiving a li:uidating
dividend! >ES.
E&am#le? @A) as invested by @A #eo#le "or () each (0 years ago
and 0 liability. Net worth% there"ore% is @A). ,a#ital stock o" <rst day
o" o#eration is @A) and #ro<ts is 0. (0 years a"ter% assets grew to
(00)% liabilities to A0). Net worth% there"ore% is @0). I" you dissolve
and wind u# the aBairs o" the cor#oration% you distribute the @0)
a"ter you #ayout the liabilities to the creditors. .ould the
stockholders be receiving the same amount that they invested o"
() each! N=. $he stockholders will receive less than (). Is there a
gain sub/ect to ta&! N=% since there is a loss. ,an we consider the
less than () recei#t o" cash% #ro#erty or assets as li:uidating
dividend! >ES. .ould such li:uidating dividend be ta&able! N=% it
will be deductible.
So i" it will ha##en that your recei#t o" li:uidating dividend is less
than what you have invested in the cor#oration% you actually
suBered a loss "rom the investment. .hatever you received%
considered as li:uidating dividend% is not sub/ect to ta&. -ut i" it6s
the other way around% there is a gain or you receive more than
what you have invested. nd whatever you have invested is the
cost o" your investment. ny diBerence o" what you receive as
li:uidating dividend "rom such cost will be considered as ta&able
income sub/ect to the rate o" 4-731.
So whenever you receive a li:uidating dividend% /ust treat it as a
ca#ital income. ,om#ute your ta& liability together with all your
other income. It6s never sub/ect to ;.$.
.hat ha##ens i" the stockholder receiving the li:uidating dividend
is a cor#oration!
o E&am#le? ,or#oration C>D is owned by -; and EF8
,or#oration. I" C>D ,or#oration li:uidates and distributes
the remaining assets to all A individual stockholders and a
cor#orate stockholder. Is such cor#orate stockholder sub/ect
to ta&!
.hatever the ta&ability% on a normal basis% i" the
stockholder% whether he is sub/ected to 4-731 or
341 because he is a N2-NE$-% or the stockholder is
a cor#oration sub/ect to 701% then use those rates in
com#uting the ta& due on the diBerence between
your li:uidating dividend and the initial investment
or the cost o" the investment that you #ut into the
cor#oration. "ter all% it6s the income that matters.
>ou shall not be ta&ed on the cost o" the investment
you #ut into unlike cash and #ro#erty dividend% you
get it out "ree "rom the cost as yet because the
cor#oration is not winding u#. Still whenever you
receive cash and #ro#erty dividends% your ca#ital is
intact in the cor#oration. -ut in li:uidating dividends%
it6s the end o" the cor#oration and the end o" your
investment. ny income is ta&able. ny loss is
deductible.
N=$E? 8osses "rom investment or income "rom
investment% such as li:uidating dividends% are ca#ital
losses and ca#ital income% res#ectively. $hey6re only
ta&able as ca#ital income and deductible against
ca#ital income i" a loss is e&#erienced.

DEDU,$I=NS
- re cor#orations allowed deductions! >ES. $he same as the available deductions "or
individual ta&#ayers! N=.
o .hat ty#es o" deductions andGor e&em#tions are available to individual
ta&#ayers!
(. +ersonal and additional e&em#tions
3. +remiums on health and hos#italiHation insurance
7. ItemiHed deductions% or in lieu o" such% o#tional standard deductions
Iowever% not all these three are available to all ty#es o" individuals.
I" an individual is #urely a com#ensation income earner% only ( and
3 would be deductible. -ut i" the individual is into business already%
whether together with E2-EE relationshi#% he can also claim any o"
the itemiHed deductions or o#tional standard deductions because
itemiHed deductions is "or business e&#enses. -ut then% all three
would not be available to an individual who is classi<ed as a N2-
NE$-. In so "ar as the cor#oration is concerned% which o" the 7
deductions are available to a cor#oration!
o ItemiHed deductions% or in lieu o" such% o#tional standard
deductions
o 2ES=N? ,or#orations venture into an activity which is "or
#ro<t. $here"ore% it is "or business and with it comes the
incurrence o" business e&#enses. $hat6s why as a rule%
cor#orations doing business in the +hili##ines% in "act% all
cor#orations engaged in trade or business in the +hili##ines
can deduct itemiHed deductions or o#tional standard
deduction i" it so chooses. -ut e&em#tions are not available
because it covers "or #ersonal and "amily living e&#enses
and cor#orations are not natural #ersons. nd #remiums on
health and hos#italiHation insurance are not as well
considered as deductions.
- .hat are the underlying #rinci#les that need to be "ollowed be"ore a cor#oration can
deduct itemiHed deductions!
o i. $he ta&#ayer must #rove that there is a law authoriHing deductions
o ii. $he ta&#ayer must #rove that he is entitled to deductions
o iii. I" the law #rovides "or re:uirement that the amount or the e&#ense #ayment
needs to be withheld o" ta&% a ta& should have been withheld% otherwise% the
deduction is not allowed
o iv. lways% we construe it strictly against the ta&#ayer
- -ut what about =SD! ,an cor#orations really claim =SD!
o >ES% e&ce#t N2;,.
2ES=N "or e&ce#tion? Such cor#oration% its ta& base is at gross. nd the
mere "act that a N2;, is construed as a cor#oration NE$-% there is no
deductions allowed "rom their income. .hatever they earn in the +hil. is
sub/ect to 701 income ta& e&ce#t those ca#ital gains "rom the sale o"
shares o" stocks in a domestic cor#oration.
- ,an =SD be allowed as a deduction i" the cor#oration is not allowed to claim itemiHed
deductions!
o N=% =SD is in lieu o" itemiHed deductions. So i" a cor#oration or any ta&#ayer is
not allowed to claim itemiHed deductions% there is no =SD allowed. -ut there are
cases or e&ce#tions when itemiHed deduction is allowed but =SD is not allowed%
such as when the ta&#ayer is a N2-E$- since =SD can be claimed by any
individual e&ce#t N2 but N2-E$- can claim itemiHed deductions because they
are sub/ect to ta& on net income.
o =SD e&am#le? I" your gross income is ()% you can automatically deduct =SD o"
@00F. +ay ta& as a cor#oration on the A00F. ItemiHed deduction is only 700F% go
"or =SD. >ou don6t need to substantiate it with recei#ts. >ou don6t even have to
incur such e&#ense. -ut i" your itemiHed deduction is J00F% "orget about =SD.
,laim such itemiHed deduction as an e&#ense. $he only #roblem is that your
books will be audited to determine whether you really have incurred J00F in total
e&#enses and whether it is substantiated with oKcial recei#ts% or invoices or in
contracts.
- .ho are not allowed to claim itemiHed deductions!
o (. Individuals% whoever that individual is% i" he is #urely earning income "rom E2-
EE relationshi#% "orget about itemiHed deduction because itemiHed deduction is
only in business% trade% or #ro"ession.
o 3. I" the individual is a N2-NE$-% no itemiHed deduction.
o 7. N2;, are never allowed itemiHed deduction or =SD.
- ItemiHed deduction becomes the de"ault o" every businesses. Every business% whether
individual ta&#ayer or a cor#oration% is re:uired to re#ort on a :uarterly basis the income
ta& liability o" that business.
o I" the ta&#ayer "orgets to choose which o#tion is it taking% whether it is itemiHed
deduction 'ID* or =SD% automatically% the de"ault is ID. -ut once in the <rst
:uarter% the ta&#ayer has already chosen =SD% you can no longer shi"t back to or
revert back to ID "or the entire year. So that means% =SD% as an o#tion% is
irrevocable "or the year at issue.
o ,an the ta&#ayer choose ID the "ollowing year! >ES because irrevocability o" an
=SD is only "or the current year. It6s on a year-to-year basis.
o I" a G++% who is not ta&able% elects to re#ort its ta&able income choosing =SD%
then the #artners who have to re#ort their ta& liability and #aid will also be liable
under =SD. I" the G++ elects ID% the #artners don6t have any other choice but to
go "or ID. So G++s and the individual #artners are taken as a single entity "or ta&
#ur#oses. Not one o" the ta&#ayers% G++ or the #artners% can choose the other
and the other one go "or the other o#tion.
EC+ENSES
- .hat are ordinary and necessary e&#enses!
o =rdinary e&#enses '=E* L re"ers to the e&#enses which are normal% usual or
common to the business% trade or #ro"ession o" the ta&#ayer.
o Necessary e&#enses 'NE* L one which is use"ul and a##ro#riate in the conduct o"
the ta&#ayer6s trade or #ro"ession.
- ,an a NE o" one business be a NE o" another business! =r is it always the case that i" the
e&#ense is necessary in this business% it is always necessary e&#ense "or another!
o N=.
o E&am#le? I" you6re into banking business and your "riend is into siomai business.
.hat e&#ense is necessary "or your business but is not necessary "or your "riend6s
business! -anking business has to hire security guards and rent armored car "or
its business as a NE% which is not a NE in a siomai business.
o So what is necessary% use"ul and a##ro#riate "or one ty#e o" business may not be
use"ul and a##ro#riate "or another kind o" business. So there is no standard rule
"or what ty#e o" e&#enses may be deductible "or this cor#oration or another
cor#oration. >ou can name more than a hundred e&#ense accounts in your
business% but may not be "ound in another ty#e o" business. -ut so long as the
classi<cation o" that business is that it6s necessary% use"ul% a##ro#riate and it6s
ordinarily incurred in the business o#erations% "or those who are similarly situated%
then it is classi<ed as a deductible business e&#ense.
o Is a ca#ital e&#ense deductible! >ES.
.hat are ca#ital e&#enses ',E*!
$hey are e&#enditures "or the e&traordinary re#airs which are
ca#italiHed and sub/ect to de#reciation. $hese are e&traordinary
e&#enses which tend to increase the value or #rolong the li"e o" the
ta&#ayer6s #ro#erty.
.hat im#ortant re:uisite "or the deductibility o" an e&#ense is not
com#lied with by a ca#ital e&#enditure making it non-deductible on the
year o" incurrence!
,a#ital e&#enditures are e&traordinary e&#enses which #rolong the
li"e o" an asset that has been re#aired. It either increases the value
or increases the li"e or #rolongs the li"e o" the asset such that it
violates the rule "or an e&#ense to be deductible% it must be #aid or
incurred during the ta&able year.
.hen you say M#aidN% it is e&#ense but it must also #ertain to the
year "or which that e&#ense is related to the income generated by
the business. I" it6s incurred during the year% i" the ,E would #rolong
the li"e o" an asset over which the asset would be use"ul "or (0
years% then the e&#ense o" the ,E should be distributed over (0
years as well to bene<t the com#any. It6s the matching #rinci#le
wherein you only deduct the e&#enses which is related to the
business activity. I" it6s only (G(0 every year% then only (G(0 o" the
e&#ense is deductible.
$he reason why it is deductible but not in the year o" #ayment or
not in the year when the year it was constructed% #urchased%
re#aired% etcO.
- .hat are the common re:uisites to make an ordinary or necessary e&#ense deductible!
o i. $he e&#enses must be ordinary and necessary
It6s ordinary when it6s normal% usual and common. lthough sometimes it
does not necessarily need to be incurred day-in% day-out but so long as it6s
usual in the ty#e o" business or the industry to which that business is in
then it can be considered as =E% not unusual.
It6s NE when it6s use"ul and a##ro#riate "or the business activities.
o ii. It must be #aid or incurred during the ta&able year 'whether calendar or <scal
year*
E&ce#tion? net o#erating loss carry-over
I" the e&#ense that you6re claiming as a deductible item this year is an
e&#ense "or the o#eration o" the #revious year% it is not deductible
e&#ense. So your e&#ense claims must be #aid this year or i" not #aid this
year% it must have been incurred.
.hat6s the diBerence between #aying an e&#ense and incurring an
e&#ense!
In the +hil.% we do not usually "ollow the cash method in
determining whether your income is already ta&able or not. .e
"ollow the accrual method o" accounting. ,ash method o"
accounting% whatever you receive in cash is considered as sales
and whatever you have #aid "or in your e&#ense% is deductible and
the diBerence is ta&able under the cash accounting method. -ut
the accrual method% whatever you have sold% so long as you have
com#leted the transaction% whether it has been #aid by your
customer or not% is re#orted as sales already and whatever you
have #aid as an e&#ense including those e&#enses "or which you
have eBected already the transaction% the services have already
been #er"ormed in your "avor% and it6s #ayable% meaning% the other
#arty% your su##lier% has already the legal right to demand #ayment
"rom you but not as yet. +robably% there is a #eriod within which
you can #ay. It6s already deductible. It sim#ly "ollows the Mall-events
testN. >ou have all the events to com#lete the transaction% then the
sale has been #er"ected% whether #aid or not% ta&able. E&#ense%
whether #aid or not% so long as service has been #er"ormed% goods
have been delivered% it6s deductible.
So in the e&#ense% so long as it has been #aid this year or has been
incurred and it #ertains to this year6s o#erations% the e&#ense is
deductible.
I" you6re claiming an e&#ense which is "or the "uture% advance
rental #ayments% is it deductible!
o Under the accrual method% it would be deductible.
Is the e&#ense #ertaining to last year6s activity deductible!
o N=. ll the e&#enses must be #aid or incurred during the
year e&ce#t net o#erating loss carry-over.
o NE$ =+E2$ING 8=SS ,22>-=VE2 'N=8,=*
I" the business incurs a loss% it6s deductible. -ut once
a business incurs N=8% meaning% the bottomline
<gure "or the entire year6s o#erations is a loss% there
is an o#tion "or the business to carry it over to the
ne&t 7 years.
So% it means to say i" it6s carried over to the ne&t 7
years% in the ne&t 7 years% it6s not the e&#ense during
those years. It #ertains to the #revious years. -ut
since it is mandated by law to be deductible% it6s an
e&ce#tion to the rule that it does not really have to
#ertain "or this year6s o#erations.
o iii. It must be #aid or incurred in connection with the trade% business or #ro"ession
o" the ta&#ayer
E&am#le? In you6re in 7 businesses. =ne manu"acturing cor#oration. =ne
real estate business. nd the other is a siomai business. >ou don6t mi& the
e&#enses. >ou cannot claim the e&#enses o" this business to that business.
It should necessarily be connected with the business that you6re in.
o iv. It must be reasonable in amountP
I" you are the #resident o" the cor#oration earning (00F a month% it may
be reasonable in so "ar as that business is concerned but your (00F will be
unreasonable in another ty#e o" cor#oration.
So there is no <& amount within which we can determine whether this ty#e
o" e&#ense claimed is reasonable or not. No <& amount but you have to
consider it in so "ar as the o#eration is concerned.
-ut there is one ty#e o" e&#ense that is regulated by the ta& authorities
and that e&#ense is Entertainment% musement and 2ecreation e&#ense
'E2 e&#ense*.
.hy! -ecause this ty#e o" e&#ense as a deduction has been
abused. )any businesses claim re#resentation e&#ense L bringing
clients to clubs. nd the amount is unreasonable. Instead o"
distributing as dividends% they claim it as re#resentation e&#ense L
they re:uire stockholder or em#loyee to bring in recei#ts and thy
can even ask recei#ts "rom you and have it reimbursed% such as
medical re#resentatives.
E2 e&#ense has been abused.
$here is already a regulation that sets a :uota "or such e&#ense.
.hat is the ceiling set by the Secretary o" ;inance!
o E2 e&#ense L to the e&tent only o" (1 o" the net sales i"
the cor#oration is engaged in services. nd 0.41 o" the net
sales i" the cor#oration is into the sale o" goods or
#ro#erties.
o 2ES=N "or the diBerence? -ecause those engage in
services usually needs re#resentation e&#ense to entertain
their clients or treat them over meetings% lunch meetings%
etc. -ut i" it is goods or #ro#erties% so long as you have the
#roduct% you can sell it.
o .hat ha##ens i" you are both engaged in the sale o" service
or in the sale o" goods! .hich will you "ollow!
>ou still have to "ollow the "ormula L (1 "or the
service and 0.41 "or the goods and #ro#erties.
E&am#le? So it means to say that i" the
cor#oration% net sales is () and it is engaged
in the sale o" service and goods% the
ma&imum E2 e&#ense "or services is only
(0F while "or goods or #ro#erties% it6s only 4F.
I" the cor#oration has 40F e&#ense%
automatically% @4F is not deductible "or goods
or #ro#erties since only 4F is the ma&imum
deductible amount.
In so "ar as salaries are concerned or bonuses o" directors% it6s
#rovided under the ,or#oration ,ode that -oard o" Directors% as
honorarium% should not e&ceed (01 o" the net income o" the
cor#oration because i" it e&ceeds% it will be considered already as
disguised dividends.
o E&am#le? I" the net income is only ()% only (00F should be
given to the -oard o" Directors "or the entire year L "or all o"
them. ny e&cess will be considered as unreasonable.
o v. It must be substantiated by suKcient evidence such as oKcial recei#ts and
other oKcial recordsP and
=Kcial recei#ts
de:uate records
mount o" e&#ense being deducted
Date and #lace where such e&#ense is #aid or incurred
Nature o" e&#ense L direct connection or relation o" the e&#ense being
deducted to the develo#ment% management% o#eration andGor conduct o"
the trade% business% or #ro"ession o" the ta&#ayer
$he evidence must be recogniHed or #roduced by the third #arty. I"
the evidence solely comes "rom the com#any L you made it% you
dra"ted it% no signature "rom the other #arty% it is sel"-serving so it is
not suKcient evidence.
E&am#le? >ou6re in the business o" manu"acturing wooden toys "or
e&#ort in Euro#e. nd "or cost-cutting #ur#oses% you don6t have a
large #ool o" em#loyees so that you sub-contract the raw materials
to the diBerent homeworkers. nd those homeworkers are actually
not registered in the business. $hey /ust do what they6re re:uired to
do and when they bring it back to you% you #ay them.
Iomeworkers% not being registered with the ta& authorities because
they6re not really into business% cannot #roduce an =.2. nor an
invoice. .hat #roo" will you #resent to the ta& authorities in order
to claim the #ayments you made to these homeworkers!
o contract or an acknowledgment recei#t will do. $hey can
surely sign. It6s not always in all cases that you can re:uire
your su##lier to #roduce an =.2. In one o" the ma/or cases
that we have in the +hili##ines is those in the business o"
manu"acturing Mcara/inanN. >ou #urchase it "rom diBerent
su##liers to grow such but they are not registered in the
business o" su##lying. $hey cannot #roduce an =.2. $he
#roblem is that i" they do not #roduce an =.2.% what #roo" do
you #resent to the government that indeed that you6ve
made #ayments "or these when it cost millions!
So in one o" the com#anies here% the only thing that
they can #roduce is the #roo" that it had been
weighed by a re#utable weighing com#any% the
de#osit that they made in millions to an individual in
)indanao. -ut i" you really want them to #roduce an
=.2.% they can show you their guns. So as a business
man% you don6t "orce them to issue an =.2. So how to
#rove to the -I2 that these are valid and legitimate
e&#enses!
$here6s already a S, actually "ollowing the
,ohan 2ule in the U.S. that some e&#enses
need not be su##orted by =.2. but so long as
it can be substantiated with other ade:uate
records #roving that in "act it has been
#urchased by the com#any and the goods
received by the com#any which were actually
converted to the #roduct sold% can be #roo"
enough that e&#enses have been #aid or
incurred. -ut not in all instances.
In this ty#e o" re:uisite% is it necessary when you want to claim
=SD!
o N=% because the law in =SD says Mwhether or not you have
incurred actual e&#ensesN. So this re:uisite a##lies only in
so "ar as ID is concerned.
o vi. It must not be against law% morals% #ublic #olicy or #ublic order
E&am#le? -ribes and kickbacks given to government #ersonnel
>ou have an assessment o" (0) in un#aid ta&es or delin:uent
ta&es. >ou come into a com#romise or common grounds. >ou will
only #ay 4) and you will be issued a ta& clearance. nd "or the 4)
that you will #ay% only 3.4) will be recei#ted as received by the
government. .herever the other 3.4) will go% we do not know. Iow
much is deductible "rom your business o#erations! (0)% 4)% 3.4)
or none o" the above!
o N=NE o" the above. .hatever #ayments you made to the
government% as kickbacks or bribes% even to the members o"
the -=, or -I2 or D=;% so long as it6s not a legitimate
#ayment o" an e&#ense% it is not deductible.
o Iow about #ayments to rebels as revolutionary ta&es!
$elecommunications towers% so that it will not be blown u#%
you have to #ay a certain amount. Is that deductible!
N=. ll ta&es% as a rule% are deductible% e&ce#t
income ta& #aid to the +hil. government% income ta&
#aid to the "oreign government% estate ta&% donor6s
ta& and V$. ll the other ta&es are deductible.
Iowever% even i" they call it as a "ormal ta& that is
#aid to the rebels% it doesn6t go to the government%
there"ore% however media will try to make it legal in
the news% it6s still a non-deductible e&#ense because
it6s contrary to law and #ublic order.
DVE2$ISING ND +2=)=$I=N8 EC+ENSE '+E*
- s a rule% +E are deductible unless it borders to creation o" goodwill "or the com#any or
creating a name "or the com#any% "uture recall% etcO
o E&am#le? DandruB sham#oos L we have Guard% Iead and Shoulders. .e6ve been
through that "or years already. .hen ,lear came in% almost all actors and
actresses became endorsers "or it. Iow much did they have as a budget "or that!
It6s (-. Is it deductible as +E in the year it was incurred!
N=. It6s e&cessive and the #ur#ose o" actually o" ,lear is not to make it as
an e&#ense in the year o" entry but rather its #ur#ose was to give a brand
and give a name recall "or the customers and it6s e&#ected to bene<t a
number o" years "or the com#any% there"ore% whatever e&#ense it had #aid
during the year o" entry will be amortiHed over "uture years. 8et6s say% "or
4 years.
$2VE8 EC+ENSES '$E*
- $E are deductible even i" it6s not recei#ted because they6re $E that we incur without
having a recei#t "rom the carriers% etcO
=+$I=N $= +2IV$E EDU,$I=N8 INS$I$U$I=N '=+EI*
- +EIs have the o#tion to deduct ca#ital e&#enditures in the year it was #aid or incurred or
the other o#tion is to de#reciate the e&#ense over the use"ul li"e o" the asset.
o E&am#le? US, would #urchase a (00) value building. It can o#t to deduct entirely
the (00) in the year o" #urchase or amortiHed the (00) over its use"ul li"e. In any
case% whatever the o#tion chosen by US,% since it6s not sub/ect to ta&% it won6t
have any eBect. It doesn6t need to match the e&#ense incurred today against the
income "or today or year-to-year basis.
IN$E2ES$S EC+ENSE 'IE*
- .hat is interest!
o It6s the amount #aid "or the use or "orbearance o" money.
E&am#le? I" you have a business and you obtained a loan "or the working
ca#ital o" your o#eration and you are to #ay (0F monthly as interest. Is the
(30F "or the entire year be deductible as a business e&#ense i" it6s related
to the business!
>ES.
s a rule% IE incurred by a business% cor#oration% com#any or ++ is
deductible so long as the common re:uisites are com#lied with?
o (. $he interest must be ordinary and necessary.
So i" you obtained a loan to use it as a working
ca#ital o" your o#erations% the interest #aid is
deductible.
o 3. It must be reasonable.
2easonableness would de#end on the siHe o" the
business o#eration.
o 7. It must be #aid or incurred during the ta&able year
o @. It must be #aid or incurred in connection with the
business
o 4. It must be substantiated by the contract itsel" and
#ayment vouchers% etc.
o A. It must not be contrary to law
o =ther additional re:uisites to make IE deductible?
i. $here must be an obligation which is valid and
subsisting
ii. $here must be an agreement in writing to #ay
interest
=therwise% not in writing% no IE deduction%
whether or not you have actually #aid an
interest
iii. $his must observe the limitation under the
arbitrage rule
iv. $his must not be between related ta&#ayers
- IE which are non-deductible? 'See outline*
o ,or#oration to cor#oration where only one individual is maintaining the
controlling interest% the interest is not deductible.
E&am#le? ,o. '#arent com#any* and ,o. - 'subsidiary com#any*. Usually
the #arent com#any grants a loan to a subsidiary com#any "or o#erational
#ur#oses. I" the agreement is stated that interest shall be #aid in writing%
is the individual% according to the grand"ather ruleO I" ,o. is owning ,o.
- (001 and the loan is granted to the subsidiary com#any where interest
is sti#ulated to be #aid% is the interest #ayments made by the subsidiary to
the #arent com#any deductible! N=. Iere% ,o. is a holding com#any o"
,o. -. .hen one is a holding com#any o" the other and e&tends loans% the
IE becomes a non-deductible e&#ense. $he 401-rule 'controlling interest
rule* is only a##licable to non-e&isting holding com#anies.
o Interest e&#ense on #re"erred stock
E&am#le? com#any declares dividends. Dividends comes out "rom your
shareholdings and shareholdings% usually% shares that you have can be
classi<ed as common shares or #re"erred shares. .henever you organiHe a
cor#oration% you may say that this grou# has common shares% this grou#
will have #re"erred shares. $he term #re"erred shares% you will have a
#re"erence in the distribution o" dividends% as a rule. I" there comes a #oint
in time that the business% in a certain year% cannot declare a dividend%
some dividend would accrue to them but not totally #aid out% nothing
would accrue to you. )eaning% they have a collectible. In the "ollowing
year% when distribution ha##ens% they will get their #rior-year accrual
dividends #lus interest% you will receive yours "or the year. .ill the interest
on the #re"erred shares be considered as deductible IE!
$he conce#t o" #aying interest and interest as a deducible e&#ense
item is it must be #ayment "or the use o" someone else6s money L
the "orbearance o" money. >ou tem#orarily borrow money% use it
and "or the use% you are to #ay interest in addition to the #rinci#al
#ayments that you will make. -ut dividend declaration is not an
obligation o" the cor#oration. In "act% under the ,or#oration ,ode% a
dividend can only be declared i" there is enough unrestricted
retained earnings or cor#orate #ro<ts that a cor#oration has. I" it is
not de#endent u#on cor#orate #ro<ts on the #re"erred shares% it is
deductible. I" it is de#endent u#on cor#orate #ro<ts% as a rule% it is
not deductible e&#ense. 2ES=N? $he cor#oration did not really
loan any money coming "rom the stockholders. $he cor#oration is
obligated to #ay out dividends once it has #ro<ts.
- .hat is the rbitrage 2ule!
o $he ta&#ayer6s allowable deduction "or IE shall be reduced by an amount e:ual to
771 o" the interest income earned by him which has been sub/ected to <nal ta&.
o $he arbitrage rule automatically limits the deductibility o" the IE by reducing 771
o" the interest income sub/ect to <nal ta&% whether or not engaged in back-to-
back loan transactions.
E&am#le? 8et6s say that the com#any has an IE o" A00F but it has no
interest income% is the IE deductible "ully! >ES. Say "or e&am#le% ,o.
'earning interest income o" (00F sub/ect to 301 <nal ta&*% ,o. - 'earning
(00F interest income "rom loans to em#loyees* and ,o. , 'no interest
income*. ll o" them obtained the () loan running "or (0 years wherein
they would be liable each "or A00F annually as IE. .hich o" the 7
cor#orations can claim the "ull A00F as e&#ense and which cannot!
,o. cannot claim "ully the A00F as a deductible IE but only 4AQF
'A00F L R771 & (00FS*. $he arbitrage rule a##lies since ,o. is
earning interest income sub/ected to <nal ta&. I" none% the arbitrage
does not a##ly% automatically "ull interest #ayment can be
deductible.
,o. - can "ully claim the A00F as a deductible IE since its interest
income is not sub/ected to <nal ta&. Interest income sub/ected to
<nal ta& is only those coming "rom the banking institutions.
,o. , can "ully claim the A00F as a deductible IE since it is not
earning interest income.
o $he #rinci#le why such rule e&ists?
$o discourage -ack-to--ack loan transactions L obtaining loan "rom one
bank and invest it to another bank in order to bene<t the diBerence
between the ta& due on interest income and the ta& bene<t "rom the IE.
o I" the IE is (00F% interest income sub/ect to <nal ta& is (00F% do you have a
deductible IE! >ES. >ou have a deductible IE o" AQF '(00F L R771 & (00FS*.
o I" the interest income is 400F sub/ect to <nal ta&% IE is (00F% do you have a
deductible IE! N=. 771 o" 400F is (A4F. So the (A4F will be deducted to (00F%
which results to no deductible IE.
- .hat is theoretical interest! Is it deductible!
o It6s an interest which is com#uted or calculated% not #aid or incurred% "or the
#ur#ose o" determining the o##ortunity cost o" investing in a business. It6s not
real. $here6s no #ayment at all. $hus% it6s not deductible nor ta&able.
- .hat is im#uted interest! Is it deductible! Is it an actual e&#ense!
o Sec. 40 o" the ta& code L llocation o" Income and Deductions L In the case o" 3 or
more organiHations% trades or businesses 'whether or not incor#orated and
whether or not organiHed in the +hili##ines* owned or controlled directly or
indirectly by the same interests% the ,ommissioner is authoriHed to distribute%
a##ortion% or allocate gross income or deductions between or among such
organiHation% trade or business% i" he determines that such distribution%
a##ortionment% or allocation is necessary in order to #revent evasion o" ta&es or
clearly to re5ect the income o" any such organiHations% trades or businesses.
o Such #rovision is #ower"ul in the sense that the -I2 can do anything with it so
long as it sees relationshi#s between cor#orations.
E&am#le? I" ,o. is related to ,o. - as the controlling or "ully owning the
other cor#oration% any e&#ense loan 'let6s say ()* to ,o. -% which is
interest-"ree% so ,o. did not earn any interest income. ,an ,o. - deduct
IE! utomatically% no IE because IE must be sti#ulated in writing and there
is no interest #ayment made. -ut the -I2 can im#ute an interest based on
the legal rate o" (31 and sub/ect such interest income on the #art o" ,o.
to ta&. -ut ,o. - is absolutely not allowed to claim the IE "or no interest
has been #aid and there is no sti#ulation in writing.
- ,an #ayment o" interest "or delin:uent ta&es be deductible!
o >ES. .henever a ta&#ayer% cor#orate or individual% is assessed o" delin:uent
ta&es% that ta&#ayer is not only liable to #ay the basic ta& but also has to #ay
surcharges o" 341 and 401 i" it is "ound to be "raudulent #lus interest o" 301 #a
and additional com#romise #enalties. So whether or not these #ayments are
deductible% is interest deductible! >ES% because it6s an indebtedness to the
government. >ou tem#orarily withheld the #ayment o" ta&es to the government
"or the use o" money during the time which you have not #aid #ro#erly your
ta&es. -ut in so "ar as #enalties% surcharges and com#romise #enalties are
concerned% on to# o" the ta& % these are not deductible. $he ta&#ayer cannot
bene<t "rom a violation that he committed against the government. It is only the
interest that is deductible.
- =#tional treatment o" IE '=$IE*
o t the o#tion o" the ta&#ayer% interest incurred to ac:uire #ro#erty used in trade%
business or e&ercise o" a #ro"ession may be allowed as a deduction or treated as
a ca#ital e&#enditure.
E&am#le? ,o. obtained a loan "or working ca#ital #ur#oses. ,o. -
obtained a loan "or construction o" a building. -oth o" them #aid () in
interest. () in IE and no interest income sub/ect to <nal ta&. $hus% the IE
not limited with the arbitrage rule. Does ,o. or ,o. - have an o#tion in
treating the IE% whether deductible now or deductible in the "uture!
,o. % the incurrence o" e&#ense is "or working ca#ital #ur#oses%
day-in day-out o#erations% the IE incurred% i" it6s not sub/ected to
arbitrage rule% would be "ully deductible as an e&#ense "or the year
o" incurrence. -ut since ,o. - obtained a loan to construct a
#ro#erty that is a ca#ital e&#enditure% the IE can also be considered
as a ca#ital e&#enditure. .here the #rinci#al cost goes% the
accessory interest e&#ense can also /oin the #rinci#al cost. So i" the
building has an estimated li"e o" (0 years or 30 years% the IE can be
considered as ca#ital added to the cost o" the building and it will be
considered as an e&#ense over the estimated li"e o" the asset that
was ac:uired using the loan amount.
$CES
- G2? ll ta&es% national or local% #aid or incurred within the ta&able year in connection
with the ta&#ayer6s trade% business or #ro"ession are deductible "rom gross income.
o E?
i. S#ecial assessment L ta& im#osed on the im#rovement o" a #arcel o"
land
ii. Income ta& L includes "oreign income ta&
+hili##ine income ta& L absolute rule? totally not deductible
;oreign income ta&
o +aid by domestic cor#orations and resident citiHens 'ta&able
within and without* L may be claimed as a deduction i" it
o#ts "or ta& deduction% otherwise% it becomes non-deductible
i" it uses the "oreign ta& #aid as ta& credits.
I" the "oreign ta& is claimed as a ta& credit% you
cannot claim it as a ta& e&#ense. -ut i" you claim it
as a ta& e&#ense% you cannot claim it as a ta& credit.
,laiming it as a ta& credit% you can claim the "ull
bene<t o" the ta& #aid abroad since ta& credit is a
deduction "rom +hili##ine income ta&. -ut i" you
claim it as an e&#ense% only to the e&tent o" 701 o"
that "oreign ta& will it reduce the ta& due since ta&
deduction% as an e&#ense% is a deduction "rom gross
income in com#uting the net income. $hus% ta& credit
is more bene<cial.
iii. $a&es which are not connected with the trade% business or #ro"ession o"
the ta&#ayer
.hatever ty#e o" ta& that is% since it6s not connected with the
trade% business or #ro"ession o" the ta&#ayer% automatically% it6s not
deductible.
iv. Estate ta&% donor6s ta&
v. V$
- Is the real #ro#erty ta& 'local ta&* #ayment made by the cor#oration on its real #ro#erty
used in trade or business a deductible e&#ense "or #ur#oses o" com#uting income ta&
liability% not real #ro#erty ta& liability!
o >ES. 2eal #ro#erty ta&es are deductible so long as?
(. It is ordinary and necessary
3. 2easonable in amount
7. It has been #aid or incurred during the ta&able
@. It has been #aid or incurred in connection with trade% business or
#ro"ession
4. Substantiated with =.2s
A. It6s not contrary to law% #ublic #olicy or morals
- E&am#le o" national ta& that is deductible? ,ustoms duties when the cor#oration is
engaged in im#ortation o" goods.
- ll ta&es% whether national or local ta&% will be considered as deductible "rom gross
income in com#uting the net ta&able income so long as it "ollows the re:uisites o" being
#aid or incurred during the ta&able year in connection with the trade% business or
#ro"ession o" the ta&#ayer sub/ect to the e&ce#tions.
- .hat ty#e o" ta&#ayer can oBset the "oreign ta&es directly by (001 against the
+hili##ine ta& due!
o i. 2esident ,itiHens L since liable o" income within and without to avoid double
ta&ation
N2, L not included because liable o" income within only L no double
ta&ation
o ii. Domestic cor#orations L since liable o" income within and without to avoid
double ta&ation
o iii. )embers o" G++s
o iv. -ene<ciaries o" estates and trusts
- I" the ta& #aid in ,hina is (0) and the ta& due on your entire income here in the
+hili##ines is 70)% can ,o. - 'which o#erates T01 in the +hili##ines and 301 in ,hina
with (00) total income. $hus% 30) "rom ,hina and T0) "rom the +hili##ines*% can ,o. -
"ully deduct the (0) against the 70)!
o N=% since the "oreign income ta& #aid to the "oreign country is not always the
amount that may be claimed as ta& credit because under the limitation #rovided
under the ta& code% it must not be more than the ratio o" "oreign income to the
total or global income multi#lied by the +hil. income ta& due.
o $hus% 30) '"oreign income*G(00) 'global income* U 301 & 70) '+hil. income ta&*
due U A) limit. $here"ore% only A) can only be claimed as a ta& credit.
o Iad it been the other way around% i" the limit is higher than the actual ta&
#ayment abroad% you claim whichever is lower in "avor o" the government.