TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 1

PART 4 CORPORATE INCOME TAXATION

Part 2

VII. Itemized Deductions (Ex, In, Ta, Lo, Ba, Cha, Re, Pen, Pre, Dep, Dep)

Note: The list of deductions is not exclusive. These deductions are those that are most commonly used by corporate as well as individual taxpayers. As a matter of fact,
if you check an income tax return for corporate taxpayers or for individual income taxpayers earning business income, these expenses are enumerated; however, at the
bottom part of the income tax return, it says there that for other expenditures, you are required to make attachments. Thus, you can claim deductions for other expenses
not listed below so long as it is related to your business.

1. Expenses

When we talk of expenses, what are deductible in full are only those business expenses which are incurred during the taxable year.

When we say business expense deductible in full it means that the company has already benefitted from the expense incurred. There is already matching
between the expense and the income. In this case, you can record it directly as an expense.

If there is a future benefit that can be derived or generated from the expenditure; then, you do not record it immediately as an expense. You record it first as
an asset or you capitalize it first.

Definition of Terms:

Business Expense vs. Capital Expense

Business Expenses - refer to all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are
directly attributable to the development, management, operation, and/or conduct of the trade, business or the exercise of a profession.

The business expenses incurred during the taxable year are deductible in full.

Capital Expenses - are expenditures for the extraordinary repairs which are capitalized and subject to depreciation. These are expenses
which tend to increase the value or prolong the life of the taxpayers property.

An example of a capital expense is an extraordinary repair. It is classified as an extraordinary repair because it either prolongs the life of the asset or it
increases the value of the asset.

A capital expense is not deductible in full. You need to capitalize the expenditure by recording it first as an asset in your balance sheet. You will recognize the
expense yearly by matching it with the income that you earned during the taxable year. Usually it is done by recording depreciation expense or amortization
expense.

For example, in a merchandising corporation, the ordinary business expenses that may be incurred are the salaries and wages of the employees. Thus, the
salaries and wages are considered as a business expense deductible in full. This is because you incurred the expense and you benefitted from the expenditure
during the taxable year or taxable period. If the company made repairs to its building to prolong the life of the building or to increase the value, the expenditure
will be considered as a capital expense because the benefit is not only good for one taxable period. Thats what we call as using the matching principle,
wherein your expenses will be matched to the income earned during the taxable year. Outflow (expenses) should be paired with inflow (income). The money
that will be used for your outflow comes from your inflow. So if you record an income of 100K but you cannot expect to record expenses amounting to 1M;
otherwise, it will be questioned where you got the money to incur those expenses. That is why the Tax Code requires that you capitalize the expense if it benefits
the company for more than one taxable year by dividing the full amount of the expense by the number of years you will be benefitted.

Ordinary vs. Necessary Expenses

Ordinary Expenses - refers to the expenses which are normal, usual or common to the business, trade or profession of the taxpayer. An
expense is ordinary when it is commonly incurred in the trade or business of the taxpayer as distinguished from capital expenditures. The
payments, however, need not be normal or habitual in the sense that the taxpayer will have to make them often. The payment may be
unique or non- recurring to the particular taxpayer affected.

For example, if you are exercising your profession as a lawyer (i.e., you are into a general professional partnership), your ordinary expenses will include the
expense for the buying of your law books or references or attending seminars; however, if you purchase a yacht or a condominium, that expenditure is not
anymore classified as an ordinary expense.

Necessary Expenses - one which is useful and appropriate in the conduct of the taxpayers trade or profession.

An ordinary expense is not similar to a necessary expense. An expense can be ordinary but not necessary. A common example is in the case of General Foods
Incorporated. In this case, General Foods was into manufacturing and selling of Tang juice and Kool Aid. It ordinarily ventures into advertising for marketing
purposes. General Foods reported advertising expenses amounting to 9M but only reported an income of approximately 1M; thus, BIR disallowed General
Foods in deducting the full amount of the advertising expenses and allowed only 50% to be deducted. This was questioned by General Foods since the expenses
incurred were ordinary in their trade and business. The SC, in this case, sided with the BIR and explained that although the expense is ordinary but spending
9M for advertising is not necessary and is not appropriate. What the SC did is they compared the amount of 9M with the other marketing and promotional
expenses reported by General Foods, which was only 500K. Also, there was no proper substantiation of the 9M advertising expense. Thus, it was disallowed.


TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 2
Extra-Ordinary Expenses - these are amortized or depreciated.

These are called extra-ordinary expenses because it either prolongs the life of the asset or increases the value of the asset. An extra-ordinary expense should
be recognized on a staggered basis and should not be deducted in full in one taxable year or period. An exception to the rule on extra-ordinary expenses
pertains to the non-stock non-profit educational institutions and even proprietary educational institutions. They are allowed to deduct the expense one-time
or in full during the taxable period.

Take note that whether an expense can be considered as ordinary or necessary depends on the type of the business.

In the recognition of expense, aside from the Matching Principle, there is also what we call as the Accrual Basis of Accounting. This is being used by BIR
when it comes to recognition of expenses. Opposite to the Accrual Basis, we also have the Cash Basis of Accounting. Insofar as BIR is concerned, they use the
Matching Principle wherein your outflow should match your inflow which is why they adhere more to the Accrual Basis of Accounting rather than Cash Basis
of Accounting.

Under Accrual Basis of Accounting, you recognize expenses when it is incurred whether or not you have paid for the expense. An expense is said to have been
incurred when you have derived the necessary benefit out of the expenditure or when the other party has already complied with its obligation such as when
the seller has already delivered the thing purchased and the buyer has not yet paid for the purchase.

The BIR uses Modified Cash Basis or Modified Accrual Basis, as the case may be. As to income, BIR usually uses the Cash Basis of Accounting wherein you
report as income cash received even if you have not yet rendered any service for the payment received. This is because, according to the BIR, it already
constitutes constructive receipt since the cash received is already at your disposal. However, when it comes to expenses, BIR uses Accrual Basis of Accounting
wherein you only recognize an expense only when it is incurred whether or not payment has been made for the expenditure.

Accrual Basis of Accounting is being used because it adheres to the All-Events Test in determining an expenditure. This means that: (1) there should already
be, on one party, a right to collect payment by the other party and, on the other party, a corresponding liability to pay the expenditure; and (2) the amount of
expenditure or the payable pertaining to the expenditure can be determined already with reasonable certainty. The amount of the expense need not be
accurately correct; it is enough that the amount is reasonably certain (e.g., the amount indicated in the billing).

a) Common Requisites for Deductibility of Ordinary and Necessary Expenses

i. The expenditure must be ordinary and necessary;

It must be normal or useful. Stated otherwise, it must not fall within the definition of capital expenses.

ii. It must be paid or incurred during the taxable year;
Exception: net operating loss carry-over (NOLCO)

Note: An expense may be incurred and paid during the same taxable period or year.

In the NOLCO, the taxpayer is allowed to make a deduction for the operating loss for a period of three years even if it does not pertain to the operation
during that particular taxable year.

iii. It must be paid or incurred in connection with the trade, business or profession of the taxpayer:

The expenditure that you are trying to deduct should be directly related to your business profession or trade. Thus, you need to keep separate records if
you are engaged into different types of businesses.

Examples of non-deductible expenses which are not related to the trade or business:
(1) Expenses for passive investments (i.e., bank financing charges) as these are considered as passive expenses
Note: You cannot deduct passive expenses against active income.
(2) Expenses on profit remittances abroad
Example: A local branch of Deutsche Bank which remits its profits to its office abroad.
Reason: These expenses do not affect or stop the operations of the business. They are not related to the trade or business; thus, they are not
ordinary or necessary expenses.
(3) Political campaign expenses
Example: A lawyer who was exercising his profession reported campaign expenses against his income from his profession after he lost in the
elections. The BIR disallowed the deduction because it was not related to the exercise of his profession.
Note: This also applies to corporations who support political candidates.
Exception: Under the Election Law, if the contribution is made to a political party which is duly registered with the COMELEC and there are
proper disclosures undertaken.

iv. It must be reasonable in amount;

As to the reasonability of the expenses, it is on a case-to-case basis. There is no limit. However, the BIR provided for a limit on one type of expense,
specifically, on the Entertainment expenses (see page 4). For some types of expenses, the law provides for conditions for deductibility and not limit as to
the amount which can be deducted.

v. It must be substantiated by evidence such as official receipts and other records; and
a. Official receipts
b. Adequate Records
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c. Amount of Expense being deducted
d. Date and place where such expense is paid or incurred
e. Nature of expense - direct connection or relation of the expense being deducted to the development, management, operation
and/ or conduct of the trade, business or profession of the taxpayer

Refer to the discussion on the Substantiation Rule, for a more detailed discussion (see page 5).

vi. It must not be against law, morals, public policy or public order

Examples: bribes, kickbacks, facilitation fees, etc.

b) Kinds of Ordinary & Necessary Expenses (CARTERS)

Compensation for services rendered
Advertising & promotional expenses
Rent expenses
Travelling expenses
Entertainment Expenses
Repairs & maintenance expenses
Supplies and materials

i. Compensation for services rendered

Special Requisites for Deductibility of these Expenses:
1. This must be reasonable, meaning, this must not be ostensible; and
2. These are, in fact payments for personal services actually rendered.

Special Requisites for Deductibility of Bonuses to Employees:
1. The bonuses are made in good faith;
2. They are given for personal services actually rendered; and
3. They do not exceed a reasonable compensation for the services rendered, when added to the stipulated salaries, measured by the
amount and quality of services performed in relation to the taxpayers business;
4. Bonuses must be given in good faith and in determining whether the bonuses will form part of the compensation for service
rendered, you have to consider the (1) nature of the business, (2) the financial capacity of the taxpayer and (3) the extent of the
services rendered;
5. General Economic Condition

Deductible expenses under compensation for personal services
1. Salaries, wages, commissions, professional fees, vacation leave pay, retirement pay and other compensation;
2. Bonuses are deductible expenses if paid in good faith as additional compensation for services rendered;
3. Pensions and compensation for injuries, if not compensated for by insurance or otherwise;
4. Grossed up monetary value (GMV) of fringe benefit provided for, as long as the final tax imposed has been paid.

ii. Advertising and promotional expenses

It must be reasonable.

Classifications:
1. Advertising to stimulate the current sale of merchandise or use of services;
Deductible in full during the taxable year when you incurred the expense
Example: 3-day sale
2. Advertising to stimulate future sales of merchandise or use of services;
Not deductible in full; should be capitalized
Example: television advertisements stimulate current and future sales
(General Foods Inc. vs. CIR)
3. Advertising to promote the sale of shares of stocks or create favorable image.
Not deductible; can be capitalized
Advertising to promote sale of shares of stocks does not relate to the trade or business
Advertising to create favorable image can be related to item no. 2 (i.e., advertising to stimulate future sales)

iii. Rent expenses

Take note that for you to be able to deduct the rent expense, you should have withheld 5% of the rental payment.

Requisites:
1. The rental payment is required as a condition for continued use or possession;
Meaning to say, this pertains to operating lease and not finance lease.
2. The purpose is for trade, business or profession;
3. The taxpayer must not be the owner of the property or he has no equitable title over the property. The taxpayer must not be
taking title to the property;
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4. This is subject to withholding tax.

iv. Travelling expenses

Special Requisites for Deductibility of Travelling Expenses:
1. The expenses must be reasonable and necessary;
2. They must be incurred or paid while away from home; and Home does not refer to your residence but to the station assignment
or post/principal place of business regardless of where the family residence is maintained i.e. business trips. This includes
transportation, meals and lodging; (RR 2-40)
Meaning to say, home pertains to the main office or the branch of your establishment. Thus, what is deductible is the travelling expense
incurred from the main office to and a branch and vice versa or from a branch to another branch and vice versa. It does not include
transportation expenses from the employees residence to the office and vice versa.
Travelling expenses include transportation, meals and lodging expenses incurred during business trips.
Note that there is no limit as to the amount of travelling expenses which can be deducted.
3. They must be paid or incurred in the conduct of trade or business.

v. Entertainment, Amusement and Recreation (EAR) expenses

Special Requisites for Deductibility of EAR Expenses:
1. Reasonable in amount;
2. Incurred during the taxable period;
3. Directly connected to the development, management and operation of trade, business or profession of the taxpayer, or that is
directly related to or in furtherance of the conduct of his or its trade, business or profession;
This presupposes that the expenses were incurred to entertain your guests and such guests should have to do with the development,
management and operation of the business.
4. Not to exceed such ceiling as the Secretary of Finance may, by rules and regulations, prescribe (Refer to RR 10- 2002); and

Limitation:
- Those engaged in sale of goods/properties: 0.5% or of 1% (0.005) of the net sales
- Those engaged in sale of service: 1% (0.01) of the net revenue
- Mixed-Apportionment Formula:
Apply only if it did not specifically provide how much of the EAR expenses pertains to net sales (sale of goods/properties) or net revenue
(sale of services) or if the taxpayer is a mixed earner

Examples:
(1) XYZ Corporation earned net sales of 200,000 and net revenue of 300,000. The total EAR expenses incurred amounted to 20,000. Can it claim
the entire amount of 20,000 as its deduction?

Total Earnings Apportionment of EAR Limitation
Net Sales 200,000 2/5 or 40% 20,000 x 40% = 8,000 vs. 200,000 x 0.005 = 1,000
Net Revenue 300,000 3/5 or 60% 20,000 x 60% = 12,000 vs. 300,000 x 0.01 = 3,000
Total 500,000 20,000 4,000

Of the 8K EAR expense pertaining to net sales, you can only deduct 1K; on the other hand, of the 12K EAR expense pertaining to the net revenue,
you can only deduct 3K.

(2) XYZ Corporation earned net sales of 200,000 and net revenue of 300,000. The total EAR expenses incurred amounted to 4,000. How much
can be claimed as deduction for EAR expenses?

Total Earnings Apportionment of EAR Limitation
Net Sales 200,000 2/5 or 40% 4,000 x 40% = 1,600 vs. 200,000 x 0.005 = 1,000
Net Revenue 300,000 3/5 or 60% 4,000 x 60% = 2,400 vs. 300,000 x 0.01 = 3,000
Total 500,000 4,000 4,000

Only 2,400 and 1,000 will be allowed as deduction for the sale of services and sale of goods, respectively.

5. Any expense incurred for entertainment, amusement, or recreation which is contrary to law, morals, public policy, or public order
shall in no case be allowed as deduction.

If, for example, you take your guests the company-owned yacht or condominium, how will you claim for the expenditure of the yacht and condominium?
You can claim it as depreciation forming part of your EAR expenses (meaning to say, EAR expenses may include depreciation expense of the facilities
used in entertaining your guests); however, this is not a wise decision since you will now be subjected to the limit of 0.05% or 1%. It would be better to
declare the yacht and condominium as property used in the ordinary trade or business and recognized depreciation for the properties since there is no
limit imposed on the depreciation expense.

v. Repairs and maintenance expenses

Expenses for repairs are deductible if such repairs are incidental or ordinary, that is, made to keep the property used in the trade or
business of the taxpayer in an ordinarily efficient operating condition. Repairs in the nature of replacement to the extent that they
TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 5
arrest deterioration and prolong the life of the property are capital expenditures and should be debited against the corresponding
allowance for depreciation.

Note: If the cost of the repair increases the life of an asset for a period of more than one year, that amount is considered extra ordinary
repair. Otherwise, it is considered ordinary repair.

For repairs and maintenance expenses, you need to differentiate if it is an ordinary repair or extra-ordinary repair. It becomes an extra-ordinary repair
if it increases the life of the property for a period of more than one (1) year or if it increases the value of the property. If it is an extra-ordinary repair,
the amount of the repair is not deductible in full because you need to capitalize it (i.e., the cost of the repair will be added to the cost of the asset) and
recognize depreciation expense yearly. However, if it is an ordinary repair, then it is deductible in full.

vi. Supplies and materials

This must be actually consumed during the taxable year.

If the supplies and materials are not fully consumed during the taxable year, then you recognize it as an asset.

Litigation Expenses

Litigation expenses defrayed by a taxpayer to collect apartment rentals and to eject delinquent tenants are ordinary and necessary
expenses in pursuing his business. However, litigation expenses that are incurred in the defense or protection of title are capital in
nature and not deductible.

This is deductible provided it pertains to a litigation that has something to do with your business or profession. However, if you incurred the litigation
expense in defending your title to a particular parcel of land, the expense will not be fully deductible but should be considered as part of the cost of the
land.

For costs incurred in defending your business in a civil suit (e.g., patent infringement, labor cases, etc.), you can deduct the litigation expenses, generally,
only when there is final adjudication of and payment pertaining to the case regardless of the result.

Option to Private Educational Institution

This also includes non-stock, non-profit educational institutions.

In addition to the allowable deductions, a private educational institution - may at is option, elect either:
1. Deduct expenditures otherwise considered as capital outlay of depreciable assets incurred during the taxable year for the expansion
of school facilities (Outright Method); or
2. To deduct allowance for depreciation thereof (Spread- out Method).

c) Substantiation Rule vis--vis Cohan Rule Principle

Substantiation Rule

There must be evidence (e.g., official receipts and other official records) for the BIR to allow deduction of an expense.
The BIR requires that for your receipt to be considered official receipt, you should first get an Authority to Print Receipt (ATP). The BIR also requires, aside
from the name of the establishment and the TIN, the name of the publisher/printer and the TIN of the printer/publisher to be indicated in the receipt. Otherwise,
it will only be treated as an acknowledgment receipt which holds no water against the BIR.

Under the Tax Code, books of accounts are required to be maintained for a period of three (3) years. However, under Revenue Regulation No. 17-2013, books
of accounts are now required to be maintained for a period of ten (10) years for post-audit purposes.

The substantiation must come from a third, independent party. Thus, the signature that you present in the receipt should not be your own signature. In case
there is no official receipt (i.e., when you avail the services of homeworkers), you can present the contract or acknowledgment receipt so long as you can
prove that your supplier cannot provide an official receipt (exception to the general rule).

Cohan Rule

This is treated as an exception to the Substantiation Rule. This was derived from the case of Cohan vs. Commissioner. It provides that if you are certain that
an expense is actually incurred but you cannot ascertain the actual amount of the expense because there are not enough documents to substantiate it, the BIR
is given the duty to determine how much will be allowed as deduction. In actual practice, there is an unwritten rule of allowing only 50% of the expenditure
as deduction and disallowing the rest.

2. Interests

Take note that an interest expense is only deductible if it pertains to forbearance of money or loan; otherwise, you cannot deduct it as interest expense.

The amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayers profession, trade or business
shall be allowed as deduction from gross income.


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a) Arbitrage Rule

The taxpayers allowable deduction for interest expense shall be reduced by an amount equal to 33% (effective January 1, 2009) of the
interest income earned by him which has been subject to final tax.

The purpose of this rule is to prevent a back-to-back loan wherein a person acquires a loan in one bank and deposits the proceeds in another bank to
avail of the advantage of the tax. If you acquire a loan in the bank, the interest expense incurred can be allowed as a deduction from your income. This
means that you gain a tax shield of 30%. If you deposit it to the bank, the interest income will be subject to 20% only. Technically, there is savings of
10%. To avoid this scenario, the Tax Code required that it should be subjected to the Arbitrage Rule.

The Arbitrage Rule will only apply when there is interest expense AND interest income subject to final tax.

Example: X Corp. borrowed from A Bank 500,000 @ 10%. Thereafter, X Corp. deposited 500,000 to B Bank @ 10% interest. Consider the following:

Assuming there is no Arbitrage Rule - If there is no deduction for interest expense -
Sales 500,000 Sales 500,000
Cost of Sales 200,000 Cost of Sales 200,000
Gross Income 300,000 Gross Income 300,000
Interest Expense (500,000 x 10%) 50,000 Multiply by Tax Rate 30%
Taxable Income 250,000 Tax Due 90,000
Multiply by Tax Rate 30%
Tax Due 75,000

If there is no Arbitrage Rule, the tax due will be lowered from 90,000 to 75,000. Thus, if the entire amount of interest expense will be allowed to be
deducted, the taxpayer will be benefitted by a tax shield of 15,000 representing the difference in the tax due (90,000 75,000) or 30% of the interest
expense (50,000 x 30%).

For the interest income (passive income) earned from B Bank, the taxpayer will be required to pay passive income tax amounting to only 10,000 which
is 20% of the total interest income of 50,000 (500,000 x 10%). If there is no Arbitrage Rule, you gained savings of 15,000 but you are required to pay
only 10,000. Thus, there is a difference of 5,000. To address this scenario, the Tax Code requires that the allowable deduction for the interest expense
be reduced by an amount equal to 33% of the interest income earned.

Take note that the 33% is the difference between the 30% (tax shield) and the 20% (passive income rate) divided by 30%.

Applying the Arbitrage Rule
Sales 500,000 Amount of loan 500,000 Interest Expense 50,000
Cost of Sales 200,000 Interest Rate 10% Less: 16,500
Gross Income 300,000 Interest Income 50,000 Allowed Deduction 33,500
Interest Expense 33,500 Multiply by 33%
Taxable Income 266,500 16,500
Multiply by Tax Rate 30%
Tax Due 79,950

Take note that the 33% will be multiplied to the interest income and not to the interest expense. After multiplying the 33% to the interest income, the
amount computed will be deducted from the interest expense to get the allowable deduction under the Arbitrage Rule.

If there is no interest income, you can deduct the full amount of the interest expense incurred for the loan.

Question: Can the interest expense be considered as capital expense? Yes. The taxpayer has a choice to deduct it immediately or to capitalize the interest
expense especially if the interest expense is not subject to Arbitrage Rule (i.e., you do not have interest income); however, you have to take into
consideration the purpose or the use or the reason why you incurred the interest expense. If the interest expense pertains to a loan, the proceeds of
which is used for the day-to-day operation of the business, the interest expense should be deducted in full during the taxable year. If the proceeds of the
loan is used to construct a building, you can treat the interest expense as a capital expense; thus, there will be no deduction for interest expense but you
will add the interest expense to the cost of the building and recognize depreciation expense every year.

Examples:
Corporation A spent 400,000 interest expense. It earns no interest income.
The amount of interest expense can be deducted in full; it is not subject to Arbitrage Rule.
Corporation B incurs interest expense of 100,000 and earns 50,000 interest income from loans to its employees which is not subject to final tax.
The amount of interest expense can be deducted in full since the interest income earned is not subject to final tax; thus, it is not subject to
Arbitrage Rule.

b) Requisites for Deductibility

(1) There must be an indebtedness;
The interest should pertain to a debt or forbearance of money.
(2) There should be an interest expense paid or incurred upon such indebtedness;
(3) The indebtedness must be that of the taxpayer;
(4) The indebtedness must be connected with the taxpayers trade, business or exercise of profession;
(5) The interest expense must have been paid or incurred during the taxable year;
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(6) The interest must have been stipulated in writing;
For theoretical expense, there is no actual interest expense; thus, it is not deductible.
(7) The interest must be legally due;
(8) The interest arrangement must not be between related taxpayers;
(9) The interest must not be incurred to finance petroleum operations; and
(10) In case of interest incurred to acquire property used in trade, business or exercise of profession, the same, was not treated as a
capital expenditure.

c) 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 deduction or treated a capital expenditure.

For the Optional Treatment of Interest Expense to apply, you must take into consideration why you incurred that interest expense and also if there is no
interest income related to it.

d) Delinquency Interest, Surcharges and Fines on Tax Payment - Not Deductible

Note: Interest on deficiency taxes may be allowed as deduction.

Take note that only the surcharges and fines are not deductible; the delinquency interest is deductible since it is already considered as a debt on the part
of the taxpayer to the government.

Delinquency pertains to late filing and late payment
Deficiency not delinquent but there is insufficient declaration of the tax due

Note that there can be delinquency and at the same time deficiency. Insofar as interest on delinquency and interest on deficiency, these are deductible
because the taxpayer is considered as indebted to the government.

e) Theoretical Interest

An interest which is computed or calculated not paid or incurred for the purposes of determining the opportunity cost of investing in a
business. This does not arise from legally demandable interest- bearing obligation. This is not a deductible interest.

f) Interest Expenses which are Non-Deductible

When you say interest expense, it pertains to a loan, which is considered as a fixed expense since you are required to pay the interest whether or not
you earn income. Since it is a fixed obligation, the interest expense is deductible.

1. Interest expense on preferred stock.
As a rule, interest on preferred stock is not deductible because there is no obligation to speak. It is in effect an interest on dividend.
Reason: the payment is dependent upon the profits of the corporation. It will only be paid if the corporation earns profits. BUT if
is not dependent upon corporate profits of earnings, it is deductible. If it is payable on a particular date of maturity without regard
to the corporate profits, it is deductible.
There is no fixed obligation on the part of the corporation; thus, it is not deductible.

2. When there is no agreement in writing to pay interest.
3. Interest expense on loan entered into between related taxpayers.

Related taxpayers (Section 36[B], NIRC)
a. members of the same family which includes:
Spouses
Brothers and sisters
Descendants and ascendants
b. Between 2 corporations owned or controlled by one individual. He must have a controlling interest over these 2 corporations,
OR if one corporation is considered as personal holding company of another corp.
c. Between a corp. and an individual; that individual owns or controls more than 50% of the outstanding capital stock of such
corporation
d. Parties to a trust:
Grant of fiduciary
Fiduciary of one trust and fiduciary of another trust but there is only one grantor
Beneficiary and fiduciary

4. Interest paid or calculated for cost- keeping purposes.
5. Interest paid in advance through discount or otherwise by an individual taxpayer reporting income on the cash basis. Such interest
shall be allowed as a deduction in the year the indebtedness is paid.
6. Interest on obligation to finance petroleum exploration.
This is exempted because of a special law. The requirement is that there must be an existing service contract agreement with the
government and an appropriate franchise from the government is given to the individual or corporation doing the petroleum exploration.
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7. Interest on unclaimed salaries of employees.
8. 33% of the interest income subjected to final tax.

3. Taxes

General Rule: All taxes, national or local paid or incurred within the taxable year in connection with the taxpayers trade, business or
profession are deductible from gross income. (Recap on Tax Benefit Rule)

Exception:
i. Special Assessment and taxes assessed against local benefits of a kind that tends to increase the value of the property.
A special assessment is not deductible because it is not a tax; it is imposed by the LGU when there are improvements in your land. This is different
from a real property tax because the former is collectible when there is improvement in the land; while, the real property tax is collectible so long
as there is real property. All real properties are subject to real property tax but not all real properties are subject to special assessment. Real
property tax can be deducted as tax expenditure; while, special assessment cannot be deducted as tax expenditure.
ii. Income Tax - includes foreign income tax
It includes foreign income tax if it has already been claimed as tax credit.
For foreign income tax, you can deduct it so long as the taxpayer has not yet availed of tax credit.
Only the taxpayers who are taxable for income within and without are allowed to claim for tax credit:
Resident Citizens
Domestic Corporations
Members of General Professional Partnerships
Beneficiaries of Estates and Trusts
Tax Deduction and Tax Credit are mutually exclusive; thus, if you claim for a tax credit, you can no longer claim it as tax deduction and vice versa.
iii. Taxes which are not connected with the trade, business or profession of the taxpayer.
iv. Estate Tax, Donors Tax
Reason: it has nothing to do with your business profession
v. Value-Added Tax
Reason: it is indirect tax; thus, it is the consumers or buyers who will bear the burden of the tax
vi. Final Taxes, being in the nature of income tax
Example: Capital Gains Tax
vii. Excess electric consumption tax
viii. Foreign income tax war profits and excess profits tax, if the taxpayer makes use of tax credit
ix. Taxes paid for commodities not connected with the taxpayers business

a) Requisites for Deductibility of Taxes
1. This must be paid or incurred during the taxable year; and
2. This must be taxes paid or incurred in connection with the trade, business or profession of the taxpayer.

b) Tax Deductions vs. Tax Credits

Taxes, as deductions, include those taxes which are paid or incurred in connection with the trade, business or profession of the taxpayer.
However, the source of a tax credit is foreign income tax paid, war profit tax, excess profit tax paid to the foreign country.

Taxes as deductions may be claimed as deductions from gross income in computing the net income WHILE tax credit is a deduction from
Philippine income tax.

The foreign income tax paid to the foreign country is not always the amount that may be claimed as a tax credit because under the
limitation provided in the Tax Code, it must not be more than the ration of foreign income to the total income multiplied by the
Philippine income tax.

Question: Which is more advantageous on the part of the taxpayer, the tax credit or the tax deduction? The tax credit is more beneficial because you
can deduct the entire amount of the tax credit. For the tax deduction, you only have a benefit or tax shield of 30%. However, there are additional
requirements by the BIR. The most common is the Tax Credit Certificate (TCC). If you do not have a TCC, you cannot claim it as a tax credit; thus, you
have no choice but to claim it as a deduction. But if you claim it as deduction (we are talking here of itemized), there must be evidence that it was paid
abroad (e.g., tax return stamped as received and paid by the taxing authority abroad).

Question: What if there is a tax treaty? If there is a tax treaty, it would now depend on the provisions or agreement in the tax treaty.

c) Who may claim tax credits for taxes of foreign countries
1. Citizens
2. Domestic corp.
3. Members of GPPS
4. Beneficiaries of estates and trusts

Limitations on deduction for NRA- ETB and RFC:
In the case of NRA- ETB in the Philippines and RFC, deductions for taxes shall be allowed only if and to the extent that they are
connected with income from sources within the Philippines.

TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 9
d) Limitations on credit

The amount of the credit taken shall be subject to the following limitations:

1. Per Country Limitation - 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 taxpayers taxable income from sources within such country
bears to his entire taxable income for the same taxable year; and

This will be applied if there are two or more foreign countries involved.
Formula: (Net Income per Country / Net Income of ALL countries) x Philippine Income Tax

2. Global Limitation - the total amount of the credit shall not exceed the same proportion of the tax against which such credit is
taken, which the taxpayers taxable income from source without the Philippines taxable under this Title bears to his entire taxable
income for the same taxable year.

This will be applied when there is only one foreign country involved.
Formula: (Net Income of ALL foreign countries / Net Income of ALL countries) x Philippine Income Tax

Examples:
1. ABC Corporation, a Non-Resident Foreign Corporation:

Philippines US Total

Gross Income 1,000,000 1,000,000 2,000,000
Expenses 500,000 500,000 1,000,000
Taxes Paid ? 160,000

The corporation cannot deduct the amount of taxes paid in the US because it is a non-resident foreign corporation. It is taxable for income earned
within and, naturally, it can only deduct expenses incurred within. It cannot also claim it as tax credit (refer to the enumeration in the previous
page).

2. Assuming ABC Corporation is a Domestic Corporation (consider the same data in no. 1):

If claimed as deduction: If claimed as tax credit:

Gross Income 2,000,000 Gross Income 2,000,000
Less: Expenses 1,000,000 Less: Expenses 1,000,000
Net Income 1,000,000 Taxable Income 1,000,000
Less: Deduction 160,000 Multiply by 30%
Taxable Income 840,000 300,000
Multiply by 30% Less: Tax Credit * 150,000
Tax Due 252,000 Tax Due 150,000

Apply the Global Limitation (Limit #2) since there is only one foreign country involved
* Global Limitation = (Net Income of ALL foreign countries / Net Income of ALL countries) x Philippine Income Tax
= (500,000 / 1,000,000) x 300,000
= 0.50 x 300,000
= 150,000

Compare the amount of global limitation with the actual amount of foreign tax paid. Whichever is lower between the global limitation and the
actual amount of foreign tax paid will be allowed as tax credit. Since the amount of limitation (150,000) is lower than the actual tax paid in US
(160,000), the corporation can claim for tax credit of up to 150,000.

3. XYZ Corporation, a Domestic Corporation:

Philippines US China Total

Gross Income 1,000,000 500,000 500,000 2,000,000
Expenses 500,000 300,000 200,000 1,000,000
Net Income 500,000 200,000 300,000 1,000,000
Taxes Paid ? 50,000 100,000

Apply the Per Country Limitation and the Global Limitation since there are two foreign countries involved; then, compare the amounts computed
for both Per Country and Global Limitation with the actual amount of foreign tax paid. Whichever is the lower amount among the three will be
considered as the allowable tax credit.

** Philippine Income Tax Due = Net Income of All countries x 30%
= 1,000,000 x 30%
= 300,000


TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 10
Limit 1: Per Country Limitation Limit 2: Global Limitation

US China
NI per country 200,000 300,000 NI of all foreign countries 500,000
Divided by NI of all countries 1,000,000 1,000,000 Divided by NI of all countries 1,000,000
0.20 0.30 0.50
Multiply by Phil. Income Tax ** 300,000 300,000 Multiply by Phil. Income Tax ** 300,000
Per Country Limitation 60,000 90,000 Global Limitation 150,000

Actual Foreign Tax Paid 50,000 100,000 Actual Foreign Tax Paid 150,000

Allowable Tax Credit 50,000 90,000

Based on the Per Country Limitation, only 140,000 (50,000 + 90,000) can be allowed as tax credit. Since this is lower than the actual amount of
foreign tax paid of 150,000 and the Global Limitation of 150,000, then only 140,000 can be claimed as tax credit. Thus, the tax due will be 160,000
computed by deducting the tax credit of 140,000 from 300,000 **.

Take note: If limitation 2 (global limitation) is lower, then you consider the amount of global limitation as the allowable tax credit. That is the
essence of referring it as limitation 1 and limitation 2; you consider first the Per Country Limitation and then the Global Limitation and not the
other way around.

e) Proof of credits (Tax Credits)

The credits shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following:
1. The total amount of income from sources without the Philippines;
2. The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit; and
3. All other information necessary for the verification and computation of such credits.

f) Tax subsequently refunded or credited

Taxes preciously allowed as deductions, 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.

Take note that for tax subsequently refunded or credited, we still follow the Tax Benefit Rule. Meaning to say, if you recognized it as a deduction in the previous
year and subsequently recovered it the following year, then it shall be considered as income in the following year because the taxpayer has been benefitted.

4. Losses

a) Classification of Losses

What is deductible as part of your itemized deductions is the ordinary loss.

i. Ordinary Losses - losses sustained in the course of trade, business or profession of the taxpayer.

If the loss was incurred because of a capital transaction, then you consider it as a capital loss. A capital transaction is one which involves a capital asset.

Net Operating Loss - the excess of allowable deduction over gross income the business in a taxable year.

Net Operating Loss Carry Over (NOLCO) - shall be carried over as a deduction from the gross income for the next 3 consecutive taxable
years immediately following the year of loss. Such loss shall be allowed as a deduction from gross income. However, any net loss incurred
in a taxable during which the taxpayer was exempt from income tax shall not be allowed as a deduction. NOLCO shall be allowed only
if there has been no substantial change in the ownership of the business or enterprise. There is no substantial change when:
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.

This means that there is no change in ownership if 75% or more is held still by the same individual or by the same person; thus, you can still carry
over the net operating loss. Stated otherwise, there is substantial change if the change in ownership of the same person is already more than 25%.

GR: Itemized deductions must be incurred during the taxable year
EXC: Net Operating Loss Carry Over (NOLCO) if in the current year you incur operating loss, you can deduct the loss the following year provided
that in the following year, you earn income
Requisites to avail of NOLCO:
The taxpayer is earning income or is not incurring a loss during the following taxable year
The taxpayer is not liable to pay Minimum Corporate Income Tax (MCIT)
MCIT applies only to corporate taxpayers
For corporate taxpayers, you have the Normal Income Tax (NIT) with a rate of 30% multiplied to the taxable income.
TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 11
For the MCIT, the rate applicable is 2% which is multiplied to the gross income. Meaning to say, even if you incur a loss or you
have a zero taxable income, if you are held liable to pay the MCIT, you still need to pay an amount equal to 2% of the gross
income.
The taxpayer does not enjoy an exemption (e.g., tax holiday)
The taxpayer is not availing the 40% Optional Standard Deduction (OSD)
Reason: NOLCO is included as one of the itemized deductions
There is no substantial change in the ownership of the business
There can be change in ownership if two corporations enter into a merger or consolidation.
Difference between merger and consolidation: In consolidation, two corporations combine and a new entity is formed; while, in
merger, two corporations combine and one entity survives. However, insofar as NOLCO is concerned, it only applies to merger.

Examples:
1. ABC Corporation incurred the following:

2012 2013 2014 2015 2016

Gross Income 500,000 1,000,000 800,000 500,000 300,000
Less: Expenses 600,000 1,200,000 650,000 700,000 400,000
Income/(Loss) (100,000) (200,000) 150,000 (200,000) (100,000)

For the year 2014, you can deduct NOLCO from 2012 amounting to 100,000 and NOLCO from 2013 amounting only to 50,000. Thus, for the year
2014, you will zero taxable income due to the NOLCO deducted from your current income.

The loss incurred in 2012 can only be deducted for three consecutive taxable years or up to year 2015; while, the loss incurred in 2013 can only
be deducted up to year 2016.

With regards to NOLCO, you apply the first-in-first-out rule. Meaning to say, the first operating loss that you incur will be the first operating
loss that you will also deduct from your current income.

2. A Corporation is owned by M (80%), C (5%), D (5%), E (5%), and F (5%). From 2010 to 2015, it incurred a loss. On the other hand, B Corporation
is owned by M (80%), N (5%), O (5%), P (5%), and Q (5%). From 2010 to 2015, it incurred a profit. A Corporation and B Corporation subsequently
entered into a merger resulting to B Corporation as the surviving entity. Is there a substantial change in ownership?
There is no substantial change in ownership because M still owns 80% of the surviving corporation or entity. Thus, the NOLCO can still be
availed of by the surviving entity or corporation.
If, however, M owns only 10% in A Corporation, the share of M will be diluted resulting to a share which is lesser than 75%; thus, there is a
substantial change in ownership. In this case, NOLCO can no longer be availed of by B Corporation.
If M owns 75% in both A Corporation and B Corporation, there is no substantial change in ownership. Thus, B Corporation can avail of
NOLCO.

ii. Capital Losses governed by rules on loss from the sale or exchange of capital assets. Losses from sales or exchanges of capital assets
shall be allowed only to the extent of gains from such sales or exchanges.

Take note that capital losses are incurred in capital transactions. A capital transaction is one which involves capital assets.

Net Capital Loss excess of capital loss over capital gains

This is determined by comparing the capital gains against the capital loss. If the capital loss is greater than the capital gains, the excess or the difference
will be considered as Net Capital Loss (NCL). If you carry over the Net Capital Loss, this will be referred to as the Net Capital Loss Carry Over
(NCLCO).

Net Capital Loss Carry over (NCLCO) not available to corporate taxpayers.

NOLCO NCLCO
can be deducted for the next 3 consecutive
taxable years
can be deducted only in the following taxable
year
can be availed of either an individual taxpayer
earning business/professional income or a
corporate taxpayer
can be availed of only by individual taxpayers
earning business/professional income and is not
available to corporate taxpayers

Recap on the types of capital assets: (1) Real property; (2) Sale of shares of stock not listed or listed but not traded in the local stock exchange; and (3)
Other capital assets.

Of the three types of capital assets, you can incur capital loss only when the transaction involves a sale of shares of stocks not listed or listed but not
traded in the local stock exchange or when it involves other capital assets. In those types of transactions, you consider the selling price and the cost in
determining the capital gains tax; thus, there is a possibility of incurring a loss.

You cannot incur capital losses when dealing with real property or in the sale of land. In computing the capital gains for the sale of real property, you
consider the selling price or the fair market value, whichever is higher. Meaning to say, for taxation purposes, you do not recognize the acquisition cost
of the land. This is because land or real property are expected to appreciate in value; thus, there is no possibility of incurring a loss when dealing with
the sale of real property or land.
TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 12

Capital Losses include the following:
a. Loss arising from failure to exercise privilege to sell or buy property
This pertains to an option contract. If you do not avail of the option, you cannot recover the option money; thus, the unrecovered option
money will be considered as a capital loss.
b. Securities becoming worthless
This relates to the decrease in the fair market value of the securities rendering the securities worthless.
You can consider the decrease in the fair market value as ordinary loss only when you are considered a dealer in securities.
c. Abandonment losses in the case of natural resources
Relates to mining business in its exploratory stage
d. Loss from wash sale or stock securities
GR: it is considered as a capital loss
EXC: it becomes an ordinary loss if you are a dealer in stock securities

Wash Sale occurs where it appears that within a good period beginning 30 days before the date of the sale or disposition of shares
or stock or securities and ending 30 days after such date, the taxpayer has acquired (by purchase of exchange) or has entered into
a contract or option to acquire, substantially identical stock or securities. No deduction for loss shall be allowed for wash sales
unless the claim is made by a dealer in stock or securities and with respect to a transaction made in the ordinary course of the
business or such dealer.

It is considered as wash sale if 30 days before or after the date of sale, you also purchased or sold the same shares of stocks or the same securities.
If you incur loss in a wash sale transaction, you cannot carry it over or you cannot deduct it because the wash sale transaction is considered a
simulated sale, meaning to say, there is no actual sale that occurred. It is treated as a way to maneuver the price of the shares of stocks. This is
because if the shares of stocks are being actively traded in the market, it will attract more investors because it will be assumed that the shares of
stocks are being sought after. Only the dealers in securities can deduct losses incurred in wash sale transactions.

iii. Wagering or Gambling Losses the amount that is deductible must not exceed the gains.

GR: cannot be deducted; the least you can do is to offset it with the gambling gains but the loss must not be higher than the gain

iv. Casualty Losses include losses from fire, storm, shipwreck, other casualty losses, robbery, embezzlement and theft.

Requirement for it to be recognized as a loss: you must have reported it with the BIR authorities within 45 days that you have incurred casualty losses
pertaining to fortuitous events or force majeure. Also, the loss must have been incurred during the taxable year and it is evidenced by closed and
completed transactions (i.e., when there is perfection of the contract, say for example, contract of sale). In relation to insurance, it must have not been
compensated by the insurer; otherwise, you cannot claim it as a casualty loss. If it is partly compensated, the amount which was not compensated can
be claimed as a deduction.

Question: What if the loss happened in December and the insurance company was not able to immediately determine the actual value of the loss? In
your sworn declaration, indicate the amount of damage and the amount of insurance. So long as the amount indicated in the sworn statement is reasonably
accurate; then, that is allowed.

v. Abandonment Losses in the event a contract area where petroleum are undertaken is partially or wholly abandoned, all accumulated
exploration and development expenditures pertaining thereto shall be allowed as a deduction.

vi. Special Losses e.g. loss arising from voluntary removal of buildings as an incident to renewal or replacement

b) Common Requisites for Deductibility of Losses
1. The loss must be incurred in the trade, business or profession of the taxpayer;
2. Losses must be actually sustained and charged off within the taxable year, and not mere anticipated losses;
3. Must be evidenced by a closed and completed transaction;
4 Must not be compensated by insurance or other forms of indemnity;
5. If it is partly compensated, only the amount not compensated by insurance is deductible
6. If it is casualty loss, the taxpayer has filed a sworn declaration of loss within 45 days after the date of discovery of the casualty or
robbery, theft or embezzlement.

5. Bad Debts

Take note that bad debts is different from doubtful accounts.

These are debts due to the taxpayer which are usually ascertained to be worthless and charged off within the taxable year.

a) Requisite for Deductibility of Bad Debts
i. Must be valid and subsisting indebtedness;
ii. Must be ascertained to be worthless:
iii. Must be charged off and uncollectible within the taxable year;
iv. Must be uncollectible in the near future; and
v. Must arise from trade, business or profession of the taxpayer.


TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 13
b) Steps to Prove the Worthlessness
i. There must be a statement of account sent to the debtor;
ii. A collection letter;
iii. If he failed to pay, refer the case to a lawyer;
iv. If lawyer may send a demand letter to the debtor; and
v. If the debtor still fails to pay the same, file an action in court for collection.

Take note that although insolvency (i.e., when the liabilities exceed the assets) of the debtor is a proper ground for you to recognize bad debts, the
declaration of insolvency should not be made by the debtor himself but should be made in an appropriate judicial proceeding.

Question: What if you could no longer locate the debtor? That could be a ground to recognize bad debts but at the very least, you should have already
commenced court action.

Question: What if the debtor already died? You should not recognize it as bad debts since you can still collect it against the estate of the debtor or from
the heirs, if the estate has been distributed; however, it will only be limited to the share of the heir of the estate.

c) Bad Debts Charged Off Subsequently Collected
If the recovery of bad debts, resulted in a tax benefit to the taxpayer, that is taxable.
If it did not result in any tax benefit to the taxpayer, that is not taxable.

6. Charitable and Other Contributions

a) Kinds of Charitable Contributions
i. Ordinary those subject to limitations as to the amount deductible from gross income (5% or 10%)
ii. Special deductible in full from gross income

b) Requisites for deductibility:
1) The contribution or gift must be actually paid.
2) It must be given to the organizations specified in the code.
3) The net income of the institution must not inure to the benefit of any private stockholder or individual.
4) It must be made within the taxable years
5) It must be evidenced by adequate records or receipts.
6) Must not exceed 10% in the case of individuals and 5% in the case of a corporation, of the taxpayers taxable income (except where
the donation is deductible in full) to be determined without the benefit of the contribution.

A. Deductible in Full (SPECIAL) B. Deductible, subject to limitation (ORDINARY)
1) Recipients is:
Government of the Philippines;
Any of its agencies or political subdivisions; or any fully-owned
government corporation

For priority activity in:
1. Science; 5. Economic Development
2. Education; 6. Human Settlement
3. Culture; 7. Youth and Sports Development
4. Health;

1) Recipient is:
Government of the Philippines;
Any of its agencies or political subdivisions

For a non-priority activity in any of the areas mentioned in A,
and exclusively for a public purpose
2) Recipient is an accredited non-government organization,
organized / operated for (purposes)
Scientific;
Education;
Cultural;
Character building/youth and sports development
Charitable;
Social welfare;
Health;
Research

And satisfying the following conditions:
1. The donation must be utilize not later than the 15
th
day of the
3
rd
month following the close of its taxable year.
2. The administrative expense must not exceed 30% of total
expenses.
3. Upon dissolution, assets must be distributed to another non-
profit domestic corporation or to the state.

2) Recipients is an accredited non-government organization,
organize/operated for (purposes)
Scientific;
Education;
Cultural;
Character building/youth and sports development
Charitable;
Social welfare;
Religious
Rehabilitation of Veterans
Social welfare institution

If the conditions in Table A is not complied with.

Subject to limitation:
a) Individual - 10% taxable income from trade business or
profession before contribution
b) Corporation 5% taxable income from trade business or
profession before contribution

TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 14
A. Deductible in Full (SPECIAL) B. Deductible, subject to limitation (ORDINARY)
3) Recipient is a foreign or international organization with an
agreement with the Philippine Government on deductibility,
or in accordance with special law.


Question: When can you say that a non-government organization is accredited? It is accredited when it has submitted the requirements and if it has the proper
accreditation from a particular department in the government. For example, if the NGO is engaged in social welfare development, the accreditation should
be given by the DSWD.

Question: What if the contribution is made to a non-government organization that is not accredited? You cannot deduct the contribution made since
accreditation is expressly required under the Tax Code.

C. Deductible in Full under Special Laws
i. Integrated Bar of the Philippines (PD 81)
ii. Developments Academy of the Philippines (PD 205)
iii. Aquaculture Department of the Southeast Asian Fisheries and Development Center[SEAFDEC] PD 292
iv. National Social Action Council (PD 294)
v. National Museum, Library and Archives (PD 373)
vi. University of the Philippines and other state colleges and universities
vii. Philippines Rural Reconstruction Movement
viii. Cultural Center of the Philippines
ix. Trustees of the Press Foundation of Asia
x. Humanitarian Science Foundation
xi. Artesian Well Fund (RA 1977)
xii. International Rice Research Institute
xiii. Department of Science and Technology (DOST) and its agencies and to public or recognize non-profit, non-stock educational
institutions (RA 3589)
xiv. Donations of prizes and awards to athletes (RA 7549)
Take note that the athletes must be playing in a sport which is duly sanctioned by the National Sports Association and the Philippine Olympic
Committee.

When you talk of donation, you should remember that there must be acceptance by the donee for there to be a valid donation. If the donation involves real
property, the acceptance by the donee should be in writing. Also, if the donation involves an amount or a value of more than 5,000, the acceptance should also
be in writing.

7. Research and Development Programs

Research and development expenditures which are paid or incurred by a taxpayer during the taxable year in connection with his trade,
business, or profession may be treated as ordinary and necessary expenses which are not chargeable to capital account. The expenditures so
treated shall be allowed as deduction during the taxable tear when paid or incurred.

a) Amortization of certain Research and Development Expenditures
The taxpayer may also elect to treat the following research and developments
Paid or incurred by the taxpayer in connection with his trade, business or profession;
Not treated as expense; and
Chargeable to capital account but not chargeable to property of character which is subject to depreciation or depletion

b) Non-deductible Research and Development Expenditures
Amount spent for the acquisition or improvements of land or for the improvement or development of natural resources.
Reason: the amount spent usually forms part of the cost of the land that you will record as an asset
Amount paid or incurred for the purpose of ascertaining the existence, location, extent or quality of any natural resources like
deposits of ore or other minerals including oil or gas.
Reason: considered as capital loss, specifically as abandonment loss

Take note that for research and development expenses, you have two choices: (1) you can deduct it in full or (2) you can amortize the expense. When you say
amortize, you are going to recognize the expense on a staggered basis by dividing the amount of the expense by the number of years that you will be benefitted
by the expenditure.

8. Pension Trusts Contributions

This is considered deductible if it pertains to contributions by the employer to a private pension plan of separate identity from the employer for the benefit of
the employees when the employees retire.

A deduction applicable only to the employer on account of its contribution to a private pension plan for the benefit of its employee. This
deduction is purely business in character.

Example: Corporation A establishes a private benefit plan, which is considered a separate entity. Corporation A makes annual contributions to the pension
plan for the benefit its employees. Note the contributions made by the employer should not be under its control; otherwise, it shall not be deductible.

TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 15
a) Contributions
i. Current year - the contribution is considered ordinary and necessary expenses full deductible.
It pertains to the current year services rendered by the employees.
ii. Past years - if it refers to the services rendered for the past 10 years, the contribution is deductible but apportioned over the next
10 years, (i.e 1/10 deductible per year).
This pertains to the contributions for the previous year that were not remitted in the previous year and only contributed in the current year.
This is also referred to as Contributions in Arrears.
A requirement for the exemption of the retirement pay is that the employee should have rendered at least ten (10) years of service.

Example: Corporation A contributed a total of 1,000,000 in the year 2014 representing current year contributions. It also remitted 1,000,000 representing
contributions for year 2013. As to the current year contributions, the amount of 1M can be deducted in full; however, for the past year contributions,
only 1/10 of 1,000,000 or 100,000 can be deducted for the year 2014. Thus, for the year 2014, the corporation can deduct a total of 1,100,000. The rest
of the contributions for the year 2013 shall be deducted in the subsequent years.

b) Requisites for Deductibility:
i. The employer must have established a pension or retirement plan to provide for the payment of reasonable pensions to his
employees;
ii. The pension plan is reasonable and actuarially sound;
iii. Contribution must be made by the employer to the pension fund;
iv. It must be funded by the employer;
v. The amount contributed must be no longer subject to the control and disposition of the employer;
vi. The payment has not yet been allowed as a deduction; and
vii. The deduction is apportioned in equal parts over a period of 10 consecutive years beginning with the year in which the transfer or
payment is made.

9. Premiums on Health and/or Hospitalization Insurance (applies to individual taxpayer) - Refer to previous outline.

10. Depreciation

Depreciation Depletion Amortization
These are recognized as capital expenses because it will benefit the taxpayer not only in the current year but for several years. You recognize
these expenses first as an asset then subsequently recognize it as an expense over the useful life of the asset (i.e., the number of years when you
can use the asset or when it can benefit you). [Note: This is in accordance with the Matching Principle.]

These are considered as non-cash expenses. Meaning to say, there is no cash outflow but you record it as an expense.
This applies to depreciable assets or those that
decrease in value due to wear and tear or those
that become obsolete but replaceable (e.g.,
machineries, cars, computers).
This is recognized in relation to wasting assets
or those assets or resources that cannot
anymore be replaced (e.g., mining).
This is applicable to intangible assets (e.g.,
purchased goodwill, royalties, and patents) or
research and development expenses.

The gradual diminution of the useful value of the property used in trade, business or profession of the taxpayer, arising from wear & tear or
natural obsolescence. The term is also applied to amortization of the value of intangible assets, the use of which in trade or business is
definitely limited in duration.

a) Requisites for deductibility of Depreciation
i. The property must be used in trade, business or profession of the taxpayer;
ii. There must be depreciable properties;

The non-depreciable properties are
Personal property not used in trade, business or profession of the taxpayer
Inventoriable stock and securities
Land
Mining and other natural resources

iii. The allowance for depreciation must be reasonable;
iv. This must be charged off during the taxable year;
v. A statement on the allowance must be attached to the return; and
vi. The method in computing the allowance for depreciation must be in accordance with the method prescribed by the secretary of
Finance upon the recommendation of the BIR Commissioner.

These prescribed methods include:
Declining balance method
Sum of the year digit method
Straight line method
Any other method as may be prescribed by the Secretary of Finance upon the recommendation of the BIR commissioner.




TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 16
Methods of Depreciation
Kind Formula
1) Straight line Cost-salvage value
estimated life
2) Declining balance Cost- depreciation x Rate
estimated life
3) Sum of the years digits (SYD) Nth period x (cost-salvage)
SYD

Note: The method of depreciation to be used will depend on the nature of the asset. If the problem is silent, the Straight-line method is used.
The salvage value or scrap value is the amount that you will receive if you sell it at the end of the useful life of the asset.

Example: The cost of the asset is 1,000,000. The salvage value is set to 100,000 and it has a useful life of ten (10) years. Compute for the
depreciation expense using the Straight-line method.

Depreciation Expense per year = (cost salvage value) / useful life
= (1,000,000 100,000) / 10
= 900,000 / 10
= 90,000

In the corporations Balance Sheet, the following amounts will be shown:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Cost 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
Less: Accumulated
Depreciation

90,000

180,000

270,000

360,000

450,000

540,000

630,000

720,000

810,000

900,000
Book Value 910,000 820,000 730,000 640,000 550,000 460,000 370,000 280,000 190,000 100,000

If the asset has no salvage or scrap value, the depreciation expense to be recognized yearly will be 100,000 (1,000,000 / 10). At the end of the 10
th
year, the
book value of the asset will be zero.

b) Agreement as to Useful Life on which Deprecation Rate is based
Where the taxpayer and the CIR have entered into an agreement in writing specifically dealing with the useful life and rate of
depreciation of the property, the rate so agreed upon shall be binding on both the taxpayer and the National Government in the absence
of facts and circumstances not taken into consideration during the adoption of such agreement. The responsibility of establishing the
existence of such facts and circumstances shall rest with the party initiating the modification.

If the taxpayer and the BIR enters into an agreement as to the useful life on which depreciation rate is based, none of the can unilaterally change the
agreement. The principle that we follow is the constitutional principle of Non-impairment of Contracts Clause. Thus, the taxpayer should seek the prior
approval of the BIR if the former wants to change the agreement.

c) Deduction for Obsolescence
If the whole or any portion of physical property is clearly shown by the taxpayer as being affected by economic conditions that will
result in its being abandoned at a future date prior to the end of its natural life, so that depreciation deduction alone would be
insufficient to return the cost at the end of its economic terms of usefulness, a reasonable deduction for obsolescence, in addition to
depreciation, may be allowed.

Obsolescence means that the property is obsolete and that you will no longer use property or you will abandon the property.

This is different from Depreciation Expense. For depreciation, the presumption there is that you will still use the property; however, if you will no longer
use it, then you should record deduction for obsolescence.

Question: Can you recognize depreciation expense and deduction for obsolescence at the same time? Yes, if the useful life of the asset is cut. For example,
a machinery has a useful life of five (5) years but on the third year it was damaged due to a typhoon and it can only be used up to the end of the third
year. On the third year, you will record depreciation expense and deduction for obsolescence to zero out the book value.

d) Depreciation of Patent or Copyright
In computing a depreciation allowance in the case of a patent or copyright, the capital sum to be replaced is the cost or other basis of
the patent or copyright. The allowance should be computed by an apportionment of the cost acquisition by the taxpayer, or since March
1, 1913 as the case may be.

11. Depletion

Depletion is the exhaustion of natural resources like mines and oil and gas well as a result of production or severance from such mines or
wells. These are non-replaceable assets.

a) Requisites for Deductibility of Depreciation
Same as that of depreciation, except that the properties involved are natural resources.

TAXATION TRANSCRIPTION - CORPORATE INCOME TAXATION (PART 2) | EH403 17
Depletion v. Depreciation
Depletion and depreciation are predicated on the same basic premise of avoiding a tax on capital. Depletion is based upon the concept
of the exhaustion of a natural resource whereas depreciation is based upon the concept production income. Thus, depletion and
depreciation are made applicable to different types of assets.

b) Determination of Amount of Depletion Cost

Essential factors:
i. The basis of property;
ii. The estimated total recoverable units in the property; and
iii. The number of units recovered during the taxable year.

There is no specified method of recognizing depletion; however, there are factors that you need to consider. Usually, it depends on the actual production
for a particular period (case-to-case basis).

Example: Estimated Total Recoverable Petroleum is 10,000 liters. The cost of the asset is 10,000,000. The following were recovered: 3,000 liters for the
first year; 5,000 liters for the second year; and 2,000 liters for the third year.

Year 1 Year 2 Year 3

Actual Units Recovered (in liters) 3,000 5,000 2,000
Divided by Estimated Total Recoverable Units (in liters) 10,000 10,000 10,000
0.30 0.50 0.20
Multiply by Cost of the Asset 10,000,000 10,000,000 10,000,000
Depletion per Year 3,000,000 5,000,000 2,000,000

c) Intangible Cost in Petroleum Operations
Any cost incurred in petroleum operations which in itself has no salvage value and which is incidental to and necessary for the drilling
of wells for the production of petroleum.
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Discussion on MCIT vs. NIT:

Minimum Corporate Income Tax (MCIT) 2% of the Gross Income
Normal Income Tax (NIT) 30% of the Taxable Income

Compare the amount for the MCIT and the NIT; whichever is the higher amount between the two will be the tax that the corporation will
remit to the BIR.

When will a corporation be subject to MCIT? As a rule, the corporation is subject to MCIT upon or on the 4
th
year from the start of the operations. For
example, if the start of the operations of the business is on 2010, on the year 2014, the corporation will be subject to either NIT or MCIT, whichever
is higher. Meaning to say, from 2010 to 2013, the corporation will be subjected to NIT (30%). However, for the year 2014 and onwards, the corporation
will be subjected to NIT or MCIT, whichever is higher.

What is the purpose of the MCIT? This is to recover the tax or to prevent a corporation from continuously reporting a loss.

What is considered as start of operations? For tax purposes, the moment you register with the BIR that will be deemed as the start of the operations.

Example: A Corporation started its operations in 1990. For the year 2014, consider the following data:

If the company earned income: If the company incurred a loss:

Gross Income 1,000,000 Gross Income 1,000,000
Less: Expenses 500,000 Less: Expenses 1,500,000
Taxable Income 500,000 Loss (500,000)
Multiply by tax rate (NIT) 30% Multiply by tax rate (NIT) 30%
Tax Due 150,000 Tax Due - 0 -

MCIT = Gross Income x 2% MCIT = Gross Income x 2%
= 1,000,000 x 2% = 1,000,000 x 2%
= 20,000 = 20,000

Since the NIT is higher than MCIT, the
corporation will be subjected to pay 150,000.
Since the company incurred a loss, the company
will be subjected to pay MCIT of 20,000.

Take note that if the corporation pays MCIT, it cannot carry over its net operating loss.

- END OF PART 2 -