By: Garry S. Pagaspas
In computing for the income tax in the Philippines, certain deductible expenses are subtracted from gross income. They are technically termed as “allowable deductions from gross income” and they could be under itemized deductions or under optional standard deductions (OSD). In either case, they share the same concept, unless stated hereunder. We share hereunder some features for your deeper understanding.
A tool to reasonably measure taxable income
In income taxation in the Philippines, a taxpayer is being subjected to income tax because it earned something – be it from business or non-business activities. In business setting, it is admitted that business expenses are necessary to earn a revenue. As such, the allowable deductions from gross income becomes a tool to equitably measure the taxpayers net income from its business undertakings. It would be unfair if the taxpayer would be taxed at gross amount without allowable deductions, if it only earned so much, otherwise, most of its net income would only go through the coffers of the taxing authority.
Relates to business expenses
Allowable deductions from gross income relates to business expenses – those expenses which are ordinary and necessary for the conduct of trade or business or profession. Expenses which are personal to the business owners or entrepreneurs and does not contribute to earning the income are not allowed deductions. Taxpayers not engaged in trade or business or practice of profession are not entitled to deduct allowable deductions – e.g., pure compensation income earners. In same manner, compensation income of individual taxpayers is not deducted allowable deductions under this context.
However, some expenses are allowed as deductible expense despite the absence of a business relation. Example, charitable contribution does not necessarily be a business related expense to be deductible. Another is the deduction for basic personal exemption and additional personal expenses for individual taxpayers to cover the personal living expenses.
Considering that the deduction relates to actual business expenses, it is required that they be supported by documents. Official reciepts and sales invoices duly registered by the Bureau of Internal Revenue (BIR) are the common suporting documents but some itemized deductible expenses require specific substantiation requirements like board resolution for bad debts expense and proof of loss in claims of casualty losses deduction.
To do away with the substantiation, a taxpayer engaged in trade or business or in practice of profession may take for optional standard deduction (OSD). Under OSD, they may deduct 40% of gross sales/receipts for individuals or 40% of gross income for corporations. No need for supporting documents under OSD in lieu of itemized deductions and the taxpayer must indicate such decision for OSD on its first quarterly income tax return (ITR).
Not contrary to law, public morals, policy, and order
Another notable feature of deductible business expenses is that it must be a legitimate and legal expenditure. This is to avoid manipulation of business expenses to lower down income taxes, or to encourage illegal activities in operating taxpayers business. Under this, facilitation fees or unofficial fees to corrupt public officials are not allowed as deductible business expenses.
Test of reasonableness
As a rule, deductible business expenses are not limited as to their respective amounts. However, they have to be reasonable in amounts as an necessary and ordinary business expense. For as long as they are related to the conduct of trade or business or practice of profession, they could be ducted in reasonable amounts and reasonableness is a factual matter.
Some expenses however, are subjected to limitations such as interest expense reduced by a certain percentage of interest income subjected to final tax, representation expense that should not exceed 1/2% of net sales of goods, or 1% of net receipts from sale of service. As we mentioned above, OSD, if opted, should not exceed 40%.
Withholding tax requirements
Under itemized deductions, if a business expense is subject to withholding tax under the rules of the BIR, it must be withheld to be deductible. No withholding, no deduction from gross income, untill payment of wittholding taxes. Common expenses subject to withholding tax are salaries and wages, professional fees, rental, and expense payments of top twenty thousand (TTC).
Under OSD, 40% is deductible even without such withholding tax. However, it will not excuse the taxpayer from payment of withholding tax. The taxpayer under OSD is still required to withhold and remmit the same to the BIR.
(Garry S. Pagaspas is a Resource Speaker with Tax and Accounting Center, Inc. He is a Certified Public Accountant and a degree holder in Bachelor of Laws engaged in active tax practice for more than seven (7) years now and a professor of taxation for more than four (4) years now. He had assisted various taxpayers in ensuring tax compliance and tax management resulting to tax savings rendering tax studies, opinions, consultancies and other related services. For comments, you may please send mail at email@example.com.)
Disclaimer: This article is for general conceptual guidance only and is not a substitute for an expert opinion. Please consult your preferred tax and/or legal consultant for the specific details applicable to your circumstances.
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