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Posts Tagged ‘allowable deductions’

31
August

Overview of Deductible Expenses in the Philippines

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.

Substantiation requirements

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 garry.pagaspas@taxacctgcenter.org.)

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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26
May

How to compute Optional Standard Deductions (OSD)?

Under the advent of Republic Act No. 8424 otherwise known as “The Tax Reform Act of 1997” (RA 8424), OSD is applicable only to individual taxpayers engaged in trade or business, or engaged in the practice of profession. It is computed at ten percent (10%) based on the gross profit after deducting the cost of sales or cost of service like the illustration below based on assumed figures:

Gross sales/receipts                                                       P220,000

Less: Sales returns, discounts & allowances             20,000

Net Sales                                                                             P200,000

Less: Cost of sales/service                                               70,000

Gross profit                                                                        P130,000

OSD rate                                                                                      10%

Allowable deduction – OSD                               P  13,000

 

Based on the amendment of Republic Act No. 8424 introduced by Republic Act No. 9337 (RA 9337), OSD is now applied at forty percent (40%) of net sales without deducting cost of sales or service for individuals, or forty percent (40%)  based on gross profit after deducting cost of sales or service for corporations. In short, the amendment made the following changes:

Individual taxpayers:

  1. Increase the applicable rate from 10% to 40%; and,
  2. Change the tax base to gross sales/receipts without deducting cost of sales;

Corporate:

  1. Included corporation in the coverage of OSD; and,
  2. Deduction of cost of sales/service in arriving the tax base.

Applying the above figures, OSD for INDIVIDUAL will now be as follows:

Gross sales/receipts                                                       P220,000

Less: Sales returns, discounts & allowances             20,000

Net Sales                                                                             P200,000

OSD rate                                                                                      40%

Allowable deduction – OSD                            P  80,000

 

On the other hand, OSD for CORPORATE taxpayer will be computed like individual taxpayer under RA 8424, except that the rate is 40% and not 10% illustrated below:

Gross sales/receipts                                                       P220,000

Less: Sales returns, discounts & allowances             20,000

Net Sales                                                                             P200,000

Less: Cost of sales/service                                               70,000

Gross profit                                                                        P130,000

OSD rate                                                                                      40%

Allowable deduction – OSD                             P 52 ,000

You may try to work on other figures to master the above OSD formulas. I likewise suggest that you consult a professional to ensure correct application of OSD on your quarterly and annual income tax returns.

 

Related post:

Tax Savings under OSD.(Post viewed 7200 times)

21
May

Tax savings under Optional Standard Deduction (OSD)

For taxpayers engaged in trade, business, or practice of profession, optional standard deduction (OSD) is a good are to look at for tax savings.  Under Section 34(L) of the Tax Code, as amended by Republic Act No. 9504 dated June 17, 2008, and hereunder quoted:

“Section 34(L) Optional Standard Deduction. – In lieu of the deductions allowed under the preceding Subsections, an individual subject to tax under Section 24, other than nonresident alien, may elect a standard deduction in an amount not exceeding forty percent (40%) of his gross sales or gross receipts, as the case maybe. In the case of a corporation subject to tax under Sections 27(A) and 28(A)(1), it may elect a standard deduction in an amount not exceeding forty percent (40%) of its gross income as defined in Section 32 of this Code. Unless the taxpayer signifies in his return his intention to elect the optional standard deduction, he shall be considered as having availed himself of the deductions allowed in the preceding Subsections. Such election when made in the return shall be irrevocable for the taxable year for which the return is made. Provided, That an individual who is entitled to claim for the optional standard deduction shall not be required to submit with his tax return such financial statements otherwise required under this Code: Provided, further, That except when the Commissioner otherwise permits the said individual shall keep such records pertaining to this gross sales or gross receipts, or the said corporation shall keep such records pertaining to this gross income as defined in Section 32 of this Code during the taxable year, as may be required by the rules and regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner.”

Based on the above provision, a taxpayer may opt for optional standard deduction (OSD) to be deducted from the gross income instead of itemized deductions, in arriving at the taxable income. Such optional standard deduction, if chosen would have the following features:

  • 40% based on gross receipts/sales for individuals or 40% based on gross income for corporate taxpayers,
  • Irrevocable for the taxable year of choice, even by amendment on the later years,
  • No substantiation is required for claimed allowable deductions and no disallowance of expense for non-withholding, but the taxpayer may nevertheless be held liable for non-withholding,
  • Individuals opting for OSD no longer required to attach audited financial statements to its annual income tax return but is still required to maintain books of accounts,
  • Corporate taxpayers availing OSD are still required audited financial statements, and,
  • To qualify for the OSD, the taxpayer should apply the same at the very first quarter of the taxable year.

The choice between OSD or itemized deductions could not be that easy to make because for a wise entrepreneur, business advantage shall be considered. In short, the determination would lead to finding which option would save taxes or which would be more advantageous to the entrepreneur. Such determination works in many ways, and may not alone be financial. Financial wise, it will be beneficial if OSD computations would be higher than the itemized deductions because this will mean lower income tax due.

  • For individuals, OSD would be better if the total expenses will not reach 40% like service concerns, professionals and the likes.
  •  For corporate taxpayers, OSD would be beneficial if there is less cost of sales/service because there could be a higher tax based for OSD, and there could be less operating expense.

On the other hand, even if figures would go against OSD, you may still avail of the same because of the following:

  •  Your substantiation is not in accordance with the regulations like if they are not in the name of the company, or no substantiation at all;
  • You are an individual and you do not want an independent Certified Public Accountant (CPA) to conduct an audit for cost cutting measures.

I leave it now to you good entrepreneurial judgment to determine how OSD works for you. I suggest you seek confirmation of a professional to assure that the anticipated benefits from OSD would turn out to be benefits, indeed.

 

Related professional service:

Tax study to determine benefits of OSD availment.(Post viewed 3633 times)

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