“I hope that in this year to come, you make mistakes. Because if you are making mistakes, then you are making new things, trying new things, learning, living, pushing yourself, changing yourself, changing your world. You’re doing things you’ve never done before, and more importantly, you’re doing something.”
— The Sandman, Neil Gaiman
While I find the thought behind this passage from my favorite book to be inspiring, I would not recommend taking such an approach when dealing with the Bureau of Internal Revenue (BIR). Mistakes in computing your tax due and filing your returns are the last thing you want to happen, as they are sure to result in a BIR finding of deficiency taxes, resulting in penalties.
Here we will specifically discuss the treatment of business-related expenses, determining whether they are deductible for income tax purposes, and preventing mistakes that result in deficiency taxes and penalties. Listed below are the common expenditures incurred by taxpayers and their proper treatment.
I. Bad debt expense/Doubtful account expense
These are provisions that are recognized when the company suspects that it may not collect receivables from customers due to bankruptcy, financial problems, or such reasons. Keep in mind that these are also known as “provision for credit losses” and are non-deductible.
Only those that were written off and ascertained to be uncollectible or worthless may be considered deductible, provided that these are supported by the necessary documents in accordance with Revenue Regulations (RR) No. 25-2002, which lists the requisites for the valid deduction of bad debts from gross income:
1) There must be an existing indebtedness due that is valid and legally demandable;
2) These must be connected with the taxpayer’s trade, business or practice of a profession;
3) These must not be sustained in a transaction entered into between related parties as enumerated under Section 36(B) of the Tax Code;
4) These must be charged off the books of account as of the end of the taxable year; and
5) These must be ascertained to be worthless and uncollectible when the debtor is insolvent at the end of the taxable year.
Additionally, for the taxpayer, in order to establish the essential requisites that the debt is actually worthless and cannot be collected, there must be evidence that it exerted diligent efforts to collect it, such as by (1) sending a statement of account; (2) sending collection letters; (3) giving the account to a lawyer for collection; and (4) filing a collection case in court; otherwise, these can be disallowed by the BIR and will be treated as non-deductible expenses for income tax purposes.
II. Interest expense;
Interest expenses may be reduced by 20% of the Interest Income subjected to final tax. Always remember that the base before multiplying the 20% rate should be gross of tax or before deducting the final withholding tax charged to interest income.
For the interest expenses related to deficiency/delinquency taxes, these are not subject to any limitation; you can use the whole amount as a non-deductible expense to arrive at income tax payable.
III. Rental expense;
The Depreciation/Amortization of right-of-use assets (ROUA) and related interest expense on lease liability (LL) under PFRS 16 should be non-deductible. Only the actual rental payments per lease agreement are part of your deductible expense for income tax purposes.
IV. Entertainment, amusement, and representation (EAR);
EAR is subject to a ceiling of 0.5% and 0.1% of Net Revenue for sellers of goods and services, respectively. Any excess over the ceiling is treated as a non-deductible expense. For companies selling both goods and services, the allocation method is to be used to compute any amount exceeding the ceiling.
Donations to the government and accredited non-stock, non-profit organizations are deductible in full. If made to other donor recipients, these are subject to a 5% limit on taxable income before deducting the donation expense.
VI. Retirement expense;
All provisions for retirement expense and interest expense/income on retirement plan assets per book are considered non-deductible.
The amount of the deductible will differ if the company has secured a BIR-approved plan in which current employees’ costs are deductible in full and any excess over the current/normal costs, also known as past service costs, are amortized over 10 consecutive years. If the company has no BIR-approved plan, only the actual payment to the retired employee may be considered a deductible expense.
VII. Taxes & licenses;
For income tax purposes, deficiency/delinquency taxes and penalties paid to the BIR are not deductible. Only the interest expense related thereto can be considered deductible as mentioned in section II of this article. Examples of these deductible taxes are FBT, DST, OPT, and LBT, while non-deductibles include payment of Income Tax, VAT, Donor’s Tax, and Stock Transaction Tax.
VIII. Unrealized/Realized forex losses.
Only the actually closed and completed transactions during the year are considered deductible. Unrealized losses recognized last year may not automatically be treated as realized this year.
This guide helps to ascertain whether the expense is deductible or not, just like the cookbook you’ll be using during the holidays for your family. The same broad cookbook rules are true for the above list of the proper treatment of expenses. As it is with cooking, some variation may apply to determine the proper amount of deductible expense.
May the upcoming 2024 busy season be fruitful in knowledge, wisdom, and experiences. Let’s embrace new lessons and apply them to make our lives better. Remember, learning how to treat expenses properly will yield better business performance.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Jerome Q. Tapaoan is a senior in charge from the Tax Advisory & Compliance division of P&A Grant Thornton. P&A Grant Thornton is one of the leading audits, tax, advisory, and outsourcing firms in the Philippines, with 29 Partners and more than 1000 staff members.
Tweet us: GrantThorntonPH, Facebook: P&A Grant Thornton,