“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.” from The Sandman, by Neil Gaiman. I personally agree with the said quote from my favorite book, but when dealing with the Bureau of Internal Revenue (BIR), mistakes in computing your tax dues and filing your returns, are the last thing you want to commit as they are tantamount to deficiency taxes and penalties for the BIR.
As the title of this article suggests, we will talk about how to treat your business-related expenses, identify if they are deductible for income tax purposes, and prevent making mistakes which results in deficiency taxes and penalties. Listed below are the common expenditures incurred by taxpayers and the related proper treatment.
I. Bad Debt Expense/Doubtful Account Expense;
These are provisions that are recognized when the company suspects that it may or may not collect its receivable from its customers due to bankruptcy, financial problems, or among other similar reasons. Keep in mind that these are also known as ‘provision for credit losses’ and are non-deductible expenses.
Only those that were written off and ascertained to be uncollectible or worthless shall be considered deductible expenses, provided that the same are supported by necessary documents to support them in accordance with Revenue Regulations (RR) No. 25-2002, which provides the list of requisites for a 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 accounts 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 accounts; (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 shall 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 shall be treated as a non-deductible expense. For companies selling both goods and services, the allocation method shall be used to compute any amount exceeding the ceiling.
V. Donation;
Donations to the government and accredited non-stock, non-profit organizations shall be 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 shall be considered non-deductible.
The amount of 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, shall be amortized over 10 consecutive years. If the company has no BIR-approved plan, only the actual payment to the retired employees shall 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 shall be considered deductible. Unrealized losses recognized last year shall not automatically be treated as realized this year.
This made-it-easy guide helps to ascertain whether the expense is deductible or not, just like the cookbook you’ll use this upcoming holiday season to prepare your family-shared dishes. The proper treatment for when to deduct or not to deduct your expenses is listed above. Similar to cooking, a slight or major variation may be needed to arrive at 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 life better. Remember, learning how to treat expenses properly will yield to a 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.
As published in BusinessWorld, dated 19 December 2023
