Tax Notes

Guidance on the Deductibility of Business Expenses Claimed Against Active Income

17 Sep 20253 min read
Contents

The Bureau of Internal Revenue (BIR) through Revenue Memorandum Circular (RMC) No. 81-2025 dated September 3, 2025, reiterating the criteria and guidelines on the deductibility of ordinary and necessary expenses under the Tax Code.

Criteria for deductibility

In order for a business expense may be allowed as deductions from gross income, the following conditions must be met:

  1. the expense must be ordinary and necessary;
  2. the expense must be paid or incurred within the taxable year;
  3. the expense must have been paid or incurred in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession; and,
  4. the expense must be supported by invoices, records or pertinent papers.

i. Ordinary and Necessary

An ordinary expense is one that is normal, usual and customary in a given trade or profession, while a necessary expense is one that is appropriate and helpful for the development of the taxpayer’s business.

The BIR highlights that mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction as business expense. The taxpayer must substantially prove by evidence or records (e.g. invoices) that the deductions claimed are allowed under the existing laws, rules and regulations, otherwise, the same will be disallowed.

ii. Must be paid or incurred within the taxable year

Deductible business expenses claimed must be for expenses that are paid or incurred within the taxable year when the corresponding revenue is earned. The term “taxable year” is either the calendar year or fiscal year, upon the basis of which the net income is computed. This guarantees that the expense is directly linked to the period during which the income is generated following the matching principle under the Generally Accepted Accounting Principles. 

iii. Must be directly attributable to trade, business, or profession

It is crucial to segregate expenses that are directly attributable to active business operations from those related to passive income generation. 

Active income refers to earnings derived from trade, business, or profession where the taxpayer is personally and systematically engaged, such as selling goods, rendering services, or practicing a profession. Passive income, on the other hand, arises without continuous or substantial taxpayer participation, such as interest, dividends, royalties, and capital gains.  Ultimately, the classification hinges on whether the income results from habitual, business-driven actions or from merely holding assets and earning returns without substantial participation. 

Expenses directly tied to the development, management, operation, or conduct of active trade or business can be deducted as they meet the criteria of being ordinary and necessary. However, expenses related to managing investments that generate passive income, such as fees for financial advice, interest from loan to finance investments, or brokerage services, and other related expenses may not qualify under the same provisions, as they do not relate directly to the taxpayer’s active business operations.

Guidelines

RMC 81-2025 highlights that deductible expenses claimed against active income must be intrinsically related to active income-generating activities. Costs related to passive income cannot be offset against active income unless the passive income itself is earned in a manner similar to the business’ active income. For taxpayers who earn from both active and passive sources, the expenses must be strictly segregated; and only those directly attributable to active operations may be deducted from active income.

Accordingly, if a taxpayer incurs expenses solely to generate tax exempt income, these expenses cannot be deducted from its regular taxable income. 

For expenses pertaining to income subject to preferential tax rate i.e. Registered Business Enterprises (RBE) availing of the 5% special corporate income tax (SCIT) rate incentive based on its gross income earned, the expenses must be carefully segregated from those subject to regular taxable income.

Please be guided accordingly.

 

Source:

P&A Grant Thornton 

Certified Public Accountants 

P&A Grant Thornton is the Philippine member firm of Grant Thornton International Ltd.

 

As published in SunStar Cebu, dated 17 September 2025

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