Tax Deductible Expenses with Limitations in the Philippines
Business expenses are costs incurred in the ordinary course of business. These are referred to as deductions and generally recognized as fully deductible for taxation purposes. However some expenses are subject to limitations as set by the current tax code.
1. Interest Expense
Interest expense is what you pay for borrowed funds used in the conduct of trade or business. The limitation on interest expense was added to the original taxation law. This is to address the issue on “tax arbitrage scheme” wherein the taxpayer would simply borrow funds from banks in order to generate deductible interest expense and simply deposit the borrowed funds in another bank to yield interest income. As a result the interest income from a deposit is subject to 20% final withholding tax while the interest expense will give a 30% tax benefit. Combining the effect of lower final tax and higher tax deductibility would result to a net benefit of around 33% of the interest expense.
Therefore interest expense deduction shall be reduced by 33% (starting 2009) of the interest income subjected to withholding tax to neutralize the tax effect of interest expense reduction and the lower final income tax rate on interest income.
For example, let us assume interest expense during the period-P100,000, and interest income, net of 20% final tax-P50,000. Under this, deductible interest expense reduction will be reduced by 33% of the amount of gross income or P20,625 (33% multiplied by the quotient of P50,000 divided by 80% (100% less 20% Final withholding Tax). Deductible expense would only be P79,375 (P100,000 less P20,625).
P100,000 – (33% x (P50,000/80%)
P100,000 – (33% x P62,500)
P100,000 – P20,625
P79,375
2. Representation and Entertainment Expense
Representation and entertainment expense are those incurred by the company in the course of business relative to entertaining or meeting with guests at a dining place, place of amusement, sporting events and similar events or places as contemplated under RR No. 10-2002.
These are allowed as deduction because it develops a friendlier atmosphere between the taxpayers and potential clients, guests or employees in order to develop a better business resulting to a higher income and eventually more taxes.
However, such expenses are subject to the following limitations on its deductibility:
- Sellers of Goods- 0.5% of net sales (net of sales returns, discounts and allowances).
- Sellers of Services- 1% of gross receipts.
Note:
For taxpayer engaged in the sale of both goods and services, specific identification or segregation has to be made. Sellers of service enjoy a higher rate because they are more prone to spending representation and entertainment in dealings with its guests, clients, or customers.
3. Charitable Contributions
Contributions must be actually paid in cash or other property before the close of taxable year to be deductible.
Deductions for charitable contributions might be deductible in full or under limitation. Donations to BIR accredited donee institutions properly documented with certificates of donations and other papers and donations to government priority projects certified by NEDA are fully deductible.
If the charitable contributions do not qualify with the above mentioned requirements, it will be subject to a limit. The deductible amount based on the taxable income before such charitable contributions should not exceed the following
- Individual Income Taxpayers – 10%
- Corporate Income Taxpayers – 5%
