3 Tax Deductible Expenses with Limitations in Philippines

By: Tax and Accounting Center Philippines

As a rule, business expenses in the Philippines that is ordinary and necessary to the conduct of trade, business, or practice of profession in the Philippines is deductible to the extent of actual payments. In general, there is no limitation on deductible amount under the itemized deductions (as compared to optional standard deduction in the Philippines that is only up to 40% of gross income), except that is has to be reasonable. Under the following expenses however, the rules provides a limitation as to the amount deductible:

Limitation on deductible Interest Expense in the Philippines

Interest expense is what you pay for borrowed funds legitimately used in business. In the past, this has been used as a tax planning scheme where taxpayer would simply borrow funds from banks or financing institutions in order to generate deductible interest expense in the Philippines. The funds borrowed are not actually used in business so it is simply deposited in a bank yielding an interest income. As a result, the interest expense lowers down the taxable income by and benefits 30% of such reduction, while the interest income is subjected to final tax lower than the income tax rate of 30% (say 20% for savings deposit). This scenario is what is commonly called as “tax arbitrage”, and is now the subject of this limitation on deductible interest expense in the Philippines.

Under the Tax Code, as amended, interest expense deduction shall be reduced by 33% (starting 2009) of the interest income subjected to final withholding tax. The purpose of which is to neutralize the tax effect of interest expense reduction and the lower final income tax rate on interest income. Please see our sample computation on the interest expense limitation in the Philippines:

Let us assume Interest expense during the period – P20,000, and Interest income, net of 20% final tax – P8,000. Under this, deductible interest expense reduction will be reduced by 33% of the amount of gross income or P3,300 (33% multiplied by the quotient of P8,000 divided by 80% (100% less 20% FWT). Deductible interest expense would only be P16,700 (P20,000 less P3,300).

Deductible representation and entertainment in Philippines

Filipinos are hospitable by nature and such trait is carried on in doing business in the Philippines. The rules allow as tax deduction those expenses of taxpayers in entertaining its guests and employees in order to develop a friendlier atmosphere for a better business yielding more taxes from better operating income. However, business is business, and taxpayer’s resources shall not be exhausted on most representations and entertainment.

For this reason, the rule provides for the following limitations on deductible representation and entertainment:

•  Sellers of goods – 0.5% of net sales, net of sales returns, discounts and allowances; and
• Sellers of services – 1% of gross receipts

If the taxpayer is engaged in the sale of both the goods and the service, then, specific identification or segregation has to be made, otherwise, the dominant figure for the principal operations would overrule the other. Notably, the sellers of service enjoy the higher rate because sellers of service are more prone to spending representation and entertainment is dealings with its guest, clients, or customers.

Tax deduction for charitable contributions