Deductible Interest Expense for Income Tax in Philippines

By: Tax and Accounting Center Philippines

Interest expense is what the taxpayer pays for borrowed funds in the conduct of trade or practice of profession. It refers to the payment for the use or forbearance or detention of money, regardless of the name it is called or denominated. It includes the amount paid for the borrower’s use of money during the term of the loan, as well as for his detention of money after the due date for its repayment.

Here are the requirements for deductibility of interest expense from taxable income laid down in Revenue Regulations No. 13-2000:

1. There must be an indebtedness;
2. There should be an interest expense paid or incurred upon such indebtedness;
3. The indebtedness must be that of the taxpayer,
4. The indebtedness must be connected with the taxpayer’s trade, business or exercise of profession.
5. The interest expense must have been paid or incurred during the taxable year;
6. The interest must have been stipulated in writing;
7. The interest must be legally due;
8. The interest payment arrangement must not be between related taxpayers as mandated in Sec. 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997;
9. The interest must not be incurred to finance petroleum operations; and
10. In case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure.

Limitation of interest expense in the Philippines

Interest expense has been a common tax savings device in the past using the “tax arbitrage” scheme. Under this tax arbitrage in the Philippines, taxpayer would secure a loan simply to generate interest expense thereby reducing the taxable income and enjoying a tax benefit thereto. The funds loaned will then be deposited with the bank to yield interest income that is subject to a final withholding tax (e.g. 20%) less than the normal income tax rate (e.g. 30% starting 2009). In effect, the taxpayer enjoys a double tax benefit – tax benefit on deduction of interest expense, and tax benefit on lower tax rate for income. To neutralize the impact of such scheme, deductible interest expense in the Philippines is reduced by 33% (starting 2009) of such interest income subjected to final withholding tax. Nevertheless, interest expense on unpaid taxes is not covered by this limitation on interest expenses in the Philippines.

Withholding tax on interest expense in the Philippines

Interest expense in the Philippines is subject to withholding tax at varied rates as follows:

1. Final withholding tax of 20% on deposit substitutes;
2. Creditable withholding tax of 20% on interest other than from deposit substitutes for all taxpayers paying such interest expense under Revenue Regulations No. 14-2012, instead of the 2% before for top twenty thousand (20,000) corporations before;
3. Final withholding tax of 20% on foreign loans, in general;

Please note that failure to withhold the corresponding rate would disqualify your claim for interest expense.

Special rules on interest expense in the Philippines

You must also be aware of the special rules applicable to specific interest expenses in the Philippines. Example is an interest expense in the purchase of a property may be included as part of the cost of the property to be depreciated instead of being claimed as interest expense in full. Another is interest expense incurred to finance petroleum operations  in the Philippines is generally not deductible under “The Oil Exploration and Development Act of 1972” or Presidential Decree No. 8, as amended by Presidential Decree No. 87.

Disclaimer: This article is for general conceptual guidance only and is not a substitute for an expert opinion. Please consult your preferred tax and/or legal consultant for the specific details applicable to your circumstances.