By: Garry S. Pagaspas
In computing for the income tax in the Philippines, certain deductible expenses are subtracted from gross income. They are technically termed as “allowable deductions from gross income” and they could be under itemized deductions or under optional standard deductions (OSD). In either case, they share the same concept, unless stated hereunder. We share hereunder some features for your deeper understanding.
A tool to reasonably measure taxable income
In income taxation in the Philippines, a taxpayer is being subjected to income tax because it earned something – be it from business or non-business activities. In business setting, it is admitted that business expenses are necessary to earn a revenue. As such, the allowable deductions from gross income becomes a tool to equitably measure the taxpayers net income from its business undertakings. It would be unfair if the taxpayer would be taxed at gross amount without allowable deductions, if it only earned so much, otherwise, most of its net income would only go through the coffers of the taxing authority.
Relates to business expenses
Allowable deductions from gross income relates to business expenses – those expenses which are ordinary and necessary for the conduct of trade or business or profession. Expenses which are personal to the business owners or entrepreneurs and does not contribute to earning the income are not allowed deductions. Taxpayers not engaged in trade or business or practice of profession are not entitled to deduct allowable deductions – e.g., pure compensation income earners. In same manner, compensation income of individual taxpayers is not deducted allowable deductions under this context.
However, some expenses are allowed as deductible expense despite the absence of a business relation. Example, charitable contribution does not necessarily be a business related expense to be deductible. Another is the deduction for basic personal exemption and additional personal expenses for individual taxpayers to cover the personal living expenses.
Substantiation requirements
Considering that the deduction relates to actual business expenses, it is required that they be supported by documents. Official reciepts and sales invoices duly registered by the Bureau of Internal Revenue (BIR) are the common suporting documents but some itemized deductible expenses require specific substantiation requirements like board resolution for bad debts expense and proof of loss in claims of casualty losses deduction.
To do away with the substantiation, a taxpayer engaged in trade or business or in practice of profession may take for optional standard deduction (OSD). Under OSD, they may deduct 40% of gross sales/receipts for individuals or 40% of gross income for corporations. No need for supporting documents under OSD in lieu of itemized deductions and the taxpayer must indicate such decision for OSD on its first quarterly income tax return (ITR).
Not contrary to law, public morals, policy, and order
Another notable feature of deductible business expenses is that it must be a legitimate and legal expenditure. This is to avoid manipulation of business expenses to lower down income taxes, or to encourage illegal activities in operating taxpayers business. Under this, facilitation fees or unofficial fees to corrupt public officials are not allowed as deductible business expenses.
Test of reasonableness
As a rule, deductible business expenses are not limited as to their respective amounts. However, they have to be reasonable in amounts as an necessary and ordinary business expense. For as long as they are related to the conduct of trade or business or practice of profession, they could be ducted in reasonable amounts and reasonableness is a factual matter.
Some expenses however, are subjected to limitations such as interest expense reduced by a certain percentage of interest income subjected to final tax, representation expense that should not exceed 1/2% of net sales of goods, or 1% of net receipts from sale of service. As we mentioned above, OSD, if opted, should not exceed 40%.
Withholding tax requirements
Under itemized deductions, if a business expense is subject to withholding tax under the rules of the BIR, it must be withheld to be deductible. No withholding, no deduction from gross income, untill payment of wittholding taxes. Common expenses subject to withholding tax are salaries and wages, professional fees, rental, and expense payments of top twenty thousand (TTC).
Under OSD, 40% is deductible even without such withholding tax. However, it will not excuse the taxpayer from payment of withholding tax. The taxpayer under OSD is still required to withhold and remmit the same to the BIR.
(Garry S. Pagaspas is a Resource Speaker with Tax and Accounting Center, Inc. He is a Certified Public Accountant and a degree holder in Bachelor of Laws engaged in active tax practice for more than seven (7) years now and a professor of taxation for more than four (4) years now. He had assisted various taxpayers in ensuring tax compliance and tax management resulting to tax savings rendering tax studies, opinions, consultancies and other related services. For comments, you may please send mail at garry.pagaspas(@)taxacctgcenter.ph).
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. For comments, you may also please send mail at info(@)taxacctgcenter.ph, or you may post a question at Tax and Accounting Center Forum and participate therein.
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The Bureau of Internal Revenue (BIR) has issued Revenue Memorandum Circular No. 35-2012 (RMC 35-2012) dated August 3, 2012 entitled “Clarifying the Taxability of Clubs Organized and Operated Exclusively for Pleasure, Recreation, and Other Non-profit Purposes”.
RMC No. 35-2012 has been issued by the BIR to clarify the income taxation and value added tax of clubs organized and operated exclusively for pleasure, recreation, and other non-profits purposes or “recreational clubs” as follows:
Income tax of recreational clubs
Under Section 26(H) of Presidential Decree No. 1158 otherwise known as National Internal Revenue Code of 1977, clubs which are organized and operated exclusively for pleasure, recreation, or other non-profit purposes or referred to as recreational clubs are exempt from income tax. However, under the National Internal Revenue Code of 1997, such provision was not included and under the doctrine of “casus pro omisso habendus est” a person or object that is omitted from an enumeration must be held to be omitted intentionally.
As such, the income tax will apply to the income of the recreational clubs from whatever source, such as the following:
Value added tax of recreational clubs
Likewise, the BIR clarified that the recreational clubs is subject to 12% VAT under Section 105 of the 1997 Tax Code, as amended and the fact that they are registered as a non-stock and non-profit would be immaterial. Quoted is the provision on Section 105 for easy reference:
“SEC. 105. Persons Liable. – Any person who, in the course of trade or business, sells barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716. The phrase ‘in the course of trade or business’ means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by nonresident foreign persons shall be considered as being course of trade or business.” (emphasis supplied)
“SEC. 105. Persons Liable. – Any person who, in the course of trade or business, sells barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code.
The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716.
The phrase ‘in the course of trade or business’ means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity.
The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by nonresident foreign persons shall be considered as being course of trade or business.” (emphasis supplied)
BIR further clarified that such conclusion has been affirmed by the Supreme Court in the case of Commissioner of Internal Revenue vs. Court of Appeals and Commonwealth Management and Services Corporation (GR No. 125355 dated March 30, 2000) which held as follows:
“It is immaterial whether the primary purpose of a corporation indicates that it receives payment for service rendered to its affiliates on a reimbursement-on-cost basis only, without realizing profit, for purposes of determining liability for VAT on services rendered. As long as the entity provides service for a fee, remuneration, then, the service rendered is subject to VAT.”
As such, the BIR concluded that clearly, the gross receipts of recreational clubs including but not limited to membership fees, assessment dues, rental income, and services fees are subject to VAT.
Comments:
RMC 35-2012 is premised on the rule that what has been excluded in the enumeration of exempt transaction, is deemed excluded. As such, they are taxable. Please note that, taxation is the rule, and exemption is the exception for the rule. It is Section 30 of the 1997 Tax Code that enumerates income tax exempt corporations. Being a taxable entity, payment to recreational clubs are not subject to the expanded withholding tax. This would mean to show that not-all non-stock and non-profit are exempted from income tax. Only those that are specifically enumerated are exempted. It might be good this time to revisit your non-stock and non-profit structure to check whether the same is exempted. If not among those enumerated, you may consider a domestic corporation for the business. You may read this article as a guide – Overview of Domestic Corporations in the Philippines.
As to being subjected to VAT, the same is imposed upon the nature of activity and has nothing to do with the structure as non-stock and non-profit activities. Recreational services are VATable as a sale of service.
Finally, I would agree with the recent move of the BIR to revisit the tax treatments of certain industries and transactions of taxpayers in the Philippines. I go with the notion that new taxes may not be necessary under the proper implementation. I would expect more BIR issuance for clarifications on taxability. As such, I would advise taxpayers to be more alert in dealing with their taxes. I would encourage their education on tax compliance to avoid misapplication and save taxes. Of course, there could be a lot more ways to learn BIR tax compliance.
Related readings
Read the FULL text of RMC No. 35-2012.Taxation of Non-profit clubs for recreation
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(Garry S. Pagaspas is a Resource Speaker with Tax and Accounting Center, Inc. He is a Certified Public Accountant and a degree holder in Bachelor of Laws engaged in active tax practice for almost two (2) decades and a professor of taxation for more than five (5) years. He had assisted various taxpayers in ensuring tax compliance and tax management resulting to tax savings rendering tax studies, opinions, consultancies and other related services. For comments, you may please send mail at garry.pagaspas(@)taxacctgcenter.ph).
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For taxpayers engaged in trade, business, or practice of profession, optional standard deduction (OSD) is a good are to look at for tax savings. Under Section 34(L) of the Tax Code, as amended by Republic Act No. 9504 dated June 17, 2008, and hereunder quoted:
“Section 34(L) Optional Standard Deduction. – In lieu of the deductions allowed under the preceding Subsections, an individual subject to tax under Section 24, other than nonresident alien, may elect a standard deduction in an amount not exceeding forty percent (40%) of his gross sales or gross receipts, as the case maybe. In the case of a corporation subject to tax under Sections 27(A) and 28(A)(1), it may elect a standard deduction in an amount not exceeding forty percent (40%) of its gross income as defined in Section 32 of this Code. Unless the taxpayer signifies in his return his intention to elect the optional standard deduction, he shall be considered as having availed himself of the deductions allowed in the preceding Subsections. Such election when made in the return shall be irrevocable for the taxable year for which the return is made. Provided, That an individual who is entitled to claim for the optional standard deduction shall not be required to submit with his tax return such financial statements otherwise required under this Code: Provided, further, That except when the Commissioner otherwise permits the said individual shall keep such records pertaining to this gross sales or gross receipts, or the said corporation shall keep such records pertaining to this gross income as defined in Section 32 of this Code during the taxable year, as may be required by the rules and regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner.”
Based on the above provision, a taxpayer may opt for optional standard deduction (OSD) to be deducted from the gross income instead of itemized deductions, in arriving at the taxable income. Such optional standard deduction, if chosen would have the following features:
The choice between OSD or itemized deductions could not be that easy to make because for a wise entrepreneur, business advantage shall be considered. In short, the determination would lead to finding which option would save taxes or which would be more advantageous to the entrepreneur. Such determination works in many ways, and may not alone be financial. Financial wise, it will be beneficial if OSD computations would be higher than the itemized deductions because this will mean lower income tax due.
On the other hand, even if figures would go against OSD, you may still avail of the same because of the following:
I leave it now to you good entrepreneurial judgment to determine how OSD works for you. I suggest you seek confirmation of a professional to assure that the anticipated benefits from OSD would turn out to be benefits, indeed.
Note: Article published before TRAIN or R.A. No. 10963 effective Jan. 2018.
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