Tax Chapter 8 Deduct From Gross Income

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

70

Chapter 8: Deductions from Gross Income

CHAPTER 8

DEDUCTIONS FROM GROSS INCOME Problem 8 – 1 DEDUCTIBLE OR NONDEDUCTIBLE FROM GROSS INCOME 1. Nondeductible 2. Deductible 3. Deductible 4. Deductible 5. Nondeductible 6. Nondeductible 7. Nondeductible 8. Deductible 9. Deductible 10. Deductible 11. Nondeductible 12. Nondeductible 13. Deductible, in lieu of tax credit (Sec. 34C3, NIRC) 14. Deductible 15. Deductible 16. Nondeductible 17. Nondeductible 18. Deductible 19. Deductible 20. Nondeductible Problem 8 – 2 TRUE OR FALSE 1. False – Some business expenses are nondeductible; some are subject to limit. 2. True 3. False – Compensation income is not subject to OSD. 4. False – NOLCO is not an itemized deduction. 5. True – Amortized over the term of the lease 6. False – ½ of 1% 7. False – 33% 8. False – Double –declining method 9. True 10. True 11. False – Income outside the Philippines by a NRC is not taxable in the Philippines, hence, no allowable deduction is allowed. 12. True 13. True 14. True 15. False – Business expenses related to business income outside the Philippines is deductible also by domestic corporations and resident Filipino. 16. False – Business expense is deductible from gross income. 17. True 18. False – 40% based on sales or gross receipts.

71

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Problem 8 – 3 1. C 2. C 3. A 4. D 5. A 6. B 7. A 8. C 9. C 10. D Problem 8 – 7

Problem 8 – 4 1. D 2. B 3. B 4. C 5. A 6. D 7. C 8. C 9. A 10. A

Problem 8 – 5 1. A 2. C 3. C 4. A 5. D 6. C 7. A 8. B 9. A 10. C

C Expensed

Change of motor of air condition Expansion of store Damages paid due to workers’ injury Repainting of building Cleaning of computers Repair of furniture Totals Problem 8 – 8 C Identifiable operating expenses – Philippines Add: Allocated operating expenses within (P200,000 x P1M/P5M) Operating expenses – Philippines Problem 8 – 9 D Police protection Interest expense paid to his father Gifts made to employees during birthday Capital loss Amount of nondeductible expenses and losses Problem 8 – 10 D Depreciation expense (P1,000,000 x 40%)/25 Loss of business equipment Deductible expense Problem 8 – 11 1. Letter A

Problem 8 – 6 1. C 2. C 3. B 4. C 5. C 6. D 7. D 8. A 9. C 10. C

D

P20,000 10,000 9,000 1,000 P40,000

Capitalized P60,000 50,000

. P110,000

P400,000 40,000 P440,000

P20,000 10,000 5,000 4,000 P39,000

P16,000 38,000 P54,000

72

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

No personal or business expense is deductible. 2.

Letter B Depreciation (P20,000 x 10%) Repair (P100,000 x 10%) Office supplies Total deduction

Problem 8 – 12

P 2,000 10,000 6,000 P18,000

B

Salary expense (P180,000 + P20,000) Estimated uncollectible accounts Compromise penalty Depreciation expense Miscellaneous expense Deductible from earnings

Tax laws P200,000

30,000 . P230,000

GAAP P200,000 10,000 50,000 30,000 5,000 P295,000

Note: For tax purposes, the miscellaneous expense is not deductible because it was not reported last year. For accounting purposes, the miscellaneous expense can be deducted as prior period adjustment from retained earnings.

Problem 8 – 13

A

Sales Multiplied by OSD rate Optional standard deduction

P300,000 40% P120,000

The compensation income is not included in determining OSD. The OSD (40% of gross sales or gross receipts) is only allowed as deduction from income derived from business. If an individual opted to use OSD, he is no longer allowed to deduct cost of sales. [Sec. 34(L), NIRC; Sec. 3, Rev. Regs. No. 16-2008] Problem 8 – 14 B Gross receipts from profession Rent income (P475,000/95%) Total gross income Multiplied by percent of OSD Optional standard deduction Problem 8 – 15

P100,000 500,000 P600,000 40% P240,000

D

Since there are no official receipts and documents to support the operating expenses, the reported operating expenses are not deductible (Sec. 34(A)(b), NIRC). The OSD is not allowed for nonresident aliens (Sec. 34(L), NIRC). No personal exemption will be granted to a nonresident alien with business in the Philippines if his country does not have an exemption reciprocity law favoring a Filipino citizen. (Sec. 9, Rev. Regs. No. 2)

73

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Problem 8 – 16

A

Sole Proprietor Sales

P1,000,00 0 . P1,000,00 0 40% P 400,000

Less: Cost of sales Basis of OSD Multiplied by OSD rate Optional standard deduction

Corporatio n P1,000,000 300,000 P 700,000 40% P 280,000

RA 9504 is specific as to the basis of OSD. For individuals, the basis of the 40% OSD shall be the “gross sales” or “gross receipts.” In the case of corporate taxpayers subject to tax under Sections 27(A) and 28(A)(1) of the Tax Code, as amended, the basis of the 40% OSD shall be the “gross income.”

Problem 8 – 17 B Operating expense before representation expense (P2,000,000 – P300,000) Representation expense – Actual - Limit (P20,000,000 x 0.005) - Lower Allowable itemized deductions

P1,700,000 P300,000 100,000 100,000 P1,800,000

Problem 8 – 18 B Salary expense Rent expense Advertising expense Depreciation expense Interest expense Tax differential on interest income (P30,000 x 33%) Total itemized deductions

P120,000 24,000 6,000 5,000 60,000 ( 9,900) P205,100

NOLCO is not an itemized deduction. Problem 8 – 19

D

Sales Cost of sales Gross income Less: OSD or Itemized deductions

Using OSD P1,200,000 - 0 P1,200,000

Using Itemized P1,200,000 700,000 P 500,000

74

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

(P1,200,000 x 40%) Net income before personal exemption

480,000 P 720,000

Allowed deduction using OSD (P1,200,000 x 40%) Less: Cost of sales Net disadvantage using OSD

- 0 P 500,000 P 480,000 700,000 (P220,000)

No itemized deduction is allowed if no official receipts, records or other pertinent papers can be used to support it (CIR vs. Isabela Cultural Corporation, G.R. No. 172231, Feb. 12, 2007). In case of individual taxpayer, the “cost of sales” or the “cost of services” are not allowed to be deducted for purposes of determining the basis of OSD inasmuch as the law (RA 9504) is specific as to the basis thereof which states that for individuals, the basis of the 40% shall be the “gross sales” or “gross receipts” and not the “gross income.” (Sec. 3, Rev. Regs. No. 16-2008) Problem 8 – 20 A Gross salaries of employees Grossed-up monetary value of fringe benefits Deductible salaries and fringe benefits expenses

P6,000,000 1,000,000 P7,000,000

Problem 8 – 21 C Assume bonus is computed after tax but before bonus. The answer is letter D = P8,143, computed as follows: Net income before charitable contribution (P75,000 + P5,000) Less: Deductible contribution (P80,000 x 5%) – lower of actual Net income before income tax and bonus B T B B B B – 0.045B 0.955B B

= = = = = = = =

P 80,000 4,000 P 76,000

15% (76,000 – T) 30% (76,000 – B) 15% [76,000 – 30% (76,000 – B)] 15% (76,000 – 24,320 + 30%B) 11,400 – 3,420 +0.045B 7,980 7,980/0.955 8,356

Proof: Income before bonus and tax Less: Income tax (P76,000 – P8,382) x 30%

P76,000 20,285

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

75

Chapter 8: Deductions from Gross Income

Income after tax but before bonus Multiplied by rate of bonus Bonus

P55,715 15% P 8,356

Problem 8 – 22 B Monthly salary Death benefits Terminal pay Continuous compensation after the burial for three months Total deductible expenses

P 5,000 50,000 25,000 15,000 P95,000

Note: Donation for coffin and other wake expenses is not business or compensation related and, hence, not deductible. (Sec. 72, Rev. Regs. 2) Problem 8 – 23

C

Purchases Decreased in inventory Increased in inventory

Inventoriable cost P300,000 20,000 . P320,000

Problem 8 – 24 D Traveling expenses (P50,000 + P200,000) Fringe benefit expense (P68,000/68%) Transportation expense – messenger Total allowable expense Problem 8 – 25 B Monthly rent (P20,000 x 60%) x 2 mos from Oct. 31 to Dec. 31 Insurance premium (P3,000 x 60%) x 2/12 Real property tax (P1,500 x 60%) x 2/12 Deductible rent expense

Supplies expense P40,000 ( 3,000) P37,000 P250,000 100,000 40,000 P390,000

P24,000 300 150 P24,450

Note: The city services is not a rent expense. Problem 8 – 26 1. Letter B Rent for 6 months based on usage (P20,000 x 6) x 80% 2. Letter D Actual cash collection for rent Problem 8 – 27 D Monthly rental expense Monthly depreciation (P600,000/8)/ 12 Monthly deductible expense

P96,000 P150,000

P2,000 6,250 P8,250

76

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Problem 8 – 28 C Rent expense (P5,000 x 12) Add: Depreciation expense [(P950,000/9.5) x 11/12] Deductible expense in 200y

P 60,000 91,667 P151,667

At the start of the used of the building, the remaining period for the contract of lease is 9.5 years. The salvage value is ignored in the computation of the depreciation because T Foods could no longer benefit on it since the improvement on the land will be owned by the lessor at the end of the 10-year contract of lease. Problem 8 – 29 1. Letter B Trading - Limit lower (P5,000,000 x .005)

P25,000

2. Letter C Servicing – actual lower

P30,000

Problem 8 – 30

B

Actual representation expense Multiplied by percent of representation expense for sales [P700,000/(P700,000 + P300,000)] Apportioned representation expense for sales Limit (P700,000 x 0.005), lower

P10,000

Actual representation expense Multiplied by percent of representation expense for revenue [P300,000/(P700,000 + P300,000)] Apportioned representation expense for sales Limit (P300,000 x 0.01) Deductible representation expense

P10,000

Problem 8 – 31 A Interest expense Tax differential (P50,000 x 33%) Deductible interest expense

Problem 8 – 32

70% P 7,000 P3,500

30% P 3,000 3,000 P6,500

P40,000 (16,500) P23,500

B

Breast-feeding assistance to the needy – additional Salary of senior citizens – additional (P100,000 x 15%) Senior’s citizen discount (P300,000 x 20%) Total special itemized deduction

P200,000 15,000 60,000 P275,000

77

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Problem 8 – 33

B Deductible

Interest Interest Interest Interest Interest Total

paid in advanced paid to a brother paid on delinquency taxes on borrowings to finance his family home paid to finance petroleum exploration

Problem 8 – 34

Nondeductible P 20,000 12,000

P 8,000 . P 8,000

30,000 100,000 P162,000

B

Interest expense on unpaid salaries Add: Nondeductible tax differential (P40,000/80%) x 33% Nondeductible interest expense

P 60,000 16,500 P 76,500

Salary expense Rent expense Deductible interest expense bank loan (P40,000 – P16,500) Total itemized deductions

P600,000 200,000 23,500 P823,500

The salaries of direct workers should be classified as deductible cost of service and not to be classified as part of itemized deductions (Rev. Regs. No.16-2008). Interest expense on unpaid salaries is not deductible. (Kuenzel & Streiff, Inc. vs. Collector of Internal Revenue, 106 Phil. 355) Problem 8 – 35 D Tax savings from interest expense (P100,000 x 30%) Final tax on interest income (P1,000,000 x 12%) x 20% Actual net tax savings

P30,000 (24,000) P 6,000

Problem 8 – 36 A Documentary stamp taxes Local tax (P6,000 – P800 – P200) Municipal tax Community tax Deductible taxes

P 1,000 5,000 2,000 1,500 P9,500

Note: The fringe benefit income taxes to key officers and rank-in-file employees are to be classified as deductible fringe benefit expense and not tax expense. Problem 8 – 37

C

Business taxes Documentary stamp taxes Automobile registration fees Postage stamp taxes

P 20,000 1,000 3,000 500

78

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Import duty taxes Total deductible taxes

50,000 P 74,500

Problem 8 – 38 D Unadjusted net income (P520,000 – P200,000) Add back: Income tax foreign country Adjusted net income Personal exemption Net taxable income

P320,000 10,000 P330,000 (50,000) P280,000

Note: The P10,000 income tax paid to foreign country is better to be treated as tax credit rather than as operating expense. Problem 8 – 39 A Asset of Oliva Payment to government (P200,000 x 50%) Balance

P 60,000 (100,000) (P40,000)

Deductible bad debts is the entire amount of collectibles

P100,000

Problem 8 – 40 B Bad debts from business actual written off (P100,000 x 40%) Bad debts from profession actual written off Deductible bad debts expense

P40,000 50,000 P90,000

Problem 8 – 41 D Annual depreciation expense (P50,000 – P5,000)/5 Multiplied by ratio of months used during the year (from June 30 to Dec. 31) Depreciation expense 200B Problem 8 – 42 A Annual depreciation (P2,300,000/11.5 years) Multiplied by ratio of months used in 200B (July 1 to Dec.) Depreciation expense Problem 8 – 43 D Oil drilling machine (P800,000 x 90%)/8 years Oil extracting machine (P900,000 x 90%)/10 years – limit Computers (P100,000 x 90%)/4 years Delivery truck (P200,000 x 90%)/5 years – limit Annual depreciation expense

P9,000 6/12 P4,500

P200,000 6/12 P100,000

P 90,000 81,000 22,500 36,000 P229,500

The useful life of properties used in or related to production of petroleum shall be ten (10) years or such shorter life as may be permitted by the BIR Commissioner. Properties not used directly in the production of petroleum shall be depreciated under the

79

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

straight-line method on the basis of an estimated useful life of five (5) years. (Sec. 34(F) (4), NIRC) Problem 8 – 44 C Depletion base (P6,000,000 – P1,000,000 + P300,000) Divided by number of extractible estimated tons Depletion per ton Multiplied by number of tons extracted during the year Depletion expense

P5,300,000 5,000,000 P 1.06 800,000 P 848,000

Problem 8 – 45 1 Letter D . Depletable costs, January 1, 200x Exploration costs Intangible development costs Total Less: Depletion expense (P15,000,000/7,500,000) x 1,200,000 Adjusted basis Divided by remaining reserves (5,000,000 + 2,500,000 – 1,200,000) New depletion rate/ unit 2 .

P12,500,000 1,000,000 1,500,000 P15,000,000 2,400,000 P 1,260,000 6,300,000 P 2.00

Letter A Depletion cost 2007 (P2 x 1,200,000 units)

3 .

P2,400,000

Letter B Value of production (P12 x 1,200,000 units) Less: Production and selling costs: Mining costs Milling costs Marketing expenses Depreciation expense

P14,400,000 P2,000,00 0 3,000,000 1,500,000 1,000,00 0

Net income from operation Multiplied by limit percentage Deductible amount fro exploration and development cost 4 .

7,500,000 P 6,900,000 25% P 1,725,000

Letter B Current exploration and development cost (P1,500,000 + P1,000,000) Less: Deductible amount of exploration and development cost (see 3) Exploration and development cost chargeable to succeeding years

P2,500,000 1,725,000 P 775,000

80

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Problem 8 – 46 B Deductible expense: Depreciation expense (P10,000,000 x 90%)/50 Capital outlay Problem 8 – 47 1 Letter B Lower of actual contribution or normal valuation Add: Amortization of excess 200A (P200,000/10) 200B (P100,000/10) Deductible retirement expense 2.

Capitalized P180,000

P10,000,000

200A 800,000

200B 800,000

200C 500,000

20,000 . 820,000

20,000 10,000 830,000

20,000 10,000 530,000

200A 0

200B 400,000

200C 300,000

Year X 700,000 10,000 710,000

Year Y 600,000 10,000 610,000

Letter A Actual retirement payments

Problem 8 – 48

Outright expense

A

Actual contribution or normal valuation, lower Add: Amortization (P100,000/10) Deductible retirement expense

Note: Only the excess of the actual contribution over the normal valuation is to be amortized over 10 years. Problem 8 – 48 B Allowed deductible contribution (P200,000 x 5%)

P10,000

Problem 8 – 49 B Allowed deductible contribution (P200,000 x 5%)

P10,000

Problem 8 – 50 D Allowed deductible contribution [(P60,000 + P5,000) x 10%]

Problem 8 – 51 B Income before charitable contribution (P500,000 – P130,000) Multiplied by percent of limit Allowed deductible contribution - lower Problem 8 – 52 PPHHI per month

P6,500

P370,000 5% P 18,500

A

Problem 8 – 53 D Not allowed to deduct PPHHI because family income exceeded P250,000 per year.

P200

81

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Problem 8 – 54 C Actual value of donation – priority program Adopt a school program – incentive (P1,000,000 x 50%) Deductible donation

P1,000,000 500,000 P1,500,000

Problem 8 – 55 1. Operating expenses (1,000,000 x 30%) – P50,000 Interest expense (P50,000 – (P40,000/80%) x 33%] Total itemized deductions Add: NOLCO Total deductible expenses

P250,000 33,500 P283,500 500,000 P783,500

Note: NOLCO is not an itemized deduction but part of deductible expenses. 2.

Gross income (P5,000,000 – P2,000,000) Multiplied by OSD rate OSD

P3,000,000 40% P1,200,000

Note: NOLCO is not allowed to be deducted if the taxpayer uses OSD. 3.

Gross income Less: OSD Net taxable income

P3,000,000 1,200,000 P1,800,000

Problem 8 – 56 Salaries of assistants Traveling expenses Light and water – office Stationeries and supplies Office rent Total operating expenses before contribution Add: Contribution subject to limit (P500,000 – P176,850) x 10%) Allowable itemized deductions

P 96,000 11,000 7,890 1,960 60,000 P176,850 32,315 P209,165

Problem 8 – 57

Bad debts written-off (P35,000 – P30,000) Depreciation expense (P140,000 – P100,000)

Sole Proprietorship P 5,000 40,000

Corporation P 5,000 40,000

Partnership P 5,000 40,000

82

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Donation to the government – priority program Donations subject to limit: Lower of actual, P170,000 or (P2,500,000 x 10%) (P2,500,000 x 5%) Total allowable deductions

50,000

50,000

50,000

170,000 . P 265,000

125,000 P 220,000

125,000 P 220,000

The research and development cost is to be treated as a deferred expense, hence, its amortization shall be made in the succeeding five years when the taxpayer realizes benefits from such expenditures (Sec. 341, NIRC). Problem 8 – 58 1. Actual contribution or normal valuation, lower Add: Amortization - 200A (P250,000/10) Deductible retirement expense 2.

Financial net income Add: Retirement benefit expense – accounting Total Less: Deductible retirement expense – taxation Net income for tax purposes

200A 1,000,000 25,000 1,025,000

200B 900,000 25,000 925,000

50,000,000 1,100,000 51,100,000 1,025,000 50,075,000

60,000,000 1,200,000 61,200,000 925,000 60,275,000

Problem 8 – 59 Salary expenses Retirement (P250,000 + P50,000/10) Representation expense (P10,000,000 x .005) Interest expense paid to the BIR - full Interest expense – limit: (P100,000 – (P96,000/80%) x 33%) Depreciation expense Rent expense Group insurance expense Bad debts expense (P100,000 x 20%) Contribution expenses: TESDA priority project (500,000 x 1.5) Local government – limit (lower is actual) Total itemized deductions

Corporation 500,000 255,000 50,000 20,000

Individual 500,000 255,000 50,000 20,000

60,400 40,000 250,000 50,000 20,000

60,400 40,000 250,000 50,000 20,000

750,000 100,000 2,095,400

750,000 100,000 2,095,400

Note: NOLCO is an allowable special deduction but not an itemized deduction.

Problem 8 – 60 1. Salaries expense (P680,000 – P100,000) Bad debts expense (P370,000 – P270,000) Retirement expense (P1,000,000 – P380,000)

Individual 580,000 100,000 620,000

Corporation 580,000 100,000 620,000

83

INCOME TAXATION 6TH Edition (BY: VALENCIA & ROXAS) SUGGESTED ANSWERS

Chapter 8: Deductions from Gross Income

Representation expense (P39,000,000 x 0.005) Rent expenses (P200,000 – P20,000) Taxes expense (P300,000 – P270,000) Life insurance expense (P150,000 – P100,000) Interest expense [(P200,000 – (50,000 x 33%) + P20,000] Total itemized deduction before contributions Contribution expenses: Donation to TESDA priority project (P500,000 x 150%) Donations for Rooming-in and Breast-feeding (200k x 2) Donations NGO’s (35% for admin.) Ind: (P39,460,000 – P30,000,000 – P1,958,500) x 10%=750,150 Corp: (P39,460,000 – P30,000,000 – P1,958,500) x 5%=375,075 Total allowable deductions

195,000 180,000 30,000 50,000 203,500 1,958,500

195,000 180,000 30,000 50,000 203,500 1,958,500

750,000 400,000 100,000

750,000 400,000 100,000

. 3,208,500

. 3,208,500

Computation of sales: Financial income Cost of sales Operating expenses deducted (P680,000 + P370,000 + P1,000,000 + P800,000 + P200,000 + P300,000 + P150,000 + P160,000 + P800,000) Total sales 2. Gross income (P39,460,000 – P30,000,000) Less: Total allowable deductions Net taxable income

P 5,000,000 30,000,000

4,460,000 P39,460,000 Individual P9,460,000 3,208,500 P6,251,500

Corporation P9,460,000 3,208,500 P6,251,500