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INCOME-TAX-DEDUCTIONS-Discussion

University of Houston
Uploaded: A year ago
Contributor: Pamskie
Category: Accounting
Type: Lecture Notes
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Filename:   INCOME-TAX-DEDUCTIONS-Discussion.docx (48.07 kB)
Page Count: 9
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DEDUCTIONS These are business expenses and losses which the law allows to reduce gross business income to arrive at net income subject to tax The items of amounts allowed as deductions represent the expenses (reduction of wealth) of the taxpayer (other than personal expenses and capital expenditures) in earning the income (increase of wealth) subject to tax as well as reasonable living expenses. Requisites before deductions are allowed There must be specific provision of law allowing the deductions, since deductions do not exist by implication. The requirements of deductibility must be met There must be proof of entitlement to the deductions. The burden of proof to establish the validity of claimed deduction is on the taxpayer. This is consistent with the rule that tax exemptions must be strictly construed against the taxpayer and liberally in favor of the State. The deductions must not have been waived. The withholding and payment of tax required must be shown General rules in claiming deductions Deductions must be paid or incurred in connection with the taxpayer’s trade, business or profession. Deductions must be supported by adequate receipts or invoices (except standard deduction). The withholding and payment of tax required must be shown. Any income payment which is otherwise deductible shall be allowed as a deduction from gross income only if it is shown that the income tax required to be withheld has been paid to the BIR (Sec. 2.58.5, RR 2- 98). Where no withholding made but still deductible A deduction will also be allowed in the following cases where no withholding of tax was made: The payee reported the income and the withholding agent/taxpayer pays the tax, including the interest incident to the failure to withhold the tax, and surcharges, if applicable, at the time of the original audit and investigation; The recipient/payee failed to report the income on the due date thereof, but the withholding agent/taxpayer pays the tax, including the interest incident to the failure to withhold the tax and surcharges, if applicable, at the time of the original audit and investigation The withholding agent erroneously underwithheld the tax but pays the difference between the correct amount and the amount of tax withheld, including the interest, incident to such error, and surcharges, if applicable, at the time of the original audit and investigation (Sec. 2.58.5, RR 2-98). Persons who are NOT ALLOWED to claim deductions from gross income NRA-NETB and NRFC are subject to final tax on their gross income derived from sources within the Philippines, hence, no deductions allowed to them. RC, NRC, and RA whose income is purely compensation income are also not entitled to such. Deductions that can be claimed by a corporation Domestic Corporations and Resident Foreign Corporation may opt between the OSD OR the Itemized Deductions Except Non-Resident Foreign Corporation which is subject to final tax on its gross income from sources within the Philippines. OPTIONAL STANDARD DEDUCTION It is a fixed percentage deduction which is allowed to certain taxpayers without regard to any expenditure. This is in lieu of the itemized deduction. The optional standard deduction is an amount not exceeding: a. 40% of the gross sales or gross receipts of a qualified individual taxpayer; or b. 40% of the gross income of a qualified corporation ITEMIZED DEDUCTIONS These are allowed deductible ordinary and necessary expenses paid or incurred during the taxable year. As a rule, these deductions require supporting documents to justify the reduction from gross income. Expenses Interest T axes Losses Bad debts Depreciation Depletion of Oil and Gas Wells and Mines Charitable and other Contributions Research and Development Contributions to Pension Trust EXEMPTION ALLOWABLE DEDUCTION An immunity or privilege, a freedom from a charge or burden to which others are subjected A subtraction from gross income Generally receipts which are excluded from taxable income Not receipts, but are expenditures which are permitted to be subtracted from income to determine the amount subject to tax Theoretical personal, family and living expenses of an individual Reduction of wealth which helped earn the income subject to tax, such as ordinary and necessary expense Itemized Deduction Optional Standard Deduction It must be substantiated by receipts It requires no proof of expenses incurred because the allowable deduction is a percentage not exceeding 40% of gross sales or receipts or gross income as the case may be. ITEMIZED DEDUCTIONS 1. GENERAL BUSINESS EXPENSES All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the - development - management, - operation and/or – conduct of the trade, business or exercise of a profession Requisites for deductibility of expenses Paid or incurred During the taxable year; The expense must be Substantiated by proof; The expense must be incurred in Trade or business carried on by the taxpayer (must be directly attributable to the development, management, operation, and or conduct of trade or business of the taxpayer, or in the exercise of the taxpayer’s profession); Expenses must Not be against public policy, public moral or law such as bribes, kickbacks, for immoral purposes. The expense must be Ordinary and necessary; The expense must be Reasonable; If subject to Withholding taxes, proof of payment to BIR; and Ordinary expenses - It is any expense that is normal or usual in relation to the taxpayer’s business and the surrounding circumstances (General Electric, Inc. v. Collector, CTA Case No. 1117, July 14, 1963). Necessary expenses - is one which is appropriate and helpful in the development of taxpayer’s business and is intended to minimize losses or to increase profits 1A. Compensation/ Salaries and Wages Requisites before an employer can deduct compensation payments to employees The payments must be reasonable. They are, in fact, payments for personal services rendered (Rev. Reg. 2, Sec. 70). Inclusions in compensation for services which are allowed as deductions from gross income Wages, salaries, commissions, professional fees, vacation-leave pay, retirement pay, and other compensation Bonuses in good faith Pensions and compensation for injuries if not compensated for by insurance or otherwise Grossed-up monetary value of fringe benefit provided for, as long as the final tax imposed has been paid. The fringe benefit must have been granted to managerial and supervisory employees, otherwise it cannot be availed as deduction. Requisites for deductibility of bonus The payment of the bonus is made in good faith for additional compensation; It must be for personal services actually rendered; and The bonus when added to salaries is “reasonable” when measured by the amount and quality of the services performed with relation to the business of the particular taxpayer. 1B. Travelling Expenses Requisites for its deductibility Reasonable and necessary expenses; Incurred or paid while away from home; and In pursuit of trade, business or profession. NOTE: Travelling expense includes transportation, meals and lodging (R.R. No. 2). “Away from home” It means away from the location of the employee’s principal place of employment regardless of where the family residence is maintained. Reimbursement for travel taxes, airport fees and other charges, if duly receipted or substantiated, may be deducted by the employer as business expenses. Subject to the above rules, expenses incurred in attending two foreign professional conventions a year shall constitute a deductible expense. 1C. Cost of Materials Materials and supplies are deductible only to the amount actually consumed or used in the operation during the taxable year, provided that the cost of such materials and supplies has not been deducted in determining the net income for any previous year. Methods utilized to determine materials used Actual consumption method or inventory method Direct purchase method 1D. Rent Expenses These are expenses incurred for the continued use or possession of property to which the taxpayer has not taken or is not taking title to or in which he has no equity other than that of a lessee, user or possessor. Requisites for its deductibility Payment was made as a condition to the continuous use of or possession of the property; Taxpayer has not taken or is not taking title to the property or has no equity other than that of a lessee, user or possessor; Property must be used in the trade or business; The creditable withholding tax of 5% must have been withheld and paid. On Cash Basis, Rent is deductible when incurred and paid. On Accrual Basis, Rent is deductible when liability is incurred during the period of use. An advance payment (prepaid rental) is not deductible expense of the lessee until the period is used, although the lessor may be required to report the amount when received. 1E. Repairs and maintenance Repairs are allowed as deduction when it is minor and ordinary, and keeps the asset in its ordinary working condition. Major and extraordinary repairs are capitalized and included in determining depreciation expense because they tend to prolong the life of the asset. 1F. Deductible Leasehold Improvements ?When a lessee constructed an improvement on the leased property, the costs of such improvement shall be depreciated over the life of the improvement or the term of the lease contract whichever period is shorter. The computed depreciation expense is allowed as deduction from gross income. 1G. Representation Expenses These are entertainment, amusement and recreation expenses incurred or paid during the year that are directly connected to the development, management and operation of the trade, business or profession of the taxpayer. Requisites for its deductibility Directly connected to the development, management, and operation of the business, trade or profession of the taxpayer; or directly related to or in furtherance of the conduct of its trade, business or exercise of a profession Not contrary to law, morals, good customs, public policy or public order Duly substantiated by adequate proof or receipt It must be limited to the ceiling requirement Ceiling or limitation on the amount allowed as entertainment, amusement and recreation expense Entertainment, amusement and recreation expense shall be allowed as a deduction from gross income but in no case shall exceed: For taxpayers engaged in sale of goods or properties – 0.50% of net sales (i.e., gross sales less sales returns or allowances and sales discounts) For taxpayers engaged in sale of services, including exercise of profession and use or lease of properties – 1% of net revenue (i.e., gross revenue less discounts) For taxpayers deriving income from both sale of goods and services – the allowable deduction shall in all cases be determined based on an apportionment formula taking into consideration the percentage of the net sales/net revenue to the total net sales/net revenue, but which in no case shall exceed the maximum percentage ceiling provided Expenses that are not considered entertainment, amusement and recreation expenses Expenses which are treated as compensation or fringe benefits for services rendered under an employer-employee relationship Expenses for charitable or fund-raising events Expenses for bona fide business meeting of stockholders, partners or directors Expenses for attending or sponsoring an employee to a business league or professional organization meeting Expenses for events organized for promotion, marketing and advertising including concerts, conferences, seminars, workshops, conventions, and other similar events Other expenses of similar nature *SEE DISCUSSION ON YOUR BOOK FOR SPECIAL DEDUCTIONS 2. INTEREST EXPENSE The cost of money incurred within a taxable year on indebtedness in connection with the taxpayer’s profession, trade or business. It shall refer 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 Requisites for deductibility There must be an indebtedness stipulated in writing The indebtedness must be that of the taxpayer in connection with the trade, business or profession The interest must have been paid or accrued during the taxable year The interest payment must not be in favor of a relative Limitation on the amount of deductible interest expense The taxpayer’s otherwise allowable deduction for interest expense shall be reduced by an amount equal to 33% of the interest income subject to final tax. Interest Expense deductible in full The business has no interest income subject to 20% FWT The interest expense is paid in favor of the government. Deductible Interest Expenses Interest on taxes, such as those paid for deficiency or delinquency, since taxes are considered indebtedness (provided that the tax is a deductible tax.) However, fines, penalties, and surcharges on account of taxes are not deductible. The interest on unpaid business tax shall not be subjected to the limitation on deduction Interest paid by a corporation on scrip dividends Interest on deposits paid by authorized banks of the BSP to depositors, if shown that the tax on such interest was withheld Interest paid by a corporate taxpayer, liable on a mortgage upon real property of which the said corporation is the legal or equitable owner, even though it is not directly liable for the indebtedness Non-deductible Interest Expense Interest on preferred stock, which in reality is dividend Interest on unpaid salaries and bonuses Interest calculated for cost keeping Interest paid where parties provide no stipulation in writing to pay interest If the indebtedness is incurred to finance petroleum exploration Interest paid on indebtedness between related taxpayers Interest on indebtedness paid in advance through discount or otherwise and the taxpayer reports income on cash basis Related Taxpayers 1. Members of the same family, brothers and sisters, whether in full or half blood, spouse, ancestors and lineal descendants Stockholders and a corporation, when he holds more than 50% in value of its outstanding capital stock, except in case of distribution in liquidation Corporation and another corporation, with interlocking stockholders Grantor and fiduciary in a trust Fiduciary of a trust and fiduciary in another trust, if the same person is a grantor with respect to each trust Fiduciary of a trust and beneficiary of such trust Interest paid in advance Interest paid in advance through discount or otherwise in case of cash basis taxpayer is allowed as deduction in the year the debt is paid. Interest periodically amortized If indebtedness is payable in periodic amortizations, interest is deducted in proportion to the amount of the principal paid. Optional treatment of interest expense on capital expenditure Interest incurred to acquire property used in trade, business or profession may be allowed either: Treated as capital expenditure (Remember your borrowing cost) As a deduction 3. TAXES Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business shall be allowed as deduction. In the case of non-resident alien individual engaged in trade or business in the Philippines and a resident foreign corporation, the deductions for taxes shall be allowed only if and to the extent that they are connected with income from sources within the Philippines Requisites for deductibility It must be paid or incurred within the taxable year In connection with the taxpayer’s profession, trade or business Tax must be imposed directly upon the taxpayer Deductible taxes Documentary Stamp Tax Occupational Taxes Privilege and license tax Excise tax Import Duties Local Business tax Automobile Registration fees Community tax Municipal tax Income tax paid to foreign country if not claimed as tax credit Non-deductible taxes Income tax provided under the NIRC (Philippine income tax) GR: Income taxes imposed by authority of any foreign country; XPN: When the taxpayer does not signify in his return his desire to avail of the tax credit. Estate tax and donor’s taxes Special assessments - taxes assessed against local benefits of a kind tending to increase the value of property assessed. Stock transaction tax - Taxes on sale, barter, exchange of shares of stock listed and traded through the local stock exchange or through initial public offering. Final taxes Presumed capital gains tax VAT Tax Credit The tax that was withheld by source shall be applied as a reduction of the tax liability of the taxpayer in the taxable year or quarter in which the income was earned or received Treatment to income taxes paid in foreign countries The taxpayer may either claim it as: 1. Foreign tax credits against Philippine income tax due of citizens and domestic corporations; or 2. A deduction from gross income of citizens and domestic corporations. Foreign tax credit It is the right of an income taxpayer to deduct from income tax payable the foreign income tax he has paid to a foreign country subject to certain limitations. This is to avoid the rigors of indirect double taxation, although not prohibited by the Constitution for being violative of the due process, results to a tax being paid twice on the same subject matter or transaction. Persons entitled to claim tax credit Resident citizens Domestic corporations Members of a GPP Beneficiary of an estate or trust Persons not entitled to claim tax credit Alien individuals, whether resident or non-residents Foreign corporation, whether resident or non- residents Non-resident citizen including overseas contracted workers and seamen Limitations when claiming tax credit The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer’s taxable income from sources within such country bears to his entire taxable income. The total amount of the credit shall not exceed the same proportion of the tax against which such redit is taken, which the taxpayer’s income from sources without the Philippines taxable under Title II of the NIRC (Tax on Income) bears to his entire taxable income for the same taxable year Limit of Tax Credit Paid to Foreign Country Formula for One Foreign Country Tax Credit = (Taxable income from within / Taxable income from all sources) x Philippine income tax Formula for Two or More Foreign Countries Same formula as above except that the allowable tax credit will be the lower of the following: a. Actual tax paid to foreign countries b. Limit on tax credit computed using individual taxable income from foreign country (as numerator) c. Limit on tax credit computed using total taxable income from foreign country (as numerator) Requirements for Tax Credit Documentation of tax that was paid Clear indication in the tax return that he is claiming tax credit 4. BAD DEBTS It is a claim that becomes worthless or uncollectible arising from money lent or from goods sold or services rendered. These are debts due to the taxpayer actually ascertained to be worthless and charged off in the books of the taxpayer within the taxable year except those: 1. Not connected with trade, business or profession; 2. Between related taxpayers It refers to debts resulting from the worthlessness or uncollectibility, in whole or in part, of amount due to the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered Requisites for deductibility There must be a valid and subsisting claim The claim must be connected with the profession, trade or business The claim must not be between related parties The claim must be actually ascertained to be worthless and uncollectible as of the end of the taxable year A claim is ascertained to be worthless when: Debtor becomes insolvent Debtor disappears Debtor died without sufficient properties to cover his debts The claim must be written off within the taxable year The debts are Uncollectible despite diligent effort exerted by the taxpayer; To prove that the taxpayer exerted diligent efforts to collect the debts: Sending of statement of accounts; Sending of collection letters; Giving the account to a lawyer for collection; and Filing a collection case in court. 5. DEPRECIATION It is the gradual diminution in the useful value of tangible property resulting from exhaustion, ordinary wear and tear and obsolescence There shall be allowed as a depreciation deduction reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in the trade or business For intangible assets such as patents, copyrights and franchise, the annual allowance to reduce their useful value is called amortization. Requisites for deductibility The property subject to depreciation must be property with life of more than one year. The property depreciated must be used in trade, business, or exercise of a profession. The depreciation must have been charged off during the taxable year. The depreciation method used must be reasonable and consistent. A depreciation schedule should be attached to the income tax return. The depreciable asset must be located in PH if taxpayer is a NRA or FC. Depreciable Assets: Only property that is used for trade, business or exercise of a profession or held for the production of income; All kinds of tangible property (other than land) with life of more than one year and do not form part of the stock in trade that are part of the inventory; All kinds of intangible property (other than shares of stock) with life of more than one year; Subject to exhaustion within a determinable period of time, that is it has a limited useful life. Non-depreciable Assets: Land, apart from the improvements of physical development added to it, cannot be depreciated; Inventories or stock in trade; Personal effects or clothings, except costumes used in theatrical business; Bodies of minerals subject to depletion; Automobiles and other transportation equipment used solely by the taxpayer for pleasure; Building used solely by the taxpayer as his residence, and the furniture or furnishing used in said building; Methods for computing Depreciation Allowance under NIRC Straight-line method – The annual depreciation charge is calculated by allocating the amount to be depreciated equally over the number of years of the estimated useful life of the tangible. It results in a constant charge over the useful life; Declining balance method – accelerated method of depreciation which writes off a relatively larger amount of the asset’s cost nearer the start of its useful life than that of the straight line; Sum of the years digit method – accelerated method of depreciation expense in the earlier years and lower charges in the later years; Any other method which may be prescribed by Department of Finance upon recommendation of the CIR. Method to be used in depreciation of properties used in petroleum operations It may either be straight line or declining balance method with a useful life of 10 years or shorter, as allowed by the CIR. If the property is not directly related to production, depreciation is for 5 years using straight line method Method to be used in depreciation of properties used in mining operations other than petroleum operations At the normal rate of depreciation if the expected life is less 10 years or less; or Depreciated over any number of years between 5 years and the expected life if the latter is more than 10 years and the depreciation thereon is allowed as deduction from taxable income. Provided, that the contractor notifies the CIR at the beginning of the depreciation period which depreciation rate allowed will be used. 6. DEPLETION It refers to the deduction form gross income arising from the exhaustion of natural resources like mines and oil and gas wells as a result of production or severance from such mines or wells. Importance: as the product of the mine is sold, a gradual sale is being made of the taxpayer’s capital interest in the property. The purpose is then, to enable a taxpayer to recover that capital interest free of income tax at its cost or on some other basis. Requisites for deductibility Depletable asset – natural resources: mines, gas and oil wells Charged off within the taxable year For Domestic Corporations – oil, gas wells or mines located within and without Resident Corporations – gas wells and mines located within the Philippines Annual depletion deductions are allowed only to mining entities which own an economic interest in mineral deposits. Economic Interest means interest in minerals in the place of investment therein or secured by operating or contract agreement for which income is derived, and return of capital expected, from the extraction of mineral. Exploration Expenditures Expenditures paid or incurred before the development stage of the mine intended to ascertain the existence, location, extent, or quality of any deposit of ore or other mineral. Development Expenditures Expenditures paid or incurred during the development stage of the mine or other natural deposits. Development stage shall begin at the time when deposits or mineral ores are shown to exist in sufficient commercial quantity and quality and shall end upon commencement of actual commercial extraction. These two expenditures may, at the option of the taxpayer, be treated as: Part of adjusted basis for depletion cost Deduction to compute taxable income from mining operations 7. CHARITABLE AND OTHER CONTRIBUTIONS It is a non-operating expense, but the law allows some contributions or gifts given within the taxable year as deductions from gross income. Requisites for deductibility Taxpayer making the contribution must be engaged in a profession, trade or business There must be an actual payment of contribution or gift The recipient must be an entity or institution specified by law The net income of the institution must not inure to the benefit of any individual or private stockholder Contributions that are deductible in full Donations to the Government of the Philippines, or political subdivisions including fully-owned government corporation to be used exclusively in undertaking priority activities in: Culture and Sports Health Economic Development Education Human Settlement Youth and Sports development Donations to Foreign institutions and international organizations in compliance with treaties and agreements with the Government. Donations to Accredited NGO’s a. Exclusively for: Cultural Charitable Health Educational Scientific research Social welfare Character building Youth and Sports Development A combination thereof Donation must be utilized not later than the 15th day of the 3rd month following the close of taxable year; Administrative expense must not exceed 30% of the total expenses; Upon dissolution, assets shall be transferred to another non-profit domestic corporation or to the State. Deferred expenses will be allowed as deduction ratably distributed over a period of not less than 60 months beginning with the month in which the taxpayer first realizes benefits from such expenditure. Research and development expenditures that are not deductible Any expenditure: For the acquisition or improvement of land or for the improvement of property to be used in connection with research and development subject to depreciation and depletion; and Paid or incurred for the purpose of ascertaining the existence, location, extent or quality of any deposit of ore or other mineral including oil or gas 9. CONTRIBUTION TO PENSION TRUSTS Donations that are subject to limitation Donations whose conditions are not complied with Donations to the Government of the Philippines or political subdivision exclusive for public purposes (not included in the priority activities) Donations to accredited non-government domestic corporations organized exclusively for: a. Scientific b. Educational c. Cultural d. Charitable e. Religious f. Rehabilitation of veteran g. Social Welfare institutions h. Youth and sports development Limitations on deductions Amount deductible shall not exceed: For individuals - 10% of taxable income before contributions For corporations - 5% of taxable income before contributions 8. RESEARCH AND DEVELOPMENT Continuous development of business products, goods, and others. Taxpayer may treat research or development expenditures, which are paid or incurred by him during the taxable year in connection with his trade, business or profession as: a. Ordinary and necessary expenses deductible from the business gross income in the year the expense are paid or incurred. b. Deferred expenses chargeable to the capital account but not chargeable to property subject to depreciation or depletion. Pension plan comprises a fund intended to provide retirement benefits to the employee. It is usually set up after some years of operations when the employer can already provide benefits to the employee. Requisites for deductibility The employer must have established a Pension or retirement plan to provide for the payment of reasonable pensions to his employees It must be Funded by the employer The pension plan is Reasonable and actuarially sound The deduction is Apportioned in equal parts over a period of 10 consecutive years beginning with the year in which the transfer or payment is made The payment has Not yet been allowed as a deduction The amount contributed must no longer be subject to the Control and disposition of the employer Two General Types of Pensions 1. Defined Benefit Plan – the ER handles and manages the fund. The benefits that the retiree would receive are defined and normally based on a certain percentage of the salary of the EE eligible to the benefit plan. 2. Defined Contribution Plan – The trust fund is handled by a third party (insurance or bank). The liability of the ER is to contribute the defined or contracted periodic contribution as per agreement with the administrator. Requirements of the plan Reasonable and actuarially sound Must be approved by the BIR. 10. LOSSES It represents reductions of resources due to unintended destruction or deprivation of things. It is generally allowed as deduction if related to business, actually sustained during the taxable year and not compensated for by insurance or other forms of indemnity. Requisites for deductibility of Losses It must be actually sustained in a closed and complete transaction It must be of the taxpayer and in relation to his trade, business, or profession It must not be compensated by insurance or other forms of indemnity The loss arise from fire, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement It must not have been claimed as deduction for estate tax purposes in the estate tax return If the loss resulted from casualty, robbery, theft or embezzlement, it must be reported to the BIR within 45 days after the occurrence of such event. Capital Losses – Losses incurred in relation to capital asset transactions. As a rule, these are deductible only from capital gains. Holding period More than 12 months: 50% deductible Less than 12 months: 100% deductible Casualty Losses - losses due to storm, fire, shipwreck or other casualties of property connected with profession, trade, or business, or from robbery, theft or embezzlement. A declaration of loss must be filed with the BIR within 45 days after the occurrence of such event. Measurement of casualty loss a. Total Loss – Actual loss is the book value of the asset. b. Partial Loss – Book value or cost to restore the asset to its normal operating condition, whichever is lower. Net Operating Loss – It means the excess of allowable deduction over gross income of the business in a taxable year. It comprises only of operating expenses and losses that are allowed by the law as deduction from gross income Operating loss does not automatically equate to Net Loss because a taxpayer may still have other sources of income. Net Operating Loss Carry-Over (NOLCO) – his refers top the excess of allowable deduction over gross income of the business in a taxable year. The net operating loss of the business or enterprise for any taxable year immediately preceding the current taxable year, which had not been previously offset as deduction from gross income shall be carried over as a deduction from gross income for the next three (3) consecutive taxable years immediately following the year of such loss: Provided that: The taxpayer was not exempt from income tax in the year of such net operating loss; and There has been no substantial change in the ownership of the business or enterprise. NOLCO is on a first-in first-out basis. “Substantial change in ownership of the business or enterprise” The 75% equity rule (or ownership or interest rule) shall only apply to transfer or assignment of the taxpayer’s net operating losses as a result of or arising from the said taxpayer’s merger or consolidation or business combination with another person. The transferee or assignee shall not be entitled to claim the same as a deduction from gross income except when as a result of the said merger, consolidation or combination, the shareholders of the transferor/assignor, or the transferor gains control of: At least 75% or more in nominal value of the outstanding issued shares or paid up capital of the transferee/assignee, if a corporation At least 75% or more interest in the business of the transferee/assignee, if not a corporation (75% equity rule) Determination of whether or not there is substantial change in ownership Substantial change in ownership shall be determined on the basis of any change in the ownership in said business or enterprise arising from or incident to its merger, consolidation, or combination with another person. It shall be determined as of the end of the taxable year when NOLCO is to be claimed as deduction Persons entitled to deduct NOLCO from Gross Income Individuals engaged in trade or business or in the exercise of his profession Domestic and Resident foreign corporation subject to the normal income tax or preferential tax rates Estates and trusts Effect of NOLCO when the corporate taxpayer is subject to MCIT The running of the three-year period for the expiry of NOLCO is not interrupted by the fact that such corporation is subject to MCIT in any taxable year during such three-year period. However, such corporation cannot enjoy the benefit of NOLCO for as long as it is subject to MCIT in any taxable period. An individual who claims the 40% OSD cannot claim deduction of NOLCO simultaneously. Even if NOLCO was not claimed, the three-year period shall continue to run. Disqualified to avail NOLCO OBUs for a foreign banking corporation and FCDU of a domestic banking corporations Enterprise registered with the BOI enjoying the Income Tax Holiday Incentive PEZA-registered enterprise SBMA-registered enterprise Foreign corporations engaged in international shipping or air carriage business in the Philippines Any person, natural or juridical, enjoying exemption from income tax Special Losses 1. Wagering losses – deductible only to the extent of gain or winnings deemed to only apply to individuals 2. Losses on wash sales of stocks Wash sale - A sale of stock or securities where substantially identical securities are acquired or purchased within 61-day period, beginning 30 days before the sale and ending 30 days after the sale. G.R.: Losses from wash sale are not deductible since these are considered as artificial loss. XPN: When taxpayer is a dealer in securities, and the transaction from which the loss resulted was made in the ordinary course of business of such dealer, the loss is deductible in full.

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