Reasonable criteria for tax deductibility in Philippines

The Revenue Memorandum Circular (RMC) No.81-2025, issued by the Philippine Bureau of Internal Revenue (BIR), lists the following criteria for the deductibility of an expense. It must be:

1. 1. Ordinary and necessary;
   2. Paid or incurred within the taxable year;
   3. Directly attributable to the development, management, operation and/or conduct of the business; and
   4. Supported by invoices, records or other pertinent papers.

Jacqueline Ann A Tan
Partner
Monitor of the Tax Department
ACCRALAW

The RMC states that an “ordinary expense” is one that is normal, usual and customary in the type of business conducted by the taxpayer. The following are not “ordinary”, and refer to decisions of the Supreme Court:

1. 1. Inordinately large: The BIR disallowed 50% of the media advertising expense of a manufacturing company, describing it as a “gargantuan expense for the advertisement of a singular product”. The taxpayer raised that the amount was justified, given the economic situation during the so-called EDSA Revolution (the “people power” demonstrations of 1986). The Supreme Court affirmed the disallowance, finding the amount to be inordinately large, as it was almost half of the corporation’s total marketing expenses and double its administrative expenses.
   2. Did not meet the “reasonableness in amount test”: The BIR disallowed 50% of the promotion expenses claimed by a hotel owner. The Supreme Court en banc upheld the disallowance and found that a dollar allocation form disclosed that the funds were used by the hotel owner’s wife for combined “medical and business reasons”.
   3. Extraordinary and unusual, with no relation to actual services: The BIR in disallowed an “officer’s remuneration” given in relation to the sale of the company’s property. The Supreme Court held that there was no basis to grant the bonus since the officer did not perform any service, and the sale was already effected by a broker who received commission.

The RMC states that an expense is “necessary” if it is helpful to the development of the taxpayer’s business, directly connected and proximately resulting from carrying on the business, and contributes to the generation of income or to minimising loss.

“Expenditures not directly related to the earnings of the business within the Philippines, such as costs incurred for the remittance of funds to an overseas head office, are not deductible” was lifted from a case involving “margin fees” paid by a local company to the Central Bank of the Philippines to remit profit to its New York head office.

The local company raised that these were necessary expenditures for the conduct of its corporate affairs. However, the Supreme Court rejected the argument due to its failure to show how the remittance to the head office of part of its profit was in furtherance of its own trade or business.

The RMC also refers to a 1967 Supreme Court en banc decision where “miscellaneous expenses” and “officer’s travelling expenses” were disallowed because they could not be satisfactorily explained or supported by papers.

The Supreme Court, however, upheld the taxpayer’s case and considered the testimony of the accountant that expenses were credited to the president, who incurred the expenses during his trip to Manila, and that vouchers and receipts were burned during the Basilan fire on 30 March 1962. The Supreme Court also held that the obligation to preserve the receipts had already lapsed by the time of the investigation.

While the Tax Code does not define the words “ordinary” and “necessary”, section 34(A) uniformly qualifies them with the words “reasonable allowance”. Judicial precedents add that other factors should be considered, such as: the nature, type and size of business; the volume and amount of net earnings; the nature of the expenditure itself; the intention of the taxpayer; the political and economic conditions of the existing time; evidence presented to substantiate the expense; and defences attendant to the taxpayer during the investigation. It is the interplay of these among other factors, properly weighed, that will yield a reasonable evaluation.

This article was first published in BusinessWorld, a Philippine.

newspaper of general circulation. The views and opinions expressed in this article are those of the author, for general information only, and do not constitute legal advice.

Jacqueline Ann A Tan is the monitor of the tax department and a partner at ACCRALAW

ACCRALAW
22/F, ACCRALAW Tower, 2nd Avenue corner 30th Street
Crescent Park West, Bonifacio Global City, 1635 Taguig,
Metro Manila, Philippines
www.accralaw.com
Contact details:
T: +632 8830 8000
E: jcalegre@accralaw.com