The Bureau of Internal Revenue (BIR) allows businesses to deduct certain expenses from their taxable income. As a rule of thumb, most of these allowed expenses should be relevant and necessary to business activities, while including others such as social security contributions and donations to charitable institutions.
When applying deductible expenses, you may choose between two options: itemized deductions and optional standard deductions (OSD). Between the two, the OSD is simpler to compute because your allowable deduction is set at 40% of your gross sales or receipts, but only itemized deductions will keep you from paying income tax if your expenses exceed your income. With itemized deductions, you’ll also have to present receipts as proof of your deductible expenses. We discuss this in detail in our article ‘Itemized Deduction vs. Optional Standard Deduction – Find Out What’s Right for You’. Meanwhile, we cover everything you need to know about deductible expenses in the following paragraphs.
What Expenses may be Deducted
Below is a list of the deductible expenses allowed by the BIR. However, to ensure that a certain business expense is indeed allowed, it is important that you consult with an accountant or a tax professional.
|Advertising and Promotions||Amortizations||Bad Debts|
|Charitable Contributions*||Commissions||Communication, Light, Water|
|Fringe Benefits*||Fuel and Oil Insurance||Interest*|
|Janitorial / Messengerial Services*||Losses*||Management / Consultancy Fee*|
|Miscellaneous||Office Supplies||Other Services|
|Professional Fees*||Rental*||Repairs and Maintenance-Labor|
|Repairs and Maintenance (Materials/Supplies)||Representation and Entertainment*||Research and Development|
|Royalties*||Salaries and Allowances*||Security Services*|
|SSS, GSIS, Philhealth, HDMF and Other Contributions*||Taxes and Licenses*||Tolling Fees|
|Training and Seminars||Transportation and Travel||Others (case to case basis)|
* See additional notes on mouse-over
Criteria for Allowable Deductions
While the list above shows what expenses may be deducted, you must ensure that these meet the following criteria set by the BIR:
The Expense Must be Business-Related. As we mentioned earlier, majority of deductible expenses allowed must be relevant and necessary to the business. These are typical disbursements that your business needs in order to operate. So if you are running a tarpaulin printing business, for example, a valid business expense may include your purchase of ink and the maintenance of your printer. That said, personal expenses are naturally excluded from allowable deductions.
It Must be Presented with Supporting Documents. This one applies to itemized deductions. In order for an expense to be deducted, you must show proof of the said expense such as a receipt or sales invoice. However if you opt for the OSD, you aren’t required to present any proof to substantiate the 40% deduction.
It Must not be Illegal, Immoral, and not Against Policy and Order. Any illegal activity is automatically excluded from deductible expenses.
The Amount Deducted Must be Reasonable. There’s a ceiling to certain expenses such as the Representation and Entertainment expense, which is capped at 0.5% of net sales for those who sell goods and 1% of revenues for service providers.
For OSD, the allowable deductible expense is automatically limited to 40% of your gross sales or receipts.
Withholding Taxes Must Have been Paid
In the above list, you’ll also see certain deductible expenses that are subject to withholding taxes. You must pay the corresponding tax to the BIR first before you can claim them as a deductible expense. Withholding taxes must also be paid whether you choose itemized deductions or the OSD.
How to Ensure Your Compliance to Rules on Deductible Expenses
Expenses that you can deduct from your gross income and the criteria of what is considered a deductible expense are fairly clear and straightforward. However, there may be some instances where exclusions would apply, creating a potential for confusion and issues with the BIR during tax season.
Because of that, it may be ideal to work with accountants and tax professionals who can help you navigate through the complexities of the tax system, so you can pay the right taxes and prevent compliance issues today and in the future. For more information, contact us today about your services at Beyond D Numbers, from tax compliance to payroll services.
Disclaimer: Information contained in this article may become outdated and is therefore meant as general guidance only. It is not intended as professional accounting or tax advice.