Philippine Tax System & Income Tax

Losses
 Losses
These represent reductions on resources due to
unintended destruction or deprivation of things
not in the ordinary course of business.
These losses shall be allowed as deductions
from gross income if actually sustained during
the taxable year and not compensated for by
insurance or other forms of indemnity.
 Kinds of Losses
Losses may be classified into three major
categories, namely:
1. Ordinary losses. These losses are usually
incurred in relation to trade, profession or
business, property used in business, profit-
seeking transaction incidental to business.
These are generally deductible from gross
income.
 Kinds of Losses
2. Capital losses. They are losses incurred in
relation to capital asset transactions. Capital
assets are resources not used in business. As
a rule, capital losses are deductible only from
capital gains.
Examples of capital losses are:
a. Losses from sale or exchanges of capital
assets
b. Losses from short sales of property
 Kinds of Losses
c. Losses arising from securities becoming
worthless, provided that the securities are
not ordinary assets
d. Losses due to failure to exercise privileges or
option to buy or sell property
3. Special kinds of losses. These are losses
incurred not related to ordinary business
transactions or capital assets transactions.
 Kinds of Losses
Examples of these losses are:
a. Losses from sales or exchange of property
between related taxpayers
b. Wagering losses
c. Losses due to voluntary removal of property
such as building, machinery, etc.
d. Losses of useful value of capital assets due to
some change in business conditions.
 Requisites for Deductibility of
Ordinary Losses
The following requisites should be met for ordinary
losses to be deductible from gross business income:
1. The loss must be actually sustained in a closed and
completed transaction;
2. The loss must be that of the taxpayer and incurred
in trade, profession or business;
3. The loss must not be compensated by insurance or
other forms of indemnity; and
4. The loss must be reported to the BIR from 30 days
to 90 days from the date of its discovery.
 Losses Not Allowed by
Law as Deductions
Some losses prohibited by the law as deductions from
gross income are:
1. Loss on voluntary removal of building on land
purchased with a view' to erect another building
2. Gambling losses not covered by gambling gains
3. Capital loss not covered by capital gains
4. Losses from exchanges of property in corporate
readjustments
5. Losses from illegal transactions
 Losses Not Allowed by
Law as Deductions
6. Losses from exchanges of property where the
property received is not substantially different from
the property disposed of
7. Losses not incurred in trade, profession or business
or in any transaction entered into for profit
8. Losses from sales or exchanges of property
between related taxpayers
 Classification of Deductible Losses
The following are deductible losses, assuming that the
requisites for deduction of losses are complied with:
1. Business losses such as losses incurred in trade or
profession;
2. Casualty losses such as losses due to storms, fires,
shipwreck or other casualties of property connected
with profession, trade or business;
3. Losses of business property due to theft, robbery or
embezzlement;
 Illustration
Swan Enterprises incurred the following losses for the
year 2016:
a. Building razed by fire, costing 5,000,000;
accumulated depreciation 3,000,000, insurance
payment received 1,600,000, salvage value 250,000.
b. Loss of 50,000 due to cash shortage embezzled by
the cashier who absconded.
c. Loss on robbery of computers costing 70,000;
accumulated depreciation, 25,000, insurance
recovered 25,000.
Illustration
 Partial Loss
If the loss is partial, the deductible loss is the lower
amount of replacement cost of the damaged portion or
the book value of the asset. At the time of loss, such
amount shall be reduced by the amount of insurance
recovery.
Illustration
Lesley Inc. sustained fire loss on its machine in 2016.
The machine, however, is partially damaged. Lesley
spent 90,000 for major repair. Prior to fire, documents
reveal that the machine had an acquisition cost of
300,000 and accumulated depreciation of 180,000.
 Illustration
Replacement cost 90,000
Compare with book value:
Acquisition cost 300,000
Less: Accumulated depreciation 180,000 120,000
Deductible loss (replacement cost, lower) 90,000
Any amount received as a loss recovery from insurance company
shall reduce the deductible loss. Thus, if Lesley received 50,000
as insurance recovery, the deductible loss would only be 40,000,
computed as follows:
 Illustration
Replacement cost 90,000
Less: Insurance Recovery 50,000
Deductible loss 40,000
Losses between Related Taxpayers
As a rule, gains in transactions between related
taxpayers are taxable, but losses incurred from
transactions between members of the family are not
deductible.
The law intends to prevent tax evasion by taxpayers
who take advantage of the deduction for losses by
means of purported or simulated sales or exchanges to
members of their families, controlled or in trust.
Losses between Related Taxpayers
The law presumes that the transactions between these
persons are devoid of free bargain between the buyer
and the seller, an one party might dictate on the terms
and conditions of the salt: or exchange. Furthermore,
losses due to related party transactions might have
been fabricated in order to evade payment of income
taxes.
 Gambling Losses
As a rule, gambling losses can only be deducted from
gambling winnings. They are not allowed as deductions
from business income, compensation income or even
from gains from sale of capital assets.
Illustration
Mr. Suga Lero provided the following data during a
taxable year:
 Gambling Losses
Compensation income 300,000
Business income 180,000
Gambling gains 20,000
Personal expenses 200,000
Business expenses 100,000
Gambling expenses 80,000
 Gambling Losses
The taxable income before personal exemptions of Mr.
Lero is:
Business income 180,000
Less: Business expenses 100,000
Income from business 80,000
Add: Compensation income 300,000
Total Income 380,000
Gambling gains 20,000
Less: Gambling losses 80,000 0
Taxable income before personal exemptions 380,000
 Losses from Theft or
Embezzlement
Lossses from theft or embezzlement of business
property not compensated with insurance
occurring in the year and discovered in another
year are deductible for the year in which these
were sustained.
Where the defalcation was committed and the
taxpayer had no means of determining the
actual date of the embezzlement, the IDSS is
deductible on the year of discovery.
 Losses from Theft or
Embezzlement
When the loss is caused by embezzlement of funds
by a known person, the loss sustained is not
deductible on the year of commission or discovery,
but in the year when the right of recovery becomes
worthless.
Illustration
Assume that Star Corporation employs a treasurer,
Mr. Na Cao, with a cash bond of 50,000. In 2016,
Star lost 500,000 from its treasury. Mow much loss
would be deductible in 2016 if the 500,000 was:
 Losses from Theft or
Embezzlement
(a) stolen by a theft?
(b) embezzled by the Mr. Cao?
If the 500,000 was stolen by a theft (unknown) to
the Star, the entire 500,000 can be deducted as a
loss in 2016.
On the other hand, if Mr. Cao was proven to have
stolen the 500,000, Star cannot immediately deduct
a loss in 2016, unless Mr. Cao abandoned his job.
 Losses from Theft or
Embezzlement
Assume that Mr. Cao abandoned his job in 2017,
and despite the reasonable effort of the company
and policemen to find him he cannot be found
anymore. In this case, Star can now deduct a loss
from embezzlement reduced by cash bond or
insurance recovery.
Receivable from the treasurer 500,000
Less: Cash bond recovery 50,000
Deductible loss in 2017 450,000
 Mortgage Losses
When a mortgage property is foreclosed and
subsequently purchased by the mortgagee, the
difference between the purchase price and the
unpaid indebtedness is not allowable as
deduction from bad debts. The loss arising from
mortgage foreclose is deferred until the
property foreclosed has been disposed of.
Accordingly, the loss on mortgage is determined
upon sale of the property by the mortgagee.
 Mortgage Losses
Illustration
In 2015, Mr. Hullier, a creditor, lent 200,000
payable in 2016, with a mortgage of property of
his debtor Mr. Utangin. Mr Utangin became
insolvent in 2016 and could not pay the
200,000. Mr. Hullier foreclosed the mortgaged
property. It was awarded to him as a highest
bidder for during a public auction in 2016. How
much loss can Mr. Hullier deduct in 2016?
 Mortgage Losses
Illustration
No loss is allowed as deduction in 2016. Mr.
Hullier cannot deduct a mortgage loss in 2016
because the property is not yet sold to a third
party.
If Mr. Hullier decided to keep the property for
himself, it becomes a purchase of property and
the 80,000 loss becomes part of the cost of the
property acquired.
 Mortgage Losses
Illustration
On the other hand, if Mr. Hullier sold the
property in 2018 for 150,000, the amount of
deductible loss on the sale of property mortgage
would be 50,000, computed as follows:
Receivable 200,000
Less: Realized amount from
sale of property 150,000
Deductible loss in 2018 50,000
 Losses due to Voluntary
Removal of Property
The following rules should be observed when it comes to losses
incurred due to voluntary removal of property:
1. As incidents to renewal and replacements. Losses due to
voluntary removal of property such as building, machinery,
and other similar assets, incident to renewals and
replacements, will be deductible from gross income.
2. As cost to remove useless structure in the real property
acquired. When a taxpayer buys real estate upon which a
building is located which he proceeds to raze with a view to
erecting thereon another building, the cost of removing the
structure is not a deductible expense from gross income,
instead, such cost will be added as part of the cost of the
acquired land.
 Losses due to Voluntary
Removal of Property
Illustration #1
Solo Mona is engaged in water delivery business. He has a
second hand delivery truck which he purchased for 60,000. He
estimated the truck’s useful life to be five (5) years. After three
(3) years, however, due to inefficiency and constant repairs, he
sold the truck for 20,000 to replace it with a better one.
 Losses due to Voluntary
Removal of Property
Illustration #1
The deductible loss due to replacement would be:
Acquisition cost of the delivery truck 60,000
Less: Accumulated depreciation for three (3) years
(60,000/5) x 3 years 36,000
Book value of the delivery truck 24,000
Less: Sales proceeds 20,000
Deductible loss due to replacement 4,000
 Losses due to Voluntary
Removal of Property
Illustration #2
Wina Wala acquired house and lot for a 900,000 lump
sum price. The acquisition of the property is intended
to make the lot available for the construction of a
factory building. Wala incurred 100,000 in demolishing
the house to give way to the construction of the factory
building.
The 100,000 cost of demolition is not allowed as
deduction from Wala’s business gross income. Such loss
shall be charged to the cost of the land. Accordingly,
the cost of the land would be 1,000,000.
 Losses due to Shrinkage in
Value of Stocks
Decline in value through market fluctuation of
investments in stocks of a corporation is not a
deductible loss. To be deductible, the loss must
be actually suffered when the stock is disposed
of.
Illustration
Lomi Liit invested in A Corporation’s common
stocks for 100,000. At balance sheet date, Liit’s
investment had market value of 75,000.
 Losses due to Shrinkage in
Value of Stocks
The 25,000 shrinkage in value of stocks is not a
deductible loss, unless the common stocks were
actually sold for 75,000 in which case, the loss is
deductible only against any capital gains.
 Losses of Useful Value
Generally, assets may lose their useful value due
to:
1. Technological changes which make operation
more expensive and the assets impractical to
use.
2. New legislation which makes the continued
profitable use of the property impossible.
 Losses of Useful Value
Losses of value of assets are not deductible from
gross income except when the asset involves
building and machineries that arc permanently
abandoned. Any loss to be deductible under this
exception must be charged off in the books and
fully explained in returns of income.
 Losses of Useful Value
Illustration
Acer Company uses a computer with an
acquisition cost of 100,000. The estimated life of
the computer is 5 years with a salvage value of
10,000. After a year, Acer updated the computer
to improve its performance spending a capital
outlay of 20,000. In the third year, Acer decided
to permanently abandon the use of such
computer due to technological changes.
 Losses of Useful Value
Illustration
How much is the deductible loss?
Acquisition cost of the machine 100,000
Cost of improvements 20,000
Total 120,000
Less: Accumulated depreciation
First year: (100,000 - 10,000)/5 18,000
Second and third years: (18,000 x 2) 36,000
(20,000/4) x 2 10,000 64,000
Book value 56,000
Less: Salvage value 10,000
Deductible loss 46,000
 Abandonment of
Petroleum Operation
If a contract area where petroleum operations are
undertaken is partially or wholly abandoned, the
following rules shall be observed:
1. All accumulated exploration and development
expenditures are allowed as deduction.
2. However, accumulated expenditures incurred in
that area prior to January 1, 1979 shall be allowed
as deduction only from any income derived from
the same contract area.
 Abandonment of
Petroleum Operation
3. In all cases, notices of abandonment shall be filed
with the BIR Commissioner.
If a producing well is subsequently abandoned, the
following rules shall be applied:
a. The unamortized cost thereof, including the
undepreciated costs of equipment directly used
therein, shall be allowed as a deduction in the year
such well, equipment or facility is abandoned.
 Abandonment of
Petroleum Operation
b. If such abandoned well is reentered and production
is resumed, or if such equipment or facility is
restored into service, the said costs shall be
included as part of gross income in the year of
resumption or restoration and shall be amortized or
depreciated, as the case may be.
 Abandonment of
Petroleum Operation
Illustration
In 2007, Calpetshell Oil Corporation has a business
income of 10,000,000, but it decided to abandon an oil
equipment with a remaining book value of 300,000.
In 2010, Calpetshell decided to reuse the said oil
equipment. Its remaining useful life is 5 years. The
following additional data are available for the taxable
year 2010:
 Abandonment of
Petroleum Operation
Illustration
Business income 10,000,000
Expenses, before depreciation of
reused equipment 4,140,000
How much is the deductible loss in 2007, and how
much is the taxable income in 2010?
The deductible loss in 2007 would be 300,000, the
book value of the abandoned oil equipment.
 Abandonment of
Petroleum Operation
Illustration
The taxable income in 2010 would be 5,800,000, computed as
follows:
Business income 10,000,000
Add: Book value of the reused equipment 300,000
Total 10,300,000
Less: Operating expenses 4,140,000
Depreciation of reuse equipment
(300,000/5) 60,000 4,200,000
Taxable income - 2010 6,100,000
 Losses from Farming
As a rule, losses incurred in the operation of farm as
business enterprise are deductible from gross income.
Section 100 of the Revenue Regulation No. 2 provides
the following guidelines:
Nondeductible Loss
No Deduction is allowed in the following farm losses:
1. Shrinkage in weight or physical value due to
deterioration of farm products, except if such
shrinkage is reflected in an inventory in determining
profits.
 Losses from Farming
2. Total casualty losses of prospective crops. (Casualty
losses may be brought by storm, flood, or fire.)
3. Value of animals that perish from among those raised
on the farm, except when such loss is reflected in
inventory.
4. If gross income is ascertained by inventories, no
deduction can be made for livestock or products lost
during the year, whether purchased for resale, or
produced on the farm, as such losses will be reflected in
the inventory by reducing the amount of livestock or
products on hand at the close of the year.
 Deductible Loss
The guidelines in order that farm losses may be
deductible are as follows:
1. If an individual owns and operates a farm in
addition to being engaged in another trade,
business, or calling, and sustains a loss from
such operation of the farm, then the amount
of loss sustained may be deducted from gross
income received from all sources, provided
the farm is not operated for recreation
purposes.
 Deductible Loss
2. If livestock has been purchased for any
purpose, and afterwards dies from disease,
exposure, or injury, or is killed by order of the
authorities, the actual purchase price of such
stock, less any depreciation allowable as a
deduction in computing net income, with
respect to such perished livestock, and also
any insurance or indemnity recovered, may
be deductible.
 Deductible Loss
3. The actual cost of other property (with
proper adjustment for depreciation), which is
destroyed by order of the authorities, may in
like manner be claimed as a loss; but if
reimbursement is made in whole or in part
on account of stock killed or property
destroyed, the amount received shall be
reported as income for the year in which
reimbursement is made.
 Deductible Loss
4. The cost of any feed, pasturage, or care
which has been deducted as an expense of
operation shall not be included as part of the
cost of the stock for the purpose of
ascertaining the amount of a deductible loss.