RMC No. 81-2025: Reiterating the Criteria and Guidelines on the Deductibility of Ordinary and Necessary Expenses Under Section 34(A)(1)(a) of the National Internal Revenue Code of 1997, as Amended

Key points

1. Who may deduct. Deductions are allowed for citizens and resident aliens, non-resident aliens engaged in trade or business, members of general professional partnerships, domestic corporations, proprietary educational institutions and hospitals, GOCCs, and resident foreign corporations under Section 28(A)(1).
2. Four conditions. The expense must be ordinary and necessary, paid or incurred within the taxable year, and paid or incurred in carrying on, or directly attributable to, the trade, business or profession. It must also be supported by invoices, records or other pertinent papers.
3. Ordinary and reasonable. The taxpayer must prove the deduction with evidence, and mere allegation is not enough. An inordinately large expense is not ordinary even if necessary, and amounts must be reasonable. Costs of remitting funds to an overseas head office are not deductible.
4. Active and passive income. Expenses must be directly tied to income-generating activities, and expenses for passive income, such as investment management fees, may not qualify. Expenses solely for tax-exempt income, or for income under final withholding tax, are not deductible against regular taxable income. Expenses for preferentially taxed income must be segregated.
5. Taxable year. Under Section 45, deductions are taken for the taxable year in which paid, accrued or incurred, depending on the accounting method, unless a different period is needed to clearly reflect income.
6. 5% SCIT enterprises. For IPA-registered enterprises on the five percent (5%) special corporate income tax under Section 294(B), gross income earned is gross sales or revenues net of sales discounts, returns, allowances and direct production costs. Indirect operating expenses such as advertising, representation, entertainment and commissions are not deductible for this purpose.

Who is affected

• Taxpayers claiming deductions under Section 34(A)(1)(a)
• Enterprises registered with Investment Promotion Agencies on the 5% SCIT