Business expense v. capital expenses
Business expenses refer to 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 the exercise of a profession.
Capital expenses are
expenditures for extraordinary repairs which are capitalized and subject to depreciation. These are expenses which tend to increase the value or prolong the life of the taxpayer’s property.
Ordinary and necessary expenses
An expense is ordinary when it is commonly incurred in the trade or business of the taxpayer as distinguished from capital expenditures. The payments, however, need not be normal or habitual in the sense that the taxpayer will have to make them often. The payment may be unique or non-recurring to the particular taxpayer affected. An expense is necessary when it
is appropriate and helpful to the taxpayer’s business or if it is intended to realize a profit or to minimize a loss.
Requisites for deductibility of business expense
1. The expenses must be ordinary and necessary.
2. It must be paid or incurred during the taxable year.
3. It must be paid or incurred in carrying on any trade or business or profession.
4. It must be reasonable in amount. 5. It must be substantiated by
sufficient evidence such as official receipts and other official records.
6. It must not be against law, morals, public policy or public order.
Substantiation requirement for business expense
Taxpayer need to substantiate with sufficient evidence, such as official receipts or other adequate records:
1. the amount of the expense being deducted; and
2. the direct connection or relation of the expense being deducted to the development,
management, operation and/or conduct of the
trade, business or
profession of the taxpayer.
What are included in business expenses?
Business expenses include:
1. Salaries, wages and other forms of compensation for personal services actually rendered, including the grossed-up monetary value of fringe benefit granted provided the fringe benefit tax has been paid.
2. Travel expenses, here and abroad, while away from home.
3. Rentals and/or other payments of property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor.
4. Entertainment,
amusement and recreation expenses.
Requisites for deductibility of compensation payments
1. The payments are reasonable. 2. They are, in fact, payments for
personal services actually rendered. [Section 70, Revenue Regulation 2]
Treatment of excessive
compensation
In the case of excessive payments by corporations, if such payments correspond or bear a close relationship to stockholdings, and are found to be distribution of earnings or profits, the excessive payments will be treated as dividends. [Section 71, Revenue Regulations 2]
If such payments constitute payment for property, they should be treated by the payor as capital expenditure and by the recipient as part of the purchase price. [Section 71, Revenue Regulations 2]
Requisites for deductibility of bonuses to employees
1. The bonuses are made in good faith.
2. They are given for personal services actually rendered.
3. They do not exceed a reasonable compensation for the services rendered, when added to the stipulated salaries, measured by the amount and quality of services performed in relation to
the taxpayer’s business. [Section 72, Revenue Regulations 2]
In Kuenzle v. CIR [28 SCRA 365] and C.M. Hoskins v. CIR [30 SCRA 434], the Supreme Court disallowed deductions for bonuses given to the top officers of the involved corporations for being unreasonable.
Pensions and compensation for injuries
Amounts paid for pensions to retired employees or to their families or others dependent upon them, or on account of injuries received by the employee, and lump sum amounts paid or accrued as compensation for injuries are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise.
Rules on repairs
Expenses for repairs are deductible if such repairs are incidental or ordinary, that is, made to keep the property used in the trade or business of the taxpayer in an ordinarily efficient operating condition.
Repairs in the nature of replacement to the extent that they arrest deterioration and prolong the life of the property are capital expenditures and should be debited against the corresponding allowance for depreciation. [Section 68, Revenue Regulations 2]
Travel expenses
Travel expenses include
meals and lodging of an employee paid for by the employer. [Section 66, Revenue Regulations 2]
Requisites for deductibility of travel expenses
1. The expenses must be reasonable and necessary.
2. They must be incurred or paid “while away from home.”
3. They must be paid or incurred in the conduct of trade or business.
Tax home
Tax home is the principal place of business, when referring to “away from home.”
Rental expense
A reasonable allowance for rentals and/or other payments which are required as a condition for the continued use or possession, for purposes of the trade, business or property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor is deductible from the gross income.
Where a leasehold is acquired for business purposes for a specified sum, the purchaser may take as a deduction in his return an adequate part of such sum each year, based on the number of years the lease has to run.
Taxes paid by a tenant to or for a landlord for business property are additional rent and constitute a deductible rent to the tenant and taxable income to the landlord;
the amount of tax being deductible by the latter.
The cost borne by the lessee in erecting buildings or making permanent improvements on ground of which he is a lessee is held to be a capital investment and not deductible as a business expense.
Requisites for rental expense
1. Required as a condition for continued use or possession 2. For purposes of the trade,
business or profession
3. 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
Entertainment, amusement and recreation expense
1. Reasonable in amount
2. Incurred during the taxable period
3. Directly connected to the development, management, and operation of the trade, business, or profession of the taxpayer, or that are directly related to or in furtherance of the conduct of his or its trade, business or profession
4. Not to exceed such ceiling as the Secretary of Finance may, by rules and regulations, prescribe 5. Any expense incurred for
entertainment, amusement or recreation which is contrary to law, morals, public policy, or public order shall in no case be allowed as a deduction
Option to private educational institutions
In addition to the allowable deductions, a private educational institution may, at its option, elect either:
1. To deduct expenditures otherwise considered as
capital outlays of
depreciable assets incurred during the taxable year for the expansion of school facilities; or
2. To deduct allowance for depreciation thereof.
Treatment of other expenses
1. Advertising expense
Not deductible business expense. Efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures.
2. Promotional expenses
Same as advertising expense 3. Litigation expenses
Litigation expenses that are incurred in the defense or protection of title are capital in nature and not deductible.
In Gutierrez v. CIR [14 SCRA 34], it was held that litigation expenses defrayed by a taxpayer to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expenses in pursuing his business.