Reasonable criteria for deductibility

Revenue Memorandum Circular No. 81-2025 was issued to reiterate guidelines on the deductibility of expenses under the Tax Code, and lists the following criteria: it must be ordinary and necessary; paid or incurred within the taxable year; paid or incurred in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business, or exercise of a profession; and, supported by invoices, records, or other pertinent papers.

A circular is an administrative issuance. It is not a law and is not binding precedent. In fact, the Tax Code does not strictly limit the definition of the words “ordinary” and “necessary.” A circumspect approach should be observed in understanding RMC 81-2025. While the guidelines refer to decisions of the Supreme Court, it must be considered that judicial precedents only apply to situations of substantially the same factual background.

RMC 81-2025 states that an “ordinary expense” is one that is normal, usual, and customary in the type of business conducted by the taxpayer. It provides that the following are not ordinary expenses, and makes reference to decisions of the Supreme Court:

1. Inordinately large expenses. The circular refers to a 2003 Supreme Court Decision (G.R. No. 143672, April 24, 2003) where the Bureau of Internal Revenue (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 BIR rejected the company’s assertion that the amount was justified given the economic situation during the time of the EDSA People Power Revolution. The Supreme Court affirmed the disallowance finding that the amount was almost half of the corporation’s total claimed marketing expenses, and almost double the amount of its general and administrative expenses.

2. Expenses that do not meet the “reasonableness in amount test.” The circular makes reference to a 1963 Supreme Court En Banc Decision (G.R. No. L-15290, May 31, 1963) where the BIR disallowed 50% of the promotion expenses claimed by a hotel owner. The Supreme Court En Banc held that the disallowance was fair considering there was no proof of connection to the business, or reasonableness of the amount, and since a dollar allocation form disclosed that the funds were actually used by the hotel owner’s wife for combined “medical and business reasons.”

3. Extraordinary and unusual amounts that have no relation to the measure of actual services. The circular makes reference to a 1982 Supreme Court Case (G.R. No. L-29790, Feb. 25, 1982) involving an “Officer’s Remuneration” in the sale of the company’s property. The Supreme Court observed that the company had no basis to grant the bonus considering the officer did not perform any service, and evidence showed that the sale was already effected by a broker who received commission.

RMC 81-2025 also states that a “necessary expense” as one that is appropriate and helpful to the development of the taxpayer’s business, and implies that the expense should be directly connected and proximately resulting from carrying on the business and must contribute to the generation of income or profit or minimizing a loss. RMC 81-2025 adds that “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” and makes reference to a 1989 Supreme Court Case (G.R. Nos. L-28508-9, July 7, 1989) which involved the disallowance of “margin fees” claimed as expenses that were paid by a local company to Central Bank of the Philippines to remit profit to its New York Head Office. The local company raised that these are necessary and ordinary expenditure for the conduct of its corporate affairs. The Supreme Court rejected the local company’s argument for 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 circular further states that “mere allegations of the taxpayer that an item of expense is ordinary and necessary,” does not justify its deduction as business expense. This sentence is lifted from a 1981 Supreme Court Decision involving a mining company (G.R. No. L-26911, Jan. 27, 1981) which referred to a 1967 Supreme Court En Banc Decision (G.R. No. L-22492, Sept. 5, 1967) where “Miscellaneous expenses” and “Officer’s traveling expenses” were disallowed by the BIR because they could not be satisfactorily explained nor supported by papers. The Supreme Court En Banc sustained the deduction. The Court considered the testimony of the company’s accountant that actual expenses were credited to the account of the president incurred in the interest of the corporation during his trip to Manila, and that the vouchers and receipts were burned during the Basilan Fire on March 30, 1962. The Supreme Court En Banc also found that the obligation of the company to keep the vouchers and receipts under the Tax Code had already lapsed by the time of the tax investigation.

Indeed, while the Tax Code does not define the words “ordinary” and “necessary,” Section 34(A) uniformly qualifies it with the words “reasonable allowance.” As there is no hard and fast rule in determining “reasonable,” case law reveals that other factors, such as: the nature, type, and size of business in which the taxpayer is engaged, the volume and amount of its net earnings, the nature of the expenditure itself, the intention of the taxpayer, the political and economic conditions of existing time, adequate evidence presented to substantiate the necessity of the expense, and defenses attendant to the taxpayer during the investigation, should be considered. It is the interplay of these, among other factors and properly weighed, that will yield a reasonable evaluation.

The views and opinions expressed in this article are those of the author. This article is for general information and educational purposes, and not offered as, and does not constitute, legal advice or legal opinion.

Jacqueline Ann A. Tan is the monitor of the Tax Department and a partner in the Angara Abello Concepcion Regala & Cruz Law Offices.