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

BUREAU OF INTERNAL REVENUE REPUBLIC OF THE PHILIPPINES DEPARTMENT OF FINANCE

Bringing In Revenues for Nation-Building SEP 0 3 -2025 PILIPINAS BAGONG

REVENUE MEMORANDUM CIRCULAR NO 081-2025

SUBJECT : 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.

TO : All Internal Revenue Officers and Others Concerned

BACKGROUND

Section 34(A)(1)(a) of the National Internal Revenue Code of 1997, as amended (Tax Code)

directly attributable to the development, management, operation and/or conduct of trade, business or exercise of profession shall be allowed as deduction from gross income, to wit: provides that ordinary and necessary expenses paid or incurred during the taxable year which are "Section 34. Deductions from Gross Income. -- xxx N WHes:b

(A) Expenses. SLO2 8 0dOS

B (1) Ordinary and Necessary Trade, Business or Professional Expenses.

(a) In General. - There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly S attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession... xxx

Under the above provision and Section 65 of Revenue Regulations No. 2-40, for an expense to be deductible from a taxpayer's gross income, it must be both "ordinary" and "necessary" in the operation of the trade, business, or exercise of a profession.

This Circular is issued to reiterate the criteria and guidelines under which business expenses

cited rulings and principles provide a comprehensive framework for determining the deductibility can be considered deductible for tax purposes, emphasizing the requirement that such expenses must be "ordinary" and "necessary" in accordance with Section 34(A)(1)(a) of the Tax Code. The

of business expenses, essential for accurately reflecting the taxable income of the organizations. trades or businesses.

BIR National Office Bldg., Senator Miriam Defensor-Santiago Avenue, Diliman, Quezon City Trunkline: 8981-7000 ; 8929-7676 Website: www.bir.gov.ph

. PERSONS ENTITLED TO DEDUCTION UNDER SECTION 34 OF THE TAX

CODE

Section 34 of the Tax Code on deductions from Gross Income, clearly provides that in computing taxable income subject to income tax, deductions are permitted only for the following:

1. Individuals who are citizens or resident aliens under Section 24(A) of the Tax Code;

Non-resident aliens engaged in trade or business in the Philippines under Section 25(A) of the Tax Code; 3 Members of general professional partnerships under Section 26 of the Tax Code; 4. Domestic corporations under Section 27(A) of the Tax Code; 5. Proprietary educational institutions and hospitals under Section 27(B) of the Tax

6. Government-owned and controlled corporations (GOCCs) under Section 27(C) Code;

7. Resident foreign corporations under Section 28(A)(1) of the Tax Code. of the Tax Code; and

III. CRITERIA FOR DEDUCTIBILITY

following conditions must be met: In order for a business expense may be allowed as deductions from gross income, the

1. the expense must be ordinary and necessary:

the expense must be paid or incurred within the taxable year;

OMIN SEP 0 3 2025 S FAINEMEN REN RURBAD 3 the expense must be supported by invoices, records or other pertinent papers.? the expense must have been paid or incurred in carrying on or which are directly business or exercise of a profession; and attributable to, the development, management, operation and/or conduct of the trade.

UNI e A The expenses must be ordinary and necessary

:Com ME B C for the business) from their gross income to determine their taxable income. For this (common and accepted in the trade or business) and "necessary" (appropriate and helpful purpose, ordinary and necessary expenses are defined as follows: Taxpayers are allowed to deduct business expenses that are both "ordinary

or recurring but should be common in the context of the business. The term "ordinary" denotes that the expense must be typical and usual in relation to the business activities. customary in the type of business conducted by the taxpayer. It does not need to be habitual Ordinary Expenses -- An "ordinary expense" is one that is normal, usual and

for the development of the taxpayer's business. This implies that the expense should be Necessary Expenses -- A "necessary expense" is one that is appropriate and helpful

Isabela Cultural Corp., G.R. No. 172231, 12 February 2007. September 2016; Atlas Consolidated Mining and Development Corporation v. CIR, 102 SCRA 246; CIR v. 2 H. Tambunting Pawnshop, Inc. v. CIR, G.R. No. 173373, 29 July 2013, 702 Phil 397-417, 715 SCRA 386-404. 1 Pilmico-Mauri Foods Corp. v. Commissioner of Internal Revenue (CIR), G.R. No. 175651 (Resolution), 14

directly connected and proximately resulting from carrying on the business and must contribute to the generation of income or profit or minimizing a loss.

The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction as business expense.4 The taxpayer must

allowed under the existing laws, rules and regulations, otherwise, the same will be substantially prove by evidence or records (i.e., invoices) that the deductions claimed are

disallowed.

Rules on Ordinary Expenses

As settled in various court cases, not all expenses, even if deemed necessary. qualify as ordinary. An expense that is inordinately large cannot be considered as an ordinary expense even if it is necessary. If an expense nearly equaled half of the total claimed expenses, it may be considered as inordinately large and, thus, could not be considered "ordinary," even if it might be "necessary" for the business's marketing strategy. Hence, in determining whether a particular expense is

Concomitantly, for an expense to be considered ordinary, they must be ordinary and ordinary, the size and relative proportion of expenses must be considered.

necessary expenses paid or incurred in carrying on any trade or business, and should meet the further test of reasonableness in amount.?

juridical) as compensation for their supposed services, but without any relation to the measure of their actual services, cannot be regarded as ordinary and necessary Further, extraordinary and unusual amounts paid to persons (natural or

the law of taxation that a taxpayer must show that its claimed deduction clearly expenses within the meaning of the law. This posture is in line with the doctrine in

of legislative grace.' As such, they must be strictly construed against the taxpayer. come within the language of the law since allowances, like exemptions, are matters

2. Rules on Necessary Expenses

office, are not deductible.1 It is important that the expense is necessary or integral Philippines, such as costs incurred for the remittance of funds to an overseas head to the income-generating activities of the business. Claims for deductions are a Expenditures not directly related to the earnings of the business within the

matter of legislative grace and do not turn on mere equitable considerations. The taxpayer in every instance has the burden of justifying the allowance of any deduction claimed..

BUrEAU OF InTERNAL RECORDS MANAGEMENT DIVISION LREVENUE

6 CIR v. General Foods (Phils.), Inc., G.R. No. 143672, April 24, 2003 4 Atlas Consolidated Mining and Development Corporation v. CIR, 102 SCRA 246 7 Zamora v. CIR, G.R. No. L-15290, L-15280, L-15289, L-15281, May 31, 1963. General Foods (Philippines), Inc. v. CIR, CTA Case No. 4386, February 8, 1994 Id SEP 0 3 2025 ADMINUNIT.I iAAC q'sbrm

I1 Merten's, Law of Federal Income Taxation, Section 25.03. Aguinaldo Industries Corp. v. CIR, G.R. No. L-29790, February 25, 1982. : Aguinaldo Industries Corp. v. CIR, G.R. No. L-29790, February 25, 1982. 1 Esso Standard Eastern, Inc. v. CIR, G.R. Nos. L-28508-9, July 7, 1989.

B. The expenses must be paid or incurred within the taxable year

be taken for the taxable year in which 'paid or accrued' or 'paid or incurred', dependent upon Section 45 of the Tax Code states that "the deductions provided for in this title shall

the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income, the deductions should be taken as of a different period."

paid or incurred within the taxable year when the corresponding revenue is earned. The term "taxable year" is defined under Sections 22(P) and 52(B) of the Tax Code as either the Therefore, the deductible business expenses claimed must be for expenses that are

calendar year or the fiscal year, upon the basis of which the net income is computed. This

income is generated, which is consistent with the matching principle under the Generally criterion guarantees that the expense is directly linked to the particular period during which

Accepted Accounting Principles.

C. The expenses must be directly attributable to trade, business, or profession

The expense must be paid or incurred in connection with the development.

that there should be a direct link between the expense being deducted and the taxpayer's business activities. management, operation, and/or conduct of the trade, business, or profession. This means

1 E P0 32025 C ANTERMEN REA 3 $ to the development, management, operation, and/or conduct of the trade, business, or continuity, or sustained activity. "Engaged in business" means occupied or employed in profession, ensuring they are essential for maintaining and generating business income.13 This provision is intended to ensure that only expenditures that are directly tied to the development, management, operation and the ongoing activities of the business are deductible, thereby providing a fair and accurate representation of the taxable profit of the business; "carrying on business" does not mean the performance of a single disconnected act, but means conducting, prosecuting, and continuing business by performing progressively all the acts normally incident thereto; while "doing business" conveys the idea of business being done, not from time to time, but all the time.12 business not have different meanings, but separately or connectedly convey the idea of progression. The phrases "engage in business," "carrying on business" or "doing business" do "Directly attributable" means the expenses must have a clear and direct connection

activities. Active incomel4 typically arises from the direct involvement (active pursuit) in determining which expenses qualify as valid deductions under the "ordinary and necessary' provisions requires careful consideration of their direct connection to income-generating When a taxpayer incurs expenses related to both active and passive income.

v. CIR, CTA EB Case Nos. 1563 & 1564 CTA Case No. 8813, September 18,2018 14 Active income - income in the active pursuit and performance of its primary purpose - Iconic Beverages, Inc. 12 Imperial v. Collector of Internal Revenue, G.R. No. L-7924, September 30, 1955. The term "directly" as defined in Black's Law Dictionary refers to something that is done without any to describe actions or relationships that occur without any intermediary. intervening agency or step; it is immediate and straightforward. This definition is often used in legal contexts

trade, business, or professional activities, while passive incomel5 comes from investments like dividends, interest, and royalties. Passive income is already subject to different rates

computation of gross income, which determines taxable income.16 Therefore, it is crucial and taxed finally at source, therefore, these incomes are no longer included in the

to segregate the expenses that are directly attributable to active business operations from those related to passive income generation.

MIN UNIT'ME c S SEP 0 32005 participation, such as interest, royalties, dividends, and capital gains, and is not subject to v. Bank of Commerce17 and Republic v. Spouses Bunsay18, where such income was taxed income arises from sources that do not require the taxpayer's continuous or direct key consideration is the level of the taxpaver 's involvement in earning the income. Passive Value-added Tax (VAT). This is affirmed in cases like Commissioner of Internal Revenue 12214 or the "Capital Markets Efficiency Promotion Act" and relevant jurisprudence, the In determining whether income is passive or active under Republic Act (RA) No.

4 separately due to its passive nature. In contrast, in the case of Iconic Beverages, Inc. vs. g S t O Commissioner of Internal Revenuel9, it clarifies that active income results from the

m active if the taxpayer repeatedly and systematically engages in activities that produce such taxpayer's active pursuit of its primary business or trade. A passive income can become

income, transforming it into a business venture. Likewise, income typically considered active may be treated as passive if it is earned occasionally or without any substantial or recurring effort. Ultimately, classification hinges on whether the income results from habitual, business-driven actions or from merely holding assets and earning returns

in the income-producing activity are the main considerations in classifying income as without substantial participation. Thus, the degree, frequency, and intent of participation

passive or active.

Expenses directly tied to the development, management, operation, or conduct of active trade or business can be deducted as they meet the criteria of being ordinary and necessary. However, expenses related to managing investments that generate passive income, such as fees for financial advice, interest from loan to finance investments, or brokerage services, and other related expenses may not qualify under the same provision, as they do not relate directly to the taxpayer's active business operations.

43 of the Tax Code demands that income be computed annually using a method that clearly tax-exempt, or final tax, should have its expenses correctly identified. Furthermore, Section Moreover, each income stream, whether subject to regular tax, preferential rates,

reflects the income. Non-compliance with these rules may lead to reclassification of expenses and potential disallowance if they are not directly tied to the development management, operation and/or business activities, ensuring fairness and transparency in tax reporting.

673-693; Capital Gains tax [CGT] is a tax on passive income- Republic v. Spouses Bunsay, G.R. No. 205473, 1s Republic of The Philippines vs. Spouses Marcelino Bunsay and Nenita Bunsay, G.R. No. 205473, December 17 CIR vs. Bank of Commerce, G.R. No. 149636, June 8, 2005. 19 Iconic Beverages, Inc. vs. CIR, CTA Case No. 8607, August 14, 2015. I5 Passive Income -The subject matter of the FWT is the passive income generated in the form of interest on deposits and yield on deposit substitutes- CIR v. Bank of Commerce, G.R. No. 149636, June 8, 2005, 498 PHIL 16 CIR vs. Philippine Airlines, Inc., G.R. No. 160528, October 9, 2006. December 10, 2019. 10, 2019.

D. Substantiation

The taxpayer must substantially prove by evidence or records the deductions claimed under the law, otherwise, the same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction.2c Pieces of evidence, such as official invoices and vouchers, must be presented to substantiate the business expenses.21

juris against the taxpayer and liberally in favor of the taxing authority; and one who claims an It is a governing principle in taxation that tax exemptions must be construed in strictissimi

exemption must be able to justify the same by the clearest grant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon vague implications. And

also be strictly construed.22 since a deduction for income tax purposes partakes of the nature of a tax exemption, then it must

IV. TAX TREATMENT OF EXPENSES PERTAINING TO TAX-EXEMPT INCOME

income tax purposes. Allowing deductions for expenses that produce tax-exempt income would Expenses solely incurred in relation to tax-exempt income are not deductible for regular

effectively give the taxpayer a double benefit - the income is exempt from tax, and the expenses reduce taxable income from other sources. Business expenses related to tax-exempt income do not contribute to the generation of taxable income and therefore do not meet the criteria of being necessary for the conduct of the business in the pursuit of income.2?

Accordingly, if a taxpayer incurs expenses solely to generate tax-exempt income, these expenses cannot be deducted from its regular taxable income.

V. TAX TREATMENT OF EXPENSES PERTAINING TO INCOME SUBJECT TO|

FINAL WITHHOLDING TAX

is considered the final tax liability on that income. Examples include interest from savings accounts or dividends from stocks, where the financial institution or the payor withholds a flat tax rate. The Income subject to final withholding tax is typically taxed at the source, and the tax withheld

expenses solely related to generating this income are usually not deductible against other taxable income subject to regular income tax. Since this passive income has already been taxed at a final rate, allowing further deductions would distort the taxation principle that final withholding tax is comprehensive and conclusive. Thus, costs related to investment management do not qualify for deductions typically reserved for business operations. RECORDS MANAGEMENT DIVISION BUREAU OF INTERNAL REVENUE

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23 Citytrust Banking Corporation vs. CIR, CTA Case No. 526 1, January 28, 1998. 21 H. Tambunting Pawnshop, Inc. v. CIR, supra; First Lepanto Taisho Insurance Corporation v. CIR, G.R. No. 22 CIR v. Isabela Cultural Corp., G.R. No. 172231, 12 February 2007. 20 Pilmico-Mauri Foods Corp., Petitioner, v. CIR, G.R. No. 175651, September 14, 2016. 197117, April 10, 2013

VI. TAX TREATMENT OF EXPENSES PERTAINING TO INCOME SUBJECT TO

PREFERENTIAL TAX RATE

specific incentives or under special laws, these expenses must be carefully segregated from those When expenses are directly attributable to income subject to a preferential tax rate due to

subject income. The primary reason for this segregation is to ensure that the expenses directly tied to the preferentially taxed income are not deducted from the regular taxable income, thereby preventing any reduction to regular taxable in the tax base of the regular income. This segregation helps in maintaining the integrity of the tax system and ensures that the benefits of preferential tax rates are not improperly extended to regular income.

income earned, in lieu of all national and local taxes, under Section 294(B) of the Tax Code, the availing of the five percent (5%) special corporate income tax (SCIT) incentive based on its gross For business enterprises registered with Investment Promotion Agencies and whose

and direct costs related to production of goods/services. Indirect operating expenses like advertising, representation. entertainment, commissions, clinic and office supplies, as well as "gross income earned" refers to gross sales/revenues net of sales discounts, returns, allowances,

disallowed as deductions for this purpose. 24 Section 1(b), Rule 2 of the Implementing Rules and Regulations of RA No. 12066 provides for the list of direct costs for purposes of determining the freight and handling costs unrelated to production, which did not qualify as direct costs are gross income of businesses under the five percent (5%) SCIT incentive.

amended, modified or revoked accordingly. All revenue issuances and BIR rulings inconsistent herewith are hereby considered

All concerned are hereby enjoined to be guided accordingly and to give this Circular as wide a publicity as possible.

This Circular takes effect immediately

Ro MEO Y.LUMAGUI, JR 2 pmissioner of Internal Revenue

K1 - MMC

BUREAU OFINTERNALREVENU RECORDS MANAGEMENT DIVISION

O

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3Y ADMIN UNIT TIME: g:sDA

24 CS Garments, Inc. v. CIR, C.T.A. EB Case No. 287 (CTA Case No. 6520), January 14, 2008.