RMC No. 19-2024 — Clarifying the tax treatment of interest expense paid or incurred on indebtedness in connection with the taxpayer's profession, trade or business and other related matters Digest | Full Text | Annex A

BUREAU OF INTERNAL REVENUE REPUBLIC OF THE PHILIPPINES DEPARTMENT OF FINANCE Quezon City BUREAU OF TNTERNAL REVENUE RECords Mgt. diVisiON TLNNTYYR CGJ FEB o5 Z024 COnhNG 0 8 U}U

September 12, 2023

REVENUE MEMORANDUM CIRCULAR NO.IG- 2O 24

SUBJECT:: Clarifying the Tax Treatment of Interest Expense Paid or Incurred on

Indebtedness in Connection with the Taxpayer's Profession, Trade or Business and Other Related Matters

TO: All Internal Revenue Officials, Employees and Others Concerned

BACKGROUND AND SCOPE:

It has been observed that the differences in the treatment of interest expense in the

and the taxpayers. In view thereof, this Circular is being issued to assist the taxpayers in their financial statements and tax returns give rise to several issues and concerns for both the BIR

indebtedness in connection with the taxpayer's profession, trade or business and other related matters. reconciliation efforts by clarifying the tax treatment of interest expense paid or incurred on

I TABULAR LIST OF DIFFERENCES

Interest on arrangements Particulars borrowing expenseInterest is recognized as an expense using the effective interest method. Interests incurred attributable Accounting Treatment to directly the Interest can be claimed as a deduction, the criteria are met. Interest incurred to acquire property used subject to certain limitations, provided all Current Tax Treatment.

acquisition of a qualifying in trade, 'business or exercise of asset are capitalized as part profession may be recognized as an of the cost of the asset. as part of the cost of the property. expense in the year incurred or capitalized

Interest paid in Interest is recognized as an E Interest can be claimed as a deduction in. advance by the expense when incurred. the year the indebtedness is paid.

BI Teau oF Iterng basis taxpayer reporting income on cash IGA year shall be allowed as deduction in such taxable year. If the indebtedness is payable in periodic principal amortized or paid during the amortizations, the amount of interest which corresponds to the amount of the

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Particulars Accounting Treatment Current Tax Treatment Interest expense Interest expense s Interest expenseisnotdeductible

parties between on indebtedness related recorded when incurred. National Internal Revenue Code of 1997. as amended. pursuant to Section 34(B)(2)(b) of the

I. ACCOUNTING TREATMENT

Interest on Borrowing Arrangements

Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds [Philippine Accounting Standards (PAS) 23.5]. The Philippine Financial

method. Reporting Standards require that -interest expense be calculated using the effective interest

acquisition, construction or production of a qualifying asset as part of the cost of that asset. All PAs 23 requires entities to capitalize borrowing costs that are directly attributable to the

(PAS 23.1 and 23.8). other borrowing costs are recognized as an expense in the period in which they are incurred

PAS 23 defines a qualifying asset as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale (PAs 23.5). Accordingly, assets that are ready for their intended use or sale when acquired are not qualifying assets and are, therefore, not eligible for interest capitalization (PAS 23.7).

Capitalization of borrowing costs commences when all of the following conditions are met:

a) The entity incurs expenditures for the asset:

c) The entity undertakes activities that are necessary to prepare the asset for its intended b) The entity incurs borrowing costs; and use or sale (PAS 23.17).

The standard requires capitalization of borrowing costs to cease when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete

construction of the asset is compiete, even though routine administrative work might still (PAS 23.22). An asset is normally ready for its intended use or sale when the physical

continue (PAS 23.23).

When an entity suspends the activities necessary to prepare an asset for its intended use or sale. capitalization of borrowing costs should also be suspended during the periods in which active development is interrupted. (PAS 23.20 and 23.21).

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RECDRDS MGTDIVISION

HI.TAX TREATMENT

Q1: When can interest expense be claimed as a deduction from gross income?

A1: Interest paid or incurred within a taxable year on indebtedness in connection with the

taxpayer's profession, trade or business shall be allowed as a deduction from gross income, subject to certain limitations, when the following requisites, provided in

and as implemented by Revenue Regulations (RR) No. 13-2000 and Section 7(B) of Section 34 (B)(2) of the National Internal Revenue Code (NIRC) of 1997, as amended,

RR No. 5-2021, are met:

1. The indebtedness must be that of the taxpayer; 2. The interest must have been stipulated in writing: 3. The interest must be legally due: 4. The interest payment arrangement must not be between related taxpayers as

mandated in Sec. 34 (B)(2)(b), in relation to Sec. 36(B), both of the NIRC of 1997. as amended:

6. The interest was not treated as "capital expenditure" if such interest was incurred in 5. The interest must not be incurred to finance petroleum operations;

7. The interest shall be reduced by an amount equivalent to twenty percent (20%) of acquiring property used in trade, business or exercise of profession; and interest income subjected to final tax. However, if the final withholding tax rate on

reduction shall be adjusted accordingly. interest income of twenty percent (20%) will be adjusted in the future, the interest

In addition, the taxpayer must have withheld the appropriate tax in order to claim the interest expense as a deduction from the gross income (refer to Q9).

Q2: PAS 23 specifically provides that only borrowing costs directly attributable to "qualifying assets" shall be capitalized. For tax purposes, when shall interest

expense be allowed for capitalization?

A2: Only the interest expense directly attributable to the acquisition of any property

(e.g., building, car, and machinery) used in trade, business or exercise of profession

acquisition of a qualifying asset under PAS 23 may be capitalized for tax purposes only if the asset is used in trade, business or exercise of profession and not if it is intended may be capitalized for tax purposes. Hence, the interest expense incurred in the

for sale (e.g., inventories).

for tax purposes, the following shall apply: Should the taxpayer elect to capitalize the interest expense incurred to acquire property used in trade, business or exercise of profession, which may include a qualifying asset.

1. The option to capitalize interest expense shall be irrevocable per specific asset/property. BUREAU OF INTERNAL REVENUE RECORDS MGT.DIMSION RNTAITYTY FEB 05 2024 YCJ MAMG Q-0K 0 Page 3 of 7

2. If the loan covers the acquisition of several properties, the interest expense on such

loan shall be proportionately capitalized on such properties. For example, if the loan

3. If the loan pertains to general borrowings or covers the acquisition of an asset on such loan shall be proportionately capitalized between the car and machinery. was contracted for the acquisition of a car and machinery, then the interest expense

intended for sale such as inventories, only the interest expense incurred or paid from the general borrowings directly attributable to the acquisition of the asset/property property used in trade, business or exercise of profession and qualifying assets

used in trade, business or exercise of profession may be capitalized by the taxpayer subject to verification by the concerned BIR office upon audit of the taxpayer's tax return. Refer to Illustration A in Annex A.

NRERRAEREREERRREARRN tZO29O31 E If the interest expense is treated as a capital expenditure, the taxpayer may only If multiple loans were contracted for the acquisition of a single property used in shall be applied consistently with all the loans relating to the acquisition of such trade, business or exercise of profession, the option to capitalize interest expense property

C claim the periodic depreciation or amortization of such capital expenditure as a

C G depreciated or amortized based on the useful life of the asset. Generally. deduction from its gross income. The capitalized interest expense shall be

depreciation or amortization shall commence upon the acquisition of the property. However, if the property is not yet ready for its intended use in the taxpayer's trade. business or exercise of profession, then the depreciation shall commence when the property is already ready for its intended use.

Q3: When the taxpayer elects to capitalize interest expense incurred or paid to acquire

property used in trade, business or exercise of profession and claims periodic depreciation or amortization on such interest expense, can the taxpayer still claim as a deduction from gross income the difference of the periodic depreciation or amortization and the interest expense actually incurred or paid should the latter be greater than the former?

A3: No. The taxpayer may only claim the periodic depreciation or amortization of the capitalized interest expense as a deduction from its gross income.

Illustration:

Paid or Incurred Interest Expense (a Interest Expense Depreciable b Excess of (a) over (b) Tax Treatment of Excess

P 200,000.00 P 143,000.00 P 57,000.00 Not allowed as deduction from gross income

Q4: Is interest expense deductible in full when claimed as an outright expense?

A4: No. The amount of interest expense paid or incurred on indebtedness in connection with

the taxpayer's trade, business or profession shall be reduced by an amount equivalent

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to twenty percent (20%) of interest income subjected to final tax pursuant to Section 34(B)(1) of the NIRC of 1997, as amended. However, for corporations subject to the regular corporate income tax rate of twenty percent (20%), the deduction is zero percent (0%) because there is no difference between the tax rates applicable to taxable income and interest income subjected to final tax. The limitation shall apply whether or not al tax arbitrage scheme was entered into by the taxpayer or regardless of the date when the interest-bearing loan and the date when the investment was made, as long as, during

was subjected to final withholding tax. This rule must be observed irrespective of the the taxable year, there is an interest expense incurred and an interest income earned that

loan currency and/or the currency in which investments or deposits were made. Refer to Illustration B in Annex A.

Q5: For financial reporting and audit purposes, what documents and/or disclosures in

relation to interest expense on indebtedness may be submitted and/or disclosed in the Notes to Financial Statements?

A5: For the proper monitoring of interest expense, the following may be submitted and/or

disclosed in the Notes to Financial Statements of the taxpayer:

1. A subsidiary ledger detailing the interest expense capitalized or expensed and/or

disclosure of interest capitalized or expensed in the Notes to Financial Statements: 2 Disclosure of the principal payments made and the interest expense paid or incurred

in the Notes to Financial Statements; and/or 3. Documents that will justify the availment of interest capitalization (e.g., Board

borrowing, year-end certification from the financial institution or creditor, loan Resolution specifying the utilization/allocation of loan proceeds for the general documents, and other similar documents).

Q6: What shall be the tax treatment of prepaid interest or interest expense paid in

advance?

A6: If within the taxable year an individual taxpayer reporting income on the cash basis

incurs an indebtedness on which an interest is paid in advance through discount or otherwise, such interest expense paid in advance shall only be allowed as a deduction in the year when the taxpayer has fully paid the indebtedness. If the indebtedness is payable in periodic amortization, the amount of interest expense that corresponds to the amount of the principal amortized or paid during a certain period shall be allowed as a deduction in such taxable year.

e that the following requisites be met in the recognition of income or expense: Under the accrual method of accounting, the all-events test shall apply. The test requires . The availability of a reasonable accurate determination of such income or liability. The fixing of a right to income or liability to pay; and

Commissioner of Internal Revenue v. Isabela Cultural Corporation, G.R. No. 172231, February 12, 2007.

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be amortized over the required period. To fully reflect the revenues generated and if a corporation prepays the interest at the loan drawdown date, the prepaid interest shall expenses incurred, the amortized portion shall be deducted from the prepaid interest as Accordingly, interest expense shall be deducted in the year paid or accrued. However.

the expense for the taxable year within the required period.

07: What shall be the tax treatment of interest expense paid or incurred on

intercompany Ioans?

A7: Interest expense shall not be deductible from gross income if both the taxpayer and the person to whom the payment has been made or is to be made are persons specified

under Section 36(B) of the NIRC of 1997, as amended.

Q8: What shall be the tax treatment of costs, other than interest, paid or incurred on

borrowing of funds?

A8: For tax purposes, costs such as service fees and commissions paid to banks and/or

lending institutions for borrowing of funds shall not be classified as interest expense but as an ordinary and necessary business expense. Such costs shall be allowed as a deduction from gross income in the year paid or incurred.

Q9: What shall be the applicable withholding tax rate/s on interest expense paid or

incurred on debt instruments not within the coverage of deposit substitutes?

A9: The interest expense paid or incurred shall be subject to the following withholding tax

rates unless otherwise provided by law or regulations:

1. Final withholding tax of twenty-five percent (25%) on interests paid to non-resident

M + 833 CC I F E 2. Final withholding tax of twenty percent (20%) on interests from foreign currency Final withholding tax of ten percent (10%) on interests from foreign currency loans Creditable withholding tax of fifteen percent (15%) on interests from any other debt an existing treaty: aliens not engaged in trade or business in the Philippines; loans paid to non-resident foreign corporations, unless entitled to a lower rate under banks under the expanded foreign currency deposit system; and paid by residents other than offshore banking units in the Philippines or other depository banks under the expanded foreign currency deposit system to depository

instruments not within the coverage of "deposit substitutes"" under RR No. 14-2012 BAUNE agents strictly arising from individual loans obtained from banks that are not paid to persons residing in the Philippines except interests paid by top withholding

that are not securitized, assigned or participated out, which shall be subject to a securitized, assigned or participated out, as well as interests paid by banks designated as top withholding agents strictly arising from loans made to such banks

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creditable withholding tax of two percent (2%) pursuant to Revenue Memorandum Circular No. 84-2012.

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

All internal revenue officials/officers, employees and others concerned are hereby enjoined to give this Circular as wide publicity as possible.

This Circular takes effect immediately

LUMAGUI, JR. Ymmissioner of Internal Revenue

C (pfrs project)

BUREAU OF INTERNAL REVENE TNRYN FEB 0 5 202L UODNA Q0s 2

RECORDS MGT DIVISION

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