(NAR) VOL. 12 NO. 1 / JANUARY - MARCH 2009
(a) There must be an indebtedness;SEC. 4. Rules on the Deducibility of Interest Expense
(b) There should be an interest expense paid or incurred upon such indebtedness;
(c) The indebtedness must be that of the taxpayer;
(d) The indebtedness must be connected with the taxpayer's trade, business or exercise of profession;
(e) The interest expense must have been paid or incurred during the taxable year;
(f) The interest expense must have been stipulated in writing;
(g) The interest must be legally due;
(h) 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 Tax Code of 1997;
(i) The interest must not be incurred to finance petroleum operations; and
(j) In case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure.
This limitation shall apply regardless of whether or not a 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 for as long as, during the taxable year, there is an interest expense incurred on one side and an interest income earned on the other side, which interest income had been subjected to final withholding tax. This rule shall be observed irrespective of the currency the loan was contracted and/or in whatever currency the investments or deposits were made.Forty-one percent (41%) beginning January 1, 1998;
Thirty-nine percent (39%) beginning January 1, 1999; andThirty-eight percent (38%) beginning January 1, 2000 and thereafter.
1998 | |||
Net income before interest expense | P 1,000,000 | ||
Less: Interest Expense | P150,000 | ||
Less: 41% of interest income from Deposit (41% x P180,000) | 73,800 | ||
Deductible interest expense | 76,200 | ||
Taxable income | P 923.800 | ||
Income tax due for taxable year 1998 (34%) | P 314.092 |
Illustration: Mr. Cruz, a self-employed individual, consistently employs the cash-basis accounting method in keeping his books of accounts. Assuming that on January 1, 1998, he contracted a loan of P1,000,000 from XYZ Bank for use in his business operations. Terms: Payable in two (2) years at 15% interest per annum, payable in advance. On January 1, 1998, he received from the bank the proceeds of his loan in the sum of P700,000, net of interest paid in advance in the amount of P300.000.
In general, the interest expense shall be taken for the taxable year in which "paid or incurred" or "paid or accrued" depending upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income, the deduction should be taken as of a different period. Thus, a self-employed individual is allowed to deduct from his gross income the entire amount of interest expense actually paid during the taxable year. However, if the interest expense is paid in advance and the accounting method used by the self-employed individual is the cash-basis accounting method, such interest expense paid in advance shall only be allowed as deduction in the year when he has fully paid his liability. So that if the said debtor has fully paid his loan as of the end of the taxable year 1999, his interest expense paid in advance on January 1, 1998 in the amount of P300,000 shall only be allowed as deduction from his gross income in the taxable year 1999.
On the other hand, even if the interest expense is paid in advance but the indebtedness is payable in periodic amortization, the amount of interest expense which corresponds to the amount of the principal amortized or paid during the respective years 1998 and 1999 shall be allowed as deduction in such respective taxable years.
(j) Between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors and lineal descendants; or(3) If the indebtedness on which the interest expense is paid is incurred to finance petroleum exploration in the Philippines. The non-deductible interest expense herein referred to pertains to interest or other consideration paid or incurred by a Service Contractor engaged in the discovery and production of indigenous petroleum in the Philippines in respect of the financing of its petroleum operations, pursuant to Section 23 of P.D. No. 8, as amended by P.D. No. 87, otherwise known as "The Oil Exploration and Development Act of 1972."
(ii) Between an individual and a corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly and indirectly, by or for such individual; or
(iii) Between two corporations more than fifty percent (50%) in value of the outstanding stock of each of which is owned, directly or indirectly, by for the same individual; or
(iv) Between the grantor and a fiduciary of any trust; or
(v) Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or
(vi) Between a fiduciary of a trust and a beneficiary of such trust.