Deductibility of accrued expenses

[Updated on February 14, 2018]

To be deductible, accrued expenses should meet all of the following requirements:

a.     All-events test

b.    Withholding tax

c.     Substantiation

Otherwise, accrued expenses which fail to meet the above requirements may not be deductible for income tax purposes.

(a) All-Events Test

Under the all-events test, accrued expenses may be claimed as deduction when the amount of liability is determined with reasonable accuracy (as evidenced by bills, request for payments, contracts, etc.) and the liability is already fixed. Hence, accruals that are mere estimates not supported by bills, contracts, etc. may not yet be deductible.

However, it can be argued that accrued expenses, even if not supported by billings or contracts, should still be expensed in the current taxable year if the Company can establish with reasonable accuracy the amount of such liability based on facts it knew, or could reasonably be expected to have known by year-end.[1]

The failure to determine the exact amount of the expenses during the taxable year when they can already be claimed as deductions cannot thus be attributed solely to the delayed billing of these liabilities by the supplier or seller.

In the exercise of due diligence, the taxpayer may inquire into the amount of its obligation to its suppliers as of year-end, since it is using the accrual method of accounting. In addition, it could also have reasonably determined the amount of unpaid expenses owing to its familiarity with the rates charged by suppliers based on its experience in dealing with them.

Moreover, RAMO No. 1-2000 provides that under the accrual method of accounting (the common method of accounting in the Philippines), expenses not being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year.

In the case of Acer Philippines, Inc. v. CIR[2], the Court of Tax Appeals (CTA) disallowed Acer’s accrued bonuses in 2004 which was claimed as salaries expense in the ITR during 2005. In this case, Acer adopted accrual method of accounting wherein income was recognized in the period it was earned irrespective of whether it was received or not, and in the same manner, expenses were accounted for in the period they were incurred and not in the period they were paid. Applying the all-events test and RAMO No. 1-2000, the CTA ruled in this wise:

“The fact that petitioner had accrued in its books of accounts for 2004 the P1,890,604.00 bonuses due to its employees, it had recognized as of the end of 2004 a fixed liability to pay such amount. Accordingly, for income tax purposes, petitioner should have deducted the amount of P1,890,604.00 from its taxable income in 2004 and not in 2005.”

(b) Withholding Tax Requirement

Under Section 34(K) of the Tax Code, expenses may be disallowed as deduction if these are not subjected to the applicable withholding taxes, if any.

The timing of withholding of applicable taxes is extensively discussed under RR No. 2-98, as amended.

Section 2.57.4 of RR No. 2-98, as amended by RR No. 12-01, provides that the obligation of the payor to deduct and withhold the tax arises at the time income is paid or payable, or accrued or recorded as an expense or asset, whichever is applicable, in the payor’s books, whichever comes first. The term “payable” refers to the date the obligation becomes due, demandable, or legally enforceable.

However, where income is not yet paid or payable but the same has been recorded as an expense or asset, whichever is applicable, in the payor’s books, the obligation to withhold shall arise in the last month of the return period in which the same is claimed as an expense or amortized for tax purposes.

Furthermore, in ING Bank N.V. Manila Branch vs CIR[3], the Supreme Court held that obligation to withhold the related withholding tax due from accrued bonuses arose at the time of accrual and not at the time of actual payment. Hence, mere accruals of bonuses that were not yet distributed to the officers and employees but were already claimed as an expense shall be subject to withholding during the year it was claimed as an expense to be deductible for income tax purposes.

Note that RR No. 12-13, as clarified by RMC No. 63-13, provides that beginning taxable year 2013, no deduction shall be allowed on expenses notwithstanding payments of withholding tax at the time of the audit investigation or reinvestigation/ reconsideration in cases where no withholding of tax was made.

[Update: RR No. 6-18 reinstated the previous provisions of the withholding tax regulations where a deduction will be allowed when the withholding agent pays the tax including the interest incident to the failure to withhold the tax, and surcharges, if applicable, at the time of a BIR audit/investigation or reconsideration/reinvestigation.]

(c) Substantiation Requirement

Under Section 34(A)(1)(b) of the Tax Code, expenses claimed as deduction must be properly substantiated by sufficient evidence, such as official receipts or other adequate records.

Adequate records may mean third-party supporting documents which are not self-serving[4] (i.e., check vouchers, journal vouchers, delivery receipts, etc.) and which will establish not only the fact of payment but also the correctness of the amount paid, as well as the taxable years when deductions were claimed[5].

In RMC No. 2-2014, purchase of goods should be supported by sales invoice (cash or charge) and purchase of services should be supported by official receipts. 

In relation to the All-Events Test as discussed earlier, to strengthen the argument on the deductibility of accrued expenses the taxpayer may present the subsequent supporting document evidencing settlement of the accrued expenses after the end of the accounting period.

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[1] CIR vs. Isabela Cultural Corporation, GR No. 172231 dated February 12, 2007

[2] CTA Case No. 8372 dated March 31, 2016

[3] G.R. No. 167679 dated July 22, 2015

[4] Sarangani Resources Corporation vs. CIR, CTA Case No. 8105, June 28, 2013

[5] Philippine Realty Corp. vs. CIR, CTA Case No. 1271, August 20, 1974