Legal basis and amended revenue regulations
- The Regulations are promulgated pursuant to Section 244 of the Tax Code of 1997.
- The Regulations specifically amend Revenue Regulations No. 5-99, further implementing Section 34(E) of the Tax Code of 1997 on requirements for bad debts deductibility.
- The amendment is made by revising Section 3 of RR 5-99 on the requisites for valid deduction of bad debts from gross income.
- The Regulations cover corporations, including banks and insurance companies, and also individuals, estates, and trusts engaged in trade or business or a professional engaged in practice of his profession.
Policy, purpose, and tax administration standard
- The Regulations establish the requisites a taxpayer must meet before a bad debt may be deducted from gross income.
- The Regulations require that the taxpayer must be able to ascertain and demonstrate with reasonable degree of certainty the uncollectibility of the debt before charging off and deducting it.
- The Commissioner of Internal Revenue determines the propriety of deductions based on pertinent evidence.
- For banks, the Commissioner of Internal Revenue determines worthlessness and uncollectibility using the same manner described for general cases, subject to an additional written approval requirement.
Scope of covered taxpayers and debts
- The deductibility rules apply to a taxpayer corporation, including banks and insurance companies, under the conditions stated for bad debts.
- The deductibility rules also apply to an individual, estate, and trust engaged in trade or business, and a professional engaged in the practice of his profession, under the conditions stated for bad debts.
- The requisites require an existing indebtedness that is valid and legally demandable.
- Deductibility is conditioned on the debt being connected with the taxpayer’s trade, business or practice of profession.
- Deductibility is barred for debts arising from certain transactions between related parties enumerated under Section 36(B) of the Tax Code of 1997.
Core requisites for valid bad-debt deduction
- A bad debt is deductible only if the taxpayer has an existing indebtedness due to the taxpayer that is valid and legally demandable.
- The debt must be connected with the taxpayer’s trade, business or practice of profession.
- The debt must not be sustained in a transaction entered into between related parties enumerated under Section 36(B) of the Tax Code of 1997.
- The taxpayer must actually charge off the debt in its books of accounts as of the end of the taxable year.
- The taxpayer must have actually ascertained the debt to be worthless and uncollectible as of the end of the taxable year.
- Before charging off and deducting, the taxpayer must ascertain and be able to demonstrate with reasonable degree of certainty the debt’s uncollectibility.
Evidence, process, and special bank rules
- The Commissioner of Internal Revenue considers all pertinent evidence, including the value of the collateral, if any, securing the debt, and the financial condition of the debtor, in determining whether a debt is worthless or uncollectible.
- A taxpayer must be able to support its determination through evidence described in the Regulations that include, among others, assignment of the case for collection to an independent collection lawyer not under the employ of the taxpayer.
- The independent collection lawyer must report on the legal obstacle and the virtual impossibility of collecting the debt from the debtor.
- The independent collection lawyer must issue a statement under oath showing the propriety of the deductions made for alleged bad debts.
- Where the surrounding circumstances indicate a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in satisfaction of execution on a judgment, a showing of those facts is sufficient evidence of worthlessness for deduction purposes.
- For banks, the Commissioner of Internal Revenue determines whether bad debts are worthless and uncollectible in the manner provided above.
- For banks, the taxpayer must submit a Bangko Sentral ng Pilipinas/Monetary Board written approval of the writing off of the indebtedness from the banks’ books of accounts at the end of the taxable year.
- No prejudice is created to the Commissioner’s determination of worthlessness and uncollectibility of debts even with the BS/MB approval requirement.
Insurance/surety receivables limitation
- No receivable from an insurance or surety company may be written off from the taxpayer’s books and claimed as bad debts deduction unless the company has been declared closed due to insolvency or for any such similar reason by the Insurance Commissioner.
Repeal, amendment, and inconsistency rule
- The Regulations repeal, amend, or modify any revenue regulations, revenue memorandum order, revenue memorandum circular, or other revenue issuances that are inconsistent with these Regulations.