Law Summary
Definition of Key Terms
- Interest: Payment for use, forbearance, or detention of money, irrespective of name or denomination, including borrower’s use and detention after due date.
- Taxpayer: Any natural or juridical person engaged in trade, business, or profession, excluding those earning compensation income from employer-employee relationships.
Requisites for Deductibility of Interest Expense
To be deductible, interest expense must meet the following criteria:
- Existence of an indebtedness.
- Interest paid or incurred on such indebtedness.
- Indebtedness belongs to the taxpayer.
- Indebtedness connected with trade, business, or profession.
- Interest paid or incurred during the taxable year.
- Interest stipulated in writing.
- Interest legally due.
- Interest payments not between related taxpayers, as defined in relevant tax code sections.
- Interest not incurred to finance petroleum operations.
- Interest related to capital acquisition not treated as capital expenditure.
Rules on the Deductibility of Interest Expense
- General Rule: Interest expenses connected to trade, business or profession are deductible.
- Limitation: Deductible interest expense must be reduced by a certain percentage of interest income subject to final withholding tax, varying depending on the year:
- 41% starting January 1, 1998.
- 39% starting January 1, 1999.
- 38% starting January 1, 2000 and onwards.
- This reduction applies regardless of tax arbitrage schemes or currency involved.
Illustration of Interest Deductibility Calculation
- Given Company A’s net income and interest figures:
- Net income before interest: P1,000,000.
- Interest income subject to final tax: P180,000.
- Interest expense on loan: P150,000.
- Deductible interest = Interest expense less 41% of interest income = P76,200.
- Taxable income after deduction = P923,800.
Interest on Unpaid Taxes
- Interest on unpaid business-related taxes is fully deductible.
- This interest is not subject to the abovementioned limitations.
Non-Deductible Interest Expenses
- Cases where interest is not deductible:
- Interest paid in advance by individual taxpayers using cash basis accounting is deductible only in the year the indebtedness is paid; if amortized, portion aligned with payment is deductible.
- Interest payments involving related parties as defined under Section 36(B) of the Tax Code including family members, certain corporate relationships, and trusts.
- Interest incurred to finance petroleum exploration operations as specified under applicable laws.
Optional Treatment for Interest on Capital Expenditure
- Taxpayers may opt to:
- Deduct in full the interest on capital expenditures in the year incurred.
- Or treat it as capital expenditure and amortize periodically according to Tax Code provisions.
Repealing Clause
- All revenue regulations, issuances, or rulings inconsistent with these regulations are repealed, amended, or modified accordingly.
Effectivity Clause
- The Regulations take effect immediately upon issuance on November 20, 2000.