Legal basis and coverage scope
- These regulations are promulgated pursuant to Section 244 of the Tax Code of 1997 to implement Section 34(E) on bad-debt deductibility (Section 1).
- Deductibility applies to: (a) a corporation, (b) an individual engaged in trade or business, and (c) a professional engaged in the practice of his profession (Section 1).
- The regulations govern the requirements for deducting bad debts from gross income (Section 1).
- The regulations include special handling for banks through the Bangko Sentral ng Pilipinas (BSP) (Section 3).
- The regulations impose limits on bad-debt deductions for receivables from insurance or surety companies (Section 3).
Definitions governing key terms
- “Bad debts” are debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered (Section 2(a)).
- “Securities” mean shares of stock and rights to subscribe for or to receive such shares, including bonds, debentures, notes, or other evidence of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form (Section 2(a)).
- “Actually ascertained to be worthless” requires more than doubtful value or difficulty of collection; worthlessness must be determined using sound business judgment based on the particular facts and circumstances (Section 2(a)).
- Worthlessness may be deferred when there is a reasonable possibility of recovery, but a mere hope of ultimate collection does not justify postponement (Section 2(a)).
- “Actually charged off from the taxpayer’s books of accounts” means the receivable recorded as such has actually become worthless, has been cancelled, and has been written off from the taxpayer’s books of accounts; estimating uncollectible accounts is not a valid basis for a bad-debt deduction (Section 2(a)).
Deductibility requisites and limitations
- A bad debt is deductible only if the following requisites are met (Section 3(a)):
- There is an existing indebtedness due to the taxpayer that is valid and legally demandable;
- The indebtedness is connected with the taxpayer’s trade, business, or practice of profession;
- The indebtedness is not sustained in a transaction entered into between related parties enumerated under Section 36(B) of the Tax Code of 1997;
- The indebtedness is actually charged off from the taxpayer’s books of accounts as of the end of the taxable year;
- The indebtedness is actually ascertained to be worthless and uncollectible as of the end of the taxable year.
- Before a taxpayer can charge off and deduct a debt, the taxpayer must ascertain and be able to demonstrate the uncollectibility of the debt with reasonable degree of certainty (Section 3(a)).
- The Commissioner of Internal Revenue considers all pertinent evidence, including the value of any collateral and the debtor’s financial condition, in determining worthlessness (Section 3(a)).
- The Commissioner may consider reports from an independent collection lawyer who is not under the employ of the taxpayer; the lawyer must report on legal obstacles and virtual impossibility of collecting and must issue a statement under oath showing the propriety of the deductions for alleged bad debts (Section 3(a)).
- Where surrounding circumstances show the debt is worthless and uncollectible and legal action would in all probability not result in satisfaction of execution on a judgment, those facts are sufficient evidence of worthlessness for deduction (Section 3(a)).
- Accounts receivable with an insignificant amount and where collection through court action may be more costly may be written off as bad debts even without conclusive evidence of definitively becoming worthless (Section 2(a) and the discussion of write-off principles integrated under the requisites).
- The regulations forbid deduction based on mere bookkeeping practices: a bad debt deduction is not allowed unless the taxpayer complies with the facts concerning cancellation and write-off after the debt has actually become worthless (Section 2(a) and Section 3(a)).
- Exception for banks: For banks, BSP through its Monetary Board ascertains worthlessness and uncollectibility and approves the writing off from the bank’s books at the end of the taxable year, while the bank must still comply with the other requisites (Section 3).
- A receivable from an insurance or surety company may not be written off and claimed as a bad-debt deduction unless the company has been declared closed due to insolvency or a similar reason by the Insurance Commissioner (Section 3).
Tax benefit recovery rule
- Recoveries of bad debts previously allowed as deductions in preceding years must be included in the taxpayer’s gross income in the year of recovery to the extent of the income tax benefit derived from the prior deduction (Section 4).
- If the prior bad-debt deduction reduced the taxpayer’s income tax in the year of deduction, subsequent recovery is treated as a receipt of realized taxable income (Section 4).
- If the taxpayer did not benefit from the prior bad-debt deduction because it did not reduce income tax (for example, due to net loss even without the deduction), subsequent recovery is treated as a mere recovery or a return of capital and is not treated as realized taxable income (Section 4).
Treatment of worthless securities
- If securities held as a capital asset become worthless and are charged off within the taxable year, the resulting loss is considered as a loss from the sale or exchange of capital asset made on the last day of that taxable year (Section 5).
- The taxpayer must prove that such securities are in fact worthless through clear and convincing evidence (Section 5).
- The rule on securities becoming worthless does not apply to banks or trust companies incorporated under the laws of the Philippines whose substantial part of business is the receipt of deposits (Section 5).
Repeal and conflict handling
- Any revenue regulations, revenue memorandum order, revenue memorandum circular, or other revenue issuances inconsistent with BIR Revenue Regulations No. 5-99 are repealed, amended, or modified accordingly (Section 6).
Effectivity and publication rule
- BIR Revenue Regulations No. 5-99 becomes effective fifteen (15) days after publication in any newspaper of general circulation (Section 7).