CHAPTER 7: DEDUCTIONS FROM GROSS INCOME

Choose the letter of the correct answer.

Principles
1. Statement 1: Deductions are items or amounts allowed to be subtracted from gross income to
arrive at the taxable income.
Statement 2: Exclusions are receipts which are excluded from the gross income, hence, do not
form part of the gross income.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect
 Answer: C

2. Which of the following is not a characteristic of a deduction?

a. It is a reduction of wealth that helped earn the income subject to tax.
b. An immunity or privilege, a freedom from a charge or burden to which others are subjected.
c. It is not a receipt.
d. It is a subtraction to arrive at income subject to tax.
 Answer: B
o “B” refers to “exclusions”, not deductions.

3. Political campaign contributions are not deductible from gross income

a. If they are not reported to the Commission on Elections.
b. If the candidate supported wins the election because of possible corruption.
c. Since they do not help earn the income from which they are to be deducted.
d. Since such amounts are not considered as income of the candidate to whom given.
 Answer: C

4. Statement 1: Deductions from gross income are not presumed.

Statement 2: As a rule, deductions means itemized deductions
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect

5. Statement 1: Revenue expenditures are period costs that are related to a particular period of
time of business operation.
Statement 2: Capital expenditures are non-recurring expenditures related to acquisition of
depreciable assets to be used in the business.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect

6. Lester bought an equipment under a two-year installment basis to be used in his office in the
practice of his profession. Lester will pay P50,000 monthly for a period of twelve (12) months.
For income tax purposes, the P50,000 monthly payment shall be:
a. Treated as business rental, hence deductible
b. Treated as capital expenditure, hence not deductible
c. Treated as depreciation expense, hence deductible
d. Treated as ordinary business expense
  ANSWER: B

PRO- FORMA JOURNAL ENTRY

Upon acquisition:
Equipment Pxx
Accounts Payable Pxx
Installment Payment:
Accounts Payable Pxx
Cash Pxx

7. Statement 1: A taxpayer can only deduct an item or amount from gross income only if there is
a law authorizing such a deduction.
Statement 2: For income tax purposes, a taxpayer is free to deduct from gross income the full
amount of the deduction allowed, or a lesser amount or not to claim any deduction at all.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect
 Answer: C

8. In cases of deductions and exemptions on income tax returns, doubts shall be resolved
a. Strictly against the taxpayer
b. Strictly against the government
c. Liberally in favor of the taxpayer
d. Liberally in favor of the employer
 Answer: A

9. Statement 1: The taxpayer has the burden of justifying the allowance of any deduction
claimed.
Statement 2: Deductions are strictly construed against the government.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect
 Answer: A

10. Statement 1: Only business expenses may be deducted from the gross income taxpayers.
Statement 2: Itemized deductions from gross income should be duly supported by vouchers or
receipts.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect
 ANSWER: C
o Personal and non-business related expenses are not allowed to be deducted
from the gross income for income taxation purposes.
o Refer also to Page 406 for non-deductible items

11. Which of the following is a deductible expense for income tax purposes?
a. Salaries of domestic servants
b. Ordinary repair of the personal car
c. Provision for doubtful accounts
d. None of the above
 ANSWER: D
o “A and B” are personal expenses
 o “C” is unrealized loss. Unrealized gains and losses are not recognized for tax
purposes.

12. This is not a requisite for business expense to be deductible

a. It must be reasonable
b. It must be paid during the taxable year
c. The withholding tax otherwise required have been deducted and remitted to the BIR
d. It must be ordinary and necessary
 Answer: B
o “B” is incorrect. Business expenses incurred and/or paid may be deducted from
the taxpayer’s gross income.

13. One of the requirements in order for expenses to be claimed as deduction for income tax
purposes is that, it should be subject to withholding tax if applicable. What is the withholding
tax rate applicable to rental payments?
a. 1%
b. 5%
c. 2%
d. 10%
 ANSWER: B
o Refer to the preceding number (letter “C”) for the requisites for business expense
to be deductible. Some of the creditable withholding tax rates under RR 11-2018
and RR 14-2018 are as follows:

PURCHASE OF/PAYMENT FOR: CWT%

Professional fees, talent fees, etc. for services rendered
Individual Payee:
If gross income did not exceed P3M 5%
If gross income > P3M or, regardless of amount if vat 10%
registered
Non Individual Payee: 10%
If gross income did not exceed P720,000 15%
If gross income is exceed P720,000
5%
Rentals
Income payments made by top withholding agents to their local
supplier of goods or services: 1%
Goods 2%
Services
10%
Income payments to beneficiaries of estates/trusts (except tax
exempt and incomes subject to FWT)

Income payments to partners of GPPs 15%

More than P720,000 10%
Not more than P720,000

Certain income payments made by credit card companies 1%

14. In the conduct of his business in 2023, Modesto found it necessary to give gifts to the
government officials with whom he had official dealings.
a. These gifts are deductible expenses subject to the substantiation rule.
b. The value of the gift, if de minimis, are allowed to be deducted.
c. Irrespective of the value, the gifts are considered as bribes and not allowed to-be deductible.
d. These gifts are deductible if found to be necessary and properly supported by receipts.
 ANSWER: B; “C” is a bribe, hence, non-deductible.
Ordinary Business/Professional Expenses
15. Which of the following is not deductible from gross income?
a. Salaries and wages of employees
b. Entertainment, amusement and recreation expenses
c. Rental expenses
d. Bribes, kickbacks and other similar payments
 ANSWER: D
o “D” is illegal payment, hence, non-deductible; Refer to page 330
o “A-C” are ordinary business expenses

16. Which of the following can be deducted from gross income in the year paid or incurred?
a. Repairs that materially add to the value of the property
b. Repair that appreciably prolong the life of the property
c. Repair that keep the property in its ordinarily efficient operating condition
d. All of the choices
 Answer: C ; “A and C” shall be capitalized.

17. Which of the following is allowable expense(s) of an employer?

a. Tax withheld by a corporation from its employees’ salary.
b. Kickback payment to a government official.
c. Distribution of profits to partners.
d. None of the above
 ANSWER: D
o “A” is a liability not a deductible expense

Sample Journal Entry:

Compensation Expense Pxx
Cash Pxx
Withholding Tax Payable Pxx

o “B” is an illegal payment, hence, non- deductible

o “C” is a distribution of company profits is not a business expense

Sample Journal Entry:

Retained Earnings Pxx
Dividend Payable/Cash Pxx

18. The following are the requisites for deduction of compensation expense, except
a. Personal services must have been actually rendered
b. The compensation for such services must be reasonable
c. Both “a” and “b”
d. Neither “a” nor “b”
 ANSWER: D; “A and B” are required for compensation expense to be deductible.

19. Which of the following is allowable compensation expense of an employer?

a. Salary of employee paid for a limited period of time after his death to his widow is allowable
deduction of the employer.
b. Manager’s expense account subject to fringe benefit tax.
c. Both “a” and “b”
d. Neither “a” nor “b”
 ANSWER: C
20. Statement 1: Cost of technical books used by a CPA in the practice of his profession is
allowable business expense.
Statement 2: Tuition fees, board and lodging incurred by a medical doctor while attending a
continuing professional education seminar is allowable business expense.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect
 ANSWER: C; Both expenditures are business related

21. Which of the following business expenses of a professional practitioner is not allowed to be
deducted from the gross income?
a. Professional expenses incurred outside the Philippines by a nonresident alien engaged in
business in the Philippines.
b. Income tax paid by a resident citizen to a foreign country.
c. Entire amount incurred for meals, lodging, and travel in connection with own business
d. None of the above
 ANSWER: A
o NRA-NETB is taxable only on income derived from Philippine sources.
Consequently, expenses incurred abroad shall not be deducted from gross
income derived in the Philippines.
o Income tax payments abroad by a resident citizen or domestic corporation may
be claimed as a tax credit or as a deduction from the gross income (OPEX), at
the option of the taxpayer.
o “C” is an ordinary and necessary business expense.

22. The following are allowable compensation expenses of the employer, except
a. Overtime pay paid to a rank-and-file employee.
b. Cash dividends paid
c. Amounts paid for pensions of retired employees
d. All of the above
 ANSWER: B
o “A and C” are ordinary business expenses, deductible from gross income
o “B” is a distribution of company’s earnings

23. Earl is the product manager of Mcdo Bee Inc. Earl had a dinner with Clifford, owner of a chain
of restaurants, to convince the latter to carry Mcdo Bee products. Clifford agreed. After dinner,
Earl and Clifford went their separate ways. Earl decided to celebrate by going to a bar where
he picked-up a partner and consumed a bottle of liquor. He drove home and on his way, he
sideswiped Delfin, a pedestrian who suffered injuries as a result of the accident. Earl settled
the case extra-judicially by paying Delfin amounting to P100,000 for actual damages (the
money comes from Mcdo Bee Inc.). Which of the following is correct?
a. The expenses incurred in having dinner with Clifford may be deducted from gross income of
Mcdo Bee.
b. The expenses incurred by Earl while celebrating with a partner in a bar is deductible to
expense of Mcdo Bee.
c. The amount paid to Delfin may be deducted from gross income of Mcdo Bee.
d. The amount paid to Delfin may be deducted but the amount will be reduced to an equitable
amount to qualify as ordinary and necessary expenses.
 ANSWER: A
o “A” is an ordinary business expense (promotional/representation cost)
o The expenses incurred in the bar as well as the amount paid to Delfin are non-
business related (personal expenses), consequently, non-deductible.
ADDITIONAL TRAINING EXPENSES UNDER THE CREATE LAW
24. (Based on illustration in RR 5-2021). COD Corporation, a domestic manufacturing corporation,
had gross sales of P100,000,000 for fiscal year ending June 30, 2021 and incurred cost of
sales of P60,000,000 and cost of sales of P17,500,000, with the following details:

Cost of Sales
Direct Materials P30,000,000
Direct Labor 20,000,000
Manufacturing Overhead 10,000,000 P60,000,000
Operating Expenses
Salaries and wages P7,000,000
Taxes 300,000
Depreciation 3,500,000
Professional Fees 200,000
Advertising Expenses 3,000,000
Training Expenses 3,000,000
Office Supplies 500,000 P17,500,000

How much is the additional allowable training expenses, if any?

a. 0
b. 1,000,000
c. 1,500,000
d. 3,000,000
 ANSWER: C
o Additional deduction = ½ of value of the actual training expenses of P3M =
P1.5M
o The amount of P1,500,000, which is one-half of the value of the actual training
expenses of P3,000’000.00, can be claimed as additional deduction, since it did
not exceed ten percent (10%) of the Direct Labor Wage. In this scenario, the
corporation’s direct labor wages incurred was P 20,000,000.00. Thus, the one-
half value of the actual training expenses of P1,500,000 did not exceed the
P2,000,000 (10% of P20,000,000.00) threshold. Provided further, that all the
prescribed requirements has been complied with (e.g., Apprenticeship
Agreement, Certification from DepEd or TESDA or CHED, whichever is
applicable). If the company’s direct labor wage is only P 10,000,000.00, the
additional deduction that can be allowed shall be P1,000,000 and not
P1,500,000.

25. How much is the taxable net income of the Company?

a. P1,500,000
b. P17,500,000
c. P40,000,000
d. P21,000,000
 ANSWER: D

Gross Sales P100,000,000

Cost of Sales ( 60,000,000)
Gross Income 40,000,000
Expenses before additional deduction from training expense ( 17,500,000)
Additional allowable deduction from training expense
(P3,000,000×½) ( 1,500,000)
Net Taxable Income P21,000,000
o Section 34(A}(1)(a)(V) of the Tax Code, as amended, provides:
Upon effectivity of CREATE law, an additional deduction from taxable income of
one-half (1/2) of the value of labor training expenses incurred for skills
development of enterprise-based trainees enrolled in public senior high schools,
public higher education institutions, or public technical vocational institutions and
duly covered by an apprenticeship agreement under presidential decree no. 442,
 series of 1974, or the “Labor Code of the Philippines”, as amended, shall be
granted to enterprises: Provided, further, that for the additional deduction for
enterprise-based training of students from public educational institutions, the
enterprise shall secure proper certification from the DEPED, TESDA, or CHED:
Provided, finally, that such deduction shall not exceed ten percent (10%) of direct
labor wage (RR 5-2021).

INTEREST EXPENSE
26. This is a non-deductible interest expense
a. Interest paid on indebtedness incurred to finance petroleum exploration.
b. Interest paid by a corporation on scrip dividends.
c. Interest paid by a corporate taxpayer who is liable on a mortgage upon real property of which
the said corporation is the legal or equitable owner.
d. Interest paid on tax deficiency if the tax where the interest is in itself an item that is deductible
from gross income.
 ANSWER: A
REQUIREMENTS FOR DEDUCTIBILITY in relation to CREATE Law, of interest
expense as laid down in RR 5-2021:
1. The indebtedness must be that of the taxpayer;
2. The interest must have been stipulated in writing;
3. The interest must be legally due;
4. 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.
5. The interest must not be incurred to finance petroleum operations; and
6. The interest was not treated as “capital expenditure”, if such interest was
incurred in acquiring property used in trade, business or exercise of profession.

Provided, further, that the taxpayer’s otherwise allowable deduction for interest
expense shall be reduced by an amount equivalent to twenty percent (20%) of
interest income subjected to final tax. However, if the final withholding tax rate on
interest income of 20% will be adjusted in the future, the interest expense
reduction rate shall be adjusted accordingly.

27. This is a deductible interest expense

a. Interest on deposits paid by authorized banks of the BSP to depositors, if it is shown that the
tax on such interest was withheld and paid.
b. Interest paid on indebtedness between related taxpayers.
c. Interest paid on preferred stock.
d. Interest paid when there is no stipulation for the payment thereof.
 ANSWER: A
o “B and D” are non-deductible as provided under RR 5-2021.
o “C” is non-deductible. It shall be treated as dividend payment rather than
payment of interest.

28. Which of the following is a deductible expense for income tax purposes?
a. Interest paid on delinquent business taxes
b. Provisions for doubtful accounts
c. Ordinary repair for personal car
d. Salaries of domestic servants.
 ANSWER: A
o “B” is deductible, provided the tax is pertaining to a tax classified as operating
expenses under the Tax Code. “Business taxes”, in general are classified as
operating expense for income taxation purposes. Consequently, the interest
 associated with those types of taxes shall likewise be treated as operating
expenses, specifically under “interest expense” account.
o “B and D” are non-deductible (RR 13-2000). Refer to the explanatory note in the
preceding number.
o “C” is non-deductible.’ It shall be treated as dividend payment rather than
payment of interest.

29. Statement 1: As a rule, the interest must be on an indebtedness of the taxpayer, otherwise it is
not deductible.
Statement 2: Interest paid by the taxpayer on a mortgage upon real estate of which he is the
legal or equitable owner, even though the taxpayer is not directly liable upon the bond or not
secured by such mortgage, may be deducted as interest on his indebtedness.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect
 ANSWER: C

30. In 2020 (PRIOR to the effectivity of the CREATE Law), Roy borrowed money from the Bank
amounting to 21,000,000 at an annual interest rate of 7%. He invested the money in deposit
substitutes earning annual interest income of 8%. How much is the deductible interest?
a. P43,600
b. P26,400
c. P70,000
d. P80,000
 ANSWER: A

Actual Interest = P1,000,000 × 75% P70,000

Less: Reduction = P1,000,000 × 8% × 33% (26,400)
Allowable Interest Expense P43,600
o This is known as the “tax arbitrage” rule. Interest expense will result to a lower
taxable income but the taxpayer will enjoy tax benefit (tax savings) of 30%. On
the other hand, the taxpayer may deposit the proceeds of the loan/borrowings in
a bank to yield interest income which will be subjected to a final tax which is
usually lower (20%) compared to the regular corporate – income tax of 30%,
thereby creating “double tax benefit’ on the part of the taxpayer. Difference = 30%
- 20% =10%. To neutralize the impact of the imbalance between the tax savings
arising from the reduced taxable income from the recognition of interest expense
and the tax charge to the interest income derived from such bank deposit, the
interest expense to be recognized shall be reduced by 33% of interest income
subjected to FWT (Difference =10; Reduction = 10%/30% = 33%). However, this
scheme shall apply only to interest expense arising from “borrowings or loans”.

31. (CREATE Law; Based on illustrations in RR 5-2021): For fiscal year ending June 30, 2021,
assuming that JHB Corporation, aside from the operating expenses of P7,500,000, incurred
interest expense of P400,000 which satisfied the prescribed requirement for deductibility, but it
also earned interest income of P100,000, net of final tax of twenty percent (20%). How much is
the allowable deduction for interest expense?
a. P25,000
b. P100,000
c. P375,000
d. P400,000
 ANSWER: C
 Actual interest expense P400,000
Less: Reduction
Interest income subject to FWT (net) P100,000
Divide by 80%
Interest income subject to FWT (gross) P125,000
Multiply by 20% (25,000)
Deductible Interest expense P375,000

o UNDER THE CREATE LAW, the taxpayer’s otherwise allowable deduction for_
interest expense shall be reduced by twenty percent (20%) of the interest income
subjected to final tax.

32. (CREATE Law; Based on illustrations in RR 5-2021). For taxable year 2021, SGC Corp.
incurred interest expense of P500,000 on its bank loan. For the year, its gross assets
amounted to P50,000,000, exclusive of the cost of the land of P7,100,000. It registered a gross
income of P10,000,000 and incurred operating expenses of P6,000,00 inclusive of P500,000
interest expense. It had interest income earned for the same year amounting to P150,000.
How much is the allowable deduction for interest expense?
a. P0
b. P150,000
c. P470,000
d. P500,000
 ANSWER: D
o THE CREATE LAW further provides that for other domestic corporations with net
taxable income not exceeding Five Million Pesos (P5,000,000) and total assets
not exceeding One Hundred Million (P100,000,000), excluding the land on which
the particular business entity’s office, plant and equipment are situated, also
known as MSMEs, the deduction is 0% since there is no difference in the income
tax rate on the taxable income (20%) with the tax rate applied on the interest
income subjected to final tax (20%). Thus, there is no interest arbitrage. The
allowable interest expense shall be the same with the actual interest
incurred.
o In the scenario provided in the problem, the corporation is subject to RCIT rate of
20% since its taxable income did not exceed P5M and its total assets did not
exceed P100M, exclusive of the land. Since the RCIT rate is 20%, and the final
tax on interest income is also at 20%, there is no difference on these two rates.
Thus, there is no interest arbitrage. The allowable interest expense, in this case,
shall be P500,000.

33. In computing allowable deduction for purposes of income taxation:

Statement 1: Beginning July 1, 2020, interest expense arising from loans or indebtedness in
connection with taxpayer’s business shall be reduced by an amount equal to 20% interest
income subjected to final tax
Statement 2: Interest incurred on money used to acquire property to be used in trade shall only
be allowed as a capital expenditure.
a. Only statement 1 is correct
b. Only statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect
 ANSWER: A
o “Statement 2” is incorrect. Interest incurred in acquiring property may be
capitalized or treated as operating expense.
o In the case of corporations, since the income tax rates changed effective July 1,
2020 (CREATE Law), it follows that the deduction from the interest expense of
20% shall be effective also on the said date.
 o In the case of individuals engaged in business or practice of profession, such
deduction shall take effect upon the effectivity of the CREATE law on April 11,
2021 instead of July 1, 2020.

34. An individual taxpayer has the following data for 2021 taxable year:

Interest paid, business loan Interest paid, loan to finance P100,000

personal car 500,000
Interest expense on delinquency business related taxes 50,000
Interest income, BDO West Avenue branch (net) 24,000

For income tax purposes, the deductible interest expense shall be:
a. P102,000
b. P138,600
c. P144,000
d. P150,000
 ANSWER: C

Interest paid on loan P100,000

Reduction (20% x P30,000) (6,000)
Interest on taxes 50,000
Allowable deductions P144,000

35. Debtor Corporation, with total assets of P15,000,000, shows the following data during taxable
year:
Sales P500,000
Interest income, net of 20% final tax 24,000
Cost of sales 300,000
Salary expense 120,000
Interest expense 60,000
Rent expense 24,000
Advertising expense 6,000
Depreciation expense 5,000

What is the correct amount of itemized deduction?

a. P202,400
b. P205,100
c. Salary expense 120,000 P215,000
d. Interest expense 60,000 P265,000
Rent expense 24,000  ANSWER: C
Advertising expense 6,000
Depreciation expense 5,000
Total Itemized Deduction P215,000

o For other domestic corporations classified as MSMEs, the deduction is 0% since

there is no difference in the income tax rate on the taxable income (20%) with the
tax rate applied on the interest income subjected to final tax (20%). Thus, there is
no interest arbitrage. The allowable interest expense shall be equal with the
actual interest incurred.

36. Leomar Corporation paid the following during 2021:

 Interest paid for late payment of 2020 income tax P50,000
Surcharge and compromise penalty for late payment of 2020 income tax 72,500
Interest on bonds issued by Leomar Corporation 1,000,000
Interest on money borrowed by Leomar Corporation from Cabarles 500,000
Incorporated (owns of 60% shares of Leomar Corporation)
Interest on preferred shares which in reality is dividend 200,000
How much is the deductible interest for 2021?
a. P1,822,500
b. P1,122,500
c. P1,000,000
d. P50,000
 ANSWER: C
o Interest Expense (on bonds issued by Leomar) = P1,000,000
o INTEREST incurred for the payment of tax or deficiency tax is allowed to be
deducted from the gross income ONLY IF the related “tax” is classified as
operating expense for taxation purposes, However, ‘income tax’ is not classified
as operating expense under the Tax Code. Therefore, the interest paid for late
payment of such tax is Nondeductible because the related tax is not classified as
operating expense.
o Surcharges as well as penalties are NON-deductible expenses.
o The interest on money borrowed by Leomar Corporation from Cabarles
Incorporated was derived from “related party transaction”. Interest expense,
losses and bad debts are NON- deductible IF incurred in relation to a transaction
with a related party. RR 13-2000 as amended by RR 5-2021 provides that the
interest payment arrangement must not be between related taxpayers as
mandated in Sec. 34(B)(2)(b), in relation to Sec. 36(B) of the Tax Code (related
party transactions).

37. How shall interest related to acquisition of property used in trade, business or profession be
treated?
a. Claim as outright expense
b. Capitalize
c. At the option of the taxpayer, may be claimed as outright expense or capitalize
d. At the option of the government, may be claimed as outright expense or capitalize
 ANSWER: C

38. Mrs. Sarabia is a self-employed individual using cash basis of accounting in recording her
business transactions. She borrowed money from the bank in 2021 payable after 2 years in
lump sum. The proceeds given to her by the bank was already net of 2100,000 interest. When
can she claim as deduction the said interest?
a. In 2021
b. In 2022
c. In 2023
d. Spread over the term of the loan
 ANSWER: C
o “Prepaid interest” of an individual under cash basis is deductible not in the year
that the interest was paid in advance but in the year that the indebtedness was
fully paid. However, if the indebtedness is payable in periodic amortization, the
amount of interest which corresponds to the amount of the principal amortized or
paid during the year shall be allowed as deduction in such taxable year. Prepaid
interest shall likewise be allowed as deduction from the gross income “at the time
of payment” for businesses engaged in rendering services using cash ‘ basis of
accounting [Basis: Sec. 34(B)(2)(a) of the Tax Code].

39. The following interest are non-deductible, except?

a. Interest paid to persons classified as related taxpayers
b. Interest related to indebtedness incurred to finance petroleum exploration
 c. Interest on preferred stock
d. Interest related to indebtedness incurred to finance working capital requirements
 ANSWER: D

RENTAL EXPENSES
40. A lessee paid the real estate tax on the property he leased. For income tax purposes, the
amount paid was:
a. Deductible as part of lease expenses.
b. Deductible as tax expense
c. Deductible as an interest expense
d. Non-deductible expense
 ANSWER: A

41. The cost of leasehold improvements shall be deductible by the lessee by

a. Spreading the cost of the improvements over the life of the improvements or remaining term of
the lease, whichever is shorter.
b. Spreading the cost of the improvements over the life of the improvements or remaining term of
the lease, whichever is longer.
c. Spreading the cost of the improvements over the term of the lease or may be expensed
outright in full, at the option of the lessee.
d. Any of the above
 ANSWER: A

42. A leasehold is acquired for business purposes for P5,000,000. The lease contract is for 10
years. How much is the deductible amount from the gross income during the year?
a. P500,000
b. P1,000,000
c. P5,000,000
d. P0
 ANSWER: A
o Deduction = P5,000,000/10 years = P500,000

43. On January 1, 2021, Mr. V leased his vacant lot for a period of 12 years to Mr. J at an annual
rate of P2,400,000. It was also agreed that Mr. J will pay the following:
 P4 800,000 representing rental payment for year 2021 and 2022.
 Security deposit of 2,400,000.
 Annual real property tax of P30,000.
The lease contract provides, among others that the lessee will construct a 5-storey building for
parking purposes at a cost of P9,500,000. Ownership of the building shall belong to the lessor
upon the expiration or termination of the lease contract. The building was completed on July 1,
2023 with an estimated useful life of 15 years. How much can Mr. J claim as deduction in
relation to the lease in 2021?
a. P2,430,000
b. P4,830,000
c. P2,400,000
d. P4,800,000
 ANSWER: A

Rentals for 2021 = P2.4M annual rent x 6 mos./12 P2,400,000

mos. 30,000
Annual real property tax P2,430,000
Total Rent Expense – 2021

44. How much can Mr. J claim as deduction in relation to the lease in 2022?
a. P2,430,000
b. P4,830,000
c. P2,400,000
d. P4,800,000
 ANSWER: A; Same solution with the preceding number.

45. Using the same information above, how much can Mr. J claim as deduction in relation to the
lease in 2023?
a. P2,430,000
b. P2,930,000
c. P2,400,000
d. P3,063,333
 ANSWER: B

Rentals for 2023 P2,400,000

Annual real property tax 30,000
Depreciation expense,
improvement 500,000
=(P9,500,000/9.5 years) x 1/2 P2,930,000
Total Rent Expense - 2023

o The leasehold improvement shall be depreciated using the shorter between the
remaining lease term and useful life.
o Remaining lease term of 9.5 years upon completion of the leasehold
improvement is shorter compared to the estimated useful life (15 years) of the
improvement.

46. Using the same information above, how much can Mr. J claim as deduction in relation to the
lease in 2024?
a. P2,430,000
b. P2,930,000
c. P3,430,000
d. P3,063,333
 ANSWER: C

Rentals for 2024 P2,400,000

Annual real property tax 30,000
Depreciation expense,
improvement 1,000,000
=P9,500,000/9.5 P3,430,000
Total Rent Expense - 2024

47. Mike leased his land to Leomar for two years beginning July 1, 2023. Leomar would pay
monthly rental of P100,000. He paid rent up to October 2023 and then defaulted for the rest of
the year. Under accrual method, how much was the income of Mike in 2023?
a. P200,000
b. P400,000
c. P600,000
d. None of the choices
 ANSWER: B
o Based on collections (4 months from July to October), regardless of the
accounting method used by the lessor.

48. Using the same data in the preceding number, under on method, how much was the income ‘of
Mike in 2023?
a. P200,000
b. P400,000
c. P600,000
d. None of the choices
  ANSWER: B
o Rental income is recognized upon receipt, (4 months from July to October),
regardless of the accounting method used by the lessor.
49. Under accrual method, how much was the deductible expense of Leomar in 20237
a. P600,000
b. P400, 000
c. P200,000
d. None of the choices
 ANSWER: A; six (6) months from July to December.

50. Under cash method, how much was the deductible expense of Leomar in 2023?
a. P600,000
b. P400,000
c. P200,000
d. None of the choices
 ANSWER: B; four(4) months from July to December.

51. Pedro leased his lot to Jose. The contract calls for Jose to construct a house which would
serve .as the residence of the latter, the ownership thereof to be transferred to Pedro after the
expiration of the lease. When the house was completely constructed, the remaining term of the
lease was 10 years. The residential house had an estimated useful life of 15 years. What is the
tax implication of the leasehold improvement?
a. Pedro derives taxable income on the improvement; Jose can claim depreciation expense as a
deduction from gross income.
b. Pedro derives taxable income on the improvement; Jose cannot claim depreciation expense as
a deduction from gross income.
c. Pedro does not derive taxable income on the improvement: Jose cannot claim depreciation
expense as a deduction from gross income.
d. Pedro does not derive taxable income on the improvement; Jose can claim depreciation
expense as a deduction from gross income.
 ANSWER: B
o Jose cannot claim depreciation expense because at the point of view of Jose, the
improvement is a personal asset (pertaining to his house), therefore, any
depreciation in relation to the improvement is non-deductible.
o Pedro will derive an income because the ownership of the property will be
transferred to him upon expiration of the lease term.

52. Assume the same facts in the immediately preceding number, except that at the time of the
completion of the residential house, the remaining term of the lease was 15 years while the
useful life of the house was 10 years. What is the tax implication of the leasehold
improvement?
a. Pedro derives taxable income on the improvement; Jose can claim depreciation expense as a
deduction from gross income.
b. Pedro derives taxable income on the improvement; Jose cannot claim depreciation expense as
a deduction from gross income.
c. Pedro does not derive taxable income on the improvement; Jose cannot claim ‘depreciation
expense as a deduction from gross income.
d. Pedro does not derive taxable income on the improvement; Jose can claim depreciation
expense as a deduction from gross income.
 ANSWER: C
o Jose cannot claim depreciation expense because at the point of view of Jose, the
improvement is a personal asset (pertaining to his house), therefore, any
depreciation in relation to the improvement is non-deductible.
 o Pedro will not derive an income from the improvement because the useful life of
the improvement is shorter than the lease term. Therefore, upon termination of
the lease, there is No more improvement to be transferred to Pedro.

TAX EXPENSE
53. Which of the following is not a requisite for taxes to be deductible?
a. Must have been paid or incurred within the taxable year.
b. Deductible only by the person/s upon whom the tax is imposed by law.
c. Must be in connection with the taxpayer’s profession, trade, or business.
d. Must be imposed by the national government.
 ANSWER: D