Several issues and concerns emerged for taxpayers due to the disparity in computing interest expenses for presentation in tax returns and financial statements. With this, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular (RMC) 19-2024 on Feb. 5, 2024, which aims to provide clarification on how interest expenses related to the taxpayer’s profession, trade or business, and other related matters should be treated for tax purposes.
Borrowing costs generally comprise interest and other costs incurred regarding the borrowing of funds. Under Philippine Accounting Standards (PAS) 23, interest expenses shall be calculated using the effective interest method. Further, the standard requires that borrowing costs directly related to the acquisition of a qualifying asset be capitalized as part of the cost of the asset rather than an outright expense.
The standard also provides that capitalization of borrowing costs should cease once substantially all the activities necessary to prepare the qualifying asset for its intended use are complete. However, the same is not always true with respect to tax treatment. In summary, below are the features of RMC 19-2024:
When can interest expenses be claimed as a deduction from gross income?
When taxpayers have paid or incurred their indebtedness for the taxable year, they can claim the interest paid or incurred as a deduction for that year. The deduction, however, is subject to limitations and criteria provided in the current regulations, as follows:
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 NIRC of 1997, as amended;
5. The interest must not be incurred to finance petroleum operations;
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; and
7. The interest shall be reduced by an amount equivalent to 20 percent of the interest income subjected to final tax. However, if the final withholding tax rate on interest income of 20 percent is adjusted in the future, the interest reduction shall be adjusted accordingly.
Lastly, to be claimed as a deduction from gross income, the taxpayer must have withheld the appropriate tax relating to the interest expense, as applicable.
For tax purposes, when shall interest expense be allowed for capitalization?
PAS 23 specifically provides that only borrowing costs directly attributable to “qualifying assets” shall be capitalized. For tax purposes, taxpayers may elect to capitalize the interest expense, which is therefore added to the acquisition cost of the property rather than immediately recognizing it as an expense, provided that the interest is directly related to the acquisition of any property (e.g., building, car or machinery) used in trade, business or exercise of profession. Further, the option to capitalize interest expenses is irrevocable per specific qualifying asset.
Should the loan be used to purchase multiple properties, the interest paid on those properties will be capitalized accordingly. For example, if the loan was made to purchase a car and machinery, the interest expense on the loan will be proportionately capitalized between the two.
If the loan pertains to general borrowings or covers the acquisition of an asset/property used in trade, business or exercise of profession and qualifying assets intended for sale, such as inventories, only the interest expense directly attributable to the asset’s use in trade, business or profession, subject to verification by the BIR office upon tax return audit, shall be capitalized.
Should one property be purchased with multiple loans for trade, business or exercise of profession, the option to capitalize interest expense must be used uniformly across all loans attached to the purchase.
In the event that interest expenses are regarded as capital expenditures, the taxpayer is limited to deducting from its gross income only the capital expenditure’s periodic depreciation or amortization. The capitalized interest expense shall be depreciated or amortized based on the asset’s useful life. Depreciation or amortization often starts the moment the property is acquired. If the property, however, is not yet ready for the taxpayer’s trade, business or exercise of profession, depreciation will commence once it is ready for its intended use.
When the taxpayer elects to capitalize interest expense incurred or paid and claims periodic depreciation, can the taxpayer still claim as a deduction from gross income the difference between the periodic depreciation or amortization and the interest expense actually incurred or paid, and should the latter be greater than the former?
No. The taxpayer cannot claim as a deduction from gross income the difference between the periodic depreciation or amortization and the interest expense paid or incurred. To illustrate, if Entity A incurred an interest expense of P200,000, its depreciable interest expense would amount to P143,000. The excess of the interest incurred over the depreciable interest expense of P57,000 shall not be allowed as a deduction from the gross income.
Is interest expense deductible in full when claimed as an outright expense?
No. Under the interest arbitrage rule, the amount of interest expense paid or incurred on indebtedness in connection with the taxpayer’s trade, business or profession shall be reduced by an amount equivalent to 20 percent of interest income subjected to final tax pursuant to Section 34(B)(1) of the NIRC of 1997, as amended.
However, in the case of corporations subject to the regular corporate income tax rate of 20 percent, there will be no reduction in the interest expense since there is no difference in both the tax rates applicable to taxable income and interest income subject to final tax.
What shall be the tax treatment of prepaid interest or interest expense paid in advance?
If an individual taxpayer reporting income on a cash basis incurs a debt on which interest is paid in advance, the interest expense incurred can only be deducted in the year the debt is fully paid. If the debt is payable in installments, the amount of interest expense corresponding to the amount of the principal amortized or paid during a certain period can be allowed as a deduction in such a taxable year.
The following requisites should be met in the all-events test for the recognition of income or expense under the accrual method of accounting:
1. The fixing of a right to income or liability to pay; and
2. The availability of a reasonable and accurate determination of such income or liability.
Accordingly, interest expenses are deducted in the year they are paid or accrued. If a corporation pays interest on the loan drawdown date, the prepaid interest must be amortized over the required period and deducted as an expense for the taxable year.
What will be the tax treatment of interest expenses paid or incurred on intercompany loans?
Interest expense cannot be deducted from the gross income if both the taxpayer and the recipient are individuals listed in Section 36(B) of the NIRC of 1997, as amended.
What shall be the tax treatment of costs, other than interest, paid or incurred on borrowing funds?
Costs other than interest, such as service fees and commissions related to borrowing money from banks and/or lending institutions, are considered regular and essential business expenses for tax purposes rather than interest expenses. Such expenditures may be deducted from gross income in the period in which they are paid or incurred.
What shall be the applicable withholding tax rate(s) on interest expense paid or incurred on debt instruments not covered by deposit substitutes?
Unless otherwise specified by law or regulation, the following withholding tax rates will apply to the interest expense paid or incurred:
1. Final withholding tax (FWT) of 25 percent on interests paid to non-resident aliens not engaged in trade or business in the Philippines;
2. FWT of 20 percent on interests from foreign currency loans paid to non-resident foreign corporations, unless entitled to a lower rate under an existing tax treaty;
3. FWT of 10 percent on interests from foreign currency loans paid by residents other than offshore banking units in the Philippines or other depository banks under the expanded foreign currency deposit system; and
4. Creditable withholding tax (CWT) of 15 percent on interests from other debt instruments not covered by “deposit substitutes.” RR 14-2012 is imposed on persons residing in the Philippines except top withholding agents’ interests from individual loans obtained from banks that are not securitized, assigned, or participated in, and those from banks designated as top withholding agents, subject to a CWT of two percent pursuant to RMC 84-2012.
The RMC takes effect immediately.
Please be guided accordingly.
Source:
P&A Grant Thornton
Certified Public Accountants
P&A Grant Thornton is the Philippine member firm of Grant Thornton International Ltd.