Frequently Asked Questions and Answers

REVENUE REGULATIONS NO. 5-99

DEDUCTIBILITY OF BAD DEBTS

Q: What are bad debts?

A: Bad debts are loans or payment for goods or services which have become worthless or uncollectible.

Q: Who may deduct bad debts for tax purposes?

A: The following taxpayers may deduct bad debts from their gross income:

a corporation,

an individual engaged in trade or business, or

a professional engaged in the practice of his profession

Q: When are bad debts deductible?

A: A bad debt is deductible only if:

The debt due the taxpayer is valid and legally due the taxpayer. The taxpayer should be able to prove that he has a right to enforce the collection of such debt.

The debt was incurred in connection with the taxpayer’s trade, business or practice of profession.

The debt was not made by the taxpayer with a related party which includes:

Members of the family

A corporation which is owned and controlled by the taxpayer (i.e. he owns or controls more than fifty percent (50%) of the value of the outstanding stock.

Personal holding company or a foreign personal holding company of the taxpayer.

Grantor and a fiduciary or trustee of any trust; or

Fiduciary or trustee of a trust and the fiduciary or trustee of another trust if the same person is a grantor with respect to each trust; or

Fiduciary of a trust and a beneficiary of such trust.

The debt is considered worthless and uncollectible at the end of the taxable year.

Q: What is a charged-off debt?

A: When money is lent by a taxpayer, he records it in his books of accounts as a receivable. When the loan has become worthless and uncollectible, it is chrarged-off, written-off, or cancelled from his books of accounts. This means that the loan is no longer considered a receivable because there is almost no hope or possibility of collecting it.

Q: When is a debt considered worthless or uncollectible?

A: Strong proofs are need to show that a debt become worthless or uncollectible. It mube shown that the borrower is in no financial position to repay the loan. An independent collection lawyer can also submit a written statement under oath that there are major legal obstacles in collecting payment for the loan. Proofs must also be shown by the taxpayer that he exhausted all available means to collect payment for the loan bu they all proved unsuccessful.

Q: Can a taxpayer postpone the recognition of a receivable as bad debt?

A: A taxpayer cannot postpone deducting a bad debt simply because he thinks and he hopes that the debt will be collected. A postponement of the deduction can only be allowed if:

The taxpayer can show proofs that he can collect payment for the debt. For example, the title of a property of the borrower is in dispute or is being contested/ There is a strong chance therefore that the taxpayer can collect payment of the debt when the property dispute is settled. The taxpayer can also show that the present conditions have become more favorable in enabling him to collect payment of the debt.

Q: Are there different rules for bad debts of banks and insurance companies?

A: Yes, the rules are different for banks and insurance companies.

In the case of banks, the Monetary Board of the Bangko Sentral ng Pilipinas (BSP) determines whether their bad debts have become worthless or uncollectible. The Monetary Board also approves the writing-off of bad debts from the books of accounts of banks at the end of the taxable year.

A bad debt from an insurance company can only be written off and claimed as a deductible expense only if the insurance company has been declared as insolvent by the Insurance Commissioner.

Q: What are the rules if a taxpayer is able to collect payment for a debt that was prevously claimed as a deduction?

A: He should include it as part of his gross income if the deduction resulted to a lower tax liability.

However, it the business reported a net loss even before the deduction of the bad debt, the deduction did not give him any tax advantage. The taxpayer does not need to declare the collected payment as part of his taxable income. It is considered a recovery of return of his capital, thus, not taxable.

Illustration:

Case 1. Company A claimed a receivable of P14,000 as bad debt deduction in 1998, Because of the deduction, its total income of P234,000 was reduced to P220,000. In case the company collects payment for the debt in the following year, the debt payment must e reported as additional income for 1999.

Case 2. Company A registered a net loss position of P100,000. A receivable of P14,000 was determined to be worthless and was thus claimed as bad debt. With the bad debt deduction, the total net loss amounted to P114,000.

If the company collects the said receivable in 1999, it is not required to report the P14,0000 as additional income. The deduction of the bad debt did not give any tax advantage.

Case 3. Company A has a taxable income of P10,000. After deducting a bad debt of P14,0000, the company reported a net loss of P4,000.

If the company collects the receivable of 14,000 in 1999, it has to report an additional income of P10,000 for the year.

Q: Can securities which have become worthless be claimed as a deduction?

A: Securities refers ti shares of stock in corporation and rights to subscribe for or to receive such shares. The term includes bonds, debentures, notes or certificates or other evidence of indebtedness, issued by any corporation, including those issued by a government or its political subdivision with interest coupons or in registered form.

If securities which are held as capital asset become worthless and charged-off within the taxable year, the resulting loss shall be considered as a loss from the sale or exchange of capital asset made on the last day of the taxable year. The taxpayer, however, has to prove through clear and convincing evidence that the securities have become worthless.