Tax relief for casualty losses
By Cheryl Edeline C. Ong
First Published in Business World (12/9/2013)
IN LAST week’s article, we talked about the taxability of donations given the recent outpouring of compassionate aid for the victims of Typhoon Yolanda last month, as well as the victims of the Bohol earthquake in October.
We now look at the other side of the coin. In light of these catastrophes, this is an opportune time to remind affected businesses of the requisites for the deductibility of casualty losses for income tax purposes in time for the year-end closing of the books.
The Tax Code allows the deduction from gross income of casualty losses arising from damage to or loss of property used in business, to the extent that these are not compensated for by insurance or other forms of indemnity, and subject to compliance with certain requirements as outlined in RMO No. 31-09, dated Oct. 16, 2009.
To be deductible, casualty losses must be incurred on properties that are actually used in business. These properties must have been properly reported as part of the taxpayer’s assets in the accounting records and financial statements in the year immediately preceding the occurrence of the loss, with the cost of acquisition clearly established and recorded. The deduction of the losses must be properly recorded in the accounting reports, with the adjustment of the applicable accounts.
Within 45 days from the date of the event causing the loss, a sworn declaration of loss must be filed with the nearest BIR Revenue District Office (RDO) in the BIR-prescribed format, stating the nature of the event that gave rise to the loss and time of its occurrence; description and location of damaged properties; items needed to compute the loss such as the cost or other basis of the properties, any depreciation allowed, value of properties before and after the event, and cost of repair; and the amount of insurance or other compensation received or receivable.
The sworn declaration must be accompanied by the audited financial statements for the preceding year and copies of any insurance policies covering the concerned properties. Failure to submit the sworn declaration within the prescribed 45-day period may result in the disallowance of the loss claimed.
For businesses affected by typhoon Yolanda, the sworn declaration must be filed on or before Dec. 23, 2013.For businesses affected by the earthquake, such sworn declaration should have been filed on or before Nov. 29, 2013.
In addition, proof of the elements of the losses claimed, such as, but not limited to, photographs of the properties before and after the event, documentary evidence of the cost of the properties, police reports in case of robbery or theft during the calamity and/or as a consequence of looting, etc. may be required to substantiate the loss. Taxpayers who have lost their books of accounts and accounting records must also report this to the BIR.
Looking at the above requirements, securing the proper substantiation would seem to be a tedious task, particularly photographs of the properties before the event. Considering this requirement, it may be prudent for business owners to now consider taking pictures of business properties as part of their year-end activities, similar to inventory-taking. Tedious though it may be, businessmen are reminded that when a company claims casualty losses as a tax deduction in its income tax return, the BIR will certainly look for the proper documentation to substantiate and justify the deduction. The rule always is that tax deductions are in the nature of tax exemptions, which are always construed in favor of the government and against the taxpayer. The burden of proof that one is entitled to a tax deduction therefore lies with the taxpayer.
Please note also that the RMO explicitly states that the amount of loss that is compensated for by insurance should not be claimed as a deductible loss. If the insurance proceeds exceed the net book value of the damaged or lost assets, they shall be subject to regular income tax, but not VAT, since the indemnification is not an actual sale of goods by the insured company to the insurance company.
In this connection, the proper timing to deduct casualty losses pending finality of the amount of insurance claims is also a potential issue. The reality is that insurance companies take time to respond to claims filed considering the volume of claims received following a calamity and the need to verify the losses incurred by the insured. For instance, if a taxpayer incurs a casualty loss in 2013, but the final amount of indemnity from the insurance company is known only in 2014 (after the filing of the 2013 ITR), can the taxpayer deduct the entire amount of loss in 2013 and declare the entire insurance proceeds as income in 2014? Again, this would largely depend on the factual circumstances and documentation available.
Notwithstanding the tax relief granted for casualty losses for purposes of the regular 30% corporate income tax (or the 5% — 32% personal income tax rates, in the case of single proprietorships), the law requires certain formalities to be complied with so as to safeguard against possible abuses. Affected businesses should avoid a situation where anticipated tax deductions are lost due to mere failure to comply with substantiation requirements. Worse, the taxpayer may end up needing to pay deficiency taxes plus penalties, which would compound the casualty loss.
Cheryl Edeline C. Ong is a tax senior director of SGV & Co.
(In last week’s article, it was noted that should donations given to the government not qualify in the foregoing criteria, or are not made to accredited NGOs, the donations shall only be deductible to the extent of 10% of the donation, in case of individuals or 5%, for corporations. It should read “10% of the taxable income of corporations and 5% for individuals”.)
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.