Requisites for Deductability of Interest Expense

For taxation purposes, interest expense is deductible if it is met with the following requisites: 

1. These must be a valid and existing indebtedness;

2. There should be an interest expense paid or incurred upon such indebtedness;

3. The indebtedness must be that of the taxpayer;

4. The indebtedness must be connected with the taxpayer's trade, business or exercise of profession;

5. The interest expense must have been paid or incurred during the taxable year;

6. The interest must have been stipulated in writing;

7. The interest must be legally due;

8. The interest payment arrangement must not between related taxpayers;

9. The interest must not be incurred to finance petroleum operations;

10. In case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure.
11. The interest payment arrangement must not be between related taxpayers as mandated in Section 34(B) (2) (b), in relation to Section 36(B), of the NIRC.
12. Is not expressly disallowed by law to be deduced from the taxpayer's gross income (e.g interest on indebtedness to finance petroleum operations); and
13. Shall be reduced by an amount equal to the 33% of the interest income subjected to final tax of 20%, earned during the same period. [Sec. 34(B)(1), NIRC].

Generally, the amount of interest paid or incurred within the taxable year on indebtedness in connection with the taxpayer profession, trade or business shall be allowable deduction from gross income: Provided, however, that the taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax:

Thirty three percent (33%) beginning January 1, 2009

Assuming that a taxpayer incurred in 2013, interest expense amounting to P100,000. This is "Otherwise Allowable Deduction for Interest Expense" but it will be reduced by an amount equal to the prescribed percentage of interest income subjected to the final tax.

Thus, if in 2013, the taxpayer received P60,000 net interest income on which the final tax was withheld and remitted to the BIR by the payor of such income, then the deductible amount of interest will be computed as follows:

Total Interest Expense                                     P100,000

Less: 33% of P60,000/.80                                    24,750

AMOUNT DEDUCTIBLE                             P  75,250

References: RMC 13-2009; RR No. 13-2000.