Tax relief from losses
Let’s Talk Tax — By Nikkolai F. Canceran
Last month, the Philippine Atmospheric Geophysical and Astronomical Services Administration (PAGASA) officially announced the start of the rainy season. Not only would the season bring an average of 20 typhoons every year but also deliver with it the equally devastating southwest monsoon or “Habagat,” the effects of which we all have witnessed in the past years.
On the other hand, the Marawi crisis has entered its seventh week and is not expected to end very soon.
What does these two events have in common? Damage to property.
For taxpayers, what could be worse for their businesses than seeing their property, machinery, equipment, merchandise inventory, etc. being damaged or lost? Such losses are certain to affect their businesses. However, the government, out of sympathy, provides tax relief to somehow ease the burden of the taxpayers.
Under the National Internal Revenue Code (NIRC), losses to property connected with the trade, business or profession (assets not used in the course of trade or business and/or are personal in nature shall therefore not be allowed) actually sustained in a taxable year and not compensated for by insurance or other forms of indemnity can be claimed as deductions for income tax purposes.
These losses could arise from even ordinary and casual losses. Ordinary losses pertain to those incurred in trade, business or profession sustained under normal business operations such as losses from destruction or disposal of inventory, machinery or equipment declared as waste or obsolete due to spoilage, deterioration, obsolescence, expiration or other causes rendering the same unfit for sale or for use in business/trade/profession.
On the other hand, casualty losses pertain to complete or partial destruction of property arising from fire, storm, shipwreck, or other such events, or even from robbery, theft or embezzlement.
For the losses to be deductible for income tax purposes, the following should be present:
• They should be actually sustained and written off during the year;
• They should not be compensated for by insurance; and
• They must be evidenced by closed and completed transactions.
Note that the amount of loss that is compensated by insurance coverage should not be claimed as a deductible loss. If the insurance proceeds exceed the net book value of the damaged assets, such excess shall be subject to the regular income tax but not to the VAT since the indemnification is not an actual sale of the goods.
For casualty losses, taxpayer must be able to comply with the following substantiation requirements and submit these within 45 days after the date of the event:
1. A sworn declaration of the loss stating the nature of the event that gave rise to the loss and the time of its occurrence, a description and location of the damaged properties, the items needed to compute the losses, i.e., cost or other basis of the properties, allowing for depreciation, if any, and the value of the property before and after the event and cost of the repair.
The sworn declaration must be accompanied by the financial statement for the year immediately preceding the event and copies of insurance policies, if any, for the concerned properties. The properties that shall be reported as casualty losses must have been properly reported as part of the taxpayer’s asset in their accounting records and financial statements in the year immediately preceding the occurrence of the loss, with the costs of acquisition clearly established and recorded. Otherwise, the claim for deduction shall not be allowed.
2. Proof of the elements of the losses claimed such as photographs of the properties taken before and after the typhoon showing the damage sustained, documentary evidence for determining the cost or valuation of the damaged properties, insurance policies, if any, and police reports in case of robbery or theft during the typhoon and/or as a consequence of looting.
Reporting a theft or robbery to the police is critical. A mere report of an alleged theft or robbery to the police authorities is not considered conclusive proof of the loss arising therefrom.
The deduction of assets as losses must be properly recorded in accounting reports, with the adjustment of the applicable amounts and the restoration of the damaged property or the acquisition of the new property to replace properly recorded and recognized either as repairs expense or capitalized as an asset.
In the event of total loss or destruction, the net book value immediately preceding the natural disaster should be used as the basis for claiming casualty losses and shall be reduced by the amount of insurance proceeds received.
Taxpayers appreciate the sympathy of the government but the challenging requirements of deductibility may not be felt as relief but another burden they need to think of. The government should give more consideration to taxpayers during these difficult times when they need a helping hand to recover. For example, it may extend the deadline of submission of the requirements or submission of other alternative or the best available documents in case the specific documents required by the Tax Code have all been lost or destroyed.
We cannot control the forces of nature or war and what destruction these bring forth, but we can control and reduce the potential risks to our business. Before another typhoon or “Habagat” looms, taxpayers should proactively start preparing for worst-case scenarios. After all, it’s better to be safe than sorry.
Nikkolai F. Canceran is a senior manager with the Tax Advisory and Compliance division of P&A Grant Thornton.