They say history repeats itself — and in taxation, that’s often true. Over the years, taxes have consistently undergone a familiar cycle of reform, resistance and frustration. While the specifics evolve, the underlying narrative remains unchanged: the government seeks revenue, taxpayers push back, and the tug-o-war continues. Today, tax issues are, in many ways, modern echoes of the past.
A recent example is the Bureau of Internal Revenue (BIR)’s issuance of Revenue Memorandum Circular (RMC) No. 81-2025, which reiterates the criteria and guidelines for deductibility of business expenses, particularly emphasizing that only expenses considered “ordinary” and “necessary” and directly attributable to the taxpayer’s business operations are deductible for income tax purposes.
Under the law, taxpayers may deduct expenses that are both ordinary and necessary for their business. Ordinary expenses refer to those that are usual and customary in the taxpayer’s line of business. These need not be habitual or recurring; they simply must be common within the context of the taxpayer’s business. Necessary expenses are those that are helpful, integral and directly connected to the business operations, contributing to income or profit generation.
RMC No. 81-2025 clarifies that not all expenses qualify as ordinary. For instance, an expense that is exorbitant — such as if it comprises half of the total deductions claimed — may not be considered ordinary. Thus, it is important for businesses to consider both the size and proportion of the expense relative to their overall operations. This interpretation appears to draw from earlier tax court rulings where excessive expenses were disallowed. However, a blanket application of this principle may be inappropriate. A more refined approach would be to assess on a case-by-case basis. For example, logistics companies may understandably incur warehousing costs that exceed half of their total deductions. Similarly, startup companies may also incur initial costs which significantly exceed their revenue in their earlier years.
When it comes to compensation for services (whether rendered by natural persons, such as employees/professionals, or juridical entities, such as third-party service providers), if the amount paid does not correlate with or does not reflect the actual services rendered, it may not be deemed ordinary and necessary. However, as the value of services rendered can be influenced by several factors, establishing clearer parameters would help ensure fairness and prevent potential misinterpretation or arbitrary application.
Substantiation remains crucial for the expenses to be allowed as deductions. Taxpayers must be able to present documents (i.e., invoices) that support these deductions. Otherwise, it may be disallowed.
While RMC No. 81-2025 has gone over several considerations in claiming expenses, I would like to focus on the segregation of expenses that it sets out. In particular, matching expenses to the related revenues, a principle grounded on the RMC’s interpretation of the term “directly attributable.” Building on this, it highlights the importance of distinguishing between (a) active and passive income, and/or (b) income subject to different tax regimes, when determining deductibility of the expenses.
The classification of the income whether active or passive depends on the taxpayer’s level of involvement. Passive income arises from activities that do not require continuous or direct participation, such as interest, royalties or dividends. On the other hand, active income stems from habitual, business-driven actions, such as operating a business or providing services, and not merely from holding assets and earning results without substantial participation. The RMC underscores that the degree, frequency and intent of the taxpayer’s participation are key factors in determining whether income should be treated as active or passive.
Expenses for managing passive investments are not deductible from active income, as they do not relate directly to active business operations.
The RMC further provides that expenses related to tax-exempt income are not deductible. It views that allowing such deductions would result in a double benefit to taxpayers: first, the income is not taxed, and second, the expenses, when deducted, reduce taxable income from other sources.
The same approach was applied by the RMC to expenses incurred in relation to income subject to final withholding tax, which have also been held as non-deductible. Since the income has already been taxed at the final rate, further deductions would undermine the principle of final taxation.
Finally, expenses related to preferentially taxed income must be carefully allocated to prevent them from reducing the taxable base of regular income. This allocation of the expenses ensures that the benefits of preferential tax rates are not extended to regular income.
Noncompliance with these rules may result in reclassification of expenses and potential disallowance.
The requirements laid out in RMC No. 81-2025 came as a surprise, to say the least. The Supreme Court (SC) in 2021 ruled that common expenses should be deductible in full against taxpayers’ income subject to regular tax. In the decision, the SC struck down an earlier BIR issuance – Revenue Regulations (RR) No. 4-2011, which attempted to mandate a method of allocating the expenses amongst income of banks and other financial institutions. The RR had provided that all costs and expenses be specifically allocated between the bank’s operations — regular banking unit (RBU) and foreign currency deposit unit (FCDU)/expanded FCDU or offshore banking unit (OBU), limiting deductions to those attributable to RBU operations. The SC, while cognizant of the matching principle of accounting, held that by allocating expenses to tax-exempt or final tax paid income, the RR unduly curtailed and amended the law governing deductible expenses.
The SC emphasized once more that administrative issuances must remain consistent with the law and cannot impose additional requirements beyond what the Tax Code provides. Thus, RR No. 4-2011 was rendered null and void.
RMC No. 81-2025 now appears to echo the invalidated RR. This time, the echoes are louder, as the implications are no longer limited to banks and financial institutions. It appears to have broadened the coverage to other businesses which are subject to different tax regimes. It begs the question — is this going to be a repeat of RR No. 4-2011? Curiously, the RMC appears to have cited several landmark rulings involving deductible expenses, except for the 2021 case.
Clarity is essential for effective compliance. RMC No. 81-2025 shows BIR’s initiative to help taxpayers determine deductible expenses. However, as a practitioner, I hope that the guidelines are further refined to align with the existing legal framework, support taxpayers in achieving better compliance, and help prevent potential misinterpretation during tax investigations. Clearer rules will help move us forward through the echoes, and into a future defined by fairness and trust.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only and should not be used as a substitute for specific advice.
Maria Jonas Yap is a director at the Tax Services department of Isla Lipana & Co., a Philippine member firm of the PwC network.