Taxation (research and Development)

RESEARCH AND DEVELOPMENT

Research and development costs are for improvements of processes and formulas, as well as the improved or new products. Research and development costs may be expenditure:

a. For acquisition or improvements of property subject to depreciation or depletion used in research and development.

Cost of acquisition or improvement of property subject to depreciation or depletion used in research and development becomes part of the costs of the asset, and deduction from it is by depreciation, or depletion, as the case may be.

b. Other research and development costs.

Other research and development costs may be treated in either of two ways:

(a) As an outright deduction (for the full expenditure), in the year that the expense was paid or incurred; or

(b) As a deferred expense, to be spread and recognized as deduction over a period of not less than sixty (60) months from the date of acquisition of benefit from the expenditure.

EXPENSES, IN GENERAL

In accounting, as well as income taxation, two kinds of business expenditure are distinguished from each other, namely, the revenue expenditure and the capital expenditure.

Revenue expenditure- benefits one accounting period and is a deduction from gross income in the year paid or incurred, if satisfying the conditions on deductibility under the National Internal Revenue Code.

Capital expenditure- usually incurred in the acquisition, betterment or permanent improvement of an asset, benefits more than one accounting period, and is not deductible from gross income in the year paid. The expenditure is capitalized and the cost is recovered through annual depreciation, if the asset has a limited useful life.

An expense must satisfy the following conditions in order to be deductible from the gross income.

a. It must be ordinary and necessary;

b. It must be paid or incurred within the taxable year;

c. It must be in carrying on, or directly attributable to, the development, management, operation and/or conduct of the trade and business, or the practice of a profession; and

d. It must be sustained by official receipts and other adequate records.

An expense is considered ordinary if it is normal in relation to the taxpayer’s business and the surrounding circumstances. The expense need not be recurring. An expense is necessary when it is intended to minimize losses, or to maximize profits.

The requirement that the expense must be paid or incurred within the taxable year is exemplified by the recognition of prepaid and accrued expenses of a taxpayer on the accrual