Over the years, the standards for what qualify as ordinary and necessary business expenses have been shaped by both the Tax Code and numerous court decisions. To clarify these rules, the BIR issued Revenue Memorandum Circular (RMC) 81-2025, reiterating the criteria for deductibility. While the circular is intended to promote consistency, it raises an important question: Was such reiteration truly necessary, or does it risk introducing new ambiguities and compliance burdens that may complicate, rather than simplify, tax administration?
The self-assessment principle underlying the ‘pay as you file’ rule requires taxpayers to accurately compute their taxable income and substantiate all business expense deductions with proper supporting documents. RMC 81-2025 reinforces the importance of compliance with these requirements to ensure proper application of tax laws.
Ordinary and necessary
An ordinary expense is one that is normal and customary for business, while a necessary expense is appropriate, helpful, and directly tied to operations. On paper, these definitions appear straightforward.
However, the RMC introduces the concepts of reasonableness and proportionality, requiring that expenses be reasonable in amount and proportionate to overall operations. This can be interpreted in two ways: one view suggests that unusually large expenses are automatically suspect, while another allows the expense if it is an industry norm, directly tied to income generation, and properly documented. This ambiguity creates uncertainty for taxpayers about how their expense claims will be evaluated.
This is especially problematic for businesses with essential costs in large amounts. If the BIR were to disallow these expenses solely because of the value or magnitude, it would distort the company’s actual profitability and unfairly penalize legitimate business activity. Ultimately, the focus should be on whether an expense is necessary, reasonable, customary, and properly substantiated-not merely on the amount.
Paid or incurred within the taxable year
Deductible business expenses must be paid or incurred within the same taxable year in which the related revenue is earned. This aligns with the matching principle under the Generally Accepted Accounting Principles (GAAP), ensuring that expenses are recognized in the same period as the income they help generate.
Directly attributable to trade, business or profession
For an expense to be deductible, it must be directly linked to business activities. However, the RMC’s distinction between active and passive income creates uncertainty: a strict view allows deductions only for active income expenses, while a broader view permits deductions for any expense directly tied to income generation. This ambiguity may result in inconsistent application among taxpayers and auditors.
Adding to this, the RMC requires that each income stream, whether subject to regular tax, preferential rates, tax exemption, or final tax, has its corresponding expenses correctly identified and allocated. While meant as a safeguard, this rule may actually increase administrative burdens and complicate compliance for businesses with multiple income sources, potentially leading to confusion and more disputes with tax authorities.
Substantiation
A fundamental principle in taxation is that tax exemptions are strictly construed against the taxpayer and liberally in favor of the taxing authority. Deductions share this nature, requiring strict interpretation and clear, convincing evidence to support any claim. It’s not enough to simply assert entitlement; businesses must substantiate their claims with official documents, such as invoices and vouchers, to validate each deduction.
Other matters
Finally, the RMC also addresses expenses related to income other than regular taxable income:
Expenses incurred solely to generate tax-exempt income are not deductible for regular income tax, as they do not contribute to taxable income and would result in a double benefit for the taxpayer.
Expenses tied exclusively to income taxed at source, such as interest or dividends, are not deductible against regular taxable income. Since the final withholding tax is intended to be comprehensive and conclusive, allowing further deductions would undermine this fundamental taxation principle.
Expenses directly linked to income subject to preferential tax rates must be separated from those related to regular income to prevent improper deductions that could reduce the regular tax base.
RMC 81-2025 was issued to clarify the rules on deductible business expenses. Yet instead of providing certainty, it risks reopening settled questions and adding compliance burdens. Terms like ‘ordinary,’ ‘necessary’ and ‘directly attributable’ may seem straightforward, but the circular’s focus on proportionality and allocation across income streams invites conflicting interpretations. This creates an environment where legitimate expenses could be disallowed not for lack of business purpose, but because of how they are classified, proportioned, or documented.
If the aim of RMC 81-2025 is to provide guidance, it should be anchored on the basic principles of the law and should not introduce additional requirements. Rather than offering clarity, adding new conditions may lead to greater confusion, contrary to the goal of promoting better tax compliance. Guidance should always make requirements straightforward and easy to follow, not create further uncertainty for taxpayers.