Deducting bad debts

By: Atty. Rey Christian M. Guintibano on December 4, 2025

FOR many businesses, unpaid receivables are an unavoidable part of operations. Whether arising from unpaid invoices, defaulted loans, or broken payment promises, bad debts can significantly affect a company financially. The National Internal Revenue Code (the “Tax Code”) acknowledges this reality and allows businesses to deduct these bad debts from their gross income, but only if strict conditions are met.

Section 34(E) of the Tax Code provides that taxpayers may deduct “debts due to the taxpayer actually ascertained to be worthless and charged off within the taxable year.” The rule applies only to debts connected with the taxpayer’s trade or business and excludes transactions between related parties enumerated under Section 36(B) of the Tax Code.

Revenue Regulations (RR) 05-99, as amended by RR 25-02, define “bad debts” as “debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered.”

The regulations also lay down the requisites for deductibility of bad debts, as follows:

• there is an existing indebtedness due to the taxpayer which is valid and legally demandable;
• the debt is connected with the taxpayer’s trade, business, or practice of profession;
• the debt is not from a transaction between related parties;
• the receivable is actually charged off the books of the taxpayer as of the end of the taxable year; and
• the debt is actually ascertained to be worthless and uncollectible as of the end of the taxable year.

The regulations also emphasize that a debt is not “worthless” simply because it is difficult to collect or long overdue. Taxpayers are expected to exercise sound business judgment based on the debtor’s financial condition, the value of any collateral, and reasonable efforts to collect.

A mere estimate of uncollectible accounts or a general allowance for doubtful accounts is not enough. The specific receivable must also be canceled and written off in the books of accounts.

In the case of Philippine Refining Co. v. Court of Appeals (GR 118794, May 8, 1996), rendered before the issuance of RRs 05-99 and 25-02, the Supreme Court already provided the basic requirements for bad debt deductions as follows: (1) there must be a valid and subsisting debt; (2) the debt must be actually ascertained to be worthless and uncollectible during the taxable year; (3) it must be charged off within that same year; and (4) it must arise from the taxpayer’s trade or business.

The Supreme Court also underscored that taxpayers must show diligent efforts to collect and identify typical steps taken in practice, such as sending statements of account, issuing collection letters, referring the account to a lawyer, and filing a collection case in court.

While not all steps are required in every case, the taxpayer must present convincing documentary evidence of attempts to collect and circumstances showing that legal action would likely be unsuccessful.

These principles were applied by the Court of Tax Appeals (CTA) in Ansi Agricultural v. Commissioner of Internal Revenue (CTA Case 8541, April 20, 2015). In that case, the taxpayer claimed more than P3.6 million in bad debt expenses. The BIR disallowed the deduction for failure to meet the substantiation requirements under Section 34(E) and RR 05-99 as amended by RR 25-02.

While Ansi Agricultural was able to show that the receivables existed, were connected with its business and were written off in its books, the CTA upheld the BIR’s disallowance of the deduction. It found as insufficient the taxpayer’s assertion that it had repeatedly followed up with its customers and that the debts had remained unpaid for several years.

It noted that there were no copies of demand letters, documentary proof of statements of account sent and proof of referral to counsel supported by written reports. Neither was there any evidence that legal action would have been useless. In fact, the CTA noted that financial statements even showed that one debtor still had substantial assets.

Ultimately, the CTA reiterated that deductions are in the nature of tax exemptions and must be proven by convincing evidence. Unsupported claims and self-serving testimony cannot establish worthlessness; hence, the claimed bad debts deduction was denied.

Bad debts are a reality of doing business, but for tax deduction purposes, they are scrutinized and must meet the criteria set out for deduction under the Tax Code and existing regulations. For taxpayers, this means that decisions to write off receivables should be supported by documentation proving that such receivables are worthless and uncollectible.

Rey Christian M. Guintibano is an Associate of Mata-Perez, Tamayo & Francisco (MTF Counsel). This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any question or comment regarding this article, you may email the author at info@mtfcounsel.com or visit MTF website at www.mtfcounsel.com

The article was published at the More to Follow Column at The Manila Times on December 4, 2025. Please see this link.

https://www.manilatimes.net/2025/12/04/business/top-business/deducting-bad-debts/2236388