Deductibility of Expenses Attributable to Passive Income

By Atty. Fulvio D. Dawilan

"Thus, for as long as the expense is properly substantiated and claimed in the proper period, it should be deductible as an expense if it is usual, normal, attributable and helpful to the conduct of trade or business of a taxpayer. No other condition should be imposed that would limit the deductibility of expenses. More importantly, the income - whether active or passive - to which the expense is related to should not affect deductibility.” 

In September of 2025, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular No. 81-2025 (RMC 81-25), providing specific criteria and guidelines for the deductibility of expenses incurred in business. While the circular recognizes the usual conditions for these expenses to be allowed as deductions in arriving at the net taxable income, it added guidelines that modified the requirements for deductibility.

Presenting these as clarifications to the existing rules, the circular distinguishes the expenses incurred in relation to the conduct of active trade or business from expenses related to generating passive income. Based on these clarifications, expenses directly tied to the development, management, operation or conduct of active trade or business can be deducted as they meet the criteria of being ordinary and necessary. But expenses related to managing investments that generate passive income, such as fees for financial advice, interest from loan to finance investments, or brokerage services, and other related expenses, may not qualify as they do not relate directly to the taxpayer’s active business operations. Following the same reason, the circular requires the segregation of expenses that are attributable to active business operations from those related to passive income generation.

Simply put, the circular requires taxpayers to identify or allocate common expenses – with deductions being limited only to expenses attributed to earning active income. Expenses related to earning passive income are to be excluded as deductions in computing net taxable income subject to the regular income tax. In other words, expenses attributed to earning passive income should not be allowed as deductions.

Barely two months after the issuance of the circular, the Court of Tax Appeals promulgated a decision (CTA Case No. 10784, November 04, 2025), touching on the subject of deductibility of expenses related to passive income. The taxpayer involved in that case is a holding company. As a holding company, a portion of its income constitutes passive income while the others are active income. In the conduct of their examination, the revenue officers allocated the expenses incurred by the taxpayer based on the amounts of active and passive income and disallowed the portion allocated to the latter. The BIR justified its action – arguing that expenses attributable to the taxpayer’s active income must be permitted, whereas expenses imputable to the taxpayer’s passive income must be disallowed – thus the need for the allocation.

The Tax Court disagreed with the BIR, holding that the allocation and consequently, the disallowance, is wanting in legal foundation. The Court emphasized that there is no requirement in the tax law that only expenses allocable to a taxpayer’s active income would be allowed as expense deduction, whereas those expenses imputable on passive income would be disallowed as an expense deduction. The very act of allocation is not mentioned in the law. To support its decision, the Tax Court cited an earlier Supreme Court decision (G.R. Nos. 240163 & 240168-69, December 1, 2021), which declared that common expenses should be deductible in full against the taxpayer’s income subject to regular tax. All expenses are deducted directly and in full without any allocation or attribution between different income streams.

I fully agree with the reasons mentioned by the Tax Court in its decision. And while this case does not directly address the issuance of RMC 81-25 and the additional requirements for determining deductibility of expenses, there is reason to believe that for as long as the deduction is  anchored on the basis of Section 34(A)(1)(a) of the Tax Code and the conditions coined by jurisprudence that interpreted it, the deduction should be allowed. Based on jurisprudence, the deductibility of ordinary and necessary expenses simply requires compliance with four conditions, and these are: (a) the expense must be ordinary and necessary; (b) the expense must be paid or incurred within the taxable year; (c) the expense must have been paid or incurred in carrying on or which are directly attributable to, the development, management, operation and/ or conduct of the trade, business or exercise of a profession; and (d) the expense must be supported by invoices, records or other pertinent papers.

Thus, for as long as the expense is properly substantiated and claimed in the proper period, it should be deductible as an expense if it is usual, normal, attributable and helpful to the conduct of trade or business of a taxpayer. No other condition should be imposed that would limit the deductibility of expenses. More importantly, the income - whether active or passive - to which the expense is related to should not affect deductibility.

The article is for general information only and is not intended, nor should be construed as a substitute for tax, legal or financial advice on any specific matter. Applicability of this article to any actual or particular tax or legal issue should be supported therefore by a professional study or advice. If you have any comments or questions concerning the article, you may e-mail the author at This email address is being protected from spambots. You need JavaScript enabled to view it. or call 8403-2001 loc 310.