Borrowing costs are interest and other costs that an entity incurs in connection the
borrowing of funds [Philippine Accounting Standards (PAS) 23.5]. The Philippine Financial
Reporting Standards require that interest expense be calculated using the effective interest method.

      PAS 23 requires entities to capitalize borrowing costs that are directly attributable to
the acquisition, construction or production of a qualifying asset as part of the cost of that asset.
      All other borrowing costs are recognized as an expense in the period in which they are
incurred (PAS 23.1 and 23.8).

      PAS 23 defines a qualifying asset as an asset that necessarily takes a substantial period
of time to get ready for its intended use or sale (PAS 23.5). Accordingly, assets that are ready
for their intended use or sale when acquired are not qualifying assets and are, therefore, not
eligible for interest capitalization (PAS 23.7). 

      Capitalization of borrowing costs commences when all of the following conditions
are met:
              a. The entity incurs expenditures for the asset;
              b. The entity incurs borrowing costs; and
              c. The entity undertakes activities that are necessary to prepare the asset for its
intended use or sale (PAS 23.17).

      The standard requires capitalization of borrowing costs to cease when substantially
all the activities necessary to prepare the qualifying asset for its intended use or sale are
complete (PAS 23.22). An asset is normally ready for its intended use or sale when the
physical construction of the asset is complete, even though routine administrative work might
still continue (PAS 23.23).

      When an entity suspends the activities necessary to prepare an asset for its intended
use or sale, capitalization of borrowing costs should also be suspended during the periods in
which active development is interrupted. (PAS 23.20 and 23.21).

      Interest paid or incurred within a taxable year on indebtedness in connection with the
taxpayer’s profession, trade or business shall be allowed as a deduction from gross income,
subject to certain limitations, when the following requisites, provided in Section 34 (B)(2) of
the National Internal Revenue Code (NIRC) of 1997, as amended, and as implemented by
Revenue Regulations (RR) No. 13-2000 and Section 7(B) of RR No. 5-2021, are met:
              a. The indebtedness must be that of the taxpayer;
              b. The interest must have been stipulated in writing;
              c. The interest must be legally due;
              d. The interest payment arrangement must not be between related taxpayers as
mandated in Sec. 34 (B)(2)(b), in relation to Sec. 36(B), both of the NIRC of
1997, as amended;
              e. The interest must not be incurred to finance petroleum operations;
              f. The interest was not treated as “capital expenditure” if such interest was incurred
in acquiring property used in trade, business or exercise of profession; and
              g. The interest shall be reduced by an amount equivalent to twenty percent (20%) of
interest income subjected to Final Tax. However, if the final Withholding Tax
rate on interest income of twenty percent (20%) will be adjusted in the future, the
interest reduction shall be adjusted accordingly.

      In addition, the taxpayer must have withheld the appropriate tax in order to claim the
interest expense as a deduction from the gross income.

      Only the interest expense directly attributable to the acquisition of any property (e.g.,
building, car, and machinery) used in trade, business or exercise of profession may be
capitalized for tax purposes. Hence, the interest expense incurred in the acquisition of a
qualifying asset under PAS 23 may be capitalized for tax purposes only if the asset is used in
trade, business or exercise of profession and not if it is intended for sale (e.g., inventories).

      Should the taxpayer elect to capitalize the interest expense incurred to acquire
property used in trade, business or exercise of profession, which may include a qualifying
asset, for tax purposes, the following shall apply:
              a. The option to capitalize interest expense shall be irrevocable per specific
asset/property.
              b. If the loan covers the acquisition of several properties, the interest expense on
such loan shall be proportionately capitalized on such properties. For example, if
the loan was contracted for the acquisition of a car and machinery, then the
interest expense on such loan shall be proportionately capitalized between the car
and machinery.
              c. If the loan pertains to general borrowings or covers the acquisition of an asset/
property used in trade, business or exercise of profession and qualifying assets
intended for sale such as inventories, only the interest expense incurred or paid
from the general borrowings directly attributable to the acquisition of the
asset/property used in trade, business or exercise of profession may be capitalized
by the taxpayer subject to verification by the concerned BIR office upon audit of
the taxpayer’s Tax Return.
              d. If multiple loans were contracted for the acquisition of a single property used in
trade, business or exercise of profession, the option to capitalize interest expense
shall be applied consistently with all the loans relating to the acquisition of such
property.
              e. If the interest expense is treated as a capital expenditure, the taxpayer may only
claim the periodic depreciation or amortization of such capital expenditure as a
deduction from its gross income. The capitalized interest expense shall be
depreciated or amortized based on the useful life of the asset. Generally,
depreciation or amortization shall commence upon the acquisition of the property.
However, if the property is not yet ready for its intended use in the taxpayer’s
trade, business or exercise of profession, then the depreciation shall commence
when the property is already ready for its intended use.

      When the taxpayer elects to capitalize interest expense incurred or paid to acquire
property used in trade, business or exercise of profession and claims periodic depreciation or
amortization on such interest expense, the taxpayer cannot claim as a deduction from gross
income the difference of the periodic depreciation or amortization and the interest expense
actually incurred or paid should the latter be greater than the former. The taxpayer may only
claim the periodic depreciation or amortization of the capitalized interest expense as a
deduction from its gross income.

      Interest expense is not deductible in full when claimed as an outright expense. The
amount of interest expense paid or incurred on indebtedness in connection with the taxpayer’s
trade, business or profession shall be reduced by an amount equivalent to twenty percent
(20%) of interest income subjected to Final Tax pursuant to Section 34(B)(1) of the NIRC of
1997, as amended. However, for corporations subject to the regular Corporate Income Tax
rate of twenty percent (20%), the deduction is zero percent (0%) because there is no difference
between the tax rates applicable to taxable income and interest income subjected to Final Tax.
The limitation shall apply whether or not a tax arbitrage scheme was entered into by the
taxpayer or regardless of the date when the interest-bearing loan and the date when the
investment was made, as long as, during the taxable year, there is an interest expense incurred
and an interest income earned that was subjected to Final Withholding Tax. This rule must
be observed irrespective of the loan currency and/or the currency in which investments or
deposits were made.

      For the proper monitoring of interest expense, the following may be submitted and/or
disclosed in the Notes to Financial Statements of the taxpayer:
             a. A subsidiary ledger detailing the interest expense capitalized or expensed and/or
disclosure of interest capitalized or expensed in the Notes to Financial
Statements;
             b. Disclosure of the principal payments made and the interest expense paid or
incurred in the Notes to Financial Statements; and/or,
             c. Documents that will justify the availment of interest capitalization (e.g., Board
Resolution specifying the utilization/allocation of loan proceeds for the general
borrowing, year-end certification from the financial institution or creditor, loan
documents, and other similar documents).

    If within the taxable year an individual taxpayer reporting income on the cash basis
incurs an indebtedness on which an interest is paid in advance through discount or otherwise,
such interest expense paid in advance shall only be allowed as a deduction in the year when
the taxpayer has fully paid the indebtedness. If the indebtedness is payable in periodic
amortization, the amount of interest expense that corresponds to the amount of the principal
amortized or paid during a certain period shall be allowed as a deduction in such taxable year.

      Under the accrual method of accounting, the all-events test shall apply. The test
requires that the following requisites be met in the recognition of income or expense:
             a. The fixing of a right to income or liability to pay; and
             b. The availability of a reasonable accurate determination of such income or liability.

      Accordingly, interest expense shall be deducted in the year paid or accrued. However,
if a corporation prepays the interest at the loan drawdown date, the prepaid interest shall be
amortized over the required period. To fully reflect the revenues generated and expenses
incurred, the amortized portion shall be deducted from the prepaid interest as the expense for
the taxable year within the required period.

      Interest expense shall not be deductible from gross income if both the taxpayer and
the person to whom the payment has been made or is to be made are persons specified under
Section 36(B) of the NIRC of 1997, as amended.

      For tax purposes, costs such as service fees and commissions paid to banks and/or
lending institutions for borrowing of funds shall not be classified as interest expense but as
an ordinary and necessary business expense. Such costs shall be allowed as a deduction from
gross income in the year paid or incurred.

      The interest expense paid or incurred shall be subject to the following Withholding
Tax rates unless otherwise provided by law or regulations:
           a. Final Withholding tax of twenty-five percent (25%) on interests paid to nonresident aliens not engaged in trade or business in the Philippines;
             b. Final Withholding Tax of twenty percent (20%) on interests from foreign
currency loans paid to non-resident foreign corporations, unless entitled to a
lower rate under an existing treaty;
             c. Final Withholding Tax of ten percent (10%) on interests from foreign currency
loans paid by residents other than offshore banking units in the Philippines or
other depository banks under the expanded foreign currency deposit system to
depository banks under the expanded foreign currency deposit system; and
             d. Creditable Withholding Tax of fifteen percent (15%) on interests from any other
debt instruments not within the coverage of “deposit substitutes” under RR No.
14-2012 paid to persons residing in the Philippines except interests paid by top
withholding agents strictly arising from individual loans obtained from banks that
are not securitized, assigned or participated out, as well as interests paid by banks
designated as top withholding agents strictly arising from loans made to such
banks that are not securitized, assigned or participated out, which shall be subject
to a Creditable Withholding Tax of two percent (2%) pursuant to Revenue
Memorandum Circular No. 84-2012.