April 5, 1986

REVENUE AUDIT MEMORANDUM ORDER NO. 04-86

SUBJECT :

Audit Guidelines in the Allocation of Home Office

Overhead Expenses Under Section 37(b)
of the
National Internal Revenue Code.

TO

All Internal Revenue Officers and Others Concerned

In order to avoid delay and conflict in the determination of Philippine

sources taxable net income of foreign taxpayers for purposes of Philippine income
tax, this Revenue Audit Memorandum is issued.
1.

Background
1.1

In computing net income from sources within the Philippines,

Section 37(b) provides that from the gross income from sources
within the Philippines ". . . there shall be deducted the
expenses, losses and other deductions properly allocated thereto
and a ratable part of any expenses, interests and losses and
other deductions effectively connected with the business or
trade conducted exclusively within the Philippines which
cannot be definitely allocated to some items or class of gross
income . . . "
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1.2

These deductions are difficult to verify because substantial

amounts thereof are incurred in the head office or elsewhere
and the corresponding supporting documents and books of
accounts are not accessible to local taxing authorities.

1.3

Heretofore only an audit certificate is presented to substantiate

the deductions incurred abroad which are allocated and
pro-rated to Philippine source gross income.

1.4

In implementing the above provision of the National Internal

Revenue Code, there is a need for adequate and satisfactory
proof and explanations in order that the claimed deductions of
the foreign taxpayer may be allowed for income tax purposes.

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2.

Audit Procedure
2.1

Functional analysis At the start of investigation there should

be a detailed examination of the functions performed both by
the Home Office and the Local Branch. For this purpose, an
organization and functional chart of the home office and local
branch should be secured.
2.11

The functions should be determined and then listed. Who

does what? What is required to do it? Who needs whom
for what?

2.12

After having listed the functions performed by each

entity, the functions themselves must be analyzed. Could
anyone else perform these functions? How difficult are
they? What skill, equipment and processes are needed?
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2.2

On the basis of the functional analysis, the claimed deduction

properly allocable can now be determined by applying the tests
of (a) relevance (necessary) to the local branch and (b)
reasonable (ordinary) charges keeping always in mind the arm's
length principle in transactions between related parties.

2.3

As to the deductions which cannot be definitely allocated, the

following are required:
2.31

Breakdown or Schedule of Home or Foreign Office

expenses being pro-rated, together with an explanation
of the nature of each expense. Take note of deductions
which are directly allocable to income earned outside the
Philippines.

2.32

Basis of pro-ration (a) Determine if the basis and

method of pro-ration are being applied consistently from
year to year. (b) Is the same amount of Home Office
expenses being allocated world-wide?

In all instances, be on the lookout for:

a.

Charges applicable to newly opened foreign branches but are

being claimed as deductions by the Philippine branch;

b.

Functions are being performed for some branches but not for
others, and yet no adjustments are made on the allocation;

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Philippine Taxation Encyclopedia 2013

c.

or any other scheme of over-allocating costs to the Philippine

branch.
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4.

All pertinent provisions of these Audit Guidelines applicable in the

investigations of subsidiaries by multi-national companies should be
observed by all internal revenue officers concerned.

(SGD.) BIENVENIDO A. TAN, JR.

Commissioner

Copyright 2014

CD Technologies Asia, Inc. and Accesslaw, Inc.

Philippine Taxation Encyclopedia 2013