How to Record and Substantiate Business Expenses

What Makes an Expense Deductible in the First Place

Section 34 of the National Internal Revenue Code allows a business to deduct expenses that are "ordinary and necessary" to carrying on its trade, business, or profession — meaning the cost is common in your line of work and reasonably helps you earn income. Rent, utilities, salaries, supplies, professional fees, and marketing costs generally qualify. Personal expenses, fines and penalties, and bribes or kickbacks never do, no matter how well documented.

Meeting the "ordinary and necessary" test is only half the requirement. The Bureau of Internal Revenue (BIR) also requires that every deduction be substantiated by adequate proof — primarily official receipts or invoices, supported by records showing the amount, the nature of the expense, and its connection to the business. An expense that is legitimate but undocumented, or documented with the wrong paper, is the single most common reason deductions get disallowed during an audit.

The Documents the BIR Wants to See

Since the Ease of Paying Taxes (EOPT) Act (RA 11976) took effect in 2024, the BIR unified the documentation rule: businesses now issue a Sales Invoice or Service Invoice as the primary proof of both sale of goods and sale of services. Official Receipts, previously required specifically for services, are no longer the mandatory primary document, though many suppliers still issue them out of habit — either is acceptable as long as it is BIR-registered.

Whatever the document is called, to support a deduction it must show:

• The seller's registered business name, address, and Taxpayer Identification Number (TIN)
• Your business's name and TIN as the buyer (not a personal name, if the expense is a company expense)
• The date of the transaction and a description of the goods or services
• The amount, with VAT shown separately if the seller is VAT-registered
• The BIR Authority to Print or the accreditation details of the invoice/receipt (or, for a Computerized Accounting System/e-invoice, the system's BIR-issued acknowledgment)

A receipt made out to "cash" or to an individual's name, a handwritten note, or a screenshot of a bank transfer is not, by itself, sufficient proof of a deductible business expense. If the amount is material, keep the supporting contract, delivery receipt, or billing statement together with the invoice.

Withholding Tax and the "No Withholding, No Deduction" Rule

Many business expenses — professional fees, rent, certain contractor payments, and commissions among them — are subject to expanded withholding tax (EWT) at rates that typically range from 1% to 15% depending on the payee and the nature of the payment. When your business pays such an expense, you are required to withhold the tax, remit it to the BIR (generally through BIR Form 1601-EQ, with the corresponding Form 0619-E for monthly remittances), and issue the payee a BIR Form 2307 (Certificate of Creditable Tax Withheld at Source).

Worked example: Suppose you hire a bookkeeper as an independent contractor and pay a professional fee of ₱20,000 for the month. If the payee is not a VAT-registered top withholding agent's usual 10% rate, you withhold 10% (₱2,000), pay the bookkeeper the net amount of ₱18,000, and remit the ₱2,000 to the BIR. You record the full ₱20,000 as your professional fees expense — not just the ₱18,000 you released — with the ₱2,000 booked as a withholding tax payable until remitted, and the 2307 you issue becomes part of your audit file.

Revenue Regulations implementing Section 34(K) provide that if an expense is subject to withholding tax but the required tax was not withheld, the BIR can disallow the entire expense as a deduction, even if the underlying invoice is otherwise valid. This is often called the "no withholding, no deduction" rule, and it is one of the most frequently missed items in small-business bookkeeping.

Recording Expenses So They Survive an Audit

Good substantiation is not just about keeping receipts in a folder — it is about recording each expense correctly and on time in your books of accounts, and being able to trace every entry back to a source document. Practical habits that hold up under a BIR examination include:

• Recording the expense on the date incurred (accrual basis) rather than only when cash is paid, and keeping the invoice number as a reference in your ledger entry
• Classifying each expense to the correct account in your chart of accounts, so recurring items like rent, utilities, and supplies are easy to reconcile against actual invoices at year-end
• Scanning or photographing paper receipts promptly — thermal-paper receipts fade within months, which is a common reason documentation "disappears" before an audit years later
• Matching every 2307 you issue or receive against the corresponding expense or income entry each quarter, not just at annual filing time

In Kontabler, once you upload or scan a supplier invoice, the expense is posted to your books automatically, matched to the correct expense account, tagged with the applicable withholding tax rate, and flagged so you don't forget to generate the Form 2307 — closing the exact gap that causes disallowed deductions.

Common Pitfalls That Trigger Disallowance

Examiners look first for expenses that are large relative to reported income but have thin support. The most frequent findings include personal expenses run through the business (a family grocery bill coded as "office supplies"), invoices issued to an owner's personal name instead of the registered business, expenses claimed without any receipt at all, and receipts from suppliers who turn out not to be BIR-registered — meaning the document itself has no legal weight as proof of purchase.

Another recurring issue is retention: under the EOPT Act, businesses are now required to preserve books of accounts and accounting records for five years from the deadline for filing the return, or from the actual filing date if filed late — shorter than the ten-year period required before 2024. Because thresholds, withholding rates, and retention rules are periodically revised by the BIR, always confirm the current figures on the BIR website (bir.gov.ph) or with your accountant before relying on them for a filing.

A deduction is only as strong as the weakest document behind it — an otherwise legitimate expense with an incomplete receipt is treated by the BIR as if it never happened.

Ultimately, substantiating expenses is less about paperwork for its own sake and more about building a paper trail that lets you, your accountant, and eventually a BIR examiner arrive at the same conclusion: the expense was real, it was necessary for the business, and the correct taxes were withheld and remitted on it.