What Makes a Business Expense "Ordinary and Necessary"? BIR Rules Under RMC No. 81-2025

A business expense is deductible under itemized deductions only if it is “ordinary and necessary” in carrying on the trade, business, or profession — a standard set out in Section 34(A)(1)(a) of the National Internal Revenue Code (NIRC) and restated by the BIR in Revenue Memorandum Circular (RMC) No. 81-2025. “Ordinary” means normal and customary for that type of business; “necessary” means appropriate and helpful to running it — neither word requires the expense to be indispensable or recurring, but both require it to be reasonable in amount and genuinely connected to the business.

This guide covers the two-part test, how RMC No. 81-2025 frames it for audit purposes, and a worked comparison of two marketing expense claims — one that passes and one that doesn’t. For the related choice between itemized deductions and the flat alternative, see Optional Standard Deduction (OSD) vs. Itemized Deductions: Which Should You Choose?.

What does “ordinary and necessary” actually mean? #

The ordinary-and-necessary standard is two separate tests a deduction must pass, not one combined phrase. “Ordinary” looks at whether the type of expense is normal or customary for a business like the taxpayer’s — a restaurant’s food-spoilage write-off is ordinary in a way it would not be for a law firm. “Necessary” looks at whether the expense is appropriate and helpful to the business’s operations — courts have read this to mean helpful and appropriate, not indispensable or the only way to achieve the result.

“Ordinary Expense: Normal, usual, and customary in the business. Necessary Expense: Appropriate, helpful, and directly connected to the business’ development and operations.”

That is a secondary-source restatement of how RMC No. 81-2025 frames the definitions, drawn from legal commentary on the circular. This site could not reach the BIR’s own PDF of RMC No. 81-2025 directly to re-verify the exact circular wording, so confirm the precise text against the BIR’s published circular before relying on it for a formal filing position.

What does RMC No. 81-2025 add to the Section 34(A)(1)(a) test? #

RMC No. 81-2025 doesn’t create a new legal test — it consolidates and reiterates how the BIR expects examiners to apply the existing ordinary-and-necessary standard, with emphasis on reasonableness of amount and direct connection to the business. The circular’s practical significance is less about new law and more about signaling that the BIR is actively re-emphasizing this ground for disallowance during audits, alongside the older, independent substantiation requirement under Section 34(A)(1)(b).

A deduction has to clear all four of these, not just the two named in the phrase “ordinary and necessary” — a common point of confusion is treating substantiation as the only thing an examiner checks, when the nature and reasonableness of the expense itself is an independent ground for disallowance.

What tends to fail the test in practice? #

Based on how the BIR and courts have historically applied this standard, expenses that draw the most scrutiny share a few patterns:

1. Disproportionate size relative to revenue — a marketing expense claim approaching half of a company’s total claimed costs, with no clear business rationale for the scale, invites disallowance as unreasonable rather than merely ordinary.
2. No clear connection to income generation — an expense that cannot be tied to the development, management, operation, or conduct of the specific trade or business being taxed.
3. Compensation not tied to actual services rendered — payments to related parties or officers that look more like profit distribution than pay for genuine work.
4. Personal or mixed-purpose costs claimed in full — expenses with a personal-consumption component claimed as 100% business, without an allocation.

Worked example: two marketing expense claims #

A ₱200,000 targeted marketing campaign tied to a specific product launch is more defensible than an unexplained ₱2,000,000 “marketing” line item on ₱4,500,000 in annual revenue.

Company A’s expense is ordinary for a business running a product launch, necessary to support it, proportionate to revenue, and backed by documents connecting the cost to a specific business purpose. Company B’s claim — even if the receipts exist — invites the BIR to question both whether the amount is reasonable and whether the underlying activity actually happened as described.

Frequently Asked Questions #

What does “ordinary and necessary” mean for a business expense deduction? #

Under NIRC Section 34(A)(1)(a), an “ordinary” expense is one that is normal, usual, or customary in the type of business being carried on — it does not need to be a recurring or habitual cost, just a reasonable one for that line of business. A “necessary” expense is one that is appropriate and helpful to the development, management, operation, or conduct of the trade, business, or profession, even if not indispensable.

What is RMC No. 81-2025? #

Revenue Memorandum Circular No. 81-2025 is a 2025 BIR circular that reiterates the criteria and guidelines for determining whether an expense is deductible as ordinary and necessary under Section 34(A)(1)(a) of the Tax Code, consolidating how examiners should apply the test during audit rather than introducing a brand-new legal standard.

Can an expense be disallowed just for being large? #

Size alone doesn’t disqualify an expense, but a disproportionately large expense relative to the business’s scale and revenue invites scrutiny, since the BIR and courts have disallowed expenses found excessive or unreasonable compared to the income they supposedly help generate. Reasonableness in amount is part of what makes an expense “ordinary.”

Does “ordinary and necessary” replace the requirement for a valid receipt? #

No. Ordinary-and-necessary is the substantive test for whether an expense is the right kind of cost to deduct; substantiation with an official receipt or invoice and adequate records is a separate, independent requirement under the same Section 34(A)(1)(b). An expense can be genuinely ordinary and necessary and still be disallowed for lack of documentary support, and a well-documented expense can still be disallowed if it fails the ordinary-and-necessary test.

Does this test apply to both itemized deduction and OSD filers? #

No. A taxpayer who elects the Optional Standard Deduction (OSD) claims a flat 40% of gross sales/receipts (individuals) or gross income (corporations) instead of itemizing actual expenses, so the ordinary-and-necessary test and its substantiation requirements are irrelevant under OSD. The test only matters for a taxpayer using itemized deductions.

Summary #

An itemized business expense deduction has to be ordinary, necessary, reasonable in amount, and substantiated — four separate hurdles under NIRC Section 34(A)(1)(a)-(b), reiterated by the BIR in RMC No. 81-2025. Test a large or unusual expense against the size, connection, and documentation questions above before claiming it, not after an examiner flags it. For the deduction-method decision this test sits inside, see Optional Standard Deduction (OSD) vs. Itemized Deductions: Which Should You Choose?.