Tax Law Digests 5 (Q-T)

TAX LAW REVIEW DIGESTS Montero
Alcisso, Arriola, Cajucom, Calalang, Claudio, Escueta, Delos Santos, Dialino, Fajardo, Imperial, Juaquino, Martin, Martinez, Mendoza, Noel, Pangcog, Plazo Raso,
Rosales, Sia, Uy, Venzuela
The requisite that it must have been paid or incurred during the
taxable year is qualified by Sec. 45 of NIRC which states that the
deduction provide for in this title shall be taken for the taxable year
in which paid or incurred dependent upon the method of
accounting upon the basis of which the net income is computed x x
x.
Q. DEDUCTION
In general
CIR v ISABELA CULTURAL CORPORATION
FACTS:
ICC uses the accrual method. RAM No. 1-2000 provides that under
the accrual method, expenses not claimed as deductions in the
current year when they are incurred CANNOT be claimed as
deduction from income for the succeeding year. The accrual
method relies upon the taxpayers right to receive amount or its
obligation to pay them NOT the actual receipt or payment. Amounts
of income accrue where the right to receive them become fixed,
where there is created an enforceable liability. Liabilities are
accrued when fixed and determinable in amount.
ICC was assessed for deficiency income tax [ BIR disallowed

expense deductions for professional and security services by 1)
auditing services by SGV & Co. 2) legal services Bengzon law office
3) El Tigre Security services] and deficiency expanded withholding
tax, when it failed to withhold 1% expanded withholding tax. The
CTA cancelled and set aside the assessment notices holding that
the claimed deductions for professional and security services were
properly claimed in 1986 since it was only in that year when the
bills demanding payment were sent to ICC. It also found that the
ICC withheld 1% expanded withholding tax for security services.
The CA affirmed hence the case at bar.
The accrual of income and expense is permitted when the ALLEVENTS TEST has been met. The test requires that: 1) fixing of a
right to income or liability to pay and 2) the availability of the
reasonable accurate determination of such income or liability. It
does not require that the amount be absolutely known only that the
taxpayer has information necessary to compute the amount with
reasonable accuracy. The test is satisfied where computation
remains uncertain if its basis is unchangeable. The amount of
liability does not have to be determined exactly, it must be
determined with reasonable accuracy.
ISSUE: W/N the aforementioned may be deducted

HELD: for the auditing and legal services NO but for the security
services YES
The requisites for deductibility of ordinary and necessary trade,
business or professional expenses, like expenses paid for legal and
auditing services are: a) the expense must be ordinary and
necessary; b) it must have been paid or incurred during the taxable
year; c) it must have been paid or incurred in carrying on the trade
or business of the taxpayer and d) it must be supported by
receipts, records and other pertinent papers.
In the case at bar, the expenses for legal services pertain to the
years 1984 and 1985. The firm has been retained since 1960. From
the nature of the claimed deduction and the span of time during
which the firm was retained, ICC can be expected to have
reasonably known the retainer fees charged by the firm as well as
compensation for its services. Exercising due diligence, they could

have inquired into the amount of their obligation. It could have

reasonably determined the amount of legal and retainer fees owing
to their familiarity with the rates charged.
February 19, 1958, that said amount should be allowed as

deduction because it was paid to its officers as allowance or bonus
pursuant to its by-laws.
The professional fees of SGV cannot be validly claimed as

deductions in 1986. ICC failed to present evidence showing that
even with only reasonable accuracy, it cannot determine the
professional fees which the company would charge.
ISSUE/HELD: W/N the bonus given to the officers of the petitioner

upon the sale of its Muntinlupa land is an ordinary and necessary
business expense deductible for income tax purposes - NO
RATIO: Sec. 30 (a) (1) of the Tax Code provides that in computing
net income, there shall be allowed as deductions Expenses,
including all the ordinary and necessary expenses paid or incurred
during the taxable year in carrying on any trade or business,
including a reasonable allowance for personal services actually
rendered.
CIR v GENERAL FOODS

AGUINALDO INDUSTRIES v CIR
The bonus given to the officers of the petitioner as their share of

the profit realized from the sale of petitioner's Muntinglupa land
cannot be deemed a deductible expense for tax purposes, even if
the aforesaid sale could be considered as a transaction for carrying
on the trade or business of the petitioner and the grant of the
bonus to the corporate officers pursuant to petitioner's by-laws
could, as an intra-corporate matter, be sustained. The records show
that the sale was effected through a broker who was paid by
petitioner a commission of P51,723.72 for his services. On the
other hand, there is absolutely no evidence of any service actually
rendered by petitioner's officers which could be the basis of a grant
to them of a bonus out of the profit derived from the sale. This
being so, the payment of a bonus to them out of the gain realized
from the sale cannot be considered as a selling expense; nor can it
be deemed reasonable and necessary so as to make it deductible
for tax purposes. The extraordinary and unusual amounts paid by
petitioner to these directors in the guise and form of compensation
for their supposed services as such, without any relation to the
measure of their actual services, cannot be regarded as ordinary
and necessary expenses within the meaning of the law. This is in
line with the doctrine in the law of taxation that the taxpayer must
show that its claimed deductions clearly come within the language
of the law since allowances, like exemptions, are matters of
legislative grace.
FACTS:
Aguinaldo Industries Corporation (AIC) is a domestic corporation
engaged in the manufacture of fishing nets, a tax-exempt industry
and the manufacture of furniture. For accounting purposes, each
division is provided with separate books of accounts. Previously,
AIC acquired a parcel of land in Muntinlupa, Rizal, as site of the
fishing net factory. Later, it sold the Muntinlupa property. AIC
derived profit from this sale which was entered in the books of the
Fish Nets Division as miscellaneous income to distinguish it from its
tax-exempt income.
For the year 1957, AIC filed two separate income tax returns for
each division. After investigation, the examiners of the BIR found
that the Fish Nets Division deducted from its gross income for that
year the amount of P61,187.48 as additional remuneration paid to
the officers of AIC. This amount was taken from the net profit of an
isolated transaction (sale of Muntinlupa land) not in the course of or
carrying on of AIC's trade or business, and was reported as part of
the selling expenses of the Muntinlupa land. Upon recommendation
of the examiner that the said sum of P61,187.48 be disallowed as
deduction from gross income, petitioner asserted in its letter of

RATIO: Section 30 (a) (1) of the Tax Code allows a deduction of "all
the ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business." An item of
expenditure, in order to be deductible under this section of the
statute, must fall squarely within its language. To be deductible as a
business expense, three conditions are imposed, namely: (1) the
expense must be ordinary and necessary, (2) it must be paid or
incurred within the taxable year, and (3) it must be paid or incurred
in carrying in a trade or business. In addition, not only must the
taxpayer meet the business test, he must substantially prove by
evidence or records the deductions claimed under the law,
otherwise, the same will be disallowed. The mere allegation of the
taxpayer that an item of expense is ordinary and necessary does
not justify its deduction.
ATLAS CONSOLIDATED MINING v CIR
FACTS:
Atlas is a corporation engaged in the mining industry registered. On
August 1962, CIR assessed against Atlas for deficiency income
taxes for the years 1957 and 1958. For the year 1957, it was the
opinion of the CIR that Atlas is not entitled to exemption from the
income tax under RA 909 because same covers only gold mines.
For the year 1958, the deficiency income tax covers the
disallowance of items claimed by Atlas as deductible from gross
income. Atlas protested for reconsideration and cancellation, thus
the CIR conducted a reinvestigation of the case.
The SC has never attempted to define with precision the terms

"ordinary and necessary." As a guiding principle, ordinarily, an
expense will be considered "necessary" where the expenditure is
appropriate and helpful in the development of the taxpayer's
business. It is "ordinary" when it connotes a payment which is
normal in relation to the business of the taxpayer and the
surrounding circumstances. The term "ordinary" does not require
that the payments be habitual or normal in the sense that the same
taxpayer will have to make them often; the payment may be
unique or non-recurring to the particular taxpayer affected.
On October 1962, the Secretary of Finance ruled that the

exemption provided in RA 909 embraces all new mines and old
mines whether gold or other minerals. Accordingly, the CIR
recomputed Atlas deficiency income tax liabilities in the light of
said ruling. On June 1964, the CIR issued a revised assessment
entirely eliminating the assessment for the year 1957. The
assessment for 1958 was reduced from which Atlas appealed to the
CTA, assailing the disallowance of the following items claimed as
deductible from its gross income for 1958: Transfer agent's fee,
Stockholders relation service fee, U.S. stock listing expenses, Suit
expenses, and Provision for contingencies. The CTA allowed said
items as deduction except those denominated by Atlas as
stockholders relation service fee and suit expenses.
There is thus no hard and fast rule on the matter. The right to a
deduction depends in each case on the particular facts and the
relation of the payment to the type of business in which the
taxpayer is engaged. The intention of the taxpayer often may be
the controlling fact in making the determination. Assuming that the
expenditure is ordinary and necessary in the operation of the
taxpayer's business, the answer to the question as to whether the
expenditure is an allowable deduction as a business expense must
be determined from the nature of the expenditure itself, which in
turn depends on the extent and permanency of the work
accomplished by the expenditure.
Both parties appealed the CTA decision to the SC by way of two (2)
separate petitions for review. Atlas appealed only the disallowance
of the deduction from gross income of the so-called stockholders
relation service fee.
ISSUE/HELD: W/N the annual public relations expense (aka
stockholders relation service fee) paid to a public relations
consultant is a deductible expense from gross income

It appears that on December 1957, Atlas increased its capital stock.

It claimed that its shares of stock were sold in the United States
because of the services rendered by the public relations firm. The
information about Atlas given out and played up in the mass
communication media resulted in full subscription of the additional
shares issued by Atlas; consequently, the stockholders relation
service fee, the compensation for services carrying on the selling
campaign, was in effect spent for the acquisition of additional
capital, ergo, a capital expenditure, and not an ordinary expense. It
is not deductible from Atlas gross income in 1958 because
expenses relating to recapitalization and reorganization of the
corporation, the cost of obtaining stock subscription, promotion
expenses, and commission or fees paid for the sale of stock
reorganization are capital expenditures. That the expense in
question was incurred to create a favorable image of the
corporation in order to gain or maintain the public's and its
stockholders' patronage, does not make it deductible as business
expense. As held in a US case, efforts to establish reputation are
akin to acquisition of capital assets and, therefore, expenses
related thereto are not business expense but capital expenditures.
and shares of stocks in different corporations. To manage the

properties, said children, namely, Antonio, Eduardo and Jose Roxas
formed a partnership called Roxas y Compania.
On June 1958, the CIR assessed deficiency income taxes against
the Roxas Brothers for the years 1953 and 1955. Part of the
deficiency income taxes resulted from the disallowance of
deductions from gross income of various business expenses and
contributions claimed by Roxas. (see expense items below)
The Roxas brothers protested the assessment but inasmuch as said
protest was denied, they instituted an appeal in the CTA, which
sustained the assessment except the demand for the payment of
the fixed tax on dealer of securities and the disallowance of the
deductions for contributions to the Philippine Air Force Chapel and
Hijas de Jesus' Retiro de Manresa. Not satisfied, Roxas brothers
appealed to the SC. The CIR did not appeal.
ISSUES/HELD: W/N the deductions for business expenses and
contributions deductible
Note: The burden of proof that the expenses incurred are ordinary
and necessary is on the taxpayer and does not rest upon the
Government. To avail of the claimed deduction, it is incumbent
upon the taxpayer to adduce substantial evidence to establish a
reasonably proximate relation petition between the expenses to the
ordinary conduct of the business of the taxpayer. A logical link or
nexus between the expense and the taxpayer's business must be
established by the taxpayer.
RATIO: With regard to the disallowed deductions (expenses for

tickets to a banquet given in honor of Sergio Osmena and beer
given as gifts to various persons, labelled
as representation
expenses), representation expenses are deductible from gross
income as expenditures incurred in carrying on a trade or business
under Section 30(a) of the Tax Code provided the taxpayer proves
that they are reasonable in amount, ordinary and necessary, and
incurred in connection with his business. In the case at bar, the
evidence does not show such link between the expenses and the
business of Roxas.
ROXAS v CTA
The petitioners also claim deductions for contributions to the Pasay

City Police, Pasay City Firemen, and Baguio City Police Christmas
funds, Manila Police Trust Fund, Philippines Herald's fund for
Manila's neediest families and Our Lady of Fatima chapel at Far
Eastern University. The contributions to the Christmas funds of the
Pasay City Police, Pasay City Firemen and Baguio City Police are not
deductible for the reason that the Christmas funds were not spent
FACTS:
Don Pedro Roxas and Dona Carmen Ayala, Spanish subjects,
transmitted to their grandchildren by hereditary succession
agricultural lands in Batangas, a residential house and lot in Manila,

for public purposes but as Christmas gifts to the families of the

members of said entities. Under Section 39(h), a contribution to a
government entity is deductible when used exclusively for public
purposes. For this reason, the disallowance must be sustained. On
the other hand, the contribution to the Manila Police trust fund is an
allowable deduction for said trust fund belongs to the Manila Police,
a government entity, intended to be used exclusively for its public
functions. The contributions to the Philippines Herald's fund for
Manila's neediest families were disallowed on the ground that the
Philippines Herald is not a corporation or an association
contemplated in Section 30 (h) of the Tax Code. It should be noted
however that the contributions were not made to the Philippines
Herald but to a group of civic spirited citizens organized by the
Philippines Herald solely for charitable purposes. There is no
question that the members of this group of citizens do not receive
profits, for all the funds they raised were for Manila's neediest
families. Such a group of citizens may be classified as an
association organized exclusively for charitable purposes
mentioned in Section 30(h) of the Tax Code.
real properties and claimed deductions which were not allowable.

The collector required him to pay deficiency income tax. On appeal
by Zamora, the CTA reduced the amount of deficiency income tax.
Zamora appealed, alleging that the CTA erred in dissallowing
P10,478.50, as promotion expenses incurred by his wife for the
promotion of the Bay View Hotel and Farmacia Zamora (which is
of P20,957.00, supposed business expenses).
Zamora alleged that the CTA erred in disallowing P10,478.50 as
promotion expenses incurred by his wife for the promotion of the
Bay View Hotel and Farmacia Zamora. He contends that the whole
amount of P20,957.00 as promotion expenses, should be allowed
and not merely one-half of it, on the ground that, while not all the
itemized expenses are supported by receipts, the absence of some
supporting receipts has been sufficiently and satisfactorily
established.
ISSUE: w/n CTA erred in allowing only one half of the promotion
expenses. NO
The contribution to Our Lady of Fatima chapel at the Far Eastern

University should also be disallowed on the ground that the said
university gives dividends to its stockholders. Located within the
premises of the university, the chapel in question has not been
shown to belong to the Catholic Church or any religious
organization. It belongs to the Far Eastern University, contributions
to which are not deductible under Section 30(h) of the Tax Code for
the reason that the net income of said university injures to the
benefit of its stockholders.
HELD:
Section 30, of the Tax Code, provides that in computing net income,
there shall be allowed as deductions all the ordinary and necessary
expenses paid or incurred during the taxable year, in carrying on
any trade or business. Since promotion expenses constitute one of
the deductions in conducting a business, same must satisfy these
requirements. Claim for the deduction of promotion expenses or
entertainment expenses must also be substantiated or supported
by record showing in detail the amount and nature of the expenses
incurred.
Considering, as heretofore stated, that the application of Mrs.
Zamora for dollar allocation shows that she went abroad on a
combined medical and business trip, not all of her expenses came
under the category of ordinary and necessary expenses; part
thereof constituted her personal expenses. There having been no
means by which to ascertain which expense was incurred by her in
connection with the business of Mariano Zamora and which was
incurred for her personal benefit, the Collector and the CTA in their
ZAMORA v CIR
FACTS:
Mariano Zamora, owner of the Bay View Hotel and Farmacia
Zamora, filed his income tax returns. The CIR found that he failed
to file his return of the capital gains derived from the sale of certain

decisions, considered 50% of the said amount of P20,957.00 as

business expenses and the other 50%, as her personal expenses.
We hold that said allocation is very fair to Mariano Zamora, there
having been no receipt whatsoever, submitted to explain the
alleged business expenses, or proof of the connection which said
expenses had to the business or the reasonableness of the said
amount of P20,957.00.
amount of P28,054.00 plus interests. The Court of Tax Appeals upon

reviewing the assessment at the taxpayer's petition, upheld
respondent's disallowance of the principal item of petitioner's
having paid to Mr. C. M. Hoskins, its founder and controlling
stockholder the amount of P99,977.91 representing 50% of
supervision fees earned by it and set aside respondent's
disallowance of three other minor items.
In the case of Visayan Cebu Terminal Co., Inc. v. CIR., it was

declared that representation expenses fall under the
category of business expenses which are allowable
deductions from gross income, if they meet the conditions
prescribed by law, particularly section 30 (a) [1], of the Tax
Code; that to be deductible, said business expenses must
be ordinary and necessary expenses paid or incurred in
carrying on any trade or business; that those expenses
must also meet the further test of reasonableness in
amount. They should also be covered by supporting papers;
in the absence thereof the amount properly deductible as
representation expenses should be determined from
available data.
Petitioner questions in this appeal the Tax Court's findings that the
disallowed payment to Hoskins was an inordinately large one,
which bore a close relationship to the recipient's dominant
stockholdings and therefore amounted in law to a distribution of its
earnings and profits.
Issue: Whether the 50% supervision fee paid to Hoskin may be
deductible for income tax purposes.
Ruling: NO.
Ratio:
Hoskin owns 99.6% of the CM Hoskins & Co. He was also the
President and Chairman of the Board. That as chairman of the
Board of Directors, he received a salary of P3,750.00 a month, plus
a salary bonus of about P40,000.00 a year and an amounting to an
annual compensation of P45,000.00 and an annual salary bonus of
P40,000.00, plus free use of the company car and receipt of other
similar allowances and benefits, the Tax Court correctly ruled that
the payment by petitioner to Hoskins of the additional sum of
P99,977.91 as his equal or 50% share of the 8% supervision fees
received by petitioner as managing agents of the real estate,
subdivision projects of Paradise Farms, Inc. and Realty Investments,
Inc. was inordinately large and could not be accorded the
treatment of ordinary and necessary expenses allowed as
deductible items within the purview of the Tax Code.
Expenses
C.M. HOSKINS&CO, INC. v CIR
Facts:
Petitioner, a domestic corporation engaged in the real estate
business as brokers, managing agents and administrators, filed its
income tax return for its fiscal year ending September 30, 1957
showing a net income of P92,540.25 and a tax liability due thereon
of P18,508.00, which it paid in due course. Upon verification of its
return, CIR, disallowed four items of deduction in petitioner's tax
returns and assessed against it an income tax deficiency in the
The fact that such payment was authorized by a standing

resolution of petitioner's board of directors, since "Hoskins had
personally conceived and planned the project" cannot change the
picture. There could be no question that as Chairman of the board

and practically an absolutely controlling stockholder of petitioner,

Hoskins wielded tremendous power and influence in the
formulation and making of the company's policies and decisions.
Even just as board chairman, going by petitioner's own
enumeration of the powers of the office, Hoskins, could exercise
great power and influence within the corporation, such as directing
the policy of the corporation, delegating powers to the president
and advising the corporation in determining executive salaries,
bonus plans and pensions, dividend policies, etc.
Petitioner's case fails to pass the test. On the right of the employer
as against respondent Commissioner to fix the compensation of its
officers and employees, we there held further that while the
employer's right may be conceded, the question of the allowance
or disallowance thereof as deductible expenses for income tax
purposes is subject to determination by CIR. As far as petitioner's
contention that as employer it has the right to fix the compensation
of its officers and employees and that it was in the exercise of such
right that it deemed proper to pay the bonuses in question, all that
We need say is this: that right may be conceded, but for income tax
purposes the employer cannot legally claim such bonuses as
deductible expenses unless they are shown to be reasonable. To
hold otherwise would open the gate of rampant tax evasion.
It is a general rule that 'Bonuses to employees made in good faith

and as additional compensation for the services actually rendered
by the employees are deductible, provided such payments, when
added to the stipulated salaries, do not exceed a reasonable
compensation for the services rendered. The conditions precedent
to the deduction of bonuses to employees are: (1) the payment of
the bonuses is in fact compensation; (2) it must be for personal
services actually rendered; and (3) the bonuses, when added to the
salaries, are 'reasonable when measured by the amount and
quality of the services performed with relation to the business of
the particular taxpayer.
Lastly, We must not lose sight of the fact that the question of
allowing or disallowing as deductible expenses the amounts paid to
corporate officers by way of bonus is determined by respondent
exclusively for income tax purposes. Concededly, he has no
authority to fix the amounts to be paid to corporate officers by way
of basic salary, bonus or additional remuneration a matter that
lies more or less exclusively within the sound discretion of the
corporation itself. But this right of the corporation is, of course, not
absolute. It cannot exercise it for the purpose of evading payment
of taxes legitimately due to the State."
There is no fixed test for determining the reasonableness of a given

bonus as compensation. This depends upon many factors, one of
them being the amount and quality of the services performed with
relation to the business.' Other tests suggested are: payment must
be 'made in good faith'; 'the character of the taxpayer's business,
the volume and amount of its net earnings, its locality, the type and
extent of the services rendered, the salary policy of the
corporation'; 'the size of the particular business'; 'the employees'
qualifications and contributions to the business venture'; and
'general economic conditions. However, 'in determining whether
the particular salary or compensation payment is reasonable, the
situation must be considered as whole. Ordinarily, no single factor
is decisive. . . . it is important to keep in mind that it seldom
happens that the application of one test can give satisfactory
answer, and that ordinarily it is the interplay of several factors,
properly weighted for the particular case, which must furnish the
final answer."
CALANOC v CIR
KUENZLE & STREIF, INC. v CIR
FACTS:
Petitioner is a domestic corporation engaged in the importation of
textiles, hardware, sundries, chemicals, pharmaceuticals, lumbers,
groceries, wines and liquor; in insurance and lumber; and in some
exports. When Petitioner filed its Income Tax Return, it deducted
from its gross income the following items:

1. salaries, directors' fees and bonuses of its non-resident

president and vice-president;
2. bonuses of its resident officers and employees; and
3. the bonuses, when added to the salaries, are reasonable

when measured by the amount and quality of the services
performed with relation to the business of the particular
taxpayer
3. interests on earned but unpaid salaries and bonuses of its

officers and employees.
There is no fixed test for determining the reasonableness of a given

bonus as compensation. However, in determining whether the
particular salary or compensation payment is reasonable, the
situation must be considered as a whole.
The CIR disallowed the deductions and assessed Petitioner for

deficiency income taxes. Petitioner requested for re-examination of
the assessment. CIR modified the same by allowing as deductible
all items comprising directors' fees and salaries of the non-resident
president and vice-president, but disallowing the bonuses insofar as
they exceed the salaries of the recipients, as well as the interests
on earned but unpaid salaries and bonuses.
Petitioner contended that it is error to apply the same measure of

reasonableness to both resident and non-resident officers because
the nature, extent and quality of the services performed by each
with relation to the business of the corporation widely differ. Said
non-resident officers had rendered the same amount of efficient
personal service and contribution to deserve equal treatment in
compensation and other emoluments. There is no special reason for
granting greater bonuses to such lower ranking officers than those
given to the non-resident president and vice president.
The CTA modified the assessment and ruled that while the bonuses
given to the non-resident officers are reasonable, bonuses given to
the resident officers and employees are quite excessive.
ISSUES/RULING:
W/N the CTA erred in allowing the deduction of the bonuses

in excess of the yearly salaries of the employees? NO.
W/N the CTA erred in ruling that the measure of the

reasonableness of the bonuses paid to its non-resident
president and vice-president should be applied to the
bonuses given to resident officers and employees in
determining their deductibility? NO.
The deductible amount of said bonuses cannot be only equal to

their respective yearly salaries considering the post-war policy of
the corporation in giving salaries at low levels because of the
unsettled conditions resulting from war and the imposition of
government controls on imports and exports and on the use of
foreign exchange which resulted in the diminution of the amount of
business and the consequent loss of profits on the part of the
corporation. The payment of bonuses in amounts a little more than
the yearly salaries received considering the prevailing
circumstances is in our opinion reasonable.
It is a general rule that "Bonuses to employees made in good faith

and as additional compensation for the services actually rendered
by the employees are deductible, provided such payments, when
added to the stipulated salaries, do not exceed a reasonable
compensation for the services rendered. The condition precedents
to the deduction of bonuses to employees are:
W/N the CTA erred in disallowing the deduction of interests

on earned but unpaid salaries and bonuses? NO.
1. the payment of the bonuses is in fact compensation;

2. it must be for personal services actually rendered; and

Under the law, in order that interest may be deductible, it must be

paid "on indebtedness." It is therefore imperative to show that
there is an existing indebtedness which may be subjected to the
payment of interest. Here the items involved are unclaimed salaries
and bonus participation which cannot constitute indebtedness
within the meaning of the law because while they constitute an
obligation on the part of the corporation, it is not the latter's fault if
they remained unclaimed. Whatever an employee may fail to
collect cannot be considered an indebtedness for it is the concern
of the employee to collect it in due time. The willingness of the
corporation to pay interest thereon cannot be considered a
justification to warrant deduction.
Picop was proper and allowable. In the instant Petition, the CIR
insists on its original position.
ISSUE:
Whether Picop is entitled to deductions against income of
interest payments on loans for the purchase of machinery and
equipment.
HELD:
YES. Interest payments on loans incurred by a taxpayer
(whether BOI-registered or not) are allowed by the NIRC as
deductions against the taxpayer's gross income. The basis is 1977
Tax Code Sec. 30 (b).1 Thus, the general rule is that interest
expenses are deductible against gross income and this certainly
includes interest paid under loans incurred in connection with the
carrying on of the business of the taxpayer. In the instant case, the
CIR does not dispute that the interest payments were made by
Picop on loans incurred in connection with the carrying on of the
registered operations of Picop, i.e., the financing of the purchase of
machinery and equipment actually used in the registered
operations of Picop. Neither does the CIR deny that such interest
payments were legally due and demandable under the terms of
such loans, and in fact paid by Picop during the tax year 1977.
Interest
PAPER INDUSTRIES v CA ( Dec. 1, 1995)
Facts:
On various years (1969, 1972 and 1977), Picop obtained
loans from foreign creditors in order to finance the purchase of
machinery and equipment needed for its operations. In its 1977
Income Tax Return, Picop claimed interest payments made in 1977,
amounting to P42,840,131.00, on these loans as a deduction from
its 1977 gross income.
The CIR disallowed this deduction upon the ground that,
because the loans had been incurred for the purchase of machinery
and equipment, the interest payments on those loans should have
been capitalized instead and claimed as a depreciation deduction
taking into account the adjusted basis of the machinery and
equipment (original acquisition cost plus interest charges) over the
useful life of such assets.
Sec. 30. Deduction from Gross Income. The following

may be deducted from gross income:
xxx xxx xxx
(b) Interest:
(1) In general. The amount of interest paid within the
taxable year on indebtedness, except on indebtedness
incurred or continued to purchase or carry obligations the
interest upon which is exempt from taxation as income under
this Title: . . . (Emphasis supplied)
Both the CTA and the Court of Appeals sustained the

position of Picop and held that the interest deduction claimed by

The contention of CIR does not spring of the 1977 Tax Code
but from Revenue Regulations 2 Sec. 79.2 However, the Court said
that the term interest here should be construed as the so-called
"theoretical interest," that is to say, interest "calculated" or
computed (and not incurred or paid) for the purpose of
determining the "opportunity cost" of investing funds in a
given business. Such "theoretical" or imputed interest
does not arise from a legally demandable interest-bearing
obligation incurred by the taxpayer who however wishes to
find out, e.g., whether he would have been better off by lending out
his funds and earning interest rather than investing such funds in
his business. One thing that Section 79 quoted above makes clear
is that interest which does constitute a charge arising under an
interest-bearing obligation is an allowable deduction from gross
income.
(a) Interest on a loan (but not theoretical interest of a

taxpayer using his own funds).
The truncated excerpt of the U.S. Income Tax Regulations quoted
by the CIR needs to be related to the relevant provisions of the U.S.
Internal Revenue Code, which provisions deal with the general topic
of adjusted basis for determining allowable gain or loss on sales or
exchanges of property and allowable depreciation and depletion of
capital assets of the taxpayer:
Present Rule. The Internal Revenue Code, and the
Regulations promulgated thereunder provide that
"No deduction shall be allowed for amounts paid or
accrued for such taxes and carrying charges as,
under regulations prescribed by the Secretary or his
delegate, are chargeable to capital account with
respect to property, if the taxpayer elects, in
accordance with such regulations, to treat such taxes
orcharges as so chargeable."
Only if sir asks: (For further discussion of CIRs contention)

It is claimed by the CIR that Section 79 of Revenue
Regulations No. 2 was "patterned after" paragraph 1.266-1 (b),
entitled "Taxes and Carrying Charges Chargeable to Capital Account
and Treated as Capital Items" of the U.S. Income Tax Regulations,
which paragraph reads as follows:
At the same time, under the adjustment of basis

provisions which have just been discussed, it is
provided that adjustment shall be made for all
"expenditures, receipts, losses, or other items"
properly chargeable to a capital account, thus
including taxes and carrying charges; however, an
exception exists, in which event such adjustment to
the capital account is not made, with respect to
taxes and carrying charges which the taxpayer has
not elected to capitalize but for which a deduction
instead has been taken. 22 (Emphasis supplied)
(B) Taxes and Carrying Charges. The items thus

chargeable to capital accounts are
(11) In the case of real property, whether improved
or
unimproved
and
whether
productive
or
nonproductive.
The "carrying charges" which may be capitalized under the

above quoted provisions of the U.S. Internal Revenue Code
include, as the CIR has pointed out, interest on a loan "(but
not theoretical interest of a taxpayer using his own funds)."
What the CIR failed to point out is that such "carrying
charges" may, at the election of the taxpayer, either be (a)
capitalized in which case the cost basis of the capital assets,
Sec. 79. Interest on Capital. Interest calculated for cost-keeping or other purposes on
account of capital or surplus invested in the business, which does not represent a charge arising
under an interest-bearing obligation, is not allowable deduction from gross income.
(Emphases supplied)
10

e.g., machinery and equipment, will be adjusted by adding

the amount of such interest payments or alternatively,
be (b) deducted from gross income of the taxpayer. Should
the taxpayer elect to deduct the interest payments against
its gross income, the taxpayer cannot at the same
time capitalize the interest payments. In other words, the
taxpayer is not entitled to both the deduction from gross
income and the adjusted (increased) basis for determining
gain or loss and the allowable depreciation charge. The U.S.
Internal Revenue Code does not prohibit the deduction of
interest on a loan obtained for purchasing machinery and
equipment against gross income, unless the taxpayer
has also or previously capitalized the same interest
payments and thereby adjusted the cost basis of such
assets.
Under the law, for interest to be deductible, it must be shown that

there be an indebtedness, that there should be interest upon it, and
that what is claimed as an interest deduction should have been
paid or accrued within the year. It is here conceded that the
interest paid by respondent was in consequence of the late
payment of her donor's tax, and the same was paid within the year
it is sought to be declared.
To sustain the proposition that the interest payment in question is
not deductible for the purpose of computing respondent's net
income, petitioner relies heavily on section 80 of Revenue
Regulation No. 2 (known as Income Tax Regulation) promulgated by
the Department of Finance, which provides that "the word `taxes'
means taxes proper and no deductions should be allowed for
amounts representing interest, surcharge, or penalties incident to
delinquency." The court below, however, held section 80 as
inapplicable to the instant case because while it implements
sections 30(c) of the Tax Code governing deduction of taxes, the
respondent taxpayer seeks to come under section 30(b) of the
same Code providing for deduction of interest on indebtedness.
CIR v VDA DE PRIETO

FACTS:
ISSUE:
On December 4, 1945, the respondent conveyed by way of gifts to

her four children, namely, Antonio, Benito, Carmen and Mauro, all
surnamed Prieto, real property with a total assessed value of
P892,497.50. After the filing of the gift tax returns on or about
February 1, 1954, the petitioner Commissioner of Internal Revenue
appraised the real property donated for gift tax purposes at
P1,231,268.00, and assessed the total sum of P117,706.50 as
donor's gift tax, interest and compromises due thereon. Of the total
sum of P117,706.50 paid by respondent on April 29, 1954, the sum
of P55,978.65 represents the total interest on account of
deliquency. This sum of P55,978.65 was claimed as deduction,
among others, by respondent in her 1954 income tax return.
Petitioner, however, disallowed the claim and as a consequence of
such disallowance assessed respondent for 1954 the total sum of
P21,410.38 as deficiency income tax due on the aforesaid
P55,978.65, including interest up to March 31, 1957, surcharge and
compromise for the late payment.
Whether or not such interest was paid upon an indebtedness within

the contemplation of section 30 (b) (1) of the Tax Code?
RULING:
Yes. According to the Supreme Court, although interest payment for
delinquent taxes is not deductible as tax under Section 30(c) of the
Tax Code and section 80 of the Income Tax Regulations, the
taxpayer is not precluded thereby from claiming said interest
payment as deduction under section 30(b) of the same Code.
SEC. 30 Deductions from gross income. In computing net income
there shall be allowed as deductions
(b) Interest:
11

(1) In general. The amount of interest paid within the

taxable year on indebtedness, except on indebtedness
incurred or continued to purchase or carry obligations the
interest upon which is exempt from taxation as income
under this Title.
The term "indebtedness" as used in the Tax Code of the United

States containing similar provisions as in the above-quoted section
has been defined as an unconditional and legally enforceable
obligation for the payment of money.
To give to the quoted portion of section 80 of our Income Tax

Regulations the meaning that the petitioner gives it would run
counter to the provision of section 30(b) of the Tax Code and the
construction given to it by courts in the United States. Such effect
would thus make the regulation invalid for a "regulation which
operates to create a rule out of harmony with the statute, is a mere
nullity." As already stated, section 80 implements only section 30(c)
of the Tax Code, or the provision allowing deduction of taxes, while
herein respondent seeks to be allowed deduction under section
30(b), which provides for deduction of interest on indebtedness.
BIR RULING NO 006-00
Taxes
CIR v LEDNICKY
Losses
PAPER INDUSTRIES v CA ( Dec. 1, 1995)
The Paper Industries Corporation of the Philippines ("Picop"), is a Philippine
registered with the Board of Investments ("BOI") as

a preferred pioneer enterprise with respect to its integrated
corporation
12
pulp and paper mill, and as a preferred non-pioneer

enterprise with respect to its integrated plywood and veneer
mills.
In 1969, 1972 and 1977, Picop obtained loans from foreign
creditors in order to finance the purchase of machinery and
equipment needed for its operations.
Picop also issued promissory notes of about P230M, on w/c it
paid P45M in interest.
In its 1977 Income Tax Return, Picop claimed the interest
payments on the loans as DEDUCTIONS from its 1977 gross
income.
The CIR disallowed this deduction upon the ground that,
because the loans had been incurred for the purchase of
machinery and equipment, the interest payments on those
loans should have been capitalized instead and claimed as a
depreciation deduction taking into account the adjusted
basis of the machinery and equipment (original acquisition
cost plus interest charges) over the useful life of such
assets.
I: W/n the interest payments can be deducted from gross
income YES transaction tax
R:
The 1977 NIRC does not prohibit the deduction of interest on
a loan incurred for acquiring machinery and equipment.
Neither does our 1977 NIRC compel the capitalization of
interest payments on such a loan.
The 1977 Tax Code is simply silent on a taxpayer's right to
elect one or the other tax treatment of such interest
payments. Accordingly, the general rule that interest
payments on a legally demandable loan are deductible from
gross income must be applied.
In this case, the CIR does not dispute that the interest
payments were made by Picop on loans incurred in
connection with the carrying on of the registered operations
of Picop, i.e., the financing of the purchase of machinery and
equipment actually used in the registered operations of
Picop. Neither does the CIR deny that such interest
payments were legally due and demandable under the

terms of such loans, and in fact paid by Picop during the tax
year 1977.
The CIR has been unable to point to any provision of the
1977 Tax Code or any other Statute that requires the
disallowance of the interest payments made by Picop.
THIS PART DI KO SUPER MAGETS:
The CIR invokes Section 79 of Revenue Regulations No. 2
w/c provides that Interest calculated for cost-keeping or
other purposes on account of capital or surplus invested in
the business, which does not represent a charge arising
under an interest-bearing obligation, is not allowable
deduction from gross income.
It is claimed by the CIR that Section 79 of Revenue
Regulations No. 2 was "patterned after" paragraph 1.266-1
(b), entitled "Taxes and Carrying Charges Chargeable to
Capital Account and Treated as Capital Items" of the U.S.
Income Tax Regulations, which paragraph reads as follows:
(B) Taxes and Carrying Charges. The items thus
chargeable to capital accounts are
accrued for such taxes and carrying charges as,

under regulations prescribed by the Secretary or his
delegate, are chargeable to capital account with
respect to property, if the taxpayer elects, in
accordance with such regulations, to treat such taxes
or charges as so chargeable."
At the same time, under the adjustment of basis
provisions which have just been discussed, it is
provided that adjustment shall be made for all
"expenditures, receipts, losses, or other items"
properly chargeable to a capital account, thus
including taxes and carrying charges; however, an
exception exists, in which event such adjustment to
the capital account is not made, with respect to
taxes and carrying charges which the taxpayer has
not elected to capitalize but for which a deduction
instead has been taken.
(11) In the case of real property, whether improved

or unimproved and whether productive or
nonproductive.
The "carrying charges" which may be capitalized under the

above quoted provisions of the U.S. Internal Revenue Code
include, as the CIR has pointed out, interest on a loan "(but
not theoretical interest of a taxpayer using his own funds)."
What the CIR failed to point out is that such "carrying
charges" may, at the election of the taxpayer, either be (a)
capitalized in which case the cost basis of the capital assets,
e.g., machinery and equipment, will be adjusted by adding
the amount of such interest payments or alternatively, be
(b) deducted from gross income of the taxpayer. Should the
taxpayer elect to deduct the interest payments against its
gross income, the taxpayer cannot at the same time
capitalize the interest payments. In other words, the
taxpayer is not entitled to both the deduction from gross
income and the adjusted (increased) basis for determining
gain or loss and the allowable depreciation charge. The U.S.
(a) Interest on a loan (but not theoretical interest of a

taxpayer using his own funds). 21
The truncated excerpt of the U.S. Income Tax Regulations quoted
by the CIR needs to be related to the relevant provisions of the U.S.
Internal Revenue Code, which provisions deal with the general topic
of adjusted basis for determining allowable gain or loss on sales or
exchanges of property and allowable depreciation and depletion of
capital assets of the taxpayer:
Present Rule. The Internal Revenue Code, and the
Regulations promulgated thereunder provide that
"No deduction shall be allowed for amounts paid or
13

being original issuances, are subject to the DST imposed

under Section 175 of the Tax Code at the rate of P2 on each
P200, or fractional part thereof, of the par value of
Internal Revenue Code does not prohibit the deduction of

interest on a loan obtained for purchasing machinery and
equipment against gross income, unless the taxpayer has
also or previously capitalized the same interest payments
and thereby adjusted the cost basis of such assets.
BIR
RULING
the new Republic shares issued. The net operating losses of

each of Republic, Fortune, MPCC and Iligan are preserved
after the proposed share swap and may be carried over and
claimed as a deduction from their respective gross income,
pursuant to Section 34(D)(3) of the Tax Code, because there
is no substantial change in the either Republic or Fortune or
MPCC or Iligan."
30-00
Digest of BIR Ruling No. 030-2000 dated August 10,

2000
BIR RULING 206-90
INCOME TAX; Tax-free merger under certain condition Pursuant to Section 40(c)(2)
This is letter requesting in behalf of Porcelana Mariwasa, Inc. (PMI),

a ruling confirming an opinion that the foreign exchange loss
incurred by PMI is a deductible loss in 1990.
of the Tax Code, no gain or loss shall be recognized by Blue

Circle Philippines, Inc. (BCPI), Round Royal, Inc. (RRI), SM
Investment Corporation (SMIC), Sysmart Corporation and
CG&E Holdings on the transfer of their Fortune, Zeus and
Iligan shares to Republic, in exchange for ne Republic shares,
because they together hold more than 51% of the total
voting stock of Republic after the transfer. The transfer
through the facilities of the PSE by the 6th to the last
transferor of their Fortune and Zeus shares to Republic in
exchange for new Republic shares will be subject to the of
1% stock transaction tax based on the gross selling price or
gross value in money of the shares transferred, while the 6th
to the last transferor of the Iligan shares will be subject to
capital gains tax (CGT) at the rate of 5%, of the par value of
the shares transferred. The new Republic shares to be issued,
It is represented that PMI is a corporation established and

organized under Philippine laws; that it has existing US dollar loans
from Noritake Company, Limited (Noritake) and Toyota Tsusho
Corporation (Toyota) in the aggregate amounts of US
$7,636,679.17 and US $3,054,671.27, respectively, that in 1989,
the parties agreed to convert the said dollar denominated loans
into pesos at the exchange rate prevailing on June 30, 1989; that in
December 1989, both agreements were approved by the Central
Bank subject to the submission of a copy each of the signed
agreements incorporating the conversion; thereafter, drafts of the
amended agreements were submitted to the Central Bank for preapproval; that on January 29, 1990, the Central Bank advised PMI's
counsel on their findings and comments on the said drafts which
were considered and incorporated in the final amended
agreements; that in June 1990, the parties submitted to the Central
14

Bank the signed agreements; that counsel of PMI is of the opinion

that in the case of PMI, the resultant loss on conversion of US dollar
denominated loans to peso is more than a shrinkage in value of
money; that the approval by the Central Bank and the signing by
the parties of the agreements covering the said conversion
established the loss, after which, the loss became final and
irrevocable, so that recoupment is reasonably impossible; and that
having been fixed and determinable, the loss is no longer
susceptible to change, hence, it could fairly be stated that such has
been sustained in a closed and completed transaction.
BIR RULING 144-85

(Technically, this ruling has no stated facts. It just said that a
request for ruling dated July 1, 1985 was sent to the BIR for the
purpose of clarifying the issue, as herein stated.)
FACTS:
Request to clarify the deductibility of foreign exchange losses
incurred by reason of the devaluation of the peso. The losses arose
from matured but unremitted principal repayments on loans
affected by the debt-restructuring program in the Philippines.
In reply the commissioner informed PMI that the annual increase in

value of an asset is not taxable income because such increase has
not yet been realized. The increase in value i.e., the gain, could
only be taxed when a disposition of the property occurred which
was of such a nature as to constitute a realization of such gain, that
is, a severance of the gain from the original capital invested in the
property. The same conclusion obtains as to losses. The annual
decline in the value of property is not normally allowable as a
deduction. Hence, to be allowable the loss must be realized.
ISSUE:
Whether or not foreign exchange losses are deductible for income
tax purposes.
When foreign currency acquired in connection with a transaction in

the regular course of business is disposed ordinary gain or loss
results from the fluctuation. The loss is deductible only for the year
it is actually sustained. It is sustained during the year in which the
loss occurs as evidenced by the completed transaction and as fixed
by identifiable occurring in that year. No taxation event has as yet
been consummated prior to the remittance of the scheduled
amortization. Accordingly, PMI's request for confirmation of opinion
was denied considering that foreign exchange losses sustained as a
result of conversion or devaluation of the peso vis-a-vis the foreign
currency or US dollar and vice versa but which remittance of
scheduled amortization consisting of principal and interests
payment on a foreign loan had not actually been made are not
deductible from gross income for income tax purposes.
HELD: NO.
The annual increase in value of an asset is NOT TAXABLE INCOME
because such increase has not yet been realized. The increase in
value, i.e., the gain, could only be taxed when a disposition of the
property occurred which was of such a nature as to constitute a
realization of such gain, that is, a severance of the gain from the
original capital invested in the property. The aforementioned rule
also applies to losses. The annual decrease in the value of property
is not normally allowable as a loss. Hence, to be allowable the loss
must be realized.
15

When foreign currency acquired in connection with a transaction in

the regular course of business is disposed of, ordinary gain or loss
results from the foreign exchange fluctuations. THE LOSS IS
DEDUCTIBLE ONLY FOR THE YEAR IT IS ACTUALLY SUSTAINED. Thus,
there is no taxable event prior to the remittance of the scheduled
amortization.
a. Funds available for Philex Mining during the

management agreement; and
b. Compensation to Philex Mining which shall be fifty per
cent (50%) of the net profit;
In the course of managing and operating the project, Philex
Mining made advances of cash and property in accordance with the
agreement. However, the mine suffered continuing losses over the
years which resulted to petitioner's withdrawal as manager and
cessation of mine operations.
Accordingly, foreign exchange losses sustained as a result of

devaluation of the peso vis-a-vis the foreign currency e.g., US
dollar, but which remittance of scheduled amortization consisting of
principal and interests payments on a foreign loan has not actually
been made are NOT DEDUCTIBLE from gross income for income tax
purposes.
The parties executed a "Compromise with Dation in

Payment" wherein Baguio Gold admitted an indebtedness to Philex
Mining, which was subsequently amended to include additional
obligations.
Subsequently, Philex Mining wrote off in its 1982 books of
account the remaining outstanding indebtedness of Baguio Gold by
charging P112,136,000.00 to allowances and reserves that were set
up in 1981 and P2,860,768.00 to the 1982 operations.
NOTE:
To sustain a loss means that the loss has occurred as evidenced

by a closed and completed transaction and as fixed by
identifiable events occurring in that year.
A closed transaction is a taxable event which has been
consummated.
In its 1982 annual income tax return, Philex Mining deducted

from its gross income the amount of P112,136,000.00 as "loss on
settlement of receivables from Baguio Gold against reserves and
allowances." However, BIR disallowed the amount as deduction for
bad debt and assessed petitioner a deficiency income tax of
P62,811,161.39.
Bad debts
Issue: Whether the deduction for bad debts was valid?

PHILEX MINING v CIR
Held: No. For a deduction for bad debts to be allowed, all

requisites must be satisfied, to wit: (a) there was a valid and
existing debt; (b) the debt was ascertained to be worthless; and (c)
it was charged off within the taxable year when it was determined
to be worthless.
Facts: Philex Mining entered into a management agreement with

Baguio Gold. The parties' agreement was denominated as "Power of
Attorney" which provided among others:
16

There was no valid and existing debt. The nature of

agreement between Philex Mining and Baguio Gold is that of a
partnership or joint venture. Under a contract of partnership, two or
more persons bind themselves to contribute money, property, or
industry to a common fund, with the intention of dividing the profits
among themselves.
allowing 3 accounts to be claimed as deductions. However, 13

supposed bad debts were disallowed as the CTA claimed that
these were not substantiated and did not satisfy the jurisprudential
requirement of worthlessness of a debt The CA denied the
petition for review.
Perusal of the agreement denominated as the "Power of

Attorney" indicates that the parties had intended to create a
partnership and establish a common fund for the purpose. They
also had a joint interest in the profits of the business as shown by a
50-50 sharing in the income of the mine.
ISSUE: Whether or not the CA was correct in disallowing the 13

accounts as bad debts.
RULING:YES.
Viewed from this light, the advances can be characterized as

petitioners investment in a partnership with Baguio Gold for the
development and exploitation of the Sto. Nino mine. Since the
advanced amount partook of the nature of an investment, it could
not be deducted as a bad debt from petitioner's gross income.
Both the CTA and CA relied on the case of Collector vs. Goodrich
International, which laid down the requisites for worthlessness of a
debt to wit:
In said case, we held that for debts to be considered as "worthless,"
and thereby qualify as "bad debts" making them deductible, the
taxpayer should show that (1) there is a valid and subsisting
debt. (2) the debt must be actually ascertained to be
worthless and uncollectible during the taxable year; (3) the
debt must be charged off during the taxable year; and (4)
the debt must arise from the business or trade of the
taxpayer. Additionally, before a debt can be considered
worthless, the taxpayer must also show that it is indeed
uncollectible even in the future.
Furthermore, there are steps outlined to be undertaken by the
taxpayer to prove that he exerted diligent efforts to collect the
debts, viz.: (1) sending of statement of accounts; (2) sending
of collection letters; (3) giving the account to a lawyer for
collection; and (4) filing a collection case in court.
PRC only used the testimony of its accountant Ms. Masagana in
order to prove that these accounts were bad debts. This was
considered by all 3 courts to be self-serving. The SC said that PRC
failed to exercise due diligence in order to ascertain that these
PHILIPPINE REFINING CO v CA
FACTS:
Philippine Refining Corp (PRC) was assessed deficiency tax
payments for the year 1985 in the amount of around 1.8M. This
figure was computed based on the disallowance of the claim of bad
debts by PRC. PRC duly protested the assessment claiming that
under the law, bad debts and interest expense are allowable
deductions.
When the BIR subsequently garnished some of PRCs properties,
the latter considered the protest as being denied and filed an
appeal to the CTA which set aside the disallowance of the interest
expense and modified the disallowance of the bad debts by
17

debts were uncollectible. In fact, PRC did not even show the
demand letters they allegedly gave to some of their debtors.
Even assuming that there was valid or subsisting debt, the debt
was not deductible in 1951 as a worthless debt as Palawan was still
in operation in 1951 and 1952 as Fernandez continued to give
advances in those years. It has been held that if the debtor
corporation although losing money or insolvent was still operating
at the end of the taxable year, the debt is not considered worthless
and therefore not deductible.
FERNANDEZ HERMANOS v CIR

Facts:
Fernandez Hermanos is an investment company. The CIR assessed
it for alleged deficiency income taxes. It claimed as deduction,
among others, losses in or bad debts of Palawan Manganese Mines
Inc. which the CIR disallowed and was sustained by the CTA.
Depreciation
BASILAN ESTATES v CIR
Issue: W/N disallowance is correct
LIMPAN INVESTMENT v CIR

FACTS:
Held: YES
BIR assessed deficiency taxes on Limpan Corp, a companythat

leases real property, for underdeclaring its rental incomefor years
1956-57 by around P20K and P81K respectively.Petitioner appeals
on the ground that portions of theseunderdeclared rents are yet to
be collected by the previousowners and turned over or received by
the corporation.Petitioner cited that some rents were deposited
with the court,such that the corporation does not have actual nor
constructivecontrol over them.The sole witness for the petitioner,
Solis (Corporate Secretary-Treasurer) admitted to some undeclared
rents in 1956 and1957, and that some balances were not collected
by thecorporation in 1956 because the lessees refused to
recognizeand pay rent to the new owners and that the corps
presidentIsabelo Lim collected some rent and reported it in his
personalincome statement, but did not turn over the rent to
thecorporation. He also cites lack of actual or constructive
controlover rents deposited with the court.
It was shown that Palawan Manganese Mines sought financial help

from Fernandez to resume its mining operations hence a
Memorandum of Agreement (MOA) was executed where Fernandez
would give yearly advances to Palawan. But it still continued to
suffer loses and Fernandez realized it could no longer recover the
advances hence claimed it as worthless. Looking at the MOA,
Fernandez did not expect to be repaid. The consideration for the
advances was 15% of the net profits. If there were no earnings or
profits there was no obligation to repay. Voluntary advances without
expectation of repayment do not result in deductible losses.
Fernandez cannot even sue for recovery as the obligation to repay
will only arise if there was net profits. No bad debt could arise
where there is no valid and subsisting debt.
ISSUE: WON the BIR was correct in assessing deficiency

taxesagainst Limpan Corp. for undeclared rental income
18

Sec. 34(H)(l) of the NIRC3 specifically mentions "accredited

domestic corporation or associations" and "non-government
organizations". On the other hand, subparagraph (2)(c) of the same
Section of the Tax Code defines a "non-government organization" to
mean a non-profit domestic corporation.
HELD:
Yes. Petitioner admitted that it indeed had undeclaredincome
(although only a part and not the full amount assessedby BIR).
Thus, it has become incumbent upon them to provetheir excuses
by clear and convincing evidence, which it hasfailed to do.Issue:
When is there constructive receipt of rent?With regard to 1957
rents deposited with the court, andwithdrawn only in 1958, the
court viewed the corporation ashaving constructively received said
rents. The non-collectionwas the petitioners fault since it refused
to refused to acceptthe rent, and not due to non-payment of
lessees. Hence,although the corporation did not actually receive
the rent, it isdeemed to have constructively received them.
In implementing Sec. 34(H) of the NIRC, RR 13-984 was issued and

in relation to the type of entities that may be accredited, which
(H) Charitable and Other Contributions.
(l) In General. Contributions or gifts actually paid or made within the taxable year
to, or for the use of the Government of the Philippines or any of its agencies or any
political subdivision thereof exclusively for public purposes, or to accredited
domestic corporations or associations organized and operated exclusively for
religious, charitable, scientific, youth and sports development, cultural or
educational purposes or for the rehabilitation of veterans, or to social welfare
institutions or to non-government organizations, in accordance with rules and
regulations promulgated by the Secretary of Finance, upon recommendation of the
Commissioner, no part of the net income of which inures to the benefit of any
private stockholder or individual in an amount not in excess of ten percent (10%) in
the case of an individual, and five percent (5%) in the case of a corporation of the
taxpayer's taxable income derived from trade, business or profession as computed
without the benefit of this and the following subparagraphs".
Depletion
CONSOLIDATED MINES v CTA
BIR RULING 19-01
FACTS:
On October 3, 2000, the Philippine Council for NGO Certification
(PCNC) sent a request for ruling to the BIR, mainly to seek an
opinion if Conservation International (CI), an international
organization, can be granted a donee institution status. Note that
CIs home office and board members are based abroad, hence,
PCNCs evaluation process on governance cannot be fully executed.
SEC. 1. Definition of Terms. For purposes of these Regulations, the terms herein
enumerated shall have the following meanings:
a) "Non-stock, non-profit corporation or organization" shall refer to a corporation
or association/ organization referred to under Section 30 (E) and (G) of the Tax Code
created or organized under Philippine laws exclusively for one or more of the
following purposes:
ISSUE:
xxx
Whether or not international organizations with home offices

abroad are qualified to be granted donee institution status.
xxx
xxx
b) "Non-government Organization (NGO)" shall refer to a non-stock, non-profit

domestic corporation or organization as defined under Section 34(H)(2)(c) of the Tax
Code organized and operated exclusively . . ."
HELD: NO.
19

specifically refers to organizations or associations created or

organized under Philippine laws.
As to (a), the Commissioner of Internal Revenue allowed a

deduction of P797,046.09 only as technical service fee and royalty
for locally manufactured products, but disallowed the sum of
P2,323,599.02 alleged to have been paid by the petitioner to 3M-St.
Paul as technical service fee and royalty on P46,471,998.00 worth
of finished products imported by the petitioner from the parent
company, on the ground that the fee and royalty should be based
only on locally manufactured goods. While as to (b), the CIR only
allowed P19,544.77 or one-fifth (1/5) of 3M Phils.capital expenditure
of P97,046.09 for its tape coater which was installed in 1973
because such expenditure should be amortized for a period of five
(5) years, hence, payment of the disallowed balance of P77,740.38
should be spread over the next four (4) years. The CIR ordered 3M
Phil. to pay P840,540 as deficiency income tax on its 1974 return,
plus P353,026.80 as 14% interest per annum from February 15,
1975 to February 15, 1976, or a total of P1,193,566.80.
Thus, the BIR opined that a non-stock, non-profit corporation or

organization must be created or organized under Philippine Laws
and that an NGO must be a non-profit domestic corporation, this
Office is of the opinion that a foreign corporation, like Conservation
International, whether resident or non-resident, cannot be
accredited as donee institution.
3M PHILIPPINES v CIR
Facts:
3M Philippines, Inc. is a subsidiary of the Minnesota Mining and
Manufacturing Company (or "3M-St. Paul") a non-resident foreign
corporation with principal office in St. Paul, Minnesota, U.S.A. It is
the exclusive importer, manufacturer, wholesaler, and distributor in
the Philippines of all products of 3M-St. Paul. To enable it to
manufacture, package, promote, market, sell and install the highly
specialized products of its parent company, and render the
necessary post-sales service and maintenance to its customers, 3M
Phils. entered into a "Service Information and Technical Assistance
Agreement" and a "Patent and Trademark License Agreement" with
the latter under which the 3m Phils. agreed to pay to 3M-St. Paul a
technical service fee of 3% and a royalty of 2% of its net sales. Both
agreements were submitted to, and approved by, the Central Bank
of the Philippines. the petitioner claimed the following deductions
as business expenses:
3M Phils. protested the CIRs assessment but it did not answer the
protest, instead issuing a warrant of levy. The CTA affirmed the
assessment on appeal.
Issue:
Whether or not 3M Phils is entitled to the deductions due to
royalties?
Ruling:
No. CB Circular No. 393 (Regulations Governing Royalties/Rentals)
dated December 7, 1973 was promulgated by the Central Bank as
an exchange control regulation to conserve foreign exchange and
avoid unnecessary drain on the country's international reserves (69
O.G. No. 51, pp. 11737-38). Section 3-C of the circular provides that
royalties shall be paid only on commodities manufactured by the
licensee under the royalty agreement:
(a) royalties and technical service fees of P 3,050,646.00; and

(b) pre-operational cost of tape coater of P97,485.08.
20

personal services actually rendered; travelling expenses while away

from home in the pursuit of a trade, profession or business, rentals
or other payments required to be made as a condition to the
continued use or possession, for the purpose of the trade,
profession or business, for property to which the taxpayer has not
taken or is not taking title or in which he has no equity.
Section 3. Requirements for Approval and Registration. The

requirements for approval and registration as provided for in
Section 2 above include, but are not limited to the following:
a. xxx xxx xxx
Petitioner points out that the Central bank "has no say in the
assessment and collection of internal revenue taxes as such power
is lodged in the Bureau of Internal Revenue," that the Tax Code
"never mentions Circular 393 and there is no law or regulation
governing deduction of business expenses that refers to said
circular." (p. 9, Petition.)
b. xxx xxx xxx

c. The royalty/rental contracts involving manufacturing' royalty,
e.g., actual transfers of technological services such as secret
formula/processes, technical know how and the like shall not
exceed five (5) per cent of the wholesale price of the
commodity/ties manufactured under the royalty agreement. For
contracts involving 'marketing' services such as the use of foreign
brands or trade names or trademarks, the royalty/rental rate shall
not exceed two (2) per cent of the wholesale price of the
commodity/ties manufactured under the royalty agreement. The
producer's or foreign licensor's share in the proceeds from the
distribution/exhibition of the films shall not exceed sixty (60) per
cent of the net proceeds (gross proceeds less local expenses) from
the exhibition/distribution of the films. ... (Emphasis supplied.) (p.
27, Rollo.)
The argument is specious, for, although the Tax Code allows

payments of royalty to be deducted from gross income as business
expenses, it is CB Circular No. 393 that defines what royalty
payments are proper. Hence, improper payments of royalty are not
deductible as legitimate business expenses.
ESSO STANDARD v CIR
FACTS:
ESSO deducted from its gross income, as part of its ordinary and
necessary business expenses, the amount it had spent for drilling
and exploration of its petroleum concessions. This claim was
disallowed by the CIR on the ground that the expenses should be
capitalized and might be written off as a loss only when a "dry
hole" should result.
Clearly, no royalty is payable on the wholesale price of finished

products imported by the licensee from the licensor. However,
petitioner argues that the law applicable to its case is only Section
29(a)(1) of the Tax Code which provides:
ESSO then filed an amended return and claimed as ordinary and

necessary expenses margin fees it had paid to the Central Bank
on its profit remittances to its New York head office. The CIR
disallowed the claimed deduction for the margin fees paid. CIR
assessed ESSO a deficiency income tax which arose from the
disallowance of the margin fees.
(a) Expenses. (1) Business expenses. (A) In general. All

ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business, including a
reasonable allowance for salaries or other compensation for
21

them often; the payment may be unique or non-recurring to the

particular taxpayer affected. There is thus no hard and fast rule
on the matter. The right to a deduction depends in each case on
the particular facts and the relation of the payment to the type
of business in which the taxpayer is engaged. The intention of
the taxpayer often may be the controlling fact in making the
determination. Assuming that the expenditure is ordinary and
necessary in the operation of the taxpayer's business, the
answer to the question as to whether the expenditure is an
allowable deduction as a business expense must be determined
from the nature of the expenditure itself, which in turn depends
on the extent and permanency of the work accomplished by the
expenditure.
ESSO paid under protest and claimed for a refund. CIR denied the
claims for refund, holding that the margin fees paid to the Central
Bank could not be considered taxes or allowed as deductible
business expenses.
ISSUES:
1. w/n margin fee is a tax and should be deductible from
ESSOs gross income. NO
2. If margin fees are not taxes, w/n they should nevertheless
be considered necessary and ordinary business expenses
and therefore still deductible from its gross income. NO.
HELD:
1. NO. A margin is not a tax but an exaction designed to curb the
excessive demands upon our international reserves. The margin
fee was imposed by the State in the exercise of its police power
and not the power of taxation.
Since the margin fees in question were incurred for the

remittance of funds to petitioner's Head Office in New York,
which is a separate and distinct income taxpayer from the
branch in the Philippines, for its disposal abroad, it can never be
said therefore that the margin fees were appropriate and helpful
in the development of petitioner's business in the Philippines
exclusively. ESSO has not shown that the remittance to the
head office of part of its profits was made in furtherance of its
own trade or business and therefore cannot be claimed as an
ordinary and necessary expense paid or incurred in carrying on
its own trade or business.
2. NO.
To be deductible as a business expense, three conditions are
imposed, namely:
(1) the expense must be ordinary and necessary,
(2) it must be paid or incurred within the taxable year, and
(3) it must be paid or incurred in carrying on a trade or
business.
In addition, not only must the taxpayer meet the business test,
he must substantially prove by evidence or records the
deductions claimed under the law, otherwise, the same will be
disallowed. The mere allegation of the taxpayer that an item of
expense is ordinary and necessary does not justify its
deduction.
Ordinarily, an expense will be considered 'necessary' where the
expenditure is appropriate and helpful in the development of
the taxpayer's business. It is 'ordinary' when it connotes a
payment which is normal in relation to the business of the
taxpayer and the surrounding circumstances. The term
'ordinary' does not require that the payments be habitual or
normal in the sense that the same taxpayer will have to make
22

The assets of a taxpayer are classified for income tax purposes into
ordinary assets and capital assets. Section 34[a] [1] of the National
Internal Revenue Code broadly defines capital assets as follows:
R. CAPITAL GAINS and LOSSES

Capital assets
[1] Capital assets.-The term 'capital assets' means

property held by the taxpayer [whether or not
connected with his trade or business], but does not
include, stock in trade of the taxpayer or other
property of a kind which would properly be included,
in the inventory of the taxpayer if on hand at the
close of the taxable year, or property held by the
taxpayer primarily for sale to customers in the
ordinary course of his trade or business, or property
used in the trade or business of a character which is
subject to the allowance for depreciation provided in
subsection [f] of section thirty; or real property used
in the trade or business of the taxpayer.
CALASANZ v CIR
Facts: Petitioner Ursula Calasanz inherited from her father de
Torres an agricultural land located in Rizal with an area of 1.6M
sqm. In order to liquidate her inheritance, Ursula Calasanz had the
land surveyed and subdivided into lots. Improvements, such as
good roads, concrete gutters, drainage and lighting system, were
introduced to make the lots saleable. Soon after, the lots were sold
to the public at a profit.
In their joint income tax return for the year 1957 filed with the
Bureau of Internal Revenue on March 31, 1958, petitioners
disclosed a profit of P31,060.06 realized from the sale of the
subdivided lots, and reported fifty per centum thereof or
P15,530.03 as taxable capital gains.
The statutory definition of capital assets is negative in nature. If

the asset is not among the exceptions, it is a capital asset;
conversely, assets falling within the exceptions are ordinary assets.
And necessarily, any gain resulting from the sale or exchange of an
asset is a capital gain or an ordinary gain depending on the kind of
asset involved in the transaction.
Upon an audit and review of the return thus filed, the Revenue
Examiner adjudged petitioners engaged in business as real estate
dealers, as defined in the NIRC, and required them to pay the real
estate dealer's tax and assessed a deficiency income tax on profits
derived from the sale of the lots based on the rates for ordinary
income.
However, there is no rigid rule or fixed formula by which it can be

determined with finality whether property sold by a taxpayer was
held primarily for sale to customers in the ordinary course of his
trade or business or whether it was sold as a capital
asset. Although several factors or indices have been recognized as
helpful guides in making a determination, none of these is decisive;
neither is the presence nor the absence of these factors conclusive.
Each case must in the last analysis rest upon its own peculiar facts
and circumstances.
Tax court upheld the finding of the CIR, hence, the present appeal.
Issues:
a. Whether or not petitioners are real estate dealers liable for real
estate dealer's fixed tax. YES
b. Whether the gains realized from the sale of the lots are taxable
in full as ordinary income or capital gains taxable at capital gain
rates. ORDINARY INCOME
Also a property initially classified as a capital asset may thereafter

be treated as an ordinary asset if a combination of the factors
indubitably tend to show that the activity was in furtherance of or
in the course of the taxpayer's trade or business. Thus, a sale of
inherited real property usually gives capital gain or loss even
Ratio:
23

though the property has to be subdivided or improved or both to

make it salable. However, if the inherited property is substantially
improved or very actively sold or both it may be treated as held
primarily for sale to customers in the ordinary course of the heir's
business.
liquidation does not foreclose a determination that a "trade or

business" is being conducted by the seller.
One may, of course, liquidate a capital asset. To do so, it is
necessary to sell. The sale may be conducted in the most
advantageous manner to the seller and he will not lose the benefits
of the capital gain provision of the statute unless he enters the real
estate business and carries on the sale in the manner in which such
a business is ordinarily conducted. In that event, the liquidation
constitutes a business and a sale in the ordinary course of such a
business and the preferred tax status is lost.
In this case, the subject land is considered as an ordinary asset.

Petitioners did not sell the land in the condition in which they
acquired it. While the land was originally devoted to rice and fruit
trees, it was subdivided into small lots and in the process
converted into a residential subdivision and given the name Don
Mariano Subdivision. Extensive improvements like the laying out of
streets, construction of concrete gutters and installation of lighting
system and drainage facilities, among others, were undertaken to
enhance the value of the lots and make them more attractive to
prospective buyers. The audited financial statements submitted
together with the tax return in question disclosed that a
considerable amount was expended to cover the cost of
improvements. There is authority that a property ceases to be a
capital asset if the amount expended to improve it is double its
original cost, for the extensive improvement indicates that the
seller held the property primarily for sale to customers in the
ordinary course of his business.
BIR RULING 27-02

Registration with HLURB or HUDCC shall be sufficient for a
seller/transferor to be considered as habitually engaged in real
estate business. If the seller/transferor is not registered with the
HLURB or HUDCC, he/it may prove that he/it is engaged in the real
estate business by offering other satisfactory evidence (e.g.
consummation during the preceding year at least 6 taxable real
estate transactions regardless of amount). (BIR Ruling No. 0272002 dated July 3, 2002)
Another distinctive feature of the real estate business discernible

from the records is the existence of contracts receivables, which
stood at P395,693.35. The sizable amount of receivables in
comparison with the sales volume of P446,407.00 during the same
period signifies that the lots were sold on installment basis and
suggests the number, continuity and frequency of the sales. Also of
significance is the circumstance that the lots were advertised for
sale to the public and that sales and collection commissions were
paid out during the period in question.
Capital assets
CHINA BANKING CORP v CA
Petitioners argument that they are merely liquidating the land must
also fail. In Ehrman vs. Commissioner, the American court in clear
and categorical terms rejected the liquidation test in determining
whether or not a taxpayer is carrying on a trade or business The
court observed that the fact that property is sold for purposes of
24

liability for the capital gains tax on the exchange of the old for the
new shares of stock. Accordingly, deficiency assessments were
imposed against the private respondents. MR denied. CTA reversed
and held that there was a valid merger. It declared that no taxable
gain was derived by petitioners from the exchange of their old
stocks solely for stocks of the New Corporation because it was
pursuant to a plan of reorganization. Thus, such exchange is
exempt from CGT.
S. DETERMINATION OF GAIN OR LOSS FROM SALE

OR TRANSFER OF PROPERTY
Exchange of property
CIR v RUFINO
FACTS:
ISSUE/RULING:
The private respondents were the majority stockholders of the
defunct Eastern Theatrical Co., Inc., (Old Corporation). Ernesto
Rufino was the president. The private respondents were also the
majority and controlling stockholders of another corporation, the
Eastern Theatrical Co Inc., (New Corporation). This corporation was
engaged in the same kind of business as the Old Corporation, i.e.
operating theaters, opera houses, places of amusement and other
related business enterprises. Vicente Rufino was the General
Manager.
W/N the CTA erred in finding that no taxable gain was derived by
the private respondents from the questioned transaction? NO
There was a valid merger although the actual transfer of the
properties subject of the Deed of Assignment was not made on the
date of the merger. In the nature of things, this was not possible.
Obviously, it was necessary for the Old Corporation to surrender its
net assets first to the New Corporation before the latter could issue
its own stock to the shareholders of the Old Corporation because
the New Corporation had to increase its capitalization for this
purpose. This required the adoption of the resolution for the
registration of such issuance with the SEC and its approval. All
these took place after the date of the merger but they were
deemed part and parcel of, and indispensable to the validity and
enforceability of, the Deed of Assignment.
The Old Corporation held a special meeting of stockholders where a

resolution was passed authorizing the Old Corporation to merge
with the New Corporation. Pursuant to the said resolution, the Old
Corporation, represented by Ernesto Rufino as President, and the
New Corporation, represented by Vicente Rufino as General
Manager, signed a Deed of Assignment providing for the
conveyance and transfer of all the business, property assets,
goodwill, and liabilities of the Old Corporation to the New
Corporation in exchange for the latter's shares of stock to be
distributed among the shareholders on the basis of one stock for
each stock held in the Old Corporation. This agreement was made
retroactive. The aforesaid transfer was eventually made. The
resolution and the Deed of Assignment were approved in a
resolution by the stockholders of the New Corporation in their
special meeting. The increased capitalization of the New
Corporation was registered and approved by the SEC.
There is no impediment to the exchange of property for stock

between the two corporations being considered to have been
effected on the date of the merger. That, in fact, was the intention,
and the reason why the Deed of Assignment was made retroactive
which provided in effect that all transactions set forth in the merger
agreement shall be deemed to be taking place simultaneously
when the Deed of Assignment became operative.
The basic consideration, of course, is the purpose of the merger, as
this would determine whether the exchange of properties involved
therein shall be subject or not to the capital gains tax. The criterion
laid down by the law is that the merger" must be undertaken for
The BIR, after examination, declared that the merger was not
undertaken for a bona fide business purpose but merely to avoid
25

a bona fide business purpose and not solely for the purpose of
escaping the burden of taxation."
Facts:
Here, the purpose of the merger was to continue the business of

the Old Corporation, whose corporate life was about to expire,
through the New Corporation to which all the assets and obligations
of the former had been transferred. What argues strongly, indeed,
for the New Corporation is that it was not dissolved after the
merger agreement. On the contrary, it continued to operate the
places of amusement originally owned by the Old Corporation and
continues to do so today after taking over the business of the Old
Corporation 27 years ago.
Petitioner was the owner of all the stock of United Mortgage

Corporation(UMC). That corporation held among its assets 1,000
shares of the Monitor Securities Corporation(MSC). Petitioner
wanted these shares transferred to her at a profit and with the
minimum income tax liability. In order to achieve this purpose,
Petitioner made it appear that she was making a reorganization
(in conforme with Revenue Act of 1928 5). Under this law, a
reorganization would effect a direct transfer of a corporations
share by way of dividend at a lower taxable transaction.
What is also worth noting is that, as in the case of the Old

Corporation when it was dissolved, there has been no distribution
of the assets of the New Corporation since then and up to now, as
far as the record discloses. To date, the private respondents have
not derived any benefit from the merger of the Old Corporation and
the New Corporation almost 3 decades earlier that will make them
subject to the capital gains tax under Section 35. They are no more
liable now than they were when the merger took effect, as the
merger, being genuine, exempted them under the law from such
tax.
In order to have an appearance of a reorganization,

she(Petitioner) organized Averill Corporation (AC). Three (3) days
later, UMC transferred the 1,000 shares of MSC to AC. Then these
shares were all transferred to Petitioner. Subsequently, AC was
dissolved with no other transaction being made other the transfer
of the shares. Petitioner then sold the shares and declared a lower
taxable liability. The Board contended that the so-called
reorganization should be considered ineffective since it was just a
scheme to have a lower tax liability.
By this decision, the government is, of course, not left entirely

without recourse, at least in the future. The fact is that the merger
had merely deferred the claim for taxes, which may be asserted by
the government later, when gains are realized and benefits are
distributed among the stockholders as a result of the merger. In
other words, the corresponding taxes are not forever foreclosed or
forfeited but may at the proper time and without prejudice to the
government still be imposed.
ISSUE:
Whether the reorganization is valid which would result to a
lower tax liability.
5
"Sec. 112. (g) Distribution of Stock on Reorganization. If there is distributed, in

pursuance of a plan of reorganization, to a shareholder in a corporation a party to
the reorganization, stock or securities in such corporation or in another corporation a
party to the reorganization, without the surrender by such shareholder of stock or
securities in such a corporation, no gain to the distributee from the receipt of such
stock of securities shall be recognized. . . ."
"(i) Definition of Reorganization. -- As used in this section . . ."
"(1) The term 'reorganization' means . . . (B) a transfer by a corporation of all or
a part of its assets to another corporation if immediately after the transfer
the transferor or its stockholders or both are in control of the corporation
to which the assets are transferred. . . ."
BIR RULING 274-87

GREGORY v HELVERING
26

HELD:
NO. It is contended that since every element required by the
foregoing subdivision (B) (refer to footnote) is to be found in what
was done, a statutory reorganization was effected, and that the
motive of the taxpayer thereby to escape payment of a tax will not
alter the result or make unlawful what the statute allows.
The Court said, although the legal right of a taxpayer to
decrease the amount of what otherwise would be his taxes, or
altogether avoid them, by means which the law permits, cannot be
doubted, the question for determination is whether what
was done, apart from the tax motive, was the thing which
the statute intended.
When subdivision (B) speaks of a transfer of assets by one
corporation to another, it means a transfer made "in pursuance of a
plan of reorganization of corporate business, and not a transfer of
assets by one corporation to another in pursuance of a plan having
no relation to the business of either, as plainly is the case here.
Simply an operation having no business or corporate
purpose -- a mere device which put on the form of a corporate
reorganization as a disguise for concealing its real character, and
the sole object and accomplishment of which was the
consummation of a preconceived plan, not to reorganize a business
or any part of a business, but to transfer a parcel of corporate
shares to the petitioner. The rule which excludes from consideration
the motive of tax avoidance is not pertinent to the situation,
because the transaction, upon its face, lies outside the plain intent
of the statute. (kasi wala nga talagang business purpose but to
circumvent the law).
27

The governing law is found in Sec. 37 (b). 6

Revenue
Regulation No. 2 of the DOF contains a similar provision, with
the additional line that the ratable part is based upon the
ratio of gross income from sources within the Philippines to
the total gross income (Sec. 160).
Hence, where an
expense is clearly related to the production of Philippinederived income or to Philippine operations, that expense can
be deducted from the gross income acquired in the
Philippines without resorting to apportionment.
T. SITUS OF TAXATION
Gross income from sources within the Phils
CIR v MARUBENI CORPORATION
CIR v BOAC
CIR v CTA AND SMITH&FRENCH OVERSEAS
Facts:
Smith Kline & French Overseas Company is a multinational
firm domiciled in Philadelphia, licensed to do business in the
Philippines. It is engaged in the importation, manufacture,
and sale of pharmaceutical drugs and chemicals.
However, the overhead expenses incurred by the parent

company in connection with finance, administration, and
research & development, all of which directly benefit its
branches all over the world, fall under a different category.
These are items which cannot be definitely allocated or
identified with the operations of the Philippine branch. Smith
can claim as its deductible share a ratable part of such
expenses based upon the ration of the local branchs gross
income to the total gross income of the corporation
worldwide.
In 1971, it declared a net taxable income of P1.4 M and paid

P511k as tax due. It claimed its share of the head office
overhead expenses (P501k) as deduction from gross income.
In its amended return, it claimed that there was an
overpayment of tax (P324k) arising from under-deduction of
the overhead expense. This was certified by international
independent auditors, the allocation of the overhead expense
made on the basis of the percentage of gross income in the
Philippines to gross income of the corporation as a whole.
CIRs Contention
The CIR does not dispute the right of Smith to avail of Sec. 37
(b) of the Tax Code and Sec. 160 of the RR. But he maintains
In 1974, without waiting for the action of the CIR, Smith filed
a petition for review with the CTA. CTA ordered CIR to refund
the overpayment or grant Smith a tax credit. CIR appealed
to the SC.
Issue: Whether Smith is entitled to a refund YES

Ratio:
28
Net income from sources in the Philippines. From the items of

gross income specified in subsection (a) of this section there shall
be deducted expenses, losses, and other deductions properly
apportioned or allocated thereto and a ratable part of any
expenses, losses, or other deductions which cannot definitely be
allocated to some item or class of gross income. The remainder, if
any, shall be included in full as net income from sources within the
Philippines.

that such right is not absolute and that there exists a

contract (service agreement) which Smith has entered into
with its home office, prescribing the amount that a branch
can deduct as its share of the main offices overhead
expenses. Since the share of the Philippine branch has been
fixed, Smith cannot claim more than the said amount.
recovered from the original assured were to be paid for by

the foreign reinsurers. The foreign reinsurers further agreed,
in consideration for managing or administering their affairs in
the Philippines, to compensate the Philippine Guaranty Co.,
Inc., in an amount equal to 5% of the reinsurance premiums.
Conflicts and/or differences between the parties under the
reinsurance contracts were to be arbitrated in Manila.
Philippine Guaranty Co., Inc. and Swiss Reinsurance Company
stipulated that their contract shall be construed by the laws
of the Philippines.
Smiths Contention
Smith, on the other hand, submits that the contract between
itself and its home office cannot amend tax laws and
regulations. The matter of allocated expenses deductible
under the law cannot be the subject of an agreement
between private parties nor can the CIR acquiesce in such an
agreement.
Pursuant to the aforesaid reinsurance contracts, Philippine

Guaranty Co., Inc. ceded premiuns to the foreign reinsurers.
Said premiums were excluded by Philippine Guaranty Co.,
Inc. from its gross income when it file its income tax returns
for 1953 and 1954. Furthermore, it did not withhold or pay
tax on them. Consequently, the Commissioner of Internal
Revenue assessed against Philippine Guaranty Co., Inc.
withholding tax on the ceded reinsurance premiums.
SC ruled for Smith Kline and said that its amended return
conforms with the law and regulations.
PHIL GUARANTY CO v CIR
Issue: Whether the reinsurance premiums ceded to foreign

reinsurers not doing business in the Philippines are subject to
withholding tax?
Facts: The Philippine Guaranty Co., Inc., a domestic

insurance company, entered into reinsurance contracts, on
various dates, with foreign insurance companies not doing
business in the Philippines.
Held: The reinsurance premiums are subject to withholding

tax. The reinsurance contracts, however, show that the
transactions or activities that constituted the undertaking to
reinsure Philippine Guaranty Co., Inc. against loses arising
from the original insurances in the Philippines were
performed in the Philippines. The liability of the foreign
reinsurers commenced simultaneously with the liability of
Philippine Guaranty Co., Inc. under the original insurances.
The reinsurance contracts made the commencement of the

reinsurers' liability simultaneous with that of Philippine
Guaranty Co., Inc. under the original insurance. Philippine
Guaranty Co., Inc. was required to keep a register in Manila
where the risks ceded to the foreign reinsurers where
entered, and entry therein was binding upon the reinsurers. A
proportionate amount of taxes on insurance premiums not
29

Philippine Guaranty Co., Inc. kept in Manila a register of the

risks ceded to the foreign reinsurers. Entries made in such
register bound the foreign resinsurers, localizing in the
Philippines the actual cession of the risks and premiums and
assumption of the reinsurance undertaking by the foreign
reinsurers. Taxes on premiums imposed by Section 259 of the
Tax Code for the privilege of doing insurance business in the
Philippines were payable by the foreign reinsurers when the
same were not recoverable from the original assured. The
foreign reinsurers paid Philippine Guaranty Co., Inc. an
amount equivalent to 5% of the ceded premiums, in
consideration for administration and management by the
latter of the affairs of the former in the Philippines in regard
to their reinsurance activities here. Disputes and differences
between the parties were subject to arbitration in the City of
Manila. All the reinsurance contracts, except that with Swiss
Reinsurance Company, were signed by Philippine Guaranty
Co., Inc. in the Philippines and later signed by the foreign
reinsurers abroad. Although the contract between Philippine
Guaranty Co., Inc. and Swiss Reinsurance Company was
signed by both parties in Switzerland, the same specifically
provided that its provision shall be construed according to
the laws of the Philippines, thereby manifesting a clear
intention of the parties to subject themselves to Philippine
law.
undertaking, as explained above, took place in the Philippines.

These insurance premiums, therefore, came from sources within
the Philippines and, hence, are subject to corporate income tax.
The foreign insurers' place of business should not be confused
with their place of activity. Business should not be continuity
and progression of transactions while activity may consist of
only a single transaction. An activity may occur outside the
place of business. Section 24 of the Tax Code does not require a
foreign corporation to engage in business in the Philippines in
subjecting its income to tax. It suffices that the activity creating
the income is performed or done in the Philippines. What is
controlling, therefore, is not the place of business but the place
of activity that created an income.
HOWDEN & CO v CIR

PHILIPPINE AMERICAN LIFE INSURANCE CO v CTA
Howden Vs CIR
(taxation from Sources in the Philippines)

FACTS:
Commonwealth Insurance Co. (CIC), a domestic corporation,
entered into reinsurance contracts with 32 British companies
not engaged in business in thePhilippines represented by
herein Plaintiff. CIC remitted to Plaintiff reinsurance
premiums and, on behalf of Plaintiff, paid income tax on the
premiums. Plaintiff filed a claim for a refund of the paid tax,
stating that it was exempted from withholding tax
reinsurance premiums received from domestic insurance
companies by foreign insurance companies not authorized to
do business in the Philippines. Plaintiffs stated that since Sec.
Section 24 of the Tax Code subjects foreign corporations to tax

on their income from sources within the Philippines. The word
"sources" has been interpreted as the activity, property or
service giving rise to the income. 1 The reinsurance premiums
were income created from the undertaking of the foreign
reinsurance companies to reinsure Philippine Guaranty Co., Inc.,
against liability for loss under original insurances. Such
30

53 and 54 were substantially re-enacted by RA 1065, 1291

and 2343,
said rulings should be given the force of law under the
principle of legislative approval by re-enactment.
ISSUE:
W/N the tax should be withheld.
HELD:
No. The principle of legislative enactment states that where a
statute is susceptible of the meaning placed upon it by a
ruling of the government agency charged with its
enforcement and the legislature thereafter re-enacts the
provisions without substantial changes, such action is
confirmatory to an extent that the ruling carries out the
legislative purpose. This principle is not applicable for
heaforementioned sections were never re-enacted. Only the
tax rate was amended. The administrative rulings invoked by
the CIR were only contained in unpublished letters. It cannot
be assumed that the legislature knew of these rulings.
Finally, the premiums remitted were to indemnify CIC against
liability. This took place within the
Philippines, thus subject to income tax
31

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TAX LAW REVIEW DIGESTS Montero

ICC was assessed for deficiency income tax [ BIR disallowed

ISSUE: W/N the aforementioned may be deducted

TAX LAW REVIEW DIGESTS Montero

have inquired into the amount of their obligation. It could have

February 19, 1958, that said amount should be allowed as

The professional fees of SGV cannot be validly claimed as

ISSUE/HELD: W/N the bonus given to the officers of the petitioner

CIR v GENERAL FOODS

The bonus given to the officers of the petitioner as their share of

TAX LAW REVIEW DIGESTS Montero

ATLAS CONSOLIDATED MINING v CIR

The SC has never attempted to define with precision the terms

On October 1962, the Secretary of Finance ruled that the

TAX LAW REVIEW DIGESTS Montero

It appears that on December 1957, Atlas increased its capital stock.

and shares of stocks in different corporations. To manage the

RATIO: With regard to the disallowed deductions (expenses for

The petitioners also claim deductions for contributions to the Pasay

TAX LAW REVIEW DIGESTS Montero

for public purposes but as Christmas gifts to the families of the

real properties and claimed deductions which were not allowable.

The contribution to Our Lady of Fatima chapel at the Far Eastern

TAX LAW REVIEW DIGESTS Montero

decisions, considered 50% of the said amount of P20,957.00 as

amount of P28,054.00 plus interests. The Court of Tax Appeals upon

In the case of Visayan Cebu Terminal Co., Inc. v. CIR., it was

The fact that such payment was authorized by a standing

TAX LAW REVIEW DIGESTS Montero

and practically an absolutely controlling stockholder of petitioner,

It is a general rule that 'Bonuses to employees made in good faith

There is no fixed test for determining the reasonableness of a given

TAX LAW REVIEW DIGESTS Montero

1. salaries, directors' fees and bonuses of its non-resident

3. the bonuses, when added to the salaries, are reasonable

3. interests on earned but unpaid salaries and bonuses of its

There is no fixed test for determining the reasonableness of a given

The CIR disallowed the deductions and assessed Petitioner for

Petitioner contended that it is error to apply the same measure of

W/N the CTA erred in allowing the deduction of the bonuses

W/N the CTA erred in ruling that the measure of the

The deductible amount of said bonuses cannot be only equal to

It is a general rule that "Bonuses to employees made in good faith

W/N the CTA erred in disallowing the deduction of interests

1. the payment of the bonuses is in fact compensation;

TAX LAW REVIEW DIGESTS Montero

Under the law, in order that interest may be deductible, it must be

Sec. 30. Deduction from Gross Income. The following

Both the CTA and the Court of Appeals sustained the

TAX LAW REVIEW DIGESTS Montero

(a) Interest on a loan (but not theoretical interest of a

Only if sir asks: (For further discussion of CIRs contention)

At the same time, under the adjustment of basis

(B) Taxes and Carrying Charges. The items thus

The "carrying charges" which may be capitalized under the

TAX LAW REVIEW DIGESTS Montero

e.g., machinery and equipment, will be adjusted by adding

Under the law, for interest to be deductible, it must be shown that

CIR v VDA DE PRIETO

On December 4, 1945, the respondent conveyed by way of gifts to

Whether or not such interest was paid upon an indebtedness within

TAX LAW REVIEW DIGESTS Montero

(1) In general. The amount of interest paid within the