ZAMORA V.

COLLECTOR
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 testify
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.
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; that when some of the
representation expenses claimed by the taxpayer were evidenced by vouchers or chits, but others were without vouchers or
chits, the court should determine from all available data, the amount properly deductible as representation expenses.
FACTS:
Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed his income tax returns the years 1951 and
1952. The Collector of Internal Revenue found that he failed to file his return of the capital gains derived from the sale of certain
real properties and claimed deductions which were not allowable. The collector required him to pay the sums of P43,758.50
and P7,625.00, as deficiency income tax for the years 1951 and 1952.
On appeal by Zamora, the Court of Tax Appeals modified the decision appealed from and ordered him to pay the reduced
total sum of P30,258.00 (P22,980.00 and P7,278.00, as deficiency income tax for the years 1951 and 1952.
Having failed to obtain a reconsideration of the decision, Mariano Zamora appealed alleging that the Court of Tax Appeals
erred (amongst other things, this being the only relevant to the topic) in disallowing 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).
Note: He contends that the whole amount of P20,957.00 as promotion expenses in his 1951 income tax returns, should be
allowed and not merely one-half of it or P10,478.50, 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. For, as alleged, the said
amount of P20,957.00 was spent by Mrs. Esperanza A. Zamora (wife of Mariano), during her travel to Japan and the United
States to purchase machinery for a new Tiki-Tiki plant, and to observe hotel management in modern hotels. The CTA, however,
found that for said trip Mrs. Zamora obtained only the sum of P5,000.00 from the Central Bank and that in her application for
dollar allocation, she stated that she was going abroad on a combined medical and business trip, which facts were not denied
by Mariano Zamora. No evidence had been submitted as to where Mariano had obtained the amount in excess of P5,000.00
given to his wife which she spent abroad. No explanation had been made either that the statement contained in Mrs. Zamora's
application for dollar allocation that she was going abroad on a combined medical and business trip, was not correct. The
alleged expenses were not supported by receipts. Mrs. Zamora could not even remember how much money she had when she
left abroad in 1951, and how the alleged amount of P20,957.00 was spent.
ISSUE:
Whether or not 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 in the absence of receipts proving the same.
HELD: NO
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 testify 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 (N.H. Van Socklan, Jr. v. Comm. of Int. Rev.; 33 BTA 544). 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
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. While in situations like the present, absolute certainty is usually not possible, the CTA should make
as close an approximation as it can, bearing heavily, if it chooses, upon the taxpayer whose inexactness is of his own making.

 In the case of Visayan Cebu Terminal Co., Inc. v. Collector of Int. Rev, 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; that when some of the representation expenses claimed by the taxpayer were evidenced by
vouchers or chits, but others were without vouchers or chits, documents or supporting papers; that there is no more than oral
proof to the effect that payments have been made for representation expenses allegedly made by the taxpayer and about the
general nature of such alleged expenses; that accordingly, it is not possible to determine the actual amount covered by
supporting papers and the amount without supporting papers, the court should determine from all available data, the amount
properly deductible as representation expenses.
KUENZLE & STREIFF INC. v. CIR
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: (1) the payment of the bonuses is in fact compensation;
(2) it must be for personal services actually rendered; and (3) 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. Here it
is admitted that the bonuses are in fact compensation and were paid for services actually rendered.
FACTS:
1. Kuenzle & Streiff for the years 1953, 1954 and 1955 filed its income tax return, declaring losses.
2. CIR filed for deficiency of income taxes against Kuenzle & Streiff Inc. for the said years in the amounts of P40,455.00,
P11,248.00 and P16,228.00, respectively, arising from the disallowance, as deductible expenses, of the bonuses paid by the
corporation to its officers, upon the ground that they were not ordinary, nor necessary, nor reasonable expenses within the
purview of Section 30(a) (1) of the National Internal Revenue Code.
3. The corporation filed with the Court of Tax Appeals a petition for review contesting the assessments. CTA favored the CIR,
however lowered the tax due on 1954. The corporation moved for reconsideration, but still lost.
4. The Corporation contends that the tax court, in arriving at its conclusion, acted "in a purely arbitrary manner", and erred in
not considering individually the total compensation paid to each of petitioner's officers and staff members in determining the
reasonableness of the bonuses in question, and that it erred likewise in holding that there was nothing in the record indicating
that the actuation of the respondent was unreasonable or unjust.
ISSUE: Whether or not the bonuses in question was reasonable and just to be allowed as a deduction?
HELD: No.
RATIO: 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: (1) the payment of the bonuses is in fact compensation; (2) it must be for personal services actually rendered;
and (3) 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. Here it is admitted that the bonuses are in fact compensation
and were paid for services actually rendered. The only question is whether the payment of said bonuses is reasonable.
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 a
whole.
It seems clear from the record that, in arriving at its main conclusion, the tax court considered, inter alia, the following
factors:
1) The paid officers, in the absence of evidence to the contrary, that they were competent, on the other the record discloses
no evidence nor has petitioner ever made the claim that all or some of them were gifted with some special talent, or had

undergone some extraordinary training, or had accomplished any particular task, that contributed materially to the success of
petitioner's business during the taxable years in question.
2) All the other employees received no pay increase in the said years.
3) The bonuses were paid despite the fact that it had suffered net losses for 3 years. Furthermore the corporation cannot use
the excuse that it is 'salary paid' to an employee because the CIR does not question the basic salaries paid by petitioner to the
officers and employees, but disallowed only the bonuses paid to petitioner's top officers at the end of the taxable years in
question.
CIR v. GENERAL FOODS (PHILS) INC.
Facts:
Respondent corporation General Foods (Phils), which is engaged in the manufacture of Tang, Calumet and Kool-Aid, filed
its income tax return for the fiscal year ending February 1985 and claimed as deduction, among other business expenses,
P9,461,246 for media advertising for Tang.
The Commissioner disallowed 50% of the deduction claimed and assessed deficiency income taxes of P2,635,141.42 against
General Foods, prompting the latter to file an MR which was denied.
General Foods later on filed a petition for review at CA, which reversed and set aside an earlier decision by CTA dismissing the
companys appeal.
Issue:
W/N the subject media advertising expense for Tang was ordinary and necessary expense fully deductible under the NIRC
Held:
No. Tax exemptions must be construed in stricissimi juris against the taxpayer and liberally in favor of the taxing authority, and
he who claims an exemption must be able to justify his claim by the clearest grant of organic or statute law. Deductions for
income taxes partake of the nature of tax exemptions; hence, if tax exemptions are strictly construed, then deductions must
also be strictly construed.
To be deductible from gross income, the subject advertising expense must comply with the following requisites: (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 or other pertinent
papers.
While the subject advertising expense was paid or incurred within the corresponding taxable year and was incurred in carrying
on a trade or business, hence necessary, the parties views conflict as to whether or not it was ordinary. To be deductible, an
advertising expense should not only be necessary but also ordinary.
The Commissioner maintains that the subject advertising expense was not ordinary on the ground that it failed the two
conditions set by U.S. jurisprudence: first, reasonableness of the amount incurred and second, the amount incurred must not
be a capital outlay to create goodwill for the product and/or private respondents business. Otherwise, the expense must be
considered a capital expenditure to be spread out over a reasonable time.
There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There being
no hard and fast rule on the matter, the right to a deduction depends on a number of factors such as but not limited to: the
type and size of business in which the taxpayer is engaged; the volume and amount of its net earnings; the nature of the
expenditure itself; the intention of the taxpayer and the general economic conditions. It is the interplay of these, among other
factors and properly weighed, that will yield a proper evaluation.
The Court finds the subject expense for the advertisement of a single product to be inordinately large. Therefore, even if it is
necessary, it cannot be considered an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services and (2)
advertising designed to stimulate the future sale of merchandise or use of services. The second type involves expenditures
incurred, in whole or in part, to create or maintain some form of goodwill for the taxpayers trade or business or for the industry
or profession of which the taxpayer is a member. If the expenditures are for the advertising of the first kind, then, except as to
the question of the reasonableness of amount, there is no doubt such expenditures are deductible as business expenses. If,
however, the expenditures are for advertising of the second kind, then normally they should be spread out over a reasonable
period of time.
The companys media advertising expense for the promotion of a single product is doubtlessly unreasonable considering it
comprises almost one-half of the companys entire claim for marketing expenses for that year under review. Petition granted,
judgment reversed and set aside.

CIR v. ISABELA CULTURAL CORPORATION

Facts: Isabela Cultural Corporation (ICC), a domestic corporation received an assessment notice for deficiency income tax and
expanded withholding tax from BIR. It arose from the disallowance of ICCs claimed expense for professional and security
services paid by ICC; as well as the alleged understatement of interest income on the three promissory notes due from Realty
Investment Inc. The deficiency expanded withholding tax was allegedly due to the failure of ICC to withhold 1% e-withholding
tax on its claimed deduction for security services.
ICC sought a reconsideration of the assessments. Having received a final notice of assessment, it brought the case to CTA, which
held that it is unappealable, since the final notice is not a decision. CTAs ruling was reversed by CA, which was sustained by SC,
and case was remanded to CTA. CTA rendered a decision in favor of ICC. It ruled that the deductions for professional and
security services were properly claimed, it said that even if services were rendered in 1984 or 1985, the amount is not yet
determined at that time. Hence it is a proper deduction in 1986. It likewise found that it is the BIR which overstate the interest
income, when it applied compounding absent any stipulation.
Petitioner appealed to CA, which affirmed CTA, hence the petition.
Issue: Whether or not the expenses for professional and security services are deductible.
Held: No. One of the requisites for the deductibility of ordinary and necessary expenses is that it must have been paid or
incurred during the taxable year. This requisite is dependent on the method of accounting of the taxpayer. In the case at bar,
ICC is using the accrual method of accounting. Hence, under this method, an expense is recognized when it is incurred. Under
a Revenue Audit Memorandum, when the method of accounting is accrual, expenses not being claimed as deductions by a
taxpayer in the current year when they are incurred cannot be claimed in the succeeding year.
The accrual of income and expense is permitted when the all-events test has been met. This test requires: 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. The test
does not demand that the amount of income or liability be known absolutely, only that a taxpayer has at its disposal the
information necessary to compute the amount with reasonable accuracy.
From the nature of the claimed deductions 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. They cannot give as an excuse the delayed billing, since it could
have inquired into the amount of their obligation and reasonably determine the amount.
CIR v. CTA & SMITH KLINE & FRRENCH OVERSEAS CO (PHIL BRANCH)
FACTS:
This case is about the refund of a 1971 income tax amounting to P324+k. Smith Kline and French Overseas Company, a
multinational firm domiciled in Philadelphia, Pennsylvania, is licensed to do business in the Philippines. It is engaged in the
importation, manufacture and sale of pharmaceuticals, drugs and chemicals.
In its 1971 original ITR, Smith Kline declared a net taxable income of P1.4+M and paid P511+k as tax due. Among the deductions
claimed from gross income was P501+k as its share of the head office overhead expenses. However, in its amended return filed
on March 1, 1973, there was an overpayment of P324+k arising from underdeduction of home office overhead. It made a formal
claim for the refund of the alleged overpayment.
In October, 1972, Smith Kline received from its international independent auditors an authenticated certification to the effect
that the Philippine share in the unallocated overhead expenses of the main office for the year ended December 31, 1971 was
actually P1.4+M.On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on its claim, Smith Kline
filed a petition for review with the CTA. The CTA ordered the CIR to refund the overpayment or grant a tax credit to Smith Kline.
The Commissioner appealed to the SC.
HELD:
The governing law is found in section 37 of the old NIRC which reads:
Xxx (b) Net income from sources in the Philippines. From the items of gross income specified in subsection (a) of this section
there shall be deducted the 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.
Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to be made to
determine the net income from Philippine sources: SEC. 160. Apportionment of deductions. From the items specified in
section 37(a), as being derived specifically from sources within the Philippines there shall be deducted the expenses, losses,
and other deductions properly apportioned or allocated thereto and a ratable part of any other expenses, losses or deductions
which can not definitely be allocated to some item or class of gross income. The remainder shall be included in full as net

income from sources within the Philippines. The ratable part is based upon the ratio of gross income from sources within the
Philippines to the total gross income.
"Example: A non-resident alien individual whose taxable year is the calendar year, derived gross income from all sources for
1939 of P180,000, including therein:
Interest on bonds of a domestic corporation P9,000
Dividends on stock of a domestic corporation 4,000
Royalty for the use of patents within the Philippines 12,000
Gain from sale of real property located within the Philippines 11,000

Total P36,000
========
that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of the gross income was
from sources without the Philippines, determined under section 37(c).
The expenses of the taxpayer for the year amounted to P78k.. Of these expenses the amount of P8k is properly allocated to
income from sources within the Philippines and the amount of P40k is properly allocated to income from sources without the
Philippines.
The remainder of the expense, P30k cannot be definitely allocated to any class of income. A ratable part thereof, based upon
the relation of gross income from sources within the Philippines to the total gross income, shall be deducted in computing net
income from sources within the Philippines. Thus, there are deducted from the P36k of gross income from sources within the
Philippines expenses amounting to P14k [representing P8k properly apportioned to the income from sources within the
Philippines and P6k a ratable part (1/5) of the expenses which could not be allocated to any item or class of gross income]. The
remainder, P22k, is the net income from sources within the Philippines.
Thus, it is manifest that where an expense is clearly related to the production of Philippine-derived income or to Philippine
operations (e.g. salaries of Philippine personnel, rental of office building in the Philippines), that expense can be deducted from
the gross income acquired in the Philippines without resorting to apportionment.
The overhead expenses incurred by the parent company in connection with finance, administration, and research and
development, all of which directly benefit its branches all over the world, including the Philippines, fall under a different
category however. These are items which cannot be definitely allocated or identified with the operations of the Philippine
branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under section 37(b) of the Revenue Code and section
160 of the regulations, Smith Kline can claim as its deductible share a ratable part of such expenses based upon the ratio of the
local branch's gross income to the total gross income, worldwide, of the multinational corporation.
The weight of evidence bolsters Smith Klines position that the amount of P1.4+M represents the correct ratable share, the
same having been computed pursuant to section 37(b) and section 160. Therefore, it is entitled to a refund.
GANCAYCO v. THE COLLECTOR
FACTS: Petitioner Santiago Gancayco seeks the review of a decision of the Court of Tax Appeals, requiring him to pay
deficiency income tax. The question whether the sum is due from Gancayco as deficiency income tax hinges on the validity of
his claim for deduction of two (2)
items, namely: (a) for farming expenses; and (b) for representation expenses.
ISSUE: WON the two claimed deductions are allowable
HELD: No. In computing net income, no deduction shall be allowed in respect of any amount paid out for new buildings or for
permanent improvements, or betterments made to increase the value of any property or estate. The cost of farm machinery,
equipment and farm building represents a capital investment and is not an allowable deduction as an item of expense.
Hence, the farming expenses allegedly incurred for clearing and developing the farm which were necessary to place it in a
productive state, were not an ordinary expense but a capital
expenditure. Accordingly, they are not deductible. As for Gancayco's claim for representation expenses, a fraction was
disallowed. Such disallowance is justified by the record, for, apart from the absence of receipts, invoices or vouchers of the
expenditures, petitioner could not specify the items constituting the same, or when or on whom or on what they were
incurred.

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:
(a) royalties and technical service fees of P 3,050,646.00; and
(b) pre-operational cost of tape coater of P97,485.08.
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 3MSt. 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.
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:
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.)
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:
(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
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.
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.)
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.

PAPER INDUSTRIES CORP. (PICOP) v. CA, CIR, CTA

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.
Both the CTA and the Court of Appeals sustained the position of Picop and held that the interest deduction claimed
by 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). 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.
The contention of CIR does not spring of the 1977 Tax Code but from Revenue Regulations 2 Sec. 79. 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.
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:
(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.
(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."
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)
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.
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.
CIR v. LEDNICKY
FACTS:
Resp spouses V.E. Lednicky and Maria Valero Lednicky are American Citizens residing in the Philippines and derived
their income from Philippine sources for the taxable years in question
1957 Sps filed their ITR for 1956 reporting a gross income P1,017,287.65 and a net income of P733,809.44 on
which P317,395.40 was assessed after deducting P4,805.59 as withholding tax.
Sps paid 326,247.41 on April 1957
March 1959 Sps filed an amended ITR for 1956. They claimed a deduction of P205,939.24 paid in 1956 to US govt.
Respondents requested refund of 112,437.90
CIR failed to answer the claim for refund, resps filed their petition with the Tax Court
G.R. No. L-18169 formerly CTA case 570[different case/year] is also a claim for refund in the amount of P150,269.00
as alleged overpaid income tax for 1955
o Facts:
In Feb 1956 Sps filed ITR for 1955 = gross income of P1,7771,124.63 and net income of
P1,052,550.67
1956 sps filed an amended ITR
Back in 1955, sps filed with the US Internal Revenue Agent in Manila their federal ITR for the years
1947,1951-54 on income from Phil sources on a cash basis
1958 Sps amended their Phil ITR for 1955 to include the deductions of US Federal income taxes,
interest accrued up to May 15, 1955, and exchange and bank charges
CTA case 570 was filed
G.R. No. 21434 formerly CTA Case No. 783, facts are similar but refer to Lednickys OTR for 1957 filed in Feb 1958
o In 1959 sps filed amended return for 1957 claiming deductions representing taxes paid to US Govt.
* Tac xourt held that the taxes may be deducted because the Sps did not signify in their ITRa desire to avail themselves of the
benefits of paragraph 3(B) of Sec. 30
COMMON ISSUE: WON a citizen of the US residing in Phils who derives income wholly from sources within the Phils may
deduct from his gross income the income taxes he has paid to US govt for the taxable year?
HELD/RATIO:
SC: CIR correct that the construction and wording of Sec. 30c(1)B of the Internal Revenue Act shows the laws intent
that the right to deduct income taxes paid to foreign government from the taxpayers gross income is given only as
an alternative or substitute to his right to claim a tax credit for such foreign income taxes
o (B) Income, war-profits, and excess profits taxes imposed by the authority of any foreign country; but this
deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have any
extent the benefits of paragraph (3) of this subsection (relating to credit for foreign countries)
So that unless the alien resident has a right to claim such tax credit if he so chooses, he is precluded from deducting
the foreign income taxes from his gross income.
For it is obvious that in prescribing that such deduction shall be allowed in the case of a taxpayer who does not
signify in his return his desire to have any extent benefits of paragraph 3, the statute assumes that the taxpayer in
question may signify his desire to claim a tax credit and waive the deduction; otherwise, the foreign taxes would
always be deductible and their mention in the list on non-deductible items in Sec. 30c might as well have been
omitted or at least expressly limited to taxes on income from sources outside the Philippine Islands
Had the law intended that foreign income taxes could be deducted from gross income in any event, regardless of the
taxpayers right to claim a tax credit, it is the latter right that should be conditioned upon the taxpayers waiving the
deduction
No danger of double credit/taxation.

o
o
o
o

Double taxation becomes obnoxious only where the taxpayer is taxed twice for the benefit of the same
governmental entity
The Philippine government only receives the proceeds of one tax
Justice and equity demand that the tax on the income should accrue to the benefit of the Philippines
Any relief from the alleged double taxation should come from the US since the formers right to burden the
taxpayer is solely predicated in is citizenship, without contributing to the production of wealth that is being
taxed
To allow an alien resident to deduct from his gross income whatever taxes he pays to his own government
amounts to conferring on the latter the power to reduce the tax income of the Philippine government
simply by increasing the tax rates on the alien resident.

CHINA BANK CORP. v. CA

Facts:
China Banking Corporation made a 53% equity investment (P16,227,851.80) in the First CBC Capital a Hongkong subsidiary
engaged in financing and investment with deposit-taking function.
It was shown that CBC has become insolvent so China Banking wrote-off its investment as worthless and treated it as a bad
debt or as an ordinary loss deductible from its gross income.
CIR disallowed the deduction on the ground that the investment should not be classified as being worthless. It also held that
assuming that the securities were worthless, then they should be classified as a capital loss and not as a bad debt since there
was no indebtedness between China Banking and CBC.
Issue:
Whether or not the investment should be classified as a capital loss.
Held:
Yes. Section 29.d.4.B of the NIRC contains provisions on securities becoming worthless. It conveys that capital loss normally
requires the concurrence of 2 conditions:
a.
there is a sale or exchange
b. the thing sold or exchanges is a capital asset.
When securities become worthless, there is strictly no sale or exchange but the law deems it to be a loss. These are allowed to
be deducted only to the extent of capital gains and not from any other income of the taxpayer. A similar kind of treatment is
given by the NIRC on the retirement of certificates of indebtedness with interest coupons or in registered form, short sales and
options to buy or sell property where no sale or exchange strictly exists. In these cases, The NIRC dispenses with the standard
requirements.
There is ordinary loss when the property sold is not a capital asset.
In the case, CBC as an investee corporation, is a subsidiary corporation of China Banking whose shares in CBC are not intended
for purchase or sale but as an investment. An equity investment is a capital asset of the investor. Unquestionably, any loss is a
capital loss to the investor.
-Additional notes:
*The loss cannot be deductible as bad debt since the shares of stock do not constitute a loan extended by it to its subsidiary or
a debt subject to obligatory repayment by the latter.