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CHINA BANKING CORP v CA (GR No.

125508, July 19, 2000)


FACTS:
Sometime in 1980, petitioner China Banking Corporation made a 53% equity investment in the
First CBC Capital (Asia) Ltd., a Hongkong subsidiary engaged in financing and investment with
deposit-taking function. The investment amounted to P16,227,851.80, consisting of 106,000
shares with a par value of P100 per share. In the course of the regular examination of the
financial books and investment portfolios of petitioner conducted by Bangko Sentral in 1986, it
was shown that First CBC Capital (Asia), Ltd., has become insolvent. With the approval of Bangko
Sentral, petitioner wrote-off as being worthless its investment in First CBC Capital (Asia), Ltd., in
its 1987 Income Tax Return and treated it as a bad debt or as an ordinary loss deductible from its
gross income.
Respondent Commissioner of Internal Revenue disallowed the deduction and assessed petitioner
for income tax deficiency in the amount of P8,533,328.04, inclusive of surcharge, interest and
compromise penalty. The disallowance of the deduction was made on the ground that the
investment should not be classified as being worthless and that, although the Hongkong
Banking Commissioner had revoked the license of First CBC Capital as a deposit-taking
company, the latter could still exercise, however, its financing and investment activities.
Assuming that the securities had indeed become worthless, respondent Commissioner of Internal
Revenue held the view that they should then be classified as capital loss, and not as a bad
debt expense there being no indebtedness to speak of between petitioner and its subsidiary.
Petitioner contested the ruling of respondent Commissioner before the CTA. The tax court
sustained the Commissioner, holding that the securities had not indeed become worthless and
ordered petitioner to pay its deficiency income tax for 1987 of P8,533,328.04 plus 20% interest
per annum until fully paid. When the decision was appealed to the Court of Appeals, the latter
upheld the CTA. In its instant petition for review on certiorari, petitioner bank assails the CA
decision.
ISSUE: Whether or not the securities had become worthless.
HELD: Yes, the securities had become worthless.
First, the equity investment in shares of stock held by CBC of approximately 53% in its Hongkong
subsidiary, the First CBC Capital (Asia), Ltd., is not an indebtedness, and it is a capital, not an
ordinary, asset.
Subject to certain exceptions, such as the compensation income of individuals and passive
income subject to final tax, as well as income of non-resident aliens and foreign corporations not
engaged in trade or business in the Philippines, the tax on income is imposed on the net income
allowing certain specified deductions from gross income to be claimed by the taxpayer. Among
the deductible items allowed by the NIRC are bad debts and losses.
An equity investment is a capital, not ordinary, asset of the investor the sale or exchange of
which results in either a capital gain or a capital loss. The gain or the loss is ordinary when the
property sold or exchanged is not a capital asset. A capital asset is defined negatively in Section
33(1) of the NIRC; viz:
(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 twenty-nine; or real property used in the
trade or business of the taxpayer.
Thus, shares of stock; like the other securities defined in Section 20(t) of the NIRC,
would be ordinary assets only to a dealer in securities or a person engaged in the
purchase and sale of, or an active trader (for his own account) in, securities. Section
20(u) of the NIRC defines a dealer in securities thus:
(u) The term dealer in securities means a merchant of stocks or securities,
whether an individual, partnership or corporation, with an established place of
business, regularly engaged in the purchase of securities and their resale to
customers; that is, one who as a merchant buys securities and sells them to
customers with a view to the gains and profits that may be derived therefrom.
Second, assuming that the equity investment of CBC has indeed become worthless,
the loss sustained is a capital, not an ordinary, loss.
In the hands, however, of another who holds the shares of stock by way of an
investment, the shares to him would be capital assets. When the shares held by such
investor become worthless, the loss is deemed to be a loss from the sale or exchange of
capital assets. Section 29(d)(4)(B) of the NIRC states:
(B) Securities becoming worthless. - If securities as defined in Section 20
become worthless during the tax year and are capital assets, the loss resulting
therefrom shall, for the purposes of his Title, be considered as a loss from the
sale or exchange, on the last day of such taxable year, of capital assets.
The above provision conveys that the loss sustained by the holder of the securities,
which are capital assets (to him), is to be treated as a capital loss as if incurred from
a sale or exchange transaction. A capital gain or a capital loss normally requires the
concurrence of two conditions for it to result: (1) There is a sale or exchange; and (2)
the thing sold or exchanged is a capital asset. When securities become worthless,
there is strictly no sale or exchange but the law deems the loss anyway to be a loss
from the sale or exchange of capital assets. 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, in effect, with the
standard requirement of a sale or exchange for the application of the capital gain
and loss provisions of the code.
Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains
derived from the sale or exchange of capital assets, and not from any other income of
the taxpayer.
In the case at bar, First CBC Capital (Asia), Ltd., the investee corporation, is a subsidiary
corporation of petitioner bank whose shares in said investee corporation are not
intended for purchase or sale but as an investment. Unquestionably then, any loss
therefrom would be a capital loss, not an ordinary loss, to the investor.
Finally, the capital loss sustained by CBC can only be deducted from capital gains if any
derived by it during the same taxable year that the securities have become worthless.
Section 34(c)(1) of the NIRC, states that the entire amount of the gain or loss
upon the sale or exchange of property, as the case may be, shall be recognized.
This should be taken within context on the general subject of the determination,

and recognition of gain or loss; it is not preclusive of, let alone renders
completely inconsequential, the more specific provisions of the code. Thus,
pursuant, to the same section of the law, no such recognition shall be made if the
sale or exchange is made in pursuance of a plan of corporate merger or
consolidation or, if as a result of an exchange of property for stocks, the
exchanger, alone or together with others not exceeding four, gains control of the
corporation. Then, too, how the resulting gain might be taxed, or whether or not
the loss would be deductible and how, are matters properly dealt with elsewhere
in various other sections of the NIRC. At all events, it may not be amiss to once
again stress that the basic rule is still that any capital loss can be deducted only
from capital gains under Section 33(c) of the NIRC.

PHILIPPINE REFINING COMPANY v COURT OF APPEALS (G.R. No. 118794 May 8, 1996)
FACTS:
This is an appeal by certiorari from the decision of respondent Court of Appeals 1 affirming the
decision of the Court of Tax Appeals which disallowed petitioner's claim for deduction as bad
debts of several accounts in the total sum of P395,324.27, and imposing a 25% surcharge and
20% annual delinquency interest on the alleged deficiency income tax liability of petitioner.
Petitioner Philippine Refining Company (PRC) was assessed by respondent Commissioner of
Internal Revenue (Commissioner) to pay a deficiency tax for the year 1985 in the amount of
P1,892,584.00.
The assessment was timely protested by petitioner on April 26, 1989, on the ground that it was
based on the erroneous disallowances of "bad debts" and "interest expense" although the same
are both allowable and legal deductions. Respondent Commissioner, however, issued a warrant
of garnishment against the deposits of petitioner at a branch of City Trust Bank, in Makati, Metro
Manila, which action the latter considered as a denial of its protest.
Petitioner accordingly filed a petition for review with the Court of Tax Appeals (CTA) on the same
assignment of error, that is, that the "bad debts" and "interest expense" are legal and allowable
deductions. In its decision 3 of February 3, 1993 in C.T.A. Case No. 4408, the CTA modified the
findings of the Commissioner by reducing the deficiency income tax assessment to P237,381.26,
with surcharge and interest incident to delinquency. In said decision, the Tax Court reversed and
set aside the Commissioner's disallowance of the interest expense of P2,666,545.19 but
maintained the disallowance of the supposed bad debts of thirteen (13) debtors in the total sum
of P395,324.27.
Petitioner then elevated the case to respondent Court of Appeals which, as earlier stated, denied
due course to the petition for review and dismissed the same on August 24, 1994.the reason of
the court was that Out of the sixteen (16) accounts alleged as bad debts, We find that only three
(3) accounts have met the requirements of the worthlessness of the accounts, hence were
properly written off as: bad debts.
Mere testimony of the Financial Accountant of the Petitioner explaining the worthlessness of said
debts is seen by this Court as nothing more than a self-serving exercise which lacks probative
value. There was no iota of documentary evidence (e.g., collection letters sent, report from
investigating fieldmen, letter of referral to their legal department, police report/affidavit that the
owners were bankrupt due to fire that engulfed their stores or that the owner has been
murdered. etc.), to give support to the testimony of an employee of the Petitioner. Mere

allegations cannot prove the worthlessness of such debts in 1985. Hence, the claim for deduction
of these thirteen (13) debts should be rejected.
ISSUE: WON all bad debts should be treated as deductions.
RULING: This pronouncement of respondent Court of Appeals relied on the ruling of this Court in
Collector vs. Goodrich International Rubber Co., 6 which established the rule in determining the
"worthlessness of a debt." 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)
(2)
(3)
(4)

sending of statement of accounts;


sending of collection letters;
giving the account to a lawyer for collection; and
filing a collection case in court.

On the foregoing considerations, respondent Court of Appeals held that petitioner did not satisfy
the requirements of "worthlessness of a debt" as to the thirteen (13) accounts disallowed as
deductions. It appears that the only evidentiary support given by PRC for its aforesaid claimed
deductions was the explanation or justification posited by its financial adviser or accountant,
Guia D. Masagana.
Her allegations were not supported by any documentary evidence, hence both the Court of
Appeals and the CTA ruled that said contentions per se cannot prove that the debts were indeed
uncollectible and can be considered as bad debts as to make them deductible. That both lower
courts are correct is shown by petitioner's own submission and the discussion thereof which we
have taken time and patience to cull from the antecedent proceedings in this case, albeit
bordering on factual settings.
The contentions of PRC that nobody is in a better position to determine when an obligation
becomes a bad debt than the creditor itself, and that its judgment should not be substituted by
that of respondent court as it is PRC which has the facilities in ascertaining the collectibility or
uncollectibility of these debts, are presumptuous and uncalled for. The Court of Tax Appeals is a
highly specialized body specifically created for the purpose of reviewing tax cases. Through its
expertise, it is undeniably competent to determine the issue of whether or not the debt is
deductible through the evidence presented before it.
Because of this recognized expertise, the findings of the CTA will not ordinarily be reviewed
absent a showing of gross error or abuse on its part. 9 The findings of fact of the CTA are binding
on this Court and in the absence of strong reasons for this Court to delve into facts, only
questions of law are open for determination. 10 Were it not, therefore, due to the desire of this
Court to satisfy petitioner's calls for clarification and to use this case as a vehicle for
exemplification, this appeal could very well have been summarily dismissed.

BASILAN ESTATES INC v CIR, (GR No. L-22492, September 5, 1967)


FACTS:
A Philippine corporation engaged in the coconut industry, Basilan Estates, Inc., with principal
offices in Basilan City, filed on March 24, 1954 its income tax returns for 1953 and paid an
income tax of P8,028. On February 26, 1959, the Commissioner of Internal Revenue, per
examiners report of February 19, 1959, assessed Basilan Estates, Inc., a deficiency income tax
of P3,912 for 1953 and P86,876.85 as 25% surtax on unreasonably accumulated profits as of
1953 pursuant to Section 25 of the Tax Code. On non-payment of the assessed amount, a
warrant of distraint and levy was issued but the same was not executed because Basilan Estates,
Inc. succeeded in getting the Deputy Commissioner of Internal Revenue to order the Director of
the district in Zamboanga City to hold execution and maintain constructive embargo instead.
Because of its refusal to waive the period of prescription, the corporations request for
reinvestigation was not given due course, and on December 2, 1960, notice was served the
corporation that the warrant of distraint and levy would be executed.
On December 20, 1960, Basilan Estates, Inc. filed before the Court of Tax Appeals a petition for
review of the Commissioners assessment, alleging prescription of the period for assessment and
collection; error in disallowing claimed depreciations, travelling and miscellaneous expenses; and
error in finding the existence of unreasonably accumulated profits and the imposition of 25%
surtax thereon. On October 31, 1963, the Court of Tax Appeals found that there was no
prescription and affirmed the deficiency assessment in toto.
ISSUE: Whether or not depreciation shall be determined on the acquisition cost or on
the reappraised value of the assets.
HELD: Depreciation is the gradual diminution in the useful value of tangible property resulting
from wear and tear and normal obsolescense. The term is also applied to amortization of the
value of intangible assets, the use of which in the trade or business is definitely limited in
duration. Depreciation commences with the acquisition of the property and its owner is not
bound to see his property gradually waste, without making provision out of earnings for its
replacement. It is entitled to see that from earnings the value of the property invested is kept
unimpaired, so that at the end of any given term of years, the original investment remains as it
was in the beginning. It is not only the right of a company to make such a provision, but it is its
duty to its bond and stockholders, and, in the case of a public service corporation, at least, its
plain duty to the public. Accordingly, the law permits the taxpayer to recover gradually his
capital investment in wasting assets free from income tax. Precisely, Section 30 (f) (1) which
states:
(1)In general. A reasonable allowance for deterioration of property arising out of its use
or employment in the business or trade, or out of its not being used: Provided, That when
the allowance authorized under this subsection shall equal the capital invested by the
taxpayer . . . no further allowance shall be made. . . .allows a deduction from gross income
for depreciation but limits the recovery to the capital invested in the asset being
depreciated.
The income tax law does not authorize the depreciation of an asset beyond its acquisition cost.
Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is that
deductions from gross income are privileges, not matters of right. They are not created by
implication but upon clear expression in the law. Moreover, the recovery, free of income tax, of
an amount more than the invested capital in an asset will transgress the underlying purpose of
a depreciation allowance. For then what the taxpayer would recover will be, not only the

acquisition cost, but also some profit. Recovery in due time thru depreciation of investment
made is the philosophy behind depreciation allowance; the idea of profit on the investment
made has never been the underlying reason for the allowance of a deduction for depreciation.
Accordingly, the claim for depreciation beyond P36,842.04 or in the amount of P10,500.49 has
no justification in the law. The determination, therefore, of the Commissioner of Internal
Revenue disallowing said amount, affirmed by the Court of Tax Appeals, is sustained.

CONSOLIDATED MINES INC v CTA, (GR No. L-18843 & L-18844, August 29, 1975)
FACTS: Consolidated filed a refund for overpayments of income taxes for the year 1951.
However, after investigation of the BIR, instead of having a refund, the company was instead
assessed for deficiency income taxes for the years 1953, 1954 and 1956 with 5% surcharge and
1% monthly interest. After investigation, for the years 1951 and 1954 (1) the company had not
accrued as an expense the share in the company profits of Benguet Consolidated Mines as
operator of the Consolidated Mines, although for income tax purposes the Consolidated had
reported income and expenses on the accrual basis; (2) depletion and depreciation expenses had
been overcharged; and (3) the claims for audit and legal fees and miscellaneous expenses for
1953 and 1954 had not been properly substantiated.; and that (b) for the year 1956 (1) the
company had overstated its claim for depletion; and (2) certain claims for miscellaneous
expenses were not duly supported by evidence. Consolidated and Benguet entered into a
development agreement whereby Consolidated, as the owner of several mining claims, allowed
Benguet to explore, develop, mine, concentrate and market the ore in the mining claims. Once
profit is derived, expenditures from its own resources shall be charged against the subsequent
gross income of the properties.
During the time Benguet is being reimbursed for all its expenditures, the net profits resulting
from the operation of the claims shall be divided 90% of the net profits pertaining to Benguet
and 10% to Consolidated. After Benguet has been fully reimbursed for its expenditures, the net
profits from the operation shall be divided between Benguet and Consolidated share and share
alike, it being understood however, that the net profits as the term is used in this agreement
shall be computed by deducting from gross income all operating expenses and all disbursements
of any nature. By 1953, Benguet had completely recouped its advances. Consolidated used the
accrual method of accounting in computing its income. One of its income is the amount paid to
Benguet as mine operator, which amount is computed as 50% of net income. Consolidated
deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the
end of each calendar year what the Commissioner alleges is 50% if and when the accounts
receivable are actually paid.
ISSUE: Whether or not Consolidateds accounting method is allowed.
HELD: YES. It is said that accounting methods for tax purposes comprise a set of rules for
determining when and how to report income and deductions. The US Internal Revenue Code
allows taxpayers to adopt the accounting method most suitable to his business, and requires
only that taxable income generally be based on the method of accounting regularly employed in
keeping the taxpayers books, provided that the method clearly reflects income. A deduction
cannot be accrued until an actual liability is incurred, even if payment has not been made.
ON DEPLETION:
The first issue raised by Consolidated is with respect to the rate of mine depletion used by the
CTA.
The Tax Code provides that in computing net income there shall be allowed as deduction, in the
case of mines, a reasonable allowance for depletion thereof not to exceed the market value in

the mine of the product thereof which has been mined and sold during the year for which the
return is made.
(Sec. 30(g) (1) (B) as an income tax concept, depletion is wholly a creation of the statue solely
a matter of legislative grace. Hence, the taxpayer has the burden of justifying the allowance of
any deduction claimed. As in connection with all other tax controversies, the burden of proof to
show that a disallowance of depletion by the Commissioner is incorrect or that an allowance
made is inadequate is upon the taxpayer, and this is true with respect to the value of the
property constituting the basis. of the deduction.
This burden-of-proof rule has been frequently applied and a value claimed has been disallowed
for lack of evidence. Here, SC considered the evidence presented (testimony of Eligio Garcia) and
the Report to Stockholders which includes the Balance Sheet as of 1946), geological report on
the estimated amount of ore in the claims, etc.) it set forth a very detailed computation of the
depletion rate, determining the value of each component of the formula of depletion, viz:
Rate of Depletion Per Unit = Cost of Mine Property/Estimated Ore Deposit of
product Mined and sold depletion is different from depreciation.
In determining the amount of cost depletion allowable the following three facts are essential:
1. The basis of the property,
2. The estimated total recoverable units in the property; and
3. The no. of units recovered during the taxable year in question.
As used as an element in cost depletion, basis means the dollar amount of the taxpayers capital
or investment in the property which he is entitled to recover tax free during the period he is
removing the mineral in the deposit.

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