Q. Deduction: in General

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
Q. DEDUCTION
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.
In general
CIR v ISABELA CULTURAL CORPORATION
FACTS:
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 ALL-EVENTS 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.
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.
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.
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.
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.
CIR v GENERAL FOODS

AGUINALDO INDUSTRIES v CIR

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 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.
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.
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.
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
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

Provision for contingencies. The CTA allowed said items as deduction except those
denominated by Atlas as stockholders relation service fee and suit expenses.
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.
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.
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
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.
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.
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.
ROXAS v CTA
FACTS:
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
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, 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.
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.
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.
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.
ISSUES/HELD: W/N the deductions for business expenses and contributions

deductible
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.
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 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.
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 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
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.
Expenses
ISSUE: w/n CTA erred in allowing only one half of the promotion expenses. NO
C.M. HOSKINS&CO, INC. v CIR
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.
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 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.
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.
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.
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.
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.
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."
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.
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.
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."
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.
CALANOC v CIR
KUENZLE & STREIF, INC. v CIR
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
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.
2.
3.
salaries, directors' fees and bonuses of its non-resident president and vicepresident;
bonuses of its resident officers and employees; and
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.
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 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.
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.
W/N the CTA erred in allowing the deduction of the bonuses in excess of
the yearly salaries of the employees? 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.
ISSUES/RULING:
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.
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.
2.
3.
W/N the CTA erred in disallowing the deduction of interests on earned but
unpaid salaries and bonuses? NO.
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.
the payment of the bonuses is in fact compensation;

it must be for personal services actually rendered; and
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

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 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
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.
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)
1
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 BOIregistered or not) are allowed by the NIRC as deductions against the taxpayer's
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)
2

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.
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)
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:
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.
(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:
CIR v VDA DE PRIETO
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."
FACTS:
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
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"

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.
SEC. 30 Deductions from gross income. In computing net income there shall be
allowed as deductions
(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.
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.
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 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.
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
ISSUE:
Whether or not such interest was paid upon an indebtedness within the
contemplation of section 30 (b) (1) of the Tax Code?
Taxes
RULING:
CIR v LEDNICKY
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.
Losses
PAPER INDUSTRIES v CA ( Dec. 1, 1995)
The Paper Industries Corporation of the Philippines ("Picop"), is a Philippine corporation
registered with the Board of Investments ("BOI") as a preferred pioneer
10

enterprise with respect to its integrated 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
(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). 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 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
11

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.
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, 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
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.
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
BIR RULING 206-90
Digest of BIR Ruling No. 030-2000 dated August 10, 2000
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.
INCOME TAX; Tax-free merger under certain condition - Pursuant to

Section 40(c)(2)
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
12

(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 pre-approval; 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 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.
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-avis 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.
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.
HELD: NO.
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,
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
13

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.
a.
b.
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.
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.
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.
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.
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.
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.
NOTE:
Funds available for Philex Mining during the management agreement;

and
Compensation to Philex Mining which shall be fifty per cent (50%) of
the net profit;
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.
Issue: Whether the deduction for bad debts was valid?

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.
Bad debts
PHILEX MINING v CIR
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,
Facts: Philex Mining entered into a management agreement with Baguio Gold. The
parties' agreement was denominated as "Power of Attorney" which provided
among others:
14

property, or industry to a common fund, with the intention of dividing the profits
among themselves.
ISSUE: Whether or not the CA was correct in disallowing the 13 accounts as bad
debts.
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.
RULING:YES.
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:
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.
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.
PHILIPPINE REFINING CO v CA
FACTS:
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.
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.
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 selfserving. The SC said that PRC failed to exercise due diligence in order to ascertain
that these debts were uncollectible. In fact, PRC did not even show the demand
letters they allegedly gave to some of their debtors.
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 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.
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
15

debts of Palawan Manganese Mines Inc. which the CIR disallowed and was
sustained by the CTA.
BASILAN ESTATES v CIR

LIMPAN INVESTMENT v CIR
FACTS:
Issue: W/N disallowance is correct
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.
Held: YES
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
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 nonpayment of lessees. Hence,although the corporation did not actually receive the
rent, it isdeemed to have constructively received them.
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.
Depletion
Depreciation
16

CONSOLIDATED MINES v CTA
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 specifically refers to organizations or
associations created or organized under Philippine laws.
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.
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 nonprofit 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.
ISSUE:
Whether or not international organizations with home offices abroad are qualified
to be granted donee institution status.
3M PHILIPPINES v CIR
Facts:
HELD: NO.
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
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 "nongovernment organization" to mean a non-profit domestic corporation.
4
3
SEC. 1. Definition of Terms. For purposes of these Regulations, the terms herein enumerated shall
have the following meanings:
(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".
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:
xxx
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 .
. ."
17

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:
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
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:
(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 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.
a. xxx xxx xxx
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.)
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:
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:
Whether or not 3M Phils is entitled to the deductions due to royalties?

Ruling:
18

(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.
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.
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.)
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.
2.
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.
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 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
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.
19

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.
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.
20

R. CAPITAL GAINS and LOSSES

[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.
Capital assets
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.
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.
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.
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:
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 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.
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
Ratio:
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:
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
21

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.
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. 027-2002 dated July 3, 2002)
Capital assets
CHINA BANKING CORP v CA
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.
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 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.
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
22

S. DETERMINATION OF GAIN OR LOSS FROM SALE

OR TRANSFER OF PROPERTY
the New Corporation because it was pursuant to a plan of reorganization. Thus,

such exchange is exempt from CGT.
Exchange of property
ISSUE/RULING:
CIR v RUFINO
W/N the CTA erred in finding that no taxable gain was derived by the private
respondents from the questioned transaction? NO
FACTS:
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 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.
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 a bona fide business purpose and not solely for the purpose
of escaping the burden of taxation."
The BIR, after examination, declared that the merger was not undertaken for
a bona fide business purpose but merely to avoid 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
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
23

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.
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.
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.
BIR RULING 274-87

GREGORY v HELVERING
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.
Facts:
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 19285). Under this law, a reorganization would
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. . . ."
"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
5
24

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).
25

T. SITUS OF TAXATION
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 Philippine-derived income or to
Philippine operations, that expense can be deducted from the gross income
acquired in the Philippines without resorting to apportionment.
Gross income from sources within the Phils

CIR v MARUBENI CORPORATION
CIR v BOAC
CIR v CTA AND SMITH&FRENCH OVERSEAS
Facts:
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.
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.
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 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
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
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.
Ratio:
26

share of the Philippine branch has been fixed, Smith cannot claim more than
the said amount.
Swiss Reinsurance Company stipulated that their contract shall be

construed by the laws of the Philippines.
Smiths Contention
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.
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.
SC ruled for Smith Kline and said that its amended return conforms with the
law and regulations.
Issue: Whether the reinsurance premiums ceded to foreign reinsurers not

doing business in the Philippines are subject to withholding tax?
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. 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
PHIL GUARANTY CO v CIR
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.
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 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
27

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.
(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.
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.
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 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.
ISSUE:
W/N the tax should be withheld.
HELD:
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.
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 reenacts 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
HOWDEN & CO v CIR

PHILIPPINE AMERICAN LIFE INSURANCE CO v CTA
Howden Vs CIR
28

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TAX LAW REVIEW DIGESTS Montero

TAX LAW REVIEW DIGESTS Montero

ISSUES/HELD: W/N the deductions for business expenses and contributions

Zamora appealed, alleging that the CTA erred in dissallowing P10,478.50, as

TAX LAW REVIEW DIGESTS Montero

TAX LAW REVIEW DIGESTS Montero

whether the particular salary or compensation payment is reasonable, the situation

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

TAX LAW REVIEW DIGESTS Montero

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

the payment of the bonuses is in fact compensation;

TAX LAW REVIEW DIGESTS Montero

TAX LAW REVIEW DIGESTS Montero

properly chargeable to a capital account, thus including taxes and

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

(B) Taxes and Carrying Charges. The items thus chargeable to

CIR v VDA DE PRIETO

Present Rule. The Internal Revenue Code, and the Regulations

At the same time, under the adjustment of basis provisions which

TAX LAW REVIEW DIGESTS Montero

on account of deliquency. This sum of P55,978.65 was claimed as deduction, among

BIR RULING NO 006-00

The Paper Industries Corporation of the Philippines ("Picop"), is a Philippine corporation

registered with the Board of Investments ("BOI") as a preferred pioneer

TAX LAW REVIEW DIGESTS Montero

TAX LAW REVIEW DIGESTS Montero

carrying charges; however, an exception exists, in which event

of the Tax Code, no gain or loss shall be recognized by Blue Circle

BIR RULING 206-90

Digest of BIR Ruling No. 030-2000 dated August 10, 2000

This is letter requesting in behalf of Porcelana Mariwasa, Inc. (PMI), a ruling

INCOME TAX; Tax-free merger under certain condition - Pursuant to

It is represented that PMI is a corporation established and organized under

TAX LAW REVIEW DIGESTS Montero

(Noritake) and Toyota Tsusho Corporation (Toyota) in the aggregate amounts of US

When foreign currency acquired in connection with a transaction in the regular

TAX LAW REVIEW DIGESTS Montero

When foreign currency acquired in connection with a transaction in the regular

Accordingly, foreign exchange losses sustained as a result of devaluation of the

Funds available for Philex Mining during the management agreement;

Issue: Whether the deduction for bad debts was valid?

TAX LAW REVIEW DIGESTS Montero

Perusal of the agreement denominated as the "Power of Attorney"

Viewed from this light, the advances can be characterized as petitioners

Furthermore, there are steps outlined to be undertaken by the taxpayer to prove

FERNANDEZ HERMANOS v CIR

TAX LAW REVIEW DIGESTS Montero

BASILAN ESTATES v CIR

Issue: W/N disallowance is correct

TAX LAW REVIEW DIGESTS Montero

CONSOLIDATED MINES v CTA

BIR RULING 19-01

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

(H) Charitable and Other Contributions.

a) "Non-stock, non-profit corporation or organization" shall refer to a corporation or association/

b) "Non-government Organization (NGO)" shall refer to a non-stock, non-profit domestic corporation

TAX LAW REVIEW DIGESTS Montero

No. CB Circular No. 393 (Regulations Governing Royalties/Rentals) dated December