TAX - CASE DIGESTS FOR THE FINALS

Bardahl formula and immediacy test

CYANAMID PHILIPPINES, INC., petitioner, vs. THE COURT OF APPEALS, THE COURT OF TAX
APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondent. G.R. No. 108067 January 20,
2000

FACTS:
Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws. It is
engaged in the manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished
goods, and an importer/inventor.
On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the payment
of deficiency income tax of P119,817.00 for taxable year 1981. Petitioner protested the assessment and
claimed that the surtax for the undue accumulation of earnings was not proper because said profits were
retained to increase petitioners working capital and it would be used for reasonable business needs of
the company.
CIR refused to allow the cancellation of the assessment of notices. CTA affirmed the decision of
CA.

ISSUE: W/N petitioner is liable for the Accumulated Earnings Tax for the year 1981.

HELD:
SC held in the affirmative. Sec. 25 of the old National Internal Revenue Code of 1977
discouraged tax avoidance through corporate surplus accumulation. When corporations do not declare
dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax
on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to
distribute earnings so that the said earnings by shareholders could, in turn, be taxed.
Petitioner relies on the so-called "Bardahl" formula, which allowed retention, as working capital
reserve, sufficient amounts of liquid assets to carry the company through one operating cycle. The
"Bardahl" formula was developed to measure corporate liquidity. The formula requires an examination of
whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and any extraordinary
expenses reasonably anticipated, plus enough to operate the business during one operating cycle.
Operating cycle is the period of time it takes to convert cash into raw materials, raw materials into
inventory, and inventory into sales, including the time it takes to collect payment for the sales. We note,
however, that the companies where the "Bardahl" formula was applied, had operating cycles much
shorter than that of petitioner.
In the case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting
that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the operating
costs of the business. As stressed by American authorities, although the "Bardahl" formula is well-
established and routinely applied by the courts, it is not a precise rule. It is used only for administrative
convenience. Petitioner's application of the "Bardahl" formula merely creates a false illusion of exactitude.
In order to determine whether profits are accumulated for the reasonable needs to avoid the
surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifest at the
time of accumulation, not intentions declared subsequently, which are mere afterthoughts.28
Furthermore, the accumulated profits must be used within a reasonable time after the close of the taxable
year. In the instant case, petitioner did not establish, by clear and convincing evidence, that such
accumulation of profit was for the immediate needs of the business.
In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue, we ruled: To determine
the "reasonable needs" of the business in order to justify an accumulation of earnings, the Courts of the
United States have invented the so-called "Immediacy Test" which construed the words "reasonable
needs of the business" to mean the immediate needs of the business, and it was generally held that if the
corporation did not prove an immediate need for the accumulation of the earnings and profits, the
accumulation was not for the reasonable needs of the business, and the penalty tax would apply.
In the present case, the Tax Court opted to determine the working capital sufficiency by using the
ratio between current assets to current liabilities. The working capital needs of a business depend upon
nature of the business, its credit policies, the amount of inventories, the rate of the turnover, the amount
of accounts receivable, the collection rate, the availability of credit to the business, and similar factors.
Petitioner, by adhering to the "Bardahl" formula, failed to impress the tax court with the required
definiteness envisioned by the statute. We agree with the tax court that the burden of proof to establish
that the profits accumulated were not beyond the reasonable needs of the company, remained on the
taxpayer.
The Supreme Court denied the instant petition.

20% Senior Citizen discount is a tax credit deductible from the tax liability
COMMISSIONER OF INTERNAL REVENUE, Petitioners, vs. CENTRAL LUZON DRUG
CORPORATION, Respondent. G.R. No. 159647 April 15, 2005

FACTS:
Respondent is a domestic corporation primarily engaged in retailing of medicines and other
pharmaceutical products. In 1996, it operated six (6) drugstores under the business name and style
Mercury Drug.
Respondent filed it Annual Income Tax Return for taxable year 1996 declaring therein that it
incurred net losses from its operations. In January 1998, respondent filed with petitioner a claim for tax
refund/credit in the amount of P904,769 allegedly arising from the 20% sales discount granted by
respondent to qualified senior citizens in compliance with RA 7432. Unable to obtain response,
respondent elevated its claim to the CTA. CTA dismissed respondents petition for lack of merit. Hence,
this petition.

ISSUE: W/N the cost of the discount granted to senior citizens pursuant to RA 7432 may be claimed as a
credit, even though an establishment operates at a loss?

HELD:
SC held in the affirmative. Respondent may claim tax refund/credit despite operating at a loss.
Although the term is not specifically defined in our Tax Code, tax credit generally refers to an
amount that is "subtracted directly from ones total tax liability." It is an "allowance against the tax itself" or
"a deduction from what is owed" by a taxpayer to the government. Since a tax credit is used to reduce
directly the tax that is due, there ought to be a tax liability before the tax credit can be applied. Without
that liability, any tax credit application will be useless. There will be no reason for deducting the latter
when there is, to begin with, no existing obligation to the government. However, as will be presented
shortly, the existence of a tax credit or its grant by law is not the same as the availment or use of such
credit. While the grant is mandatory, the availment or use is not.
If a net loss is reported by, and no other taxes are currently due from, a business establishment,
there will obviously be no tax liability against which any tax credit can be applied. For the establishment to
choose the immediate availment of a tax credit will be premature and impracticable. Nevertheless, the
irrefutable fact remains that, under RA 7432, Congress has granted without conditions a tax credit benefit
to all covered establishments.
Although this tax credit benefit is available, it need not be used by losing ventures, since there is
no tax liability that calls for its application. Neither can it be reduced to nil by the quick yet callow stroke of
an administrative pen, simply because no reduction of taxes can instantly be effected. By its nature, the
tax credit may still be deducted from a future, not a present, tax liability, without which it does not have
any use. In the meantime, it need not move. But it breathes.
The Supreme Court denied the petition.