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III. DEDUCATIONS FROM GROSS INCOME

A-F.

G. Expenses

CASE:

ATLAS CONSOLIDATED MINING v CIR GR No. L-26911, Jan. 27, 1981

FACTS:

Atlas is a corporation engaged in the mining industry. 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.

On October 1962, the Secretary of Finance ruled that the exemption provided in RA 909 embraces all new mines and old mines whether gold or other minerals. Accordingly, the CIR recomputed Atlas deficiency income tax liabilities in the light of said ruling. On June 1964, the CIR issued a revised assessment entirely eliminating the assessment for the year 1957. The assessment for 1958 was reduced from which Atlas appealed to the CTA, assailing the disallowance of the following items claimed as deductible from its gross income for 1958: Transfer agent's fee, Stockholders relation service fee, U.S. stock listing expenses, Suit expenses, and Provision for contingencies. The CTA allowed said items as deduction except those denominated by Atlas as stockholders relation service fee and suit expenses.

Both parties appealed the CTA decision to the SC by way of two (2) separate petitions for review. Atlas appealed only the disallowance of the deduction from gross income of the so-called stockholders relation service fee.

ISSUE/HELD: W/N the ‘annual public relations expense’ (aka stockholders relation service fee) paid to a public relations consultant is a deductible expense from gross income

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.

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.

There is thus no hard and fast rule on the matter. The right to a deduction depends in each case on the particular facts and the relation of the payment to the type of business in which the taxpayer is engaged. The intention of the taxpayer often may be the controlling fact in making the determination. Assuming that the expenditure is ordinary and necessary in the operation of the taxpayer's business, the answer to the question as to whether the expenditure is an allowable deduction as a business expense must be determined from the nature of the expenditure itself, which in turn depends on the extent and permanency of the work accomplished by the expenditure.

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.

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.

ADDITIONAL NOTES:

On the second assignment of error, aside from alleging lack of proof of payment of the expense deducted, the Commissioner contended that such expense should be disallowed for not being ordinary and necessary and not incurred in trade or business, as required under Section 30 (a) (1) of the National Internal Revenue Code. He asserted that said fees were therefore incurred not for the production of income but for the acquisition petition of capital in view of the definition that an expense is deemed to be incurred in trade or business if it was incurred for the production of income, or in the expectation of producing income for the business. In support of his contention, the Commissioner cited the ruling in Dome Mines, Ltd vs. Commisioner of Internal Revenue involving the same issue as in the case at bar where the U.S. Board of Tax Appeal ruled that expenses for listing capital stock in the stock exchange are not ordinary and necessary expenses incurred in carrying on the taxpayer's business which was gold mining and selling, which business is strikingly similar to Atlas.

On the other hand, the Court of Tax Appeal relied on the ruling in the case of Chesapeake Corporation of Virginia vs. Commissioner of Internal Revenue where the Tax Court allowed the deduction of stock exchange fee in dispute, which is an annually recurring cost for the annual maintenance of the listing.

We find the Chesapeake decision controlling with the facts and circumstances of the instant case. In Dome Mines, Ltd case the stock listing fee was disallowed as a deduction not only because the expenditure did not meet the statutory test but also because the same was paid only once, and the benefit acquired thereby continued indefinitely, whereas, in the Chesapeake Corporation case, fee paid to the stock exchange was annual and recurring. In the instant case, we deal with the stock listing fee paid annually to a stock exchange for the privilege of having its stock listed. It must be noted that the Court of Tax Appeal rejected the Dome Mines case because it involves a payment made only once, hence, it was held therein that the single payment made to the stock exchange was a capital expenditure, as distinguished from the instant case, where payments were made annually. For this reason, we hold that said listing fee is an ordinary and necessary business expense

CASE:

CIR v. ISABELA CULTURAL CORPORATION

(2007)

Lessons Applicable: Accrual method, burden of proof in accrual method,

deductibility of ordinary and necessary trade, business, or professional expenses, all

events

test

Laws

Applicable:

FACTS:

BIR disallowed Isabela Cultural Corp. deductible expenses for services which were rendered in 1984 and 1985 but only billed, paid and claimed as a deduction on 1986.

After CA sent its demand letters, Isabela protested.

 

CTA found it proper to be claimed in 1986 and affirmed by CA

 

ISSUE:

W/N

 

Isabela

who

uses

accrual

method

can

claim

on

1986 only

HELD:

case

is

remanded

to

the

BIR for the computation of Isabela Cultural

Corporation’s liability under Assessment Notice No. FAS-1-86-90-000680.

NO

The requisites for the 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; - qualified by

Section 45 of the National Internal Revenue Code (NIRC) which states that:

"[t]he deduction provided for in this Title shall be taken for the taxable year in

which ‘paid or accrued’ or ‘paid or incurred’, dependent upon the method of

accounting upon the basis of which the net income is computed

 

(c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and

(d) it must be supported by receipts, records or other pertinent papers.

 

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed

to do so cannot deduct the same for the next year.

 

The accrual method relies upon the taxpayer’s right to receive amounts or its

obligation to pay them, in opposition to actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue where the right to receive them become fixed, where there is created an enforceable liability. Similarly, liabilities are accrued when fixed and determinable in amount, without regard to indeterminacy merely of time of payment.

The accrual of income and expense is permitted when the all-events test has been met. This test requires: (1) fixing of a right to income or liability to pay; and

(2) the availability of the reasonable accurate determination of such income or liability.

  • The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be determined with reasonable accuracy. However, the test does not demand that the amount of income or liability be known absolutely, only that a taxpayer has at his disposal the information necessary to compute the amount with reasonable accuracy. The all-events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test is satisfied where a computation may be unknown, but is not as much as unknowable, within the taxable year. The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate amount.

  • The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at the closing of its books for the taxable year.

  • Accrual method of accounting presents largely a question of fact; such that the taxpayer bears the burden of proof of establishing the accrual of an item of income or deduction.

  • In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for reimbursement of the expenses of said firm in connection with ICC’s tax problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960’s. - failed to prove the burden

CASE:

Esso Standard Eastern, Inc. v CIR

GR

Nos

L-28508-9,

July

7,

1989

Doctrine: For an item to be deductible as a business expense, the expense must be ordinary and necessary; it must be paid or incurred within the taxable year; and it must be paid or incurred in carrying on a trade or business. In addition, the taxpayer must substantially prove by evidence or records the deductions claimed under law, otherwise, the same will be disallowed.

FACTS:

ESSO deducted from its gross income for 1959, as part of its ordinary and necessary business expenses, the amount it had spent for drilling and exploration of its petroleum concessions. The Commissioner disallowed the claim on the ground that

the expenses should be capitalized and might be written off as a loss only when a

“dry hole” should result. Hence, ESSO filed an amended return where it asked for the

refund of P323,270 by reason of its abandonment, as dry holes, of several of its oil

wells. It also claimed as ordinary and necessary expenses in the same return amount representing margin fees it had paid to the Central Bank on its profit remittances to its New York Office.

ISSUE: Whether the margin fees may be considered ordinary and necessary expenses when paid.

HELD:

For an item to be deductible as a business expense, the expense must be ordinary and necessary; it must be paid or incurred within the taxable year; and it must be paid or incurred in carrying on a trade or business. In addition, the taxpayer must substantially prove by evidence or records the deductions claimed under law, otherwise, the same will be disallowed. There has been no attempt to define “ordinary and necessary” with precision. However, as guiding principle in the proper adjudication of conflicting claims, an expenses is 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. Assuming that the expenditure is ordinary and necessary in the operation of the

taxpayer’s business; the expenditure, to be an allowable deduction as a business

expense, must be determined from the nature of the expenditure itself, and on the extent and permanency of the work accomplished by the expenditure. Herein, 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. The petitioner merely presumed that all corporate expenses are necessary and appropriate in the absence of a showing that they are illegal or ultra vires; which is erroneous. Claims for deductions are a matter of legislative grace and do not turn on mere equitable considerations.

CASE: Commissioner of Internal Revenue vs. Sony Philippines. Inc.

G.R. No. 178697

Facts:

November 17, 2010

In 1998, the CIR issued Letter of Authority authorizing certain revenue

officers to examine Sony’s books of accounts and other accounting records regarding revenue taxes for “the period 1997 and unverified prior years.” In the

following year, a preliminary assessment for 1997 deficiency taxes and penalties was issued by the CIR which Sony protested. Afterwards, the CIR issued final assessment notices, the formal letter of demand and the details of discrepancies. Then Sony filed a petition for review before the CTA. The CTA-First Division ruled on the following: 1) disallowed the deficiency VAT assessment because the subsidized advertising expense paid by Sony which was duly covered by a VAT invoice resulted in an input VAT credit; 2) maintained the deficiency EWT

assessment on Sony’s motor vehicles and on professional fees paid to general

professional partnership; 3) disallowed the EWT assessment on rental expense; 4) upheld the penalties for the late payment of VAT on royalties. In sum, the CTA-First

Division partly granted Sony’s petition by cancelling the deficiency VAT assessment

but upheld a modified deficiency EWT assessment as well as the penalties. Because

the CTA-First Division denied its motion for reconsideration, CIR filed a petition for review with the CTA-EB. However, the latter dismissed the petition. Hence, this petition was filed before the SC.

Issue:

Whether or not Sony Philippines is engaged in the sale of services to Sony

International Singapore (SIS), thus liable to pay VAT.

Held:

No. The deficiency VAT assessment should have been disallowed. CIR’s argument

that Sony’s advertising expense could not be considered as an input VAT credit because the same was eventually reimbursed by Sony International Singapore (SIS) is erroneous.

Sony’s deficiency VAT assessment stemmed from the CIR’s disallowance of the input

VAT credits that should have been realized from the advertising expense of the latter. It is evident under Sec. 110 of the 1997 Tax Code that an advertising expense duly covered by a VAT invoice is a legitimate business expense. There is also no denying that Sony incurred advertising expense. However, the Court does not agree

that the same subsidy should be subject to the 10% VAT. The said subsidy termed by the CIR as reimbursement was not even exclusively earmarked for Sony’s advertising expense for it was but an assistance or aid in view of Sony’s dire or adverse economic conditions, and was only “equivalent to the latter’s (Sony’s)

advertising expenses.

There must be a sale, barter or exchange of goods or properties before any VAT may be levied. Certainly, there was no such sale, barter or exchange in the subsidy given by SIS to Sony. It was but a dole out by SIS and not in payment for goods or properties sold, bartered or exchanged by Sony.

Sony did not render any service to SIS at all. The service rendered by the advertising companies, paid for by Sony using SIS dole-out, were for Sony and not SIS. Therefore, Sony Philippines is not liable to pay VAT because there was no sale of goods or services provided to SIS.

CASE: CIR v. General Foods

(2003)

Test of Reasonableness

Facts:

Respondent corporation General Foods (Phils), which is engaged in the manufacture of “Tang”, “Calumet” and “Kool-Aid”, filed its income tax return for the fiscal year ending February 1985 and claimed as deduction, among other business expenses, P9,461,246 for media advertising for “Tang”.

The Commissioner disallowed 50% of the deduction claimed and assessed deficiency income taxes of P2,635,141.42 against General Foods, prompting the latter to file an MR which was denied.

General Foods later on filed a petition for review at CA, which reversed and set aside

an earlier decision by CTA dismissing the company’s appeal.

Issue:

W/N the subject media advertising expense for “Tang” was ordinary and necessary

expense fully deductible under the NIRC

Held:

No. Tax exemptions must be construed in stricissimi juris against the taxpayer and liberally in favor of the taxing authority, and he who claims an exemption must be able to justify his claim by the clearest grant of organic or statute law. Deductions for income taxes partake of the nature of tax exemptions; hence, if tax exemptions are strictly construed, then deductions must also be strictly construed. To be deductible from gross income, the subject advertising expense must comply with the following requisites: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers.

While the subject advertising expense was paid or incurred within the corresponding taxable year and was incurred in carrying on a trade or business, hence necessary, the parties’ views conflict as to whether or not it was ordinary. To be deductible, an advertising expense should not only be necessary but also ordinary.

The Commissioner maintains that the subject advertising expense was not ordinary

on the ground that it failed the two conditions set by U.S. jurisprudence: first,

“reasonableness” of the amount incurred and second, the amount incurred must not be a capital outlay to create “goodwill” for the product and/or private respondent’s

business. Otherwise, the expense must be considered a capital expenditure to be spread out over a reasonable time.

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There being no hard and fast rule on the matter, the right to a deduction depends on a number of factors such as but not limited to: the type and size of business in which the taxpayer is engaged; the volume and amount of its net earnings; the nature of the expenditure itself; the intention of the taxpayer and the general economic conditions. It is the interplay of these, among other factors and properly weighed, that will yield a proper evaluation.

The Court finds the subject expense for the advertisement of a single product to be inordinately large. Therefore, even if it is necessary, it cannot be considered an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC.

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services and (2) advertising designed to stimulate

the future sale of merchandise or use of services. The second type involves expenditures incurred, in whole or in part, to create or maintain some form of

goodwill for the taxpayer’s trade or business or for the industry or profession of

which the taxpayer is a member. If the expenditures are for the advertising of the

first kind, then, except as to the question of the reasonableness of amount, there is no doubt such expenditures are deductible as business expenses. If, however, the expenditures are for advertising of the second kind, then normally they should be spread out over a reasonable period of time.

The company’s media advertising expense for the promotion of a single product is doubtlessly unreasonable considering it comprises almost one-half of the company’s entire claim for marketing expenses for that year under review. Petition granted, judgment reversed and set aside.

CASE: Pirovano v. CIR (1965)

DOCTRINE: (Note: the court did not discuss income tax or exclusions at all! I’ll just add the doctrine in the future once I know it. Right now, there is nothing about exclusions from income tax.)

FACTS:

Enrico Pirovano was the President and General Manager of Dela Rama Steamship Co. During his lifetime, he made significant contributions to the success of the corporation. His life was then insured by the corporation which paid the premiums and is the beneficiary under the insurance policy. When Enrico Pirovano died, the corporation donated the proceeds of the life insurance policy to his 4 minor

children. The CIR then assessed donor and donee’s tax against the corporation and the Pirovano children. The children contested the imposition of the donee’s tax

arguing that the donation was a remuneratory one, made in consideration of the

services rendered by their father. According to the children, the remuneratory donation is not a taxable gift.

Held:

The SC ruled in favor of the CIR and affirmed the imposition of the donee’s tax. The consideration for the donation was the company's gratitude for the services, and not the services themselves.

There is nothing on record to show that when the late Enrico Pirovano was not fully compensated for services rendered to the De la Rama Steamship Co. The fact that

Pirovano’s services contributed in a large measure to the success of the company

did not give rise to a recoverable debt, and the conveyances made by the company to his heirs remain a gift or donation.

This is emphasized by the Second Resolution, that "out of gratitude" thecompany decided to renounce its interest in the proceeds of the life insurance policies. The true consideration for the donation was, therefore, the company's gratitude for his services, and not the services themselves. Whether the donation was remuneratory or simple, the conveyance remained a taxable gift under the NIRC.

Argument of Pirovano heirs: The entire property donated should not be considered as a gift for taxation purposes; only that portion, which is in excess of the value of the services rendered by the deceased should be considered as a taxable gift. Under Section 111 of the Tax Code: Where property is transferred for less, than an adequate and full consideration in money or money's worth, then the amount by which the value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift.

The term consideration used in this section refers to "anything that is bargained for

by the promisor and given by the promisee in exchange for the promise.” In this

case, Pirovano's successful activities as officer of the De la Rama Steamship Co. cannot be deemed as consideration for the donation, since the services were rendered long before the Company ceded the value of the life policies to said heirs. Cession and services were not the result of one bargain or of a mutual exchange of

promises. Moreover, the actual consideration for the cession of the policies was the Company's gratitude to Pirovano. Hence, under section 111 of the Code there is no consideration which can be deducted from that of the property transferred as a gift. Like "love and affection," gratitude has no economic value and is not "consideration" in the sense that the word is used in the Tax Code.

CASE:

AGUINALDO INDUSTRIES CORPORATION (FISHING NETS DIVISION) vs. COMMISSIONER OF INTERNAL REVENUE and THE COURT OF TAX APPEALS

Facts: Upon investigation of petitioner's 1957 income tax returns of its Fish Nets Division, the Bureau of Internal Revenue examiner found that the amount of P61,187.48 was deducted from the gross income as additional remuneration paid to the officers of petitioner and that such amount was taken from the net profit which petitioner derived from an isolated transaction (sale of a parcel of its land) which is not in the course of or carrying on of petitioner's trade or business. The examiner recommended disallowance of the deduction, but petitioner insisted otherwise, claiming that the payment of the allowance or bonus was pursuant to its by-laws. The Court of Tax Appeals held the petitioner liable for deficiency income tax plus surcharge and interest

Issue: WON the profit derived from the sale of its land is tax-exempt income under Republic Act No. 901

Held: No. Petitioner may not raise the question of tax exemption for the first time on review where such question was not raised at the administrative forum

Issue: WON the bonus given to the officers of petitioner as share in the profit realized from the sale of the land is deductible expense for tax purposes

Held: No. The bonus given should be considered as deductible for income tax purposes only if payment was made for service actually rendered and it is reasonable and necessary. The records show that the sale was effected through a broker who was paid by petitioner a commission 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. Thus, 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.

HOSPITAL DE SAN JUAN DE DIOS, INC. vs. COMMISSIONER OF INTERNAL REVENUE

Facts: Petitioner is engaged in both taxable and non-taxable operations. For the years 1952 to 1955, the petitioner allocated its administrative expenses. The respondent disallowed, however, the interests and dividends from sharing in the allocation of administrative expenses on the ground that the expenses incurred in the administration or management of petitioner's investments are not allowable business expenses inasmuch as they were not incurred in 'carrying on any trade or business' within the contemplation of Section 30 (a)(1) of the Revenue Code. Hence, were assessed for deficiency income taxes.

Issue: WON administrative expenses should be considered as a deduction/allocated to its interest and dividend income for income tax purposes.

Held: No. the principle of allocating expenses is grounded on the premise that the taxable income was derived from carrying on a trade or business, as distinguished from mere receipt of interests and dividends from one's investments, the Court of Tax Appeals correctly ruled that said income should not share in the allocation of administrative expenses. Hospital de San Juan De Dios, Inc., according to its Articles of Incorporation, was established for purposes "which are benevolent, charitable and religious, and not for financial gain". It is not carrying on a trade or business for the word "business" in its ordinary and common use means "human efforts which have for their end living or reward; it is not commonly used as descriptive of charitable, religious, educational or social agencies" or "any particular occupation or employment habitually engaged in especially for livelihood or gain" or "activities where profit is the purpose or livelihood is the motive."

CASE: Republic v. meralco (2002)

Facts:

On 23 December 1993, Meralco filed with the Energy Regulatory Board (ERB) anapplication for the revision of its rate schedules. On 28 January 1994, the ERB issued anorder granting a provisional increase of P0.184/kwh subject to the condition that in eventthat the board finds that Meralco is entitled to a lesser increase in rates all excess amountscollected shall be refunded or credited to its customers. Subsequently, ERB rendered itsdecision adopting the audit of the Commission on Audit (COA) and authorized Meralco toimplement a rate adjustment of P0.017/kwh, but ordered the refund of the excess amount of P0.167/kwh collected from the billing cycles of February 1994 to February 1997, holding thatincome tax should not be treated as operating expense, and applying the net averageinvestment method in the computation of the rate base. On appeal, the Court of Appeals setaside the ERB decision insofar as it directed the reduction of the rates by P0.167/kwh and therefund to Meralco’s customers. Motions for reconsideration were denied. Hence, this petition.

RULING: Petitions are granted and the decision of CA is reversed.

Whether CA erred in setting aside ERB’s order to reduce the rate and to grant excess refund to MERALCO’s customers? – YES

Regulation of Rates is founded upon the police powers of the State and statutes

The regulation of rates to be charged by public utilities is founded upon the police powers of the State and statutes prescribing rules for the control and regulation of public utilities are a valid exercise thereof.

When private property is used for a public purpose and is affected with public interest, it ceases to be juris privati only and becomes subject to regulation. The regulation is to promote the common good. Submission to regulation may be withdrawn by the owner by discontinuing use; but as long as use of the property is continued, the same is subject to public regulation. In regulating rates charged by public utilities, the State protects the public against arbitrary and excessive rates while maintaining the efficiency and quality of services rendered. However, the power to regulate rates does not give the State the right to prescribe rates which are so low as to deprive the public utility of a reasonable return on investment. Thus, the rates prescribed by the State must be one that yields a fair return on the public utility upon the value of the property performing the service and one that is reasonable to the public for the services rendered. The fixing of just and reasonable rates involves a balancing of the investor and the consumer interests. Justice Brandeis, dissent in Southwestern Bell Tel. Co. v PSC: “The thing devoted by the investor to the public use is not specific property, tangible and intangible, but capital embarked in an enterprise. Upon the capital so invested, the Federal Constitution guarantees to the utility the opportunity to earn a fair return. The investor agrees, by embarking capital in a utility, that its charges to the public shall be reasonable. His company is the substitute for the State in the performance of the public service, thus becoming a public servant. The compensation which the Constitution guarantees an opportunity to earn is the reasonable cost of conducting the business.

Findings and conclusions of the ERB on the rate that can be charged by MERALCO to the public should be respected.

The ERB was created under Executive Order No. 172 to regulate, among others,

the distribution of energy resources and to fix rates to be charged by public utilities involved in the distribution of electricity. In the fixing of rates, the only standard which the legislature is required to prescribe for the guidance of the administrative authority is that the rate be reasonable and just. It has been held that even in the absence of an express requirement as to reasonableness, this standard may be implied.

What is a just and reasonable rate is a question of fact calling for the exercise of discretion, good sense, and a fair, enlightened and independent

judgment. The requirement of reasonableness comprehends such rates which must not be so low as to be confiscatory, or too high as to be oppressive. In determining whether a rate is confiscatory, it is essential also to consider the given situation, requirements and opportunities of the utility.

To the extent that the administrative agency has not been arbitrary or capricious in the exercise of its power, the time-honored principle is that courts should not interfere. The principle of separation of powers dictates that courts should hesitate to review the acts of administrative officers except in clear cases of grave abuse of discretion.

In determining the just and reasonable rates to be charged by a public

utility, three major factors are considered by the regulating agency: a) rate of return; b) rate base and c) the return itself or the computed revenue to be earned by the public utility based on the rate of return and rate base. In the cases at bar, the resolution of the issues involved hinges on the determination of the kind and the amount of operating expenses that should be allowed to a public utility to generate a fair return and the proper valuation of the rate base or the value of the property entitled to a return.

Whether income tax as operating expense can be allowed for rate-

determination purposes? NO In determining whether or not a rate yields a fair return to the utility, the operating expenses of the utility must be considered. The return allowed to a public utility in accordance with the prescribed rate must be sufficient to provide for the payment of such reasonable operating expenses incurred by the public utility in the provision of its services to the public. However, only such expenses and in such amounts as are reasonable for the efficient operation of the utility should be allowed for determination of the rates to be charged by a public utility. Income tax paid by a public utility is inconsistent with the nature of operating expenses. In general, operating expenses are those which are reasonably incurred in connection with business operations to yield revenue or income. They are items of expenses which contribute or are attributable to the production of income or revenue. Income tax is imposed on an individual or entity as a form of excise tax or a tax on the privilege of earning income. In exchange for the protection extended by the State to the taxpayer, the government collects taxes as a source of revenue to finance its activities. To charge consumers for expenses incurred by a public utility which are not related to the service or benefit derived by the customers from the public utility is unjustified and inequitable.

Whether use of net average investment method is unreasonable? NO, ERB did not abuse its discretion when it applied the net average investment method

Republic’s argument: the net average investment method (also known as actual number of months use method) recommended by COA and adopted by the ERB should be used MERALCO’s argument: the average investment method (also known as the trending method) to determine the proportionate value of properties should be applied Under the net average investment method, properties and equipment used in the operation of a public utility are entitled to a return only on the actual number of months they are in service during the period.

The average investment method computes the proportionate value of the property by adding the value of the property at the beginning and at the end of the test year with the resulting sum divided by two. By using the net average investment method, the ERB and the COA considered for determination of the rate base the value of properties and equipment used by MERALCO in proportion to the period that the same were actually used during the period in question. This treatment is consistent with the settled rule in rate regulation that the determination of the rate base of a public utility entitled to a return must be based on properties and equipment actually being used or are useful to the operations of the public utility. MERALCO has not adequately shown that the rates prescribed by the ERB are unjust or confiscatory as to deprive its stockholders a reasonable return on investment. In the early case of Ynchausti S.S. Co. v. Public Utility Commissioner, this Court held: [t]here is a legal presumption that the rates fixed by an administrative agency are reasonable, and it must be conceded that the fixing of rates by the Government, through its authorized agents, involves the exercise of reasonable discretion and, unless there is an abuse of that discretion, the courts will not interfere .

ROXAS v. CTA, GR No L-25043, April 26, 1968

Facts: Don Pedro Roxas and Dona Carmen Ayala, Spanish subjects, transmitted to their grandchildren by hereditary succession several properties. To manage the above-mentioned properties, said children, namely, Antonio Roxas, Eduardo Roxas and Jose Roxas, formed a partnership called Roxas y Compania. At the conclusion of the WW2, the tenants who have all been tilling the lands in Nasugbu for generations expressed their desire to purchase from Roxas y Cia. the parcels which they actually occupied. For its part, the Government, in consonance with the constitutional mandate to acquire big landed estates and apportion them among landless tenants-farmers, persuaded the Roxas brothers to part with their landholdings. Conferences were held with the farmers in the early part of 1948 and finally the Roxas brothers agreed to sell 13,500 hectares to the Government for distribution to actual occupants for a price of P2,079,048.47 plus P300,000.00 for survey and subdivision expenses. It turned out however that the Government did not have funds to cover the purchase price, and so a special arrangement was made for the Rehabilitation Finance Corporation to advance to Roxas y Cia. The amount of P1,500,000.00 as loan. Collateral for such loan were the lands proposed to be sold to the farmers. Under the arrangement, Roxas y Cia. allowed the farmers to buy the lands for the same price but by installment, and contracted with the Rehabilitation Finance Corporation to pay its loan from the proceeds of the yearly amortizations paid by the farmers. The CIR demanded from Roxas y Cia the payment of deficiency income taxes resulting from the inclusion as income of Roxas y Cia. of the unreported 50% of the net profits for 1953 and 1955 derived from the sale of the Nasugbu farm lands to the tenants, and the disallowance of deductions from gross income of various business

expenses and contributions claimed by Roxas y Cia. and the Roxas brothers. For the reason that Roxas y Cia. subdivided its Nasugbu farm lands and sold them to the farmers on installment, the Commissioner considered the partnership as engaged in the business of real estate, hence, 100% of the profits derived therefrom was taxed. The Roxas brothers protested the assessment but inasmuch as said protest was denied, they instituted an appeal in the CTA which sustained the assessment. Hence, this appeal. Issue: Is Roxas y Cia. liable for the payment of deficiency income for the sale of Nasugbu farmlands? Held: NO. The proposition of the CIR cannot be favorably accepted in this isolated transaction with its peculiar circumstances in spite of the fact that there were hundreds of vendees. Although they paid for their respective holdings in installment for a period of 10 years, it would nevertheless not make the vendor Roxas y Cia. a real estate dealer during the 10-year amortization period. It should be borne in mind that the sale of the Nasugbu farm lands to the very farmers who tilled them for generations was not only in consonance with, but more in obedience to the request and pursuant to the policy of our Government to allocate lands to the landless. It was the bounden duty of the Government to pay the agreed compensation after it had persuaded Roxas y Cia. to sell its haciendas, and to subsequently subdivide them among the farmers at very reasonable terms and prices. However, the Government could not comply with its duty for lack of funds. Obligingly, Roxas y Cia. shouldered the Government's burden, went out of its way and sold lands directly to the farmers in the same way and under the same terms as would have been the case had the Government done it itself. For this magnanimous act, the municipal council of Nasugbu passed a resolution expressing the people's gratitude. In fine, Roxas y Cia. cannot be considered a real estate dealer for the sale in question. Hence, pursuant to Section 34 of the Tax Code the lands sold to the farmers are capital assets, and the gain derived from the sale thereof is capital gain, taxable only to the extent of 50%.

ZAMORA v. COLLECTOR [G.R. No. L-15290. May 31, 1963.]

FACTS: Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed his income tax returns. The Collector of Internal Revenue found that the promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora were not allowable deductions. Mariano Zamora contends that the whole amount of the promotion expenses in his income tax returns, should be allowed and not merely one-half of it, on the ground that, while not all the itemized expenses are supported by receipts, the absence of some supporting receipts has been sufficiently and satisfactorily established. ISSUE: In the absence of receipts, WON to allow as deduction all or merely one-half of the promotion expenses of Mrs. Zamora claimed in Mariano Zamora's income tax returns HELD: One-half only. Claims for the deduction of promotion expenses r entertainment expenses must also be substantiated or supported by record showing in detail the amount and nature of the expense incurred. Considering 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 as business expense and the other 50%, as her personal expenses. While in situations like the present, absolute certainty is usually not possible, the CTA should make as close an approximate as it can, bearing heavily, if it chooses, upon the taxpayer whose inexactness is of his own making.

ILLEGAL EXPENSES CALANOC V COLLECTOR

Facts:

  • Calanoc was authorized to solicit and receive contributions for the orphans and destitute kids of the Child Welfare Workers Club of the Social Welfare Commission.

  • Dec 1949, Calanoc financed and promoted a boxing exhibition at the Rizal Memorial Stadium for said charitable purpose

  • He applied for exemption from payment of the amusement tax as provided in Sec 260 NIRC
    CIR investigated the tax case of Calanoc and it was found that there was gross sale of Php 26,553, expenditure of 25,157 and profit of 1,375.30 Profit was remitted to Social Welfare Commission. CIR demanded Calanoc oto pay 533

  • Sec of Finance denied the application of Calanoc for exemption from payment of amusement tax CTA: Affirmed the assessment of 7k Calanoc; denies receving a stadium fee of 1k : Although it was shown that 1k was paid by O-OSO Beverages : His accountant is dead SC: the items of expenditures for deduction are exorbitant and not supported by receipts CTA Affirmed

KUENZLE & STREIFF, INC. vs. THE COLLECTOR OF INTERNAL REVENUE

Facts: Petitioner claimed as a deduction for income tax purposes for the years 1950, 1951 and 1952 salaries, directors' fees and bonuses of its non-resident president and vice-president; bonuses of some of its resident officers and employees; and interests on earned but unpaid salaries and bonuses of its officers and employees. Petitioner gave to its non- resident president and vice president for the years 1950 and 1951 bonuses equal to 133-1/2% of their annual salaries and bonuses equal to 125 2/3% for the year 1952. Petitioner however gave its resident officers and employees higher bonuses on the alleged reason because of their valuable contribution to the business of the corporation which has made it possible for it to realize huge profits during the aforesaid years. The respondent disallowed the said deductions hence they were

assessed for deficiency income taxes. Upon re-examination by the respondents, they allowed as deductions 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. Issue: WON the excessive bonuses and interest should be allowed as a deduction for income tax purposes. Held: No. 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" Requisites for deductibility of employee bonuses: (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". There is no fixed test for determining the reasonableness of a given bonus as compensation. Deductible amount of bonuses is not limited to the amount of salary of its recipient. The prevailing circumstances should be considered. However In this case, the bonuses given to resident employees were higher than its non-resident officers on the reason that the resident officers and employees had performed their duty well and rendered efficient service. It does not necessarily follow that they should be given greater amount of additional compensation in the form of bonuses than what was given to the non- resident officers. The non-resident officers had rendered the same amount of

efficient personal service and contribution to deserve equal treatment in compensation and other emoluments with the particularity that their liberation yearly salaries had

been much smaller. Interest should also be

disallowed. .

Under the law, in order that

interest may be deductible, it must be paid "on indebtedness" (Section 30, (b) (1) of the National Internal Revenue Code). 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 in our opinion 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. The willingness of the corporation to pay interest thereon cannot be considered a justification to

warrant deduction.

VISAYAN CEBU TERMINAL CO. INC. VS COLLECTOR OF INTERNAL REVENUE Facts: Visayan Cebu Terminal Co. Inc. is a corporation organized for the purpose of handling arrastre operations in the port of Cebu. Visayan filed its income tax return for 1951 claiming the following items as deductions from the company’s gross income: (1) salaries, (2) representation

expenses (PhP 75,855.88), and (3) miscellaneous expenses. The Collector of Internal Revenue disallowed the entire amount of representation expenses. The Court of Tax Appeals allowed representation expenses but set the limit at PhP 10,000.00. Issue: Whether or not the full amount of representation expenses should be allowed as a deduction from Visayan’s gross income. Held: The Court sustained the Tax Court in holding that representation expenses fall

under the category of business expenses which are allowable deductions from gross income if they meet the following requisites laid down in the Tax Codethey must be ordinary and necessary expense paid or incurred in carrying on any trade or business and they must meet the test of reasonableness in amount. The Court

further agreed with the computation made by the CTA. Because of the company’s

failure to provide evidence for all such expenses (the corporation claims that the supporting papers were destroyed when the house of the company treasurer, where the records were kept was burned), the Court should determine from all available

data the amount properly deductible as representation expenses. The Court sustained the finding of the CTA that PhP 10,000.00 may be considered reasonably

necessary as the company’s representation expenses based on figures presented

during the proceedings.

GANCAYCO V COLLECTOR

Facts:

  • Gancayco filed his Income tax Return (ITR) for 1949. CIR notified him that his liability is Php 9.793.62, which he paid 1950
    CIR after a year wrote to Gancayco saying that there was tax due from him for a total of Php 29,554.05 Gancayco asked for reconsideration and the tax assessed wasreduced
    CIR issued a warrant of distraint for the deficient liability Gancayco filed petition with CTA CTA: Required Gancayco to pay Php 16, 860.31 for tax deficiency in1949 Gancayco: the right to collect the deficiency income tax is barred by thestatute of limitations. : the 5 yr period for judicial action should be counted from May 12 50, the date of original assessment SC: Section 316 provides: The civil remedies for the collection of internal revenue taxes, fees, or charges, and any increment thereto resulting from

delinquency shall be (a) by distraint of goods, chattels, or effects, and other personal property of whatever character, including stocks and other securities, debts, credits, bank accounts, and interest in and rights to personal property, and by levy upon real property; and (b) by judicial action. Either of these remedies or both simultaneously may be pursued in the discretion of the authorities charged with the collection of such taxes. No exemption shall be allowed against the internal revenue taxes in any case. : Deduction for expenses may be allowed, however in this case, Gancayco was not able to prove any expense as there were no receipts or other proofs. CTA AFFIRMED

CASE: Cohan v. Commissioner

Brief Fact Summary. Beneficiaries of trusts are attempting to claim Medicaid eligibility and argue that the assets held in trust should not be considered when computing their eligibility. The state argues that the language of the statute and the

legislative intent

compel

a

different

result.

Synopsis of Rule of Law. Under the Medicaid statute if there is even a small amount of discretion regarding the availability of funds then whatever the beneficiary could most receive in the full exercise of that discretion is the amount to be counted as available for Medicaid eligibility

Facts. In several consolidated cases the grantors of irrevocable trusts, of which the grantors or their spouse were beneficiary and to which the grantor had transferred substantial assets, claimed eligibility for Medicaid assistance because the trust denies the trustee any discretion to make sums available to the grantor if such available would render the grantor ineligible for public assistance. The grantors of

these trusts argue that since no funds are available by the terms of the trusts if such

would render them ineligible that the grantors’ eligibility is assured. The state

argues that this frustrates the stated purpose of Congress in enacting the MQT statute. The MQT statute provides that if there are circumstances under which payment from the trust could be made to or for the benefit of the individual then

such payment shall be considered as a resource available to the individual. The trial court held against the beneficiaries of the trusts that under the statute if there was even a small amount of discretion regarding the availability of funds then whatever the beneficiary could most receive in the full exercise of that discretion was the amount to be counted as available for Medicaid eligibility. The beneficiaries appeal.

now

Issue. Whether or not, and what amount, should be considered when determine Medicaid eligibility for individuals who are the beneficiaries of trusts for which the trustee is denied discretion to make available sums that would disqualify the individuals from Medicaid eligibility?

Held. Yes. Affirmed. Whatever the beneficiary could receive in the full exercise of the trustee’s discretion is to be considered for Medicaid eligibility.

United States v. Gilmore372 U.S. 39 (1963)

Gilmore was a wealthy guy who owned a series of automobile dealerships. He became involved in a messy divorce, and paid a lot of money for legal service trying to keep his wife from getting his business. When he filed his taxes, Gilmore claimed a deduction on his taxes for the legal fees. The IRS denied the deduction. Gilmore appealed. Gilmore claimed the fees were deductible under 26 U.S.C. §23(a)(2) (now

known as 26 U.S.C. §212(2)) which allow for deductions for "management, conservation, or maintenance of property held for the production of income." Had he lost the case, he would have lost the business, so Gilmore argued that it was covered because he was conserving his business. The IRS argued that even though the potential consequences of the litigation were that Gilmore could lose property, that litigation arose out of a personal legal conflict, not investment or business related, so it was not deductible. The IRS argued that if Gilmore won, then almost all legal fees in all civil lawsuits would be deductible, because a loss will always result in a loss of property. The Trial Court found mostly for Gilmore. The IRS appealed.

The Trial Court found that a part of the motivation was personal, but that another part was motivated by a desire to conserve income-producing property. The Court found that about 80% of the motivation was to conserve income-producing property. Therefore, the Court found that Gilmore could deduct 80% of his legal fees.

The US Supreme Court reversed and found the legal fees to be completely non- deductible. The US Supreme Court found that if the underlying dispute is personal in nature, then the legal fees are not deductible under §212, even though there are income-producing assets at stake. The Court found that there was no rational basis for making the distinction between personal and business motivation, so there was no methodology a court could use for making a percentage determination like the Trial Court did.

Woodward v. Commissioner case brief

Woodward

v.

Commissioner

Subject: Tax treatment of expenses incurred in appraisal litigation. FACTS Taxpayers owned/controlled majority of common stock in publishing corporation. They voted their controlling shares of the stock of the corporation in favor of perpetual extension of the charter. Minority voted against. Taxpayers

attempted to negotiate purchase of the dissenting stockholder’s shares, agreement

could not be reached on the shares real value. Taxpayers then brought an action in state court to appraise the value of the minority stock interest. Court fixed the

value, taxpayers purchased shares from the minority at that value.

Taxpayers paid attorney’s, accountants’ and appraisers >$25,000 for services in

litigation.

On their income tax return, they claimed deductions for the expenses,

stating: “ordinary and necessary expenses paid for the management, conservation, and maintenance of property held for the production of income” deductible under

§212.

ARGUMENT Taxpayers argue that the costs in question were property deducted b/c the legal proceedings did not directly involve the question of title to the minority stock, but

was instead concerned solely with the value of the stock.

(court rejects argument,

states: the origin of the claim was in the process of the acquisition of the stock itself.)

 

RULES

1.

Ask whether the origin of the

claim that is litigated is

in

the process of the

acquisition

 

itself.

2.

Costs incurred in the acquisition or disposition of a capital asset are to be treated

as

capital

expenditures.

3.

If an expense is capital, it cannot be deducted as ordinary and necessary, either as

a business expense under §162 or as an expense of management, conservation or

maintenance

under

§212.

APPLICATION Court rejects a test that looks to the consequences of the litigation, and does not

consider taxpayer’s motives or purposes in undertaking litigation, but examines the

origin

and

character

of

the

claim.

-Litigation

was

required

to

fix

the

price.

-The expenses incurred in that litigation were property treated as part of the cost of

the stock which taxpayers acquired.

H. INTEREST CASE: CIR v. PALANCA FACTS: Don Carlos Palanca, Sr. donated in favor of his

H. INTEREST

CASE: CIR v. PALANCA FACTS: Don Carlos Palanca, Sr. donated in favor of his son, the petitioner, herein shares of stock in La Tondeña, Inc. amounting to 12,500 shares. For failure to file a return on the donation within the statutory period, the petitioner was assessed the sums of P97,691.23, P24,442.81 and P47,868.70 as gift tax, 25% surcharge and interest, respectively, which he paid on June 22, 1955. The petitioner filed with the BIR his income tax return for the calendar year 1955, claiming, among others, a deduction for interest amounting to P9,706.45 and reporting a taxable income of P65,982.12. On the basis of this return, he was assessed the sum of P21,052.91, as income tax, which he paid, as follows: Petitioner filed an amended return for the calendar year 1955, claiming therein an additional deduction in the amount of P47,868.70 representing interest paid on the donee's gift tax, thereby reporting a taxable net income of P18,113.42 and a tax due thereon in the sum of P3,167.00. The claim for deduction was based on the provisions of Section 30(b) (1) of the Tax Code, which authorizes the deduction from gross income of interest paid within the

taxable year on indebtedness. A claim for the refund of alleged overpaid income taxes for the year 1955 amounting to P17,885.01, which is the difference between the amount of P21,052.01 he paid as income taxes under his original return and of P3,167.00, was filed together with this amended return. BIR denied the claim. On August 12, 1958, the petitioner once more filed an amended income tax return for the calendar year 1955, claiming, in addition to the interest deduction of P9,076.45 appearing in his original return, a deduction in the amount of P60,581.80, representing interest on the estate and inheritance taxes on the 12,500 shares of stock, thereby reporting a net taxable income for 1955 in the amount of P5,400.32 and an income tax due thereon in the sum of P428.00. Again this was denied. CTA reversed. ISSUE/S: 1) Whether the amount paid by respondent Palanca for interest on his delinquent estate and inheritance tax is deductible from the gross income for that year under Section 30 (b) (1) of the Revenue Code; 2) Whether the claim for refund has prescribed. HELD: 1) Yes. While "taxes" and "debts" are distinguishable legal concepts, in certain cases as in the suit at bar, on account of their nature, the distinction becomes inconsequential. We do not see any element in this case which can justify a departure from or abandonment of the doctrine in the Prieto case. In both this and the said case, the taxpayer sought the allowance as deductible items from the gross income of the amounts paid by them as interests on delinquent tax liabilities. Of course, what was involved in the cited case was the donor's tax while the present suit pertains to interest paid on the estate and inheritance tax. This difference, however, submits no appreciable consequence to the rationale of this Court's previous determination that interests on taxes should be considered as interests on indebtedness within the meaning of Section 30(b) (1) of the Tax Code. 2) No. The 30-day period under Section 11 of Republic Act 1125 did not even commence to run in this incident. It should be recalled that while the herein petitioner originally assessed the respondent-claimant for alleged gift tax liabilities, the said assessment was subsequently abandoned and in its lieu, a new one was prepared and served on the respondent-taxpayer. In this new assessment, the petitioner charged the said respondent with an entirely new liability and for a substantially different amount from the first. While initially the petitioner assessed the respondent for donee's gift tax in the amount of P170,002.74, in the subsequent assessment the latter was asked to pay P191,591.62 for delinquent estate and inheritance tax. Considering that it is the interest paid on this latter- assessed estate and inheritance tax that respondent Palanca is claiming refund for, then the thirty-day period under the abovementioned section of Republic Act 1125 should be computed from the receipt of the final denial by the Bureau of Internal Revenue of the said claim. In the second place, the claim at bar refers to the alleged overpayment by respondent Palanca of his 1955 income tax. Inasmuch as the said account was paid by him by installment, then the computation of the two year prescriptive period, under Section 306 of the National Internal Revenue Code, should be from the date of the last installment.

PAPER INDUSTRIES V CA

FACTS: Petitioner is registered with the BOI as a preferred pioneer 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. It received from the CIR two (2) letters of assessment and demand (a) one for deficiency transaction tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate amount of P88,763,255.00. Picop protested the assessment of deficiency transaction tax and documentary and science stamp taxes. These protests were not formally acted upon by respondent CIR. On 26 September 1984, the CIR issued a warrant of distraint on personal property and a warrant of levy on real property against Picop, to enforce collection of the contested assessments; in effect, the CIR denied Picop's protests. Thereupon, Picop went before the CTA. Picop and the CIR both went to the Supreme Court on separate Petitions for Review of the above decision of the CTA. In two (2) Resolutions dated 7 February 1990 and 19 February 1990, respectively, the Court referred the two (2) Petitions to the Court of Appeals. The Court of Appeals consolidated the two (2) cases and rendered a decision, dated 31 August 1992, which further reduced the liability of Picop to P6,338,354.70. Picop now maintains that it is not liable at all to pay any of the assessments or any part thereof. It assails the propriety of the thirty-five percent (35%) deficiency transaction tax which the Court of Appeals held due from it in the amount of P3,578,543.51. Picop also questions the imposition by the Court of Appeals of the deficiency income tax of P1,481,579.15, resulting from disallowance of certain claimed financial guarantee expenses and claimed year-end adjustments of sales and cost of sales figures by Picop's external auditors. 3 The CIR, upon the other hand, insists that the Court of Appeals erred in finding Picop not liable for surcharge and interest on unpaid transaction tax and for documentary and science stamp taxes and in allowing Picop to claim as deductible expenses. ISSUE/S: 1) Whether Picop is liable for the thirty-five percent (35%) transaction tax; 2) Whether Picop is liable for interest and surcharge on unpaid transaction tax; 3) Whether Picop is entitled to deduct against current income interest payments on loans for the purchase of machinery and equipment; 4) Whether Picop is entitled to deduct against current income net operating losses incurred by Rustan Pulp and Paper Mills, Inc; 5) Whether Picop is entitled to deduct against current income certain claimed financial guarantee expenses; 6) Whether Picop had understated its sales and overstated its cost of sales for 1977; 7) Whether Picop is liable for the corporate development tax of five percent (5%) of its income for 1977. HELD: 1) We agree with the CTA and the Court of Appeals that Picop's tax exemption under R.A. No. 5186, as amended, does not include exemption from the thirty-five percent (35%) transaction tax. In the first place, the thirty-five percent (35%) transaction tax is an income tax, that is, it is a tax on the interest income of the lenders or creditors. It is thus clear that the transaction tax is an income tax and as such, in any event, falls outside the scope of the tax exemption granted to registered pioneer enterprises by Section 8 of R.A. No. 5186, as amended. 2) Section 51 (c) and (e) of the 1977 Tax Code did not authorize the imposition of a surcharge

and penalty interest for failure to pay the thirtyfive percent (35%) transaction tax imposed under Section 210 (b) of the same Code. The corresponding provision in the current Tax Code very clearly embraces failure to pay all taxes imposed in the Tax Code, without any regard to the Title of the Code where provisions imposing particular taxes are textually located. Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be extended beyond the ordinary and reasonable intendment of the language actually used by the legislative authority in granting the exemption. The issuance of debenture bonds is certainly conceptually distinct from pulping and paper manufacturing operations. But no one contends that issuance of bonds was a principal or regular business activity of Picop; only banks or other financial institutions are in the regular business of raising money by issuing bonds or other instruments to the general public. 3) We have already noted that our 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. We conclude that the CTA and the Court of Appeals did not err in allowing the deductions of Picop's 1977 interest payments on its loans for capital equipment against its gross income for 1977. 4) After prolonged consideration and analysis of this matter, the Court is unable to agree with the CTA and Court of Appeals on the deductibility of RPPM's accumulated losses against Picop's 1977 gross income. It is important to note at the outset that in our jurisdiction, the ordinary rule that is, the rule applicable in respect of corporations not registered with the BOI as a preferred pioneer enterprise is that net operating losses cannot be carried over. Under our Tax Code, both in 1977 and at present, losses may be deducted from gross income only if such losses were actually sustained in the same year that they are deducted or charged off. Thus it is that R.A. No. 5186 introduced the carry-over of net operating losses as a very special incentive to be granted only to registered pioneer enterprises and only with respect to their registered operations. In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. In effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated operating losses. We consider and so hold that there is nothing in Section 7 (c) of R.A. No. 5186 which either requires or permits such a result. Indeed, that result makes non-sense of the legislative purpose which may be seen clearly to be projected by Section 7 (c), R.A. No. 5186. We conclude that the deduction claimed by Picop in the amount of P44,196,106.00 in its 1977 Income Tax Return must be

disallowed. 5) We must support the CTA and the Court of Appeals in their foregoing rulings. A taxpayer has the burden of proving entitlement to a claimed deduction. Even Picop's own vouchers were not submitted in evidence and the BIR Examiners denied that such vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only confirm the fact of disbursement but not necessarily the purpose thereof. 6) The CIR has made out at least a prima facie case that Picop had understated its sales and overstated its cost of sales as set out in its Income Tax Return. For the CIR has a right to assume that Picop's Books of Accounts speak the truth in this case since, as already noted, they embody what must appear to be admissions against Picop's own interest. 7) The adjusted net income of Picop for 1977, as will be seen below, is P48,687,355.00. Its net worth figure or total stockholders' equity as reflected in its Audited Financial Statements for 1977 is P464,749,528.00. Since its adjusted net income for 1977 thus exceeded ten percent (10%) of its net worth, Picop must be held liable for the five percent (5%) corporate development tax in the amount of

P2,434,367.75.

CIR V VIUDA DE PRIETO

FACTS: 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 CIR appraised the real property donated for gift tax purposes at P1,231,268.00, and assessed the total sum of P117,706.50 as donor's gift tax, interest and compromises due thereon. Of the total sum of P117,706.50 paid by respondent on April 29, 1954, the sum of P55,978.65 represents the total interest on account of deliquency. This sum of P55,978.65 was claimed as deduction, among others, by respondent in her 1954 income tax return. Petitioner, however, disallowed the claim and as a consequence of such disallowance assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the aforesaid P55,978.65, including interest up to March 31, 1957, surcharge and compromise for the late payment. 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. ISSUE/S: Whether or not such interest was paid upon an indebtedness within the contemplation of section 30 (b) (1) of the Tax Code. HELD: Yes. 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. Although taxes already due have not, strictly speaking, the same concept as debts, they are, however, obligations that may be considered as such. The term "debt" is properly used in a comprehensive sense as embracing not merely money due by contract but whatever one is bound to render to another, either for contract, or the

requirement of the law. It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her gross income under section 30(b) of the Tax Code above quoted. This conclusion finds support in the established jurisprudence in the United States after whose laws our Income Tax Law has been patterned. Thus, under sec. 23(b) of the Internal Revenue Code of 1939, as amended , which contains similarly worded provisions as sec. 30(b) of our Tax Code, the uniform ruling is that interest on taxes is interest on indebtedness and is deductible.

I. TAXES

Facts:

Central Luzon Drug Corporation has been a retailer of medicines and other pharmaceutical products since December 19, 1994. In 1995, it opened three (3) drugstores as a franchisee under the business name and style of "Mercury Drug."

For the period January 1995 to December 1995, in conformity to the mandate of Sec. 4(a) of R.

Subsequently, on December 27, 1996, claiming that according to Sec. 4(a) of R.A. No.

7432, the amount of P219,778 should be applied as a tax credit, respondent filed a

claim for refund in the amount of P150,193

he amount of P150,193 claimed as a

... refund represents the tax credit allegedly due to respondent under R.A. No. 7432.

the CTA dismissed the petition, declaring that even if the law treats the 20% sales discounts granted to senior citizens as a tax credit, the same cannot apply when there is no tax liability or the amount of the tax credit is greater than the tax due

. In ...

the latter case, the tax credit will only be to the extent of the tax liability.

Also, no refund can be granted as no tax was erroneously, illegally and actually collected based on the provisions of Section 230, now Section 229, of the Tax Code.

Furthermore, the law does not state that a refund can be claimed by the private establishment concerned as an alternative to the tax credit.

Thus, respondent filed with the CA a Petition for Review

On May 31, 2001, the CA rendered a Decision stating that Section 229 of the Tax Code does not apply in this case. It concluded that the 20% discount given to senior citizens which is treated as a tax credit pursuant to Sec. 4(a) of R.A. No. 7432 is

considered just compensation

and, as such, may be carried over to the next taxable

... period if there is no current tax liability

Issues:

whether the 20% sales discount granted by respondent to qualified senior citizens pursuant to Sec. 4(a) of R.A. No. 7432 may be claimed as a tax credit or as a deduction from gross sales in accordance with Sec. 2(1) of Revenue

Regulations No. 2-94.

Regulations No. 2-94.

Ruling:

The CA and the CTA correctly ruled that based on the plain wording of the law discounts given under R.A. No. 7432 should be treated as tax credits, not deductions from income.

The above provision explicitly employed the word "tax credit." Nothing in the provision suggests for it to mean a "deduction" from gross sales. To construe it otherwise would be a departure from the clear mandate of the law.

Thus, the 20% discount required by the Act to be given to senior citizens is a tax credit, not a deduction from the gross sales of the establishment concerned.

As a corollary to this, the definition of "tax credit" found in Section 2(1) of Revenue

Regulations No. 2-94 is

erroneous as it refers to tax credit as the amount

... representing the 20% discount that "shall be deducted by the said establishment

from their gross sales for value added tax and other percentage tax purposes." This

definition is contrary to what our lawmakers

had envisioned with regard to the

... treatment of the discount granted to senior citizens.

Finally, for purposes of clarity, Sec. 229[11] of the Tax Code does not apply to cases that fall under Sec. 4 of R.A. No. 7432 because the former provision governs exclusively all kinds of refund or credit of internal revenue taxes that were

erroneously or

illegally imposed and collected pursuant to the Tax Code while the

... latter extends the tax credit benefit to the private establishments concerned even before tax payments have been made.

The tax credit that is contemplated under the Act is a form of just compensation, not

a

remedy for taxes that were erroneously or illegally assessed and collected. In the

... same vein, prior payment of any tax liability is not a precondition before a taxable

entity can benefit from the tax credit. The credit may be availed of upon payment of

the tax due, if any. Where

there is no tax liability or where a private establishment

... reports a net loss for the period, the tax credit can be availed of and carried over to

the next taxable year.

It must also be stressed that unlike in Sec. 229 of the Tax Code wherein the remedy of refund is available to the taxpayer, Sec. 4 of the law speaks only of a tax credit, not a refund.

As earlier mentioned, the tax credit benefit granted to the establishments can be deemed as their just compensation for private property taken by the State for public

use. The privilege enjoyed by the senior citizens does not come directly from the

State, but rather from the

...

private establishments concerned.

CIR v. LEDNICKY

Facts: V. E. Lednicky and Maria Valero Lednicky, are husband and wife, both American citizens residing in the Philippines, and have derived all their income from

Philippine sources for the taxable years under question. [GR L-18286] In compliance with local law, the spouses, on 27 March 1957, filed their income tax return for 1956, reporting therein a gross income of P1,017,287.65 and a net income of P733,809.44 on which the amount of P317,395.41 was assessed after deducting P4,805.59 as withholding tax. Pursuant

to the Commissioner of Internal Revenue’s assessment notice, the spouses paid the

total amount of P326,247.41, inclusive of the withheld taxes, on 15 April 1957. On 17 March 1959, the spouses filed an amended income tax return for 1956. The amendment consists in a claimed deduction of P205,939.24 paid in 1956 to the US government as federal income tax for 1956. Simultaneously with the filing of the amended return, the spouses requested the refund of P112,437.90. When the Commissioner of Internal Revenue failed to answer the claim for refund, the spouses filed their petition with the tax court on 11 April 1959 as CTA Case 646. [GR L-18165] On 28 February 1956, the spouses filed their domestic income tax return for 1955, reporting a gross income of P1,771,124.63 and a net income of P1,052,550.67. On 19 April 1956, they filed an amended income tax return, the amendment upon the original being a lesser net income of P1,012,554.51, and, on the basis of this amended return, they paid P570,252.00, inclusive of withholding taxes. After audit, the Commissioner determined a deficiency of P16,116.00, which amount the spouses paid on 5 December 1956. Back in 1955, however, the spouses filed with the US Internal Revenue Agent in Manila their Federal income tax return for the years 1947, 1951, 1952, 1953 and 1954 on income from Philippine sources on a cash basis. Payment of these federal income taxes, including penalties and

delinquency interest in the amount of $264,588.82, were made in 1955 to the US Director of Internal Revenue, Baltimore, Maryland, through the National City Bank of New York, Manila Branch. Exchange and bank charges in remitting payment totaled P4,143.91. On 11 August 1958 the said respondents amended their Philippines income tax return for 1955 to including US Federal income taxes, interest accruing up to 15 May 1955, and exchange and bank charges, totaling P516,345.15 and therewith filed a claim for refund of the sum of P166,384.00, which was later reduced to P150,269.00. The spouses brought suit in the Tax Court, which

was docketed therein as CTA Case 570. [GR 21434] The facts are similar to above

cases but refer to the spouses’ income tax returns for 1957, filed on 28 February

1958, and for which the spouses paid a total sum of P196,799.65. In 1959, they filed an amended return for 1957, claiming deduction of P190,755.80, representing taxes

paid to the US Government on income derived wholly from Philippine sources. On the strength thereof, spouses seek refund of P90,520.75 as overpayment (CTA Case 783). The Tax Court decided for the spouses. Issue: WON there should be a refund for the spouses Held: NO. The Supreme Court reversed the decisions of the Court of Tax Appeals, and affirmed the disallowance of the refunds claimed by the spouses, with costs against said spouses. 1. Section 30 (c-1) of the Philippine Internal Revenue Code Section 30 (c) (1) (Deduction from gross income) provides that “in computing net income there shall be allowed as deductions: (c) Taxes: (1) In general. Taxes paid or accrued within

the taxable year, except (A) The income tax provided for under this Title; (B) Income, war-profits, and excess profits taxes imposed by the authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign countries); (C) Estate, inheritance and gift taxes; and (D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.” 2. Paragraph (c) (3) (b) of the Tax Code; Credits against tax for taxes of foreign countries Paragraph 3 (B) of the subsection (Credits against tax for taxes of foreign countries), reads: “If the taxpayer signifies in his return his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited with (B) Alien resident of the Philippines. In the case of an alien resident of the Philippines, the amount of any such taxes paid or accrued during the taxable year to any foreign country, if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the Philippines residing in such country;” 3. Paragraph (c) (4) of the Tax Code; Limitation on credit The tax credit so authorized is limited under paragraph 4 (A and B) of the same subsection, in the following terms: “Par. (c) (4) Limitation on credit. — The amount of the credit taken under this section shall be subject to each of the following limitations: (A) The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer’s net income from sources within such country taxable under this Title bears to his entire net income for the same taxable year; and (B) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer’s net income from sources without the Philippines taxable under this Title bears to his entire net income for the same taxable year.”

4. Law’s intent that right to deduct income taxes paid to foreign government

taken as an alternative or substitute to claim of tax credit for such foreign

income tax Construction and wording of Section 30 (c) (1) (B) of the Internal Revenue Act shows the law’s intent that the right to deduct income taxes paid to

foreign government from the taxpayer’s gross income is given only as an alternative or substitute to his right to claim a tax credit for such foreign income taxes under section 30 (c) (3) and (4); so that unless the alien resident has a right to claim such tax credit if he so chooses, he is precluded from deducting the

foreign income taxes from his gross income. For it is obvious that in prescribing that such deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) (relating to credits for taxes paid to foreign countries), the statute assumes that the taxpayer in question also may signify his desire, to claim a tax credit and waive the deduction; otherwise, the foreign taxes would always be deductible, and their mention in the list of nondeductible items in Section 30 (c) might as well have been omitted, or at least expressly limited to taxes on income from sources outside the Philippine Islands. Had the law intended that foreign income taxes could be deducted from gross income in any event, regardless of the

taxpayer’s right to claim a tax credit, it is the latter right that should be conditioned upon the taxpayer’s waiving the deduction; in which case the right to reduction

under subsection (c-1-B) would have been made absolute or unconditional (by omitting foreign taxes from the enumeration of non- deductions), while the right to a tax credit under subsection (c-3) would have been expressly conditioned upon the

taxpayer’s not claiming any deduction under subsection (c-1). 5. Danger of double credit does not exist if taxpayer cannot claim benefit from

either headings at his option The purpose of the law is to prevent the taxpayer from claiming twice the benefits of his payment of foreign taxes, by deduction from gross income (subs. c-1) and by tax credit (subs. c-3). This danger of double credit certainly can not exist if the taxpayer can not claim benefit under either of these

headings at his option, so that he must be entitled to a tax credit (the spouses admittedly are not so entitled because all their income is derived from Philippine sources), or the option to deduct from gross income disappears altogether.

6. When double taxation; Tax income should accrue to benefit of the Philippines

Double taxation becomes obnoxious only where the taxpayer is taxed twice for the benefit of the same governmental entity (cf. Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579, Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the present case, while the taxpayers would have to pay two taxes on the same income, the Philippine

government only receives the proceeds of one tax. As between the Philippines, where the income was earned and where the taxpayer is domiciled, and the United States, where that income was not earned and where the taxpayer did not reside, it is indisputable that justice and equity demand that the tax on the income should accrue to the benefit of the Philippines. Any relief from the alleged double taxation should come from the United States, and not from the Philippines, since the former’s right to burden the taxpayer is solely predicated on his citizenship, without contributing to the production of the wealth that is being taxed. To allow an alien resident to deduct from his gross income whatever taxes he pays to his own government amounts to conferring on the latterpower to reduce the tax income of the Philippine government simply by increasing the tax rates on the alien resident. Everytime the rate of taxation imposed upon an alien resident is increased by his own government, his deduction from Philippine taxes would correspondingly increase, and the proceeds for the Philippines diminished, thereby subordinating our own taxes to those levied by a foreign government. Such a result is incompatible with the status of the Philippines as an independent and sovereign state.

J. Losses

FERNANDEZ HERMANOS v. CIR

Facts: These four appeals involve two decisions of the Court of Tax Appeals determining the taxpayer's income tax liability for the years 1950 to 1954 and for

the year 1957. Both the taxpayer and the Commissioner of Internal Revenue, as petitioner and respondent in the cases a quo respectively, appealed from the Tax

Court's decisions, insofar as their respective contentions on particular tax items were therein resolved against them. Issue: Proper/Improper Allowances/Disallowances of Losses Held: Re allowances/disallowances of losses. (a) Allowance of losses in Mati Lumber Co. (1950). The Commissioner of Internal Revenue questions the Tax Court's allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum of P8,050.00 representing the cost of shares of stock of Mati Lumber Co. acquired by the taxpayer on January 1, 1948, on the ground that the worthlessness of said stock in the year 1950 had not been clearly established. The Commissioner contends that although the said Company was no longer in operation in 1950, it still had its sawmill and equipment which must be of considerable value. There was adequate basis for the writing off of the stock as worthless securities. Assuming that the Company would later somehow realize some proceeds from its sawmill and equipment, which were still existing as claimed by the Commissioner, and that such proceeds would later be distributed to its stockholders such as the taxpayer, the amount so received by the taxpayer would then properly be reportable as income of the taxpayer in the year it is received. (b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). The taxpayer appeals from the Tax Court's disallowance of its writing off in 1951 as a loss or bad debt the sum of P353,134.25, which it had advanced or loaned to Palawan Manganese Mines, Inc. Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearly advances starting from 1945, which advances amounted to P587,308.07 by the end of 1951. Despite these advances and the resumption of operations by Palawan Manganese Mines, Inc., it continued to suffer losses. By 1951, petitioner became convinced that those advances could no longer be recovered. While it continued to give advances, it decided to write off as worthless the sum of P353,134.25. Under the circumstances, was the sum of P353,134.25 properly claimed by petitioner as deduction in its income tax return for 1951, either as losses or bad debts? It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be repaid. It is true that some testimonial evidence was presented to show that there was some agreement that the advances would be repaid, but no documentary evidence was presented to this effect. The memorandum agreement signed by the parties appears to be very clear that the consideration for the advances made by petitioner was 15% of the net profits of Palawan Manganese Mines, Inc. In other words, if there were no earnings or profits, there was no obligation to repay those advances. It has been held that the voluntary advances made without expectation of repayment do not result in deductible losses. The Tax Court's is allowance of the write-off was proper. The Solicitor General has rightly pointed out that the taxpayer has taken an "ambiguous position " and "has not definitely taken a stand on whether the amount involved is claimed as losses or as bad debts but insists that it is either a loss or a bad debt." 4 We sustain the government's position that the advances made by the taxpayer to its 100% subsidiary, Palawan Manganese Mines, Inc. amounting to P587,308,07 as of 1951 were

investments and not loans. 5 (c) Disallowance of losses in Balamban Coal Mines (1950 and

1951). The Court sustains the Tax Court's disallowance of the sums of P8,989.76 and P27,732.66 spent by the taxpayer for the operation of its Balamban coal mines in Cebu in 1950 and 1951, respectively, and claimed as losses in the taxpayer's returns for said years. The Tax Court correctly held that the losses "are deductible in 1952, when the mines were abandoned, and not in 1950 and 1951, when they were still in operation." 9 The taxpayer's claim that these expeditions should be allowed as losses for the corresponding years that they were incurred, because it made no sales of coal during said years, since the promised road or outlet through which the coal could be transported from the mines to the provincial road was not constructed, cannot be sustained. Some definite event must fix the time when the loss is sustained, and here it was the event of actual abandonment of the mines in 1952. (d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). The Tax Court overruled the Commissioner's disallowance of these items of losses thus: Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950, P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954. These deductions were disallowed by respondent on the ground that the farm was operated solely for pleasure or as a hobby and not for profit. This conclusion is based on the fact that the farm was operated continuously at a loss. From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for business and not pleasure. It was mainly a cattle farm, although a few race horses were also raised. It does not appear

that the farm was used by petitioner for entertainment, social activities, or other nonbusiness purposes. Therefore, it is entitled to deduct expenses and losses in connection with the operation of said farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939- 1, p.164) Section 100 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, authorizes farmers to determine their gross income on the basis of inventories. Said regulations provide: "If gross income is ascertained by inventories, no deduction can be made for livestock or products lost during the year, whether purchased for resale, produced on the farm, as such losses will be reflected in the inventory by reducing the amount of livestock or products on hand at the close of the year." Evidently, petitioner determined its income or losses in the operation of said farm on the basis of inventories. We quote from the memorandum of counsel for petitioner: "The Taxpayer deducted from its income tax returns for the years from 1950 to 1954 inclusive, the corresponding yearly losses sustained in the operation of Hacienda Dalupiri, which losses represent the excess of its yearly expenditures over the receipts; that is, the losses represent the difference between the sales of livestock and the actual cash disbursements or expenses." (Pages 21-22, Memorandum for Petitioner.) As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in its operation, which losses were determined by means of inventories authorized under Section 100 of Revenue Regulations No. 2, it was error for respondent to have disallowed the deduction of said losses. The same is true with

respect to loss sustained in the operation of the Hacienda Samal for the years 1951 and 1952. 10 The Commissioner questions that the losses sustained by the taxpayer were properly based on the inventory method of accounting. He concedes, however, "that the regulations referred to does not specify how the inventories are to be made. The Tax Court, however, felt satisfied with the evidence presented by the

taxpayer

which merely consisted of an alleged physical count of the number of the

... livestock in Hacienda Dalupiri for the years involved." 11 The Tax Court was satisfied with the method adopted by the taxpayer as a farmer breeding livestock, reporting on the basis of receipts and disbursements. We find no Compelling reason to disturb its findings.

K. Bad Debts

PHILIPPINE REFINING COMPANY V COURT OF APPEALS

Facts: In 1985, petitioner filed its ITR where it claimed 16 items amounting to P713,070.93 as bad debts and therefor deductible. Subsequently, the Commissioner for Internal Revenue disallowed such deductions and assessed petitioner to pay a deficiency tax for the year of 1985. Petitioner paid the deficiency tax under protest which the Commissioner denied. Upon a petition for review, the CTA modified the findings of the Commissioner by reducing the deficiency tax assessment on the basis that three of the sixteen supposed bad debts could be allowed as deductions. The CA later on agreed with the

CTA. Held: The SC upheld the ruling of the CA which it found to be in accordance with the SC's ruling in Collector v Goodrich. It held the petitioner failed to substantiate the “worthlessness” of the 13 debts which it claimed as deductions. As per the ruling in Collector v Goodrich, to qualify as a bad debt, a TP must show: 1. that there is a valid and subsisting debt;

  • 2. that the debt must be actually ascertained to be worthless and uncollectible

durring 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 TP.

In addition, the Court said, before a debt can be considered worthless, the TP must also show that it is indeed uncollectible even in the future. Furthermore, the TP must undertake several steps to prove that he exerted diligent efforts to collect the

debt:

  • 1. sending statements of accounts to the debtors; 2. sending of collection letters; 3.

giving the account to a lawyer for collection; and

  • 4. filing a collection case in court. In the case at bar, the petitioner miserably failed

to show any of the foregoing. The only piece of evidence it offered to show the worthlessness of the debts was the testimony of the company's financial adviser or accountant. The Court found that this lacked the required probity to establish that the accounts it claimed as bad debts were indeed worthless. Apart from such

testimony, the petitioner failed to introduce even a single iota of evidence to bolster its claim of worthlessness. (NOTE: In the rest of the case, the Court presents the

allegation of the petitioner as to why it could not collect on any of the 13 debts followed by a statement how the petitioner failed to introduce evidence to substantiate such allegation.)

CHINA BANKING CORPORATION V COURT OF APPEALS

Facts: Petitioners mad a 53% equity investment in First CBC Capital (Asia) Limited to the amount of P16,227,851.80 consisting of 106,000 shares with par value of P100 per share. Subsequently, First CBC was found to be insolvent. Petitioners, with the approval of the BSP, wrote off as worthless its investment in the company and treated it as a bad debt or ordinary loss deductible from its gross income. The Commissioner of Internal Revenue disallowed the deduction saying that the investment could not be considered "worthless" since First CBC could still exercise its financing and

investment activities even if it was no longer licensed as a depository. Even assuming that the securities had become worthless, it still cannot be considered as a "bad debt" or expense since there is no indebtedness between petitioner and First CBC. It should be classified as a "capital loss." Held: The SC found in favor of respondents.

  • 1. Not and indebtedness. An equity investment in shares of stock cannot be

considered as an indebtedness of First CBC Capital to China Bank. The former has no

obligation to repay the latter the amount invested. The amount China Bank invested in First CBC is, in fact, an asset.

  • 2. Capital asset, not ordinary. Capital assets are defined in the negative by Sec 33(1)

of the NIRC as property held by the TP exclusive of items primarily for the sale to customers in the ordinary course of business, or property used in trade or business.

Hence, securities, such as equity holdings, are ordinary assets only in the hands of a

dealer, or a person actively engaged in trading in the same for his own account.

  • 3. Section 29(d)(4)(B) of the NIRC treats the worthlessness of the securities held

as capital assets as a loss resulting from the sale or exchange of capital assets.

Strictly speaking, no sale occurs when securities held as capital assets become

worthless. Nonetheless, the law treats it as a loss from a sale just the same.

  • 4. Section 33 of the NIRC provides that the capital loss sustained can only be

deducted from any capital gain derived within the taxable year. The same provision enumerates assets which are not subject to the said limitation but equity holdings are not one of them.

PHILIPPINE REFINING COMPANY V COURT OF APPEALS

Facts: In 1985, petitioner filed its ITR where it claimed 16 items amounting to P713,070.93 as bad debts and therefor deductible. Subsequently, the Commissioner for Internal Revenue disallowed such deductions and assessed petitioner to pay a deficiency tax for the year of 1985. Petitioner paid the deficiency tax under protest which the Commissioner denied. Upon a petition for review, the CTA modified the findings of the Commissioner by reducing the deficiency tax assessment on the basis that three of the sixteen

supposed bad debts could be allowed as deductions. The CA later on agreed with the CTA. Held: The SC upheld the ruling of the CA which it found to be in accordance with the SC's ruling in Collector v Goodrich. It held the petitioner failed to substantiate the

“worthlessness” of the 13 debts which it claimed as deductions. As per the ruling in

Collector v Goodrich, to qualify as a bad debt, a TP must show: 1. that there is a valid and subsisting debt;

  • 2. that the debt must be actually ascertained to be worthless and uncollectible

durring 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 TP.

In addition, the Court said, before a debt can be considered worthless, the TP must also show that it is indeed uncollectible even in the future. Furthermore, the TP must undertake several steps to prove that he exerted diligent efforts to collect the debt:

  • 1. sending statements of accounts to the debtors; 2. sending of collection letters; 3.

giving the account to a lawyer for collection; and

  • 4. filing a collection case in court. In the case at bar, the petitioner miserably failed

to show any of the foregoing. The only piece of evidence it offered to show the worthlessness of the debts was the testimony of the company's financial adviser or accountant. The Court found that this lacked the required probity to establish that the accounts it claimed as bad debts were indeed worthless. Apart from such testimony, the petitioner failed to introduce even a single iota of evidence to bolster its claim of worthlessness. (NOTE: In the rest of the case, the Court presents the allegation of the petitioner as to why it could not collect on any of the 13 debts followed by a statement how the petitioner failed to introduce evidence to substantiate such allegation.)

Collector of Internal Revenue v Goodrich International Rubber Co. (21 SCRA 1336; No. L-22265)

Facts: In 1951 and 1952, respondent Goodrich filed it ITR in which it claimed an aggregate amount (consisting of 18 individual accounts) of P50,455.41 as deductible for being bad debts. The Collector of Internal Revenue disallowed the deductions and accordingly assessed Goodrich accordingly. Goodrich protested the assessment and subsequently filed an appeal with the CTA which allowed the deductions for bad debts. Hence, this appeal by the Government. Held: Petition is partially meritorious. Some of the items claimed by Goodrich can rightfully be written off as bad debts. The SC rejected the claim for deduction of 10 items because Goodrich failed to establish that that the debts were actually worthless or that it had reasonable grounds to believe them to be so in 1951. The law permits the deduction of debts “actually ascertained to be worthless within the taxable year,” obviously to prevent arbitrary action by the TP to unduly avoid tax liability. Good faith on the part of the TP is not enough. He must furthermore show that he had reasonably

investigated the relevant facts and had drawn a reasonable inference from the information thus obtained by him. At any rate, respondent failed to prove that the debts were indeed worthless and that the debtors had no ability to pay them. On the contrary, of these 10 accounts some payments were actually made (some in full) after they had been characterized as bad debts and written off. The Court however ruled that 8 of the 18 claimed bad debts can be allowed as deductions. Common among these 8 was the action of Goodrich in persistently demanding payment from its debtors; it's endorsement of the accounts to counsel for collection; the pursuit of legal remedies for the collection on these debts; and the continuing failure/clear inability of the debtors to pay off their obligations.

Philex Mining Corp. v. Commissioner of Internal Revenue

G.R. No. 148187 April 16, 2008 Ynares-Santiago, J.

FACTS:

Philex Mining Corp. entered into an agreement with Baguio Gold Mining Co. for the former to manage and operate the latter’s mining claim, known as the Sto. Nino Mine. The parties’ agreement was denominated as “Power of Attorney” which

provides inter alia:

  • 4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall

make available to the MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS (P11,000,000.00), in such amounts as from time to time may be required by the

MANAGERS within the said 3-year period, for use in the MANAGEMENT of the STO. NINO MINE. The said ELEVEN MILLION PESOS (P11,000,000.00) shall be

deemed, for internal audit purposes, as the owner’s account in the Sto. Nino

PROJECT. Any part of any income of the PRINCIPAL from the STO. NINO MINE,

which is left with the Sto. Nino PROJECT, shall be added to such owner’s account.

  • 5. Whenever the MANAGERS shall deem it necessary and convenient in

connection with the MANAGEMENT of the STO. NINO MINE, they may transfer their own funds or property to the Sto. Nino PROJECT, in accordance with the following arrangements:

  • (a) The properties shall be appraised and, together with the cash, shall be

carried by the Sto. Nino PROJECT as a special fund to be known as the MANAGERS

account.

  • (b) The total of the MANAGERS’ account shall not exceed P11,000,000.00,

except with prior approval of the PRINCIPAL; provided, however, that if the compensation of the MANAGERS as herein provided cannot be paid in cash from the Sto. Nino PROJECT, the amount not so paid in cash shall be added to the

MANAGERS’ account.

  • (c) The cash and property shall not thereafter be withdrawn from the Sto. Nino

PROJECT until termination of this Agency.

  • (d) The MANAGERS’ account shall not accrue interest. Since it is the desire of

the PRINCIPAL to extend to the MANAGERS the benefit of subsequent appreciation of property, upon a projected termination of this Agency, the ratio which the MANAGERS’ account has to the owner’s account will be determined, and the corresponding proportion of the entire assets of the STO. NINO MINE, excluding the claims, shall be transferred to the MANAGERS, except that such transferred assets shall not include mine development, roads, buildings, and similar property which will be valueless, or of slight value, to the MANAGERS. The MANAGERS can, on the other hand, require at their option that property originally transferred by them to the Sto. Nino PROJECT be re-transferred to them. Until such assets are transferred to the MANAGERS, this Agency shall remain subsisting.

x x x x

  • 12. The compensation of the MANAGER shall be fifty per cent (50%) of the net

profit of the Sto. Nino PROJECT before income tax. It is understood that the MANAGERS shall pay income tax on their compensation, while the PRINCIPAL

shall pay income tax on the net profit of the Sto. Nino PROJECT after deduction

therefrom of the MANAGERS’ compensation.

  • Philex Mining made advances of cash and property in accordance with paragraph 5 of the agreement. However, the mine suffered continuing losses over the years which resulted to Philex Mining’s withdrawal as manager of the mine and in the eventual cessation of mine operations.

  • The parties executed a “Compromise with Dation in Payment” wherein Baguio Gold admitted an indebtedness to petitioner in the amount of P179,394,000.00 and agreed to pay the same in three segments by first assigning Baguio Gold’s tangible assets to Philex Mining, transferring to the latter Baguio Gold’s equitable title in its Philodrill assets and finally settling the remaining liability through properties that Baguio Gold may acquire in the future.

  • The parties executed an “Amendment to Compromise with Dation in Payment” where the parties determined that Baguio Gold’s indebtedness to petitioner actually amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other creditors that petitioner had assumed as guarantor. These liabilities pertained to long-term loans amounting to US$11,000,000.00 contracted by Baguio Gold from the Bank of America NT & SA and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two segments by first assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a remaining outstanding indebtedness to petitioner in the amount of P114,996,768.00.

  • 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, the BIR disallowed the amount as deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39. Philex Mining protested before the BIR arguing that the deduction must be allowed since all requisites for a bad debt deduction were 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. BIR denied petitioner’s protest. It held that the alleged debt was not ascertained to be worthless since Baguio Gold remained existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a valid and subsisting debt considering that, under the management contract, petitioner was to be paid 50% of the project’s net profit.

ISSUE: WON the parties entered into a contract of agency coupled with an interest which is not revocable at will

HELD: No. An examination of the “Power of Attorney” reveals that a partnership or joint venture was indeed intended by the parties.

  • In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the principal due to an interest of a third party that depends upon it, or the mutual interest of both principal and agent. In this case, the non- revocation or non-withdrawal under paragraph 5(c) applies to the advances made by petitioner who is supposedly the agent and not the principal under the contract. Thus, it cannot be inferred from the stipulation that the parties’ relation under the agreement is one of agency coupled with an interest and not a partnership.

  • Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the parties was one of agency and not a partnership. Although the said provision states that “this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS’ account,” it does not necessarily follow that the parties entered into an agency contract coupled with an interest that cannot be withdrawn by Baguio Gold.

  • The main object of the “Power of Attorney” was not to confer a power in favor of petitioner to contract with third persons on behalf of Baguio Gold but to create a business relationship between petitioner and Baguio Gold, in which the former was to manage and operate the latter’s mine through the parties’ mutual contribution of material resources and industry. The essence of an agency, even one that is coupled with interest, is the agent’s ability to represent his principal and bring about business relations between the latter and third persons.

The strongest indication that petitioner was a partner in the Sto. Nino Mine is the fact that it would receive 50% of the net profits as “compensation” under paragraph 12 of the agreement. The entirety of the parties’ contractual stipulations simply leads to no other conclusion than that petitioner’s “compensation” is actually its share in the income of the joint venture. Article 1769 (4) of the Civil Code explicitly provides that the “receipt by a person of a

share in the profits of a business is prima facie evidence that he is a partner in the

business.”

L. DEPRECIATION

BASILAN ESTATES, INC. v. CIR Facts: Basilan Estates, Inc. claimed deductions for the depreciation of its assets on the basis of their acquisition cost. As of January 1, 1950 it changed the depreciable value of said assets by increasing it to conform with the increase in cost for their replacement. Accordingly, from 1950 to 1953 it deducted from gross income the value of depreciation computed on the reappraised value. CIR disallowed the deductions claimed by petitioner, consequently assessing the latter of deficiency income taxes. Issue:Whether or not the depreciation shall be determined on the acquisition cost rather than the reappraised value of the assets. Held: Yes. The following tax law provision allows a deduction from gross income for

depreciation but limits the recovery to the capital invested in the asset being depreciated: (1)In general. A reasonable allowance for deterioration of property arising out of its use or employment in the business or trade, or out of its not being used: Provided, That when the allowance authorized under this subsection shall

equal the capital invested by the taxpayer

no further allowance shall be

made. . .

. The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is that deductions from gross income are privileges, not matters of right. They are not created by implication but upon clear expression in the law. Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and normal obsolescense. It commences with the acquisition of the property and its owner is not bound to see his property gradually waste, without making provision out of earnings for its replacement. The recovery, free of income tax, of an amount more than the invested capital in an asset will transgress the underlying purpose of a depreciation allowance. For then what the taxpayer would recover will be, not only the acquisition cost, but also some profit. Recovery in due time thru depreciation of investment made is the philosophy behind depreciation allowance; the idea of profit on the investment made has never been the underlying reason for the allowance of a deduction for depreciation.

. . .

Victorias Milling Co., Inc. v. Municipality of Victorias

Facts:

In 1947, the Provincial Assessor assessed for purposes of the 1948 real property tax, machineries belonging to Victorias Milling after allowing a deduction of 50% for

depreciation. In 1949, the same machineries were assessed which is equivalent to the assessed value for 1948 minus 3% depreciation. In both isntances, Victorias paid the taxes under protest. For 1950 to 1953, the same machineries were assessed and corresponding taxes were paid under protest.

Victorias did not appeal from the aforesaid assessments to the Provincial Board of Assessment Appeals as required in Sec. 17 of the Assessment Law. Instead, it filed a complaint with the CFI againt the provincial treasurer of Negros Occidental alleging that the assessor erroneously did not follow the straight line method in determining its depreciation of its machineries as provided for by the provincial circular and respectively prayed for the refund. The provincial treasurer appealed from the SC but was dismissed. Upon motion of Victorias, the CFI issued a writ of execution. The SC set aside the judgment that was rendered by the trial court because it did not have jurisdiction ov er the case, jurisddiction having been transferred to the CTA.

Issue: WON the CFI had jurisdiction to entertain the complaint?

Held:

No. here, the provincial assessor of Negros Occidental had the power to make the assessments in question under Section 7 of the Assessment law. Since the PA had

the power to make the assessments, but in the exercise of such he deviated from the

procedure set down by law, in that he employed the “fixed percentage of diminishing book value method” instead of the straight line method in depreciating

machineries, logically the assessment should be considered onerous.

The designation given by the municipal authorities does not decide whether the imposition is properly a license tax or a license fee. The determining factors are the purpose and effect of the imposition as may be apparent from the provisions of the ordinance. Thus, "when no police inspection, supervision, or regulation is provided, nor any standard set for the applicant to establish, or that he agrees to attain or maintain, but any and all persons engaged in the business designated, without qualification or hindrance, may come, and a license on payment of the stipulated sum will issue, to do business, subject to no prescribed rule of conduct and under no guardian eye, but according to the unrestrained judgment or fancy of the applicant and licensee, the presumption is strong that the power of taxation, and not the police power, is being exercised."