Deductions 1

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TAX LAW REVIEW DIGESTS – MonteroAlcisso, Arriola, Cajucom, Calalang, Claudio, Escueta, Delos Santos, Dialino, Fajardo, Imperial, Juaquino, Martin, Martinez, Mendoza, Noel, Pangcog, Plazo Raso,Rosales, Sia, Uy, Venzuela

Q. DEDUCTION

In general

[C.T.A. CASE NO. 128. June 29, 1957.]VISAYAN CEBUTERMINAL CO., INC., appellant, vs. COLLECTOR OF

INTERNALREVENUE, appellee.

D E C I S I O N

The appellant, Visayan Cebu Terminal Co., Inc., is a corporation

organized for the purpose of handling arrastre operations in the

port of Cebu. It was awarded the contract for the said arrastre

operations by the Bureau of Customs, pursuant to Act No. 3002, as

amended. On March 1, 1952, appellant filed its income tax return

for 1951 reporting a gross in come of P420,633.40 and claimeddeductions amounting to P379,036.95,leaving a net income of

P41,596.45 on which it paid income tax in the sum of P8,319.29.

The sum of P379,036.95 claimed as deductions consisted of various

items, among which were the following:

1.Salaries —

(a)Salary and bonus of Juan Eugenio LoP1,875.00

(b)Salary of Felix Go Chan250.00

(c)Salary of Teotimo Tiu Tian250,00P2,375.00————

2.Representation expenses75,855.883.Miscellaneous expenses —

(a)Christmas bonus given to variouspersonsP1,500.00

(b)Tips to ships'officers4,800.006,300.00—————————

TotalP84,530.88=========

The said sums of P2,375.00, P75,855.88 and P6,300.00,

representing salaries,representation expenses and miscellaneous

expenses, respectively, or a total of P84,530.88, were disallowed bythe Collector of Internal Revenue, thus giving rise to a deficiency

assessment of P18,991.00. The disallowances were explained by

the Collector in his letter of February 4, 1954, as follows:P2,375.00

— Salaries. This item represents bonus allegedly paid to Messrs.

Felix G. Chan, T.R. Tiam and Juan Eugenio Co in the amounts of

P250.00, P250.00 andP1,875.00, respectively. The first two

amounts were disallowed because they were paid to persons who

were not (appellant's) bonafide employees and,therefore, not

entitled to any compensation. The amount of P1,875.00 given to

Mr. Juan Eugenio Co who is (appellant's) employee and a

stockholder at the same time was likewise disallowed because the

payment is considered distribution of dividend.P75,855.88 —

Representation expenses. This amount consists of 15% of the net

profit given to your (appellant's) general manager, 8% of the net

profit given to(appellant's) vice-president, both of whom are

members of the Board of Directors, and 5% of the net profit to each

of the rest of the five members of the Board of Directors and to a

legal counsel. The amount of P75,855.88 represents distributions to

(appellant's) aforesaid officers based on the percent of the net

profit. It has been observed that the recipients of the aforesaid

amount are(appellant's) substantial stockholders. The allegedpayments, therefore, partake more of the nature of dividend

distribution than representation expense.P6,300.00 —

Miscellaneous expenses. This discrepancy is constituted by the

amount of P1,500.00 which (appellant) gave as Christmas bonus to

various persons who are not (appellant's) bonafide employees and

the sum of P4,800.00given as tips to unknown persons. The whole

amount cannot be allowed as deduction because they were not

ordinary and necessary expenses.Upon request for reconsideration,

1




the Collector modified the deficiency income tax assessment by

allowing the deduction from appellant's gross income of the salary

of Juan Eugenio Lo in the sum of P1,875.00 and miscellaneous

expenses amounting to P532.00, at the same time maintaining the

disallowance of the full amount of P75,855.88 as representationexpenses. The revised deficiency assessment is itemized in the

letter of the Collector dated March 26, 1955, and is reproduced

below:

Net income as per returnP41,596.45

Disallowances:per investigation:salaries of

officersP2,375.00allowed per reaudit1,875.00500.00per

investigation

and re audit, representationexpenses75,855.88perinvestigation,miscellaneousexpensesP6,300.00

allowed per reaudit532.005,768.00—————————

Net income subject to tax per reauditP123,720.33—————

Tax due on P123,720.33:P100,000.00 at 20%P20,000.00P23,720.00

at 28%6,642.00P26,642.00—————

Less tax previously assessed and paidP8,325.00—————

Deficiency taxP18,317.00Add:5% surcharge915.851% monthly

interest from5/31/53 to 4/30/554,212.91Compromise for late

payment40.00—————

Total amount due on April 30, 1955P23,485.76

=========

Appellant has agreed to the disallowance of the sum of P500.00,

representing the salaries of Felix Go Chan and Teotimo Tiu Tian at

P250.00 each, and the sum of P5,768.00, representing

miscellaneous expenses. The only issue raised in this appeal

relates to the deductibility of the sum of P75,855.88 as

representation expenses.

In computing net income, the law allows the deduction from gross

income of —"All the ordinary and necessary expenses paid or

incurred during the taxables year in carrying on any trade or

business, including a reasonable allowance for salaries or other

compensation for personal services actually rendered . . ." (Sec.30

(a)(1), National Internal Revenue Code.)Representation or

entertainment expenses fall under the category of business

expenses and are allowable deductions from gross income if they

meet the conditions prescribed by law.In order that expenses may

be deductible, they must be —(1)Ordinary and necessary,

and(2)Paid or incurred during the taxable year under one of the

following conditions —(a)In carrying on any trade or business;(b)For

the production or collection of income;(c)For the management,

conservation, or maintenance of property held forthe production of

income;(d)In connection with the determination, refund or

collection of any tax. (Par.11,000 P-H Fed. 1955.)Even if expenses

were paid or incurred in carrying on a trade or business within the

taxable year; or for the production or collection of income; or for

the management, conservation, or maintenance of property held

for the production of income; or in connection with thedetermination, refund or collection of any tax, such expenses would

not be deductible unless they were both ordinary and necessary.

An expense is generally considered necessary where the

expenditure is appropriate or helpful in the development of the

taxpayer's business or that the same is proper for the purpose of

realizing a profit or minimizing a loss. An expense is ordinary when

it connotes a payment which is normal in relation to the business of

the taxpayer and the surrounding circumstances. As to the

2




meaning of the word "ordinary", the Supreme Court of the United

States stated:"Now, what is ordinary, though there must always be

a strain of constancy within it, is none the less a variable affected

by time and place and circumstance.Ordinary in this context does

not mean that the payments must be habitual or normal in thesense that the same taxpayer will have to make them often. A

lawsuit affecting the safety of a business may happen once in a

lifetime. The counsel fees may be so heavy that repetition is

unlikely. Nonetheless, the expense is an ordinary one because we

know from experience that payments for such a purpose, whether

the amount is large or small, are the common and accepted means

of defense against attack. Cf. Kornhauser v. United States, 276U.S.

145, 48 S. Ct. 219 72 L. Ed. 505 (6 AFTR 7358). The situation is

unique in the life of the individual affected, but not in the life of the

group, the community, of

which he is a part. At such times there are norms of conduct that

help to stabilize our judgment, and make it certain and objective.

The instance is not erratic, but is brought within a known type."

(Welch v. Helvering, 290 U.S. 111, cited in Par.11,008 P-H Fed.

1955.)Business expenses, in order to be deductible, must not only

be ordinary and necessary but must also meet the further test of

reasonableness in amount. The element of reasonableness in

amount is inherent in the phrase ordinary and necessary". It was

not the intention of Congress to automatically allow as deductions

operating expenses incurred or paid by the taxpayer in anunlimited amount. (Commissioner vs. Lincoln Elec. Co., 176 Fed. 2d

815, 38 AFTR 411.)Have the requirements for deductibility of the

sum of P75,855.88 been satisfied?Counsel for the Government

admit that "the expense of P75,855.88 was paid and incurred

within the taxable year 1951." It is, however, contended that " it is

not ordinary and necessary expense nor was it incurred in carrying

on the trade or business of the appellant in 1951." It was, according

to the Collector, in the nature of a dividend distribution. (Page 5,

Memorandum for the Appellee.) On the other hand, appellant

sought to prove that the said amount was actually spent by its

officers and members of the Board of Directors for the promotion

and enhancement of the business of the corporation. Let us

examine the facts.It appears that by a resolution of the Board of Directors of appellant corporation dated July 22, 1949, a dividend of

50% of the net profit was authorized to be declared to the

stockholders annually and the other 50% was to be used to

reimburse the representation expenses of the General Manager,

members of the Board of Directors and the legal consultant at the

following rates: General Manager, 12%; Assistant General Manager,

8%; members of the Board of Directors and the legal consultant,

5% each of the net profit. During the period of four years from 1949

to 1952, appellant had gross incomes, net profits and claimed

representation expenses, as follows:

LL pr Representation Year Gross Income

Net

ProfitExpenses1949P722,135.42P61,257.53P83,703.541950451,30

3.2133,023.7810,424.391951420,479.3941,596.4575,855.8819524

25,326.8654,207.3163,618.64lIt also appears from the testimony of

Dioscoro B. Casco, Accountant-Bookkeeper of appellant, that

reimbursement of representation expenses incurred by the officers

and members of the Board of Directors were made upon

presentation of the corresponding vouchers and chits, but therewere instances when reimbursements were made without

presentation of supporting papers. Casco justified reimbursement

of a claim for representation expenses without

presentation of supporting papers by stating that he did not have

the courage to ask the officers and members of the Board to

comply with the requirement because of the "unquestioned

integrity of these people and the high esteem of the community

3




toward them." Besides, "it was the policy of the office to give them

free way to spend such amount without, of course, complete

supporting papers."As to how the amounts claimed by the officers

and members of the Board were spent, Casco testified that, with

respect to the manager, they were spent for"hotel andaccommodation charges and entertainment expenses while in

Manila;entertainment of the agents of the ship and other officers

and also importers when he comes to Manila on official business for

the Company." As regards the members of the Board, he testified

that "they used to present chits covering their expenses for the

entertainments of friends who came from other places to see Cebu

to get indentions of their imports. The members of the Board of

Directors or the liaison officers entertained them, in which case

these liaison officers submitted hotel and accommodation expenses

and also transportation expenses." (Pp. 61-62, t.s.n.; p. 20,Memorandum for Appellant.)From the evidence adduced by

appellant, there were two sets of representation expenses. One

covers expenses supported by appropriate vouchers and chits;the

other covers expenses without supporting papers. Unfortunately, it

is not possible to determine the actual amount covered by

supporting papers and the amount without supporting papers. It is

alleged that the records were destroyed when the house of

Buenaventura M. Veloso, treasurer of Appellant, where the records

were kept was burned. We may, therefore, accept as correct the

fact that at least a portion of the amount of P75,855.88 was spent

for representation expenses of appellant corporation, while the

portion thereof not covered by supporting papers was spent for

purposes not clearly established. The first qualifies for the

deduction, the other does not. It is up to us to determine from all

available data the amount properly deductible as representation

expenses. It would seem unjust to disallow the deduction of the

entire amount for lack of documentary evidence to establish the

precise amount beyond a reasonable doubt. The practice under the

Federal Income Tax Law of the United States is —". . . that while a

taxpayer is not relieved from the burden of substantiating his

claimed deductions, the examining agent should exercise careful

judgment which will permit reasonable determinations for

entertainment expense,provided he is satisfied that there is a

proper basis for some allowance.Disallowing amounts claimed fordeduction merely because there is available no documentary

evidence which will establish the precise amount beyond a

reasonable doubt ignores commonly recognized business practices

as well as the fact proof may be established by credible oral

testimony. On the other hand, it is not the policy to allow an

arbitrary percentage of the claimed deduction merely for purpose

of settlement. Ir-Min. No. 54-92, Par. 76,750 P-H Fed. 1954."

(Par.11,300 P-H Fed. 1955.

In this case, it is impossible to determine the precise amount spent

for representation. But it is our duty to make a determination, even

if the result be merely an approximation."In the production of his

plays Cohan was obliged to be free-handed in entertaining actors,

employees, and, as he naively adds, dramatic critics. He had also

to travel much, at times with his attorney. These expenses

amounted to substantial sums, but he kept no account and

probably could not have done so.At the trial before the Board he

estimated that he had spent eleven thousand dollars in this fashion

during the first six months of 1921, twenty-two thousand dollars,

between July first, 1921, and June thirtieth, 1922, and as much for

his following fiscal year, fifty-five thousand dollars in all. The Boardrefused to allow him any part of this, on the ground that it was

impossible to tell how much he had in fact spent, in the absence of

any items or details. The question is how far this refusal is justified,

in view of the finding that he had spent much and that the sums

were allowable expenses. Absolute certainty in such matters is

usually impossible and is not necessary; the Board should make as

close an approximation as it can, bearing heavily if it chooses upon

the taxpayer whose inexactitude is of his own making. But to allow

4




nothing at all appears to us inconsistent with saying that something

was spent. True, we do not know how many trips Cohan made, nor

how large his entertainments were; yet there was obviously some

basis for computations, if necessary by drawing upon the Board's

personal estimates of the minimum of such expenses. The amountmay be trivial and unsatisfactory, but there was basis for some

allowance, and it was wrong to refuse any, even though it were the

traveling expenses of a single trip. It is not fatal that the result will

inevitably be speculative; many important decisions must be such.

We think that the Board was in error as to this and must reconsider

the evidence." (Pp. 543-544, Vol. 39 Fed. Rep.)We shall, therefore,

endeavor to ascertain the amount actually spent by appellant for

representation or entertainment which we deem reasonably

necessary in carrying on its business. As already adverted to

above, appellant claimed representation expenses from 1949 to1952 in the following

amounts:1949P83,703.54195010,424.39195175,855.88195263,61

8.64We presume that, as in 1951, the expenses incurred by the

officers and members of the Board of Directors were not all covered

by supporting papers showing that said expenses were all for

entertainment purposes as testified by appellant's accountant-

bookkeeper. From the above figures, we may infer that the sum of

P10,000.00 may be considered reasonably necessary for

entertainment expenses of appellant in 1951, it having claimed a

little over that amount in 1950, when its gross income was more

than its gross incomes in 1951

and 1952. Moreover, it allegedly spent for entertainment purposes

in 1948 the sum of P500.00 only.It is argued, however, that the

whole amount claimed by the appellant should be disallowed

because there is no necessity for appellant to incur expenses for

entertainment, the business in which it is engaged being a

monopoly. To accept this preposition is to ignore the commonly

recognized business practices. A business concern, whether a

monopoly or one which operates in a highly competitive market,

has need to provide for entertainment or representation expenses

to preserve and maintain the goodwill and patronage of its

customers and to win more customers if possible. Moreover, in the

case of appellant, while it is true that it has the exclusive contractto undertake arrastre operations in the port of Cebu, the contract is

for a limited period after which it has to compete again with others

before it may win a renewal of the contract. There is,

therefore,necessity for it to provide for a reasonable amount for

representation or entertainment expenses.It is also contended that

the sum of P75,855.88 being claimed as representation expenses

was an indirect distribution of dividend, the officers and members

of the Board of Directors of appellant being the holders of the

majority stock of the corporation, together with their relatives. The

records show that the officers and members of the Board of Directors of appellant corporation had never been the holders of

the majority stock of the corporation. It is true that some of their

relatives were and are stockholders of said corporation, but it has

not been shown that the stocks in the names of such relatives were

owned or controlled,directly or indirectly, by the officers and

members of the Board of Directors.Accordingly, there is no basis for

holding that the officers and members of the Board of Directors of

appellant own or control the majority stock to justify the inference

that representation expenses being claimed are an indirect

distribution of dividend.Finally, it is argued that while the officers

and members of the Board of Directors of appellant corporation

reported in their income tax returns the amounts received by them

as reimbursements for alleged representation expenses, they did

not claim deduction of the amounts actually spent by them. From

this the conclusion is drawn that the amounts received by them

were not in reality reimbursements for representation expenses but

a distribution of part of the net profit of the corporation. We can not

accept the soundness of this proposition. The failure of a person to

claim deduction in connection with income derived from a

5




corporation cannot affect the legality of the deduction claimed by

the corporation in respect of the amount paid by it to such person.

Of the same nature is the argument of appellant that because the

Collector of Internal Revenue has not questioned the legality of the

deduction for representation expenses claimed in other years inamounts nearly the same as the claim in1951, there is no

justification for questioning the deduction for representation

expenses in that year. The legality of a deficiency assessment

cannot be affected by the failure to assess in cases of similar

nature. The rule is well established that the Government is not

estopped by error or mistake on the part of its agents. (Pineda v.

Court of First Instance of Tayabas, 52 Phil. 803.)FOR THE

FOREGOING CONSIDERATIONS, the decision appealed from is

hereby modified, and appellant is hereby ordered to pay to the

Collector of Internal Revenue, within a reasonable period to befixed by the latter, the sum of P15,517.00, computed below:

Net income per returnP41,596.45

Disallowances:

(1)Salaries500.00

(2)Representation Expenses:As claimed by appellantP75,855.88

Allowed10,000.0065,855.88

(3)Miscellaneousexpenses5,768.00—————

Net income subject to taxP113,720.33—————

Tax due on P113,720.33:P100,000.00 at 20%P20,000.00P13,720.00

at 28%3,842.00P23,842.00

Less tax previously assessed and paid8,325.00—————

Deficiency taxP15,517.00

=========

With costs against appellant. cdasiaSO ORDERED.ROMAN M.

UMALIAssociate JudgeWE CONCUR:

G.R. No. L-12798 May 30, 1960

VISAYAN CEBU TERMINAL CO., INC., petitioner-appellant,

vs.

COLLECTOR OF INTERNAL REVENUE, respondent-

appellee.

Duterte and Rodriguez for petitioner.

Assistant Solicitor General Jose P. Alejandro and Atty. Sixto J.

Javier for respondent.

CONCEPCION, J.:

Petitioner Visayan Cebu Terminal Co., Inc., seeks a review of

the decision of the Court of Tax Appeals in the above entitled

case. The dispositive part of said decision reads as follows:

FOR THE FOREGOING CONSIDERATIONS, the decision

appealed from is hereby modified, and appellant is hereby

ordered to pay the Collector of Internal Revenue, within a

reasonable period to be fixed by the latter, the sum of

P15,517.00, computed below:

Net income per return P41,596.45

Disallowances:

6




(1) Salaries 500.00

(2) Representation Expenses:

As claimed by appellant 75,855.88

Allowed 10,000.00 65,855.88

(3) Miscellaneous expenses 5,768.00

————

Net income subject to tax P113,720.33

Tax due on P113,720.33:

P100,000.00 at 20% P20,000.00

P13,720.00 at 28% 3,842.00 P23,842.00

Less tax previously assessed and paid 8,325.00

————

Deficiency tax P15,517.00

With costs against appellant.

The facts, which are not disputed, are set forth in the

aforementioned decision, from which we quote:

"The appellant, Visayan Terminal Co. Inc., is a corporation

organized for the purpose of handling arrastre operations in

the port of Cebu. It was awarded the contract for the said

arrastre operations by the Bureau of Customs, pursuant to

Act No. 3002, as amended.

"On March 1, 1952, appellant filed its income tax return for

1951 reporting a gross income of P420,633.40 and claimed

deductions amounting to P379,036.95, leaving a net income

of P41,596.45 on which it paid income tax in the sum of

P8,319.20. The sum of P379,036.95 claimed as deductions

consisted of various items, among which were the following:

1. Salaries —

(a) Salary and bonus of Juan

Eugenio Lo P1,875.00

(b) Salary of Felix Go Chan 250.00

(c) Salary of Teomino Tiu

Tiam 250.00 P 2,375.00

2. Representation expenses 75,855.88

3. Miscellaneous expenses

(a) Christmas bonus given to

various persons P1,500.00

(b) Tips to ships' officers 4,800.00 6,300.00

TOTAL P84,530.88

The said sums of P2,375.00, P75,855.88 and P6,300.00,representing salaries, representation expenses and

miscellaneous expenses, respectively, or a total of

P84,530.88, were disallowed by the Collector of Internal

Revenue, thus giving rise to a deficiency assessment of

P18,991.00.

x x x x x x x x x

Upon request for reconsideration, the Collector modified the

deficiency income tax assessment by allowing the deductionfrom appellant's gross income of the salary of Juan Eugenio

Lo in the sum of P1,875.00 and miscellaneous expenses

amounting to P532.00, at the same time maintaining the

disallowance of the full amount of P75,855.88 as

representation expenses. The revised deficiency assessment

is itemized in the letter of the Collector dated March 26,

1955, and is reproduced below:

7




Net income as per return P41.596.45

Disallowances:

per investigation:

salaries of officers P 2,375.00

allowed per reaudit 1,875.00 500.00

per investigation and reaudit,

representation expenses 75,855.88

per investigation, miscellaneous

expenses 6,300.00

allowed per reaudit 532.00 5,768.00

——— ————

Net income subject to tax per

reaudit P123,720.33

Tax due on P123,720.33:P100,000.00 at 20% P20,000.00

P23,720.00 at 28% 6,642.00 P26,642.00

————

Less tax previously assessed and paid 8,325.00

—————

Deficiency tax P18,317.00

Add: 5% surcharge 915.85

1% monthly interest from

5/31/53 to 4/30/55 4,212.91Compromise for late payment 40.00

—————

Total amount due on April 30,1955 P23,485.76

Appellant has agreed to the disallowance of the sum P500.00

representing the salaries of Felix Go Chan and Teotimo Tiu

Tiam at P250.00 each, and the sum of P5,768.00,

representing miscellaneous expenses. The only issue raised

in this appeal relates to the deductibility of the sum of

P75,855.88 as representation expenses.

Passing upon said issue, which is, also, the only one raised in

this appeal, the lower court held that "representation ...expenses fall under the category of business expenses

which" are allowable deductions from gross income if they

meet the conditions prescribed by law", particularly section

30(a) (1) of the National Internal Revenue Code; that, to be

deductible, said business expenses must "ordinary and

necessary expenses paid or incurred in carrying on any trade

or business"; that those expenses "must also, meet the

further test of reasonableness in amount", this test being

"inherent in the phase `ordinary and necessary'"; that someof the representation expenses claimed by appellant had

been evidenced by vouchers or chits, but others were

reimbursed "without presentation of supporting papers; that

the aforementioned vouchers or chits were allegedly

"destroyed when the house of Buenaventura M. Veloso,

treasurer of appellant, where the records were kept was

burned"; that, accordingly, "it is not possible to determine

the actual amount covered by supporting papers and the

amount without supporting papers"; that the court should,

therefore, "determine from all available data the amountproperly deductible as representation expenses"; that

"during the period of four (4) years from 1949 to 1952,

appellant had gross income, net income, net profits and

claimed representation expenses as follows:

Year Gross Income Net Profit Representation

Expenses

8




1949 P722,135.42 P61,257.53 P83,703.54

1950 451,303.21 33,023.78 10,424.39

1951 420,479.39 41,596.45 75,855.88

1952 425,326.86 34,207.31 63,618.64

and that "from the above figures, we may infer that the sum

of P10,000 may be considered reasonably necessary for

entertainment expenses of appellant in 1951, it having

claimed a little over the amount in 1950, when its gross

income was more than its gross income in 1951 and 1952",

and because "it allegedly spent for entertainment purposes

in 1948 the sum of P500.00 only." Hence, the lower court

modified the assessment of the taxes due from appellant

herein the manner set forth in the beginning of this decision.

In its brief, appellant does not assail any of the premises

upon which the aforementioned conclusion of the lower court

was predicated. What is more, it relied upon, and, even,

quoted some of the views expressed in the decision appealed

from. Appellant, however, maintains that said court had

acted arbitrarily in considering the representation expenses

in 1950, not those incurred in 1949 and 1952, in fixing the

amount deductible in 1951. This pretense is clearly

untenable. It appears: (a) that part of the allegedrepresentation expenses had never had any supporting

paper; (b) that the vouchers and chits covering other

representation expenses had been allegedly destroyed; (c)

that there is no documentary evidence on record of any of

the representation expenses in question; (d) that no

testimonial evidence has been introduced on any specific

item of said alleged expenses; (e) that there is no more than

oral proof to the effect that payments had been made to

appellant's officers for representation expenses allegedly

made by the latter and about the general nature of such

alleged expenses; (f) that the gross income in 1950

exceeded the gross income in 1951 and 1952, and (g) that

the representation expenses in 1948 amounted to P500 only.

Under these circumstances, the lower court was fully justified

in concluding that the representation expenses in 1951

should be slightly less than those incurred in 1950.

Upon the other hand, appellant has not even tried to show

why its representation expenses in 1951 should be deemed

bigger than the amount allowed by the lower court. In fact,

the latter had been patently fair and reasonable, if not ratherliberal, in allowing appellant to deduct P10,000.00 as

representation expenses for 1951, there being absolutely no

concrete evidence of the sums then actually spent for

purposes of representation. It may not be amiss to note that

the explanation to the effect that the supporting paper of

some of those expenses had been destroyed when the house

of the treasurer was burned, can hardly be regarded as

satisfactory, for appellant's records are supposed to be kept

in its offices, not in the residence of one of its officers.

Being in accordance with the facts and the law, the decision

appealed from is hereby affirmed, with costs against

petitioner-appellant, Visayan Cebu Terminal Co., Inc. It is so

ordered.

G.R. No. L-23226 November 28, 1967

ALHAMBRA CIGAR and CIGARETTE MANUFACTURING

9




COMPANY, petitioner-appellant,

vs.

THE COMMISSIONER OF INTERNAL REVENUE,

respondent-appellee.

Gamboa and Gamboa for petitioner-appellant.

Office of the Solicitor General for respondent-appellee.

FERNANDO, J.:

This Court, in this petition for the review of a decision of the

Court of Tax Appeals is not faced with a problem of undue

complexity. The law governing the matter has been

authoritatively expounded in an opinion by the then Justice,

now Chief Justice, Concepcion in Alhambra Cigar v. Collector of Internal Revenue,1 a case involving the same parties over

a similar question but covering an earlier period of time. The

limits of a power of respondent Commissioner of Internal

Revenue to allow deductions from the gross income "the

ordinary and necessary expenses paid or increased during

the taxable year in carrying on any trade or business,

including a reasonable allowance for salaries and other

compensation for personal services actually rendered . . ." 2

had thus been authoritatively expounded. What remains tobe decided in this litigation is whether the decision of the

Court of Tax Appeals sought to be reviewed reflected with

fidelity the doctrine thus announced or deviated therefrom.

According to the petition for review, Alhambra Cigar &

Cigarette Manufacturing Company, petitioner-appellant, "is a

corporation duly organized and existing under the laws of the

Philippines, with principal office at 31 Tayuman street, Tondo,

Manila; and the respondent-appellee is the duly appointed

and qualified Commissioner of Internal Revenue, vested with

authority to act as such for the Government of the Republic

of the Philippines, . . . .3

In the petition for review it was contended that the Court of

Tax Appeals, in affirming the action taken by respondent-

appellee Commissioner of Internal Revenue, erred "(a) In

holding that A. P. Kuenzle and H.A. Streiff who were the

President and Vice-President, respectively, of the petitioner-

appellant, were entitled to a salary of only P6,000.00 each

year, for 1954, 1955, 1956 and 1957, and a bonus equal to

the reduced bonus of W. Eggmann for each of said years; and

disallowing as deductions the portions of their salary andbonus in excess of said amounts; (b) In disallowing, as

deductions, all the directors' fees and commissions paid by

the petitioner-appellant to A.P. Kuenzle and H.A. Streiff; (c) In

holding that the petitioner-appellant is liable for the alleged

deficiency income taxes in question."4

It is indisputable as noted in the brief for petitioner-appellant

that the deductions disallowed by respondent-appellee,

Commissioner of Internal Revenue, for the year 1954 to 1957

designated as salaries, officers; bonus, officers; commissionsto managers and directors' fees "relate exclusively to the

compensations paid by the petitioner-appellant in 1954,

1955, 1956 and 1957, to A. P. Kuenzle and H.A. Streiff who

were, during the said years, as they had been in prior years

and still are, directors and the president and vice-president,

respectively, of the petitioner-appellant. . . ."5

Under the category of salaries, officers of the fixed annual10




compensation of A. P. Kuenzle and H. A. Streiff in the amount

of P15,000.00 each "the respondent-appellee allowed for

each of them a salary of only P6,000.00 and disallow the

balance of P9,000.00, or a total disallowance of P18,00.0,0

for both of them, for each of the years in question."6 Under

that of the bonus, officers of the amount under such category

paid to the above gentlemen for the year 1954 of P14,750.00

each, "the respondent-appellee allowed each of them a

bonus of only P5,850.00, and disallowed the balance of

P8,900.00 or a total disallowance of P17,800.00 for both of

them."7 For the year 1955, the bonus being paid, once again,

amounting to P14,750.00 to each of them, "the respondent-

appellee allowed for each of them, a bonus of only

P7,000.00, and disallowed the balance of P7,750.00 each, ora total disallowance of P15,500.00 for both of them."8 For the

year 1956, again the amount, not suffering any change for

each, "the respondent-appellee allowed for each of them a

bonus of only P5,500.00 and disallowed the balance of

P9,250.00 each, or a total disallowance of P18,500.00 for

both of them."9 Lastly, for the year 1957, of a similar amount

payable to each in the concept of bonus, "the respondent-

appellee allowed for each of them a bonus of only P6,500.00,

and disallowed the balance of P8,250.00 each, or a total

disallowance of P16,500.00 for both of them."10

As to the deduction in the concept of commissions to

managers, the brief for the petitioner appellant states: "The

commissions paid by the petitioner-appellant to A. P. Kuenzle

and H. A. Streiff in the amount of P13,607.61 each in 1954,

or a total of P27,215.22 for both of them; P14,097.62 each in

1955, or a total of P28,195.24 for both of them; P13,180.87

each in 1956, or a total of P26,361.74 for both of them; and

P13,144.29 each in 1957, or a total of P26,288.48 for both of

them, were entirely disallowed by the respondent-

appellee."11

Concerning the directors' fees paid to both officials by

petitioner-appellant, it is noted in the brief that "in the

amount of P11,504.71 each in 1954, or a total of P23,009.42

for both of them; P10,693.02 each in 1955, or a total of

P21,386.04 for both of them; P10,360.23 each in 1956, or a

total of P20,720.46 for both of them; and P9,716.63 each in

1957, or a total of P19,433.26 for both of them were also

entirely disallowed by the respondent-appellee."12

In the decision of the respondent Court of Tax Appeals

sought to be reviewed, there was an appraisal of the

evidence on which respondent-appellee Commissioner of

Internal Revenue based the above deduction on salaries and

bonuses: "The evidence shows that prior to 1954, Messrs. A.

P. Kuenzle and H. A. Streiff President and Vice-President,

respectively, of petitioner corporation, were each paid an

annual salary P6,000.00 and a bonus of about four times as

much as the annual salary. In Alhambra Cigar and Cigarette

Manufacturing Company v. Coll. of Int. Rev. C.T.A. No. 142 January 31, 1957 (affd. in G.R. Nos. L-12026 & L-12131, May

29, 1959), this Court held that considering the nature of the

services performed by Messrs. Kuenzle and Streiff the salary

of P6,000.00 paid to each of them was reasonable and,

therefore, deductions is ordinary and necessary business

expense. The bonus paid to each of said officers was

however reduced to the amount equivalent to that paid to

11




Mr. W. Eggmann, the resident Treasurer and Manager of

petitioner. Following the decision of the Supreme Court in G.

R. Nos. L-12026 & L- 12131, . . ., respondent allowed as

deduction P6,000.00 as salary to Messrs. Kuenzle and Streiff

and a bonus equivalent to that paid annually to Mr. Eggmann

from 1954 to 1957, as indicated above."13

Then the decision of respondent Court of Tax Appeals in

affirming what respondent-appellee did explained why:

"Upon the evidence of record, we find no justification to

reverse or modify the decision of respondent with respect to

the disallowance of a portion of the salaries and bonuses

paid to Messrs. Kuenzle and Streiff. Petitioner seeks to justify

the increase in the salaries of Messrs. Kuenzle and Streiff onthe ground of increased costs of living. The said officers of

petitioner are, however, non-residents of the Philippines."14

It may be stated in this connection that the brief for

petitioner-appellant did not actually dispute the fact of non-

residence of the aforesaid officials. Thus: "A. P. Kuenzle or H.

A. Streiff usually came to the Philippines every two years,

and generally stayed from five to eight weeks (t.s.n., pp. 203-

204). During the years in question, H. A. Streiff was in the

Philippines from January 27 to March 20, 1954. He waspersonally present at the special meeting of the board of

directors of the petitioner-appellant on February 19, 1954

and at the regular meeting on February 27, 1954, the

minutes of all of which he signed as Vice-President (Exhibits

Q, Q-1 and Q-2). He was also personally present at the semi-

annual meeting of stockholders of the petitioner-appellant on

February 19, 1954, the minutes of which he also signed as

vice-president (Exh. R). A. P. Kuenzle was in the Philippines

from February 3 to March 8, 1956 (t.s.n., pp. 204-205). He

was personally present at the special meeting of the board of

directors on February 22, and on February 23, 1956, and at

the semi-annual general meeting of stockholders on February

23, 1956, the minutes of all of which he signed as President

(Exhs. Q-8, Q-9. and R-4). H. A. Streiff came again to the

Philippines in 1958, and he personally attended the special

meeting of the board of directors on March 7, 1968, the

minutes of which he also, signed as Vice-President (Exh. Q-

16)."15

There was in the brief of petitioner-appellant stress laid on

those work performed by them, both in and outside thePhilippines. "During their stay in the Philippines, A. P. Kuenzle

or H. A. Streiff inspected the install petitions of the petitioner-

appellant, and discussed with the local management,

personnel and management matters, long-range planning

and policies of the company (t.s.n., pp. 205-206). Aside from

these visits of A. P. Kuenzle and H. A. Streiff to the

Philippines, there were other personal consultations between

them and the local management. There were about seven

staff members in the local management, and each of them

went on home leave every four years and for consultations inSwitzerland with the general managers, AP Kuenzle and H. A.

Streiff. These home leaves each lasted for six months. In this

way, at least one staff member went on home leave every

year and for consultations with the general

manager. . . ."16

As to commissions and directors' fees, it is the finding of the

12




Court of Tax Appeals: "In connection with the commissions

paid to Messrs. Kuenzle and Streiff there is no evidence of

any particular service rendered by them to petitioner to

warrant payment of commissions. Counsel for petitioner

sought to prove the various types of services performed by

said officers, but the services mentioned are those for which

they have been more than adequately compensated in the

form of salaries and bonuses. As regards the directors' fees,

it is admitted that Messrs. Kuenzle and Streiff "usually came

to the Philippines every two years, and generally stayed from

five to eight weeks." (Page 17, Memorandum for Petitioner.)

We cannot see any justification for the payment of director's

fees of about P10,000.00 to each of said officers for coming

to the Philippines to visit their corporation once in two years.Being non-resident President and Vice-President of Petitioner

corporation of which they are the controlling stockholders,

we are more inclined to believe that said commissions and

directors' fees, payment of which was based on a certain

percentage of the annual profits of petitioner, are in the

nature of dividend distributions,"17

Considering how carefully the Court of Tax Appeals

considered the matter of the disallowances in the light of

Section 30 of the National Internal Revenue Code, the taskfor petitioner-appellant in proving that it erred in holding that

A. P. Kuenzle and H. A. Streiff were entitled only to the salary

of P6,000.00 each a year, for 1954, 1955, 1956 and 1957,

and a bonus equal to the reduced bonus of one of its officials

a certain W. Eggmann, for each of said years, and in

disallowing as deductions the directors' fees and

commissions paid by it to them, was far from easy. Nor could

it be said that petitioner-appellant did succeed in such effort

As mentioned earlier, the previous case of Alhambra Cigar &

Cigarette Manufacturing Company v. The Collector of Internal

Revenue,18 has laid down the applicable principle of law.

In the language of then Justice, now Chief Justice,

Concepcion: "In the light of the tenor of the foregoing

provision, whenever a controversy arises on the deductibility,

for purposes of income tax, of certain items for alleged

compensation of officers of the taxpayer, two (2) questions

become material, namely: (a) Have "personal services" been

"actually rendered" by said officers? (b) In the affirmative

case, what is the "reasonable allowance" therefore? When

the Collector of Internal Revenue disallowed the fees,bonuses and commissions aforementioned, and the company

appealed therefrom, it became necessary for the [Court of

Tax Appeals] to determine whether said officer had correctly

applied section 30 of the Tax Code, and this, in turn, required

the consideration of the two (2) questions already adverted

to. In the circumstances surrounding the case, we are of the

opinion that the [Court of Tax Appeals] has correctly

construed and applied said provision." So it is now. This

appeal too cannot prosper.

Even if there were no such previous decision, it would still

follow, in the light of the controlling doctrines, that the Court

of Tax Appeals must be sustained. The well written brief for

petitioner-appellant citing Botany Worsted Bills v. United

States,19 states: "Whether the amounts disallowed by the

respondent-appellee in the respective years were reasonable

compensation for personal services, is a question of fact to

13




be determined from all the evidence."20 That the question

thus involved is inherently factual, appears to be undeniable.

This Court is bound by the finding of facts of the Court of Tax

Appeals, especially so, where as here, the evidence in

support thereof is more than substantial, only questions of

law thus being left open to it for determination.21 Without

ignoring this various factors which petitioner-appellant would

have this Court consider in passing upon the determination

made by the Court of Tax Appeals but with full recognition of

the fact that the two officials were non-residents, it cannot be

said that it committed the alleged errors, calling for the

interposition of the corrective authority of this Court. Nor as a

matter of principle is it advisable for this Court to set aside

the conclusion reached by an agency such as the Court of Tax Appeals which is, by the very nature of its function,

dedicated exclusively to the study and consideration of tax

problems and has necessarily developed an expertise on the

subject unless, as did not happen here, there has been an

abuse or improvident exercise of its authority.

WHEREFORE, the decision of the Court of Tax Appeals is

affirmed, with costs against petitioner-appellant.

Expenses for police protection is illegal!

G.R. No. L-15922 November 29, 1961

C. F. CALANOC, petitioner,

vs.

THE COLLECTOR OF INTERNAL REVENUE, respondent.

Francisco M. Gonzales for petitioner.

Office of the Solicitor General and Special Attorney Librada

del Rosario-Natividad for respondent.

LABRADOR, J.:

This is a petition to review the decision of the Court of Tax

Appeals affirming an assessment of P7,378.57, by the

Collector of Internal Revenue as amusement tax and

surcharge due on a boxing and wrestling exhibition held by

petitioner Calanoc on December 3, 1949 at the Rizal

Memorial Stadium.

By authority of a solicitation permit issued by the Social

Welfare Commission on November 24, 1949, whereby the

petitioner was authorized to solicit and receive contributionsfor the orphans and destitute children of the Child Welfare

Workers Club of the Commission, the petitioner on December

3, 1949 financed and promoted a boxing and wrestling

exhibition at the Rizal Memorial Stadium for the said

charitable purpose. Before the exhibition took place, the

petitioner applied with the respondent Collector of Internal

Revenue for exemption from payment of the amusement tax,

relying on the provisions of Section 260 of the National

Internal Revenue Code, to which the respondent answered

that the exemption depended upon petitioner's compliance

with the requirements of law.

After the said exhibition, the respondent, through his agent,

investigated the tax case of the petitioner, and from the

statement of receipts which was furnished the agent, the

latter found that the gross sales amounted to P26,553.00;

the expenditures incurred was P25,157.62; and the net profit

14




was only P1,375,30. Upon examination of the said receipts,

the agent also found the following items of expenditures: (a)

P461.65 for police protection; (b) P460.00 for gifts; (c)

P1,880.05 for parties; and (d) several items for

representation.

Out of the proceeds of the exhibition, only P1,375.38 was

remitted to the Social Welfare Commission for the said

charitable purpose for which the permit was issued.

On November 24, 1951, the Collector of Internal Revenue

demanded from the petitioner payment of the amount of

533.00; the expenditures incurred was P25,157.62; and the

net profit was only P1,375,38. Upon examination of the

Secretary of Finance dated June 15, 1948, authorizing denial

of application for exemption from payment of amusement

tax in cases where the net proceeds are not substantial or

where the expenses are exorbitant. Not satisfied with the

assessment imposed upon him, the petitioner brought this

case to the Court of Tax Appeals for review.

After hearing, the tax court rendered the decision sought

herein to be reviewed. Hence, this petition.

Before this Court, the petitioner questions the validity of theassessment of P7,378.57 imposed upon him by the

respondent, as affirmed by the tax court. He denies having

received the stadium fee P1,000, which is not included in the

receipts, and claims that if he did, he can not be made to pay

almost seven times the amount as amusement tax. But

evidence was submitted that while he did not receive said

stadium fee of P1,000, said amount was paid by the O-SO

Beverages directly to the stadium for advertisement

privileges in the evening of the entertainments. As the fee

was paid by said concessionaire, petitioner had no right to

include the P1,000 stadium fee among the items of his

expenses. It results, therefore, that P1,000 went into

petitioner's pocket which is not accounted for.

Furthermore petitioner admitted that he could not justify the

other expenses, such as those for police protection and gifts.

He claims further that the accountant who prepared the

statement of receipts is already dead and could no longer be

questioned on the items contained in said statement.

We have examined the records of the case and we agree

with the lower court that most of the items of expenditures

contained in the statement submitted to the agent are either

exorbitant or not supported by receipts. We agree with the

tax court that the payment of P461.65 for police protection is

illegal as it is a consideration given by the petitioner to the

police for the performance by the latter of the functions

required of them to be rendered by law. The expenditures of

P460.00 for gifts, P1,880.05 for parties and other items for

representation are rather excessive, considering that the

purpose of the exhibition was for a charitable cause.

WHEREFORE, the decision sought herein to be reviewed is

hereby affirmed, with costs against the petitioner.

CIR v ISABELA CULTURAL CORPORATION

FACTS:

ICC was assessed for deficiency income tax [ BIR disallowed

15




expense deductions for professional and security services by 1)

auditing services by SGV & Co. 2) legal services Bengzon law office

3) El Tigre Security services] and deficiency expanded withholding

tax, when it failed to withhold 1% expanded withholding tax. The

CTA cancelled and set aside the assessment notices holding thatthe claimed deductions for professional and security services were

properly claimed in 1986 since it was only in that year when the

bills demanding payment were sent to ICC. It also found that the

ICC withheld 1% expanded withholding tax for security services.

The CA affirmed hence the case at bar.

ISSUE: W/N the aforementioned may be deducted

HELD: For the auditing and legal services NO but for the security

services YES

The requisites for deductibility of ordinary and necessary trade,

business or professional expenses, like expenses paid for legal and

auditing services are: a) the expense must be ordinary and

necessary; b) it must have been paid or incurred during the taxable

year; c) it must have been paid or incurred in carrying on the trade

or business of the taxpayer and d) it must be supported by

receipts, records and other pertinent papers.

The requisite that it must have been paid or incurred during the

taxable year is qualified by Sec. 45 of NIRC which states that “the

deduction provide for in this title shall be taken for the taxable yearin which ‘paid or incurred’ dependent upon the method of

accounting upon the basis of which the net income is computed x x

x”.

ICC uses the accrual method. RAM No. 1-2000 provides that under

the accrual method, expenses not claimed as deductions in the

current year when they are incurred CANNOT be claimed as

deduction from income for the succeeding year. The accrual

method relies upon the taxpayer’s right to receive amount or its

obligation to pay them NOT the actual receipt or payment.

Amounts of income accrue where the right to receive them becomefixed, where there is created an enforceable liability. Liabilities are

accrued when fixed and determinable in amount.

The accrual of income and expense is permitted when the ALL-

EVENTS TEST has been met. The test requires that: 1) fixing of a

right to income or liability to pay and 2) the availability of the

reasonable accurate determination of such income or liability. It

does not require that the amount be absolutely known only that the

taxpayer has information necessary to compute the amount with

reasonable accuracy. The test is satisfied where computation

remains uncertain if its basis is unchangeable. The amount of

liability does not have to be determined exactly, it must be

determined with reasonable accuracy.

In the case at bar, the expenses for legal services pertain to the

years 1984 and 1985. The firm has been retained since 1960. From

the nature of the claimed deduction and the span of time during

which the firm was retained, ICC can be expected to have

reasonably known the retainer fees charged by the firm as well as

compensation for its services. Exercising due diligence, they could

have inquired into the amount of their obligation. It could havereasonably determined the amount of legal and retainer fees owing

to their familiarity with the rates charged.

The professional fees of SGV cannot be validly claimed as

deductions in 1986. ICC failed to present evidence showing that

even with only reasonable accuracy, it cannot determine the

professional fees which the company would charge.

16




CIR v GENERAL FOODSAGUINALDO INDUSTRIES v CIR

FACTS:

Aguinaldo Industries Corporation (AIC) is a domestic corporationengaged in the manufacture of fishing nets, a tax-exempt industryand the manufacture of furniture. For accounting purposes, eachdivision is provided with separate books of accounts. Previously,AIC acquired a parcel of land in Muntinlupa, Rizal, as site of thefishing net factory. Later, it sold the Muntinlupa property. AICderived profit from this sale which was entered in the books of theFish Nets Division as miscellaneous income to distinguish it from itstax-exempt income.

For the year 1957, AIC filed two separate income tax returns foreach division. After investigation, the examiners of the BIR foundthat the Fish Nets Division deducted from its gross income for thatyear the amount of P61,187.48 as additional remuneration paid tothe officers of AIC. This amount was taken from the net profit of anisolated transaction (sale of Muntinlupa land) not in the course of orcarrying on of AIC's trade or business, and was reported as part of the selling expenses of the Muntinlupa land. Upon recommendationof the examiner that the said sum of P61,187.48 be disallowed asdeduction from gross income, petitioner asserted in its letter of February 19, 1958, that said amount should be allowed asdeduction because it was paid to its officers as allowance or bonus

pursuant to its by-laws.

ISSUE/HELD: W/N the bonus given to the officers of the petitionerupon the sale of its Muntinlupa land is an ordinary and necessarybusiness expense deductible for income tax purposes - NO

RATIO: Sec. 30 (a) (1) of the Tax Code provides that in computingnet income, there shall be allowed as deductions ‘Expenses,including all the ordinary and necessary expenses paid or incurredduring the taxable year in carrying on any trade or business,

including a reasonable allowance for personal services actually rendered.

The bonus given to the officers of the petitioner as their share of

the profit realized from the sale of petitioner's Muntinglupa landcannot be deemed a deductible expense for tax purposes, even if the aforesaid sale could be considered as a transaction for carryingon the trade or business of the petitioner and the grant of thebonus to the corporate officers pursuant to petitioner's by-lawscould, as an intra-corporate matter, be sustained. The records showthat the sale was effected through a broker who was paid bypetitioner a commission of P51,723.72 for his services. On theother hand, there is absolutely no evidence of any service actuallyrendered by petitioner's officers which could be the basis of a grantto them of a bonus out of the profit derived from the sale. Thisbeing so, the payment of a bonus to them out of the gain realized

from the sale cannot be considered as a selling expense; nor can itbe deemed reasonable and necessary so as to make it deductiblefor tax purposes. The extraordinary and unusual amounts paid bypetitioner to these directors in the guise and form of compensationfor their supposed services as such, without any relation to themeasure of their actual services, cannot be regarded as ordinary and necessary expenses within the meaning of the law. This is inline with the doctrine in the law of taxation that the taxpayer mustshow that its claimed deductions clearly come within the languageof the law since allowances, like exemptions, are matters of legislative grace.

ATLAS CONSOLIDATED MINING v CIR

FACTS:

Atlas is a corporation engaged in the mining industryregistered. On August 1962, CIR assessed against Atlas fordeficiency income taxes for the years 1957 and 1958. For theyear 1957, it was the opinion of the CIR that Atlas is notentitled to exemption from the income tax under RA 909

17




because same covers only gold mines. For the year 1958, thedeficiency income tax covers the disallowance of itemsclaimed by Atlas as deductible from gross income. Atlasprotested for reconsideration and cancellation, thus the CIR

conducted a reinvestigation of the case.

On October 1962, the Secretary of Finance ruled that theexemption provided in RA 909 embraces all new mines andold mines whether gold or other minerals. Accordingly, theCIR recomputed Atlas deficiency income tax liabilities in thelight of said ruling. On June 1964, the CIR issued a revisedassessment entirely eliminating the assessment for the year1957. The assessment for 1958 was reduced from whichAtlas appealed to the CTA, assailing the disallowance of thefollowing items claimed as deductible from its gross income

for 1958: Transfer agent's fee, Stockholders relation servicefee, U.S. stock listing expenses, Suit expenses, and Provisionfor contingencies. The CTA allowed said items as deductionexcept those denominated by Atlas as stockholders relationservice 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 thedisallowance of the deduction from gross income of the so-called stockholders relation service fee.

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

RATIO: Section 30 (a) (1) of the Tax Code allows a deductionof "all the ordinary and necessary expenses paid or incurredduring the taxable year in carrying on any trade or business."An item of expenditure, in order to be deductible under thissection of the statute, must fall squarely within its language.

To be deductible as a business expense, three conditions areimposed, namely: (1) the expense must be ordinary andnecessary, (2) it must be paid or incurred within the taxableyear, and (3) it must be paid or incurred in carrying in a trade

or business. In addition, not only must the taxpayer meet thebusiness test, he must substantially prove by evidence orrecords the deductions claimed under the law, otherwise, thesame will be disallowed. The mere allegation of the taxpayerthat an item of expense is ordinary and necessary does not justify its deduction.

The SC has never attempted to define with precision theterms "ordinary and necessary." As a guiding principle,ordinarily, an expense will be considered "necessary" wherethe expenditure is appropriate and helpful in the

development of the taxpayer's business. It is "ordinary" whenit connotes a payment which is normal in relation to thebusiness of the taxpayer and the surrounding circumstances. The term "ordinary" does not require that the payments behabitual or normal in the sense that the same taxpayer willhave to make them often; the payment may be unique ornon-recurring to the particular taxpayer affected.

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

18




It appears that on December 1957, Atlas increased its capitalstock. It claimed that its shares of stock were sold in theUnited States because of the services rendered by the publicrelations firm. The information about Atlas given out and

played up in the mass communication media resulted in fullsubscription of the additional shares issued by Atlas;consequently, the ‘stockholders relation service fee’, thecompensation 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. Itis not deductible from Atlas gross income in 1958 becauseexpenses relating to recapitalization and reorganization of the corporation, the cost of obtaining stock subscription,promotion expenses, and commission or fees paid for thesale of stock reorganization are capital expenditures. That

the expense in question was incurred to create a favorableimage of the corporation in order to gain or maintain thepublic's and its stockholders' patronage, does not make itdeductible as business expense. As held in a US case, effortsto establish reputation are akin to acquisition of capitalassets and, therefore, expenses related thereto are notbusiness expense but capital expenditures.

Note: The burden of proof that the expenses incurred areordinary and necessary is on the taxpayer and does not restupon the Government. To avail of the claimed deduction, it is

incumbent upon the taxpayer to adduce substantial evidenceto establish a reasonably proximate relation petition betweenthe expenses to the ordinary conduct of the business of thetaxpayer. A logical link or nexus between the expense andthe taxpayer's business must be established by the taxpayer.

ROXAS v CTA

FACTS:

Don Pedro Roxas and Dona Carmen Ayala, Spanish subjects,transmitted to their grandchildren by hereditary succession

agricultural lands in Batangas, a residential house and lot in Manila,and shares of stocks in different corporations. To manage theproperties, said children, namely, Antonio, Eduardo and Jose Roxasformed a partnership called Roxas y Compania.

On June 1958, the CIR assessed deficiency income taxes againstthe Roxas Brothers for the years 1953 and 1955. Part of thedeficiency income taxes resulted from the disallowance of deductions from gross income of various business expenses andcontributions claimed by Roxas. (see expense items below)

The Roxas brothers protested the assessment but inasmuch as said

protest was denied, they instituted an appeal in the CTA, whichsustained the assessment except the demand for the payment of the fixed tax on dealer of securities and the disallowance of thedeductions for contributions to the Philippine Air Force Chapel andHijas de Jesus' Retiro de Manresa. Not satisfied, Roxas brothersappealed to the SC. The CIR did not appeal.

ISSUES/HELD: W/N the deductions for business expenses andcontributions deductible

RATIO: With regard to the disallowed deductions (expenses for

tickets to a banquet given in honor of Sergio Osmena and beergiven as gifts to various persons, labelled as representationexpenses), representation expenses are deductible from grossincome as expenditures incurred in carrying on a trade or businessunder Section 30(a) of the Tax Code provided the taxpayer provesthat they are reasonable in amount, ordinary and necessary, andincurred in connection with his business. In the case at bar, theevidence does not show such link between the expenses and thebusiness of Roxas.

19




The petitioners also claim deductions for contributions to the PasayCity Police, Pasay City Firemen, and Baguio City Police Christmasfunds, Manila Police Trust Fund, Philippines Herald's fund forManila's neediest families and Our Lady of Fatima chapel at FarEastern University. The contributions to the Christmas funds of thePasay City Police, Pasay City Firemen and Baguio City Police are notdeductible for the reason that the Christmas funds were not spent for public purposes but as Christmas gifts to the families of themembers of said entities. Under Section 39(h), a contribution to agovernment entity is deductible when used exclusively for public purposes. For this reason, the disallowance must be sustained. Onthe other hand, the contribution to the Manila Police trust fund is anallowable deduction for said trust fund belongs to the Manila Police,a government entity, intended to be used exclusively for its publicfunctions. The contributions to the Philippines Herald's fund forManila's neediest families were disallowed on the ground that thePhilippines Herald is not a corporation or an associationcontemplated in Section 30 (h) of the Tax Code. It should be notedhowever that the contributions were not made to the PhilippinesHerald but to a group of civic spirited citizens organized by thePhilippines Herald solely for charitable purposes. There is noquestion that the members of this group of citizens do not receiveprofits, for all the funds they raised were for Manila's neediestfamilies. Such a group of citizens may be classified as anassociation organized exclusively for charitable purposesmentioned in Section 30(h) of the Tax Code.

The contribution to Our Lady of Fatima chapel at the Far Eastern

University should also be disallowed on the ground that the saiduniversity gives dividends to its stockholders. Located within thepremises of the university, the chapel in question has not beenshown to belong to the Catholic Church or any religiousorganization. It belongs to the Far Eastern University, contributionsto which are not deductible under Section 30(h) of the Tax Code forthe reason that the net income of said university injures to the

benefit of its stockholders.

ZAMORA v CIR

FACTS:

Mariano Zamora, owner of the Bay View Hotel and FarmaciaZamora, filed his income tax returns. The CIR found that he failedto file his return of the capital gains derived from the sale of certainreal properties and claimed deductions which were not allowable. The collector required him to pay deficiency income tax. On appealby Zamora, the CTA reduced the amount of deficiency income tax.

Zamora appealed, alleging that the CTA erred in dissallowingP10,478.50, as promotion expenses incurred by his wife for thepromotion of the Bay View Hotel and Farmacia Zamora (which is ½of P20,957.00, supposed business expenses).

Zamora alleged that the CTA erred in disallowing P10,478.50 aspromotion expenses incurred by his wife for the promotion of theBay View Hotel and Farmacia Zamora. He contends that the wholeamount of P20,957.00 as promotion expenses, should be allowedand not merely one-half of it, on the ground that, while not all theitemized expenses are supported by receipts, the absence of somesupporting receipts has been sufficiently and satisfactorilyestablished.

ISSUE: w/n CTA erred in allowing only one half of the promotionexpenses. NO

HELD:Section 30, of the Tax Code, provides that in computing netincome, there shall be allowed as deductions all the ordinary andnecessary expenses paid or incurred during the taxable year, incarrying on any trade or business. Since promotion expensesconstitute one of the deductions in conducting a business, samemust satisfy these requirements. Claim for the deduction of promotion expenses or entertainment expenses must also besubstantiated or supported by record showing in detail the amountand nature of the expenses incurred.

Considering, as heretofore stated, that the application of Mrs.

20




Zamora for dollar allocation shows that she went abroad on acombined medical and business trip, not all of her expenses cameunder the category of ordinary and necessary expenses; partthereof constituted her personal expenses. There having been nomeans by which to ascertain which expense was incurred by her inconnection with the business of Mariano Zamora and which wasincurred for her personal benefit, the Collector and the CTA in theirdecisions, considered 50% of the said amount of P20,957.00 asbusiness expenses and the other 50%, as her personal expenses.We hold that said allocation is very fair to Mariano Zamora, therehaving been no receipt whatsoever, submitted to explain thealleged business expenses, or proof of the connection which saidexpenses had to the business or the reasonableness of the saidamount of P20,957.00.

In the case of Visayan Cebu Terminal Co., Inc. v. CIR., it wasdeclared that representation expenses fall under thecategory of business expenses which are allowabledeductions from gross income, if they meet the conditionsprescribed by law, particularly section 30 (a) [1], of the TaxCode; that to be deductible, said business expenses mustbe ordinary and necessary expenses paid or incurred incarrying on any trade or business; that those expensesmust also meet the further test of reasonableness inamount. They should also be covered by supporting papers;in the absence thereof the amount properly deductible asrepresentation expenses should be determined fromavailable data.

Expenses

C.M. HOSKINS&CO, INC. v CIR

Facts:

Petitioner, a domestic corporation engaged in the real estatebusiness as brokers, managing agents and administrators,

filed its income tax return for its fiscal year endingSeptember 30, 1957 showing a net income of P92,540.25and a tax liability due thereon of P18,508.00, which it paid indue course. Upon verification of its return, CIR, disallowed

four items of deduction in petitioner's tax returns andassessed against it an income tax deficiency in the amount of P28,054.00 plus interests. The Court of Tax Appeals uponreviewing the assessment at the taxpayer's petition, upheldrespondent's disallowance of the principal item of petitioner'shaving paid to Mr. C. M. Hoskins, its founder and controllingstockholder the amount of P99,977.91 representing 50% of supervision fees earned by it and set aside respondent'sdisallowance of three other minor items.

Petitioner questions in this appeal the Tax Court's findings

that the disallowed payment to Hoskins was an inordinatelylarge one, which bore a close relationship to the recipient'sdominant stockholdings and therefore amounted in law to adistribution of its earnings and profits.

Issue: Whether the 50% supervision fee paid to Hoskin maybe deductible for income tax purposes.

Ruling: NO.

Ratio:

Hoskin owns 99.6% of the CM Hoskins & Co. He was also thePresident and Chairman of the Board. That as chairman of the Board of Directors, he received a salary of P3,750.00 amonth, plus a salary bonus of about P40,000.00 a year andan amounting to an annual compensation of P45,000.00 andan annual salary bonus of P40,000.00, plus free use of thecompany car and receipt of other similar allowances andbenefits, the Tax Court correctly ruled that the payment by

21




petitioner to Hoskins of the additional sum of P99,977.91 ashis equal or 50% share of the 8% supervision fees receivedby petitioner as managing agents of the real estate,subdivision projects of Paradise Farms, Inc. and Realty

Investments, Inc. was inordinately large and could not beaccorded the treatment of ordinary and necessary expensesallowed as deductible items within the purview of the TaxCode.

The fact that such payment was authorized by a standingresolution of petitioner's board of directors, since "Hoskinshad personally conceived and planned the project" cannotchange the picture. There could be no question that asChairman of the board and practically an absolutelycontrolling stockholder of petitioner, Hoskins wielded

tremendous power and influence in the formulation andmaking of the company's policies and decisions. Even just asboard chairman, going by petitioner's own enumeration of the powers of the office, Hoskins, could exercise great powerand influence within the corporation, such as directing thepolicy of the corporation, delegating powers to the presidentand advising the corporation in determining executivesalaries, bonus plans and pensions, dividend policies, etc.

It is a general rule that 'Bonuses to employees made in goodfaith and as additional compensation for the services actually

rendered by the employees are deductible, provided suchpayments, when added to the stipulated salaries, do notexceed a reasonable compensation for the servicesrendered. The conditions precedent to the deduction of bonuses to employees are: (1) the payment of the bonuses isin fact compensation; (2) it must be for personal servicesactually rendered; and (3) the bonuses, when added to thesalaries, are 'reasonable when measured by the amount andquality of the services performed with relation to the

business of the particular taxpayer.

There is no fixed test for determining the reasonableness of agiven bonus as compensation. This depends upon many

factors, one of them being the amount and quality of theservices performed with relation to the business.' Other testssuggested are: payment must be 'made in good faith'; 'thecharacter of the taxpayer's business, the volume and amountof its net earnings, its locality, the type and extent of theservices rendered, the salary policy of the corporation'; 'thesize of the particular business'; 'the employees' qualificationsand contributions to the business venture'; and 'generaleconomic conditions. However, 'in determining whether theparticular salary or compensation payment is reasonable, thesituation must be considered as whole. Ordinarily, no single

factor is decisive. . . . it is important to keep in mind that itseldom happens that the application of one test can givesatisfactory answer, and that ordinarily it is the interplay of several factors, properly weighted for the particular case,which must furnish the final answer."

Petitioner's case fails to pass the test. On the right of theemployer as against respondent Commissioner to fix thecompensation of its officers and employees, we there heldfurther that while the employer's right may be conceded, thequestion of the allowance or disallowance thereof as

deductible expenses for income tax purposes is subject todetermination by CIR. As far as petitioner's contention that asemployer it has the right to fix the compensation of itsofficers and employees and that it was in the exercise of such right that it deemed proper to pay the bonuses inquestion, all that We need say is this: that right may beconceded, but for income tax purposes the employer cannotlegally claim such bonuses as deductible expenses unlessthey are shown to be reasonable. To hold otherwise would

22




open the gate of rampant tax evasion.

Lastly, We must not lose sight of the fact that the question of allowing or disallowing as deductible expenses the amounts

paid to corporate officers by way of bonus is determined byrespondent exclusively for income tax purposes. Concededly,he has no authority to fix the amounts to be paid tocorporate officers by way of basic salary, bonus or additionalremuneration — a matter that lies more or less exclusivelywithin the sound discretion of the corporation itself. But thisright of the corporation is, of course, not absolute. It cannotexercise it for the purpose of evading payment of taxeslegitimately due to the State."

CALANOC v CIR

KUENZLE & STREIF, INC. v CIR

FACTS:

Petitioner is a domestic corporation engaged in theimportation of textiles, hardware, sundries, chemicals,pharmaceuticals, lumbers, groceries, wines and liquor; ininsurance and lumber; and in some exports. When Petitionerfiled its Income Tax Return, it deducted from its gross income

the following items:

1. salaries, directors' fees and bonuses of its non-residentpresident and vice-president;

2. bonuses of its resident officers and employees; and

3. interests on earned but unpaid salaries and bonuses of its officers and employees.

The CIR disallowed the deductions and assessed Petitionerfor deficiency income taxes. Petitioner requested for re-examination of the assessment. CIR modified the same byallowing as deductible all items comprising directors' fees

and salaries of the non-resident president and vice-president,but disallowing the bonuses insofar as they exceed thesalaries of the recipients, as well as the interests on earnedbut unpaid salaries and bonuses.

The CTA modified the assessment and ruled that while thebonuses given to the non-resident officers are reasonable,bonuses given to the resident officers and employees arequite excessive.

ISSUES/RULING:

W/N the CTA erred in ruling that the measure of thereasonableness of the bonuses paid to its non-residentpresident and vice-president should be applied to thebonuses given to resident officers and employees indetermining their deductibility? NO.

It is a general rule that "Bonuses to employees made in goodfaith and as additional compensation for the services actuallyrendered by the employees are deductible, provided suchpayments, when added to the stipulated salaries, do notexceed a reasonable compensation for the servicesrendered.” The condition precedents to the deduction of bonuses to employees are:

1. the payment of the bonuses is in fact compensation;2. it must be for personal services actually rendered; and

3. the bonuses, when added to the salaries, are

23




reasonable when measured by the amount and qualityof the services performed with relation to the businessof the particular taxpayer

There is no fixed test for determining the reasonableness of agiven bonus as compensation. However, in determiningwhether the particular salary or compensation payment isreasonable, the situation must be considered as a whole.

Petitioner contended that it is error to apply the samemeasure of reasonableness to both resident and non-residentofficers because the nature, extent and quality of theservices performed by each with relation to the business of the corporation widely differ. Said non-resident officers hadrendered the same amount of efficient personal service and

contribution to deserve equal treatment in compensation andother emoluments. There is no special reason for grantinggreater bonuses to such lower ranking officers than thosegiven to the non-resident president and vice president.

W/N the CTA erred in allowing the deduction of thebonuses in excess of the yearly salaries of theemployees? NO.

The deductible amount of said bonuses cannot be onlyequal to their respective yearly salaries considering the post-war policy of the corporation in giving salaries at low levelsbecause of the unsettled conditions resulting from war andthe imposition of government controls on imports andexports and on the use of foreign exchange which resulted inthe diminution of the amount of business and the consequentloss of profits on the part of the corporation. The payment of bonuses in amounts a little more than the yearly salariesreceived considering the prevailing circumstances is in ouropinion reasonable.

W/N the CTA erred in disallowing the deduction of interests on earned but unpaid salaries and bonuses?NO.

Under the law, in order that interest may be deductible, itmust be paid "on indebtedness." It is therefore imperative toshow that there is an existing indebtedness which may besubjected to the payment of interest. Here the items involvedare unclaimed salaries and bonus participation which cannotconstitute indebtedness within the meaning of the lawbecause while they constitute an obligation on the part of thecorporation, it is not the latter's fault if they remainedunclaimed. Whatever an employee may fail to collect cannotbe considered an indebtedness for it is the concern of theemployee to collect it in due time. The willingness of the

corporation to pay interest thereon cannot be considered a justification to warrant deduction.

Interest

PAPER INDUSTRIES v CA ( Dec. 1, 1995)

Facts:

On various years (1969, 1972 and 1977), Picop obtained

loans from foreign creditors in order to finance the purchase of

machinery and equipment needed for its operations. In its 1977Income Tax Return, Picop claimed interest payments made in 1977,

amounting to P42,840,131.00, on these loans as a deduction from

its 1977 gross income.

The CIR disallowed this deduction upon the ground that,

because the loans had been incurred for the purchase of machinery

and equipment, the interest payments on those loans should have

been capitalized instead and claimed as a depreciation deduction

24




taking into account the adjusted basis of the machinery and

equipment (original acquisition cost plus interest charges) over the

useful life of such assets.

Both the CTA and the Court of Appeals sustained theposition of Picop and held that the interest deduction claimed by

Picop was proper and allowable. In the instant Petition, the CIR

insists on its original position.

ISSUE:

Whether Picop is entitled to deductions against income of

interest payments on loans for the purchase of machinery and

equipment.

HELD:

YES. Interest payments on loans incurred by a taxpayer

(whether BOI-registered or not) are allowed by the NIRC as

deductions against the taxpayer's gross income. The basis is 1977

Tax Code Sec. 30 (b).1 Thus, the general rule is that interest

expenses are deductible against gross income and this certainly

includes interest paid under loans incurred in connection with the

carrying on of the business of the taxpayer. In the instant case, the

CIR does not dispute that the interest payments were made by

1

Sec. 30. Deduction from Gross Income. — The followingmay be deducted from gross income:xxx xxx xxx

(b) Interest :(1) In general. — The amount of interest paid within

the taxable year on indebtedness, except on indebtednessincurred or continued to purchase or carry obligations theinterest upon which is exempt from taxation as income underthis Title: . . . (Emphasis supplied)

Picop on loans incurred in connection with the carrying on of the

registered operations of Picop, i.e., the financing of the purchase of

machinery and equipment actually used in the registered

operations of Picop. Neither does the CIR deny that such interest

payments were legally due and demandable under the terms of such loans, and in fact paid by Picop during the tax year 1977.

The contention of CIR does not spring of the 1977 Tax Code

but from Revenue Regulations 2 Sec. 79.2 However, the Court said

that the term “interest” here should be construed as the so-called

"theoretical interest," that is to say, interest "calculated" or

computed (and not incurred or paid ) for the purpose of

determining the "opportunity cost" of investing funds in a

given business. Such "theoretical" or imputed interest

does not arise from a legally demandable interest-bearing

obligation incurred by the taxpayer who however wishes tofind out, e.g., whether he would have been better off by lending out

his funds and earning interest rather than investing such funds in

his business. One thing that Section 79 quoted above makes clear

is that interest which does constitute a charge arising under an

interest-bearing obligation is an allowable deduction from gross

income.

Only if sir asks: (For further discussion of CIR’s contention)

It is claimed by the CIR that Section 79 of Revenue

Regulations No. 2 was "patterned after" paragraph 1.266-1 (b),

entitled "Taxes and Carrying Charges Chargeable to Capital

Account and Treated as Capital Items" of the U.S. Income Tax

2 Sec. 79. Interest on Capital. — Interest calculated for cost-keeping

or other purposes on account of capital or surplus invested in the

business, which does not represent a charge arising under an

interest-bearing obligation, is not allowable deduction from gross

income. (Emphases supplied)25




Regulations, which paragraph reads as follows:

(B) Taxes and Carrying Charges. — The itemsthus chargeable to capital accounts are —

(11) In the case of real property, whetherimproved or unimproved and whetherproductive or nonproductive.

(a) Interest on a loan (but not theoreticalinterest of a taxpayer using his own funds).

The truncated excerpt of the U.S. Income Tax Regulationsquoted by the CIR needs to be related to the relevantprovisions of the U.S. Internal Revenue Code, whichprovisions deal with the general topic of adjusted basis fordetermining allowable gain or loss on sales or exchanges of property and allowable depreciation and depletion of capitalassets of the taxpayer:

Present Rule. The Internal Revenue Code, andthe Regulations promulgated thereunderprovide that "No deduction shall be allowed foramounts paid or accrued for such taxesand carrying charges as, under regulations

prescribed by the Secretary or his delegate, arechargeable to capital account with respect toproperty, if the taxpayer elects, in accordancewith such regulations, to treat such taxesorcharges as so chargeable."

At the same time, under the adjustment of basisprovisions which have just been discussed, it isprovided that adjustment shall be made for all

"expenditures, receipts, losses, or other items"properly chargeable to a capital account, thusincluding taxes and carrying charges;however, an exception exists, in which event

such adjustment to the capital account is notmade, with respect to taxes and carryingcharges which the taxpayer has not elected tocapitalize but for which a deduction instead hasbeen taken. 22 (Emphasis supplied)

The "carrying charges" which may be capitalized underthe above quoted provisions of the U.S. InternalRevenue Code include, as the CIR has pointed out,interest on a loan "(but not theoretical interest of ataxpayer using his own funds)." What the CIR failed to

point out is that such "carrying charges" may, at theelection of the taxpayer, either be (a) capitalized inwhich case the cost basis of the capital assets, e.g.,machinery and equipment, will be adjusted by addingthe amount of such interest payments or alternatively,be (b) deducted from gross income of the taxpayer.Should the taxpayer elect to deduct the interestpayments against its gross income, the taxpayercannot at the same time capitalize the interestpayments. In other words, the taxpayer is not entitledto both the deduction from gross income and the

adjusted (increased) basis for determining gain or lossand the allowable depreciation charge. The U.S.Internal Revenue Code does not prohibit the deductionof interest on a loan obtained for purchasingmachinery and equipment against grossincome, unless the taxpayer has also or previouslycapitalized the same interest payments and therebyadjusted the cost basis of such assets.

26




CIR v VDA DE PRIETO

FACTS:

On December 4, 1945, the respondent conveyed by way of gifts toher four children, namely, Antonio, Benito, Carmen and Mauro, allsurnamed Prieto, real property with a total assessed value of P892,497.50. After the filing of the gift tax returns on or aboutFebruary 1, 1954, the petitioner Commissioner of Internal Revenueappraised the real property donated for gift tax purposes atP1,231,268.00, and assessed the total sum of P117,706.50 asdonor's gift tax, interest and compromises due thereon. Of the totalsum of P117,706.50 paid by respondent on April 29, 1954, the sumof 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 aforesaidP55,978.65, including interest up to March 31, 1957, surcharge andcompromise for the late payment.

Under the law, for interest to be deductible, it must be shown thatthere be an indebtedness, that there should be interest upon it,and that what is claimed as an interest deduction should have beenpaid or accrued within the year. It is here conceded that theinterest paid by respondent was in consequence of the latepayment of her donor's tax, and the same was paid within the yearit is sought to be declared.

To sustain the proposition that the interest payment in question isnot deductible for the purpose of computing respondent's netincome, petitioner relies heavily on section 80 of RevenueRegulation No. 2 (known as Income Tax Regulation) promulgatedby the Department of Finance, which provides that "the word`taxes' means taxes proper and no deductions should be allowedfor amounts representing interest, surcharge, or penalties incidentto delinquency." The court below, however, held section 80 as

inapplicable to the instant case because while it implementssections 30(c) of the Tax Code governing deduction of taxes, therespondent taxpayer seeks to come under section 30(b) of thesame Code providing for deduction of interest on indebtedness.

ISSUE:

Whether or not such interest was paid upon an indebtedness withinthe contemplation of section 30 (b) (1) of the Tax Code?

RULING:

Yes. According to the Supreme Court, although interest paymentfor delinquent taxes is not deductible as tax under Section 30(c) of the Tax Code and section 80 of the Income Tax Regulations, thetaxpayer is not precluded thereby from claiming said interestpayment as deduction under section 30(b) of the same Code.

SEC. 30 Deductions from gross income. — In computing netincome there shall be allowed as deductions —

(b) Interest:

(1) In general. — The amount of interest paid withinthe taxable year on indebtedness, except onindebtedness incurred or continued to purchase orcarry obligations the interest upon which is exempt

from taxation as income under this Title.

The term "indebtedness" as used in the Tax Code of theUnited States containing similar provisions as in the above-quoted section has been defined as an unconditional andlegally enforceable obligation for the payment of money.

To give to the quoted portion of section 80 of our Income Tax Regulations the meaning that the petitioner gives it

27




would run counter to the provision of section 30(b) of the TaxCode and the construction given to it by courts in the UnitedStates. Such effect would thus make the regulation invalid fora "regulation which operates to create a rule out of harmony

with the statute, is a mere nullity." As already stated, section80 implements only section 30(c) of the Tax Code, or theprovision allowing deduction of taxes, while hereinrespondent seeks to be allowed deduction under section30(b), which provides for deduction of interest onindebtedness.

BIR RULING NO 006-00

Taxes

CIR v LEDNICKY

Losses

PAPER INDUSTRIES v CA ( Dec. 1, 1995)

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

corporation registered with the Board of Investments ("BOI") asa preferred pioneer enterprise with respect to its integratedpulp and paper mill, and as a preferred non-pioneer enterprise with respect to its integrated plywood and veneermills.

• In 1969, 1972 and 1977, Picop obtained loans from foreigncreditors in order to finance the purchase of machinery andequipment needed for its operations.

• Picop also issued promissory notes of about P230M, on w/c itpaid P45M in interest.

• In its 1977 Income Tax Return, Picop claimed the interest

payments on the loans as DEDUCTIONS from its 1977 grossincome.

• The CIR disallowed this deduction upon the ground that,because the loans had been incurred for the purchase of machinery and equipment, the interest payments on thoseloans should have been capitalized instead and claimed as adepreciation deduction taking into account the adjustedbasis of the machinery and equipment (original acquisitioncost plus interest charges) over the useful life of suchassets.

• I: W/n the interest payments can be deducted from grossincome – YES transaction tax

• R:

• The 1977 NIRC does not prohibit the deduction of intereston 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 interestpayments. Accordingly, the general rule that interestpayments on a legally demandable loan are deductible fromgross income must be applied.

• In this case, the CIR does not dispute that the interestpayments were made by Picop on loans incurred inconnection with the carrying on of the registered operationsof Picop, i.e., the financing of the purchase of machinery andequipment actually used in the registered operations of Picop. Neither does the CIR deny that such interest

payments were legally due and demandable under theterms of such loans, and in fact paid by Picop during the taxyear 1977.

• The CIR has been unable to point to any provision of the1977 Tax Code or any other Statute that requires thedisallowance of the interest payments made by Picop.

• THIS PART DI KO SUPER MAGETS:

• The CIR invokes Section 79 of Revenue Regulations No. 2w/c provides that Interest calculated for cost-keeping or

28




other purposes on account of capital or surplus invested inthe business, which does not represent a charge arisingunder an interest-bearing obligation, is not allowablededuction from gross income.

• It is claimed by the CIR that Section 79 of RevenueRegulations No. 2 was "patterned after" paragraph 1.266-1(b), entitled "Taxes and Carrying Charges Chargeable toCapital Account and Treated as Capital Items" of the U.S.Income Tax Regulations, which paragraph reads as follows:

(B) Taxes and Carrying Charges. — The items thus

chargeable to capital accounts are —

(11) In the case of real property, whether improved

or unimproved and whether productive or

nonproductive.

(a) Interest on a loan (but not theoretical interest of ataxpayer using his own funds). 21

The truncated excerpt of the U.S. Income Tax Regulations quoted

by the CIR needs to be related to the relevant provisions of the U.S.

Internal Revenue Code, which provisions deal with the general topic

of adjusted basis for determining allowable gain or loss on sales or

exchanges of property and allowable depreciation and depletion of

capital assets of the taxpayer:

Present Rule. The Internal Revenue Code, and the

Regulations promulgated thereunder provide that"No deduction shall be allowed for amounts paid or

accrued for such taxes and carrying charges as,

under regulations prescribed by the Secretary or his

delegate, are chargeable to capital account with

respect to property, if the taxpayer elects, in

accordance with such regulations, to treat such taxes

or charges as so chargeable."

At the same time, under the adjustment of basis

provisions which have just been discussed, it is

provided that adjustment shall be made for all

"expenditures, receipts, losses, or other items"

properly chargeable to a capital account, thusincluding taxes and carrying charges; however, an

exception exists, in which event such adjustment to

the capital account is not made, with respect to

taxes and carrying charges which the taxpayer has

not elected to capitalize but for which a deduction

instead has been taken.

The "carrying charges" which may be capitalized under the

above quoted provisions of the U.S. Internal Revenue Code

include, as the CIR has pointed out, interest on a loan "(but

not theoretical interest of a taxpayer using his own funds)."What the CIR failed to point out is that such "carrying

charges" may , at the election of the taxpayer, either be (a)

capitalized in which case the cost basis of the capital assets,

e.g., machinery and equipment, will be adjusted by adding

the amount of such interest payments or alternatively, be

(b) deducted from gross income of the taxpayer. Should the

taxpayer elect to deduct the interest payments against its

gross income, the taxpayer cannot at the same time

capitalize the interest payments. In other words, the

taxpayer is not entitled to both the deduction from grossincome and the adjusted (increased) basis for determining

gain or loss and the allowable depreciation charge. The U.S.

Internal Revenue Code does not prohibit the deduction of

interest on a loan obtained for purchasing machinery and

equipment against gross income, unless the taxpayer has

also or previously capitalized the same interest payments

and thereby adjusted the cost basis of such assets.

29




BIR RULING 30-00

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

2000

INCOME TAX; Tax-free merger under certain condition

- Pursuant to Section 40(c)(2)

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

Circle Philippines, Inc. (BCPI), Round Royal, Inc. (RRI), SM

Investment Corporation (SMIC), Sysmart Corporation and

CG&E Holdings on the transfer of their Fortune, Zeus and

Iligan shares to Republic, in exchange for ne Republic shares,

because they together hold more than 51% of the total

voting stock of Republic after the transfer. The transfer

through the facilities of the PSE by the 6th to the last

transferor of their Fortune and Zeus shares to Republic in

exchange for new Republic shares will be subject to the ½ of

1% stock transaction tax based on the gross selling price or

gross value in money of the shares transferred, while the 6th

to the last transferor of the Iligan shares will be subject to

capital gains tax (CGT) at the rate of 5%, of the par value of

the shares transferred. The new Republic shares to be

issued, being original issuances, are subject to the DSTimposed under Section 175 of the Tax Code at the rate of P2

on each P200, or fractional part thereof, of the par value of

the new Republic shares issued. The net operating losses of

each of Republic, Fortune, MPCC and Iligan are preserved

after the proposed share swap and may be carried over and

claimed as a deduction from their respective gross income,

pursuant to Section 34(D)(3) of the Tax Code, because there

is no substantial change in the either Republic or Fortune or

MPCC or Iligan."

BIR RULING 206-90

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

a ruling confirming an opinion that the foreign exchange loss

incurred by PMI is a deductible loss in 1990.

It is represented that PMI is a corporation established and

organized under Philippine laws; that it has existing US dollar loans

from Noritake Company, Limited (Noritake) and Toyota Tsusho

Corporation (Toyota) in the aggregate amounts of US

$7,636,679.17 and US $3,054,671.27, respectively, that in 1989,

the parties agreed to convert the said dollar denominated loansinto pesos at the exchange rate prevailing on June 30, 1989; that in

December 1989, both agreements were approved by the Central

Bank subject to the submission of a copy each of the signed

agreements incorporating the conversion; thereafter, drafts of the

amended agreements were submitted to the Central Bank for pre-

approval; that on January 29, 1990, the Central Bank advised PMI's

counsel on their findings and comments on the said drafts which

were considered and incorporated in the final amended

agreements; that in June 1990, the parties submitted to the Central

Bank the signed agreements; that counsel of PMI is of the opinion

that in the case of PMI, the resultant loss on conversion of US dollar

denominated loans to peso is more than a shrinkage in value of

money; that the approval by the Central Bank and the signing by

the parties of the agreements covering the said conversion

established the loss, after which, the loss became final and

irrevocable, so that recoupment is reasonably impossible; and that

having been fixed and determinable, the loss is no longer

susceptible to change, hence, it could fairly be stated that such has

30




been sustained in a closed and completed transaction.

In reply the commissioner informed PMI that the annual increase in

value of an asset is not taxable income because such increase has

not yet been realized. The increase in value i.e., the gain, couldonly be taxed when a disposition of the property occurred which

was of such a nature as to constitute a realization of such gain, that

is, a severance of the gain from the original capital invested in the

property. The same conclusion obtains as to losses. The annual

decline in the value of property is not normally allowable as a

deduction. Hence, to be allowable the loss must be realized.

When foreign currency acquired in connection with a transaction in

the regular course of business is disposed ordinary gain or loss

results from the fluctuation. The loss is deductible only for the year

it is actually sustained. It is sustained during the year in which theloss occurs as evidenced by the completed transaction and as fixed

by identifiable occurring in that year. No taxation event has as yet

been consummated prior to the remittance of the scheduled

amortization. Accordingly, PMI's request for confirmation of opinion

was denied considering that foreign exchange losses sustained as a

result of conversion or devaluation of the peso vis-a-vis the foreign

currency or US dollar and vice versa but which remittance of

scheduled amortization consisting of principal and interests

payment on a foreign loan had not actually been made are not

deductible from gross income for income tax purposes.

BIR RULING 144-85

(Technically, this ruling has no stated facts. It just said that a

request for ruling dated July 1, 1985 was sent to the BIR for the

purpose of clarifying the issue, as herein stated.)

FACTS:

Request to clarify the deductibility of foreign exchange losses

incurred by reason of the devaluation of the peso. The losses arose

from matured but unremitted principal repayments on loansaffected by the debt-restructuring program in the Philippines.

ISSUE:

Whether or not foreign exchange losses are deductible for income

tax purposes.

HELD: NO.

The annual increase in value of an asset is NOT TAXABLE INCOME

because such increase has not yet been realized. The increase in

value, i.e., the gain, could only be taxed when a disposition of theproperty occurred which was of such a nature as to constitute a

realization of such gain, that is, a severance of the gain from the

original capital invested in the property. The aforementioned rule

also applies to losses. The annual decrease in the value of property

is not normally allowable as a loss. Hence, to be allowable the loss

must be realized.

When foreign currency acquired in connection with a transaction in

the regular course of business is disposed of, ordinary gain or loss

results from the foreign exchange fluctuations. THE LOSS IS

DEDUCTIBLE ONLY FOR THE YEAR IT IS ACTUALLY SUSTAINED.

Thus, there is no taxable event prior to the remittance of the

scheduled amortization.

Accordingly, foreign exchange losses sustained as a result of

devaluation of the peso vis-a-vis the foreign currency e.g., US

dollar, but which remittance of scheduled amortization consisting of

principal and interests payments on a foreign loan has not actually

31




been made are NOT DEDUCTIBLE from gross income for income tax

purposes.

NOTE:

• To sustain a loss means that the loss has occurred as evidencedby a closed and completed transaction and as fixed byidentifiable events occurring in that year.

• A closed transaction is a taxable event which has beenconsummated.

Bad debts

PHILEX MINING v CIR

Facts: Philex Mining entered into a management agreement withBaguio Gold. The parties' agreement was denominated as "Power

of Attorney" which provided among others:

a. Funds available for Philex Mining during the

management agreement; and

b. Compensation to Philex Mining which shall be fifty per

cent (50%) of the net profit;

In the course of managing and operating the project, Philex

Mining made advances of cash and property in accordance with theagreement. However, the mine suffered continuing losses over the

years which resulted to petitioner's withdrawal as manager and

cessation of mine operations.

The parties executed a "Compromise with Dation in

Payment" wherein Baguio Gold admitted an indebtedness to Philex

Mining, which was subsequently amended to include additional

obligations.

Subsequently, Philex Mining wrote off in its 1982 books of

account the remaining outstanding indebtedness of Baguio Gold by

charging P112,136,000.00 to allowances and reserves that were

set up in 1981 and P2,860,768.00 to the 1982 operations.

In its 1982 annual income tax return, Philex Mining

deducted from its gross income the amount of P112,136,000.00 as

"loss on settlement of receivables from Baguio Gold against

reserves and allowances." However, BIR disallowed the amount as

deduction for bad debt and assessed petitioner a deficiency income

tax of P62,811,161.39.

Issue: Whether the deduction for bad debts was valid?

Held: No. For a deduction for bad debts to be allowed, all

requisites must be satisfied, to wit: (a) there was a valid andexisting 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.

There was no valid and existing debt. The nature of

agreement between Philex Mining and Baguio Gold is that of a

partnership or joint venture. Under a contract of partnership, two or

more persons bind themselves to contribute money, property, or

industry to a common fund, with the intention of dividing the profits

among themselves.

Perusal of the agreement denominated as the "Power of

Attorney" indicates that the parties had intended to create a

partnership and establish a common fund for the purpose. They

also had a joint interest in the profits of the business as shown by a

50-50 sharing in the income of the mine.

Viewed from this light, the advances can be characterized

as petitioner’s investment in a partnership with Baguio Gold for the

32




development and exploitation of the Sto. Nino mine. Since the

advanced amount partook of the nature of an investment, it could

not be deducted as a bad debt from petitioner's gross income.

PHILIPPINE REFINING CO v CA

FACTS:

Philippine Refining Corp (PRC) was assessed deficiency tax

payments for the year 1985 in the amount of around 1.8M. This

figure was computed based on the disallowance of the claim of bad

debts by PRC. PRC duly protested the assessment claiming that

under the law, bad debts and interest expense are allowable

deductions.

When the BIR subsequently garnished some of PRC’s properties,the latter considered the protest as being denied and filed an

appeal to the CTA which set aside the disallowance of the interest

expense and modified the disallowance of the bad debts by

allowing 3 accounts to be claimed as deductions. However, 13

supposed “bad debts” were disallowed as the CTA claimed that

these were not substantiated and did not satisfy the jurisprudential

requirement of “worthlessness of a debt” The CA denied the

petition for review.

ISSUE:Whether or not the CA was correct in disallowing the 13

accounts as bad debts.

RULING: YES.

Both the CTA and CA relied on the case of Collector vs. Goodrich

International, which laid down the requisites for “worthlessness of a

debt” to wit:

In said case, we held that for debts to be considered as

"worthless," and thereby qualify as "bad debts" making themdeductible, the taxpayer should show that (1) there is a validand subsisting debt. (2) the debt must be actuallyascertained to be worthless and uncollectible during the

taxable year; (3) the debt must be charged off during thetaxable year; and (4) the debt must arise from the businessor trade of the taxpayer. Additionally, before a debt can beconsidered worthless, the taxpayer must also show that it isindeed uncollectible even in the future.Furthermore, there are steps outlined to be undertaken bythe taxpayer to prove that he exerted diligent efforts tocollect the debts, viz.: (1) sending of statement of accounts;(2) sending of collection letters; (3) giving the account to alawyer for collection; and (4) filing a collection case in court.PRC only used the testimony of its accountant Ms. Masagana

in order to prove that these accounts were bad debts. Thiswas considered by all 3 courts to be self-serving. The SC saidthat PRC failed to exercise due diligence in order to ascertainthat these debts were uncollectible. In fact, PRC did not evenshow the demand letters they allegedly gave to some of theirdebtors.FERNANDEZ HERMANOS v CIRFacts:

Fernandez Hermanos is an investment company. The CIR assessed

it for alleged deficiency income taxes. It claimed as deduction,

among others, losses in or bad debts of Palawan Manganese MinesInc. which the CIR disallowed and was sustained by the CTA.

Issue: W/N disallowance is correct

Held: YES

It was shown that Palawan Manganese Mines sought financial help

from Fernandez to resume its mining operations hence a

Memorandum of Agreement (MOA) was executed where Fernandez

33




would give yearly advances to Palawan. But it still continued to

suffer loses and Fernandez realized it could no longer recover the

advances hence claimed it as worthless. Looking at the MOA,

Fernandez did not expect to be repaid. The consideration for the

advances was 15% of the net profits. If there were no earnings orprofits there was no obligation to repay. Voluntary advances

without expectation of repayment do not result in deductible

losses. Fernandez cannot even sue for recovery as the obligation to

repay will only arise if there was net profits. No bad debt could

arise where there is no valid and subsisting debt.

Even assuming that there was valid or subsisting debt, the debt

was not deductible in 1951 as a worthless debt as Palawan was still

in operation in 1951 and 1952 as Fernandez continued to give

advances in those years. It has been held that if the debtor

corporation although losing money or insolvent was still operatingat the end of the taxable year, the debt is not considered worthless

and therefore not deductible.

Depreciation

BASILAN ESTATES v CIRLIMPAN INVESTMENT v CIR

FACTS:

BIR assessed deficiency taxes on Limpan Corp, acompanythat leases real property, for underdeclaring itsrental incomefor years 1956-57 by around P20K and P81K respectively.Petitioner appeals on the ground that portions of theseunderdeclared rents are yet to be collected by thepreviousowners and turned over or received by thecorporation.Petitioner cited that some rents were depositedwith the court,such that the corporation does not have actualnor constructivecontrol over them.The sole witness for the

petitioner, Solis (Corporate Secretary-Treasurer) admitted tosome undeclared rents in 1956 and1957, and that somebalances were not collected by thecorporation in 1956because the lessees refused to recognizeand pay rent to the

new owners and that the corp’s presidentIsabelo Limcollected some rent and reported it in his personalincomestatement, but did not turn over the rent to thecorporation.He also cites lack of actual or constructive controlover rentsdeposited with the court.

ISSUE: WON the BIR was correct in assessing deficiencytaxesagainst Limpan Corp. for undeclared rental income

HELD:

Yes. Petitioner admitted that it indeed had undeclaredincome(although only a part and not the full amount assessedbyBIR). Thus, it has become incumbent upon them to provetheirexcuses by clear and convincing evidence, which it hasfailedto do.Issue: When is there constructive receipt of rent?Withregard to 1957 rents deposited with the court, andwithdrawnonly in 1958, the court viewed the corporation ashavingconstructively received said rents. The non-collectionwas thepetitioner’s fault since it refused to refused to acceptthe rent,and not due to non-payment of lessees. Hence,although thecorporation did not actually receive the rent, it isdeemed to

have constructively received them.

Depletion

CONSOLIDATED MINES v CTABIR RULING 19-01FACTS:

On October 3, 2000, the Philippine Council for NGO Certification

(PCNC) sent a request for ruling to the BIR, mainly to seek an34




opinion if Conservation International (CI), an international

organization, can be granted a donee institution status. Note that

CI’s home office and board members are based abroad, hence,

PCNC’s evaluation process on governance cannot be fully executed.

ISSUE:

Whether or not international organizations with home offices

abroad are qualified to be granted donee institution status.

HELD: NO.Sec. 34(H)(l) of the NIRC3 specifically mentions

"accredited domestic corporation or associations" and "non-

government organizations". On the other hand, subparagraph (2)(c)

of the same Section of the Tax Code defines a "non-government

organization" to mean a non-profit domestic corporation.

In implementing Sec. 34(H) of the NIRC, RR 13-984 was issued and

3(H) Charitable and Other Contributions. —

(l) In General. — Contributions or gifts actually paid or made within the taxable year

to, or for the use of the Government of the Philippines or any of its agencies or any

political subdivision thereof exclusively for public purposes, or to accredited

domestic corporations or associations organized and operated exclusively for

religious, charitable, scientific, youth and sports development, cultural or

educational purposes or for the rehabilitation of veterans, or to social welfare

institutions or to non-government organizations, in accordance with rules and

regulations promulgated by the Secretary of Finance, upon recommendation of the

Commissioner, no part of the net income of which inures to the benefit of anyprivate stockholder or individual in an amount not in excess of ten percent (10%) in

the case of an individual, and five percent (5%) in the case of a corporation of the

taxpayer's taxable income derived from trade, business or profession as computed

without the benefit of this and the following subparagraphs".

4SEC. 1.Definition of Terms. — For purposes of these Regulations, the terms herein

enumerated shall have the following meanings:

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

or association/ organization referred to under Section 30 (E) and (G) of the Tax Code

in relation to the type of entities that may be accredited, which

specifically refers to organizations or associations created or

organized under Philippine laws.

Thus, the BIR opined that a non-stock, non-profit corporation or

organization must be created or organized under Philippine Laws

and that an NGO must be a non-profit domestic corporation, this

Office is of the opinion that a foreign corporation, like Conservation

International, whether resident or non-resident, cannot be

accredited as donee institution.

3M PHILIPPINES v CIR

Facts:

3M Philippines, Inc. is a subsidiary of the Minnesota Mining and

Manufacturing Company (or "3M-St. Paul") a non-resident foreign

corporation with principal office in St. Paul, Minnesota, U.S.A. It is

the exclusive importer, manufacturer, wholesaler, and distributor in

the Philippines of all products of 3M-St. Paul. To enable it to

manufacture, package, promote, market, sell and install the highly

specialized products of its parent company, and render the

necessary post-sales service and maintenance to its customers, 3M

Phils. entered into a "Service Information and Technical Assistance

Agreement" and a "Patent and Trademark License Agreement" with

the latter under which the 3m Phils. agreed to pay to 3M-St. Paul a

technical service fee of 3% and a royalty of 2% of its net sales.created or organized under Philippine laws exclusively for one or more of the

following purposes:

xxx xxx xxx

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

domestic corporation or organization as defined under Section 34(H)(2)(c) of the Tax

Code organized and operated exclusively . . ."

35




Both agreements were submitted to, and approved by, the Central

Bank of the Philippines. the petitioner claimed the following

deductions as business expenses:

(a) royalties and technical service fees of P 3,050,646.00; and

(b) pre-operational cost of tape coater of P97,485.08.

As to (a), the Commissioner of Internal Revenue allowed a

deduction of P797,046.09 only as technical service fee and royalty

for locally manufactured products, but disallowed the sum of

P2,323,599.02 alleged to have been paid by the petitioner to 3M-St.

Paul as technical service fee and royalty on P46,471,998.00 worth

of finished products imported by the petitioner from the parent

company, on the ground that the fee and royalty should be based

only on locally manufactured goods. While as to (b), the CIR onlyallowed P19,544.77 or one-fifth (1/5) of 3M Phils.capital

expenditure of P97,046.09 for its tape coater which was installed in

1973 because such expenditure should be amortized for a period of

five (5) years, hence, payment of the disallowed balance of

P77,740.38 should be spread over the next four (4) years. The CIR

ordered 3M Phil. to pay P840,540 as deficiency income tax on its

1974 return, plus P353,026.80 as 14% interest per annum from

February 15, 1975 to February 15, 1976, or a total of

P1,193,566.80.

3M Phils. protested the CIR’s assessment but it did not answer theprotest, instead issuing a warrant of levy. The CTA affirmed the

assessment on appeal.

Issue:

Whether or not 3M Phils is entitled to the deductions due to

royalties?

Ruling:

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

dated December 7, 1973 was promulgated by the Central Bank as

an exchange control regulation to conserve foreign exchange and

avoid unnecessary drain on the country's international reserves (69

O.G. No. 51, pp. 11737-38). Section 3-C of the circular provides that

royalties shall be paid only on commodities manufactured by the

licensee under the royalty agreement:

Section 3. Requirements for Approval and Registration. — The

requirements for approval and registration as provided for in

Section 2 above include, but are not limited to the following:

a. xxx xxx xxx

b. xxx xxx xxx

c. The royalty/rental contracts involving manufacturing' royalty,

e.g., actual transfers of technological services such as secret

formula/processes, technical know how and the like shall not

exceed five (5) per cent of the wholesale price of the

commodity/ties manufactured under the royalty agreement. For

contracts involving 'marketing' services such as the use of foreign

brands or trade names or trademarks, the royalty/rental rate shall

not exceed two (2) per cent of the wholesale price of the

commodity/ties manufactured under the royalty agreement. The

producer's or foreign licensor's share in the proceeds from the

distribution/exhibition of the films shall not exceed sixty (60) per

cent of the net proceeds (gross proceeds less local expenses) from

the exhibition/distribution of the films. ... (Emphasis supplied.) (p.

27, Rollo.)

36




Clearly, no royalty is payable on the wholesale price of finished

products imported by the licensee from the licensor. However,

petitioner argues that the law applicable to its case is only Section

29(a)(1) of the Tax Code which provides:

(a) Expenses. — (1) Business expenses. — (A) In general. — All

ordinary and necessary expenses paid or incurred during the

taxable year in carrying on any trade or business, including a

reasonable allowance for salaries or other compensation for

personal services actually rendered; travelling expenses while

away from home in the pursuit of a trade, profession or business,

rentals or other payments required to be made as a condition to

the continued use or possession, for the purpose of the trade,

profession or business, for property to which the taxpayer has not

taken or is not taking title or in which he has no equity.

Petitioner points out that the Central bank "has no say in the

assessment and collection of internal revenue taxes as such power

is lodged in the Bureau of Internal Revenue," that the Tax Code

"never mentions Circular 393 and there is no law or regulation

governing deduction of business expenses that refers to said

circular." (p. 9, Petition.)

The argument is specious, for, although the Tax Code allows

payments of royalty to be deducted from gross income as business

expenses, it is CB Circular No. 393 that defines what royalty

payments are proper. Hence, improper payments of royalty are notdeductible as legitimate business expenses.

ESSO STANDARD v CIR

FACTS:

ESSO deducted from its gross income, as part of its ordinary andnecessary business expenses, the amount it had spent for drilling

and exploration of its petroleum concessions. This claim wasdisallowed by the CIR on the ground that the expenses should becapitalized and might be written off as a loss only when a "dryhole" should result.

ESSO then filed an amended return and claimed as ordinary andnecessary expenses margin fees it had paid to the Central Bankon its profit remittances to its New York head office. The CIRdisallowed the claimed deduction for the margin fees paid. CIRassessed ESSO a deficiency income tax which arose from thedisallowance of the margin fees.

ESSO paid under protest and claimed for a refund. CIR denied theclaims for refund, holding that the margin fees paid to the CentralBank could not be considered taxes or allowed as deductiblebusiness expenses.

ISSUES:1. w/n margin fee is a tax and should be deductible from

ESSO’s gross income. NO2. If margin fees are not taxes, w/n they should nevertheless

be considered necessary and ordinary business expensesand therefore still deductible from its gross income. NO.

HELD:1. NO. A margin is not a tax but an exaction designed to curb the

excessive demands upon our international reserves. The marginfee was imposed by the State in the exercise of its police powerand not the power of taxation.

2. NO. To be deductible as a business expense, three conditions areimposed, namely:

(1) the expense must be ordinary and necessary,(2) it must be paid or incurred within the taxable year, and(3) it must be paid or incurred in carrying on a trade or

business.In addition, not only must the taxpayer meet the business test,he must substantially prove by evidence or records the

37




deductions claimed under the law, otherwise, the same will bedisallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify itsdeduction.

Ordinarily, an expense will be considered 'necessary' where theexpenditure is appropriate and helpful in the development of the taxpayer's business. It is 'ordinary' when it connotes apayment which is normal in relation to the business of thetaxpayer and the surrounding circumstances. The term'ordinary' does not require that the payments be habitual ornormal in the sense that the same taxpayer will have to makethem often; the payment may be unique or non-recurring to theparticular taxpayer affected. There is thus no hard and fast ruleon the matter. The right to a deduction depends in each case onthe particular facts and the relation of the payment to the typeof business in which the taxpayer is engaged. The intention of

the taxpayer often may be the controlling fact in making thedetermination. Assuming that the expenditure is ordinary andnecessary in the operation of the taxpayer's business, theanswer to the question as to whether the expenditure is anallowable deduction as a business expense must be determinedfrom the nature of the expenditure itself, which in turn dependson the extent and permanency of the work accomplished by theexpenditure.

Since the margin fees in question were incurred for theremittance of funds to petitioner's Head Office in New York,which is a separate and distinct income taxpayer from the

branch in the Philippines, for its disposal abroad, it can never besaid therefore that the margin fees were appropriate andhelpful in the development of petitioner's business in thePhilippines exclusively. ESSO has not shown that the remittanceto the head office of part of its profits was made in furtheranceof its own trade or business and therefore cannot be claimed asan ordinary and necessary expense paid or incurred in carryingon its own trade or business.

38




R. CAPITAL GAINS and LOSSES

Capital assets

CALASANZ v CIR

Facts: Petitioner Ursula Calasanz inherited from her father de Torres an agricultural land located in Rizal with an area of 1.6M sqm. In order to liquidate her inheritance, UrsulaCalasanz had the land surveyed and subdivided into lots.Improvements, such as good roads, concrete gutters,drainage and lighting system, were introduced to make thelots saleable. Soon after, the lots were sold to the public at aprofit.

In their joint income tax return for the year 1957 filed withthe Bureau of Internal Revenue on March 31, 1958,petitioners disclosed a profit of P31,060.06 realized from thesale of the subdivided lots, and reported fifty per centumthereof or P15,530.03 as taxable capital gains.

Upon an audit and review of the return thus filed, theRevenue Examiner adjudged petitioners engaged in businessas real estate dealers, as defined in the NIRC, and requiredthem to pay the real estate dealer's tax and assessed adeficiency income tax on profits derived from the sale of the

lots based on the rates for ordinary income.

Tax court upheld the finding of the CIR, hence, the presentappeal.

Issues:

a. Whether or not petitioners are real estate dealers liable forreal estate dealer's fixed tax. YES

b. Whether the gains realized from the sale of the lots aretaxable in full as ordinary income or capital gains taxable atcapital gain rates. ORDINARY INCOME

Ratio:

The assets of a taxpayer are classified for income taxpurposes into ordinary assets and capital assets. Section34[a] [1] of the National Internal Revenue Code broadlydefines capital assets as follows:

[1] Capital assets.-The term 'capital assets'means property held by the taxpayer [whetheror not connected with his trade or business], butdoes not include, stock in trade of the taxpayer

or other property of a kind which would properlybe included, in the inventory of the taxpayer if on hand at the close of the taxable year, orproperty held by the taxpayer primarily for saleto customers in the ordinary course of his tradeor business, or property used in the trade orbusiness of a character which is subject to theallowance for depreciation provided insubsection [f] of section thirty; or real propertyused in the trade or business of the taxpayer.

The statutory definition of capital assets is negative innature. If the asset is not among the exceptions, it is acapital asset; conversely, assets falling within the exceptionsare ordinary assets. And necessarily, any gain resulting fromthe sale or exchange of an asset is a capital gain or anordinary gain depending on the kind of asset involved in thetransaction.

However, there is no rigid rule or fixed formula by which it

39




can be determined with finality whether property sold by ataxpayer was held primarily for sale to customers in theordinary course of his trade or business or whether it wassold as a capital asset. Although several factors or

indices have been recognized as helpful guides in making adetermination, none of these is decisive; neither is thepresence nor the absence of these factors conclusive. Eachcase must in the last analysis rest upon its own peculiar factsand circumstances.

Also a property initially classified as a capital asset maythereafter be treated as an ordinary asset if a combination of the factors indubitably tend to show that the activity was infurtherance of or in the course of the taxpayer's trade orbusiness. Thus, a sale of inherited real property usually gives

capital gain or loss even though the property has to besubdivided or improved or both to make it salable. However,if the inherited property is substantially improved or veryactively sold or both it may be treated as held primarily forsale to customers in the ordinary course of the heir'sbusiness.

In this case, the subject land is considered as an ordinaryasset. Petitioners did not sell the land in the condition inwhich they acquired it. While the land was originally devotedto rice and fruit trees, it was subdivided into small lots and in

the process converted into a residential subdivision andgiven the name Don Mariano Subdivision. Extensiveimprovements like the laying out of streets, construction of concrete gutters and installation of lighting system anddrainage facilities, among others, were undertaken toenhance the value of the lots and make them more attractiveto prospective buyers. The audited financialstatements submitted together with the tax return inquestion disclosed that a considerable amount was expended

to cover the cost of improvements. There is authority that aproperty ceases to be a capital asset if the amount expendedto improve it is double its original cost, for the extensiveimprovement indicates that the seller held the property

primarily for sale to customers in the ordinary course of hisbusiness. Another distinctive feature of the real estate businessdiscernible from the records is the existence of contractsreceivables, which stood at P395,693.35. The sizable amountof receivables in comparison with the sales volume of P446,407.00 during the same period signifies that the lotswere sold on installment basis and suggests the number,continuity and frequency of the sales. Also of significance isthe circumstance that the lots were advertised for sale to

the public and that sales and collection commissions werepaid out during the period in question.

Petitioners argument that they are merely liquidating theland must also fail. In Ehrman vs. Commissioner, theAmerican court in clear and categorical terms rejected theliquidation test in determining whether or not a taxpayer iscarrying on a trade or business The court observed that thefact that property is sold for purposes of liquidation does notforeclose a determination that a "trade or business" is beingconducted by the seller.

One may, of course, liquidate a capital asset. To do so, it isnecessary to sell. The sale may be conducted in the mostadvantageous manner to the seller and he will not lose thebenefits of the capital gain provision of the statute unless heenters the real estate business and carries on the sale in themanner in which such a business is ordinarily conducted. Inthat event, the liquidation constitutes a business and a salein the ordinary course of such a business and the preferred

40




tax status is lost.

BIR RULING 27-02

Registration with HLURB or HUDCC shall be sufficient for aseller/transferor to be considered as habitually engaged inreal estate business. If the seller/transferor is not registeredwith the HLURB or HUDCC, he/it may prove that he/it isengaged in the real estate business by offering othersatisfactory evidence (e.g. consummation during thepreceding year at least 6 taxable real estate transactionsregardless of amount). (BIR Ruling No. 027-2002 dated July 3,2002)

Capital assets

CHINA BANKING CORP v CA

41




S. DETERMINATION OF GAIN OR LOSS FROM SALE

OR TRANSFER OF PROPERTY

Exchange of property

CIR v RUFINO

FACTS:

The private respondents were the majority stockholders of the defunct Eastern Theatrical Co., Inc., (Old Corporation).Ernesto Rufino was the president. The private respondentswere also the majority and controlling stockholders of another corporation, the Eastern Theatrical Co Inc., (NewCorporation). This corporation was engaged in the same kind

of business as the Old Corporation, i.e. operating theaters,opera houses, places of amusement and other relatedbusiness enterprises. Vicente Rufino was the GeneralManager.

The Old Corporation held a special meeting of stockholderswhere a resolution was passed authorizing the OldCorporation to merge with the New Corporation. Pursuant tothe said resolution, the Old Corporation, represented byErnesto Rufino as President, and the New Corporation,represented by Vicente Rufino as General Manager, signed aDeed of Assignment providing for the conveyance andtransfer of all the business, property assets, goodwill, andliabilities of the Old Corporation to the New Corporation inexchange for the latter's shares of stock to be distributedamong the shareholders on the basis of one stock for eachstock held in the Old Corporation. This agreement was maderetroactive. The aforesaid transfer was eventually made. Theresolution and the Deed of Assignment were approved in aresolution by the stockholders of the New Corporation in their

special meeting. The increased capitalization of the NewCorporation was registered and approved by the SEC.

The BIR, after examination, declared that the merger was not

undertaken for a bona fide business purpose but merely toavoid liability for the capital gains tax on the exchange of theold for the new shares of stock. Accordingly, deficiencyassessments were imposed against the private respondents.MR denied. CTA reversed and held that there was a validmerger. It declared that no taxable gain was derived bypetitioners from the exchange of their old stocks solely forstocks of the New Corporation because it was pursuant to aplan of reorganization. Thus, such exchange is exempt fromCGT.

ISSUE/RULING:

W/N the CTA erred in finding that no taxable gain wasderived by the private respondents from the questionedtransaction? NO

There was a valid merger although the actual transfer of theproperties subject of the Deed of Assignment was not madeon the date of the merger. In the nature of things, this wasnot possible. Obviously, it was necessary for the OldCorporation to surrender its net assets first to the New

Corporation before the latter could issue its own stock to theshareholders of the Old Corporation because the NewCorporation had to increase its capitalization for this purpose. This required the adoption of the resolution for theregistration of such issuance with the SEC and its approval.All these took place after the date of the merger but theywere deemed part and parcel of, and indispensable to thevalidity and enforceability of, the Deed of Assignment.

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There is no impediment to the exchange of property for stockbetween the two corporations being considered to have beeneffected on the date of the merger. That, in fact, was theintention, and the reason why the Deed of Assignment was

made retroactive which provided in effect that alltransactions set forth in the merger agreement shall bedeemed to be taking place simultaneously when the Deed of Assignment became operative.

The basic consideration, of course, is the purpose of themerger, as this would determine whether the exchange of properties involved therein shall be subject or not to thecapital gains tax. The criterion laid down by the law is thatthe merger" must be undertaken for a bona fide businesspurpose and not solely for the purpose of escaping the

burden of taxation."

Here, the purpose of the merger was to continue thebusiness of the Old Corporation, whose corporate life wasabout to expire, through the New Corporation to which all theassets and obligations of the former had been transferred.What argues strongly, indeed, for the New Corporation is thatit was not dissolved after the merger agreement. On thecontrary, it continued to operate the places of amusementoriginally owned by the Old Corporation and continues to doso today after taking over the business of the Old

Corporation 27 years ago.

What is also worth noting is that, as in the case of the OldCorporation when it was dissolved, there has been nodistribution of the assets of the New Corporation since thenand up to now, as far as the record discloses. To date, theprivate respondents have not derived any benefit from themerger of the Old Corporation and the New Corporationalmost 3 decades earlier that will make them subject to the

capital gains tax under Section 35. They are no more liablenow than they were when the merger took effect, as themerger, being genuine, exempted them under the law fromsuch tax.

By this decision, the government is, of course, not leftentirely without recourse, at least in the future. The fact isthat the merger had merely deferred the claim for taxes,which may be asserted by the government later, when gainsare realized and benefits are distributed among thestockholders as a result of the merger. In other words, thecorresponding taxes are not forever foreclosed or forfeitedbut may at the proper time and without prejudice to thegovernment still be imposed.

BIR RULING 274-87

GREGORY v HELVERING

Facts:

Petitioner was the owner of all the stock of United Mortgage

Corporation(UMC). That corporation held among its assets 1,000

shares of the Monitor Securities Corporation(MSC). Petitioner

wanted these shares transferred to her at a profit and with the

minimum income tax liability. In order to achieve this purpose,

Petitioner made it appear that she was making a “reorganization”(in conforme with Revenue Act of 19285). Under this law, a

5"Sec. 112. (g) Distribution of Stock on Reorganization. If there is

distributed, in pursuance of a plan of reorganization, to a shareholder in acorporation a party to the reorganization, stock or securities in such corporation orin another corporation a party to the reorganization, without the surrender by suchshareholder of stock or securities in such a corporation, no gain to the distributeefrom the receipt of such stock of securities shall be recognized. . . ."

"(i) Definition of Reorganization. -- As used in this section . . .""(1) The term 'reorganization' means . . . (B) a transfer by a corporation of allor a part of its assets to another corporation if immediately after the

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“reorganization” would effect a direct transfer of a corporation’s

share by way of dividend at a lower taxable transaction.

In order to have an appearance of a “reorganization”,

she(Petitioner) organized Averill Corporation (AC). Three (3) days

later, UMC transferred the 1,000 shares of MSC to AC. Then these

shares were all transferred to Petitioner. Subsequently, AC was

dissolved with no other transaction being made other the transfer

of the shares. Petitioner then sold the shares and declared a lower

taxable liability. The Board contended that the so-called

“reorganization” should be considered ineffective since it was just a

scheme to have a lower tax liability.

ISSUE:

Whether the “reorganization” is valid which would result to

a lower tax liability.

HELD:

NO. It is contended that since every element required by the

foregoing subdivision (B) (refer to footnote) is to be found in what

was done, a statutory reorganization was effected, and that the

motive of the taxpayer thereby to escape payment of a tax will not

alter the result or make unlawful what the statute allows.

The Court said, although the legal right of a taxpayer to

decrease the amount of what otherwise would be his taxes, or

altogether avoid them, by means which the law permits, cannot be

doubted, the question for determination is whether what

was done, apart from the tax motive, was the thing which

the statute intended.

transfer the transferor or its stockholders or both are in control of thecorporation to which the assets are transferred. . . ."

When subdivision (B) speaks of a transfer of assets by one

corporation to another, it means a transfer made "in pursuance of a

plan of reorganization of corporate business, and not a transfer of

assets by one corporation to another in pursuance of a plan having

no relation to the business of either, as plainly is the case here.

Simply an operation having no business or corporate

purpose -- a mere device which put on the form of a corporate

reorganization as a disguise for concealing its real character, and

the sole object and accomplishment of which was the

consummation of a preconceived plan, not to reorganize a business

or any part of a business, but to transfer a parcel of corporate

shares to the petitioner. The rule which excludes from

consideration the motive of tax avoidance is not pertinent to the

situation, because the transaction, upon its face, lies outside the

plain intent of the statute. (kasi wala nga talagang businesspurpose but to circumvent the law).

T. SITUS OF TAXATION

Gross income from sources within the Phils

CIR v MARUBENI CORPORATIONCIR v BOACCIR v CTA AND SMITH&FRENCH OVERSEAS

Facts:

Smith Kline & French Overseas Company is a multinational

firm domiciled in Philadelphia, licensed to do business in the

Philippines. It is engaged in the importation, manufacture,

and sale of pharmaceutical drugs and chemicals.

In 1971, it declared a net taxable income of P1.4 M and paid

P511k as tax due. It claimed its share of the head office

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overhead expenses (P501k) as deduction from gross income.

In its amended return, it claimed that there was an

overpayment of tax (P324k) arising from under-deduction of

the overhead expense. This was certified by international

independent auditors, the allocation of the overhead expensemade on the basis of the percentage of gross income in the

Philippines to gross income of the corporation as a whole.

In 1974, without waiting for the action of the CIR, Smith filed

a petition for review with the CTA. CTA ordered CIR to refund

the overpayment or grant Smith a tax credit. CIR appealed

to the SC.

Issue: Whether Smith is entitled to a refund – YES

Ratio:

The governing law is found in Sec. 37 (b).6 Revenue

Regulation No. 2 of the DOF contains a similar provision, with

the additional line that “the ratable part is based upon the

ratio of gross income from sources within the Philippines to

the total gross income” (Sec. 160). Hence, where an

expense is clearly related to the production of Philippine-

derived income or to Philippine operations, that expense can

6 Net income from sources in the Philippines. – From the items of

gross income specified in subsection (a) of this section there shall

be deducted expenses, losses, and other deductions properly

apportioned or allocated thereto and a ratable part of any

expenses, losses, or other deductions which cannot definitely be

allocated to some item or class of gross income. The remainder, if

any, shall be included in full as net income from sources within the

Philippines.

be deducted from the gross income acquired in the

Philippines without resorting to apportionment.

However, the overhead expenses incurred by the parent

company in connection with finance, administration, andresearch & development, all of which directly benefit its

branches all over the world, fall under a different category.

These are items which cannot be definitely allocated or

identified with the operations of the Philippine branch. Smith

can claim as its deductible share a ratable part of such

expenses based upon the ration of the local branch’s gross

income to the total gross income of the corporation

worldwide.

CIR’s Contention

The CIR does not dispute the right of Smith to avail of Sec. 37

(b) of the Tax Code and Sec. 160 of the RR. But he maintains

that such right is not absolute and that there exists a

contract (service agreement) which Smith has entered into

with its home office, prescribing the amount that a branch

can deduct as its share of the main office’s overhead

expenses. Since the share of the Philippine branch has been

fixed, Smith cannot claim more than the said amount.

Smith’s Contention

Smith, on the other hand, submits that the contract between

itself and its home office cannot amend tax laws and

regulations. The matter of allocated expenses deductible

under the law cannot be the subject of an agreement

between private parties nor can the CIR acquiesce in such an

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agreement.

SC ruled for Smith Kline and said that its amended return

conforms with the law and regulations.

PHIL GUARANTY CO v CIR

Facts: The Philippine Guaranty Co., Inc., a domestic

insurance company, entered into reinsurance contracts, on

various dates, with foreign insurance companies not doing

business in the Philippines.

The reinsurance contracts made the commencement of the

reinsurers' liability simultaneous with that of Philippine

Guaranty Co., Inc. under the original insurance. PhilippineGuaranty Co., Inc. was required to keep a register in Manila

where the risks ceded to the foreign reinsurers where

entered, and entry therein was binding upon the reinsurers.

A proportionate amount of taxes on insurance premiums not

recovered from the original assured were to be paid for by

the foreign reinsurers. The foreign reinsurers further agreed,

in consideration for managing or administering their affairs in

the Philippines, to compensate the Philippine Guaranty Co.,

Inc., in an amount equal to 5% of the reinsurance premiums.

Conflicts and/or differences between the parties under the

reinsurance contracts were to be arbitrated in Manila.

Philippine Guaranty Co., Inc. and Swiss Reinsurance

Company stipulated that their contract shall be construed by

the laws of the Philippines.

Pursuant to the aforesaid reinsurance contracts, Philippine

Guaranty Co., Inc. ceded premiuns to the foreign reinsurers.

Said premiums were excluded by Philippine Guaranty Co.,

Inc. from its gross income when it file its income tax returns

for 1953 and 1954. Furthermore, it did not withhold or pay

tax on them. Consequently, the Commissioner of InternalRevenue assessed against Philippine Guaranty Co., Inc.

withholding tax on the ceded reinsurance premiums.

Issue: Whether the reinsurance premiums ceded to foreign

reinsurers not doing business in the Philippines are subject to

withholding tax?

Held: The reinsurance premiums are subject to withholding

tax. The reinsurance contracts, however, show that the

transactions or activities that constituted the undertaking toreinsure Philippine Guaranty Co., Inc. against loses arising

from the original insurances in the Philippines were

performed in the Philippines. The liability of the foreign

reinsurers commenced simultaneously with the liability of

Philippine Guaranty Co., Inc. under the original insurances.

Philippine Guaranty Co., Inc. kept in Manila a register of the

risks ceded to the foreign reinsurers. Entries made in such

register bound the foreign resinsurers, localizing in the

Philippines the actual cession of the risks and premiums and

assumption of the reinsurance undertaking by the foreign

reinsurers. Taxes on premiums imposed by Section 259 of

the Tax Code for the privilege of doing insurance business in

the Philippines were payable by the foreign reinsurers when

the same were not recoverable from the original assured.

The foreign reinsurers paid Philippine Guaranty Co., Inc. an

amount equivalent to 5% of the ceded premiums, in

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consideration for administration and management by the

latter of the affairs of the former in the Philippines in regard

to their reinsurance activities here. Disputes and differences

between the parties were subject to arbitration in the City of

Manila. All the reinsurance contracts, except that with SwissReinsurance Company, were signed by Philippine Guaranty

Co., Inc. in the Philippines and later signed by the foreign

reinsurers abroad. Although the contract between Philippine

Guaranty Co., Inc. and Swiss Reinsurance Company was

signed by both parties in Switzerland, the same specifically

provided that its provision shall be construed according to

the laws of the Philippines, thereby manifesting a clear

intention of the parties to subject themselves to Philippine

law.

Section 24 of the Tax Code subjects foreign corporations totax on their income from sources within the Philippines. Theword "sources" has been interpreted as the activity, propertyor service giving rise to the income. 1 The reinsurancepremiums were income created from the undertaking of theforeign reinsurance companies to reinsure PhilippineGuaranty Co., Inc., against liability for loss under originalinsurances. Such undertaking, as explained above, took placein the Philippines. These insurance premiums, therefore,

came from sources within the Philippines and, hence, aresubject to corporate income tax.

The foreign insurers' place of business should not beconfused with their place of activity. Business should not becontinuity and progression of transactions while activity mayconsist of only a single transaction. An activity may occuroutside the place of business. Section 24 of the Tax Codedoes not require a foreign corporation to engage in business

in the Philippines in subjecting its income to tax. It sufficesthat the activity creating the income is performed or done inthe Philippines. What is controlling, therefore, is not the placeof business but the place of activity that created an income.

HOWDEN & CO v CIRPHILIPPINE AMERICAN LIFE INSURANCE CO v CTA

Howden Vs CIR

(taxation from Sources in the Philippines)

FACTS:

Commonwealth Insurance Co. (CIC), a domestic corporation,entered into reinsurance contracts with 32 British companiesnot engaged in business in thePhilippines represented byherein Plaintiff. CIC remitted to Plaintiff reinsurancepremiums and, on behalf of Plaintiff, paid income tax on thepremiums. Plaintiff filed a claim for a refund of the paid tax,stating that it was exempted from withholding taxreinsurance premiums received from domestic insurancecompanies by foreign insurance companies not authorized todo business in the Philippines. Plaintiffs stated that since Sec.53 and 54 were substantially re-enacted” by RA 1065, 1291and 2343,said rulings should be given the force of law under theprinciple of legislative approval by re-enactment.

ISSUE:W/N the tax should be withheld.

HELD:

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No. The principle of legislative enactment states that where astatute is susceptible of the meaning placed upon it by aruling of the government agency charged with itsenforcement and the legislature thereafter re-enacts theprovisions without substantial changes, such action isconfirmatory to an extent that the ruling carries out thelegislative purpose. This principle is not applicable forheaforementioned sections were never re-enacted. Only thetax rate was amended. The administrative rulings invoked bythe CIR were only contained in unpublished letters. It cannotbe assumed that the legislature knew of these rulings.Finally, the premiums remitted were to indemnify CIC againstliability. This took place within thePhilippines, thus subject to income tax

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Documents

Deductions 1