Republic of the Philippines

SUPREME COURT
Manila

Petitioners protested the said assessment in a letter of June 26,

1979 asserting that they had availed of tax amnesties way back in
1974.

FIRST DIVISION

In a reply of August 22, 1979, respondent Commissioner informed

petitioners that in the years 1968 and 1970, petitioners as coowners in the real estate transactions formed an unregistered
partnership or joint venture taxable as a corporation under Section
20(b) and its income was subject to the taxes prescribed under
Section 24, both of the National Internal Revenue Code 1 that the
unregistered partnership was subject to corporate income tax as
distinguished from profits derived from the partnership by them
which is subject to individual income tax; and that the availment of
tax amnesty under P.D. No. 23, as amended, by petitioners relieved
petitioners of their individual income tax liabilities but did not
relieve them from the tax liability of the unregistered partnership.
Hence, the petitioners were required to pay the deficiency income
tax assessed.

G.R. No. 78133 October 18, 1988

MARIANO P. PASCUAL and RENATO P. DRAGON, petitioners,
vs.
THE COMMISSIONER OF INTERNAL REVENUE and COURT OF
TAX APPEALS, respondents.
De la Cuesta, De las Alas and Callanta Law Offices for petitioners.
The Solicitor General for respondents
GANCAYCO, J.:
The distinction between co-ownership and an unregistered
partnership or joint venture for income tax purposes is the issue in
this petition.
On June 22, 1965, petitioners bought two (2) parcels of land from
Santiago Bernardino, et al. and on May 28, 1966, they bought
another three (3) parcels of land from Juan Roque. The first two
parcels of land were sold by petitioners in 1968 toMarenir
Development Corporation, while the three parcels of land were sold
by petitioners to Erlinda Reyes and Maria Samson on March
19,1970. Petitioners realized a net profit in the sale made in 1968
in the amount of P165,224.70, while they realized a net profit of
P60,000.00 in the sale made in 1970. The corresponding capital
gains taxes were paid by petitioners in 1973 and 1974 by availing
of the tax amnesties granted in the said years.
However, in a letter dated March 31, 1979 of then Acting BIR
Commissioner Efren I. Plana, petitioners were assessed and
required to pay a total amount of P107,101.70 as alleged deficiency
corporate income taxes for the years 1968 and 1970.

Petitioners filed a petition for review with the respondent Court of

Tax Appeals docketed as CTA Case No. 3045. In due course, the
respondent court by a majority decision of March 30,
1987, 2 affirmed the decision and action taken by respondent
commissioner with costs against petitioners.
It ruled that on the basis of the principle enunciated
in Evangelista 3 an unregistered partnership was in fact formed by
petitioners which like a corporation was subject to corporate
income tax distinct from that imposed on the partners.
In a separate dissenting opinion, Associate Judge Constante
Roaquin stated that considering the circumstances of this case,
although there might in fact be a co-ownership between the
petitioners, there was no adequate basis for the conclusion that
they thereby formed an unregistered partnership which made "hem
liable for corporate income tax under the Tax Code.
Hence, this petition wherein petitioners invoke as basis thereof the
following alleged errors of the respondent court:

A. IN HOLDING AS PRESUMPTIVELY CORRECT THE

DETERMINATION
OF
THE
RESPONDENT
COMMISSIONER, TO THE EFFECT THAT PETITIONERS
FORMED AN UNREGISTERED PARTNERSHIP SUBJECT
TO CORPORATE INCOME TAX, AND THAT THE BURDEN
OF OFFERING EVIDENCE IN OPPOSITION THERETO
RESTS UPON THE PETITIONERS.
B. IN MAKING A FINDING, SOLELY ON THE BASIS OF
ISOLATED
SALE
TRANSACTIONS,
THAT
AN
UNREGISTERED
PARTNERSHIP
EXISTED
THUS
IGNORING THE REQUIREMENTS LAID DOWN BY LAW
THAT
WOULD
WARRANT
THE
PRESUMPTION/CONCLUSION THAT A PARTNERSHIP
EXISTS.
C. IN FINDING THAT THE INSTANT CASE IS SIMILAR TO
THE EVANGELISTA CASE AND THEREFORE SHOULD
BE DECIDED ALONGSIDE THE EVANGELISTA CASE.
D. IN RULING THAT THE TAX AMNESTY DID NOT
RELIEVE THE PETITIONERS FROM PAYMENT OF OTHER
TAXES FOR THE PERIOD COVERED BY SUCH
AMNESTY. (pp. 12-13, Rollo.)
The petition is meritorious.
The basis of the subject decision of the respondent court is the
ruling of this Court in Evangelista. 4
In the said case, petitioners borrowed a sum of money from their
father which together with their own personal funds they used in
buying several real properties. They appointed their brother to
manage their properties with full power to lease, collect, rent, issue
receipts, etc. They had the real properties rented or leased to
various tenants for several years and they gained net profits from
the rental income. Thus, the Collector of Internal Revenue
demanded the payment of income tax on a corporation, among
others, from them.

In resolving the issue, this Court held as follows:

The issue in this case is whether petitioners are
subject to the tax on corporations provided for in
section 24 of Commonwealth Act No. 466, otherwise
known as the National Internal Revenue Code, as well
as to the residence tax for corporations and the real
estate dealers' fixed tax. With respect to the tax on
corporations, the issue hinges on the meaning of the
terms corporation and partnership as used in
sections 24 and 84 of said Code, the pertinent parts
of which read:
Sec. 24. Rate of the tax on corporations.There shall
be levied, assessed, collected, and paid annually
upon the total net income received in the preceding
taxable year from all sources by every corporation
organized in, or existing under the laws of the
Philippines, no matter how created or organized but
not including duly registered general co-partnerships
(companies collectives), a tax upon such income
equal to the sum of the following: ...
Sec. 84(b). The term "corporation" includes
partnerships, no matter how created or organized,
joint-stock companies, joint accounts (cuentas en
participation), associations or insurance companies,
but does not include duly registered general copartnerships (companies colectivas).
Article 1767 of the Civil Code of the Philippines
provides:
By the 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.
Pursuant to this article, the essential elements of a
partnership are two, namely: (a) an agreement to

contribute money, property or industry to a common

fund; and (b) intent to divide the profits among the
contracting parties. The first element is undoubtedly
present in the case at bar, for, admittedly, petitioners
have agreed to, and did, contribute money and
property to a common fund. Hence, the issue
narrows down to their intent in acting as they did.
Upon consideration of all the facts and circumstances
surrounding the case, we are fully satisfied that their
purpose was to engage in real estate transactions for
monetary gain and then divide the same among
themselves, because:
1. Said common fund was not something they found
already in existence. It was not a property inherited
by them pro indiviso. They created it purposely. What
is more they jointly borrowed a substantial portion
thereof in order to establish said common fund.
2. They invested the same, not merely in one
transaction, but in a series of transactions. On
February 2, 1943, they bought a lot for P100,000.00.
On April 3, 1944, they purchased 21 lots for
P18,000.00. This was soon followed, on April 23,
1944, by the acquisition of another real estate for
P108,825.00. Five (5) days later (April 28, 1944),
they got a fourth lot for P237,234.14. The number of
lots (24) acquired and transcations undertaken, as
well as the brief interregnum between each,
particularly the last three purchases, is strongly
indicative of a pattern or common design that was
not limited to the conservation and preservation of
the aforementioned common fund or even of the
property acquired by petitioners in February, 1943.
In other words, one cannot but perceive a character
of habituality peculiar to business transactions
engaged in for purposes of gain.
3. The aforesaid lots were not devoted to residential
purposes or to other personal uses, of petitioners

herein. The properties were leased separately to

several persons, who, from 1945 to 1948 inclusive,
paid the total sum of P70,068.30 by way of rentals.
Seemingly, the lots are still being so let, for
petitioners do not even suggest that there has been
any change in the utilization thereof.
4. Since August, 1945, the properties have been
under the management of one person, namely,
Simeon Evangelists, with full power to lease, to
collect rents, to issue receipts, to bring suits, to sign
letters and contracts, and to indorse and deposit
notes and checks. Thus, the affairs relative to said
properties have been handled as if the same
belonged to a corporation or business enterprise
operated for profit.
5. The foregoing conditions have existed for more
than ten (10) years, or, to be exact, over fifteen (15)
years, since the first property was acquired, and over
twelve (12) years, since Simeon Evangelists became
the manager.
6. Petitioners have not testified or introduced any
evidence, either on their purpose in creating the set
up already adverted to, or on the causes for its
continued existence. They did not even try to offer
an explanation therefor.
Although, taken singly, they might not suffice to
establish the intent necessary to constitute a
partnership, the
collective
effect
of
these
circumstances is such as to leave no room for doubt
on the existence of said intent in petitioners herein.
Only
one
or
two
of
the
aforementioned
circumstances were present in the cases cited by
petitioners herein, and, hence, those cases are not in
point. 5

In the present case, there is no evidence that petitioners entered

into an agreement to contribute money, property or industry to a
common fund, and that they intended to divide the profits among
themselves. Respondent commissioner and/ or his representative
just assumed these conditions to be present on the basis of the fact
that petitioners purchased certain parcels of land and became coowners thereof.
In Evangelists, there was a series of transactions where petitioners
purchased twenty-four (24) lots showing that the purpose was not
limited to the conservation or preservation of the common fund or
even the properties acquired by them. The character of habituality
peculiar to business transactions engaged in for the purpose of
gain was present.
In the instant case, petitioners bought two (2) parcels of land in
1965. They did not sell the same nor make any improvements
thereon. In 1966, they bought another three (3) parcels of land
from one seller. It was only 1968 when they sold the two (2) parcels
of land after which they did not make any additional or new
purchase. The remaining three (3) parcels were sold by them in
1970. The transactions were isolated. The character of habituality
peculiar to business transactions for the purpose of gain was not
present.
In Evangelista, the properties were leased out to tenants for several
years. The business was under the management of one of the
partners. Such condition existed for over fifteen (15) years. None of
the circumstances are present in the case at bar. The co-ownership
started only in 1965 and ended in 1970.
Thus, in the concurring opinion of Mr. Justice Angelo Bautista
in Evangelista he said:
I wish however to make the following observation
Article 1769 of the new Civil Code lays down the rule
for determining when a transaction should be
deemed a partnership or a co-ownership. Said article
paragraphs 2 and 3, provides;

(2) Co-ownership or co-possession does not itself

establish a partnership, whether such co-owners or
co-possessors do or do not share any profits made by
the use of the property;
(3) The sharing of gross returns does not of itself
establish a partnership, whether or not the persons
sharing them have a joint or common right or
interest in any property from which the returns are
derived;
From the above it appears that the fact that those
who agree to form a co- ownership share or do not
share any profits made by the use of the property
held in common does not convert their venture into a
partnership. Or the sharing of the gross returns does
not of itself establish a partnership whether or not
the persons sharing therein have a joint or common
right or interest in the property. This only means
that, aside from the circumstance of profit, the
presence of other elements constituting partnership
is necessary, such as the clear intent to form a
partnership, the existence of a juridical personality
different from that of the individual partners, and the
freedom to transfer or assign any interest in the
property by one with the consent of the
others (Padilla, Civil Code of the Philippines
Annotated, Vol. I, 1953 ed., pp. 635-636)
It is evident that an isolated transaction whereby two
or more persons contribute funds to buy certain real
estate for profit in the absence of other
circumstances showing a contrary intention cannot
be considered a partnership.
Persons who contribute property or funds for a
common enterprise and agree to share the gross
returns of that enterprise in proportion to their
contribution, but who severally retain the title to
their respective contribution, are not thereby

rendered partners. They have no common stock or

capital, and no community of interest as principal
proprietors in the business itself which the proceeds
derived. (Elements of the Law of Partnership by Flord
D. Mechem 2nd Ed., section 83, p. 74.)
A joint purchase of land, by two, does not constitute
a co-partnership in respect thereto; nor does an
agreement to share the profits and losses on the sale
of land create a partnership; the parties are only
tenants in common. (Clark vs. Sideway, 142 U.S.
682,12 Ct. 327, 35 L. Ed., 1157.)
Where plaintiff, his brother, and another agreed to
become owners of a single tract of realty, holding as
tenants in common, and to divide the profits of
disposing of it, the brother and the other not being
entitled to share in plaintiffs commission, no
partnership existed as between the three parties,
whatever their relation may have been as to third
parties. (Magee vs. Magee 123 N.E. 673, 233 Mass.
341.)
In order to constitute a partnership inter sese there
must be: (a) An intent to form the same; (b)
generally participating in both profits and losses; (c)
and such a community of interest, as far as third
persons are concerned as enables each party to
make contract, manage the business, and dispose of
the whole property.-Municipal Paving Co. vs. Herring
150 P. 1067, 50 III 470.)
The common ownership of property does not itself
create a partnership between the owners, though
they may use it for the purpose of making gains; and
they may, without becoming partners, agree among
themselves as to the management, and use of such
property and the application of the proceeds
therefrom. (Spurlock vs. Wilson, 142 S.W. 363,160
No. App. 14.) 6

The sharing of returns does not in itself establish a partnership

whether or not the persons sharing therein have a joint or common
right or interest in the property. There must be a clear intent to
form a partnership, the existence of a juridical personality different
from the individual partners, and the freedom of each party to
transfer or assign the whole property.
In the present case, there is clear evidence of co-ownership
between the petitioners. There is no adequate basis to support the
proposition that they thereby formed an unregistered partnership.
The two isolated transactions whereby they purchased properties
and sold the same a few years thereafter did not thereby make
them partners. They shared in the gross profits as co- owners and
paid their capital gains taxes on their net profits and availed of the
tax amnesty thereby. Under the circumstances, they cannot be
considered to have formed an unregistered partnership which is
thereby liable for corporate income tax, as the respondent
commissioner proposes.
And even assuming for the sake of argument that such
unregistered partnership appears to have been formed, since there
is no such existing unregistered partnership with a distinct
personality nor with assets that can be held liable for said
deficiency corporate income tax, then petitioners can be held
individually liable as partners for this unpaid obligation of the
partnership p. 7 However, as petitioners have availed of the
benefits of tax amnesty as individual taxpayers in these
transactions, they are thereby relieved of any further tax liability
arising therefrom.
WHEREFROM, the petition is hereby GRANTED and the decision of
the respondent Court of Tax Appeals of March 30, 1987 is hereby
REVERSED and SET ASIDE and another decision is hereby rendered
relieving petitioners of the corporate income tax liability in this
case, without pronouncement as to costs.
SO ORDERED.
Cruz, Grio-Aquino and Medialdea, JJ., concur.

Narvasa, J., took no part.

PASCUAL v. Commissioner of Internal Revenue #10 BUSORG

G.R. No. 78133 October 18, 1988
GANCAYCO, J.:
FACTS:
On June 22, 1965, petitioners bought two (2)parcels of land from
Santiago Bernardino, et eland on May 28, 1966, they bought
another three (3) parcels of land from Juan Roque. The first two
parcels of land were sold by petitioners in 1968 to Marenir
Development Corporation, while the three parcels of land were sold
by petitioners to Erlinda Reyes and Maria Samson on March
19,1970. Petitioner realized a net profit in the sale made in 1968 in
the amount of P165, 224.70, while they realized a net profit of
P60,000 in the sale made in 1970. The corresponding capital gains
taxes were paid by petitioners in 1973 and 1974 .Respondent
Commissioner informed petitioners that in the years 1968 and
1970, petitioners as co-owners in the real estate transactions
formed an unregistered partnership or joint venture taxable as a
corporation under Section 20(b)and its income was subject to the
taxes prescribed under Section 24, both of the National Internal
Revenue Code; that the unregistered partnership was subject to
corporate income tax as distinguished from profits derived from the
partnership by them which is subject to individual income tax.
ISSUE:
Whether petitioners formed an unregistered partnership subject to
corporate income tax(partnership vs. co-ownership)
RULING:
Article 1769 of the new Civil Code lays down the rule for
determining when a transaction should be deemed a partnership or
a co-ownership. Said article paragraphs 2 and 3, provides:(2) Coownership or co-possession does not itself establish a partnership,
whether such co-owners or co-possessors do or do not share any
profits made by the use of the property; (3) The sharing of gross
returns does not of itself establish a partnership, whether or not the
persons sharing them have a joint or common right or interest in
any property from which the returns are derived; The sharing of
returns does not in itself establish a partnership whether or not the
persons sharing therein have a joint or common right or interest in

the property. There must be a clear intent to form a partnership,

the existence of a juridical personality different from the individual
partners, and the freedom of each party to transfer or assign the
whole property. In the present case, there is clear evidence of coownership between the petitioners. There is no adequate basis to
support the proposition that they thereby formed an unregistered
partnership. The two isolated transactions whereby they purchased
properties and sold the same a few years thereafter did not thereby
make them partners. They shared in the gross profits as co- owners
and paid their capital gains taxes on their net profits and availed of
the tax amnesty thereby. Under the circumstances, they cannot be
considered to have formed an unregistered partnership which is
thereby liable for corporate income tax, as the respondent
commissioner proposes. And even assuming for the sake of
argument that such unregistered partnership appears to have been
formed, since there is no such existing unregistered partnership
with a distinct personality nor with assets that can be held liable for
said deficiency corporate income tax, then petitioners can be held
individually liable as partners for this unpaid obligation of the
partnership

[G.R. No. L-26145. February 20, 1984.]

THE MANILA WINE MERCHANTS, INC., Petitioner, v. THE
COMMISSIONER OF INTERNAL REVENUE, Respondent.
Rafael D. Salcedo for Petitioner.
The Solicitor General for Respondent.

SYLLABUS
1. TAXATION; NATIONAL INTERNAL REVENUE CODE; CORPORATE
INCOME TAX; ADDITIONAL TAX ON ACCUMULATED EARNINGS;
EXEMPTION THEREFROM. A prerequisite to the imposition of the
tax has been that the corporation be formed or availed of for the
purpose of avoiding the income tax (or surtax) on its shareholders,
or on the shareholders of any other corporation by permitting the
earnings and profits of the corporation to accumulate instead of
dividing them among or distributing them to the shareholders. If
the earnings and profits were distributed, the shareholders would
be required to pay an income tax thereon whereas, if the
distribution were not made to them, they would incur no tax in
respect to the undistributed earnings and profits of the corporation
(Mertens, Law on Federal Income Taxation, Vol. 7, Chapter 39, p.
44). The touchstone of liability is the purpose behind the
accumulation of the income and not the consequences of the
accumulation (Ibid., p. 47). Thus, if the failure to pay dividends is
due to some other cause, such as the use of undistributed earnings
and profits for the reasonable needs of the business, such purpose
does not fall within the interdiction of the statute (Ibid., p. 45).
2. ID.; ID.; ID.; ID.; ID.; WHEN ACCUMULATION CONSIDERED
UNREASONABLE. An accumulation of earnings or profits
(including undistributed earnings or profits of prior years) is
unreasonable if it is not required for the purpose of the business,
considering all the circumstances of the case (Sec. 21, Revenue
Regulations No. 2).
3. ID.; ID.; ID.; ID.; ID.; "REASONABLE NEEDS OF THE BUSINESS,"
CONSTRUED. To determine the "reasonable needs" of the
business in order to justify an accumulation of earnings, the Courts
of the United States have invented the so-called "Immediacy Test"
which construed the words "reasonable needs of the business" to
mean the immediate needs of the business, and it was generally
held that if the corporation did not prove an immediate need for the
accumulation of the earnings and profits, the accumulation was not
for the reasonable needs of the business, and the penalty tax would
apply. American cases likewise hold that investment of the earnings
and profits of the corporation in stock or securities of an unrelated
business usually indicates an accumulation beyond the reasonable
needs of the business. (Helvering v. Chicago Stockyards Co., 318
US 693; Helvering v. National Grocery Co., 304 US 282).

4. REMEDIAL LAW; APPEALS; FACTUAL FINDINGS OF THE COURT OF

TAX APPEALS, BINDING. The finding of the Court of Tax Appeals
that the purchase of the U.S.A. Treasury bonds were in no way
related to petitioners business of importing and selling wines
whisky, liquors and distilled spirits, and thus construed as an
investment beyond the reasonable needs of the business is binding
on Us, the same being factual (Renato Raymundo v. Hon. De Jova,
101 SCRA 495). Furthermore, the wisdom behind thus finding
cannot be doubted, The case of J.M. Perry & Co. v. Commissioner of
Internal Revenue supports the same.
5. TAXATION; NATIONAL INTERNAL REVENUE CODE; INCOME TAX OF
CORPORATIONS; ADDITIONAL TAX ON ACCUMULATED EARNINGS;
EXCEPTION THEREFROM; ACCUMULATION OF EARNINGS, MUST BE
USED FOR REASONABLE NEEDS OF BUSINESS WITHIN A
REASONABLE TIME. The records further reveal that from May
1951 when petitioner purchased the U.S.A. Treasury shares, until
1962 when it finally liquidated the same, it (petitioner) never had
the occasion to use the said shares in aiding or financing its
importation. This militates against the purpose enunciated earlier
by petitioner that the shares were purchased to finance its
importation business. To justify an accumulation of earnings and
profits for the reasonably anticipated future needs, such
accumulation must be used within a reasonable time after the close
of the taxable year (Mertens, Ibid., p. 104).
6. ID.; ID.; ID.; ID.; ID.; ID.; INTENTION AT THE TIME OF
ACCUMULATION, BASIS OF THE TAX; ACCUMULATION OF PROFITS IN
CASE AT BAR, UNREASONABLE. In order to determine whether
profits are accumulated for the reasonable needs of the business as
to avoid the surtax upon shareholders, the controlling intention of
the taxpayer is that which is manifested at the time of
accumulation not subsequently declared intentions which are
merely the product of afterthought (Basilan Estates, Inc. v. Comm.
of Internal Revenue, 21 SCRA 17 citing Jacob Mertens, Jr., The law of
Federal Income Taxation, Vol. 7, Cumulative Supplement, p. 213;
Smoot and San & Gravel Corp. v. Comm., 241 F 2d 197). A
speculative and indefinite purpose will not suffice. The mere
recognition of a future problem and the discussion of possible and
alternative solutions is not sufficient. Definiteness of plan coupled
with action taken towards its consummation are essential (Fuel
Carriers, Inc. v. US 202 F supp. 497; Smoot Sand & Gravel Corp. v.
Comm., supra). Viewed on the foregoing analysis and tested under
the "immediacy doctrine," We are convinced that the Court of Tax
Appeals is correct in finding that the investment made by petitioner

in the U.S.A. Treasury shares in 1951 was an accumulation of profits

in excess of the reasonable needs of petitioners
business.chanroblesvirtuallawlibrary
7. ID.; ID.; ID.; ID.; ACCUMULATIONS OF PRIOR YEARS TAKEN INTO
ACCOUNT IN DETERMINATION OF LIABILITY THEREFOR. The rule
is now settled in Our jurisprudence that undistributed earnings or
profits of prior years are taken into consideration in determining
unreasonable accumulation for purposes of the 25% surtax. The
case of Basilan Estates, Inc. v. Commissioner of Internal Revenue
further strengthen this rule in determining unreasonable
accumulation for the year concerned.In determining whether
accumulations of earnings or profits in a particular year are within
the reasonable needs of a corporation, it is necessary to take into
account prior accumulations, since accumulations prior to the year
involved may have been sufficient to cover the business needs and
additional accumulations during the year involved would not
reasonably be necessary.
DECISION

On December 31, 1957, herein respondent caused the examination

of herein petitioners book of account and found the latter of having
unreasonably accumulated surplus of P428,934.32 for the calendar
year 1947 to 1957, in excess of the reasonable needs of the
business subject to the 25% surtax imposed by Section 25 of the
Tax Code.
On February 26, 1963, the Commissioner of Internal Revenue
demanded upon the Manila Wine Merchants, Inc. payment of
P126,536.12 as 25% surtax and interest on the latters
unreasonable accumulation of profits and surplus for the year 1957,
computed as follows:chanrob1es virtual 1aw library
Unreasonable accumulation of surtax P428,934.42

25% surtax due thereon P107,234.00

Add: 1/2% monthly interest from June 20,
1959 to June 20, 1962 19,302.12

GUERRERO, J.:
In this Petition for Review on Certiorari, Petitioner, the Manila Wine
Merchants, Inc., disputes the decision of the Court of Tax Appeals
ordering it (petitioner) to pay respondent, the Commissioner of
Internal Revenue, the amount of P86,804.38 as 25% surtax plus
interest which represents the additional tax due petitioner for
improperly accumulating profits or surplus in the taxable year 1957
under Sec. 25 of the National Internal Revenue Code.chanrobles
virtualawlibrary chanrobles.com:chanrobles.com.ph
The Court of Tax Appeals made the following finding of facts, to
wit:jgc:chanrobles.com.ph
"Petitioner, a domestic corporation organized in 1937, is principally
engaged in the importation and sale of whisky, wines, liquors and
distilled spirits. Its original subscribed and paid capital was
P500,000.00. Its capital of P500,000.00 was reduced to
P250,000.00 in 1950 with the approval of the Securities and
Exchange Commission but the reduction of the capital was never
implemented. On June 21, 1958, petitioners capital was increased
to P1,000,000.00 with the approval of the said Commission.

TOTAL AMOUNT DUE AND COLLECTIBLE P126,536.12

=========
Respondent contends that petitioner has accumulated earnings
beyond the reasonable needs of its business because the average
ratio of the cash dividends declared and paid by petitioner from
1947 to 1957 was 40.33% of the total surplus available for
distribution at the end of each calendar year. On the other hand,
petitioner contends that in 1957, it distributed 100% of its net
earnings after income tax and part of the surplus for prior years.
Respondent further submits that the accumulated earnings tax
should be based on 25% of the total surplus available at the end of
each calendar year while petitioner maintains that the 25% surtax
is imposed on the total surplus or net income for the year after
deducting therefrom the income tax due.
The records show the following analysis of petitioners net income,
cash dividends and earned surplus for the years 1946 to 1957:

1
Percentage of
Dividends to
Net Income Total Cash Net Income Balance
After Income Dividends After of Earned
Year Tax Paid Income Tax Surplus
1946 P 613,790.00 P 200,000. 32.58% P 234,104.81
1947 425,719.87 360,000. 84.56% 195,167.10
1948 415,591.83 375,000. 90.23% 272,991.38
1949 335,058.06 200,000. 59.69% 893,113.42
1950 399,698.09 600,000. 150.11% 234,987.07
1951 346,257.26 300,000. 86.64% 281,244.33
1952 196,161.97 200,000. 101.96% 277,406.30
1953 169,714.04 200,000. 117.85% 301,138.84
1954 238,124.85 250,000. 104.99% 289,262.69
1955 312,284.74 200,000. 64.04% 401,548.43
1956 374,240.28 300,000. 80.16% 475,788.71
1957 353,145.71 400,000. 113.27% 428,934.42

P4,179,787.36 P3,585.000. 85.77% P3,785.688.50
========== ========= ======= ==========
Another basis of respondent in assessing petitioner for
accumulated earnings tax is its substantial investment of surplus or
profits in unrelated business. These investments are itemized as
follows:chanrob1es virtual 1aw library

1. Acme Commercial Co., Inc. P 27,501.00

2. Union Insurance Society
of Canton 1,145.76
3. U.S.A. Treasury Bond 347,217.50
4. Wack Wack Golf &
Country Club 1.00

375,865.26
=========
As to the investment of P27,501.00 made by petitioner in the Acme
Commercial Co., Inc., Mr. N.R.E. Hawkins, president of the petitioner
corporation 2 explained as follows:chanrob1es virtual 1aw library
The first item consists of shares of Acme Commercial Co., Inc.
which the Company acquired in 1947 and 1949. In the said years,
we thought it prudent to invest in a business which patronizes us.
As a supermarket, Acme Commercial Co., Inc. is one of our best
customers. The investment has proven to be beneficial to the
stockholders of this Company. As an example, the Company
received cash dividends in 1961 totalling P16,875.00 which was
included in its income tax return for the said year.
As to the investments of petitioner in Union Insurance Society of
Canton and Wack Wack Golf Club in the sums of P1,145.76 and
P1.00, respectively, the same official of the petitioner-corporation
stated that: 3
The second and fourth items are small amounts which we believe
would not affect this case substantially. As regards the Union
Insurance Society of Canton shares, this was a pre-war investment,
when Wise & Co., Inc., Manila Wine Merchants and the said
insurance firm were common stockholders of the Wise Bldg. Co.,,
Inc. and the three companies were all housed in the same building.
Union Insurance invested in Wise Bldg. Co., Inc. but invited Manila
Wine Merchants, Inc. to buy a few of its shares.

As to the U.S.A. Treasury Bonds amounting to P347,217.50, Mr.

Hawkins explained as follows: 4
With regards to the U.S.A. Treasury Bills in the amount of
P347,217.50, in 1950, our balance sheet for the said year shows
the Company had deposited in current account in various banks
P629,403.64 which was not earning any interest. We decided to
utilize part of this money as reserve to finance our importations
and to take care of future expansion including acquisition of a lot
and the construction of our own office building and bottling plant.
At that time, we believed that a dollar reserve abroad would be
useful to the Company in meeting immediate urgent orders of its
local customers. In order that the money may earn interest, the
Company, on May 31, 1951 purchased US Treasury bills with 90-day
maturity and earning approximately 1% interest with the face value
of US$175,000.00. US Treasury Bills are easily convertible into cash
and for the said reason they may be better classified as cash rather
than investments.
The Treasury Bills in question were held as such for many years in
view of our expectation that the Central Bank inspite of the controls
would allow no-dollar licenses importations. However, since the
Central Bank did not relax its policy with respect thereto, we
decided sometime in 1957 to hold the bills for a few more years in
view of our plan to buy a lot and construct a building of our own.
According to the lease agreement over the building formerly
occupied by us in Dasmarias St., the lease was to expire
sometime in 1957. At that time, the Company was not yet qualified
to own real property in the Philippines. We therefore waited until
60% of the stocks of the Company would be owned by Filipino
citizens before making definite plans. Then in 1959 when the
Company was already more than 60% Filipino owned, we
commenced looking for a suitable location and then finally in 1961,
we bought the man lot with an old building on Otis St., Paco, our
present site, for P665,000.00. Adjoining smaller lots were bought
later. After the purchase of the main property, we proceeded with
the remodelling of the old building and the construction of
additions, which were completed at a cost of P143,896.00 in April,
1962.
In view of the needs of the business of this Company and the
purchase of the Otis lots and the construction of the improvements
thereon, most of its available funds including the Treasury Bills had
been utilized, but inspite of the said expenses the Company
consistently declared dividends to its stockholders. The Treasury

Bills were liquidated on February 15, 1962.

Respondent found that the accumulated surplus in question were
invested to unrelated business which were not considered in the
immediate needs of the Company such that the 25% surtax be
imposed therefrom."cralaw virtua1aw library
Petitioner appealed to the Court of Tax Appeals.
On the basis of the tabulated figures, supra, the Court of Tax
Appeals found that the average percentage of cash dividends
distributed was 85.77% for a period of 11 years from 1946 to 1957
and not only 40.33% of the total surplus available for distribution at
the end of each calendar year actually distributed by the petitioner
to its stockholders, which is indicative of the view that the Manila
Wine Merchants, Inc. was not formed for the purpose of preventing
the imposition of income tax upon its shareholders. 5
With regards to the alleged substantial investment of surplus or
profits in unrelated business, the Court of Tax Appeals held that the
investment of petitioner with Acme Commercial Co., Inc., Union
Insurance Society of Canton and with the Wack Wack Golf and
Country Club are harmless accumulation of surplus and, therefore,
not subject to the 25% surtax provided in Section 25 of the Tax
Code. 6
As to the U.S.A. Treasury Bonds amounting to P347,217.50, the
Court of Tax Appeals ruled that its purchase was in no way related
to petitioners business of importing and selling wines, whisky,
liquors and distilled spirits. Respondent Court was convinced that
the surplus of P347,217.50 which was invested in the U.S.A.
Treasury Bonds was availed of by petitioner for the purpose of
preventing the imposition of the surtax upon petitioners
shareholders by permitting its earnings and profits to accumulate
beyond the reasonable needs of business. Hence, the Court of Tax
Appeals modified respondents decision by imposing upon
petitioner the 25% surtax for 1957 only in the amount of
P86,804.38 computed as follows:chanrob1es virtual 1aw library
Unreasonable accumulation
of surplus P347,217.50

25% surtax due thereon P 86,804.38 7

On May 30, 1966, the Court of Tax Appeals denied the motion for
reconsideration filed by petitioner on March 30, 1966. Hence, this
petition.
Petition assigns the following errors:chanrob1es virtual 1aw library
I
The Court of Tax Appeals erred in holding that petitioner was
availed of for the purpose of preventing the imposition of a surtax
on its shareholders.
II
The Court of Tax Appeals erred in holding that petitioners purchase
of U.S.A. Treasury Bills in 1951 was an investment in unrelated
business subject to the 25% surtax in 1957 as surplus profits
improperly accumulated in the latter years.
III
The Court of Tax Appeals erred in not finding that petitioner did not
accumulate its surplus profits improperly in 1957, and in not
holding that such surplus profits, including the so-called unrelated
investments, were necessary for its reasonable business needs.
IV
The Court of Tax Appeals erred in not holding that petitioner had
overcome the prima facie presumption provided for in Section 25(c)
of the Revenue Code.
V
The Court of Tax Appeals erred in finding petition liable for the
payment of the surtax of P86,804.38 and in denying petitioners
Motion for Reconsideration and/or New Trial.
The issues in this case can be summarized as follows: (1) whether
the purchase of the U.S.A. Treasury bonds by petitioner in 1951 can

be construed as an investment to an unrelated business and hence,

such was availed of by petitioner for the purpose of preventing the
imposition of the surtax upon petitioners shareholders by
permitting its earnings and profits to accumulate beyond the
reasonable needs of the business, and if so, (2) whether the
penalty tax of twenty-five percent (25%) can be imposed on such
improper accumulation in 1957 despite the fact that the
accumulation occurred in 1951.chanrobles virtualawlibrary
chanrobles.com:chanrobles.com.ph
The pertinent provision of the National Internal Revenue Code reads
as follows:jgc:chanrobles.com.ph
"Sec. 25. Additional tax on corporations improperly accumulating
profits or surplus. (a) Imposition of Tax. If any corporation,
except banks, insurance companies, or personal holding companies
whether domestic or foreign, is formed or availed of for the purpose
of preventing the imposition of the tax upon its shareholders or
members or the shareholders or members of another corporation,
through the medium of permitting its gains and profits to
accumulate instead of being divided or distributed, there is levied
and assessed against such corporation, for each taxable year, a tax
equal to twenty-five per centum of the undistributed portion of its
accumulated profits or surplus which shall be in addition to the tax
imposed by section twenty-four and shall be computed, collected
and paid in the same manner and subject to the same provisions of
law, including penalties, as that tax: Provided, that no such tax
shall be levied upon any accumulated profits or surplus, if they are
invested in any dollar-producing or dollar-saving industry or in the
purchase of bonds issued by the Central Bank of the Philippines.
x

(c) Evidence determinative of purpose. The fact that the earnings

of profits of a corporation are permitted to accumulate beyond the
reasonable needs of the business shall be determinative of the
purpose to avoid the tax upon its shareholders or members unless
the corporation, by clear preponderance of evidence, shall prove
the contrary." (As amended by Republic Act No. 1823).
As correctly pointed out by the Court of Tax Appeals, inasmuch as
the provisions of Section 25 of the National Internal Revenue Code
were bodily lifted from Section 102 of the U.S. Internal Revenue
Code of 1939, including the regulations issued in connection
therewith, it would be proper to resort to applicable cases decided

by the American Federal Courts for guidance and

enlightenment.chanrobles virtual lawlibrary
A prerequisite to the imposition of the tax has been that the
corporation be formed or availed of for the purpose of avoiding the
income tax (or surtax) on its shareholders, or on the shareholders
of any other corporation by permitting the earnings and profits of
the corporation to accumulate instead of dividing them among or
distributing them to the shareholders. If the earnings and profits
were distributed, the shareholders would be required to pay an
income tax thereon whereas, if the distribution were not made to
them, they would incur no tax in respect to the undistributed
earnings and profits of the corporation. 8 The touchstone of liability
is the purpose behind the accumulation of the income and not the
consequences of the accumulation. 9 Thus, if the failure to pay
dividends is due to some other cause, such as the use of
undistributed earnings and profits for the reasonable needs of the
business, such purpose does not fall within the interdiction of the
statute. 10
An accumulation of earnings or profits (including undistributed
earnings or profits of prior years) is unreasonable if it is not
required for the purpose of the business, considering all the
circumstances of the case. 11
In purchasing the U.S.A. Treasury Bonds, in 1951, petitioner argues
that these bonds were so purchased (1) in order to finance their
importation; and that a dollar reserve abroad would be useful to the
Company in meeting urgent orders of its local customers and (2) to
take care of future expansion including the acquisition of a lot and
the construction of their office building and bottling plant.
We find no merit in the petition.
To avoid the twenty-five percent (25%) surtax, petitioner has to
prove that the purchase of the U.S.A. Treasury Bonds in 1951 with a
face value of $175,000.00 was an investment within the reasonable
needs of the Corporation.
To determine the "reasonable needs" of the business in order to
justify an accumulation of earnings, the Courts of the United States
have invented the so-called "Immediacy Test" which construed the
words "reasonable needs of the business" to mean the immediate
needs of the business, and it was generally held that if the
corporation did not prove an immediate need for the accumulation
of the earnings and profits, the accumulation was not for the

reasonable needs of the business, and the penalty tax would apply.
12 American cases likewise hold that investment of the earnings
and profits of the corporation in stock or securities of an unrelated
business usually indicates an accumulation beyond the reasonable
needs of the business. 13
The finding of the Court of Tax Appeals that the purchase of the
U.S.A. Treasury bonds were in no way related to petitioners
business of importing and selling wines whisky, liquors and distilled
spirits, and thus construed as an investment beyond the reasonable
needs of the business 14 is binding on Us, the same being factual.
15 Furthermore, the wisdom behind thus finding cannot be
doubted, The case of J.M. Perry & Co. v. Commissioner of Internal
Revenue 16 supports the same. In that case, the U.S. Court said the
following:jgc:chanrobles.com.ph
"It appears that the taxpayer corporation was engaged in the
business of cold storage and wareshousing in Yahima, Washington.
It maintained a cold storage plant, divided into four units, having a
total capacity of 490,000 boxes of fruits. It presented evidence to
the effect that various alterations and repairs to its plant were
contemplated in the tax years, . . .
It also appeared that in spite of the fact that the taxpayer
contended that it needed to maintain this large cash reserve on
hand, it proceeded to make various investments which had no
relation to its storage business. In 1934, it purchased mining stock
which it sold in 1935 at a profit of US $47,995.29. . . .
All these things may reasonably have appealed to the Board as
incompatible with a purpose to strengthen the financial position of
the taxpayer and to provide for needed alteration."cralaw
virtua1aw library
The records further reveal that from May 1951 when petitioner
purchased the U.S.A. Treasury shares, until 1962 when it finally
liquidated the same, it (petitioner) never had the occasion to use
the said shares in aiding or financing its importation. This militates
against the purpose enunciated earlier by petitioner that the shares
were purchased to finance its importation business. To justify an
accumulation of earnings and profits for the reasonably anticipated
future needs, such accumulation must be used within a reasonable
time after the close of the taxable year. 17
Petitioner advanced the argument that the U.S.A. Treasury shares
were held for a few more years from 1957, in view of a plan to buy

a lot and construct a building of their own; that at that time (1957),
the Company was not yet qualified to own real property in the
Philippines, hence it (petitioner) had to wait until sixty percent
(60%) of the stocks of the Company would be owned by Filipino
citizens before making definite plans. 18
These arguments of petitioner indicate that it considers the U.S.A.
Treasury shares not only for the purpose of aiding or financing its
importation but likewise for the purpose of buying a lot and
constructing a building thereon in the near future, but conditioned
upon the completion of the 60% citizenship requirement of stock
ownership of the Company in order to qualify it to purchase and
own a lot. The time when the company would be able to establish
itself to meet the said requirement and the decision to pursue the
same are dependent upon various future contingencies. Whether
these contingencies would unfold favorably to the Company and if
so, whether the Company would decide later to utilize the U.S.A.
Treasury shares according to its plan, remains to be seen. From
these assertions of petitioner, We cannot gather anything definite
or certain. This, We cannot approve.chanrobles law library
In order to determine whether profits are accumulated for the
reasonable needs of the business as to avoid the surtax upon
shareholders, the controlling intention of the taxpayer is that which
is manifested at the time of accumulation not subsequently
declared intentions which are merely the product of afterthought.
19 A speculative and indefinite purpose will not suffice. The mere
recognition of a future problem and the discussion of possible and
alternative solutions is not sufficient. Definiteness of plan coupled
with action taken towards its consummation are essential. 20 The
Court of Tax Appeals correctly made the following ruling: 21
"As to the statement of Mr. Hawkins in Exh. "B" regarding the
expansion program of the petitioner by purchasing a lot and
building of its own, we find no justifiable reason for the retention in
1957 or thereafter of the US Treasury Bonds which were purchased
in 1951.
x

"Moreover, if there was any thought for the purchase of a lot and
building for the needs of petitioners business, the corporation may
not with impunity permit its earnings to pile up merely because at
some future time certain outlays would have to be made. Profits
may only be accumulated for the reasonable needs of the business,

and implicit in this is further requirement of a reasonable

time."cralaw virtua1aw library
Viewed on the foregoing analysis and tested under the "immediacy
doctrine," We are convinced that the Court of Tax Appeals is correct
in finding that the investment made by petitioner in the U.S.A.
Treasury shares in 1951 was an accumulation of profits in excess of
the reasonable needs of petitioners business.
Finally, petitioner asserts that the surplus profits allegedly
accumulated in the form of U.S.A. Treasury shares in 1951 by it
(petitioner) should not be subject to the surtax in 1957. In other
words, petitioner claims that the surtax of 25% should be based on
the surplus accumulated in 1951 and not in 1957.
This is devoid of merit.
The rule is now settled in Our jurisprudence that undistributed
earnings or profits of prior years are taken into consideration in
determining unreasonable accumulation for purposes of the 25%
surtax. 22 The case of Basilan Estates, Inc. v. Commissioner of
Internal Revenue 23 further strengthen this rule, and We
quote:jgc:chanrobles.com.ph
"Petitioner questions why the examiner covered the period from
1948-1953 when the taxable year on review was 1953. The surplus
of P347,507.01 was taken by the examiner from the balance sheet
of the petitioner for 1953. To check the figure arrived at, the
examiner traced the accumulation process from 1947 until 1953,
and petitioners figure stood out to be correct. There was no error in
the process applied, for previous accumulations should be
considered in determining unreasonable accumulation for the year
concerned.In determining whether accumulations of earnings or
profits in a particular year are within the reasonable needs of a
corporation, it is necessary to take into account prior
accumulations, since accumulations prior to the year involved may
have been sufficient to cover the business needs and additional
accumulations during the year involved would not reasonably be
necessary." chanroblesvirtuallawlibrary
WHEREFORE, IN VIEW OF THE FOREGOING, the decision of the
Court of Tax Appeals is AFFIRMED in toto, with costs against
petitioner.
SO ORDERED.

Makasiar, Aquino, Concepcion, Jr., Abad Santos, De Castro and

Escolin, JJ., concur.

G.R. No. 143672

April 24, 2003

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
GENERAL FOODS (PHILS.), INC., respondent.
CORONA, J.:
Petitioner Commissioner of Internal Revenue (Commissioner)
assails the resolution1 of the Court of Appeals reversing the
decision2 of the Court of Tax Appeals which in turn denied the
protest filed by respondent General Foods (Phils.), Inc., regarding
the assessment made against the latter for deficiency taxes.
The records reveal that, on June 14, 1985, respondent corporation,
which is engaged in the manufacture of beverages such as "Tang,"
"Calumet" and "Kool-Aid," filed its income tax return for the fiscal
year ending February 28, 1985. In said tax return, respondent
corporation claimed as deduction, among other business expenses,
the amount of P9,461,246 for media advertising for "Tang."
On May 31, 1988, the Commissioner disallowed 50% or P4,730,623
of the deduction claimed by respondent corporation. Consequently,
respondent corporation was assessed deficiency income taxes in
the amount of P2,635, 141.42. The latter filed a motion for
reconsideration but the same was denied.
On September 29, 1989, respondent corporation appealed to the
Court of Tax Appeals but the appeal was dismissed:
With such a gargantuan expense for the advertisement of a
singular product, which even excludes "other advertising and
promotions" expenses, we are not prepared to accept that such
amount is reasonable "to stimulate the current sale of
merchandise" regardless of Petitioners explanation that such
expense "does not connote unreasonableness considering the
grave economic situation taking place after the Aquino
assassination characterized by capital fight, strong deterioration of
the purchasing power of the Philippine peso and the slacking
demand for consumer products" (Petitioners Memorandum, CTA
Records, p. 273). We are not convinced with such an explanation.
The staggering expense led us to believe that such expenditure
was incurred "to create or maintain some form of good will for the
taxpayers trade or business or for the industry or profession of

which the taxpayer is a member." The term "good will" can hardly
be said to have any precise signification; it is generally used to
denote the benefit arising from connection and reputation (Words
and Phrases, Vol. 18, p. 556 citing Douhart vs. Loagan, 86 III. App.
294). As held in the case of Welch vs. Helvering, efforts to establish
reputation are akin to acquisition of capital assets and, therefore,
expenses related thereto are not business expenses but capital
expenditures. (Atlas Mining and Development Corp. vs.
Commissioner of Internal Revenue, supra). For sure such
expenditure was meant not only to generate present sales but
more for future and prospective benefits. Hence, "abnormally large
expenditures for advertising are usually to be spread over the
period of years during which the benefits of the expenditures are
received" (Mertens, supra, citing Colonial Ice Cream Co., 7 BTA
154).
WHEREFORE, in all the foregoing, and finding no error in the case
appealed from, we hereby RESOLVE to DISMISS the instant petition
for lack of merit and ORDER the Petitioner to pay the respondent
Commissioner the assessed amount of P2,635,141.42 representing
its deficiency income tax liability for the fiscal year ended February
28, 1985."3
Aggrieved, respondent corporation filed a petition for review at the
Court of Appeals which rendered a decision reversing and setting
aside the decision of the Court of Tax Appeals:
Since it has not been sufficiently established that the item it
claimed as a deduction is excessive, the same should be allowed.
WHEREFORE, the petition of petitioner General Foods (Philippines),
Inc. is hereby GRANTED. Accordingly, the Decision, dated 8
February 1994 of respondent Court of Tax Appeals is REVERSED and
SET ASIDE and the letter, dated 31 May 1988 of respondent
Commissioner of Internal Revenue is CANCELLED.
SO ORDERED.4
Thus, the instant petition, wherein the Commissioner presents for
the Courts consideration a lone issue: whether or not the subject
media advertising expense for "Tang" incurred by respondent
corporation was an ordinary and necessary expense fully
deductible under the National Internal Revenue Code (NIRC).
It is a governing principle in taxation that tax exemptions must be
construed in strictissimi juris against the taxpayer and liberally in

favor of the taxing authority;5 and he who claims an exemption

must be able to justify his claim by the clearest grant of organic or
statute law. An exemption from the common burden cannot be
permitted to exist upon vague implications.6
Deductions for income tax purposes partake of the nature of tax
exemptions; hence, if tax exemptions are strictly construed, then
deductions must also be strictly construed.
We then proceed to resolve the singular issue in the case at bar.
Was the media advertising expense for "Tang" paid or incurred by
respondent corporation for the fiscal year ending February 28, 1985
"necessary and ordinary," hence, fully deductible under the NIRC?
Or was it a capital expenditure, paid in order to create "goodwill
and reputation" for respondent corporation and/or its products,
which should have been amortized over a reasonable period?
Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC
provides:
(A) Expenses.(1) Ordinary
expenses.-

and

necessary

trade,

business

or

professional

(a) In general.- There shall be allowed as deduction from gross

income all ordinary and necessary expenses paid or incurred during
the taxable year in carrying on, or which are directly attributable to,
the development, management, operation and/or conduct of the
trade, business or exercise of a profession.
Simply put, to be deductible from gross income, the subject
advertising expense must comply with the following requisites: (a)
the expense must be ordinary and necessary; (b) it must have been
paid or incurred during the taxable year; (c) it must have been paid
or incurred in carrying on the trade or business of the taxpayer; and
(d) it must be supported by receipts, records or other pertinent
papers.7
The parties are in agreement that the subject advertising expense
was paid or incurred within the corresponding taxable year and was
incurred in carrying on a trade or business. Hence, it was
necessary. However, their views conflict as to whether or not it was
ordinary. To be deductible, an advertising expense should not only
be necessary but also ordinary. These two requirements must be
met.

The Commissioner maintains that the subject advertising expense

was not ordinary on the ground that it failed the two conditions set
by U.S. jurisprudence: first, "reasonableness" of the amount
incurred and second, the amount incurred must not be a capital
outlay to create "goodwill" for the product and/or private
respondents business. Otherwise, the expense must be considered
a capital expenditure to be spread out over a reasonable time.
We agree.

for advertising of the second kind, then normally they should be

spread out over a reasonable period of time.
We agree with the Court of Tax Appeals that the subject advertising
expense was of the second kind. Not only was the amount
staggering; the respondent corporation itself also admitted, in its
letter protest8 to the Commissioner of Internal Revenues
assessment, that the subject media expense was incurred in order
to protect respondent corporations brand franchise, a critical point
during the period under review.

There is yet to be a clear-cut criteria or fixed test for determining

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

The protection of brand franchise is analogous to the maintenance

of goodwill or title to ones property. This is a capital expenditure
which should be spread out over a reasonable period of time.9

In the case at bar, the P9,461,246 claimed as media advertising

expense for "Tang" alone was almost one-half of its total claim for
"marketing expenses." Aside from that, respondent-corporation also
claimed P2,678,328 as "other advertising and promotions expense"
and another P1,548,614, for consumer promotion.

True, it is the taxpayers prerogative to determine the amount of

advertising expenses it will incur and where to apply them.11 Said
prerogative, however, is subject to certain considerations. The first
relates to the extent to which the expenditures are actually capital
outlays; this necessitates an inquiry into the nature or purpose of
such expenditures.12 The second, which must be applied in
harmony with the first, relates to whether the expenditures are
ordinary and necessary. Concomitantly, for an expense to be
considered ordinary, it must be reasonable in amount. The Court of
Tax Appeals ruled that respondent corporation failed to meet the
two foregoing limitations.

Furthermore, the subject P9,461,246 media advertising expense for

"Tang" was almost double the amount of respondent corporations
P4,640,636 general and administrative expenses.
We find the subject expense for the advertisement of a single
product to be inordinately large. Therefore, even if it is necessary, it
cannot be considered an ordinary expense deductible under then
Section 29 (a) (1) (A) of the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate
the current sale of merchandise or use of services and (2)
advertising designed to stimulate the future sale of merchandise or
use of services. The second type involves expenditures incurred, in
whole or in part, to create or maintain some form of goodwill for the
taxpayers trade or business or for the industry or profession of
which the taxpayer is a member. If the expenditures are for the
advertising of the first kind, then, except as to the question of the
reasonableness of amount, there is no doubt such expenditures are
deductible as business expenses. If, however, the expenditures are

Respondent corporations venture to protect its brand franchise

was tantamount to efforts to establish a reputation. This was akin
to the acquisition of capital assets and therefore expenses related
thereto were not to be considered as business expenses but as
capital expenditures.10

We find said ruling to be well founded. Respondent corporation

incurred the subject advertising expense in order to protect its
brand franchise. We consider this as a capital outlay since it
created goodwill for its business and/or product. The P9,461,246
media advertising expense for the promotion of a single product,
almost one-half of petitioner corporations entire claim for
marketing expenses for that year under review, inclusive of other
advertising and promotion expenses of P2,678,328 and P1,548,614
for consumer promotion, is doubtlessly unreasonable.
It has been a long standing policy and practice of the Court to
respect the conclusions of quasi-judicial agencies such as the Court
of Tax Appeals, a highly specialized body specifically created for the

purpose of reviewing tax cases. The CTA, by the nature of its

functions, is dedicated exclusively to the study and consideration of
tax problems. It has necessarily developed an expertise on the
subject. We extend due consideration to its opinion unless there is
an abuse or improvident exercise of authority.13 Since there is
none in the case at bar, the Court adheres to the findings of the
CTA.
Accordingly, we find that the Court of Appeals committed reversible
error when it declared the subject media advertising expense to be
deductible as an ordinary and necessary expense on the ground
that "it has not been established that the item being claimed as
deduction is excessive." It is not incumbent upon the taxing
authority to prove that the amount of items being claimed is
unreasonable. The burden of proof to establish the validity of
claimed deductions is on the taxpayer.14 In the present case, that
burden was not discharged satisfactorily.
WHEREFORE, premises considered, the instant petition is
GRANTED. The assailed decision of the Court of Appeals is hereby
REVERSED and SET ASIDE. Pursuant to Sections 248 and 249 of the
Tax Code, respondent General Foods (Phils.), Inc. is hereby ordered
to pay its deficiency income tax in the amount of P2,635,141.42,
plus 25% surcharge for late payment and 20% annual interest
computed from August 25, 1989, the date of the denial of its
protest, until the same is fully paid.
SO ORDERED.

GR No. 143672| April 24, 2003 | J. Corona

Test of Reasonableness
Facts:
Respondent corporation General Foods (Phils), which is engaged in
the manufacture of Tang, Calumet and Kool-Aid, filed its
income tax return for the fiscal year ending February 1985 and
claimed as deduction, among other business expenses, P9,461,246
for media advertising for Tang.
The Commissioner disallowed 50% of the deduction claimed and
assessed deficiency income taxes of P2,635,141.42 against General
Foods, prompting the latter to file an MR which was denied.

General Foods later on filed a petition for review at CA, which

reversed and set aside an earlier decision by CTA dismissing the
companys appeal.
Issue:
W/N the subject media advertising expense for Tang was ordinary
and necessary expense fully deductible under the NIRC
Held:
No. Tax exemptions must be construed in stricissimi juris against
the taxpayer and liberally in favor of the taxing authority, and he
who claims an exemption must be able to justify his claim by the
clearest grant of organic or statute law. Deductions for income
taxes partake of the nature of tax exemptions; hence, if tax
exemptions are strictly construed, then deductions must also be
strictly construed.
To be deductible from gross income, the subject advertising
expense must comply with the following requisites: (a) the expense
must be ordinary and necessary; (b) it must have been paid or
incurred during the taxable year; (c) it must have been paid or
incurred in carrying on the trade or business of the taxpayer; and
(d) it must be supported by receipts, records or other pertinent
papers.
While the subject advertising expense was paid or incurred within
the corresponding taxable year and was incurred in carrying on a
trade or business, hence necessary, the parties views conflict as
to whether or not it was ordinary. To be deductible, an advertising
expense should not only be necessary but also ordinary.
The Commissioner maintains that the subject advertising expense
was not ordinary on the ground that it failed the two conditions set
by U.S. jurisprudence: first, reasonableness of the amount
incurred and second, the amount incurred must not be a capital
outlay to create goodwill for the product and/or private
respondents business. Otherwise, the expense must be considered
a capital expenditure to be spread out over a reasonable time.
There is yet to be a clear-cut criteria or fixed test for determining
the reasonableness of an advertising expense. There being no hard
and fast rule on the matter, the right to a deduction depends on a
number of factors such as but not limited to: the type and size of
business in which the taxpayer is engaged; the volume and amount

of its net earnings; the nature of the expenditure itself; the

intention of the taxpayer and the general economic conditions. It is
the interplay of these, among other factors and properly weighed,
that will yield a proper evaluation.
The Court finds the subject expense for the advertisement of a
single product to be inordinately large. Therefore, even if it is
necessary, it cannot be considered an ordinary expense deductible
under then Section 29 (a) (1) (A) of the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate
the current sale of merchandise or use of services and (2)
advertising designed to stimulate the future sale of merchandise or
use of services. The second type involves expenditures incurred, in
whole or in part, to create or maintain some form of goodwill for the
taxpayers trade or business or for the industry or profession of
which the taxpayer is a member. If the expenditures are for the
advertising of the first kind, then, except as to the question of the
reasonableness of amount, there is no doubt such expenditures are
deductible as business expenses. If, however, the expenditures are
for advertising of the second kind, then normally they should be
spread out over a reasonable period of time.
The companys media advertising expense for the promotion of a
single product is doubtlessly unreasonable considering it comprises
almost one-half of the companys entire claim for marketing
expenses for that year under review. Petition granted, judgment
reversed and set aside.

DECISION
YNARES-SANTIAGO, J.:
Petitioner Commissioner of Internal Revenue (CIR) assails the
September 30, 2005 Decision1 of the Court of Appeals in CA-G.R.
SP No. 78426 affirming the February 26, 2003 Decision2 of the
Court of Tax Appeals (CTA) in CTA Case No. 5211, which cancelled
and set aside the Assessment Notices for deficiency income tax
and expanded withholding tax issued by the Bureau of Internal
Revenue (BIR) against respondent Isabela Cultural Corporation
(ICC).
The facts show that on February 23, 1990, ICC, a domestic
corporation, received from the BIR Assessment Notice No. FAS-1-8690-000680 for deficiency income tax in the amount of P333,196.86,
and Assessment Notice No. FAS-1-86-90-000681 for deficiency
expanded withholding tax in the amount of P4,897.79, inclusive of
surcharges and interest, both for the taxable year 1986.
The deficiency income tax of P333,196.86, arose from:
(1) The BIRs disallowance of ICCs claimed expense deductions for
professional and security services billed to and paid by ICC in 1986,
to wit:
(a) Expenses for the auditing services of SGV & Co.,3 for the year
ending December 31, 1985;4
(b) Expenses for the legal services [inclusive of retainer fees] of the
law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna &
Bengson for the years 1984 and 1985.5
(c) Expense for security services of El Tigre Security & Investigation
Agency for the months of April and May 1986.6
(2) The alleged understatement of ICCs interest income on the
three promissory notes due from Realty Investment, Inc.

G.R. No. 172231

February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.
ISABELA CULTURAL CORPORATION, Respondent.

The deficiency expanded withholding tax of P4,897.79 (inclusive of

interest and surcharge) was allegedly due to the failure of ICC to
withhold 1% expanded withholding tax on its claimed P244,890.00
deduction for security services.7

On March 23, 1990, ICC sought a reconsideration of the subject

assessments. On February 9, 1995, however, it received a final
notice before seizure demanding payment of the amounts stated in
the said notices. Hence, it brought the case to the CTA which held
that the petition is premature because the final notice of
assessment cannot be considered as a final decision appealable to
the tax court. This was reversed by the Court of Appeals holding
that a demand letter of the BIR reiterating the payment of
deficiency tax, amounts to a final decision on the protested
assessment and may therefore be questioned before the CTA. This
conclusion was sustained by this Court on July 1, 2001, in G.R. No.
135210.8 The case was thus remanded to the CTA for further
proceedings.
On February 26, 2003, the CTA rendered a decision canceling and
setting aside the assessment notices issued against ICC. It held
that the claimed deductions for professional and security services
were properly claimed by ICC in 1986 because it was only in the
said year when the bills demanding payment were sent to ICC.
Hence, even if some of these professional services were rendered
to ICC in 1984 or 1985, it could not declare the same as deduction
for the said years as the amount thereof could not be determined
at that time.
The CTA also held that ICC did not understate its interest income on
the subject promissory notes. It found that it was the BIR which
made an overstatement of said income when it compounded the
interest income receivable by ICC from the promissory notes of
Realty Investment, Inc., despite the absence of a stipulation in the
contract providing for a compounded interest; nor of a
circumstance, like delay in payment or breach of contract, that
would justify the application of compounded interest.
Likewise, the CTA found that ICC in fact withheld 1% expanded
withholding tax on its claimed deduction for security services as
shown by the various payment orders and confirmation receipts it
presented as evidence. The dispositive portion of the CTAs
Decision, reads:
WHEREFORE, in view of all the foregoing, Assessment Notice No.
FAS-1-86-90-000680 for deficiency income tax in the amount of
P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for
deficiency expanded withholding tax in the amount of P4,897.79,
inclusive of surcharges and interest, both for the taxable year 1986,
are hereby CANCELLED and SET ASIDE.

SO ORDERED.9
Petitioner filed a petition for review with the Court of Appeals,
which affirmed the CTA decision,10 holding that although the
professional services (legal and auditing services) were rendered to
ICC in 1984 and 1985, the cost of the services was not yet
determinable at that time, hence, it could be considered as
deductible expenses only in 1986 when ICC received the billing
statements for said services. It further ruled that ICC did not
understate its interest income from the promissory notes of Realty
Investment, Inc., and that ICC properly withheld and remitted taxes
on the payments for security services for the taxable year 1986.
Hence, petitioner, through the Office of the Solicitor General, filed
the instant petition contending that since ICC is using the accrual
method of accounting, the expenses for the professional services
that accrued in 1984 and 1985, should have been declared as
deductions from income during the said years and the failure of ICC
to do so bars it from claiming said expenses as deduction for the
taxable year 1986. As to the alleged deficiency interest income and
failure to withhold expanded withholding tax assessment, petitioner
invoked the presumption that the assessment notices issued by the
BIR are valid.
The issue for resolution is whether the Court of Appeals correctly:
(1) sustained the deduction of the expenses for professional and
security services from ICCs gross income; and (2) held that ICC did
not understate its interest income from the promissory notes of
Realty Investment, Inc; and that ICC withheld the required 1%
withholding tax from the deductions for security services.
The requisites for the deductibility of ordinary and necessary trade,
business, or professional expenses, like expenses paid for legal and
auditing services, are: (a) the expense must be ordinary and
necessary; (b) it must have been paid or incurred during the
taxable year; (c) it must have been paid or incurred in carrying on
the trade or business of the taxpayer; and (d) it must be supported
by receipts, records or other pertinent papers.11
The requisite that it must have been paid or incurred during the
taxable year is further qualified by Section 45 of the National
Internal Revenue Code (NIRC) which states that: "[t]he deduction
provided for in this Title shall be taken for the taxable year in which
paid or accrued or paid or incurred, dependent upon the method
of accounting upon the basis of which the net income is computed
x x x".

Accounting methods for tax purposes comprise a set of rules for

determining when and how to report income and deductions.12 In
the instant case, the accounting method used by ICC is the accrual
method.
Revenue Audit Memorandum Order No. 1-2000, provides that under
the accrual method of accounting, expenses not being claimed as
deductions by a taxpayer in the current year when they are
incurred cannot be claimed as deduction from income for the
succeeding year. Thus, a taxpayer who is authorized to deduct
certain expenses and other allowable deductions for the current
year but failed to do so cannot deduct the same for the next
year.13
The accrual method relies upon the taxpayers right to receive
amounts or its obligation to pay them, in opposition to actual
receipt or payment, which characterizes the cash method of
accounting. Amounts of income accrue where the right to receive
them become fixed, where there is created an enforceable liability.
Similarly, liabilities are accrued when fixed and determinable in
amount, without regard to indeterminacy merely of time of
payment.14
For a taxpayer using the accrual method, the determinative
question is, when do the facts present themselves in such a
manner that the taxpayer must recognize income or expense? The
accrual of income and expense is permitted when the all-events
test has been met. This test requires: (1) fixing of a right to income
or liability to pay; and (2) the availability of the reasonable accurate
determination of such income or liability.
The all-events test requires the right to income or liability be fixed,
and the amount of such income or liability be determined with
reasonable accuracy. However, the test does not demand that the
amount of income or liability be known absolutely, only that a
taxpayer has at his disposal the information necessary to compute
the amount with reasonable accuracy. The all-events test is
satisfied where computation remains uncertain, if its basis is
unchangeable; the test is satisfied where a computation may be
unknown, but is not as much as unknowable, within the taxable
year. The amount of liability does not have to be determined
exactly; it must be determined with "reasonable accuracy."
Accordingly, the term "reasonable accuracy" implies something less
than an exact or completely accurate amount.[15]

The propriety of an accrual must be judged by the facts that a

taxpayer knew, or could reasonably be expected to have known, at
the closing of its books for the taxable year.[16] Accrual method of
accounting presents largely a question of fact; such that the
taxpayer bears the burden of proof of establishing the accrual of an
item of income or deduction.17
Corollarily, it is a governing principle in taxation that tax
exemptions must be construed in strictissimi juris against the
taxpayer and liberally in favor of the taxing authority; and one who
claims an exemption must be able to justify the same by the
clearest grant of organic or statute law. An exemption from the
common burden cannot be permitted to exist upon vague
implications. And since a deduction for income tax purposes
partakes of the nature of a tax exemption, then it must also be
strictly construed.18
In the instant case, the expenses for professional fees consist of
expenses for legal and auditing services. The expenses for legal
services pertain to the 1984 and 1985 legal and retainer fees of the
law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna &
Bengson, and for reimbursement of the expenses of said firm in
connection with ICCs tax problems for the year 1984. As testified
by the Treasurer of ICC, the firm has been its counsel since the
1960s.19 From the nature of the claimed deductions 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 the compensation for its legal services. The failure to
determine the exact amount of the expense during the taxable
year when they could have been claimed as deductions cannot thus
be attributed solely to the delayed billing of these liabilities by the
firm. For one, ICC, in the exercise of due diligence could have
inquired into the amount of their obligation to the firm, especially
so that it is using the accrual method of accounting. For another, it
could have reasonably determined the amount of legal and retainer
fees owing to its familiarity with the rates charged by their long
time legal consultant.
As previously stated, the accrual method presents largely a
question of fact and that the taxpayer bears the burden of
establishing the accrual of an expense or income. However, ICC
failed to discharge this burden. As to when the firms performance
of its services in connection with the 1984 tax problems were
completed, or whether ICC exercised reasonable diligence to
inquire about the amount of its liability, or whether it does or does
not possess the information necessary to compute the amount of

said liability with reasonable accuracy, are questions of fact which

ICC never established. It simply relied on the defense of delayed
billing by the firm and the company, which under the
circumstances, is not sufficient to exempt it from being charged
with knowledge of the reasonable amount of the expenses for legal
and auditing services.
In the same vein, the professional fees of SGV & Co. for auditing
the financial statements of ICC for the year 1985 cannot be validly
claimed as expense deductions in 1986. This is so because ICC
failed to present evidence showing that even with only "reasonable
accuracy," as the standard to ascertain its liability to SGV & Co. in
the year 1985, it cannot determine the professional fees which said
company would charge for its services.
ICC thus failed to discharge the burden of proving that the claimed
expense deductions for the professional services were allowable
deductions for the taxable year 1986. Hence, per Revenue Audit
Memorandum Order No. 1-2000, they cannot be validly deducted
from its gross income for the said year and were therefore properly
disallowed by the BIR.

security services. Said Assessment is valid as to the BIRs

disallowance of ICCs expenses for professional services. The Court
of Appeals cancellation of Assessment Notice No. FAS-1-86-90000681 in the amount of P4,897.79 for deficiency expanded
withholding tax, is sustained.
WHEREFORE, the petition is PARTIALLY GRANTED. The September
30, 2005 Decision of the Court of Appeals in CA-G.R. SP No. 78426,
is AFFIRMED with the MODIFICATION that Assessment Notice No.
FAS-1-86-90-000680, which disallowed the expense deduction of
Isabela Cultural Corporation for professional and security services,
is declared valid only insofar as the expenses for the professional
fees of SGV & Co. and of the law firm, Bengzon Zarraga Narciso
Cudala Pecson Azcuna & Bengson, are concerned. The decision is
affirmed in all other respects.
The case is remanded to the BIR for the computation of Isabela
Cultural Corporations liability under Assessment Notice No. FAS-186-90-000680.
SO ORDERED.

As to the expenses for security services, the records show that

these expenses were incurred by ICC in 198620 and could therefore
be properly claimed as deductions for the said year.
Anent the purported understatement of interest income from the
promissory notes of Realty Investment, Inc., we sustain the findings
of the CTA and the Court of Appeals that no such understatement
exists and that only simple interest computation and not a
compounded one should have been applied by the BIR. There is
indeed no stipulation between the latter and ICC on the application
of compounded interest.21 Under Article 1959 of the Civil Code,
unless there is a stipulation to the contrary, interest due should not
further earn interest.
Likewise, the findings of the CTA and the Court of Appeals that ICC
truly withheld the required withholding tax from its claimed
deductions for security services and remitted the same to the BIR is
supported by payment order and confirmation receipts.22 Hence,
the Assessment Notice for deficiency expanded withholding tax was
properly cancelled and set aside.
In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount
of P333,196.86 for deficiency income tax should be cancelled and
set aside but only insofar as the claimed deductions of ICC for

G.R. No. 148187

April 16, 2008

PHILEX MINING CORPORATION, petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
DECISION
YNARES-SANTIAGO, J.:
This is a petition for review on certiorari of the June 30, 2000
Decision1 of the Court of Appeals in CA-G.R. SP No. 49385, which

affirmed the Decision2 of the Court of Tax Appeals in C.T.A. Case

No. 5200. Also assailed is the April 3, 2001 Resolution3 denying the
motion for reconsideration.
The facts of the case are as follows:
On April 16, 1971, petitioner Philex Mining Corporation (Philex
Mining), entered into an agreement4 with Baguio Gold Mining
Company ("Baguio Gold") for the former to manage and operate
the latters mining claim, known as the Sto. Nino mine, located in
Atok and Tublay, Benguet Province. The parties agreement was
denominated as "Power of Attorney" and provided for the following
terms:
4. Within three (3) years from date thereof, the PRINCIPAL (Baguio
Gold) shall make available to the MANAGERS (Philex Mining) up to
ELEVEN MILLION PESOS (P11,000,000.00), in such amounts as from
time to time may be required by the MANAGERS within the said 3year period, for use in the MANAGEMENT of the STO. NINO MINE.
The said ELEVEN MILLION PESOS (P11,000,000.00) shall be
deemed, for internal audit purposes, as the owners account in the
Sto. Nino PROJECT. Any part of any income of the PRINCIPAL from
the STO. NINO MINE, which is left with the Sto. Nino PROJECT, shall
be added to such owners account.
5. Whenever the MANAGERS shall deem it necessary and
convenient in connection with the MANAGEMENT of the STO. NINO
MINE, they may transfer their own funds or property to the Sto.
Nino PROJECT, in accordance with the following arrangements:
(a) The properties shall be appraised and, together with the cash,
shall be carried by the Sto. Nino PROJECT as a special fund to be
known as the MANAGERS account.
(b) The total of the MANAGERS account shall not exceed
P11,000,000.00, except with prior approval of the PRINCIPAL;
provided, however, that if the compensation of the MANAGERS as
herein provided cannot be paid in cash from the Sto. Nino PROJECT,
the amount not so paid in cash shall be added to the MANAGERS
account.
(c) The cash and property shall not thereafter be withdrawn from
the Sto. Nino PROJECT until termination of this Agency.
(d) The MANAGERS account shall not accrue interest. Since it is the
desire of the PRINCIPAL to extend to the MANAGERS the benefit of

subsequent appreciation of property, upon a projected termination

of this Agency, the ratio which the MANAGERS account has to the
owners account will be determined, and the corresponding
proportion of the entire assets of the STO. NINO MINE, excluding
the claims, shall be transferred to the MANAGERS, except that such
transferred assets shall not include mine development, roads,
buildings, and similar property which will be valueless, or of slight
value, to the MANAGERS. The MANAGERS can, on the other hand,
require at their option that property originally transferred by them
to the Sto. Nino PROJECT be re-transferred to them. Until such
assets are transferred to the MANAGERS, this Agency shall remain
subsisting.
xxxx
12. The compensation of the MANAGER shall be fifty per cent (50%)
of the net profit of the Sto. Nino PROJECT before income tax. It is
understood that the MANAGERS shall pay income tax on their
compensation, while the PRINCIPAL shall pay income tax on the net
profit of the Sto. Nino PROJECT after deduction therefrom of the
MANAGERS compensation.
xxxx
16. The PRINCIPAL has current pecuniary obligation in favor of the
MANAGERS and, in the future, may incur other obligations in favor
of the MANAGERS. This Power of Attorney has been executed as
security for the payment and satisfaction of all such obligations of
the PRINCIPAL in favor of the MANAGERS and as a means to fulfill
the same. Therefore, this Agency shall be irrevocable while any
obligation of the PRINCIPAL in favor of the MANAGERS is
outstanding, inclusive of the MANAGERS account. After all
obligations of the PRINCIPAL in favor of the MANAGERS have been
paid and satisfied in full, this Agency shall be revocable by the
PRINCIPAL upon 36-month notice to the MANAGERS.
17. Notwithstanding any agreement or understanding between the
PRINCIPAL and the MANAGERS to the contrary, the MANAGERS may
withdraw from this Agency by giving 6-month notice to the
PRINCIPAL. The MANAGERS shall not in any manner be held liable to
the PRINCIPAL by reason alone of such withdrawal. Paragraph 5(d)
hereof shall be operative in case of the MANAGERS withdrawal.
x x x x5

In the course of managing and operating the project, Philex Mining

made advances of cash and property in accordance with paragraph
5 of the agreement. However, the mine suffered continuing losses
over the years which resulted to petitioners withdrawal as
manager of the mine on January 28, 1982 and in the eventual
cessation of mine operations on February 20, 1982.6
Thereafter, on September 27, 1982, the parties executed a
"Compromise with Dation in Payment"7 wherein Baguio Gold
admitted an indebtedness to petitioner in the amount of
P179,394,000.00 and agreed to pay the same in three segments by
first assigning Baguio Golds tangible assets to petitioner,
transferring to the latter Baguio Golds equitable title in its Philodrill
assets and finally settling the remaining liability through properties
that Baguio Gold may acquire in the future.
On December 31, 1982, the parties executed an "Amendment to
Compromise with Dation in Payment"8 where the parties
determined that Baguio Golds indebtedness to petitioner actually
amounted to P259,137,245.00, which sum included liabilities of
Baguio Gold to other creditors that petitioner had assumed as
guarantor. These liabilities pertained to long-term loans amounting
to US$11,000,000.00 contracted by Baguio Gold from the Bank of
America NT & SA and Citibank N.A. This time, Baguio Gold
undertook to pay petitioner in two segments by first assigning its
tangible assets for P127,838,051.00 and then transferring its
equitable title in its Philodrill assets for P16,302,426.00. The parties
then ascertained that Baguio Gold had a remaining outstanding
indebtedness to petitioner in the amount of P114,996,768.00.
Subsequently, petitioner 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, petitioner 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."9 However, the Bureau of Internal Revenue (BIR)
disallowed the amount as deduction for bad debt and assessed
petitioner a deficiency income tax of P62,811,161.39.
Petitioner protested before the BIR arguing that the deduction must
be allowed since all requisites for a bad debt deduction were
satisfied, to wit: (a) there was a valid and existing debt; (b) the

debt was ascertained to be worthless; and (c) it was charged off

within the taxable year when it was determined to be worthless.
Petitioner emphasized that the debt arose out of a valid
management contract it entered into with Baguio Gold. The bad
debt deduction represented advances made by petitioner which,
pursuant to the management contract, formed part of Baguio
Golds "pecuniary obligations" to petitioner. It also included
payments made by petitioner as guarantor of Baguio Golds longterm loans which legally entitled petitioner to be subrogated to the
rights of the original creditor.
Petitioner also asserted that due to Baguio Golds irreversible
losses, it became evident that it would not be able to recover the
advances and payments it had made in behalf of Baguio Gold. For a
debt to be considered worthless, petitioner claimed that it was
neither required to institute a judicial action for collection against
the debtor nor to sell or dispose of collateral assets in satisfaction
of the debt. It is enough that a taxpayer exerted diligent efforts to
enforce collection and exhausted all reasonable means to collect.
On October 28, 1994, the BIR denied petitioners protest for lack of
legal and factual basis. It held that the alleged debt was not
ascertained to be worthless since Baguio Gold remained existing
and had not filed a petition for bankruptcy; and that the deduction
did not consist of a valid and subsisting debt considering that,
under the management contract, petitioner was to be paid fifty
percent (50%) of the projects net profit.10
Petitioner appealed before the Court of Tax Appeals (CTA) which
rendered judgment, as follows:
WHEREFORE, in view of the foregoing, the instant Petition for
Review is hereby DENIED for lack of merit. The assessment in
question, viz: FAS-1-82-88-003067 for deficiency income tax in the
amount of P62,811,161.39 is hereby AFFIRMED.
ACCORDINGLY, petitioner Philex Mining Corporation is hereby
ORDERED to PAY respondent Commissioner of Internal Revenue the
amount of P62,811,161.39, plus, 20% delinquency interest due
computed from February 10, 1995, which is the date after the 20day grace period given by the respondent within which petitioner
has to pay the deficiency amount x x x up to actual date of
payment.
SO ORDERED.11

The CTA rejected petitioners assertion that the advances it made

for the Sto. Nino mine were in the nature of a loan. It instead
characterized the advances as petitioners investment in a
partnership with Baguio Gold for the development and exploitation
of the Sto. Nino mine. The CTA held that the "Power of Attorney"
executed by petitioner and Baguio Gold was actually a partnership
agreement. Since the advanced amount partook of the nature of an
investment, it could not be deducted as a bad debt from
petitioners gross income.
The CTA likewise held that the amount paid by petitioner for the
long-term loan obligations of Baguio Gold could not be allowed as a
bad debt deduction. At the time the payments were made, Baguio
Gold was not in default since its loans were not yet due and
demandable. What petitioner did was to pre-pay the loans as
evidenced by the notice sent by Bank of America showing that it
was merely demanding payment of the installment and interests
due. Moreover, Citibank imposed and collected a "pre-termination
penalty" for the pre-payment.
The Court of Appeals affirmed the decision of the CTA.12 Hence,
upon denial of its motion for reconsideration,13 petitioner took this
recourse under Rule 45 of the Rules of Court, alleging that:
I.
The Court of Appeals erred in construing that the advances made
by Philex in the management of the Sto. Nino Mine pursuant to the
Power of Attorney partook of the nature of an investment rather
than a loan.
II.
The Court of Appeals erred in ruling that the 50%-50% sharing in
the net profits of the Sto. Nino Mine indicates that Philex is a
partner of Baguio Gold in the development of the Sto. Nino Mine
notwithstanding the clear absence of any intent on the part of
Philex and Baguio Gold to form a partnership.
III.
The Court of Appeals erred in relying only on the Power of Attorney
and in completely disregarding the Compromise Agreement and the
Amended Compromise Agreement when it construed the nature of
the advances made by Philex.

IV.
The Court of Appeals erred in refusing to delve upon the issue of
the propriety of the bad debts write-off.14
Petitioner insists that in determining the nature of its business
relationship with Baguio Gold, we should not only rely on the
"Power of Attorney", but also on the subsequent "Compromise with
Dation in Payment" and "Amended Compromise with Dation in
Payment" that the parties executed in 1982. These documents,
allegedly evinced the parties intent to treat the advances and
payments as a loan and establish a creditor-debtor relationship
between them.
The petition lacks merit.
The lower courts correctly held that the "Power of Attorney" is the
instrument that is material in determining the true nature of the
business relationship between petitioner and Baguio Gold. Before
resort may be had to the two compromise agreements, the parties
contractual intent must first be discovered from the expressed
language of the primary contract under which the parties business
relations were founded. It should be noted that the compromise
agreements were mere collateral documents executed by the
parties pursuant to the termination of their business relationship
created under the "Power of Attorney". On the other hand, it is the
latter which established the juridical relation of the parties and
defined the parameters of their dealings with one another.
The execution of the two compromise agreements can hardly be
considered as a subsequent or contemporaneous act that is
reflective of the parties true intent. The compromise agreements
were executed eleven years after the "Power of Attorney" and
merely laid out a plan or procedure by which petitioner could
recover the advances and payments it made under the "Power of
Attorney". The parties entered into the compromise agreements as
a consequence of the dissolution of their business relationship. It
did not define that relationship or indicate its real character.
An examination of the "Power of Attorney" reveals that a
partnership or joint venture was indeed intended by the parties.
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.15 While a corporation, like petitioner, cannot generally

enter into a contract of partnership unless authorized by law or its

charter, it has been held that it may enter into a joint venture
which is akin to a particular partnership:
The legal concept of a joint venture is of common law origin. It has
no precise legal definition, but it has been generally understood to
mean an organization formed for some temporary purpose. x x x It
is in fact hardly distinguishable from the partnership, since their
elements are similar community of interest in the business,
sharing of profits and losses, and a mutual right of control. x x x
The main distinction cited by most opinions in common law
jurisdictions is that the partnership contemplates a general
business with some degree of continuity, while the joint venture is
formed for the execution of a single transaction, and is thus of a
temporary nature. x x x This observation is not entirely accurate in
this jurisdiction, since under the Civil Code, a partnership may be
particular or universal, and a particular partnership may have for its
object a specific undertaking. x x x It would seem therefore that
under Philippine law, a joint venture is a form of partnership and
should be governed by the law of partnerships. The Supreme Court
has however recognized a distinction between these two business
forms, and has held that although a corporation cannot enter into a
partnership contract, it may however engage in a joint venture with
others. x x x (Citations omitted) 16
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.
Under the "Power of Attorney", petitioner and Baguio Gold
undertook to contribute money, property and industry to the
common fund known as the Sto. Nio mine.17 In this regard, we
note that there is a substantive equivalence in the respective
contributions of the parties to the development and operation of
the mine. Pursuant to paragraphs 4 and 5 of the agreement,
petitioner and Baguio Gold were to contribute equally to the joint
venture assets under their respective accounts. Baguio Gold would
contribute P11M under its owners account plus any of its income
that is left in the project, in addition to its actual mining claim.
Meanwhile, petitioners contribution would consist of its expertise in
the management and operation of mines, as well as the managers
account which is comprised of P11M in funds and property and
petitioners "compensation" as manager that cannot be paid in
cash.

However, petitioner asserts that it could not have entered into a

partnership agreement with Baguio Gold because it did not "bind"
itself to contribute money or property to the project; that under
paragraph 5 of the agreement, it was only optional for petitioner to
transfer funds or property to the Sto. Nio project "(w)henever the
MANAGERS shall deem it necessary and convenient in connection
with the MANAGEMENT of the STO. NIO MINE."18
The wording of the parties agreement as to petitioners
contribution to the common fund does not detract from the fact
that petitioner transferred its funds and property to the project as
specified in paragraph 5, thus rendering effective the other
stipulations of the contract, particularly paragraph 5(c) which
prohibits petitioner from withdrawing the advances until
termination of the parties business relations. As can be seen,
petitioner became bound by its contributions once the transfers
were made. The contributions acquired an obligatory nature as
soon as petitioner had chosen to exercise its option under
paragraph 5.
There is no merit to petitioners claim that the prohibition in
paragraph 5(c) against withdrawal of advances should not be taken
as an indication that it had entered into a partnership with Baguio
Gold; that the stipulation only showed that what the parties entered
into was actually a contract of agency coupled with an interest
which is not revocable at will and not a partnership.
In an agency coupled with interest, it is the agency that cannot be
revoked or withdrawn by the principal due to an interest of a third
party that depends upon it, or the mutual interest of both principal
and agent.19 In this case, the non-revocation or non-withdrawal
under paragraph 5(c) applies to the advances made by petitioner
who is supposedly the agent and not the principal under the
contract. Thus, it cannot be inferred from the stipulation that the
parties relation under the agreement is one of agency coupled with
an interest and not a partnership.
Neither can paragraph 16 of the agreement be taken as an
indication that the relationship of the parties was one of agency
and not a partnership. Although the said provision states that "this
Agency shall be irrevocable while any obligation of the PRINCIPAL in
favor of the MANAGERS is outstanding, inclusive of the MANAGERS
account," it does not necessarily follow that the parties entered into
an agency contract coupled with an interest that cannot be
withdrawn by Baguio Gold.

It should be stressed that the main object of the "Power of

Attorney" was not to confer a power in favor of petitioner to
contract with third persons on behalf of Baguio Gold but to create a
business relationship between petitioner and Baguio Gold, in which
the former was to manage and operate the latters mine through
the parties mutual contribution of material resources and industry.
The essence of an agency, even one that is coupled with interest, is
the agents ability to represent his principal and bring about
business relations between the latter and third persons.20 Where
representation for and in behalf of the principal is merely incidental
or necessary for the proper discharge of ones paramount
undertaking under a contract, the latter may not necessarily be a
contract of agency, but some other agreement depending on the
ultimate undertaking of the parties.21
In this case, the totality of the circumstances and the stipulations in
the parties agreement indubitably lead to the conclusion that a
partnership was formed between petitioner and Baguio Gold.
First, it does not appear that Baguio Gold was unconditionally
obligated to return the advances made by petitioner under the
agreement. Paragraph 5 (d) thereof provides that upon termination
of the parties business relations, "the ratio which the MANAGERS
account has to the owners account will be determined, and the
corresponding proportion of the entire assets of the STO. NINO
MINE, excluding the claims" shall be transferred to petitioner.22 As
pointed out by the Court of Tax Appeals, petitioner was merely
entitled to a proportionate return of the mines assets upon
dissolution of the parties business relations. There was nothing in
the agreement that would require Baguio Gold to make payments
of the advances to petitioner as would be recognized as an item of
obligation or "accounts payable" for Baguio Gold.
Thus, the tax court correctly concluded that the agreement
provided for a distribution of assets of the Sto. Nio mine upon
termination, a provision that is more consistent with a partnership
than a creditor-debtor relationship. It should be pointed out that in
a contract of loan, a person who receives a loan or money or any
fungible thing acquires ownership thereof and is bound to pay the
creditor an equal amount of the same kind and quality.23 In this
case, however, there was no stipulation for Baguio Gold to actually
repay petitioner the cash and property that it had advanced, but
only the return of an amount pegged at a ratio which the
managers account had to the owners account.

In this connection, we find no contractual basis for the execution of

the two compromise agreements in which Baguio Gold recognized a
debt in favor of petitioner, which supposedly arose from the
termination of their business relations over the Sto. Nino mine. The
"Power of Attorney" clearly provides that petitioner would only be
entitled to the return of a proportionate share of the mine assets to
be computed at a ratio that the managers account had to the
owners account. Except to provide a basis for claiming the
advances as a bad debt deduction, there is no reason for Baguio
Gold to hold itself liable to petitioner under the compromise
agreements, for any amount over and above the proportion agreed
upon in the "Power of Attorney".
Next, the tax court correctly observed that it was unlikely for a
business corporation to lend hundreds of millions of pesos to
another corporation with neither security, or collateral, nor a
specific deed evidencing the terms and conditions of such loans.
The parties also did not provide a specific maturity date for the
advances to become due and demandable, and the manner of
payment was unclear. All these point to the inevitable conclusion
that the advances were not loans but capital contributions to a
partnership.
The strongest indication that petitioner was a partner in the Sto
Nio mine is the fact that it would receive 50% of the net profits as
"compensation" under paragraph 12 of the agreement. The entirety
of the parties contractual stipulations simply leads to no other
conclusion than that petitioners "compensation" is actually its
share in the income of the joint venture.
Article 1769 (4) of the Civil Code explicitly provides that the
"receipt by a person of a share in the profits of a business is prima
facie evidence that he is a partner in the business." Petitioner
asserts, however, that no such inference can be drawn against it
since its share in the profits of the Sto Nio project was in the
nature of compensation or "wages of an employee", under the
exception provided in Article 1769 (4) (b).24
On this score, the tax court correctly noted that petitioner was not
an employee of Baguio Gold who will be paid "wages" pursuant to
an employer-employee relationship. To begin with, petitioner was
the manager of the project and had put substantial sums into the
venture in order to ensure its viability and profitability. By pegging
its compensation to profits, petitioner also stood not to be
remunerated in case the mine had no income. It is hard to believe

that petitioner would take the risk of not being paid at all for its
services, if it were truly just an ordinary employee.
Consequently, we find that petitioners "compensation" under
paragraph 12 of the agreement actually constitutes its share in the
net profits of the partnership. Indeed, petitioner would not be
entitled to an equal share in the income of the mine if it were just
an employee of Baguio Gold.25 It is not surprising that petitioner
was to receive a 50% share in the net profits, considering that the
"Power of Attorney" also provided for an almost equal contribution
of the parties to the St. Nino mine. The "compensation" agreed
upon only serves to reinforce the notion that the parties relations
were indeed of partners and not employer-employee.
All told, the lower courts did not err in treating petitioners
advances as investments in a partnership known as the Sto. Nino
mine. The advances were not "debts" of Baguio Gold to petitioner
inasmuch as the latter was under no unconditional obligation to
return the same to the former under the "Power of Attorney". As for
the amounts that petitioner paid as guarantor to Baguio Golds
creditors, we find no reason to depart from the tax courts factual
finding that Baguio Golds debts were not yet due and demandable
at the time that petitioner paid the same. Verily, petitioner pre-paid
Baguio Golds outstanding loans to its bank creditors and this
conclusion is supported by the evidence on record.26
In sum, petitioner cannot claim the advances as a bad debt
deduction from its gross income. Deductions for income tax
purposes partake of the nature of tax exemptions and are strictly
construed against the taxpayer, who must prove by convincing
evidence that he is entitled to the deduction claimed.27 In this
case, petitioner failed to substantiate its assertion that the
advances were subsisting debts of Baguio Gold that could be
deducted from its gross income. Consequently, it could not claim
the advances as a valid bad debt deduction.
WHEREFORE, the petition is DENIED. The decision of the Court of
Appeals in CA-G.R. SP No. 49385 dated June 30, 2000, which
affirmed the decision of the Court of Tax Appeals in C.T.A. Case No.
5200 is AFFIRMED. Petitioner Philex Mining Corporation is ORDERED
to PAY the deficiency tax on its 1982 income in the amount of
P62,811,161.31, with 20% delinquency interest computed from
February 10, 1995, which is the due date given for the payment of
the deficiency income tax, up to the actual date of payment.
SO ORDERED.

Philex Mining Corporation vs. CIR [G.R. No. 148187 (April

16, 2008)]
Facts: Petitioner Philex entered into an agreement with Baguio Gold
Mining Corporation for the former to manage the latters mining
claim know as the Sto. Mine. The parties agreement was
denominated as Power of Attorney. The mine suffered continuing
losses over the years, which resulted in petitioners withdrawal as
manager of the mine. The parties executed a Compromise Dation
in Payment, wherein the debt of Baguio amounted to Php.
112,136,000.00. Petitioner deducted said amount from its gross
income in its annual tax income return as loss on the settlement of
receivables from Baguio Gold against reserves and allowances.
BIR disallowed the amount as deduction for bad debt. Petitioner
claims that it entered a contract of agency evidenced by the
power of attorney executed by them and the advances made by
petitioners is in the nature of a loan and thus can be deducted from
its gross income. Court of Tax Appeals (CTA) rejected the claim and
held that it is a partnership rather than an agency. CA affirmed CTA
Issue: Whether or not it is an agency.
Held: No. The lower courts correctly held that the Power of
Attorney (PA) is the instrument material that is material in
determining the true nature of the business relationship between
petitioner and Baguio. An examination of the said PA reveals that a
partnership or joint venture was indeed intended by the parties.
While a corporation like the petitioner cannot generally enter into a
contract of partnership unless authorized by law or its charter, it
has been held that it may enter into a joint venture, which is akin to
a particular partnership. The PA indicates that the parties had
intended to create a PAT and establish a common fund for the
purpose. They also had a joint interest in the profits of the business
as shown by the 50-50 sharing of income of the mine.
Moreover, in an agency coupled with interest, it is the agency that
cannot be revoked or withdrawn by the principal due to an interest
of a third party that depends upon it or the mutual interest of both
principal and agent. In this case the non-revocation or nonwithdrawal under the PA applies to the advances made by the
petitioner who is the agent and not the principal under the
contract. Thus, it cannot be inferred from the stipulation that it is
an agency