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G.R. No. 118794. May 8, 1996

Philippine Refining Corp (PRC) was assessed deficiency tax payments for the year 1985 in the
amount of around 1.8M. This figure was computed based on the disallowance of the claim of bad debts by
PRC. PRC duly protested the assessment claiming that under the law, bad debts and interest expense are
allowable deductions.
When the BIR subsequently garnished some of PRCs properties, the latter considered the protest
as being denied and filed an appeal to the CTA which set aside the disallowance of the interest expense
and modified the disallowance of the bad debts by allowing 3 accounts to be claimed as deductions.
However, 13 supposed bad debts were disallowed as the CTA claimed that these were not substantiated
and did not satisfy the jurisprudential requirement of worthlessness of a debt The CA denied the
petition for review.
Issue: Whether or not all the bad debts should be treated as deductions.
Held: No. The Supreme Court stated laid down the requirements a taxpayer must show for a debt to be
considered as a "bad debt" which will in turn make it deductable. The requirements are as follows: that (1)
there is a valid and subsisting debt. (2) the debt must be actually ascertained to be worthless and
uncollectible during the taxable year; (3) the debt must be charged off during the taxable year; and (4) the
debt must arise from the business or trade of the taxpayer. Additionally, before a debt can be considered
worthless, the taxpayer must also show that it is indeed uncollectible even in the future.
In addition to that, there are steps that can be done by the taxpayer to show that he gave a diligent
effort in collecting the debt. These steps are: (1) sending of statement of accounts; (2) sending of
collection letters; (3) giving the account to a lawyer for collection; and (4) filing a collection case in
In the case at bar, PRC failed to establish the requirements to make the subject debt a "bad debt".
They only used the testimony of its accountant Ms. Masagana in order to prove that these accounts were
bad debts. This was considered by all 3 courts to be self-serving. The SC said that PRC failed to exercise
due diligence in order to ascertain that these debts were uncollectible. In fact, PRC did not even show the
demand letters they allegedly gave to some of their debtors.
Petition Denied

Fernanded Hermanos INC vs CIR

Facts: The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal
purpose of engaging in business as an "investment company" with main office at Manila. Upon
verification of the taxpayer's income tax returns for the period in question, the Commissioner of Internal
Revenue assessed against the taxpayer the sums of P13,414.00, P119,613.00, P11,698.00, P6,887.00 and
P14,451.00 as alleged deficiency income taxes for the years 1950, 1951, 1952, 1953 and 1954,
respectively. The assessments were the result of alleged discrepancies found upon the examination and
verification of the taxpayer's income tax returns for the said years. The Tax court sustained the CIR's
disallowance of the bad debts of Palawan Mines. Both sides appealed until it reached the Supreme Court.
Issue: Whether or not the rulings of the Tax Court regarding the disallowances of the debts to the
Palawan Manganese Mines are correct.
Held: Yes.
The court noted that there was a memorandum signed by the parties involved. In this memorandum, it
was stated that if there were no earnings or profits, there was no obligation to repay those advances. It has
been held that the voluntary advances made without expectation of repayment do not result in deductible
losses. Petitioner could not sue for recovery under the memorandum agreement because the obligation of
Palawan Manganese Mines, Inc. was to pay petitioner 15% of its net profits, not the advances. Therefore
no bad debt could arise because one requirement is missing which is that there be a valid and subsisting
Tax Court Ruling Affirmed in toto