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L.

Deductions from Gross Income Requirement: Must be substantiated for audit


purposes
Deduction- refer to the amounts which the law
allows to be stubtracted from gross income in order Entertainment expenses not deductible:
to arrive at net income 1. Those treated as fringe benefits for services
under empl-emp relationship
1. Expenses 2. expenses for charitable or fund raising events
i. Sec 34 (A) of the NIRC 3. Meeting of SH, partners or directors
4.Sponsorship on an employees business league
What are the deductible expenses? or professional org meeting
a. Necessary Expenses- appropriate and helpful in 5. expenses for events organized for promotion
the development of taxpayers business and are and marketing
intended to minimize losses or to increase profits
(day to day expenses) ii. Sec. 36(A) of the NIRC
b. Ordinary Expenses- normal or usual in relation Not deductible in computing net income:
to the taxpayers business in the surrounding a. personal,living, family expenses
circumstances b. payment for new buildings, permanent
improvements etc
ie. Of Expenses that will increase value of property
a. Salaries, wages, compensation including fringe c. payment for restoration of property
benefits d. premiums paid on life insurance policy of any
b. travel expenses officer or employee when taxpayer is direct or
c. entertainment expenses indirect beneficiary
d. rentals on properties
e. Depreciation of assets in case of private iii. Sec. 45 of the NIRC
educational institutions -Deductible when pair or accrued or paid or
incurred unless to clearly reflect the income, it
Which are not considered expenses? should be deducted at a diff period
a. Bribes and kickbacks directly or indirectly paid to -in case of death of tax payer-> deductions falling on
govt officials date of his death
b. Capital Expenditures except for depreciables of
private educational institutions CASES:

1. RR No. 10-02 dated July 10, 2002 CIR vs. Isabela Cultural Corporation
Requisites of Business Expenses to be FACTS:
deductible? Isabela Cultural Corp.(ICC for brevity) , a domestic
1. Ordinary and Necessary corporation received from BIR assessment notice no.
2. Pair or incurred within taxable year FAS-1-86-90000680 (680 for brevity) for deficiency
3. Substantiated with official receipts or income tax in the amount of PhP 333,196.86 and
adequate records assessment notice no. FAS-1-86-90-000681 (681 for
4. paid or incurred in carrying trade or business brevity) for deficiency expanded withholding tax in
5. if subject to withholding taxes proof of the amount of PhP 4,897.79, inclusive of surcharge
payment to the Bureau of Internal Revenue must and interest both for the taxable year 1986. The
be shown. deficiency income tax of PhP 333,196 arose from BIR
6. must be reasonable (not too lavish) disallowance of ICC claimed expenses deductions for
professional and security services billed to and paid
Ceiling on Entertainment Expense is by ICC in 1986.
imposed upon the ffg: The deficiency expanded withholding tax of
1. IND engaged in Business PhP4,897.79 was allegedly due to the failure of ICC to
2. IND engaged in practice of profession withhold 1% expanded withholding tax on its claimed
3. Domestic Coporations PhP244,890 deduction for security services.
4. Resident Corporations Court of Tax Appeal and Court of Appeal affirmed that
5. GPP including its members the professional services were rendered to ICC in
1984 and 1985, the cost of the service was not yet
Ceiling: Actual amount but not more than .50% determinable at that time, hence, it could be
of net sales for those engaged in sale of goods or considered as deductible expenses only in 1986
properties; 1% of net revenue for those engaged when ICC received the billing statement for said
in sale of services and exercise of profession or service. It further ruled that ICC did not state its
lease of properties interest income from the promissory notes of Realty
Investment and that ICC properly withheld the
remitted taxes on the payment for security services which overstate the interest income, when it applied
for the taxable year 1986. compounding absent any stipulation.
Petitioner contend that since ICC is using the accrual Petitioner appealed to CA, which affirmed CTA, hence
method of accounting, the expenses for the the petition.
professional services that accrued in 1984 and 9185 ISSUE: Whether or not the expenses for professional
should have been declared as deductions from and security services are deductible.
income during the said years and the failure of ICC to HELD:
do so bars it from claiming said expenses as No. One of the requisites for the deductibility of
deduction for the taxable year 1986. ordinary and necessary expenses is that it must have
ISSUE (1): WON CA is correct in sustaining the been paid or incurred during the taxable year. This
deduction of the expenses for professionals and requisite is dependent on the method of accounting
security services form ICC gross income? of the taxpayer. In the case at bar, ICC is using the
ISSUE (2): WON CA correctly held that ICC did not accrual method of accounting. Hence, under this
understate its interest income from the promissory method, an expense is recognized when it is
notes of Realty Investment, Inc; that ICC withheld the incurred. Under a Revenue Audit Memorandum, when
required 1% withholding tax from the deduction for the method of accounting is accrual, expenses not
security services. being claimed as deductions by a taxpayer in the
HELD(1): NO current year when they are incurred cannot be
Revenue Audit Memorandum Order No.1-2000 claimed in the succeeding year.
provides that under the accrual method of The accrual of income and expense is permitted
accounting, expenses not being claimed as when the all-events test has been met. This test
deductions by a tax payer in the current year when requires: 1) fixing of a right to income or liability to
they are incurred cannot be claimed as deductions pay; and 2) the availability of the reasonable
from the income for the succeeding year. accurate determination of such income or liability.
HELD(2): The test does not demand that the amount of income
Sustaining the finding of the CTA and CA that no such or liability be known absolutely, only that a taxpayer
understatement exist and that only simple interest has at its disposal the information necessary to
computation and not a compounded one should have compute the amount with reasonable accuracy.
been applied by the BIR. There is no indeed no From the nature of the claimed deductions and the
stipulation between the latter and ICC on the span of time during which the firm was retained, ICC
application of compound interest. can be expected to have reasonably known the
Under Article 1959 of the Civil Code, unless there is a retainer fees charged by the firm. They cannot give
stipulation to the contrary, interest due should not as an excuse the delayed billing, since it could have
further earn interest. inquired into the amount of their obligation and
reasonably determine the amount.
CIR vs. Isabela Cultural Corporation
FACTS: CIR v General Foods, Inc. GR No. 172231
Isabela Cultural Corporation (ICC), a domestic FACTS:
corporation received an assessment notice for Respondent corporation General Foods (Phils), which
deficiency income tax and expanded withholding tax is engaged in the manufacture of Tang, Calumet
from BIR. It arose from the disallowance of ICCs and Kool-Aid, filed its income tax return for the
claimed expense for professional and security fiscal year ending February 1985 and claimed as
services paid by ICC; as well as the alleged deduction, among other business expenses,
understatement of interest income on the three P9,461,246 for media advertising for Tang. The
promissory notes due from Realty Investment Inc. Commissioner disallowed 50% of the deduction
The deficiency expanded withholding tax was claimed and assessed deficiency income taxes of
allegedly due to the failure of ICC to withhold 1% e- P2,635,141.42 against General Foods, prompting the
withholding tax on its claimed deduction for security latter to file an MR which was denied. General Foods
services. later on filed a petition for review at CA, which
ICC sought a reconsideration of the assessments. reversed and set aside an earlier decision by CTA
Having received a final notice of assessment, it dismissing the companys appeal.
brought the case to CTA, which held that it is ISSUE: W/N the subject media advertising expense
unappealable, since the final notice is not a decision. for Tang was ordinary and necessary expense fully
CTAs ruling was reversed by CA, which was deductible under the NIRC
sustained by SC, and case was remanded to CTA. CTA HELD: No.
rendered a decision in favor of ICC. It ruled that the Tax exemptions must be construed in stricissimi juris
deductions for professional and security services against the taxpayer and liberally in favor of the
were properly claimed, it said that even if services taxing authority, and he who claims an exemption
were rendered in 1984 or 1985, the amount is not must be able to justify his claim by the clearest grant
yet determined at that time. Hence it is a proper of organic or statute law. Deductions for income
deduction in 1986. It likewise found that it is the BIR taxes partake of the nature of tax exemptions;
hence, if tax exemptions are strictly construed, then half of the companys entire claim for marketing
deductions must also be strictly construed. expenses for that year under review. Petition
To be deductible from gross income, the subject granted, judgment reversed and set aside.
advertising expense must comply with the following
requisites: (a) the expense must be ordinary and CIR v General Foods, Inc. GR No. 172231
necessary; (b) it must have been paid or incurred FACTS:
during the taxable year; (c) it must have been paid In its income tax return, respondent corporation
or incurred in carrying on the trade or business of the claimed as deduction, among other business
taxpayer; and (d) it must be supported by receipts, expenses, the amount for media advertising for
records or other pertinent papers. Tang, one of its products.
While the subject advertising expense was paid or ISSUE:
incurred within the corresponding taxable year and WON the subject media advertising expense for
was incurred in carrying on a trade or business, Tang incurred by respondent was an ordinary and
hence necessary, the parties views conflict as to necessary expense fully deductible under the NIRC
whether or not it was ordinary. To be deductible, an HELD: Not deductible.
advertising expense should not only be necessary Deductions for income tax purposes partake of the
but also ordinary. nature of tax exemptions; hence, must be strictly
The Commissioner maintains that the subject construed. To be deductible from gross income, the
advertising expense was not ordinary on the ground subject advertising expense must be ordinary and
that it failed the two conditions set by U.S. necessary. There being no hard and fast rule on the
jurisprudence: first, reasonableness of the amount reasonableness of an advertising expense, the right
incurred and second, the amount incurred must not to a deduction depends on a number of factors such
be a capital outlay to create goodwill for the as but not limited to: the type and size of business in
product and/or private respondents business. which the taxpayer is engaged; the volume and
Otherwise, the expense must be considered a capital amount of its net earnings; the nature of the
expenditure to be spread out over a reasonable time. expenditure itself; the
There is yet to be a clear-cut criteria or fixed test for intention of the taxpayer and the general economic
determining the reasonableness of an advertising conditions. The amount claimed as media advertising
expense. There being no hard and fast rule on the expense for Tang alone was almost one-half of its
matter, the right to a deduction depends on a total claim for marketing expenses. Furthermore, it
number of factors such as but not limited to: the type was almost double the amount of respondent
and size of business in which the taxpayer is corporation's general and administrative expenses.
engaged; the volume and amount of its net earnings; The subject expense for the advertisement of a
the nature of the expenditure itself; the intention of single product is inordinately large. Said venture of
the taxpayer and the general economic conditions. It respondent to protect its brand franchise was
is the interplay of these, among other factors and tantamount to efforts to establish a reputation, and
properly weighed, that will yield a proper evaluation. should not, therefore, be considered as business
The Court finds the subject expense for the expense but as capital expenditure, which normally
advertisement of a single product to be inordinately should be spread out over a reasonable period of
large. Therefore, even if it is necessary, it cannot be time.
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. ATLAS CONSOLIDATED MINING & DEVT CORP VS
The second type involves expenditures incurred, in COMMISSIONER OF INTERNAL REVENUE
whole or in part, to create or maintain some form of FACTS:
goodwill for the taxpayers trade or business or for Atlas Consolidated Mining & Devt Corp is a
the industry or profession of which the taxpayer is a corporation engaged in the mining industry. It was
member. If the expenditures are for the advertising assessed deficiency income tax for the year 1958 as
of the first kind, then, except as to the question of a result of the disallowance of certain items claimed
the reasonableness of amount, there is no doubt by the company as deductions from its gross income.
such expenditures are deductible as business Atlas claimed the following items as deductible from
expenses. If, however, the expenditures are for its gross income: (1) transfer agents fee, (2)
advertising of the second kind, then normally they stockholders relation service fee, (3) US stock listing
should be spread out over a reasonable period of expenses, (4) suit expenses, (5) provision for
time. contingencies. The
The companys media advertising expense for the Commissioner of Internal Revenue disallowed all
promotion of a single product is doubtlessly these items. Atlas elevated the issue to the Court of
unreasonable considering it comprises almost one- Tax Appeals. The CTA rendered a decision allowing
the said items, except for the stockholders relation Failure to assert a question within a reasonable time
service fee and the suit expenses. Both Atlas and the warrants a presumption that the party entitled to
CIR went to the Supreme Court to appeal the CTA assert it either has abandoned or declined to assert
decision. In GR No. L-26911, Atlas argues that the it. The Court held that the US stock listing fee is an
CTA should not have disallowed the stockholders ordinary and necessary business expense and was
relation service fee. The corporation contends that correctly allowed by the CTA as a deduction. The
such fee constitutes an ordinary and necessary stock listing fee is paid annually to a stock exchange
business expense, and should, therefore, be allowed for the privilege of having Atlas stock listed. A single
as a deductible expense from the companys gross payment made to the stock exchange is considered a
income. In GR No. L-26924, the CIR argues that the capital expenditure (Domes Mines case). However,
transfer agents fee and the US stock listing fee payments to the stock exchange made annually or in
should not have been allowed as deductions from a recurring manner are considered ordinary and
gross income in the absence of proof of payment for necessary business expenses (Chesapeake
such expenses. The CIR also argues that the US stock Corporation case). The fees paid by Atlas partake of
listing expenses should be disallowed for not being the latter. The Court reiterated that it is well-settled
ordinary and necessary and not incurred in trade or that litigation expenses incurred in defense or
business, as required under Sec 30 (a) (1) of the protection of title are capital in nature and not
National Internal Revenue Code. The CIR also deductible. The Court sustained the CIR that the
contends that the correct amount of disallowance for correct amount of disallowance for litigation or suit
suit expenses should be PhP 17,499.98 and not PhP expenses is PhP 17,499.98.
6,666.65.
ISSUE: ATLAS CONSOLIDATED MINING & DEVT CORP VS
In GR No. L-26911, whether or not the expenses paid COMMISSIONER OF INTERNAL REVENUE
for the services rendered by a public relations firm, P.
K. Macker & Co., labeled as stockholders relation FACTS:
service fee is an allowable deduction as business
expense. In GR No. L-26924, whether or not the
transfer agents fee and the US stock listing fee Atlas is a corporation engaged in the mining industry
should have been allowed as deduction in the registered. On August 1962, CIR assessed against
absence of proof of payments. Whether or not the US Atlas for deficiency income taxes for the years 1957
stock listing expenses should be disallowed for not and 1958. For the year 1957, it was the opinion of
being ordinary and necessary and not incurred in the CIR that Atlas is not entitled to exemption from
trade or business. Whether PhP 17,499.98 or PhP the income tax under RA 909 because same covers
6,666.65 is the correct amount of disallowance for only gold mines. For the year 1958, the deficiency
suit expenses. income tax covers the disallowance of items claimed
HELD: by Atlas as deductible from gross income. Atlas
GR No. L-26911. Under Sec 30 (a) (1) of the Tax protested for reconsideration and cancellation, thus
Code, three conditions have to be complied with the CIR conducted a reinvestigation of the case.
before a business expense is allowed as a deduction
from gross income: (1) the expense must be ordinary
and necessary, (2) it must be paid or incurred within On October 1962, the Secretary of Finance ruled that
the taxable year, and (3) it must be paid or incurred the exemption provided in RA 909 embraces all new
in carrying a trade or business. The Court sustained mines and old mines whether gold or other minerals.
the ruling of the CTA that the expenditure paid to P. Accordingly, the CIR recomputed Atlas deficiency
K. Macker & Co. denominated as stockholders income tax liabilities in the light of said ruling. On
relation service fee is not an ordinary expense. The June 1964, the CIR issued a revised assessment
fee was paid to the PR firm as ompensation entirely eliminating the assessment for the year
for services carrying on the selling campaign in an 1957. The assessment for 1958 was reduced from
effort to sell Atlas additional capital stock. Such is which Atlas appealed to the CTA, assailing the
not an ordinary expense because, according to the disallowance of the following items claimed as
Court, expenses relating to the recapitalization and
deductible from its gross income for 1958: Transfer
reorganization of a corporation, the cost of obtaining
agent's fee, Stockholders relation service fee, U.S.
stock subscription,
promotion expenses, and commission or fees paid for stock listing expenses, Suit expenses, and Provision
the sale of stock reorganization are capital for contingencies. The CTA allowed said items as
expenditures. The stockholders relation service fee deduction except those denominated by Atlas as
is not deductible from Atlas gross income. stockholders relation service fee and suit expenses.
GR No. L-26924. The Court agreed with the CTA that
the CIR cannot raise the issue of payment for the first Both parties appealed the CTA decision to the SC by
time on appeal. The fact of payment was never way of two (2) separate petitions for review. Atlas
controverted by the CIR during the proceedings. appealed only the disallowance of the deduction from
gross income of the so-called stockholders relation It appears that on December 1957, Atlas increased
service fee. its capital stock. It claimed that its shares of stock
were sold in the United States because of the
ISSUE/HELD: W/N the annual public relations services rendered by the public relations firm. The
expense (aka stockholders relation service fee) paid information about Atlas given out and played up in
to a public relations consultant is a deductible the mass communication media resulted in full
expense from gross income subscription of the additional shares issued by Atlas;
consequently, the stockholders relation service fee,
the compensation for services carrying on the selling
RATIO: Section 30 (a) (1) of the Tax Code allows a
campaign, was in effect spent for the acquisition of
deduction of "all the ordinary and necessary
additional capital, ergo, a capital expenditure, and
expenses paid or incurred during the taxable year in
not an ordinary expense. It is not deductible from
carrying on any trade or business." An item of
Atlas gross income in 1958 because expenses
expenditure, in order to be deductible under this
relating to recapitalization and reorganization of the
section of the statute, must fall squarely within its
corporation, the cost of obtaining stock subscription,
language. To be deductible as a business expense,
promotion expenses, and commission or fees paid for
three conditions are imposed, namely: (1) the
the sale of stock reorganization are capital
expense must be ordinary and necessary, (2) it must
expenditures. That the expense in question was
be paid or incurred within the taxable year, and (3) it
incurred to create a favorable image of the
must be paid or incurred in carrying in a trade or
corporation in order to gain or maintain the public's
business. In addition, not only must the taxpayer
and its stockholders' patronage, does not make it
meet the business test, he must substantially prove
deductible as business expense. As held in a US
by evidence or records the deductions claimed under
case, efforts to establish reputation are akin to
the law, otherwise, the same will be disallowed. The
acquisition of capital assets and, therefore, expenses
mere allegation of the taxpayer that an item of
related thereto are not business expense but capital
expense is ordinary and necessary does not justify its
expenditures.
deduction.

Note: The burden of proof that the expenses incurred


The SC has never attempted to define with precision
are ordinary and necessary is on the taxpayer and
the terms "ordinary and necessary." As a guiding
does not rest upon the Government. To avail of the
principle, ordinarily, an expense will be considered
claimed deduction, it is incumbent upon the taxpayer
"necessary" where the expenditure is appropriate
to adduce substantial evidence to establish a
and helpful in the development of the taxpayer's
reasonably proximate relation petition between the
business. It is "ordinary" when it connotes a payment
expenses to the ordinary conduct of the business of
which is normal in relation to the business of the
the taxpayer. A logical link or nexus between the
taxpayer and the surrounding circumstances. The
expense and the taxpayer's business must be
term "ordinary" does not require that the payments
established by the taxpayer.
be habitual or normal in the sense that the same
taxpayer will have to make them often; the payment
may be unique or non-recurring to the particular
taxpayer affected.
TAMBUNTING PAWNSHOP v CIR
There is thus no hard and fast rule on the matter. The DOCTRINE: To be entitled to claim a tax deduction,
right to a deduction depends in each case on the the taxpayer must competently establish the factual
and documentary bases of its claim.
particular facts and the relation of the payment to
FACTS:
the type of business in which the taxpayer is
H. Tambunting Pawnshop, Inc. (petitioner), a
engaged. The intention of the taxpayer often may be domestic corporation duly licensed and authorized to
the controlling fact in making the determination. engage in the pawnshop business, appeals the
Assuming that the expenditure is ordinary and adverse decision promulgated on April 24, 2006,
necessary in the operation of the taxpayer's whereby the Court of Tax Appeals En Bane (CTA En
business, the answer to the question as to whether Bane) affirmed the decision of the CTA First Division
the expenditure is an allowable deduction as a ordering it to pay deficiency income taxes in the
business expense must be determined from the amount of P4,536,687.15 for taxable year 1997, plus
nature of the expenditure itself, which in turn 20% delinquency interest computed from August 29,
depends on the extent and permanency of the work 2000 until full payment, but cancelling the
accomplished by the expenditure. compromise penalties for lack of basis.
BIR through then Acting Regional Director Lucien E.
Sayuno of Revenue Region No. 6 in Manila, issued
assessment notices and demand letters, all withholding taxes, such returns are not the
numbered 32-1-97, assessing Tambunting for documents required by law to substantiate the rental
deficiency percentage tax, income tax and expense. Petitioner should have submitted official
compromise penalties for taxable year 1997 receipts to support its claim.
amounting to 69K. Moreover, the issue on the submission of cash
Tambunting instituted an administrative protest vouchers as evidence to prove expenses incurred has
against the assessment notices and demand letters been addressed by this Court in the assailed
with the Commissioner of Internal Revenue. Resolution, to wit:
Tambunting brought a petition for review in the CTA, In order that the cash vouchers may be given
pursuant to Section 228 of the National Internal probative value, these must be validated with official
Revenue Code of 1997, citing the inaction of the receipts. In order that the cash vouchers may be
Commissioner of Internal Revenue on its protest given probative value, these must be validated with
within the 180-day period prescribed by law. official receipts.
CTA: Tambunting is still liable for deficiency income CT A En Bane aptly rejected Tam bunting's claim for
tax in the reduced amount of P4,536,687.15. deductions due to losses from fire and theft. The
However, the compromise penalties in the sum of documents it had submitted to support the claim,
P49,000.00 is hereby CANCELLED for lack of legal namely: (a) the certification from the Bureau of Fire
basis. Protection in Malolos; (b) the certification from the
Tambunting filed a petition for review in the CTA En Police Station in Malolos; (c) the accounting entry for
Banc, arguing that the First Division erred in the losses; and (d) the list of properties lost, were not
disallowing its deductions on the ground that it had enough. What were required were for Tambunting to
not substantiated them by sufficient evidence. submit the sworn declaration of loss mandated by
CTA En Banc denied. Revenue Regulations 12-77. Its failure to do so was
ISSUE: prejudicial to the claim because the sworn
WON CTA should have allowed its deductions declaration of loss was necessary to forewarn the BIR
because it had been able to prove its entitlement to that it had suffered a loss whose extent it would be
the deductions through all the documentary and claiming as a deduction of its tax liability, and thus
testimonial evidence presented in court. enable the BIR to conduct its own investigation of the
WON Tambunting had thus shown beyond doubt that incident leading to the loss. Indeed, the documents
it had incurred the losses in its auction sales; and Tambunting submitted to the BIR could not serve the
that it substantially complied with the requirements purpose of their submission without the sworn
of Revenue Regulations No. 12-77 on the declaration of loss.
deductibility of its losses.
HELD: 2. INTERESTS
CTA EN Banc is correct. Because this case involved i. Sec. 34(B) of the NIRC
assessments relating to transactions incurred by ii. Sec. 36 of the NIRC
Tambunting prior to the effectivity of Republic Act No. Not deductible in computing net
8424 (National Internal Revenue Code of 1997, or income:
NIRC of 1997), the provisions governing the propriety a. personal,living, family expenses
of the deductions was Presidential Decree 1158 (NIRC b. payment for new buildings, permanent
of 1977). In that regard, the pertinent provisions here improvements etc
are of Section 29 (d) (2) & (3)of the NIRC of 1977. that will increase value of property
In this case, petitioner's reliance on the entries made c. payment for restoration of property
in the "Subasta" book were not sufficient to d. premiums paid on life insurance policy of
substantiate the claimed deduction of loss on auction any officer or employee when taxpayer is
sale. As admitted by the petitioner, the contents in direct or indirect beneficiary
the "Rematado" and "Subasta" books do not reflect e. Losses from sales or exchange of property
the true amounts of the total capital and the auction when:
sale, respectively. Be that as it may, petitioner still 1. between members of family (includes
failed to adduce evidence to substantiate the other bro and sis)
expenses alleged to have been incurred in 2.individuals with more than 50% of
connection with the sale of pawned items. shares of corp except during liquidation
Among the expenses allegedly incurred, courts may 3. bet 2 corp with more than 50% shares
consider only those supported by credible evidence 4. between grantor and a fiduciary trust
and which appear to have been genuinely incurred in 5. between 2 fiduciaries with same
connection with the trade or business of the grantor
taxpayer. 6. between fiduciary of trust and
As previously discussed, the proper substantiation beneficiary
requirement for an expense to be allowed is the
official receipt or invoice. While the rental payments iii. RR No. 13-00 dated November 20, 2000
were subjected to the applicable expanded
Requirements for deductibility of (2.3) Proof or acknowledgment of receipt of
interest expense the contributed/donated property by the
1. There must be an indebtedness; recipient public school.
2. There should be an interest expense paid (3) That the application, together with the
or incurred upon such indebtedness; approved Agreement endorsed by the
3. The indebtedness must be that of the National Secretariat, shall be filed with the
taxpayer, Revenue District Office (RDO) having
4. The indebtedness must be connected with jurisdiction over the place of business of the
the taxpayers trade, business or exercise donor/adopting private entity, copy furnished
of profession. the RDO having jurisdiction over the
5. The interest expense must have been paid property, if the contribution/donation is in the
or incurred during the taxable year; form of real property.
6. The interest must have been stipulated in (b) Exemption of the Assistance made by the
writing; donor from payment of donors tax pursuant
7. The interest must be legally due; to Sections 101 (A)(2) and (B)(1) of the Tax
8. The interest payment arrangement must Code of 1997.
not be between related taxpayers as
mandated in Sec. 34(B)(2)(b), in relation iv. Tax Arbitrage Rule/ Scheme
to Sec. 36(B), both of the Tax Code of taxpayer would secure a loan simply to
1997; generate interest expense thereby reducing
9. The interest must not be incurred to the taxable income and enjoying a tax
finance petroleum operations; and benefit thereto. The funds loaned will then be
10. In case of interest incurred to acquire deposited with the bank to yield interest
property used in trade, business or income that is subject to a final withholding
exercise of profession, the same was not tax (e.g. 20%) less than the normal income
treated as a capital expenditure. tax rate (e.g. 30% starting 2009). In effect,
the taxpayer enjoys a double tax benefit
SEC. 3. TAX INCENTIVES ACCRUING TO THE tax benefit on deduction of interest expense,
ADOPTING PRIVATE ENTITY. A pre-qualified and tax benefit on lower tax rate for income.
adopting private entity, which enters into an To neutralize the impact of such scheme,
Agreement with a public school, shall be deductible interest expense in the Philippines
entitled to the following tax incentives: is reduced by 33% (starting 2009) of such
(a) Deduction from the gross income of the interest income subjected to final withholding
amount of contribution/donation that were tax. Nevertheless, interest expense on
actually, directly and exclusively incurred for unpaid taxes is not covered by this limitation
the Program, subject to limitations, on interest expenses in the Philippines.
conditions and rules set forth in Section
34(H) of the Tax Code, plus an additional CASES:
amount equivalent to fifty percent (50%) of
such contribution/donation subject to the Commissioner of Internal Revenue vs. Vda. De
following conditions: Prieto (1960)
(1) That the deduction shall be availed of in
the taxable year in which the expenses have FACTS:
been paid or incurred; On December 4, 1945, Consuelo L. Vda. De Prieto
(2) That the taxpayer can substantiate the conveyed by way of gifts to her four children
deduction with sufficient evidence, such as (Antonio, Benito, Carmen and Mauro), real property
official receipts or delivery receipt and other with total assessed value of 892,497.50.
adequate records CIR appraised the real property donated for gift tax
(2.1) The amount of expenses being claimed
purposes at 1,231.268.00, and assessed the total
as deduction;
sum of 117,706.50 as donors gift tax, interests
(2.2) The direct connection or relation of the
and compromises due thereon.
expenses to the adopting private entitys
Of the total sum of 117,706.50 paid by Consuelo, the
participation in the Adopt-a-School Program.
sum of 55,978.65 represents the total
The adopting private entity shall also provide
interest on account of delinquency. Said sum
a list of projects and/or activities undertaken
of the total interest was claimed as
and the cost of each undertaking, indicating
deduction by Consuelo in her 1954 income
in particular where and how the assistance
tax return.
has been utilized as supported by the
Agreement; and CIR disallowed the claim and as a consequence,
assessed Consuelo the total sum of 21,410.38 as
deficiency income tax due on the aforesaid
55,978.65, including interest up to March 1957, Internal Revenue Code of 1939, as amended, which
surcharge and compromise for the late payment. contains similarly worded provisions as section
Under the law, for interest to be deductible, it must 30(b) of Phil Tax Code, the uniform ruling in the US
be shown that there be an indebtedness, that there jurisprudence is that interest on taxes is interest
should be interest upon it, and that what is claimed on indebtedness and is deductible. This rule
as an interest deduction should have been paid or applies even though the tax is nondeductible, like
accrued within the year. It is here conceded that the donors tax.
the interest paid by Consuelo was in consequence 3. Section 80 is inapplicable to the instant case
of the late payment of her donors tax, and the because while it implements section 30(c) of the
same was paid within the year it is sought to be Tax Code governing deduction of taxes, Consuelo
deducted. seeks to come under section 30(b) providing for
To sustain the proposition that the interest payment deduction of interest on indebtedness.
is not deductible, CIR relies heavily on section 80 of
the Revenue Regulation No. 2( Income Tax In conclusion, the SC is of the opinion that although
Regulation) promulgated by the Department of interest payment for delinquent taxes is not
Finance, which provides that the word taxes deductible as tax under section 30(c) of the Tax
means taxes proper and no deductions should be Code and Section 80 of RR2, the taxpayer is not
allowed for amounts representing interest, precluded thereby from claiming said interest
surcharge, or penalties incident to delinquency. payment as deduction under section (b) of the same
CTA reversed the decision of CIR. code.

ISSUES: Commissioner of Internal Revenue vs. Vda. De


1. WON such interest was paid upon indebtedness Prieto (1960)
within the contemplation of section 30(b) (1) of the
Tax Code. FACTS:
2. WON the interest paid for the late payment of the Respondent Vda. de Prieto conveyed by way
donors tax is deductible from the gross income of gifts a real property to her children. The
under section 30(b) of the Tax Code. Commissioner of Internal Revenue appraised the
3. WON section 80 of the Revenue Regulation No. 2 is property donated at P1,231,268.00, and assessed
applicable in this case, thus the deduction should the total sum of P117,706.50 as donor's gift tax,
not be allowed. interest and compromises due thereon. Of the total
sum of P117,706.50 paid by respondent on April 29,
HELD: 1954, the sum of P55,978.65 represents the total
1.Yes, the donors tax may be considered as interest on account of deliquency. Said sum was
indebtedness within the contemplation of the Tax claimed as deduction, among others, by respondent
Code. in her 1954 income tax return. Petitioner disallowed
2.Yes, given that the donors tax may be considered as the claim and as a consequence of such disallowance
indebtedness, the interest paid for the late assessed respondent for 1954 deficiency income tax
payment of the donors tax is deductible from the due on the aforesaid P55,978.65, including interest
gross income under section 30(b) of the Tax Code. 1957, surcharge and compromise for the late
3.No, section 80 of RR2 is not applicable in this case payment.
because the said section of RR2 pertains to or ISSUE:
implements section 30(c) of the Tax Code, Whether or not interest paid for the late
governing deduction of taxes, and not section 30 payment of tax is deductible from gross income.
(b) on deduction of interest on indebtedness, which HELD:
is the provision invoked by Consuelo. YES. For interest to be deductible, it must be
shown that: (1) there be an indebtedness, (2) there
RATIO: should be interest upon it, and (3) what is claimed as
1.The term indebtedness as used in the US Tax Code an interest deduction should have been paid or
containing similar provisions as in the Phil Tax Code accrued within the year. In this case, the last two
has been defined as an unconditional and legally requirements are undisputed. The only question is if
enforceable obligation for the payment of money. interest on account of late payments of taxes be
Within the meaning of that definition, it is apparent considered as indebtedness. Indebtedness has been
that a tax may be considered an indebtedness. As defined as an unconditional and legally enforceable
stated by the SC in the case of Santiago Sambrano obligation for the payment of money. Within the
vs. CTA and CIR: Although taxes already due have meaning of that definition, it is apparent that a tax
not, strictly speaking, the same concept as debts, may be considered indebtedness. Although taxes
they are, however, obligations that may be already due have not, strictly speaking, the same
considered as such. concept as debts, they are, however, obligations that
2.This conclusion finds support in the established may be considered as such. Where statute imposes a
jurisprudence in the US. Under section 23(b) of the personal liability for a tax, the tax becomes, at least
in a board sense, a debt. It follows that the interest HELD: YES. CTA affirmed.
paid by herein respondent for the late payment of [Dispositive] In conclusion, we are of the opinion
her donor's tax is deductible from her gross income. and so hold that although interest payment for
In conclusion, interest payment for delinquent taxes delinquent taxes is not deductible as tax under
is not deductible as tax but the taxpayer is not Section 30(c) of the Tax Code and section 80 of the
precluded thereby from claiming said payment as Income Tax Regulations, the taxpayer is not
deduction on account of interest. precluded thereby from claiming said interest
payment as deduction under section 30(b) of the
SUMMARY: same Code.
Respondent donated real property to her children. In view of the foregoing, the decision sought to be
She paid the assessed donors gift tax, which reviewed is affirmed, without pronouncement as to
assessment included interest on account of costs.
delinquency. The following year, in her income tax RATIO:
return, respondent claimed the interest as a Under the law, for interest to be deductible, it
deduction. The CIR disallowed the deduction, but the must be shown that (1) there be an indebtedness, (2)
CTA reversed and allowed it. The SC affirmed the CTA there should be interest upon it, (3) and that what is
decision. Interest on tax is interest on claimed as an interest deduction should have been
indebtedness and is thus deductible. US Tax paid or accrued within the year. In this case, ALL
Code (which our provisions are based on) three are present and admitted by both parties. It is
contemplates tax as an indebtedness. Jurisprudence just the interpretation of the interest paid that is in
has also held the same; although taxes arent issue here and WON it falls within the contemplation
conceptually the same as debts, they may be of the law.
considered as such. Interest on tax, such as that paid by respondent
for the late payment of donors tax, is interest on
FACTS: indebtedness and is thus deductible.
Respondent conveyed as gifts to her four children o Meaning of indebtedness in the US Tax Code
Antonio, Benito, Carmen, and Mauro (like, so (which contains similar provisions as ours)
conyo names) real property with total assessed an unconditional and legally enforceable
value of P892,497.50. obligation for the payment of money.
The gift tax returns was filed. The CIR appraised Within that definition, it is apparent that
respondents real property donation for gift tax a tax may be considered an
purposes at P1,231,268, and assessed indebtedness.
P117,706.50 as donors gift tax, interest and o Sambrano vs CTA&CIR
compromises due. The assessment was duly paid Although taxes already due arent the
by respondent. Take note that P55,978.65 of the same concept as debts, they are
assessed P117,706.50 represented the total however, obligations which may be
interest on account of delinquency. considered as such.
That sum of P55,978.65 (total interest on account Debt" is properly used in a
of delinquency) was then claimed as a deduction comprehensive sense as embracing not
by respondent in her 1954 income tax return. merely money due by contract but
The CIR, however, disallowed the deduction claim whatever one is bound to render to
and assessed respondent for 1954 the sum of another, either for contract, or the
P21,410.38 as deficiency income tax on the requirement of the law.
aforesaid P55,978.65. It included interest, Where statute imposes a personal
surcharge, and compromise for the late payment. liability for a tax, the tax becomes, at
The CTA reversed the the CIR decision. least in a board sense, a debt.
A tax is a debt for which a creditor's bill
ISSUE: may be brought in a proper case.
WON the interest paid by respondent (the P55K++)
was paid upon an indebtedness within the [Argument of CIR] Look at Sec. 80 of Revenue
contemplation of Sec 30(B)(1)1 of the Tax Code. Regulation #2 of the DOF!! the word `taxes'
means taxes proper and no deductions should be
1 SEC. 30 Deductions from gross income. In computing net allowed for amounts representing interest, surcharge,
income there shall be allowed as deductions x x x xxx or penalties incident to delinquency."
xxx

(b) Interest: SC Nope. That revenue regulation merely


incorporates the established application of the
(1) In general. The amount of interest paid within the taxable year
on indebtedness, except on indebtedness incurred or continued to
purchase or carry obligations the interest upon which is exempt from
taxation as income under this Title.
tax deduction statute in the US, where deduction to the instant case because while it implements
of "taxes" has always been limited to taxes sections 30(c) of the Tax Code governing deduction
proper and has never included interest on of taxes, the respondent taxpayer seeks to come
delinquent taxes, penalties and surcharges. under section 30(b) of the same Code providing for
o In any case, lower court was correct when it deduction of interest on indebtedness.
held that Sec. 80 is inapplicable to the ISSUE:
instant case. Sec. 80 implements sections Whether or not such interest was paid upon an
30(c) of the Tax Code governing deduction of indebtedness within the contemplation of section 30
taxes; here, respondent seeks to come under (b) (1) of the Tax Code?
section 30(b) providing for deduction of RULING:
interest on indebtedness. Yes. According to the Supreme Court, although
o To follow the interpretation of the CIR of Sec. interest payment for delinquent taxes is not
80 would contravene Sec. 30(B) of the Tax deductible as tax under Section 30(c) of the Tax Code
Code and the construction of said law by US and section 80 of the Income Tax Regulations, the
Courts. A regulation which operates to create taxpayer is not precluded thereby from claiming said
a rule not in harmony with the statute is a interest payment as deduction under section 30(b) of
mere nullity. the same Code.

Commissioner of Internal Revenue vs. Vda. De SEC. 30 Deductions from gross income. In
Prieto (1960) computing net income there shall be allowed as
FACTS: deductions
On December 4, 1945, the respondent conveyed by
way of gifts to her four children, namely, Antonio,
Benito, Carmen and Mauro, all surnamed Prieto, real (b) Interest:
property with a total assessed value of P892,497.50.
After the filing of the gift tax returns on or about (1) In general. The amount of interest paid
February 1, 1954, the petitioner Commissioner of within the taxable year on indebtedness,
Internal Revenue appraised the real property except on indebtedness incurred or
donated for gift tax purposes at P1,231,268.00, and continued to purchase or carry obligations
assessed the total sum of P117,706.50 as donor's gift the interest upon which is exempt from
tax, interest and compromises due thereon. Of the
taxation as income under this Title.
total sum of P117,706.50 paid by respondent on April
29, 1954, the sum of P55,978.65 represents the total
interest on account of deliquency. This sum of The term "indebtedness" as used in the Tax Code of
P55,978.65 was claimed as deduction, among others, the United States containing similar provisions as in
by respondent in her 1954 income tax return. the above-quoted section has been defined as an
Petitioner, however, disallowed the claim and as a unconditional and legally enforceable obligation for
consequence of such disallowance assessed the payment of money.
respondent for 1954 the total sum of P21,410.38 as
deficiency income tax due on the aforesaid
To give to the quoted portion of section 80 of our
P55,978.65, including interest up to March 31, 1957,
surcharge and compromise for the late payment. Income Tax Regulations the meaning that the
petitioner gives it would run counter to the provision
Under the law, for interest to be deductible, it must of section 30(b) of the Tax Code and the construction
be shown that there be an indebtedness, that there given to it by courts in the United States. Such effect
should be interest upon it, and that what is claimed would thus make the regulation invalid for a
as an interest deduction should have been paid or "regulation which operates to create a rule out of
accrued within the year. It is here conceded that the harmony with the statute, is a mere nullity." As
interest paid by respondent was in consequence of already stated, section 80 implements only section
the late payment of her donor's tax, and the same 30(c) of the Tax Code, or the provision allowing
was paid within the year it is sought to be declared. deduction of taxes, while herein respondent seeks to
To sustain the proposition that the interest payment be allowed deduction under section 30(b), which
in question is not deductible for the purpose of provides for deduction of interest on indebtedness.
computing respondent's net income, petitioner relies
heavily on section 80 of Revenue Regulation No. 2
(known as Income Tax Regulation) promulgated by
the Department of Finance, which provides that "the PAPER INDUSTRIES v CA ( Dec. 1, 1995)
word `taxes' means taxes proper and no deductions
should be allowed for amounts representing interest, FACTS:
surcharge, or penalties incident to delinquency." The On various years (1969, 1972 and 1977), Picop
court below, however, held section 80 as inapplicable obtained loans from foreign creditors in order to
finance the purchase of machinery and equipment interest," that is to say, interest "calculated" or
needed for its operations. In its 1977 Income Tax computed (and not incurred or paid) for the
Return, Picop claimed interest payments made in purpose of determining the "opportunity cost"
1977, amounting to P42,840,131.00, on these loans of investing funds in a given business. Such
as a deduction from its 1977 gross income. "theoretical" or imputed interest does not arise
The CIR disallowed this deduction upon the ground from a legally demandable interest-bearing
that, because the loans had been incurred for the obligation incurred by the taxpayer who
purchase of machinery and equipment, the interest however wishes to find out, e.g., whether he would
payments on those loans should have been have been better off by lending out his funds and
capitalized instead and claimed as a depreciation earning interest rather than investing such funds in
deduction taking into account the adjusted basis of his business. One thing that Section 79 quoted above
the machinery and equipment (original acquisition makes clear is that interest which does constitute a
cost plus interest charges) over the useful life of such charge arising under an interest-bearing
assets. obligation is an allowable deduction from gross
Both the CTA and the Court of Appeals sustained the income.
position of Picop and held that the interest deduction Only if sir asks: (For further discussion of CIRs
claimed by Picop was proper and allowable. In the contention)
instant Petition, the CIR insists on its original It is claimed by the CIR that Section 79 of Revenue
position. Regulations No. 2 was "patterned after" paragraph
ISSUE: Whether Picop is entitled to deductions 1.266-1 (b), entitled "Taxes and Carrying Charges
against income of interest payments on loans for the Chargeable to Capital Account and Treated as Capital
purchase of machinery and equipment. Items" of the U.S. Income Tax Regulations, which
HELD: YES. paragraph reads as follows:
Interest payments on loans incurred by a taxpayer
(whether BOI-registered or not) are allowed by the (B) Taxes and Carrying Charges. The items
NIRC as deductions against the taxpayer's gross thus chargeable to capital accounts are
income. The basis is 1977 Tax Code Sec. 30 (b). 2
Thus, the general rule is that interest expenses are
deductible against gross income and this certainly (11) In the case of real property, whether
includes interest paid under loans incurred in improved or unimproved and whether
connection with the carrying on of the business of productive or nonproductive.
the taxpayer. In the instant case, the CIR does not
dispute that the interest payments were made by (a) Interest on a loan (but not theoretical
Picop on loans incurred in connection with the interest of a taxpayer using his own funds).
carrying on of the registered operations of Picop, i.e.,
the financing of the purchase of machinery and
equipment actually used in the registered operations The truncated excerpt of the U.S. Income Tax
of Picop. Neither does the CIR deny that such interest Regulations quoted by the CIR needs to be related to
payments were legally due and demandable under the relevant provisions of the U.S. Internal Revenue
the terms of such loans, and in fact paid by Picop Code, which provisions deal with the general topic of
during the tax year 1977. adjusted basis for determining allowable gain or loss
The contention of CIR does not spring of the 1977 Tax on sales or exchanges of property and allowable
Code but from Revenue Regulations 2 Sec. 79.3 depreciation and depletion of capital assets of the
However, the Court said that the term interest here taxpayer:
should be construed as the so-called "theoretical
Present Rule. The Internal Revenue Code,
2 Sec. 30. Deduction from Gross Income. The following may be and the Regulations promulgated thereunder
deducted from gross income:xxx xxx xxx
(b) Interest: provide that "No deduction shall be allowed
(1) In general. The amount of interest paid within the for amounts paid or accrued for such taxes
taxable year on indebtedness, except on indebtedness incurred or
continued to purchase or carry obligations the interest upon which is
and carrying charges as, under regulations
exempt from taxation as income under this Title: . . . (Emphasis prescribed by the Secretary or his delegate,
supplied) are chargeable to capital account with
respect to property, if the taxpayer elects, in
accordance with such regulations, to treat
such taxes orcharges as so chargeable."
3 Sec. 79. Interest on Capital. Interest calculated for cost-keeping or
other purposes on account of capital or surplus invested in the At the same time, under the adjustment of
business, which does not represent a charge arising under an interest-bearing
basis provisions which have just been
obligation, is not allowable deduction from gross income. (Emphases
supplied) discussed, it is provided that adjustment
shall be made for all "expenditures, receipts, (d) Taxes assessed against local benefits of a kind
losses, or other items" properly chargeable to tending to increase the value of the property
a capital account, thus including taxes and assessed.
carrying charges; however, an exception Provided, That taxes allowed under this Subsection,
exists, in which event such adjustment to the when refunded or credited, shall be included as part
capital account is not made, with respect to of gross income in the year of receipt to the extent of
taxes and carrying charges which the the income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a
taxpayer has not elected to capitalize but for
nonresident alien individual engaged in trade or
which a deduction instead has been
business in the Philippines and a resident foreign
taken. 22 (Emphasis supplied) corporation, the deductions for taxes provided in
paragraph (1) of this Subsection (C) shall be allowed
The "carrying charges" which may be capitalized only if and to the extent that they are connected with
under the above quoted provisions of the U.S. income from sources within the Philippines.
Internal Revenue Code include, as the CIR has (3) Credit Against Tax for Taxes of Foreign Countries. -
pointed out, interest on a loan "(but not theoretical If the taxpayer signifies in his return his desire to
interest of a taxpayer using his own funds)." What have the benefits of this paragraph, the tax imposed
the CIR failed to point out is that such "carrying by this Title shall be credited with:
charges" may, at the election of the taxpayer, either (a) Citizen and Domestic Corporation. - In the case of
a citizen of the Philippines and of a domestic
be (a) capitalized in which case the cost basis of the
corporation, the amount of income taxes paid or
capital assets, e.g., machinery and equipment, will
incurred during the taxable year to any foreign
be adjusted by adding the amount of such interest country; and
payments or alternatively, be (b) deducted from (b) Partnerships and Estates. - In the case of any
gross income of the taxpayer. Should the taxpayer such individual who is a member of a general
elect to deduct the interest payments against its professional partnership or a beneficiary of an estate
gross income, the taxpayer cannot at the same or trust, his proportionate share of such taxes of the
time capitalize the interest payments. In other words, general professional partnership or the estate or
the taxpayer is not entitled to both the deduction trust paid or incurred during the taxable year to a
from gross income and the adjusted (increased) foreign country, if his distributive share of the income
basis for determining gain or loss and the allowable of such partnership or trust is reported for taxation
depreciation charge. The U.S. Internal Revenue under this Title.
Code does not prohibit the deduction of interest on a An alien individual and a foreign corporation shall not
loan obtained for purchasing machinery and be allowed the credits against the tax for the taxes of
equipment against gross income, unless the taxpayer foreign countries allowed under this paragraph.
(4) Limitations on Credit. - The amount of the credit
has also or previously capitalized the same interest
taken under this Section shall be subject to each of
payments and thereby adjusted the cost basis of
the following limitations:
such assets. (a) The amount of the credit in respect to the tax
paid or incurred to any country shall not exceed the
same proportion of the tax against which such credit
is taken, which the taxpayer's taxable income from
sources within such country under this Title bears to
his entire taxable income for the same taxable year;
and
3. TAXES (b) The total amount of the credit shall not exceed
i. Sec. 34(C) of the NIRC the same proportion of the tax against which such
(1) In General. - Taxes paid or incurred within the credit is taken, which the taxpayer's taxable income
taxable year in connection with the taxpayer's from sources without the Philippines taxable under
profession, trade or business, shall be allowed as this Title bears to his entire taxable income for the
deduction, except same taxable year.
(a) The income tax provided for under this Title; (5) Adjustments on Payment of Incurred Taxes. - If
(b) Income taxes imposed by authority of any foreign accrued taxes when paid differ from the amounts
country; but this deduction shall be allowed in the claimed as credits by the taxpayer, or if any tax paid
case of a taxpayer who does not signify in his return is refunded in whole or in part, the taxpayer shall
his desire to have to any extent the benefits of notify the Commissioner; who shall redetermine the
paragraph (3) of this subsection (relating to credits amount of the tax for the year or years affected, and
for taxes of foreign countries); the amount of tax due upon such redetermination, if
(c) Estate and donor's taxes; and any, shall be paid by the taxpayer upon notice and
demand by the Commissioner, or the amount of tax
overpaid, if any, shall be credited or refunded to the
taxpayer. In the case of such a tax incurred but not refund in the amount of P150,269.00 as
paid, the Commissioner as a condition precedent to alleged overpaid income tax for 1955
the allowance of this credit may require the taxpayer o Facts:
to give a bond with sureties satisfactory to and to be In Feb 1956 Sps filed ITR for 1955 =
approved by the Commissioner in such sum as he gross income of P1,7771,124.63 and net
may require, conditioned upon the payment by the income of P1,052,550.67
taxpayer of any amount of tax found due upon any 1956 sps filed an amended ITR
such redetermination. The bond herein prescribed Back in 1955, sps filed with the US
shall contain such further conditions as the Internal Revenue Agent in Manila their
Commissioner may require. federal ITR for the years 1947,1951-54
(6) Year in Which Credit Taken. - The credits provided on income from Phil sources on a cash
for in Subsection (C)(3) of this Section may, at the basis
option of the taxpayer and irrespective of the method 1958 Sps amended their Phil ITR for
of accounting employed in keeping his books, be 1955 to include the deductions of US
taken in the year which the taxes of the foreign Federal income taxes, interest accrued
country were incurred, subject, however, to the up to May 15, 1955, and exchange and
conditions prescribed in Subsection (C)(5) of this bank charges
Section. If the taxpayer elects to take such credits in CTA case 570 was filed
the year in which the taxes of the foreign country
G.R. No. 21434 formerly CTA Case No. 783,
accrued, the credits for all subsequent years shall be
facts are similar but refer to Lednickys OTR
taken upon the same basis and no portion of any
for 1957 filed in Feb 1958
such taxes shall be allowed as a deduction in the
o In 1959 sps filed amended return for
same or any succeeding year.
1957 claiming deductions
(7) Proof of Credits. - The credits provided in
representing taxes paid to US Govt.
Subsection (C)(3) hereof shall be allowed only if the
* Tac xourt held that the taxes may be deducted
taxpayer establishes to the satisfaction of the
because the Sps did not signify in their ITRa desire
Commissioner the following:
to avail themselves of the benefits of paragraph 3(B)
(a) The total amount of income derived from sources
of Sec. 30
without the Philippines;
COMMON ISSUE: WON a citizen of the US residing in
(b) The amount of income derived from each country,
Phils who derives income wholly from sources within
the tax paid or incurred to which is claimed as a
the Phils may deduct from his gross income the
credit under said paragraph, such amount to be
income taxes he has paid to US govt for the taxable
determined under rules and regulations prescribed
year?
by the Secretary of Finance; and
HELD/RATIO:
(c) All other information necessary for the verification
and computation of such credits. SC: CIR correct that the construction and
wording of Sec. 30c(1)B of the Internal
CASES: Revenue Act shows the laws intent that the
right to deduct income taxes paid to foreign
CIR V LEDNICKY government from the taxpayers gross
income is given only as an alternative or
FACTS: substitute to his right to claim a tax credit for
Resp spouses V.E. Lednicky and Maria Valero such foreign income taxes
o (B) Income, war-profits, and excess
Lednicky are American Citizens residing in
the Philippines and derived their income from profits taxes imposed by the
Philippine sources for the taxable years in authority of any foreign country; but
question this deduction shall be allowed in the
case of a taxpayer who does not
1957 Sps filed their ITR for 1956 reporting a
signify in his return his desire to have
gross income P1,017,287.65 and a net
any extent the benefits of paragraph
income of P733,809.44 on which
(3) of this subsection (relating to
P317,395.40 was assessed after deducting
credit for foreign countries)
P4,805.59 as withholding tax.
So that unless the alien resident has a right
Sps paid 326,247.41 on April 1957
to claim such tax credit if he so chooses, he
March 1959 Sps filed an amended ITR for is precluded from deducting the foreign
1956. They claimed a deduction of income taxes from his gross income.
P205,939.24 paid in 1956 to US govt.
For it is obvious that in prescribing that such
Respondents requested refund of 112,437.90
deduction shall be allowed in the case of a
CIR failed to answer the claim for refund, taxpayer who does not signify in his return
resps filed their petition with the Tax Court his desire to have any extent benefits of
G.R. No. L-18169 formerly CTA case paragraph 3, the statute assumes that the
570[different case/year] is also a claim for
taxpayer in question may signify his desire to answer the claim for refund, the spouses filed their
claim a tax credit and waive the deduction; petition with the tax court on 11 April 1959 as CTA
otherwise, the foreign taxes would always be Case 646. [GR L- 18165] On 28 February 1956, the
deductible and their mention in the list on spouses filed their domestic income tax return for
non-deductible items in Sec. 30c might as 1955, reporting a gross income of P1,771,124.63 and
well have been omitted or at least expressly a net income of P1,052,550.67. On 19 April 1956,
limited to taxes on income from sources they filed an amended income tax return, the
outside the Philippine Islands amendment upon the original being a lesser net
Had the law intended that foreign income income of P1,012,554.51, and, on the basis of this
taxes could be deducted from gross income amended return, they paid P570,252.00, inclusive of
in any event, regardless of the taxpayers withholding taxes. After audit, the Commissioner
right to claim a tax credit, it is the latter right determined a deficiency of P16,116.00, which
that should be conditioned upon the amount the spouses paid on 5 December 1956. Back
taxpayers waiving the deduction in 1955, however, the spouses filed with the US
No danger of double credit/taxation. Internal Revenue Agent in Manila their Federal
o Double taxation becomes obnoxious only income tax return for the years 1947, 1951, 1952,
where the taxpayer is taxed twice for the 1953 and 1954 on income from Philippine sources on
benefit of the same governmental entity a cash basis. Payment of these federal income taxes,
o The Philippine government only receives including penalties and delinquency interest in the
the proceeds of one tax amount of $264,588.82, were made in 1955 to the
o Justice and equity demand that the tax US Director of Internal Revenue, Baltimore, Maryland,
on the income should accrue to the through the National City Bank of New York, Manila
benefit of the Philippines Branch. Exchange and bank charges in remitting
o Any relief from the alleged double payment totaled P4,143.91. On 11 August 1958 the
said respondents amended their Philippines income
taxation should come from the US since
tax return for 1955 to including US Federal income
the formers right to burden the taxpayer
taxes, interest accruing up to 15 May 1955, and
is solely predicated in is citizenship,
exchange and bank charges, totaling P516,345.15
without contributing to the production of
and therewith filed a claim for refund of the sum of
wealth that is being taxed
P166,384.00, which was later reduced to
o To allow an alien resident to deduct from
P150,269.00. The spouses brought suit in the Tax
his gross income whatever taxes he pays
Court, which was docketed therein as CTA Case 570.
to his own government amounts to
[GR 21434] The facts are similar to above cases but
conferring on the latter the power to
refer to the spouses income tax returns for 1957,
reduce the tax income of the Philippine
filed on 28 February 1958, and for which the spouses
government simply by increasing the tax
paid a total sum of P196,799.65. In 1959, they filed
rates on the alien resident.
an amended return for 1957, claiming deduction of
P190,755.80, representing taxes paid to the US
CIR vs. Lednicky [G.R. Nos. L-18169, L-18286, &
Government on income derived wholly from
L-21434. July 31, 1964.]
Philippine sources. On the strength thereof, spouses
FACTS:
seek refund of P90,520.75 as overpayment (CTA
V. E. Lednicky and Maria Valero Lednicky, are
Case 783). The Tax Court decide for the spouses. The
husband and wife, both American citizens residing in
Commissioner thus elevated under separate petitions
the Philippines, and have derived all their income
for review of the corresponding decisions of the Court
from Philippine sources for the taxable years under
of Tax Appeals to the Supreme Court. Since these
question. [GR L-18286] In compliance with local law,
cases involve the same parties and issues akin to
the spouses, on 27 March 1957, filed their income
each case presented, the Court decided them jointly.
tax return for 1956, reporting therein a gross income
HELD:
of P1,017,287.65 and a net income of P733,809.44
The Supreme Court reversed the decisions of the
on which the amount of P317,395.41 was assessed
Court of Tax Appeals, and affirmed the disallowance
after deducting P4,805.59 as withholding tax.
of the refunds claimed by the spouses, with costs
Pursuant to the Commissioner of Internal Revenues
against said spouses.
assessment notice, the spouses paid the total
1. Section 30 (c-1) of the Philippine Internal Revenue
amount of P326,247.41, inclusive of the withheld
Code Section 30 (c) (1) (Deduction from gross
taxes, on 15 April 1957. On 17 March 1959, the
income) provides that in computing net income
spouses filed an amended income tax return for
there shall be allowed as deductions: (c) Taxes: (1) In
1956. The amendment consists in a claimed
general. Taxes paid or accrued within the taxable
deduction of P205,939.24 paid in 1956 to the US
year, except (A) The income tax provided for under
government as federal income tax for 1956.
this Title; (B) Income, war-profits, and excess profits
Simultaneously with the filing of the amended return,
taxes imposed by the authority of any foreign
the spouses requested the refund of P112,437.90.
country; but this deduction shall be allowed in the
When the Commissioner of Internal Revenue failed to
case of a taxpayer who does not signify in his return non-deductible items in Section 30 (c) might as well
his desire to have to any extent the benefits of have been omitted, or at least expressly limited to
paragraph (3) of this subsection (relating to credit for taxes on income from sources outside the Philippine
taxes of foreign countries); (C) Estate, inheritance Islands. Had the law intended that foreign income
and gift taxes; and (D) Taxes assessed against local taxes could be deducted from gross income in any
benefits of a kind tending to increase the value of the event, regardless of the taxpayers right to claim a
property assessed. tax credit, it is the latter right that should be
2. Paragraph (c) (3) (b) of the Tax Code; Credits conditioned upon the taxpayers waiving the
against tax for taxes of foreign countries Paragraph 3 deduction; in which case the right to reduction under
(B) of the subsection (Credits against tax for taxes of subsection (c-1-B) would have been made absolute
foreign countries), reads: If the taxpayer signifies in or unconditional (by omitting foreign taxes from the
his return his desire to have the benefits of this enumeration of non- deductions), while the right to a
paragraph, the tax imposed by this Title shall be tax credit under subsection (c-3) would have been
credited with (B) Alien resident of the Philippines. expressly conditioned upon the taxpayers not
In the case of an alien resident of the Philippines, the claiming any deduction under subsection (c-1).
amount of any such taxes paid or accrued during the 5. Danger of double credit does not exist if taxpayer
taxable year to any foreign country, if the foreign cannot claim benefit from either headings at his
country of which such alien resident is a citizen or option The purpose of the law is to prevent the
subject, in imposing such taxes, allows a similar taxpayer from claiming twice the benefits of his
credit to citizens of the Philippines residing in such payment of foreign taxes, by deduction from gross
country; income (subs. c-1) and by tax credit (subs. c-3). This
3. Paragraph (c) (4) of the Tax Code; Limitation on danger of double credit certainly can not exist if the
credit The tax credit so authorized is limited under taxpayer can not claim benefit under either of these
paragraph 4 (A and B) of the same subsection, in the headings at his option, so that he must be entitled to
following terms: Par. (c) (4) Limitation on credit. a tax credit (the spouses admittedly are not so
The amount of the credit taken under this section entitled because all their income is derived from
shall be subject to each of the following limitations: Philippine sources), or the option to deduct from
(A) The amount of the credit in respect to the tax gross income disappears altogether.
paid or accrued to any country shall not exceed the 6. When double taxation; Tax income should accrue
same proportion of the tax against which such credit to benefit of the Philippines Double taxation becomes
is taken, which the taxpayers net income from obnoxious only where the taxpayer is taxed twice for
sources within such country taxable under this Title the benefit of the same governmental entity (cf.
bears to his entire net income for the same taxable Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579,
year; and (B) The total amount of the credit shall not Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the
exceed the same proportion of the tax against which present case, while the taxpayers would have to pay
such credit is taken, which the taxpayers net income two taxes on the same income, the Philippine
from sources without the Philippines taxable under government only receives the proceeds of one tax.
this Title bears to his entire net income for the same As between the Philippines, where the income was
taxable year. earned and where the taxpayer is domiciled, and the
4. Laws intent that right to deduct income taxes paid United States, where that income was not earned
to foreign government taken as an alternative or and where the taxpayer did not reside, it is
substitute to claim of tax credit for such foreign indisputable that justice and equity demand that the
income tax Construction and wording of Section 30 tax on the income should accrue to the benefit of the
(c) (1) (B) of the Internal Revenue Act shows the Philippines. Any relief from the alleged double
laws intent that the right to deduct income taxes taxation should come from the United States, and not
paid to foreign government from the taxpayers gross from the Philippines, since the formers right to
income is given only as an alternative or substitute burden the taxpayer is solely predicated on his
to his right to claim a tax credit for such foreign citizenship, without contributing to the production of
income taxes under section 30 (c) (3) and (4); so that the wealth that is being taxed.
unless the alien resident has a right to claim such tax 7. Fundamental doctrine of income taxation The
credit if he so chooses, he is precluded from fundamental doctrine of income taxation provides
deducting the foreign income taxes from his gross that the right of a government to tax income
income. For it is obvious that in prescribing that such emanates from its partnership in the production of
deduction shall be allowed in the case of a taxpayer income, by providing the protection, resources,
who does not signify in his return his desire to have incentives, and proper climate for such production.
to any extent the benefits of paragraph (3) (relating 8. Interpretation cannot result to an absurd situation
to credits for taxes paid to foreign countries), the The interpretation given by the spouses to the
statute assumes that the taxpayer in question also revenue law provision in question operates, in its
may signify his desire, to claim a tax credit and waive application, to place a resident alien with only
the deduction; otherwise, the foreign taxes would domestic sources of income in an equal, if not in a
always be deductible, and their mention in the list of better, position than one who has both domestic and
foreign sources of income, a situation which is
manifestly unfair and short of logic.
9. Erroneous interpretation would subrogate
Philippine taxes to those levied by a foreign
government To allow an alien resident to deduct from
his gross income whatever taxes he pays to his own
government amounts to conferring on the latter
power to reduce the tax income of the Philippine
government simply by increasing the tax rates on the
alien resident. Everytime the rate of taxation
imposed upon an alien resident is increased by his 4. LOSSES
own government, his deduction from Philippine taxes Refer to such losses which do not come under the
would correspondingly increase, and the proceeds for category of bad debts, inventory losses,
the Philippines diminished, thereby subordinating our depreciation, etc and which arise in taxpayers
own taxes to those levied by a foreign government. profession trade or business
Such a result is incompatible with the status of the
Philippines as an independent and sovereign state. Kinds of Losses:
a. Ordinary- incurred in trade or business or
Commissioner of Internal Revenue vs W.E. practice of profession
Lednicky and Maria Lednicky b. Capital Losses- deductible to the extent of
GR Nos. L-18262 and L-21434, 1964 capital gains
FACTS: 1. Losses from sale or exchange of capital
Spouses are both American citizens residing in the assets
Philippines and have derived all their income from 2. Losses resulting from securities becoming
Philippine sources for taxable years in question. worthless and which are capital assets
3. Losses from Short Sale of property
On March, 1957, filed their ITR for 1956, reporting 4. Losses due to failure to exercise privilege or
gross income of P1,017,287.65 and a net income of P option to buy or sell property
733,809.44. On March 1959, file an amended c. Special Losses- ie. Wagering Losses(to the extent
claimed deduction of P 205,939.24 paid in 1956 to of gain in such transactions), losses on wash sales
the United States government as federal income tax (sec 38)
of 1956.
ISSUE: i. Sec 34(D) of the NIRC
Whether a citizen of the United States residing in the Losses- Losses actually sustained during the taxable
Philippines, who derives wholly from sources within year and not compensated for by insurance or other
the Philippines, may deduct his gross income from forms of indemnity shall be allowed as deductions:
the income taxes he has paid to the United States (a) If incurred in trade, profession or business;
government for the said taxable year? (b) Of property connected with the trade, business or
HELD: profession, if the loss arises from fires, storms,
An alien resident who derives income wholly from shipwreck, or other casualties, or from robbery, theft
sources within the Philippines may not deduct from or embezzlement.
gross income the income taxes he paid to his home Prescription/ when must submit report to Sec
country for the taxable year. The right to deduct of Finance: not be less than thirty (30) days nor more
foreign income taxes paid given only where than ninety (90) days from the date of discovery of
alternative right to tax credit exists. Section 30 of the the casualty or robbery, theft or embezzlement
NIRC, Gross Income Par. C (3): Credits against tax giving rise to the loss.
per taxes of foreign countries. If the taxpayer
signifies in his return his desire to have the benefits ii. Casualty Losses
of this paragraph, the tax imposed by this shall be a. RMO 31-09 dated October 16, 2009
credited with: Paragraph (B), Alien resident of the -prescribes the policies and guidelines for declaration
Philippines; and, Paragraph C (4), Limitation on and reporting or casualty losses incurred as result of
credit. An alien resident not entitled to tax credit for Typhoons Ondoy and Pepeng
foreign income taxes paid when his income is derived Requirements:
wholly from sources within the Philippines. Double 1. Sworn Declaration of Loss ( filed within 45 days
taxation becomes obnoxious only where the taxpayer after date of event)
is taxed twice for the benefit of the same 2. Proof of the elements of the losses claimed such
governmental entity. In the present case, although as photos, documents, insurance policy, police report
the taxpayer would have to pay two taxes on the (a mere allged theft or robbery to police authorities is
same income but the Philippine government only not considered conclusive proof)
receives the proceeds of one tax, there is no
obnoxious double taxation.
Taxpayer engaged in trade and business- may claim b) For mines other than oil and gas wells, a
business deductions casualty losses for properties net operating loss (realized without the
used in business that were damaged or reported as benefit of incentives provided for under the
losses Omnibus Investments Code of 1997) incurred
in any of its first ten(10) years of operation
Extent of loss to be deducted-> do not include the may be carried over as a deduction from
amount covered by insurance taxable income for the next five (5) years
immediately following the year of such loss.
Destruction of property-> net book value c) No substantial Change in Ownership (75%
immediately preceding disaster Rule)

Restoration-> recorded as repairs expense or Who may avail of NOLCO:


capitalized assets 1. Any individual, including estates and trusts,
engaged in trade or business or in the exercise of
iii. Net Operating Loss Carry-Over profession, and
The net operating loss of the business or enterprise 2. domestic and resident foreign corporations
for any taxable year immediately preceding the
current taxable year, which had not been previously Who may not avail NOLCO:
offset as deduction from gross income shall be 1) Offshore Banking Unit of a foreign banking
carried over as a deduction from gross income for the corporation, and Foreign Currency Deposit Unit of a
next 3 consecutive taxable years immediately domestic or foreign banking corporation, duly
following the year of such loss, provided that any net authorized as such by the Bangko Sentral ng Pilpinas;
loss incurred in a taxable year during which the 2) enterprises registered with the Board of
taxpayer is exempt from income tax shall not be Investments (BOI), with respect to its BOI-registered
allowed as a deduction. activity enjoying the Income Tax Holiday incentive;
The deduction is allowed only if there has been no 3) enterprises registered with the Philippine
substantial change in the ownership of the business Economic Zone Authority (PEZA), with respect to its
or enterprise in that PEZA-registered business activity;
a. Not less than 75% in nominal value of outstanding 4) enterprises registered under the Bases Conversion
issued shares, if the business is in the name of a and Development Act of 1992;
corporation, is held by or on behalf of the same 5) foreign corporations engaged in international
persons; or shipping or air carriage business in the Philippines;
b. Not less than 75% of the paid up capital of the and
corporation, if the business is in the name of a 6) any person, natural or juridical, enjoying
corporation, is held by or on behalf of the same exemption from income tax, pursuant to the
persons. provisions of the Code or any special law, with
respect to its operation during the period for which
For mines other than oil and gas wells, a net the aforesaid exemption is applicable.
operating loss without the benefit of incentives
provided under EO No. 226,as amended, incurred in NOTE: The 3 year period shall continue to run
any of the first 10 years of operation may be carried notwithstanding that the corporation paid its taxes
over as a deduction, from taxable income for the under MCIT, or that the individual availed of the 10%
next 5 years immediately following the year of such OSD
loss. The entire amount of the loss shall be carried
over to the first of the 5 taxable years following the An individual who claims the 10% optional standard
loss, and any portion of such loss which exceeds the deduction shall not simultaneously claim deduction
taxable income of such first year shall be deducted in of the NOLCO, provided that the three-year
like manner from the taxable income of the next reglementary period shall continue to run
remaining 4 years. notwithstanding the fact that the said individual
availed of the
Net operating loss = excess of allowable deductions 10% optional standard deduction during the said
over gross income. period. In the case of corporations, the three-year
reglementary period on the carry-over of NOLCO
a. RR No. 14-01 dated August 27, 2001- shall also continue to run notwithstanding the fact
NOLCO as deduction from Gross Income that it has paid its income tax under the Minimum
a) Only net operating losses accumulated by Corporate
a qualified taxpayer beginning January Income Tax computation. NOLCO shall be availed of
1, 1998 may be carried over as a deduction on a first-in, first-out basis.
from gross income to the next three (3)
immediately succeeding taxable years CASES:
following the year of such loss.
PAPER INDUSTRIES v CA ( Dec. 1, 1995) Statute that requires the disallowance of the
FACTS: interest payments made by Picop.
The Paper Industries Corporation of the THIS PART DI KO SUPER MAGETS:
Philippines ("Picop"), is a Philippine The CIR invokes Section 79 of Revenue
corporation registered with the Board of Regulations No. 2 w/c provides that Interest
Investments ("BOI") as a preferred pioneer calculated for cost-keeping or other purposes
enterprise with respect to its integrated pulp on account of capital or surplus invested in
and paper mill, and as a preferred non- the business, which does not represent a
pioneer enterprise with respect to its charge arising under an interest-bearing
integrated plywood and veneer mills. obligation, is not allowable deduction from
In 1969, 1972 and 1977, Picop obtained gross income.
loans from foreign creditors in order to It is claimed by the CIR that Section 79 of
finance the purchase of machinery and Revenue Regulations No. 2 was "patterned
equipment needed for its operations. after" paragraph 1.266-1 (b), entitled "Taxes
Picop also issued promissory notes of about and Carrying Charges Chargeable to Capital
P230M, on w/c it paid P45M in interest. Account and Treated as Capital Items" of the
In its 1977 Income Tax Return, Picop claimed U.S. Income Tax Regulations, which
the interest payments on the loans as paragraph reads as follows:
DEDUCTIONS from its 1977 gross income. (B) Taxes and Carrying Charges.
The CIR disallowed this deduction upon the The items thus chargeable to capital
ground that, because the loans had been accounts are
incurred for the purchase of machinery and (11) In the case of real property, whether
equipment, the interest payments on those improved or unimproved and whether
loans should have been capitalized instead productive or nonproductive.
and claimed as a depreciation deduction (a) Interest on a loan (but not theoretical
taking into account the adjusted basis of the interest of a taxpayer using his own funds). 21
machinery and equipment (original The truncated excerpt of the U.S. Income Tax
acquisition cost plus interest charges) over Regulations quoted by the CIR needs to be related to
the useful life of such assets. the relevant provisions of the U.S. Internal Revenue
Code, which provisions deal with the general topic of
ISSUE: adjusted basis for determining allowable gain or loss
W/n the interest payments can be deducted on sales or exchanges of property and allowable
from gross income YES transaction tax depreciation and depletion of capital assets of the
taxpayer:
RULING: Present Rule. The Internal Revenue Code, and
The 1977 NIRC does not prohibit the the Regulations promulgated thereunder
deduction of interest on a loan incurred for provide that "No deduction shall be allowed for
acquiring machinery and equipment. Neither amounts paid or accrued for such taxes and
does our 1977 NIRC compel the capitalization carrying charges as, under regulations
of interest payments on such a loan. prescribed by the Secretary or his delegate, are
chargeable to capital account with respect to
The 1977 Tax Code is simply silent on a
property, if the taxpayer elects, in accordance
taxpayer's right to elect one or the other tax
with such regulations, to treat such taxes or
treatment of such interest payments.
charges as so chargeable."
Accordingly, the general rule that interest
At the same time, under the adjustment of
payments on a legally demandable loan are
basis provisions which have just been
deductible from gross income must be
discussed, it is provided that adjustment shall
applied.
be made for all "expenditures, receipts, losses,
In this case, the CIR does not dispute that the
or other items" properly chargeable to a capital
interest payments were made by Picop on account, thus including taxes and carrying
loans incurred in connection with the charges; however, an exception exists, in
carrying on of the registered operations of which event such adjustment to the capital
Picop, i.e., the financing of the purchase of account is not made, with respect to taxes and
machinery and equipment actually used in carrying charges which the taxpayer has not
the registered operations of Picop. Neither elected to capitalize but for which a deduction
does the CIR deny that such interest instead has been taken.
payments were legally due and demandable The "carrying charges" which may be capitalized
under the terms of such loans, and in fact under the above quoted provisions of the U.S.
paid by Picop during the tax year 1977. Internal Revenue Code include, as the CIR has
The CIR has been unable to point to any pointed out, interest on a loan "(but not theoretical
provision of the 1977 Tax Code or any other interest of a taxpayer using his own funds)." What
the CIR failed to point out is that such "carrying substantial part of whose business is the receipt of
charges" may, at the election of the taxpayer, either deposits, be considered as a loss from the sale or
be (a) capitalized in which case the cost basis of the exchange, on the last day of such taxable year, of
capital assets, e.g., machinery and equipment, will capital assets.
be adjusted by adding the amount of such interest
payments or alternatively, be (b) deducted from ii. RR No. 5-99
gross income of the taxpayer. Should the taxpayer Requirements for Deductibility:
elect to deduct the interest payments against its I. there must be an existing indebtedness due to the
gross income, the taxpayer cannot at the same time taxpayer which must be valid and legally
capitalize the interest payments. In other words, the demandable
taxpayer is not entitled to both the deduction from II. it must be connected with the taxpayers trade,
gross income and the adjusted (increased) basis for business, or practice of profession
determining gain or loss and the allowable III. it must not be sustained in a transaction entered
depreciation charge. The U.S. Internal Revenue Code into between related parties enumerated under Sec.
does not prohibit the deduction of interest on a loan 36 (b)
obtained for purchasing machinery and equipment IV. it must be actually charged off the books of
against gross income, unless the taxpayer has also accounts of the taxpayer as of the end of the taxable
or previously capitalized the same interest payments year.
and thereby adjusted the cost basis of such assets. V. It must be actually ascertained to be worthless and
uncollectible as of the end of the taxable year.
The recovery of bad debts previously allowed as
deduction in the preceding year or years will be
5. BAD DEBTS included as part of the taxpayer's gross income in
-refer to those debts resulting from the worthlessness the year of such recovery to the extent of the income
or uncollectibility in whole or in parts of amounts due tax benefit of said deduction.
the taxpayer by others, arising money let or from
uncollectible amounts of income from goods sold or TAX BENEFIT RULE
services rendered. The recovery of bad debts previously claimed as
deduction shall be included as part of gross income
*Before a debt can be ascertained to be worthless, in the year of recovery to the extent of the income
the creditor must have taken all reasonable steps to tax benefit of said deduction.
collect within the period of prescription, and in the Under the tax benefit rule, the recovery of amounts
light of the following circumstances, acting in good deducted in previous years from gross income
faith, he may justify an ascertainment of become taxable income unless to the extent thereof,
worthlessness of a debt: the deduction did not result in any tax benefit to the
i. insufficiency of collateral taxpayer.
ii. bankruptcy or insolvency Example: If in the year the taxpayer claimed
iii. loss of evidence of indebtedness deduction of bad debts written-off, he realized a
iv. disappearance of debtor, who fled leaving no reduction of the income tax due from him on account
properties of the said deduction, his subsequent recovery
v. death of debtor leaving no properties thereof from his debtor shall be treated as a receipt
vi. injury to debtor incapacitating him from work of realized taxable income. Conversely, if the said
vii. fruitless efforts to collect small amounts from taxpayer did not benefit from the deduction of the
debtors scattered all over the country. said bad debt written-off because it did not result to
any reduction of his income tax in the year of such
i. Sec 34(E) of the NIRC deduction (i.e. where the result of his business
Definition. Debts due to the taxpayer actually operation was a net loss even without deduction of
ascertained to be worthless and charged off within the bad debts written-off), then his subsequent
the taxable year except those not connected with recovery thereof shall be treated as a mere recovery
profession, trade or business and those sustained in or return of capital, hence, not treated as receipt of
a transaction entered into between parties realized taxable income.
mentioned under Section 36 (B) of this Code: - not deductible.
Provided, That recovery of bad debts previously - Refer to E10 above on who are related taxpayers.
allowed as deduction in the preceding years shall be (members of a family (brothers/sisters of the whole
included as part of the gross income in the year of or half blood, spouse, ancestors and lineal
recovery to the extent of the income tax benefit of descendants an individual and corporation, if the
said deduction. individual owns, directly or indirectly, more than 50%
in value of the outstanding stock two corporations, if
Securities Becoming Worthless. Loss in the case more than 50% in value of the outstanding stock in
of a taxpayer other than a bank or trust company both is owned, directly or indirectly, by the same
incorporated under the laws of the Philippines a individual, if either one of such corporations was a
personal holding company or a foreign personal demand letters they allegedly gave to some of their
holding company debtors.
the grantor and a fiduciary of any trust
fiduciary of a trust and the fiduciary of another trust PHILIPPINE REFINING CO v CA
if the same person is a grantor with respect to each FACTS:
trust fiduciary of a trust and a beneficiary of such Plaintiff Philippine Refining Co. and defendant Jarque
trust.) executed three mortgages on the motor vessels
Pandan and Zargazo. The documents were recorded
CASES: as transfer and encumbrances of the vessels for the
port of Cebu and each was denominated a chattel
PHILIPPINE REFINING CO v CA mortgage.
FACTS:
Philippine Refining Corp (PRC) was assessed The first two mortgages did not have an affidavit of
deficiency tax payments for the year 1985 in the good faith. A fourth mortgage was executed by
amount of around 1.8M. This figure was computed Jarque and Ramon Aboitiz over motorship Zaragoza
based on the disallowance of the claim of bad debts and was entered in the Chattel Mortgage Registry on
by PRC. PRC duly protested the assessment claiming May 12, 1932, within the period of 30 days prior to
that under the law, bad debts and interest expense the foreclosure/institution of the insolvency
are allowable deductions. proceedings.
When the BIR subsequently garnished some of PRCs Jose Curaminas filed with the CFI of Cebu a petition
properties, the latter considered the protest as being praying that Francisco Jarque be declared an
denied and filed an appeal to the CTA which set aside insolvent debtor. This was granted and Jarques
the disallowance of the interest expense and properties were then assigned to Curaminas.
modified the disallowance of the bad debts by A problem arose when Judge Jose Hontiveros declined
allowing 3 accounts to be claimed as deductions. to order the foreclosure of the mortgages, and
However, 13 supposed bad debts were disallowed instead, ruled that they were defective because they
as the CTA claimed that these were not substantiated did not have affidavits of good faith.
and did not satisfy the jurisprudential requirement of ISSUE:
worthlessness of a debt The CA denied the petition 1. Whether or not the mortgages of the vessels
for review. are governed by the Chattel Mortgage Law
ISSUE: Whether or not the CA was correct in 2. Whether or not an affidavit of good faith is
disallowing the 13 accounts as bad debts. needed to enforce achattel mortgage on a vessel
RULING: YES. RULING:
Both the CTA and CA relied on the case of Collector Yes. Personal property includes vessels. They are
vs. Goodrich International, which laid down the subject to the provisions of the Chattel Mortgage
requisites for worthlessness of a debt to wit: Law. The Chattel Mortgage Law says that a good
In said case, we held that for debts to be considered chattel mortgage includes an affidavit of good faith.
as "worthless," and thereby qualify as "bad debts" The absence of such affidavit makes mortgage
making them deductible, the taxpayer should show unenforceable against creditors and subsequent
that (1) there is a valid and subsisting debt. (2) the encumbrances. The judge was correct.
debt must be actually ascertained to be worthless
and uncollectible during the taxable year; (3) the Note: A mortgage on a vessel is generally like other
debt must be charged off during the taxable year; chattel mortgages. The only difference between a
and (4) the debt must arise from the business or chattel mortgage of a vessel and a chattel mortgage
trade of the taxpayer. Additionally, before a debt can of other personalty is that the first must be noted in
be considered worthless, the taxpayer must also the registry of the register of deeds.
show that it is indeed uncollectible even in the
future. FERNANDEZ HERMANOS v CIR
Furthermore, there are steps outlined to be FACTS:
undertaken by the taxpayer to prove that he exerted Fernandez Hermanos is an investment company. The
diligent efforts to collect the debts, viz.: (1) sending CIR assessed it for alleged deficiency income taxes. It
of statement of accounts; (2) sending of collection claimed as deduction, among others, losses in or bad
letters; (3) giving the account to a lawyer for debts of Palawan Manganese Mines Inc. which the
collection; and (4) filing a collection case in court. CIR disallowed and was sustained by the CTA.
PRC only used the testimony of its accountant Ms. ISSUE: W/N disallowance is correct
Masagana in order to prove that these accounts were HELD: YES
bad debts. This was considered by all 3 courts to be It was shown that Palawan Manganese Mines sought
self-serving. The SC said that PRC failed to exercise financial help from Fernandez to resume its mining
due diligence in order to ascertain that these debts operations hence a Memorandum of Agreement
were uncollectible. In fact, PRC did not even show the (MOA) was executed where Fernandez would give
yearly advances to Palawan. But it still continued to
suffer loses and Fernandez realized it could no longer 3. Disallowed. These losses represent sums spent by
recover the advances hence claimed it as worthless. the petitioner for the operation of its Balamban coal
Looking at the MOA, Fernandez did not expect to be mines in 1950 and 1951. The petitioner should have
repaid. The consideration for the advances was 15% treated them as losses in 1952 when the mines were
of the net profits. If there were no earnings or profits abandoned and not in 1950 and 1951 on the ground
there was no obligation to repay. Voluntary advances that the mines made no sales of coal during those
without expectation of repayment do not result in years.
deductible losses. Fernandez cannot even sue for 4. Allowed. These losses represent sums spent by
recovery as the obligation to repay will only arise if petitioner for the operation of the 2 haciendas. The
there was net profits. No bad debt could arise where amounts were properly reported as deductions for
there is no valid and subsisting debt. the correct years. The only reason why the CIR
Even assuming that there was valid or subsisting disallowed them was on the ground that the farms
debt, the debt was not deductible in 1951 as a were operated solely for pleasure or as a hobby and
worthless debt as Palawan was still in operation in not for profit. But the Supreme Court is not
1951 and 1952 as Fernandez continued to give convinced, and being for business, the petitioner
advances in those years. It has been held that if the may properly deduct the same.
debtor corporation although losing money or
insolvent was still operating at the end of the taxable FERNANDEZ HERMANOS v CIR
year, the debt is not considered worthless and
therefore not deductible. "The filing of an answer to taxpayer's petition for
review is considered as institution of judicial action."
FERNANDEZ HERMANOS v CIR FACTS:
FACTS: Fernandez Hermanos Inc. is a domestic The Commissioner of Internal Revenue assessed the
corporation organized for the principal purpose of petitioner investment corporation of deficiency
engaging in business as an investment company. income taxes for the years 1950 to 1954 and for
The CIR disallowed the following deductions: 1957. There were two conflicting dates of
1. losses in Mati Lumber Co in 1950 assessment, which are vital to the compliance with
2. losses or bad debts in Palawan Manganese Mines the statute of limitations, based on each claim of the
Inc in 1951 petitioner and the respondent; the Commisioner's
3. losses in Balamban Coal Mines in 1950 and 1951 record of date of assesment is February 27, 1956
4. losses in Hacienda Dalupiri and Hacienda Samal while the petitioner believes the demand was made
from 1950-1954 on December 27, 1955 so that, as the petitioner
HELD: The Supreme Court discussed the allowance corporation claims, the Commissioner's action to
or disallowance of each in the following manner: recover its tax liability should be deemed to have
1. Allowed. These losses represent the shares of prescribed for failure on the part of the
stock (worth P8,050) petitioner acquired from Mati in Commissioner to file a complaint for collection
Jan. 1, 1948. The petitioner was correct in writing off against it in an appropriate civil action.
and claiming as a deduction in 1950 the amount on ISSUE: Has the action for collection prescribed?
the ground that the lumber company had ceased HELD: No. It has been held that "a judicial action for
operations and became insolvent in that year. The the collection of a tax is begun by the filing of a
CIR was incorrect in arguing that since the company complaint with the proper court of first instance, or
still owned a sawmill and some equipment, the where the assessment is appealed to the Court of Tax
shares of stock still had value. The proper Appeals, by filing an answer to the taxpayer's
assessment would be to treat as income for the year petition for review wherein payment of the tax is
in which petitioner gets the proceeds from the prayed for." This is but logical for where the taxpayer
liquidation of those assets. avails of the right to appeal the tax assessment to
2. Disallowed. These losses represent part of the the Court of Tax Appeals, the said Court is vested
loans extended by the petitioner to its 100% owned with the authority to pronounce judgment as to the
subsidiary. Petitioner advanced financial assistance taxpayer's liability to the exclusion of any other
to Palawan from 1945 to 1952. By way of payment, court. In the present case, regardless of whether the
Palawan was to give petitioner 15% of net profits. assessments were made on February 24 and 27,
Whether Palawan was able to pay the loans or not 1956, as claimed by the Commissioner, or on
because it continued to operate at a loss is December 27, 1955 as claimed by the taxpayer, the
immaterial. Petitioner cannot properly claim as a loss government's right to collect the taxes due has
the advances given to Palawan in 1951 for that year. clearly not prescribed, as the taxpayer's appeal or
There can be no partial writing off as a loss or bad petition for review was filed with the Tax Court on
debt under the Tax Code. Those losses or bad debts May 4, 1960, with the Commissioner filing on May 20,
ascertained within the taxable year are deductible in 1960 his Answer with a prayer for payment of the
full or not at all. Petitioner continued to give Palawan taxes due, long before the expiration of the five-year
advances even beyond 1951. It was only in 1956 period to effect collection by judicial action counted
when Palawan decided to cease operations. from the date of assessment.
deductible expenditures were made and correct , fair
FERNANDEZ HERMANOS v CIR and equitable credit adjustments were given by way
FACTS: of eliminating non-taxable items.
Four cases involve two decisions of the Court of Tax Proper adjustments to conform to the income tax
Appeal s determining the taxpayer ' s income tax laws. Proper adjustments for non-deductible items
liability for the years 1950 to 1954 and for the year must be made. The following non-deductibles , as the
1957. Both the taxpayer and the Commissioner of case may be, must be
Internal Revenue, as petitioner and respondent in the added to the increase of decrease in the net worth:
cases a quo respectively , appealed from the Tax 1. Personal living or family expenses
Court's decisions , insofar as their respective 2. Premiums paid on any life insurance policy
contentions on particular tax items were therein 3. Losses from sales or exchanges of property
resolved against them. Since the issues raised are between members of the family
inter related, the Court resolves the four appeals in 4. Income taxes paid
this joint decision. 5. Other non-deductible taxes
The taxpayer , Fernandez Hermanos, Inc. , is a 6. Election expenses and other expense against
domestic corporation organized for the principal public policy
purpose of engaging in business as an " investment 7. Non-deductible contributions
company " wi th main office at Manila. Upon 8. Gifts to others
verification of the taxpayer's income tax returns for 9. Estate inheritance and gift taxes
the period in quest ion, the Commissioner of Internal 10. Net Capital Loss
Revenue assessed against the taxpayer the sums of
P13,414.00, P119,613.00, P11,698.00, P6,887.00 and On the other hand, non- taxable items should be
P14,451.00 as alleged deficiency income taxes for deducted therefrom. These items are necessary
the year s 1950, 1951, 1952, 1953 and 1954, adjustments to avoid the inclusion of what otherwise
respectively. Said assessments were the result of are non-taxable receipts. They are:
alleged discrepancies found upon the examination 1. inheritance gifts and bequests received
and verification of the taxpayer's income tax returns 2. non- taxable gains
for the said years, summarized by the Tax Court in its 3. compensation for injuries or sickness
decision of June 10, 1963 in CTA Case No. 787, as 4. proceeds of life insurance policies
follows: 5. sweepstakes
ISSUE: The correctness of the Tax Court's rulings 6. winnings
with respect to the disputed items of disallowances 7. interest on government securities and increase in
enumerated in the Tax Court's summary reproduced net worth are not taxable if they are shown not to be
HELD: the result of unreported income but to be the result
That the circumstances are such that the method of the correction of errors in the taxpayers entries in
does not reflect the taxpayers income with the books relating to indebtedness
reasonable accuracy and certainty and proper and
just additions of personal expenses and other non-