Tax Law Digests 5 (Q-T)

TAX LAW REVIEW DIGESTS – Montero
Alcisso, Arriola, Cajucom, Calalang, Claudio, Escueta, Delos Santos, Dialino, Fajardo, Imperial, Juaquino, Martin, Martinez, Mendoza, Noel, Pangcog, Plazo Raso, Rosales, Sia, Uy, Venzuela
Q. DEDUCTION
ICC uses the accrual method. RAM No. 1-2000 provides that under the accrual
method, expenses not claimed as deductions in the current year when they are
In general incurred CANNOT be claimed as deduction from income for the succeeding year.
The accrual method relies upon the taxpayer’s right to receive amount or its
CIR v ISABELA CULTURAL CORPORATION obligation to pay them NOT the actual receipt or payment. Amounts of income
accrue where the right to receive them become fixed, where there is created an
FACTS:
enforceable liability. Liabilities are accrued when fixed and determinable in amount.
ICC was assessed for deficiency income tax [ BIR disallowed expense deductions for
The accrual of income and expense is permitted when the ALL-EVENTS TEST has
professional and security services by 1) auditing services by SGV & Co. 2) legal
been met. The test requires that: 1) fixing of a right to income or liability to pay and
services Bengzon law office 3) El Tigre Security services] and deficiency expanded
2) the availability of the reasonable accurate determination of such income or
withholding tax, when it failed to withhold 1% expanded withholding tax. The CTA
liability. It does not require that the amount be absolutely known only that the
cancelled and set aside the assessment notices holding that the claimed deductions
taxpayer has information necessary to compute the amount with reasonable
for professional and security services were properly claimed in 1986 since it was
accuracy. The test is satisfied where computation remains uncertain if its basis is
only in that year when the bills demanding payment were sent to ICC. It also found
unchangeable. The amount of liability does not have to be determined exactly, it
that the ICC withheld 1% expanded withholding tax for security services. The CA
must be determined with reasonable accuracy.
affirmed hence the case at bar.
In the case at bar, the expenses for legal services pertain to the years 1984 and
ISSUE: W/N the aforementioned may be deducted
1985. The firm has been retained since 1960. From the nature of the claimed
HELD: for the auditing and legal services NO but for the security services YES deduction and the span of time during which the firm was retained, ICC can be
expected to have reasonably known the retainer fees charged by the firm as well as
The requisites for deductibility of ordinary and necessary trade, business or compensation for its services. Exercising due diligence, they could have inquired into
professional expenses, like expenses paid for legal and auditing services are: a) the the amount of their obligation. It could have reasonably determined the amount of
expense must be ordinary and necessary; b) it must have been paid or incurred legal and retainer fees owing to their familiarity with the rates charged.
during the taxable year; c) it must have been paid or incurred in carrying on the
trade or business of the taxpayer and d) it must be supported by receipts, records The professional fees of SGV cannot be validly claimed as deductions in 1986. ICC
and other pertinent papers. failed to present evidence showing that even with only reasonable accuracy, it
cannot determine the professional fees which the company would charge.
The requisite that it must have been paid or incurred during the taxable year is
qualified by Sec. 45 of NIRC which states that “the deduction provide for in this title
shall be taken for the taxable year in which ‘paid or incurred’ dependent upon the CIR v GENERAL FOODS
method of accounting upon the basis of which the net income is computed x x x”.
1
AGUINALDO INDUSTRIES v CIR intra-corporate matter, be sustained. The records show that the sale was effected
through a broker who was paid by petitioner a commission of P51,723.72 for his
services. On the other hand, there is absolutely no evidence of any service actually
FACTS: rendered by petitioner's officers which could be the basis of a grant to them of a
bonus out of the profit derived from the sale. This being so, the payment of a bonus
Aguinaldo Industries Corporation (AIC) is a domestic corporation engaged in the to them out of the gain realized from the sale cannot be considered as a selling
manufacture of fishing nets, a tax-exempt industry and the manufacture of expense; nor can it be deemed reasonable and necessary so as to make it
furniture. For accounting purposes, each division is provided with separate books of deductible for tax purposes. The extraordinary and unusual amounts paid by
accounts. Previously, AIC acquired a parcel of land in Muntinlupa, Rizal, as site of the petitioner to these directors in the guise and form of compensation for their
fishing net factory. Later, it sold the Muntinlupa property. AIC derived profit from supposed services as such, without any relation to the measure of their actual
this sale which was entered in the books of the Fish Nets Division as miscellaneous services, cannot be regarded as ordinary and necessary expenses within the
income to distinguish it from its tax-exempt income. meaning of the law. This is in line with the doctrine in the law of taxation that the
taxpayer must show that its claimed deductions clearly come within the language of
For the year 1957, AIC filed two separate income tax returns for each division. After the law since allowances, like exemptions, are matters of legislative grace.
investigation, the examiners of the BIR found that the Fish Nets Division deducted
from its gross income for that year the amount of P61,187.48 as additional
remuneration paid to the officers of AIC. This amount was taken from the net profit
of an isolated transaction (sale of Muntinlupa land) not in the course of or carrying ATLAS CONSOLIDATED MINING v CIR
on of AIC's trade or business, and was reported as part of the selling expenses of the
Muntinlupa land. Upon recommendation of the examiner that the said sum of
P61,187.48 be disallowed as deduction from gross income, petitioner asserted in its FACTS:
letter of February 19, 1958, that said amount should be allowed as deduction
because it was paid to its officers as allowance or bonus pursuant to its by-laws. Atlas is a corporation engaged in the mining industry registered. On August 1962,
CIR assessed against Atlas for deficiency income taxes for the years 1957 and 1958.
ISSUE/HELD: W/N the bonus given to the officers of the petitioner upon the sale of For the year 1957, it was the opinion of the CIR that Atlas is not entitled to
its Muntinlupa land is an ordinary and necessary business expense deductible for exemption from the income tax under RA 909 because same covers only gold mines.
income tax purposes - NO For the year 1958, the deficiency income tax covers the disallowance of items
claimed by Atlas as deductible from gross income. Atlas protested for
RATIO: Sec. 30 (a) (1) of the Tax Code provides that in computing net income, there reconsideration and cancellation, thus the CIR conducted a reinvestigation of the
shall be allowed as deductions ‘Expenses, including all the ordinary and necessary case.
expenses paid or incurred during the taxable year in carrying on any trade or
business, including a reasonable allowance for personal services actually rendered. On October 1962, the Secretary of Finance ruled that the exemption provided in RA
909 embraces all new mines and old mines whether gold or other minerals.
The bonus given to the officers of the petitioner as their share of the profit realized Accordingly, the CIR recomputed Atlas deficiency income tax liabilities in the light of
from the sale of petitioner's Muntinglupa land cannot be deemed a deductible said ruling. On June 1964, the CIR issued a revised assessment entirely eliminating
expense for tax purposes, even if the aforesaid sale could be considered as a the assessment for the year 1957. The assessment for 1958 was reduced from
transaction for carrying on the trade or business of the petitioner and the grant of which Atlas appealed to the CTA, assailing the disallowance of the following items
the bonus to the corporate officers pursuant to petitioner's by-laws could, as an claimed as deductible from its gross income for 1958: Transfer agent's fee,
2
Stockholders relation service fee, U.S. stock listing expenses, Suit expenses, and the question as to whether the expenditure is an allowable deduction as a business
Provision for contingencies. The CTA allowed said items as deduction except those expense must be determined from the nature of the expenditure itself, which in
denominated by Atlas as stockholders relation service fee and suit expenses. turn depends on the extent and permanency of the work accomplished by the
expenditure.
Both parties appealed the CTA decision to the SC by way of two (2) separate
petitions for review. Atlas appealed only the disallowance of the deduction from It appears that on December 1957, Atlas increased its capital stock. It claimed that
gross income of the so-called stockholders relation service fee. its shares of stock were sold in the United States because of the services rendered
by the public relations firm. The information about Atlas given out and played up in
ISSUE/HELD: W/N the ‘annual public relations expense’ (aka stockholders relation the mass communication media resulted in full subscription of the additional shares
service fee) paid to a public relations consultant is a deductible expense from gross issued by Atlas; consequently, the ‘stockholders relation service fee’, the
income compensation for services carrying on the selling campaign, was in effect spent for
the acquisition of additional capital, ergo, a capital expenditure, and not an ordinary
RATIO: Section 30 (a) (1) of the Tax Code allows a deduction of "all the ordinary and expense. It is not deductible from Atlas gross income in 1958 because expenses
necessary expenses paid or incurred during the taxable year in carrying on any trade relating to recapitalization and reorganization of the corporation, the cost of
or business." An item of expenditure, in order to be deductible under this section of obtaining stock subscription, promotion expenses, and commission or fees paid for
the statute, must fall squarely within its language. To be deductible as a business the sale of stock reorganization are capital expenditures. That the expense in
expense, three conditions are imposed, namely: (1) the expense must be ordinary question was incurred to create a favorable image of the corporation in order to
and necessary, (2) it must be paid or incurred within the taxable year, and (3) it must gain or maintain the public's and its stockholders' patronage, does not make it
be paid or incurred in carrying in a trade or business. In addition, not only must the deductible as business expense. As held in a US case, efforts to establish reputation
taxpayer meet the business test, he must substantially prove by evidence or records are akin to acquisition of capital assets and, therefore, expenses related thereto are
the deductions claimed under the law, otherwise, the same will be disallowed. The not business expense but capital expenditures.
mere allegation of the taxpayer that an item of expense is ordinary and necessary
does not justify its deduction. Note: The burden of proof that the expenses incurred are ordinary and necessary is
on the taxpayer and does not rest upon the Government. To avail of the claimed
The SC has never attempted to define with precision the terms "ordinary and deduction, it is incumbent upon the taxpayer to adduce substantial evidence to
necessary." As a guiding principle, ordinarily, an expense will be considered establish a reasonably proximate relation petition between the expenses to the
"necessary" where the expenditure is appropriate and helpful in the development ordinary conduct of the business of the taxpayer. A logical link or nexus between the
of the taxpayer's business. It is "ordinary" when it connotes a payment which is expense and the taxpayer's business must be established by the taxpayer.
normal in relation to the business of the taxpayer and the surrounding
circumstances. The term "ordinary" does not require that the payments be habitual
or normal in the sense that the same taxpayer will have to make them often; the ROXAS v CTA
payment may be unique or non-recurring to the particular taxpayer affected.
There is thus no hard and fast rule on the matter. The right to a deduction depends FACTS:
in each case on the particular facts and the relation of the payment to the type of
business in which the taxpayer is engaged. The intention of the taxpayer often may Don Pedro Roxas and Dona Carmen Ayala, Spanish subjects, transmitted to their
be the controlling fact in making the determination. Assuming that the expenditure grandchildren by hereditary succession agricultural lands in Batangas, a residential
is ordinary and necessary in the operation of the taxpayer's business, the answer to house and lot in Manila, and shares of stocks in different corporations. To manage
3
the properties, said children, namely, Antonio, Eduardo and Jose Roxas formed a exclusively for its public functions. The contributions to the Philippines Herald's fund
partnership called Roxas y Compania. for Manila's neediest families were disallowed on the ground that the Philippines
Herald is not a corporation or an association contemplated in Section 30 (h) of the
On June 1958, the CIR assessed deficiency income taxes against the Roxas Brothers Tax Code. It should be noted however that the contributions were not made to the
for the years 1953 and 1955. Part of the deficiency income taxes resulted from the Philippines Herald but to a group of civic spirited citizens organized by the
disallowance of deductions from gross income of various business expenses and Philippines Herald solely for charitable purposes. There is no question that the
contributions claimed by Roxas. (see expense items below) members of this group of citizens do not receive profits, for all the funds they raised
were for Manila's neediest families. Such a group of citizens may be classified as an
The Roxas brothers protested the assessment but inasmuch as said protest was association organized exclusively for charitable purposes mentioned in Section 30(h)
denied, they instituted an appeal in the CTA, which sustained the assessment except of the Tax Code.
the demand for the payment of the fixed tax on dealer of securities and the
disallowance of the deductions for contributions to the Philippine Air Force Chapel The contribution to Our Lady of Fatima chapel at the Far Eastern University should
and Hijas de Jesus' Retiro de Manresa. Not satisfied, Roxas brothers appealed to the also be disallowed on the ground that the said university gives dividends to its
SC. The CIR did not appeal. stockholders. Located within the premises of the university, the chapel in question
has not been shown to belong to the Catholic Church or any religious organization.
ISSUES/HELD: W/N the deductions for business expenses and contributions It belongs to the Far Eastern University, contributions to which are not deductible
deductible under Section 30(h) of the Tax Code for the reason that the net income of said
university injures to the benefit of its stockholders.
RATIO: With regard to the disallowed deductions (expenses for tickets to a banquet
given in honor of Sergio Osmena and beer given as gifts to various persons, labelled
as representation expenses), representation expenses are deductible from gross
income as expenditures incurred in carrying on a trade or business under Section ZAMORA v CIR
30(a) of the Tax Code provided the taxpayer proves that they are reasonable in
amount, ordinary and necessary, and incurred in connection with his business. In FACTS:
the case at bar, the evidence does not show such link between the expenses and the
business of Roxas. Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, filed his
income tax returns. The CIR found that he failed to file his return of the capital gains
derived from the sale of certain real properties and claimed deductions which were
The petitioners also claim deductions for contributions to the Pasay City Police,
not allowable. The collector required him to pay deficiency income tax. On appeal
Pasay City Firemen, and Baguio City Police Christmas funds, Manila Police Trust
by Zamora, the CTA reduced the amount of deficiency income tax.
Fund, Philippines Herald's fund for Manila's neediest families and Our Lady of
Fatima chapel at Far Eastern University. The contributions to the Christmas funds of
Zamora appealed, alleging that the CTA erred in dissallowing P10,478.50, as
the Pasay City Police, Pasay City Firemen and Baguio City Police are not deductible
promotion expenses incurred by his wife for the promotion of the Bay View Hotel
for the reason that the Christmas funds were not spent for public purposes but as
and Farmacia Zamora (which is ½ of P20,957.00, supposed business expenses).
Christmas gifts to the families of the members of said entities. Under Section 39(h),
a contribution to a government entity is deductible when used exclusively for public
Zamora alleged that the CTA erred in disallowing P10,478.50 as promotion expenses
purposes. For this reason, the disallowance must be sustained. On the other hand,
incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora.
the contribution to the Manila Police trust fund is an allowable deduction for said
He contends that the whole amount of P20,957.00 as promotion expenses, should
trust fund belongs to the Manila Police, a government entity, intended to be used
4
be allowed and not merely one-half of it, on the ground that, while not all the
itemized expenses are supported by receipts, the absence of some supporting
receipts has been sufficiently and satisfactorily established.
Expenses
ISSUE: w/n CTA erred in allowing only one half of the promotion expenses. NO
HELD: C.M. HOSKINS&CO, INC. v CIR

Section 30, of the Tax Code, provides that in computing net income, there shall be
allowed as deductions all the ordinary and necessary expenses paid or incurred Facts:
during the taxable year, in carrying on any trade or business. Since promotion
expenses constitute one of the deductions in conducting a business, same must Petitioner, a domestic corporation engaged in the real estate business as brokers,
satisfy these requirements. Claim for the deduction of promotion expenses or managing agents and administrators, filed its income tax return for its fiscal year
entertainment expenses must also be substantiated or supported by record showing ending September 30, 1957 showing a net income of P92,540.25 and a tax liability
in detail the amount and nature of the expenses incurred. due thereon of P18,508.00, which it paid in due course. Upon verification of its
return, CIR, disallowed four items of deduction in petitioner's tax returns and
Considering, as heretofore stated, that the application of Mrs. Zamora for dollar assessed against it an income tax deficiency in the amount of P28,054.00 plus
allocation shows that she went abroad on a combined medical and business trip, interests. The Court of Tax Appeals upon reviewing the assessment at the taxpayer's
not all of her expenses came under the category of ordinary and necessary petition, upheld respondent's disallowance of the principal item of petitioner's
expenses; part thereof constituted her personal expenses. There having been no having paid to Mr. C. M. Hoskins, its founder and controlling stockholder the amount
means by which to ascertain which expense was incurred by her in connection with of P99,977.91 representing 50% of supervision fees earned by it and set aside
the business of Mariano Zamora and which was incurred for her personal benefit, respondent's disallowance of three other minor items.
the Collector and the CTA in their decisions, considered 50% of the said amount of
P20,957.00 as business expenses and the other 50%, as her personal expenses. We Petitioner questions in this appeal the Tax Court's findings that the disallowed
hold that said allocation is very fair to Mariano Zamora, there having been no payment to Hoskins was an inordinately large one, which bore a close relationship
receipt whatsoever, submitted to explain the alleged business expenses, or proof of to the recipient's dominant stockholdings and therefore amounted in law to a
the connection which said expensegancs had to the business or the reasonableness distribution of its earnings and profits.
of the said amount of P20,957.00.
Issue: Whether the 50% supervision fee paid to Hoskin may be deductible for
In the case of Visayan Cebu Terminal Co., Inc. v. CIR., it was declared that income tax purposes.
representation expenses fall under the category of business expenses which are
allowable deductions from gross income, if they meet the conditions prescribed Ruling: NO.
by law, particularly section 30 (a) [1], of the Tax Code; that to be deductible, said
business expenses must be ordinary and necessary expenses paid or incurred in Ratio:
carrying on any trade or business; that those expenses must also meet the further
test of reasonableness in amount. They should also be covered by supporting Hoskin owns 99.6% of the CM Hoskins & Co. He was also the President and
papers; in the absence thereof the amount properly deductible as representation Chairman of the Board. That as chairman of the Board of Directors, he received a
expenses should be determined from available data. salary of P3,750.00 a month, plus a salary bonus of about P40,000.00 a year and an
amounting to an annual compensation of P45,000.00 and an annual salary bonus of
5
P40,000.00, plus free use of the company car and receipt of other similar whether the particular salary or compensation payment is reasonable, the situation
allowances and benefits, the Tax Court correctly ruled that the payment by must be considered as whole. Ordinarily, no single factor is decisive. . . . it is
petitioner to Hoskins of the additional sum of P99,977.91 as his equal or 50% share important to keep in mind that it seldom happens that the application of one test
of the 8% supervision fees received by petitioner as managing agents of the real can give satisfactory answer, and that ordinarily it is the interplay of several factors,
estate, subdivision projects of Paradise Farms, Inc. and Realty Investments, Inc. was properly weighted for the particular case, which must furnish the final answer."
inordinately large and could not be accorded the treatment of ordinary and
necessary expenses allowed as deductible items within the purview of the Tax Petitioner's case fails to pass the test. On the right of the employer as against
Code. respondent Commissioner to fix the compensation of its officers and employees, we
there held further that while the employer's right may be conceded, the question of
The fact that such payment was authorized by a standing resolution of petitioner's the allowance or disallowance thereof as deductible expenses for income tax
board of directors, since "Hoskins had personally conceived and planned the purposes is subject to determination by CIR. As far as petitioner's contention that as
project" cannot change the picture. There could be no question that as Chairman of employer it has the right to fix the compensation of its officers and employees and
the board and practically an absolutely controlling stockholder of petitioner, Hoskins that it was in the exercise of such right that it deemed proper to pay the bonuses in
wielded tremendous power and influence in the formulation and making of the question, all that We need say is this: that right may be conceded, but for income
company's policies and decisions. Even just as board chairman, going by petitioner's tax purposes the employer cannot legally claim such bonuses as deductible
own enumeration of the powers of the office, Hoskins, could exercise great power expenses unless they are shown to be reasonable. To hold otherwise would open
and influence within the corporation, such as directing the policy of the corporation, the gate of rampant tax evasion.
delegating powers to the president and advising the corporation in determining
executive salaries, bonus plans and pensions, dividend policies, etc. Lastly, We must not lose sight of the fact that the question of allowing or disallowing
as deductible expenses the amounts paid to corporate officers by way of bonus is
It is a general rule that 'Bonuses to employees made in good faith and as additional determined by respondent exclusively for income tax purposes. Concededly, he has
compensation for the services actually rendered by the employees are deductible, no authority to fix the amounts to be paid to corporate officers by way of basic
provided such payments, when added to the stipulated salaries, do not exceed a salary, bonus or additional remuneration — a matter that lies more or less
reasonable compensation for the services rendered. The conditions precedent to exclusively within the sound discretion of the corporation itself. But this right of the
the deduction of bonuses to employees are: (1) the payment of the bonuses is in corporation is, of course, not absolute. It cannot exercise it for the purpose of
fact compensation; (2) it must be for personal services actually rendered; and (3) evading payment of taxes legitimately due to the State."
the bonuses, when added to the salaries, are 'reasonable when measured by the
amount and quality of the services performed with relation to the business of the
particular taxpayer. CALANOC v CIR
There is no fixed test for determining the reasonableness of a given bonus as KUENZLE & STREIF, INC. v CIR
compensation. This depends upon many factors, one of them being the amount and
quality of the services performed with relation to the business.' Other tests FACTS:
suggested are: payment must be 'made in good faith'; 'the character of the
taxpayer's business, the volume and amount of its net earnings, its locality, the type Petitioner is a domestic corporation engaged in the importation of textiles,
and extent of the services rendered, the salary policy of the corporation'; 'the size of hardware, sundries, chemicals, pharmaceuticals, lumbers, groceries, wines and
the particular business'; 'the employees' qualifications and contributions to the liquor; in insurance and lumber; and in some exports. When Petitioner filed its
business venture'; and 'general economic conditions. However, 'in determining Income Tax Return, it deducted from its gross income the following items:
6
1. salaries, directors' fees and bonuses of its non-resident president and vice- There is no fixed test for determining the reasonableness of a given bonus as
president; compensation. However, in determining whether the particular salary or
2. bonuses of its resident officers and employees; and compensation payment is reasonable, the situation must be considered as a whole.
3. interests on earned but unpaid salaries and bonuses of its officers and Petitioner contended that it is error to apply the same measure of reasonableness
employees. to both resident and non-resident officers because the nature, extent and quality of
the services performed by each with relation to the business of the corporation
The CIR disallowed the deductions and assessed Petitioner for deficiency income widely differ. Said non-resident officers had rendered the same amount of efficient
taxes. Petitioner requested for re-examination of the assessment. CIR modified the personal service and contribution to deserve equal treatment in compensation and
same by allowing as deductible all items comprising directors' fees and salaries of other emoluments. There is no special reason for granting greater bonuses to such
the non-resident president and vice-president, but disallowing the bonuses insofar lower ranking officers than those given to the non-resident president and vice
as they exceed the salaries of the recipients, as well as the interests on earned but president.
unpaid salaries and bonuses.
W/N the CTA erred in allowing the deduction of the bonuses in excess of
The CTA modified the assessment and ruled that while the bonuses given to the the yearly salaries of the employees? NO.
non-resident officers are reasonable, bonuses given to the resident officers and
employees are quite excessive. The deductible amount of said bonuses cannot be only equal to their respective
yearly salaries considering the post-war policy of the corporation in giving salaries at
ISSUES/RULING: low levels because of the unsettled conditions resulting from war and the
imposition of government controls on imports and exports and on the use of foreign
W/N the CTA erred in ruling that the measure of the reasonableness of the exchange which resulted in the diminution of the amount of business and the
bonuses paid to its non-resident president and vice-president should be consequent loss of profits on the part of the corporation. The payment of bonuses
applied to the bonuses given to resident officers and employees in in amounts a little more than the yearly salaries received considering the prevailing
determining their deductibility? NO. circumstances is in our opinion reasonable.
It is a general rule that "Bonuses to employees made in good faith and as additional W/N the CTA erred in disallowing the deduction of interests on earned but
compensation for the services actually rendered by the employees are deductible, unpaid salaries and bonuses? NO.
provided such payments, when added to the stipulated salaries, do not exceed a
reasonable compensation for the services rendered.” The condition precedents to Under the law, in order that interest may be deductible, it must be paid "on
the deduction of bonuses to employees are: indebtedness." It is therefore imperative to show that there is an existing
indebtedness which may be subjected to the payment of interest. Here the items
1. the payment of the bonuses is in fact compensation; involved are unclaimed salaries and bonus participation which cannot constitute
2. it must be for personal services actually rendered; and indebtedness within the meaning of the law because while they constitute an
obligation on the part of the corporation, it is not the latter's fault if they remained
unclaimed. Whatever an employee may fail to collect cannot be considered an
3. the bonuses, when added to the salaries, are reasonable when measured
indebtedness for it is the concern of the employee to collect it in due time. The
by the amount and quality of the services performed with relation to the
willingness of the corporation to pay interest thereon cannot be considered a
business of the particular taxpayer
justification to warrant deduction.
7
Interest interest expenses are deductible against gross income and this certainly includes
interest paid under loans incurred in connection with the carrying on of the
business of the taxpayer. In the instant case, the CIR does not dispute that the
PAPER INDUSTRIES v CA ( Dec. 1, 1995) interest payments were made by Picop on loans incurred in connection with the
carrying on of the registered operations of Picop, i.e., the financing of the purchase
Facts:
of machinery and equipment actually used in the registered operations of Picop.
On various years (1969, 1972 and 1977), Picop obtained loans from foreign Neither does the CIR deny that such interest payments were legally due and
creditors in order to finance the purchase of machinery and equipment needed for demandable under the terms of such loans, and in fact paid by Picop during the tax
its operations. In its 1977 Income Tax Return, Picop claimed interest payments made year 1977.
in 1977, amounting to P42,840,131.00, on these loans as a deduction from its 1977
The contention of CIR does not spring of the 1977 Tax Code but from
gross income.
Revenue Regulations 2 Sec. 79. 2 However, the Court said that the term “interest”
The CIR disallowed this deduction upon the ground that, because the loans here should be construed as the so-called "theoretical interest," that is to say,
had been incurred for the purchase of machinery and equipment, the interest interest "calculated" or computed (and not incurred or paid) for the purpose of
payments on those loans should have been capitalized instead and claimed as a determining the "opportunity cost" of investing funds in a given business. Such
depreciation deduction taking into account the adjusted basis of the machinery and "theoretical" or imputed interest does not arise from a legally demandable
equipment (original acquisition cost plus interest charges) over the useful life of interest-bearing obligation incurred by the taxpayer who however wishes to find
such assets. out, e.g., whether he would have been better off by lending out his funds and
earning interest rather than investing such funds in his business. One thing that
Both the CTA and the Court of Appeals sustained the position of Picop and Section 79 quoted above makes clear is that interest which does constitute a charge
held that the interest deduction claimed by Picop was proper and allowable. In the arising under an interest-bearing obligation is an allowable deduction from gross
instant Petition, the CIR insists on its original position. income.
ISSUE:
xxx xxx xxx
Whether Picop is entitled to deductions against income of interest
(b) Interest:
payments on loans for the purchase of machinery and equipment. (1) In general. — The amount of interest paid within the taxable year
on indebtedness, except on indebtedness incurred or continued to purchase
HELD:
or carry obligations the interest upon which is exempt from taxation as
YES. Interest payments on loans incurred by a taxpayer (whether BOI- income under this Title: . . . (Emphasis supplied)
registered or not) are allowed by the NIRC as deductions against the taxpayer's
gross income. The basis is 1977 Tax Code Sec. 30 (b). 1 Thus, the general rule is that 2
Sec. 79. Interest on Capital. — Interest calculated for cost-keeping or other purposes on
1 account of capital or surplus invested in the business, which does not represent a charge arising
Sec. 30. Deduction from Gross Income. — The following may be deducted under an interest-bearing obligation, is not allowable deduction from gross income.
from gross income: (Emphases supplied)
8
Only if sir asks: (For further discussion of CIR’s contention) to capitalize but for which a deduction instead has been
taken. 22 (Emphasis supplied)
It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was
"patterned after" paragraph 1.266-1 (b), entitled "Taxes and Carrying Charges The "carrying charges" which may be capitalized under the above quoted
Chargeable to Capital Account and Treated as Capital Items" of the U.S. Income Tax provisions of the U.S. Internal Revenue Code include, as the CIR has
Regulations, which paragraph reads as follows: pointed out, interest on a loan "(but not theoretical interest of a taxpayer
using his own funds)." What the CIR failed to point out is
that such "carrying charges" may, at the election of the taxpayer, either be
(B) Taxes and Carrying Charges. — The items thus chargeable to
(a) capitalized in which case the cost basis of the capital assets, e.g.,
capital accounts are —
machinery and equipment, will be adjusted by adding the amount of such
interest payments or alternatively, be (b) deducted from gross income of
(11) In the case of real property, whether improved or unimproved the taxpayer. Should the taxpayer elect to deduct the interest payments
and whether productive or nonproductive. against its gross income, the taxpayer cannot at the same time capitalize
the interest payments. In other words, the taxpayer is not entitled to both
(a) Interest on a loan (but not theoretical interest of a taxpayer the deduction from gross income and the adjusted (increased) basis for
using his own funds). determining gain or loss and the allowable depreciation charge. The U.S.
Internal Revenue Code does not prohibit the deduction of interest on a
The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs loan obtained for purchasing machinery and equipment against gross
to be related to the relevant provisions of the U.S. Internal Revenue Code, which income, unless the taxpayer has also or previously capitalized the same
provisions deal with the general topic of adjusted basis for determining allowable interest payments and thereby adjusted the cost basis of such assets.
gain or loss on sales or exchanges of property and allowable depreciation and
depletion of capital assets of the taxpayer:
CIR v VDA DE PRIETO
Present Rule. The Internal Revenue Code, and the Regulations
promulgated thereunder provide that "No deduction shall be FACTS:
allowed for amounts paid or accrued for such taxes and carrying
charges as, under regulations prescribed by the Secretary or his On December 4, 1945, the respondent conveyed by way of gifts to her four children,
delegate, are chargeable to capital account with respect to namely, Antonio, Benito, Carmen and Mauro, all surnamed Prieto, real property
property, if the taxpayer elects, in accordance with such with a total assessed value of P892,497.50. After the filing of the gift tax returns on
regulations, to treat such taxes orcharges as so chargeable." or about February 1, 1954, the petitioner Commissioner of Internal Revenue
appraised the real property donated for gift tax purposes at P1,231,268.00, and
At the same time, under the adjustment of basis provisions which assessed the total sum of P117,706.50 as donor's gift tax, interest and compromises
have just been discussed, it is provided that adjustment shall be due thereon. Of the total sum of P117,706.50 paid by respondent on April 29, 1954,
made for all "expenditures, receipts, losses, or other items" the sum of P55,978.65 represents the total interest on account of deliquency. This
properly chargeable to a capital account, thus including taxes and sum of P55,978.65 was claimed as deduction, among others, by respondent in her
carrying charges; however, an exception exists, in which event 1954 income tax return. Petitioner, however, disallowed the claim and as a
such adjustment to the capital account is not made, with respect consequence of such disallowance assessed respondent for 1954 the total sum of
to taxes and carrying charges which the taxpayer has not elected
9
P21,410.38 as deficiency income tax due on the aforesaid P55,978.65, including (1) In general. — The amount of interest paid within the taxable year on
interest up to March 31, 1957, surcharge and compromise for the late payment. indebtedness, except on indebtedness incurred or continued to purchase
or carry obligations the interest upon which is exempt from taxation as
Under the law, for interest to be deductible, it must be shown that there be an income under this Title.
indebtedness, that there should be interest upon it, and that what is claimed as an
interest deduction should have been paid or accrued within the year. It is here The term "indebtedness" as used in the Tax Code of the United States containing
conceded that the interest paid by respondent was in consequence of the late similar provisions as in the above-quoted section has been defined as an
payment of her donor's tax, and the same was paid within the year it is sought to be unconditional and legally enforceable obligation for the payment of money.
declared.
To give to the quoted portion of section 80 of our Income Tax Regulations the
To sustain the proposition that the interest payment in question is not deductible meaning that the petitioner gives it would run counter to the provision of section
for the purpose of computing respondent's net income, petitioner relies heavily on 30(b) of the Tax Code and the construction given to it by courts in the United States.
section 80 of Revenue Regulation No. 2 (known as Income Tax Regulation) Such effect would thus make the regulation invalid for a "regulation which operates
promulgated by the Department of Finance, which provides that "the word `taxes' to create a rule out of harmony with the statute, is a mere nullity." As already
means taxes proper and no deductions should be allowed for amounts representing stated, section 80 implements only section 30(c) of the Tax Code, or the provision
interest, surcharge, or penalties incident to delinquency." The court below, however, allowing deduction of taxes, while herein respondent seeks to be allowed deduction
held section 80 as inapplicable to the instant case because while it implements under section 30(b), which provides for deduction of interest on indebtedness.
sections 30(c) of the Tax Code governing deduction of taxes, the respondent
taxpayer seeks to come under section 30(b) of the same Code providing for
deduction of interest on indebtedness. BIR RULING NO 006-00
ISSUE:
Taxes
Whether or not such interest was paid upon an indebtedness within the
contemplation of section 30 (b) (1) of the Tax Code?
CIR v LEDNICKY
RULING:
Losses
Yes. According to the Supreme Court, although interest payment for delinquent
taxes is not deductible as tax under Section 30(c) of the Tax Code and section 80 of
PAPER INDUSTRIES v CA ( Dec. 1, 1995)
the Income Tax Regulations, the taxpayer is not precluded thereby from claiming
said interest payment as deduction under section 30(b) of the same Code.
 The Paper Industries Corporation of the Philippines ("Picop"), is a Philippine corporation
registered with the Board of Investments ("BOI") as a preferred pioneer
SEC. 30 Deductions from gross income. — In computing net income there shall be enterprise with respect to its integrated pulp and paper mill, and as a
allowed as deductions — preferred non-pioneer enterprise with respect to its integrated plywood
and veneer mills.
(b) Interest:
10
 In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in arising under an interest-bearing obligation, is not allowable deduction
order to finance the purchase of machinery and equipment needed for its from gross income.
operations.  It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was
 Picop also issued promissory notes of about P230M, on w/c it paid P45M in "patterned after" paragraph 1.266-1 (b), entitled "Taxes and Carrying
interest. Charges Chargeable to Capital Account and Treated as Capital Items" of the
 In its 1977 Income Tax Return, Picop claimed the interest payments on the U.S. Income Tax Regulations, which paragraph reads as follows:
loans as DEDUCTIONS from its 1977 gross income. (B) Taxes and Carrying Charges. — The items thus chargeable to
 The CIR disallowed this deduction upon the ground that, because the loans capital accounts are —
had been incurred for the purchase of machinery and equipment, the
interest payments on those loans should have been capitalized instead and (11) In the case of real property, whether improved or unimproved
claimed as a depreciation deduction taking into account the adjusted basis and whether productive or nonproductive.
of the machinery and equipment (original acquisition cost plus interest
charges) over the useful life of such assets. (a) Interest on a loan (but not theoretical interest of a taxpayer
 I: W/n the interest payments can be deducted from gross income – YES using his own funds). 21
transaction tax
 R: The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs
 The 1977 NIRC does not prohibit the deduction of interest on a loan to be related to the relevant provisions of the U.S. Internal Revenue Code, which
incurred for acquiring machinery and equipment. Neither does our 1977
provisions deal with the general topic of adjusted basis for determining allowable
NIRC compel the capitalization of interest payments on such a loan.
gain or loss on sales or exchanges of property and allowable depreciation and
 The 1977 Tax Code is simply silent on a taxpayer's right to elect one or the
other tax treatment of such interest payments. Accordingly, the general depletion of capital assets of the taxpayer:
rule that interest payments on a legally demandable loan are deductible
from gross income must be applied. Present Rule. The Internal Revenue Code, and the Regulations
 In this case, the CIR does not dispute that the interest payments were promulgated thereunder provide that "No deduction shall be
made by Picop on loans incurred in connection with the carrying on of the allowed for amounts paid or accrued for such taxes and carrying
registered operations of Picop, i.e., the financing of the purchase of charges as, under regulations prescribed by the Secretary or his
machinery and equipment actually used in the registered operations of delegate, are chargeable to capital account with respect to
Picop. Neither does the CIR deny that such interest payments were legally property, if the taxpayer elects, in accordance with such
due and demandable under the terms of such loans, and in fact paid by
regulations, to treat such taxes or charges as so chargeable."
Picop during the tax year 1977.
 The CIR has been unable to point to any provision of the 1977 Tax Code or
At the same time, under the adjustment of basis provisions which
any other Statute that requires the disallowance of the interest payments
made by Picop. have just been discussed, it is provided that adjustment shall be
 THIS PART DI KO SUPER MAGETS: made for all "expenditures, receipts, losses, or other items"
 The CIR invokes Section 79 of Revenue Regulations No. 2 w/c provides that properly chargeable to a capital account, thus including taxes and
Interest calculated for cost-keeping or other purposes on account of capital carrying charges; however, an exception exists, in which event
or surplus invested in the business, which does not represent a charge such adjustment to the capital account is not made, with respect
11
to taxes and carrying charges which the taxpayer has not elected (SMIC), Sysmart Corporation and CG&E Holdings on the transfer of their
to capitalize but for which a deduction instead has been taken. Fortune, Zeus and Iligan shares to Republic, in exchange for ne Republic
shares, because they together hold more than 51% of the total voting stock
The "carrying charges" which may be capitalized under the above quoted
provisions of the U.S. Internal Revenue Code include, as the CIR has of Republic after the transfer. The transfer through the facilities of the PSE
pointed out, interest on a loan "(but not theoretical interest of a taxpayer by the 6th to the last transferor of their Fortune and Zeus shares to Republic
using his own funds)." What the CIR failed to point out is that such in exchange for new Republic shares will be subject to the ½ of 1% stock
"carrying charges" may, at the election of the taxpayer, either be (a) transaction tax based on the gross selling price or gross value in money of
capitalized in which case the cost basis of the capital assets, e.g., the shares transferred, while the 6th to the last transferor of the Iligan
machinery and equipment, will be adjusted by adding the amount of such shares will be subject to capital gains tax (CGT) at the rate of 5%, of the par
interest payments or alternatively, be (b) deducted from gross income of value of the shares transferred. The new Republic shares to be issued, being
the taxpayer. Should the taxpayer elect to deduct the interest payments
original issuances, are subject to the DST imposed under Section 175 of the
against its gross income, the taxpayer cannot at the same time capitalize
Tax Code at the rate of P2 on each P200, or fractional part thereof, of the par
the interest payments. In other words, the taxpayer is not entitled to both
value of
the deduction from gross income and the adjusted (increased) basis for
determining gain or loss and the allowable depreciation charge. The U.S.
the new Republic shares issued. The net operating losses of each of
Internal Revenue Code does not prohibit the deduction of interest on a loan
Republic, Fortune, MPCC and Iligan are preserved after the proposed share
obtained for purchasing machinery and equipment against gross income,
unless the taxpayer has also or previously capitalized the same interest
swap and may be carried over and claimed as a deduction from their
payments and thereby adjusted the cost basis of such assets. respective gross income, pursuant to Section 34(D)(3) of the Tax Code,
because there is no substantial change in the either Republic or Fortune or
MPCC or Iligan."
BIR RULING 30-00
BIR RULING 206-90

Digest of BIR Ruling No. 030-2000 dated August 10, 2000
This is letter requesting in behalf of Porcelana Mariwasa, Inc. (PMI), a ruling
confirming an opinion that the foreign exchange loss incurred by PMI is a deductible
loss in 1990.
INCOME TAX; Tax-free merger under certain condition - Pursuant to Section
40(c)(2) It is represented that PMI is a corporation established and organized under
Philippine laws; that it has existing US dollar loans from Noritake Company, Limited
of the Tax Code, no gain or loss shall be recognized by Blue Circle (Noritake) and Toyota Tsusho Corporation (Toyota) in the aggregate amounts of US
Philippines, Inc. (BCPI), Round Royal, Inc. (RRI), SM Investment Corporation $7,636,679.17 and US $3,054,671.27, respectively, that in 1989, the parties agreed
12
to convert the said dollar denominated loans into pesos at the exchange rate vis the foreign currency or US dollar and vice versa but which remittance of
prevailing on June 30, 1989; that in December 1989, both agreements were scheduled amortization consisting of principal and interests payment on a foreign
approved by the Central Bank subject to the submission of a copy each of the signed loan had not actually been made are not deductible from gross income for income
agreements incorporating the conversion; thereafter, drafts of the amended tax purposes.
agreements were submitted to the Central Bank for pre-approval; that on January
29, 1990, the Central Bank advised PMI's counsel on their findings and comments BIR RULING 144-85
on the said drafts which were considered and incorporated in the final amended
(Technically, this ruling has no stated facts. It just said that a request for ruling dated
agreements; that in June 1990, the parties submitted to the Central Bank the signed
July 1, 1985 was sent to the BIR for the purpose of clarifying the issue, as herein
agreements; that counsel of PMI is of the opinion that in the case of PMI, the
stated.)
resultant loss on conversion of US dollar denominated loans to peso is more than a
shrinkage in value of money; that the approval by the Central Bank and the signing
by the parties of the agreements covering the said conversion established the loss,
after which, the loss became final and irrevocable, so that recoupment is reasonably FACTS:
impossible; and that having been fixed and determinable, the loss is no longer
Request to clarify the deductibility of foreign exchange losses incurred by reason of
susceptible to change, hence, it could fairly be stated that such has been sustained
the devaluation of the peso. The losses arose from matured but unremitted
in a closed and completed transaction.
principal repayments on loans affected by the debt-restructuring program in the
In reply the commissioner informed PMI that the annual increase in value of an Philippines.
asset is not taxable income because such increase has not yet been realized. The
increase in value i.e., the gain, could only be taxed when a disposition of the
property occurred which was of such a nature as to constitute a realization of such ISSUE:
gain, that is, a severance of the gain from the original capital invested in the
property. The same conclusion obtains as to losses. The annual decline in the value Whether or not foreign exchange losses are deductible for income tax purposes.
of property is not normally allowable as a deduction. Hence, to be allowable the
loss must be realized.
When foreign currency acquired in connection with a transaction in the regular HELD: NO.
course of business is disposed ordinary gain or loss results from the fluctuation. The
The annual increase in value of an asset is NOT TAXABLE INCOME because such
loss is deductible only for the year it is actually sustained. It is sustained during the
increase has not yet been realized. The increase in value, i.e., the gain, could only be
year in which the loss occurs as evidenced by the completed transaction and as
taxed when a disposition of the property occurred which was of such a nature as to
fixed by identifiable occurring in that year. No taxation event has as yet been
constitute a realization of such gain, that is, a severance of the gain from the original
consummated prior to the remittance of the scheduled amortization. Accordingly,
capital invested in the property. The aforementioned rule also applies to losses. The
PMI's request for confirmation of opinion was denied considering that foreign
annual decrease in the value of property is not normally allowable as a loss. Hence,
exchange losses sustained as a result of conversion or devaluation of the peso vis-a-
to be allowable the loss must be realized.
13
b. Compensation to Philex Mining which shall be fifty per cent (50%) of

the net profit;
When foreign currency acquired in connection with a transaction in the regular
course of business is disposed of, ordinary gain or loss results from the foreign In the course of managing and operating the project, Philex Mining made
exchange fluctuations. THE LOSS IS DEDUCTIBLE ONLY FOR THE YEAR IT IS ACTUALLY advances of cash and property in accordance with the agreement. However, the
SUSTAINED. Thus, there is no taxable event prior to the remittance of the scheduled mine suffered continuing losses over the years which resulted to petitioner's
amortization. withdrawal as manager and cessation of mine operations.
The parties executed a "Compromise with Dation in Payment" wherein

Baguio Gold admitted an indebtedness to Philex Mining, which was subsequently
Accordingly, foreign exchange losses sustained as a result of devaluation of the peso amended to include additional obligations.
vis-a-vis the foreign currency e.g., US dollar, but which remittance of scheduled
amortization consisting of principal and interests payments on a foreign loan has not Subsequently, Philex Mining wrote off in its 1982 books of account the
actually been made are NOT DEDUCTIBLE from gross income for income tax remaining outstanding indebtedness of Baguio Gold by charging P112,136,000.00 to
purposes. allowances and reserves that were set up in 1981 and P2,860,768.00 to the 1982
operations.
In its 1982 annual income tax return, Philex Mining deducted from its gross
NOTE: income the amount of P112,136,000.00 as "loss on settlement of receivables from
Baguio Gold against reserves and allowances." However, BIR disallowed the amount
 To sustain a loss means that the loss has occurred as evidenced by a closed and
completed transaction and as fixed by identifiable events occurring in that year. as deduction for bad debt and assessed petitioner a deficiency income tax of
 A closed transaction is a taxable event which has been consummated. P62,811,161.39.
Issue: Whether the deduction for bad debts was valid?

Bad debts
Held: No. For a deduction for bad debts to be allowed, all requisites must be
satisfied, to wit: (a) there was a valid and existing debt; (b) the debt was ascertained
PHILEX MINING v CIR to be worthless; and (c) it was charged off within the taxable year when it was
determined to be worthless.
Facts: Philex Mining entered into a management agreement with Baguio Gold. The
parties' agreement was denominated as "Power of Attorney" which provided among There was no valid and existing debt. The nature of agreement between
others: Philex Mining and Baguio Gold is that of a partnership or joint venture. Under a
contract of partnership, two or more persons bind themselves to contribute money,
a. Funds available for Philex Mining during the management agreement; property, or industry to a common fund, with the intention of dividing the profits
and among themselves.
14
Perusal of the agreement denominated as the "Power of Attorney" RULING:YES.

indicates that the parties had intended to create a partnership and establish a
common fund for the purpose. They also had a joint interest in the profits of the Both the CTA and CA relied on the case of Collector vs. Goodrich International,
business as shown by a 50-50 sharing in the income of the mine. which laid down the requisites for “worthlessness of a debt” to wit:
Viewed from this light, the advances can be characterized as petitioner’s In said case, we held that for debts to be considered as "worthless," and thereby
qualify as "bad debts" making them deductible, the taxpayer should show that (1)
investment in a partnership with Baguio Gold for the development and exploitation
there is a valid and subsisting debt. (2) the debt must be actually ascertained to be
of the Sto. Nino mine. Since the advanced amount partook of the nature of an worthless and uncollectible during the taxable year; (3) the debt must be charged
investment, it could not be deducted as a bad debt from petitioner's gross income. off during the taxable year; and (4) the debt must arise from the business or trade
of the taxpayer. Additionally, before a debt can be considered worthless, the
taxpayer must also show that it is indeed uncollectible even in the future.
Furthermore, there are steps outlined to be undertaken by the taxpayer to prove
PHILIPPINE REFINING CO v CA that he exerted diligent efforts to collect the debts, viz.: (1) sending of statement of
accounts; (2) sending of collection letters; (3) giving the account to a lawyer for
FACTS:
collection; and (4) filing a collection case in court.
PRC only used the testimony of its accountant Ms. Masagana in order to prove that
Philippine Refining Corp (PRC) was assessed deficiency tax payments for the year
these accounts were bad debts. This was considered by all 3 courts to be self-
1985 in the amount of around 1.8M. This figure was computed based on the serving. The SC said that PRC failed to exercise due diligence in order to ascertain
disallowance of the claim of bad debts by PRC. PRC duly protested the assessment that these debts were uncollectible. In fact, PRC did not even show the demand
claiming that under the law, bad debts and interest expense are allowable letters they allegedly gave to some of their debtors.
deductions.
FERNANDEZ HERMANOS v CIR
When the BIR subsequently garnished some of PRC’s properties, the latter
considered the protest as being denied and filed an appeal to the CTA which set
Facts:
aside the disallowance of the interest expense and modified the disallowance of the
bad debts by allowing 3 accounts to be claimed as deductions. However, 13 Fernandez Hermanos is an investment company. The CIR assessed it for alleged
supposed “bad debts” were disallowed as the CTA claimed that these were not deficiency income taxes. It claimed as deduction, among others, losses in or bad
substantiated and did not satisfy the jurisprudential requirement of “worthlessness debts of Palawan Manganese Mines Inc. which the CIR disallowed and was
of a debt” The CA denied the petition for review. sustained by the CTA.
ISSUE: Whether or not the CA was correct in disallowing the 13 accounts as bad Issue: W/N disallowance is correct
debts.
15
Held: YES respectively.Petitioner appeals on the ground that portions of theseunderdeclared

rents are yet to be collected by the previousowners and turned over or received by
It was shown that Palawan Manganese Mines sought financial help from Fernandez the corporation.Petitioner cited that some rents were deposited with the court,such
to resume its mining operations hence a Memorandum of Agreement (MOA) was that the corporation does not have actual nor constructivecontrol over them.The
executed where Fernandez would give yearly advances to Palawan. But it still sole witness for the petitioner, Solis (Corporate Secretary-Treasurer) admitted to
some undeclared rents in 1956 and1957, and that some balances were not collected
continued to suffer loses and Fernandez realized it could no longer recover the
by thecorporation in 1956 because the lessees refused to recognizeand pay rent to
advances hence claimed it as worthless. Looking at the MOA, Fernandez did not
the new owners and that the corp’s presidentIsabelo Lim collected some rent and
expect to be repaid. The consideration for the advances was 15% of the net profits. reported it in his personalincome statement, but did not turn over the rent to
If there were no earnings or profits there was no obligation to repay. Voluntary thecorporation. He also cites lack of actual or constructive controlover rents
advances without expectation of repayment do not result in deductible losses. deposited with the court.
Fernandez cannot even sue for recovery as the obligation to repay will only arise if
there was net profits. No bad debt could arise where there is no valid and subsisting ISSUE: WON the BIR was correct in assessing deficiency taxesagainst Limpan Corp.
debt. for undeclared rental income
HELD:
Even assuming that there was valid or subsisting debt, the debt was not deductible Yes. Petitioner admitted that it indeed had undeclaredincome (although only a part
in 1951 as a worthless debt as Palawan was still in operation in 1951 and 1952 as and not the full amount assessedby BIR). Thus, it has become incumbent upon them
Fernandez continued to give advances in those years. It has been held that if the to provetheir excuses by clear and convincing evidence, which it hasfailed to
do.Issue: When is there constructive receipt of rent?With regard to 1957 rents
debtor corporation although losing money or insolvent was still operating at the end
deposited with the court, andwithdrawn only in 1958, the court viewed the
of the taxable year, the debt is not considered worthless and therefore not corporation ashaving constructively received said rents. The non-collectionwas the
deductible. petitioner’s fault since it refused to refused to acceptthe rent, and not due to non-
payment of lessees. Hence,although the corporation did not actually receive the
rent, it isdeemed to have constructively received them.
Depreciation Depletion
BASILAN ESTATES v CIR CONSOLIDATED MINES v CTA
LIMPAN INVESTMENT v CIR BIR RULING 19-01
FACTS: FACTS:
BIR assessed deficiency taxes on Limpan Corp, a companythat leases real property, On October 3, 2000, the Philippine Council for NGO Certification (PCNC) sent a
for underdeclaring its rental incomefor years 1956-57 by around P20K and P81K request for ruling to the BIR, mainly to seek an opinion if Conservation International
16
(CI), an international organization, can be granted a donee institution status. Note

that CI’s home office and board members are based abroad, hence, PCNC’s
evaluation process on governance cannot be fully executed. Thus, the BIR opined that a non-stock, non-profit corporation or organization must
be created or organized under Philippine Laws and that an NGO must be a non-
ISSUE: profit domestic corporation, this Office is of the opinion that a foreign corporation,
like Conservation International, whether resident or non-resident, cannot be
Whether or not international organizations with home offices abroad are qualified accredited as donee institution.
to be granted donee institution status.
HELD: NO.
3M PHILIPPINES v CIR
Sec. 34(H)(l) of the NIRC3 specifically mentions "accredited domestic corporation or
associations" and "non-government organizations". On the other hand, Facts:
subparagraph (2)(c) of the same Section of the Tax Code defines a "non-government
3M Philippines, Inc. is a subsidiary of the Minnesota Mining and Manufacturing
organization" to mean a non-profit domestic corporation.
Company (or "3M-St. Paul") a non-resident foreign corporation with principal office
In implementing Sec. 34(H) of the NIRC, RR 13-984 was issued and in relation to the in St. Paul, Minnesota, U.S.A. It is the exclusive importer, manufacturer, wholesaler,
type of entities that may be accredited, which specifically refers to organizations or and distributor in the Philippines of all products of 3M-St. Paul. To enable it to
associations created or organized under Philippine laws. manufacture, package, promote, market, sell and install the highly specialized
products of its parent company, and render the necessary post-sales service and
3
(H) Charitable and Other Contributions. — maintenance to its customers, 3M Phils. entered into a "Service Information and
Technical Assistance Agreement" and a "Patent and Trademark License Agreement"
(l) In General. — Contributions or gifts actually paid or made within the taxable year to, or for the use of with the latter under which the 3m Phils. agreed to pay to 3M-St. Paul a technical
the Government of the Philippines or any of its agencies or any political subdivision thereof exclusively
for public purposes, or to accredited domestic corporations or associations organized and operated
service fee of 3% and a royalty of 2% of its net sales. Both agreements were
exclusively for religious, charitable, scientific, youth and sports development, cultural or educational submitted to, and approved by, the Central Bank of the Philippines. the petitioner
purposes or for the rehabilitation of veterans, or to social welfare institutions or to non-government claimed the following deductions as business expenses:
organizations, in accordance with rules and regulations promulgated by the Secretary of Finance, upon
recommendation of the Commissioner, no part of the net income of which inures to the benefit of any (a) royalties and technical service fees of P 3,050,646.00; and
private stockholder or individual in an amount not in excess of ten percent (10%) in the case of an
individual, and five percent (5%) in the case of a corporation of the taxpayer's taxable income derived
Philippine laws exclusively for one or more of the following purposes:
from trade, business or profession as computed without the benefit of this and the following
subparagraphs". xxx xxx xxx
4
SEC. 1. Definition of Terms. — For purposes of these Regulations, the terms herein enumerated shall b) "Non-government Organization (NGO)" — shall refer to a non-stock, non-profit domestic corporation
have the following meanings: or organization as defined under Section 34(H)(2)(c) of the Tax Code organized and operated
exclusively . . ."
a) "Non-stock, non-profit corporation or organization" — shall refer to a corporation or association/
organization referred to under Section 30 (E) and (G) of the Tax Code created or organized under
17
(b) pre-operational cost of tape coater of P97,485.08. Section 3. Requirements for Approval and Registration. — The requirements for
approval and registration as provided for in Section 2 above include, but are not
As to (a), the Commissioner of Internal Revenue allowed a deduction of limited to the following:
P797,046.09 only as technical service fee and royalty for locally manufactured
products, but disallowed the sum of P2,323,599.02 alleged to have been paid by the a. xxx xxx xxx
petitioner to 3M-St. Paul as technical service fee and royalty on P46,471,998.00
worth of finished products imported by the petitioner from the parent company, on
the ground that the fee and royalty should be based only on locally manufactured
b. xxx xxx xxx
goods. While as to (b), the CIR only allowed P19,544.77 or one-fifth (1/5) of 3M
Phils.capital expenditure of P97,046.09 for its tape coater which was installed in c. The royalty/rental contracts involving manufacturing' royalty, e.g., actual transfers
1973 because such expenditure should be amortized for a period of five (5) years, of technological services such as secret formula/processes, technical know how and
hence, payment of the disallowed balance of P77,740.38 should be spread over the the like shall not exceed five (5) per cent of the wholesale price of the
next four (4) years. The CIR ordered 3M Phil. to pay P840,540 as deficiency income commodity/ties manufactured under the royalty agreement. For contracts involving
tax on its 1974 return, plus P353,026.80 as 14% interest per annum from February 'marketing' services such as the use of foreign brands or trade names or trademarks,
15, 1975 to February 15, 1976, or a total of P1,193,566.80. the royalty/rental rate shall not exceed two (2) per cent of the wholesale price of
the commodity/ties manufactured under the royalty agreement. The producer's or
3M Phils. protested the CIR’s assessment but it did not answer the protest, instead
foreign licensor's share in the proceeds from the distribution/exhibition of the films
issuing a warrant of levy. The CTA affirmed the assessment on appeal.
shall not exceed sixty (60) per cent of the net proceeds (gross proceeds less local
Issue: expenses) from the exhibition/distribution of the films. ... (Emphasis supplied.) (p.
27, Rollo.)
Whether or not 3M Phils is entitled to the deductions due to royalties?
Clearly, no royalty is payable on the wholesale price of finished products imported
Ruling: by the licensee from the licensor. However, petitioner argues that the law applicable
to its case is only Section 29(a)(1) of the Tax Code which provides:
No. CB Circular No. 393 (Regulations Governing Royalties/Rentals) dated December
7, 1973 was promulgated by the Central Bank as an exchange control regulation to (a) Expenses. — (1) Business expenses. — (A) In general. — All ordinary and
conserve foreign exchange and avoid unnecessary drain on the country's necessary expenses paid or incurred during the taxable year in carrying on any trade
international reserves (69 O.G. No. 51, pp. 11737-38). Section 3-C of the circular or business, including a reasonable allowance for salaries or other compensation for
provides that royalties shall be paid only on commodities manufactured by the personal services actually rendered; travelling expenses while away from home in
licensee under the royalty agreement: the pursuit of a trade, profession or business, rentals or other payments required to
be made as a condition to the continued use or possession, for the purpose of the
trade, profession or business, for property to which the taxpayer has not taken or is
not taking title or in which he has no equity.
18
Petitioner points out that the Central bank "has no say in the assessment and
collection of internal revenue taxes as such power is lodged in the Bureau of HELD:
Internal Revenue," that the Tax Code "never mentions Circular 393 and there is no 1. NO. A margin is not a tax but an exaction designed to curb the excessive
demands upon our international reserves. The margin fee was imposed by the
law or regulation governing deduction of business expenses that refers to said
State in the exercise of its police power and not the power of taxation.
circular." (p. 9, Petition.)
2. NO.
The argument is specious, for, although the Tax Code allows payments of royalty to
To be deductible as a business expense, three conditions are imposed, namely:
be deducted from gross income as business expenses, it is CB Circular No. 393 that (1) the expense must be ordinary and necessary,
defines what royalty payments are proper. Hence, improper payments of royalty are (2) it must be paid or incurred within the taxable year, and
not deductible as legitimate business expenses. (3) it must be paid or incurred in carrying on a trade or business.
In addition, not only must the taxpayer meet the business test, he must
substantially prove by evidence or records the deductions claimed under the
ESSO STANDARD v CIR law, otherwise, the same will be disallowed. The mere allegation of the
taxpayer that an item of expense is ordinary and necessary does not justify its
FACTS: deduction.
ESSO deducted from its gross income, as part of its ordinary and necessary business Ordinarily, an expense will be considered 'necessary' where the expenditure is
expenses, the amount it had spent for drilling and exploration of its petroleum appropriate and helpful in the development of the taxpayer's business. It is
concessions. This claim was disallowed by the CIR on the ground that the expenses 'ordinary' when it connotes a payment which is normal in relation to the
should be capitalized and might be written off as a loss only when a "dry hole" business of the taxpayer and the surrounding circumstances. The term
should result. 'ordinary' does not require that the payments be habitual or normal in the
sense that the same taxpayer will have to make them often; the payment may
ESSO then filed an amended return and claimed as ordinary and necessary expenses be unique or non-recurring to the particular taxpayer affected. There is thus no
margin fees it had paid to the Central Bank on its profit remittances to its New York hard and fast rule on the matter. The right to a deduction depends in each case
head office. The CIR disallowed the claimed deduction for the margin fees paid. CIR on the particular facts and the relation of the payment to the type of business
assessed ESSO a deficiency income tax which arose from the disallowance of the in which the taxpayer is engaged. The intention of the taxpayer often may be
margin fees. the controlling fact in making the determination. Assuming that the
expenditure is ordinary and necessary in the operation of the taxpayer's
ESSO paid under protest and claimed for a refund. CIR denied the claims for refund, business, the answer to the question as to whether the expenditure is an
holding that the margin fees paid to the Central Bank could not be considered taxes allowable deduction as a business expense must be determined from the
or allowed as deductible business expenses. nature of the expenditure itself, which in turn depends on the extent and
permanency of the work accomplished by the expenditure.
ISSUES:
1. w/n margin fee is a tax and should be deductible from ESSO’s gross income. Since the margin fees in question were incurred for the remittance of funds to
NO petitioner's Head Office in New York, which is a separate and distinct income
2. If margin fees are not taxes, w/n they should nevertheless be considered taxpayer from the branch in the Philippines, for its disposal abroad, it can never
necessary and ordinary business expenses and therefore still deductible be said therefore that the margin fees were appropriate and helpful in the
from its gross income. NO.
19
development of petitioner's business in the Philippines exclusively. ESSO has

not shown that the remittance to the head office of part of its profits was made
in furtherance of its own trade or business and therefore cannot be claimed as
an ordinary and necessary expense paid or incurred in carrying on its own trade
or business.
20
R. CAPITAL GAINS and LOSSES [1] Capital assets.-The term 'capital assets' means property held by
the taxpayer [whether or not connected with his trade or
Capital assets business], but does not include, stock in trade of the taxpayer or
other property of a kind which would properly be included, in the
CALASANZ v CIR inventory of the taxpayer if on hand at the close of the taxable
year, or property held by the taxpayer primarily for sale to
Facts: Petitioner Ursula Calasanz inherited from her father de Torres an agricultural customers in the ordinary course of his trade or business, or
land located in Rizal with an area of 1.6M sqm. In order to liquidate her inheritance, property used in the trade or business of a character which is
Ursula Calasanz had the land surveyed and subdivided into lots. Improvements, subject to the allowance for depreciation provided in subsection
such as good roads, concrete gutters, drainage and lighting system, were introduced [f] of section thirty; or real property used in the trade or business
to make the lots saleable. Soon after, the lots were sold to the public at a profit. of the taxpayer.
In their joint income tax return for the year 1957 filed with the Bureau of Internal The statutory definition of capital assets is negative in nature. If the asset is not
Revenue on March 31, 1958, petitioners disclosed a profit of P31,060.06 realized among the exceptions, it is a capital asset; conversely, assets falling within the
from the sale of the subdivided lots, and reported fifty per centum thereof or exceptions are ordinary assets. And necessarily, any gain resulting from the sale or
P15,530.03 as taxable capital gains. exchange of an asset is a capital gain or an ordinary gain depending on the kind of
asset involved in the transaction.
Upon an audit and review of the return thus filed, the Revenue Examiner adjudged
petitioners engaged in business as real estate dealers, as defined in the NIRC, and However, there is no rigid rule or fixed formula by which it can be determined with
required them to pay the real estate dealer's tax and assessed a deficiency income finality whether property sold by a taxpayer was held primarily for sale to customers
tax on profits derived from the sale of the lots based on the rates for ordinary in the ordinary course of his trade or business or whether it was sold as a capital
income. asset. Although several factors or indices have been recognized as helpful guides in
making a determination, none of these is decisive; neither is the presence nor the
Tax court upheld the finding of the CIR, hence, the present appeal. absence of these factors conclusive. Each case must in the last analysis rest upon its
own peculiar facts and circumstances.
Issues: Also a property initially classified as a capital asset may thereafter be treated as an
ordinary asset if a combination of the factors indubitably tend to show that the
a. Whether or not petitioners are real estate dealers liable for real estate dealer's activity was in furtherance of or in the course of the taxpayer's trade or business.
fixed tax. YES Thus, a sale of inherited real property usually gives capital gain or loss even though
b. Whether the gains realized from the sale of the lots are taxable in full as ordinary the property has to be subdivided or improved or both to make it salable. However,
income or capital gains taxable at capital gain rates. ORDINARY INCOME if the inherited property is substantially improved or very actively sold or both it
may be treated as held primarily for sale to customers in the ordinary course of the
Ratio: heir's business.
In this case, the subject land is considered as an ordinary asset. Petitioners did not
The assets of a taxpayer are classified for income tax purposes into ordinary assets sell the land in the condition in which they acquired it. While the land was originally
and capital assets. Section 34[a] [1] of the National Internal Revenue Code broadly devoted to rice and fruit trees, it was subdivided into small lots and in the process
defines capital assets as follows: converted into a residential subdivision and given the name Don Mariano
Subdivision. Extensive improvements like the laying out of streets, construction of
21
concrete gutters and installation of lighting system and drainage facilities, among during the preceding year at least 6 taxable real estate transactions regardless of
others, were undertaken to enhance the value of the lots and make them more amount). (BIR Ruling No. 027-2002 dated July 3, 2002)
attractive to prospective buyers. The audited financial statements submitted
together with the tax return in question disclosed that a considerable amount was
expended to cover the cost of improvements. There is authority that a property Capital assets
ceases to be a capital asset if the amount expended to improve it is double its
original cost, for the extensive improvement indicates that the seller held the
property primarily for sale to customers in the ordinary course of his business. CHINA BANKING CORP v CA
Another distinctive feature of the real estate business discernible from the records is
the existence of contracts receivables, which stood at P395,693.35. The sizable
amount of receivables in comparison with the sales volume of P446,407.00 during
the same period signifies that the lots were sold on installment basis and suggests
the number, continuity and frequency of the sales. Also of significance is the
circumstance that the lots were advertised for sale to the public and that sales and
collection commissions were paid out during the period in question.
Petitioners argument that they are merely liquidating the land must also fail.
In Ehrman vs. Commissioner, the American court in clear and categorical terms
rejected the liquidation test in determining whether or not a taxpayer is carrying on
a trade or business The court observed that the fact that property is sold for
purposes of liquidation does not foreclose a determination that a "trade or
business" is being conducted by the seller.
One may, of course, liquidate a capital asset. To do so, it is necessary to sell. The sale
may be conducted in the most advantageous manner to the seller and he will not
lose the benefits of the capital gain provision of the statute unless he enters the real
estate business and carries on the sale in the manner in which such a business is
ordinarily conducted. In that event, the liquidation constitutes a business and a sale
in the ordinary course of such a business and the preferred tax status is lost.
BIR RULING 27-02
Registration with HLURB or HUDCC shall be sufficient for a seller/transferor to be

considered as habitually engaged in real estate business. If the seller/transferor is
not registered with the HLURB or HUDCC, he/it may prove that he/it is engaged in
the real estate business by offering other satisfactory evidence (e.g. consummation
22
S. DETERMINATION OF GAIN OR LOSS FROM SALE Corporation because it was pursuant to a plan of reorganization. Thus, such
exchange is exempt from CGT.
OR TRANSFER OF PROPERTY
ISSUE/RULING:
Exchange of property
CIR v RUFINO W/N the CTA erred in finding that no taxable gain was derived by the private
respondents from the questioned transaction? NO
FACTS:
There was a valid merger although the actual transfer of the properties subject of
the Deed of Assignment was not made on the date of the merger. In the nature of
The private respondents were the majority stockholders of the defunct Eastern
things, this was not possible. Obviously, it was necessary for the Old Corporation to
Theatrical Co., Inc., (Old Corporation). Ernesto Rufino was the president. The private
surrender its net assets first to the New Corporation before the latter could issue its
respondents were also the majority and controlling stockholders of another
own stock to the shareholders of the Old Corporation because the New Corporation
corporation, the Eastern Theatrical Co Inc., (New Corporation). This corporation was
had to increase its capitalization for this purpose. This required the adoption of the
engaged in the same kind of business as the Old Corporation, i.e. operating
resolution for the registration of such issuance with the SEC and its approval. All
theaters, opera houses, places of amusement and other related business
these took place after the date of the merger but they were deemed part and parcel
enterprises. Vicente Rufino was the General Manager.
of, and indispensable to the validity and enforceability of, the Deed of Assignment.
The Old Corporation held a special meeting of stockholders where a resolution was
There is no impediment to the exchange of property for stock between the two
passed authorizing the Old Corporation to merge with the New Corporation.
corporations being considered to have been effected on the date of the merger.
Pursuant to the said resolution, the Old Corporation, represented by Ernesto Rufino
That, in fact, was the intention, and the reason why the Deed of Assignment was
as President, and the New Corporation, represented by Vicente Rufino as General
made retroactive which provided in effect that all transactions set forth in the
Manager, signed a Deed of Assignment providing for the conveyance and transfer of
merger agreement shall be deemed to be taking place simultaneously when the
all the business, property assets, goodwill, and liabilities of the Old Corporation to
Deed of Assignment became operative.
the New Corporation in exchange for the latter's shares of stock to be distributed
among the shareholders on the basis of one stock for each stock held in the Old
Corporation. This agreement was made retroactive. The aforesaid transfer was The basic consideration, of course, is the purpose of the merger, as this would
eventually made. The resolution and the Deed of Assignment were approved in a determine whether the exchange of properties involved therein shall be subject or
resolution by the stockholders of the New Corporation in their special meeting. The not to the capital gains tax. The criterion laid down by the law is that the merger"
increased capitalization of the New Corporation was registered and approved by the must be undertaken for a bona fide business purpose and not solely for the purpose
SEC. of escaping the burden of taxation."
The BIR, after examination, declared that the merger was not undertaken for a bona Here, the purpose of the merger was to continue the business of the Old
fide business purpose but merely to avoid liability for the capital gains tax on the Corporation, whose corporate life was about to expire, through the New
exchange of the old for the new shares of stock. Accordingly, deficiency assessments Corporation to which all the assets and obligations of the former had been
were imposed against the private respondents. MR denied. CTA reversed and held transferred. What argues strongly, indeed, for the New Corporation is that it was not
that there was a valid merger. It declared that no taxable gain was derived by dissolved after the merger agreement. On the contrary, it continued to operate the
petitioners from the exchange of their old stocks solely for stocks of the New places of amusement originally owned by the Old Corporation and continues to do
so today after taking over the business of the Old Corporation 27 years ago.
23
What is also worth noting is that, as in the case of the Old Corporation when it was effect a direct transfer of a corporation’s share by way of dividend at a lower taxable
dissolved, there has been no distribution of the assets of the New Corporation since transaction.
then and up to now, as far as the record discloses. To date, the private respondents
have not derived any benefit from the merger of the Old Corporation and the New In order to have an appearance of a “reorganization”, she(Petitioner)
Corporation almost 3 decades earlier that will make them subject to the capital organized Averill Corporation (AC). Three (3) days later, UMC transferred the 1,000
gains tax under Section 35. They are no more liable now than they were when the shares of MSC to AC. Then these shares were all transferred to Petitioner.
merger took effect, as the merger, being genuine, exempted them under the law
Subsequently, AC was dissolved with no other transaction being made other the
from such tax.
transfer of the shares. Petitioner then sold the shares and declared a lower taxable
By this decision, the government is, of course, not left entirely without recourse, at liability. The Board contended that the so-called “reorganization” should be
least in the future. The fact is that the merger had merely deferred the claim for considered ineffective since it was just a scheme to have a lower tax liability.
taxes, which may be asserted by the government later, when gains are realized and
benefits are distributed among the stockholders as a result of the merger. In other ISSUE:
words, the corresponding taxes are not forever foreclosed or forfeited but may at
the proper time and without prejudice to the government still be imposed. Whether the “reorganization” is valid which would result to a lower tax
liability.
HELD:
BIR RULING 274-87
NO. It is contended that since every element required by the foregoing
GREGORY v HELVERING subdivision (B) (refer to footnote) is to be found in what was done, a statutory
reorganization was effected, and that the motive of the taxpayer thereby to escape
Facts:
payment of a tax will not alter the result or make unlawful what the statute allows.
Petitioner was the owner of all the stock of United Mortgage
The Court said, although the legal right of a taxpayer to decrease the
Corporation(UMC). That corporation held among its assets 1,000 shares of the
amount of what otherwise would be his taxes, or altogether avoid them, by means
Monitor Securities Corporation(MSC). Petitioner wanted these shares transferred to
which the law permits, cannot be doubted, the question for determination is
her at a profit and with the minimum income tax liability. In order to achieve this
whether what was done, apart from the tax motive, was the thing which the
purpose, Petitioner made it appear that she was making a “reorganization” (in
statute intended.
conforme with Revenue Act of 1928 5). Under this law, a “reorganization” would
5 When subdivision (B) speaks of a transfer of assets by one corporation to
"Sec. 112. (g) Distribution of Stock on Reorganization. If there is distributed, in pursuance of a
plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities another, it means a transfer made "in pursuance of a plan of reorganization of
in such corporation or in another corporation a party to the reorganization, without the surrender by corporate business, and not a transfer of assets by one corporation to another in
such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt
of such stock of securities shall be recognized. . . ."
pursuance of a plan having no relation to the business of either, as plainly is the case
"(i) Definition of Reorganization. -- As used in this section . . ." here.
"(1) The term 'reorganization' means . . . (B) a transfer by a corporation of all or a part of its assets to
another corporation if immediately after the transfer the transferor or its stockholders or both are in
control of the corporation to which the assets are transferred. . . ."
24
Simply an operation having no business or corporate purpose -- a mere

device which put on the form of a corporate reorganization as a disguise for
concealing its real character, and the sole object and accomplishment of which was
the consummation of a preconceived plan, not to reorganize a business or any part
of a business, but to transfer a parcel of corporate shares to the petitioner. The rule
which excludes from consideration the motive of tax avoidance is not pertinent to
the situation, because the transaction, upon its face, lies outside the plain intent of
the statute. (kasi wala nga talagang business purpose but to circumvent the law).
25
T. SITUS OF TAXATION The governing law is found in Sec. 37 (b). 6 Revenue Regulation No. 2 of the
DOF contains a similar provision, with the additional line that “the ratable
Gross income from sources within the Phils part is based upon the ratio of gross income from sources within the
CIR v MARUBENI CORPORATION
Philippines to the total gross income” (Sec. 160). Hence, where an expense
CIR v BOAC is clearly related to the production of Philippine-derived income or to
CIR v CTA AND SMITH&FRENCH OVERSEAS Philippine operations, that expense can be deducted from the gross income
acquired in the Philippines without resorting to apportionment.
Facts:
However, the overhead expenses incurred by the parent company in
Smith Kline & French Overseas Company is a multinational firm domiciled in
connection with finance, administration, and research & development, all of
Philadelphia, licensed to do business in the Philippines. It is engaged in the
which directly benefit its branches all over the world, fall under a different
importation, manufacture, and sale of pharmaceutical drugs and chemicals.
category. These are items which cannot be definitely allocated or identified
In 1971, it declared a net taxable income of P1.4 M and paid P511k as tax with the operations of the Philippine branch. Smith can claim as its
due. It claimed its share of the head office overhead expenses (P501k) as deductible share a ratable part of such expenses based upon the ration of
deduction from gross income. In its amended return, it claimed that there the local branch’s gross income to the total gross income of the corporation
was an overpayment of tax (P324k) arising from under-deduction of the worldwide.
overhead expense. This was certified by international independent auditors,
CIR’s Contention
the allocation of the overhead expense made on the basis of the percentage
of gross income in the Philippines to gross income of the corporation as a The CIR does not dispute the right of Smith to avail of Sec. 37 (b) of the Tax
whole. Code and Sec. 160 of the RR. But he maintains that such right is not
absolute and that there exists a contract (service agreement) which Smith
In 1974, without waiting for the action of the CIR, Smith filed a petition for
has entered into with its home office, prescribing the amount that a branch
review with the CTA. CTA ordered CIR to refund the overpayment or grant
can deduct as its share of the main office’s overhead expenses. Since the
Smith a tax credit. CIR appealed to the SC.
share of the Philippine branch has been fixed, Smith cannot claim more than
Issue: Whether Smith is entitled to a refund – YES the said amount.
6
Ratio: Net income from sources in the Philippines. – From the items of gross income
specified in subsection (a) of this section there shall be deducted expenses, losses,
and other deductions properly apportioned or allocated thereto and a ratable part
of any expenses, losses, or other deductions which cannot definitely be allocated to
some item or class of gross income. The remainder, if any, shall be included in full
as net income from sources within the Philippines.
26
Smith’s Contention Pursuant to the aforesaid reinsurance contracts, Philippine Guaranty Co.,
Inc. ceded premiuns to the foreign reinsurers. Said premiums were excluded
Smith, on the other hand, submits that the contract between itself and its by Philippine Guaranty Co., Inc. from its gross income when it file its income
home office cannot amend tax laws and regulations. The matter of allocated tax returns for 1953 and 1954. Furthermore, it did not withhold or pay tax
expenses deductible under the law cannot be the subject of an agreement on them. Consequently, the Commissioner of Internal Revenue assessed
between private parties nor can the CIR acquiesce in such an agreement. against Philippine Guaranty Co., Inc. withholding tax on the ceded
SC ruled for Smith Kline and said that its amended return conforms with the reinsurance premiums.
law and regulations. Issue: Whether the reinsurance premiums ceded to foreign reinsurers not
doing business in the Philippines are subject to withholding tax?
PHIL GUARANTY CO v CIR
Held: The reinsurance premiums are subject to withholding tax. The
Facts: The Philippine Guaranty Co., Inc., a domestic insurance company, reinsurance contracts, however, show that the transactions or activities that
entered into reinsurance contracts, on various dates, with foreign insurance constituted the undertaking to reinsure Philippine Guaranty Co., Inc. against
companies not doing business in the Philippines. loses arising from the original insurances in the Philippines were performed
in the Philippines. The liability of the foreign reinsurers commenced
The reinsurance contracts made the commencement of the reinsurers'
simultaneously with the liability of Philippine Guaranty Co., Inc. under the
liability simultaneous with that of Philippine Guaranty Co., Inc. under the
original insurances. Philippine Guaranty Co., Inc. kept in Manila a register of
original insurance. Philippine Guaranty Co., Inc. was required to keep a
the risks ceded to the foreign reinsurers. Entries made in such register
register in Manila where the risks ceded to the foreign reinsurers where
bound the foreign resinsurers, localizing in the Philippines the actual cession
entered, and entry therein was binding upon the reinsurers. A proportionate
of the risks and premiums and assumption of the reinsurance undertaking
amount of taxes on insurance premiums not recovered from the original
by the foreign reinsurers. Taxes on premiums imposed by Section 259 of the
assured were to be paid for by the foreign reinsurers. The foreign reinsurers
Tax Code for the privilege of doing insurance business in the Philippines
further agreed, in consideration for managing or administering their affairs
were payable by the foreign reinsurers when the same were not recoverable
in the Philippines, to compensate the Philippine Guaranty Co., Inc., in an
from the original assured. The foreign reinsurers paid Philippine Guaranty
amount equal to 5% of the reinsurance premiums. Conflicts and/or
Co., Inc. an amount equivalent to 5% of the ceded premiums, in
differences between the parties under the reinsurance contracts were to be
consideration for administration and management by the latter of the affairs
arbitrated in Manila. Philippine Guaranty Co., Inc. and Swiss Reinsurance
of the former in the Philippines in regard to their reinsurance activities here.
Company stipulated that their contract shall be construed by the laws of the
Disputes and differences between the parties were subject to arbitration in
Philippines.
the City of Manila. All the reinsurance contracts, except that with Swiss
Reinsurance Company, were signed by Philippine Guaranty Co., Inc. in the
27
Philippines and later signed by the foreign reinsurers abroad. Although the
contract between Philippine Guaranty Co., Inc. and Swiss Reinsurance Commonwealth Insurance Co. (CIC), a domestic corporation, entered into
Company was signed by both parties in Switzerland, the same specifically reinsurance contracts with 32 British companies not engaged in business in
thePhilippines represented by herein Plaintiff. CIC remitted to Plaintiff
provided that its provision shall be construed according to the laws of the
reinsurance premiums and, on behalf of Plaintiff, paid income tax on the
Philippines, thereby manifesting a clear intention of the parties to subject premiums. Plaintiff filed a claim for a refund of the paid tax, stating that it
themselves to Philippine law. was exempted from withholding tax reinsurance premiums received from
domestic insurance companies by foreign insurance companies not
Section 24 of the Tax Code subjects foreign corporations to tax on their income authorized to do business in the Philippines. Plaintiffs stated that since Sec.
from sources within the Philippines. The word "sources" has been interpreted as 53 and 54 were substantially re-enacted” by RA 1065, 1291 and 2343,
the activity, property or service giving rise to the income. 1 The reinsurance said rulings should be given the force of law under the principle of legislative
premiums were income created from the undertaking of the foreign reinsurance approval by re-enactment.
companies to reinsure Philippine Guaranty Co., Inc., against liability for loss
under original insurances. Such undertaking, as explained above, took place in ISSUE:
the Philippines. These insurance premiums, therefore, came from sources
W/N the tax should be withheld.
within the Philippines and, hence, are subject to corporate income tax.
HELD:
The foreign insurers' place of business should not be confused with their place
of activity. Business should not be continuity and progression of transactions
No. The principle of legislative enactment states that where a statute is
while activity may consist of only a single transaction. An activity may occur
outside the place of business. Section 24 of the Tax Code does not require a
susceptible of the meaning placed upon it by a ruling of the government
foreign corporation to engage in business in the Philippines in subjecting its agency charged with its enforcement and the legislature thereafter re-
income to tax. It suffices that the activity creating the income is performed or enacts the provisions without substantial changes, such action is
done in the Philippines. What is controlling, therefore, is not the place of confirmatory to an extent that the ruling carries out the legislative purpose.
business but the place of activity that created an income. This principle is not applicable for heaforementioned sections were never
re-enacted. Only the tax rate was amended. The administrative rulings
invoked by the CIR were only contained in unpublished letters. It cannot be
assumed that the legislature knew of these rulings. Finally, the premiums
remitted were to indemnify CIC against liability. This took place within the
HOWDEN & CO v CIR Philippines, thus subject to income tax
PHILIPPINE AMERICAN LIFE INSURANCE CO v CTA
Howden Vs CIR
(taxation from Sources in the Philippines)
FACTS:
28

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TAX LAW REVIEW DIGESTS – Montero

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

BIR RULING 206-90

b. Compensation to Philex Mining which shall be fifty per cent (50%) of

The parties executed a "Compromise with Dation in Payment" wherein

Issue: Whether the deduction for bad debts was valid?

Perusal of the agreement denominated as the "Power of Attorney" RULING:YES.

Held: YES respectively.Petitioner appeals on the ground that portions of theseunderdeclared

BASILAN ESTATES v CIR CONSOLIDATED MINES v CTA

LIMPAN INVESTMENT v CIR BIR RULING 19-01

(CI), an international organization, can be granted a donee institution status. Note

development of petitioner's business in the Philippines exclusively. ESSO has

BIR RULING 27-02

Registration with HLURB or HUDCC shall be sufficient for a seller/transferor to be

Simply an operation having no business or corporate purpose -- a mere

(taxation from Sources in the Philippines)

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