contractor’s tax) were extinguished upon its availment of tax amnesty
4. Sources of Income Rules under Executive Orders Nos. 41 and 64; and 2) whether or not
Sec. 42, Tax Code
Gross Income from sources within the
Phils.
1. CIR v Marubeni
G.R. No. 137377; December 18, 2001
Gross Income from Sources within the Philippines
REYES NOTES:
Q.18.1. In CIR v Marubeni, assuming that Marubeni was disqualified
from availing of the income tax amnesty would the income from the
services rendered in connection with the turn-key projects constitutes
income from Philippine Sources?
A: The answer is both yes and no. The answer is yes with
regard to those services performed in the Philippines. The
answer is, however, no with regard to those services rendered
in Japan. Such services were rendered outside the taxing
jurisdiction and thus constitute as income without the
Philippines. Marubeni, being a foreign corporation, is taxable
only on income within the Philippines and hence, income from
services rendered in the Philippines.
CASE:
Marubeni Corporation is a foreign corporation organized and
existing under the laws of Japan. Marubeni received a letter from
CIR assessing it several deficiency taxes i.e. deficiency income tax,
deficiency branch profit remittance tax, deficiency contractor’s tax,
and deficiency commercial broker’s tax from the undeclared gross
receipts/ gross income from Philphos and NDC construction projects
which were both completed in 1984. EO 41 and 64 was issued
declaring a one-time amnesty covering unpaid income taxes for the
years 1981-1985 and estate and donor’s taxes, respectively.
Marubeni availed these tax amnesty.
The issues in this case are: 1) whether or not Marubeni’s
deficiency tax liabilities (income tax, branch profit remittance tax and
Marubeni is liable to contractor’s taxes assessed by CIR with
regard to its liability on the gross receipts of the Foreign
Offshore Portion contract.
With regard to the first issue, SC affirmed that Marubeni is not
disqualified from availing the tax amnesty for unpaid income tax and
branch profit remittance tax. But SC ruled that Marubeni is
disqualified from the availing the tax amnesty for unpaid contractor’s
tax since it fell under the exception provided for in Section 4 (b) of
E.O. No. 41 (see ratio#1).
As to the second issue, SC ruled that No, Marubeni is not
liable to contractor’s taxes assessed by CIR with regard to its
liability on the gross receipts of the Foreign Offshore Portion
contract. SC ruled that a services for the design, fabrication,
engineering and manufacture of the materials and equipment
under Japanese Yen Portion I (Foreign Offshore Portion) were
made and completed in Japan. These services were rendered
outside the taxing jurisdiction of the Philippines and are therefore not
subject to contractor’s tax. Such services were rendered outside
the taxing jurisdiction and thus constitute as income without
the Philippines. Marubeni, being a foreign corporation, is
taxable only on income within the Philippines and hence,
income from services rendered in the Philippines.
FACTS:
Marubeni Corporation is a foreign corporation organized and
existing under the laws of Japan. It is engaged in general
import and export trading, financing and the construction
business. It is duly registered to engage in such business in the
Philippines and maintains a branch office in Manila.
Commissioner of Internal Revenue (CIR) issued a letter of
authority to examine the books of accounts of the Manila
branch office of Marubeni Corp for the fiscal year ending March
1985. In the course of the examination, CIR found Marubeni to
have undeclared income from two (2) contracts in the
Philippines, both of which were completed in 1984.
(1) One of the contracts was with the National Development
Company (NDC) in connection with the construction and
installation of a wharf/port complex at the Leyte Industrial
Development Estate in the municipality of Isabel, province
 of Leyte.
(2) The other contract was with the Philippine Phosphate
Fertilizer Corporation (Philphos) for the construction of an
ammonia storage complex also at the Leyte Industrial
Development Estate.
CIR’s revenue examiners recommended an assessment for
deficiency income, branch profit remittance, contractor’s and
commercial broker’s taxes. Marubeni questioned such
assessment.
Marubeni received a letter from CIR assessing it several
deficiency taxes i.e. deficiency income tax, deficiency
branch profit remittance tax, deficiency contractor’s tax,
and deficiency commercial broker’s tax from the
undeclared gross receipts/ gross income from Philphos
and NDC construction projects.
On September 26, 1986, Marubeni filed two (2) petitions for
review with the Court of Tax Appeals.
(1) The first petition questioned the deficiency income, branch
profit remittance and contractor’s tax assessments in
petitioner’s assessment letter.
(2) The second questioned the deficiency commercial broker’s
assessment in the same letter.
Earlier, on August 2, 1986, Executive Order (E.O.) No. 41[2]
declaring a one-time amnesty covering unpaid income
taxes for the years 1981 to 1985 was issued.
o Under this E.O., a taxpayer who wished to avail of the
income tax amnesty should, on or before October 31,
1986:
1. file a sworn statement declaring his net worth as of
December 31, 1985;
2. file a certified true copy of his statement declaring his
net worth as of December 31, 1980 on record with the
Bureau of Internal Revenue (BIR), or if no such record
exists, file a statement of said net worth subject to
verification by the BIR; and
3. file a return and pay a tax equivalent to ten per cent
(10%) of the increase in net worth from December 31,
1980 to December 31, 1985.
In accordance with the terms of E.O. No. 41, Marubeni filed
its tax amnesty return dated October 30, 1986 and attached
thereto its sworn statement of assets and liabilities and net
worth as of Fiscal Year (FY) 1981 and FY 1986.
o The return was received by the BIR on November 3, 1986
and respondent paid the amount of P2,891,273.00
equivalent to ten percent (10%) of its net worth increase
between 1981 and 1986.
On November 17, 1986, the scope and coverage of E.O. No.
41 was expanded by Executive Order (E.O.) No. 64.
o In addition to the income tax amnesty granted by E.O. No.
41 for the years 1981 to 1985, E.O. No. 64 included estate
and donor’s taxes under Title III and the tax on business
under Chapter II, Title V of the National Internal Revenue
Code, also covering the years 1981 to 1985.
o E.O. No. 64 further provided that the immunities and
privileges under E.O. No. 41 were extended to the
foregoing tax liabilities, and the period within which the
taxpayer could avail of the amnesty was extended to
December 15, 1986. Those taxpayers who already filed
their amnesty return under E.O. No. 41, as amended,
could avail themselves of the benefits, immunities and
privileges under the new E.O. by filing an amended return
and paying an additional 5% on the increase in net worth
to cover business, estate and donor’s tax liabilities. The
period of amnesty under E.O. No. 64 was extended to
January 31, 1987 by E.O No. 95 dated December 17,
1986.
On December 15, 1986, respondent filed a supplemental tax
amnesty return under the benefit of E.O. No. 64 and paid a
further amount of P1,445,637.00 to the BIR equivalent to five
percent (5%) of the increase of its net worth between 1981 and
1986.
Almost ten (10) years after filing of the case, CTA rendered a
decision in the first petition of Marubeni.
o The tax court found that Marubeni had properly availed of
the tax amnesty under E.O. Nos. 41 and 64 and declared
the deficiency taxes subject of said case as deemed
cancelled and withdrawn.
CA affirmed the ruling of CTA.
ISSUES:
 1. Whether or not Marubeni’s deficiency tax liabilities (income tax,
branch profit remittance tax and contractor’s tax) were
extinguished upon its availment of tax amnesty under
Executive Orders Nos. 41 and 64.
2. Whether or not Marubeni is liable to contractor’s taxes
assessed by CIR with regard to its liability on the gross
receipts of the Foreign Offshore Portion contract.
RATIO:
1. Marubeni’s deficiency tax liabilities with regard to income
tax and branch profit remittance tax are extinguished upon
its availment of tax amnesty under EO 41. However, as to
the contractor’s tax deficiency, Marubeni is not relieved
from its liability.
Petitioner’s Contention:
o CIR claims that Marubeni is disqualified from availing of
the said amnesties because the latter falls under the
exception in Section 4 (b) of E.O. No. 41. It argued that
at the time Marubeni filed for income tax amnesty on
October 30, 1986, the first petition of Marubeni had
already been filed and was pending before the CTA.
Marubeni therefore fell under the exception in Section 4
(b) of E.O. No. 41.
SC RULING:
o There are three (3) types of taxes involved herein—
income tax, branch profit remittance tax and contractor’s
tax. These taxes are covered by the amnesties granted
by E.O. Nos. 41 and 64.
o As to the Deficiency Tax for Income Tax:
Accdg to Section 4 (b) of E.O. No. 41, among the
taxpayers who may not avail of the amnesty herein
granted are those with income tax cases already
filed in Court as of the effectivity hereof.
Section 4 (b) of E.O. No. 41 is very clear and
unambiguous. It excepts from income tax amnesty
those taxpayers “with income tax cases already filed
in court as of the effectivity hereof.” The point of
reference is the date of effectivity of E.O. No. 41.
The filing of income tax cases in court must have
been made before and as of the date of effectivity of
E.O. No. 41.
Thus, for a taxpayer not to be disqualified under
Section 4 (b) there must have been no income tax
cases filed in court against him when E.O. No. 41
took effect. This is regardless of when the taxpayer
filed for income tax amnesty, provided of course he
files it on or before the deadline for filing.
E.O. No. 41 took effect on August 22, 1986. The
first petition of Marubeni questioning the deficiency
income, branch profit remittance and contractor’s
tax assessments was filed by Marubeni with the
CTA on September 26, 1986.
When E.O. No. 41 became effective on August 22,
1986, the first petition had not yet been filed in
court. Marubeni Corporation did not fall under
the said exception in Section 4 (b), hence,
Marubeni Corporation was not disqualified from
availing of the amnesty for income tax under
E.O. No. 41.
o As to the Deficiency Branch Profit Remittance Tax:
The same ruling also applies to the deficiency
branch profit remittance tax assessment. A branch
profit remittance tax is defined and imposed in
Section 24 (b) (2) (ii), Title II, Chapter III of the
National Internal Revenue Code. In the tax code,
this tax falls under Title II on Income Tax. It is a tax
on income. Marubeni therefore did not fall under
the exception in Section 4 (b) when it filed for
amnesty of its deficiency branch profit
remittance tax assessment.
o With respect to the contractor’s tax assessment and
Marubeni’s availment of the amnesty under E.O. No.
64:
SC ruled that when E.O. No. 64 took effect on
November 17, 1986, the first petition was already
filed and pending in court. By the time Marubeni
filed its supplementary tax amnesty return on
December 15, 1986, it already fell under the
exception in Section 4 (b) of E.O. Nos. 41 and 64
and was disqualified from availing of the
 business tax amnesty granted therein.
2. No, Marubeni is not liable to contractor’s taxes assessed by
CIR with regard to its liability on the gross receipts of the
Foreign Offshore Portion contract.
Background of the two contracts entered into by Marubeni:
o The NDC and Philphos are two government corporations.
o In 1980, the NDC, as the corporate investment arm of the
Philippine Government, established the Philphos to
engage in the large-scale manufacture of phosphatic
fertilizer for the local and foreign markets.
o In 1982, the NDC opened for public bidding a project to
construct and install a modern, reliable, efficient and
integrated wharf/port complex at the Leyte Industrial
Development Estate.
o Marubeni, Japan pre-qualified and on March 22, 1982, the
NDC and Marubeni entered into an agreement entitled
“Turn-Key Contract for Leyte Industrial Estate Port
Development Project Between National Development
Company and Marubeni Corporation.
o Philphos opened for public bidding a project to construct
and install two ammonia storage tanks in Isabel. Like the
NDC contract, it was Marubeni Head Office in Japan that
participated in and won the bidding. Thus, Philphos and
Marubeni entered into an agreement entitled “Turn-Key
Contract for Ammonia Storage Complex Between
Philippine Phosphate Fertilizer Corporation and Marubeni
Corporation.”
o The division of the price into Japanese Yen Portions I and
II and the Philippine Pesos Portion under the two contracts
corresponds to the two parts into which the contracts were
classified—the Foreign Offshore Portion and the
Philippine Onshore Portion. In both contracts, the
Japanese Yen Portion I corresponds to the Foreign
Offshore Portion. Japanese Yen Portion II and the
Philippine Pesos Portion correspond to the Philippine
Onshore Portion.
Respondent’s Contention:
o Assuming it did not validly avail of the amnesty under the
two Executive Orders, it is still not liable for the
deficiency contractor’s tax because the income from
the projects came from the “Offshore Portion” of the
contracts.
o The two contracts were divided into two parts, i.e., the
Onshore Portion and the Offshore Portion. All materials
and equipment in the contract under the “Offshore Portion”
were manufactured and completed in Japan, not in the
Philippines, and are therefore not subject to Philippine
taxes.
Petitioner’s Contention:
o CIR argues that since the two agreements are turn-key,
they call for the supply of both materials and services to
the client, they are contracts for a piece of work and are
indivisible. The situs of the two projects is in the
Philippines, and the materials provided and services
rendered were all done and completed within the territorial
jurisdiction of the Philippines. Accordingly, Marubeni’s
entire receipts from the contracts, including its receipts
from the Offshore Portion, constitute income from
Philippine sources. The total gross receipts covering
both labor and materials should be subjected to
contractor’s tax in accordance with the ruling in
Commissioner of Internal Revenue v. Engineering
Equipment & Supply Co.
SC RULING:
o A contractor’s tax is imposed in the National Internal
Revenue Code (NIRC). According to Sec. 205 of NIRC, an
independent contractor is a person whose activity consists
essentially of the sale of all kinds of services for a
fee, regardless of whether or not the performance of the
service calls for the exercise or use of the physical or
mental faculties of such contractors or their employees.
The word “contractor” refers to a person who, in the
pursuit of independent business, undertakes to do a
specific job or piece of work for other persons, using his
own means and methods without submitting himself to
control as to the petty details.
o A contractor’s tax is a tax imposed upon the privilege
of engaging in business. It is generally in the nature of
an excise tax on the exercise of a privilege of selling
services or labor rather than a sale on products; and
 is directly collectible from the person exercising the
privilege.
o Being an excise tax, it can be levied by the taxing
authority only when the acts, privileges or
business are done or performed within the
jurisdiction of said authority. Like property taxes, it
cannot be imposed on an occupation or privilege
outside the taxing district.
o Under the Philippine Onshore Portion, Marubeni does
not deny its liability for the contractor’s tax on the
income from the two projects. In fact Marubeni claims,
which CIR has not denied, that the income it derived
from the Onshore Portion of the two projects had
been declared for tax purposes and the taxes thereon
already paid to the Philippine government.
o SC ruled that it is with regard to the gross receipts
from the Foreign Offshore Portion of the two contracts
that the liabilities involved in the assessments subject
of this case arose.
o In the case at bar, it is undisputed that Marubeni was an
independent contractor under the terms of the two subject
contracts. Marubeni, however, argues that the work
therein were not all performed in the Philippines because
some of them were completed in Japan in accordance
with the provisions of the contracts.
o Between Marubeni and the two Philippine
corporations, payments for all materials and
equipment under Japanese Yen Portion I were made
to Marubeni by NDC and Philphos also in Japan.
Clearly, the service of “design and engineering, supply
and delivery, construction, erection and installation,
supervision, direction and control of testing and
commissioning, coordination…” of the two projects
involved two taxing jurisdictions. These acts occurred in
two countries – Japan and the Philippines. While the
construction and installation work were completed
within the Philippines, the evidence is clear that some
pieces of equipment and supplies were completely
designed and engineered in Japan. The two sets of ship
unloader and loader, the boats and mobile equipment for
the NDC project and the ammonia storage tanks and
refrigeration units were made and completed in Japan.
They were already finished products when shipped to the
Philippines. The other construction supplies listed under
the Offshore Portion such as the steel sheets, pipes and
structures, electrical and instrumental apparatus, these
were not finished products when shipped to the
Philippines. They, however, were likewise fabricated
and manufactured by the sub-contractors in Japan. All
services for the design, fabrication, engineering and
manufacture of the materials and equipment under
Japanese Yen Portion I were made and completed in
Japan. These services were rendered outside the
taxing jurisdiction of the Philippines and are therefore
not subject to contractor’s tax.
o Commissioner of Internal Revenue v. Engineering
Equipment & Supply Co: SC found in this case that
Engineering Equipment, although an independent
contractor, was not engaged in the manufacture of air
conditioning units in the Philippines. Engineering
Equipment designed, supplied and installed centralized
air-conditioning systems for clients who contracted its
services. Engineering, however, did not manufacture all
the materials for the air-conditioning system. It imported
some items for the system it designed and installed.
o Contrary to CIR’s claim, the case of
Commissioner of Internal Revenue v.
Engineering Equipment & Supply Co is not in
point. The issues in that case dealt with
services performed within the local taxing
jurisdiction. There was no foreign element
involved in the supply of materials and
services.
FINAL VERDICT: petition is DENIED.
2. CIR V BOAC BRITISH OVERSEAS AIRWAYS CORPORATION
REYES NOTES/ CASE: (p.17,Q.18.2)
ABC Airways is a foreign airline. While it did not carry passengers
and/or cargo to or from the Philippines, ABC maintains a general
sales agent of is tickets in the Philippines. Is the sale of the tickets
taxable as income from sources within the Philippines?
YES. For the source of income to be considered as coming from the
Philippines, it is sufficient that the income is derived from activity
within the Philippines. In ABC’s case the sale of the tickets in the
Philippines is the activity that produces the income. The tickets
exchanged hands here in the country and the payments for fares
were also made with Philippine currency. The site of the source of
payments is the Philippines. The absence of flight operations to and
from the Philippines is not determinative of the source of income/site
of income taxation for the test of taxability is the “source.”
FACTS:
• BOAC is a 100% British Government-owned corporation. It
operates air transportation service and sells transportation tickets
over the routes of the other airline members.
• BOAC has no landing rights for traffic purposes in the Philippines
and it was not granted a Certificate of public convenience and
necessity to operate in the Philippines by the Civil Aeronautics
Board (CAB) (except for 9-month period — temporary landing
permit)
• It did not carry passengers and/or cargo to or from the Philippines,
BUT it maintained a general sales agent in the Philippines —
Wamer Barnes and Company, Ltd. (WB), and later Qantas Airways
(QA) — which was responsible for selling BOAC tickets covering
passengers and cargoes
• 1st case
• CIR assessed BOAC to the aggregate amount of
P2,498,358.56 for deficiency income taxes (1959-1963),
BOAC protested
Subsequent investigation — new assessment (1959-1967) for
• from salaries, wages or compensation for personal service of
P858,307.79 — which was paid under protest
• BOAC claimed for refund of the 2nd amount (800k), which was
denied by CIR, but before which BOAC had already filed a
petition with CTA
• 2nd case
• BOAC was assessed deficiency income taxes, interest and
penalty for P549,327.43 (1968-69, 1970-71) and the additional
amounts of P1k and P1.8k as compromise penalties for
violation of Sec.46 (requiring filing of corporation returns)
penalised under Sec.74 of the NIRC
• BOAC requested that the assessment be countermanded and
set aside
• CIR denied the request, and re-issued the deficiency of
P534,132.08 for the years 1969,70-71 plus P1k as
compromise penalty under Sec.74 of the Tax Code.
• BOAC thus filed this to CTA praying that it would be absolved
of liability for deficiency income tax for 1969-71
• 1st and 2nd case were tried jointly
• CTA reversed CIR decision
• proceeds of sales of BOAC passage tickets in the Philippines
by the agents (WB, QA) do not constitutee BOAC income from
Philippine sources “since no service of carriage of passengers
or freight was performed by BOAC within the Philippines” and
therefore is not subject to Philippine income tax
• income from transportation is income from services so that the
place where services are rendered determines the source.
• CTA ordered CIR to credit BOAC with the sum of P858,307.79
and to cancel the deficiency income tax assessments against
BOAC for P534,132.08
• Hence this petition for review on certiorari
ISSUES:
1. Whether or not the revenue derived by BOAC constitute
income from Philippine sources, thus taxable
HELD & RATIO:
• YES.
• Tax Code’s definition of “gross income”
• "Gross income" includes gains, profits, and income derived
 whatever kind and in whatever form paid, or from profession,
vocations, trades, business, commerce, sales, or dealings in
property, whether real or personal, growing out of the
ownership or use of or interest in such property; also from
interests, rents, dividends, securities, or the transactions of
any business carried on for gain or profile, or gains, profits,
and income derived from any source whatever (Sec. 29[3]
• This includes sales of transport documents.
• The words “ income from any source whatever” disclose a
legislative policy to include all income not expressly exempted
within the class of taxable income under our laws
• The records show that the Philippine gross income of BOAC
amounted to P10,428,328.00
• >>>> For the source of income to be considered as coming
from the Philippines, it is sufficient that the income is derived
from activity within the Philippines. In BOAC's case, the sale of
tickets in the Philippines is the activity that produces the income.
The tickets exchanged hands here and payments for fares were
also made here in Philippine currency. The site of the source of
payments is the Philippines. The flow of wealth proceeded from,
and occurred within, Philippine territory, enjoying the protection
accorded by the Philippine government. In consideration of such
protection, the flow of wealth should share the burden of
supporting the government.
• BOAC argues that the income was derived from transportation is
income from services, which is performed outside of the
Philippines.
1. Court denied this and said: The test of taxability is the "source";
and the source of an income is that activity ... which produced
the income. Unquestionably, the passage documentations in
these cases were sold in the Philippines and the revenue
therefrom was derived from a activity regularly pursued within the
Philippines. business a And even if the BOAC tickets sold covered
the "transport of passengers and cargo to and from foreign cities",
it cannot alter the fact that income from the sale of tickets was
derived from the Philippines. The word "source" conveys one
essential idea, that of origin, and the origin of the income herein is
the Philippines
FINAL VERDICT: Petition is GRANTED. The CA and RTC decisions
are affirmed.
BOAC is ordered to pay P534,132.08 as deficiency income tax for
the fiscal years 1968-69 to 1970-71 plus 5% surcharge, and 1%
monthly interest from April 16, 1972 for a period not to exceed three
(3) years in accordance with the Tax Code.
2. CIR v. CTA & “SMITH KLINE & French Overseas Co.”
Refund
REYES NOTES/ CASE:
Smith & Kline & French Overseas Co. is claiming a tax
refund in the amount of 324, 255 because of audited statements
prepared by the audit firm Peat, Marwick, Mitchell and Company. It is
contended by the CIR that the Private Res has no right to deduct the
same because it is not an expense incurred from operations in the
Philippines. The CTA ruled in favor of Private Res. The SC affirmed
citing Sec. 160 of the NIRC which actually says that you can deduct
that stuff. (So what was the issue in the first place diba?)
FACTS:
This current petition is about the petition for refund of private
respondent in 1971 in the amount of 324,255. The private
RES in the instant case is a company engaged in the
purveying of pharmaceuticals.
In 1971 it was declared that Private RES had an income of
PHP 1,489,277 from its operations within the Philippines. It
paid PHP 511,247 because of this. It claimed however
deductions in the amount of P501,040 because this was the
amount of the expenses of the head office that it was
shouldering from the parent company for its expenses with
regard to finance, administration, and research and
development. There was an international audit firm called
Peat, Marwick, Mitchell and Company that actually told them
however that they had still overpayed because if you used
the proportion of the gross income that they provided to the
Smith Kline parent company they actually could deduct more
from their taxable income. This is presumably because their
operations in the Philippines made up a large amount of the
 gross income of the company and could therefore be used to
defray more of the taxes.
The CTA ruled that the CIR has to pay back the tax refund.
.
ISSUES:
1. Whether or not Smith Kline is entitled to the deduction
and hence the refund
HELD & RATIO:
1. NO, 37(b) of the code itself indicate that costs incurred from
operations within the Philippines can be used to reduce tax
liability, well duh because you didn’t earn nga diba?
The important thing to note is that the Supreme
Court ruled in this case that the expenses incurred
by the parent company in this case were ruled to be
a different class of income altogether.
Sec. 160 of the Regulations actually allows for
apportionment of expenses and therefore the same
can be deducted in fact from the operations of the
Private RES in the Philippines.
FINAL VERDICT: Petition is not granted. CTA affirmed.
Notes/ Source:
SEC. 160. Apportionment of deductions. — From the items specified
in section 37(a), as being derived specifically from sources within the
Philippines there shall be deducted the expenses, losses, and other
deductions properly apportioned or allocated thereto and a ratable
part of any other expenses, losses or deductions which can not
definitely be allocated to some item or class of gross income. The
remainder shall be included in full as net income from sources within
the Philippines. The ratable part is based upon the ratio of gross
income from sources within the Philippines to the total gross income.
3. Phil. Guaranty Co. vs CIR
Phil Guaranty Co. v. CIR & CTA
REYES NOTES/ CASE:
In this case sir, we have Phil. Guaranty entering into reinsurance
contracts with several foreign companies. These were made in
contemplation that they would be better protected from the inherent
risk of insuring people’s stupidity. The CIR assessed the various
remittances they had sent to these foreign companies against them.
The CTA ruled against Phil. Guaranty. The SC ruled that yes these
remittances arouse from sources w/in the Philippines and that they
were subject of withholding tax.
FACTS:
Phil. Guaranty entered into contracts to reinsure the
insurance policies that they give. This is where they are
insured against the insurance policies coming due. Basically,
if someone breaks a leg, a person they insured, they pay
that person and are in turn paid by Imperio Compañia de
Seguros, La Union y El Fenix Español, Overseas Assurance
Corp., Ltd., Socieded Anonima de Reaseguros Alianza,
Tokio Marino & Fire Insurance Co., Ltd., Union Assurance
Society Ltd., Swiss Reinsurance Company and Tariff
Reinsurance Limited. Philippine Guaranty Co., Inc.
The consideration for the contract, of course, was a portion
of the insurance premiums that were being paid to them.
These would be paid to the various companies that were
reinsuring their contracts. There was a registry of these fees
paid to the reinsurers in Manila.
In the years of 1953 & 1954 the amounts of 842,466.71 PHP
& 721,471.85 were paid respectively. These amounts were
excluded from the computation of income tax. No withholding
tax was made on them. (BOOM BITCHES YOU THOUGHT
YOU DIDN’T NEED TO PAY!) It was subsequently assessed
to have to pay taxes on the above amounts.
Philippine Guaranty Co., Inc., protested the assessment on
the ground that reinsurance premiums ceded to foreign
 reinsurers not doing business in the Philippines are not
subject to withholding tax. Its protest was denied and it
appealed to the Court of Tax Appeals.
Because the CTA is on the right of the two names up there
you can probably tell they lost in the CTA.
Petitioner maintain that the reinsurance premiums in
question did not constitute income from sources within the
Philippines because the foreign reinsurers did not engage in
business in the Philippines, nor did they have office here.

ISSUES:
2. W/N the income was derived from within the
Philippines?

HELD & RATIO:

2. OH NIGGA YES!
The reinsurance contracts, show that the transactions or
activities that constituted the undertaking to reinsure
Philippine Guaranty Co., Inc. against loses arising from the
original insurances in the Philippines were performed in the
Philippines.
Taxes on premiums imposed by Section 259 of the Tax
Code for the privilege of doing insurance business in the
Philippines were payable by the foreign reinsurers when the
same were not recoverable from the original assured.
Section 24 of the Tax Code subjects foreign corporations to
tax on their income from sources within the Philippines. The
word "sources" has been interpreted as the activity, property
or service giving rise to the income.
The Petitioners also contested additionally that they didn’t
need to withhold the premiums but this was a matter already
ruled on in Alexander Howden & Co., Ltd. vs. Collector of
Internal Revenue, L-19393, April 14, 1965. Where it was
stated that they had to.
FINAL VERDICT: Petition is Denied, Phil Guaranty ordered to pay
the amounts assessed against it by the CIR.
 4. HOWDEN vs CIR
REYES NOTES:
“Sources” means the activity, property, or service giving rise to the
income. The original insurance undertakings took place in the
Philippines. It is not required that the foreign corporation be engaged
in the Philippines. What is controlling is not the place of business, but
the place of activity that created the income.
CASE:
Commonwealth Insurance Co, a domestic insurance
corporation entered into a reinsurance agreement with 32 British
Companies not engaged or trade in the Philippines. Commonwealth
agreed to cede to them insurance risks that they have underwritten in
the Philippines. Alexander Howden Inc represented those companies
signed a reinsurance contract with those companies in London and
brought said contract to Philippines to be signed by Commonwealth.
Pursuant to the aforesaid contracts, Commonwealth Insurance Co.,
remitted P798,297.47 to Alexander Howden & Co., Ltd., as
reinsurance premiums. A ruling of the Commissioner of Internal
Revenue was invoked, stating that it exempted from withholding tax
reinsurance premiums received from domestic insurance companies
by foreign insurance companies not authorized to do business in the
Philippines. Alexander Howden instituted an action to recover their
income tax. Howden claims that the income was sourced from
outside the Philippines by companies doing business outside and
thus cannot be taxed for income. The Court held however that the
reinsurance premiums were paid in the Philippines and it is the place
where the income is generated that is controlling and not where the
place of business is.
Reinsurance is insurance that is purchased by an insurance
company (the "ceding company" or "cedant" or "cedent" under the
arrangement) from one or more other insurance companies (the
"reinsurer") directly or through a broker as a means of risk
management, sometimes in practice including tax mitigation and
other reasons described below. The ceding company and the
reinsurer enter into a reinsurance agreement which details the
conditions upon which the reinsurer would pay a share of the claims
incurred by the ceding company. The reinsurer is paid a "reinsurance
premium" by the ceding company, which issues insurance policies to
its own policyholders. (Wikipedia)
FACTS:
In 1950 the Commonwealth Insurance Co., a domestic
corporation, entered into reinsurance contracts with 32
British insurance companies not engaged in trade or
business in the Philippines, whereby the Commonwealth
agreed to cede to them a portion of the premiums on
insurances on fire, marine and other risks it has underwritten
in the Philippines.
Alexander Howden & Co., Ltd., also a British corporation not
engaged in business in this country, represented the
aforesaid British insurance companies. The reinsurance
contracts were prepared and signed by the foreign reinsurers
in England and sent to Manila where Commonwealth
Insurance Co. signed them.
Pursuant to the aforesaid contracts, Commonwealth
Insurance Co., in 1951, remitted P798,297.47 to Alexander
Howden & Co., Ltd., as reinsurance premiums. In behalf of
Alexander Howden & Co., Ltd., Commonwealth Insurance
Co. filed in April 1952 an income tax return declaring the
sum of P798,297.47, with accrued interest thereon in the
amount of P4,985.77, as Alexander Howden & Co., Ltd.'s
gross income for calendar year 1951. It also paid the Bureau
of Internal Revenue P66,112.00 income tax thereon.
On May 12, 1954, within the two-year period provided for by
law, Alexander Howden & Co., Ltd. filed with the Bureau of
Internal Revenue a claim for refund of the P66,112.00, later
reduced to P65,115.00, because Alexander Howden & Co.,
Ltd. agreed to the payment of P977.00 as income tax on the
P4,985.77 accrued interest.
A ruling of the Commissioner of Internal Revenue, dated
December 8, 1953, was invoked, stating that it exempted
from withholding tax reinsurance premiums received from
 domestic insurance companies by foreign insurance
companies not authorized to do business in the Philippines.
Subsequently, Alexander Howden & Co., Ltd. instituted an
action in the Court of First Instance of Manila for the
recovery of the aforesaid amount claimed. Pursuant to
Section 22 of Republic Act 1125 the case was certified to the
Court of Tax Appeals. On November 24, 1961 the Tax Court
denied the claim.
ISSUES:
3. Are portions of premiums earned from insurances locally
underwritten by a domestic corporation, ceded to and
received by non-resident foreign reinsurance companies,
thru a non-resident foreign insurance broker, pursuant to
reinsurance contracts signed by the reinsurers abroad but
signed by the domestic corporation in the Philippines,
subject to income tax or not? (MAIN ISSUE)
4. If subject thereto, may or may not the income tax on
reinsurance premiums be withheld pursuant to Sections 53
and 54 of the National Internal Revenue Code?
HELD & RATIO:
3. YES. The source of an income is the property, activity or
service that produced the income.
The reinsurance premiums remitted to appellants by
virtue of the reinsurance contracts, accordingly, had
for their source the undertaking to indemnify
Commonwealth Insurance Co. against liability. Said
undertaking is the activity that produced the
reinsurance premiums, and the same took place in
the Philippines. In the first place, the reinsured, the
liabilities insured and the risks originally underwritten
by Commonwealth Insurance Co., upon which the
reinsurance premiums and indemnity were based,
were all situated in the Philippines. Secondly,
contrary to appellants' view, the reinsurance
contracts were perfected in the Philippines, for
Commonwealth Insurance Co. signed them last in
Manila. The American cases cited are inapplicable to
this case because in all of them the reinsurance
contracts were signed outside the jurisdiction of the
taxing State. And, thirdly, the parties to the
reinsurance contracts in question evidently intended
Philippine law to govern. Article 11 thereof provided
for arbitration in Manila, according to the laws of the
Philippines, of any dispute arising between the
parties in regard to the interpretation of said
contracts or rights in respect of any transaction
involved. Furthermore, the contracts provided for the
use of Philippine currency as the medium of
exchange and for the payment of Philippine taxes.
An income may be earned by a corporation in the
Philippines although such corporation conducts all
its businesses abroad. Precisely, Section 24 of the
Tax Code does not require a foreign corporation to
be engaged in business in the Philippines in order
for its income from sources within the Philippines to
be taxable. It subjects foreign corporations not doing
business in the Philippines to tax for income from
sources within the Philippines. If by source of
income is meant the business of the taxpayer,
foreign corporations not engaged in business in the
Philippines would be exempt from taxation on their
income from sources within the Philippines.
2. YES, they may be withheld since they are still Income.
Appellants further contend that reinsurance
premiums not being among those mentioned in
Section 37 of the Tax Code as income from sources
within the Philippines, the same should not be
treated as such. Section 37, however, is not an all-
inclusive enumeration. It states that "the following
items of gross income shall be treated as gross
income from sources within the Philippines." It does
not state or imply that an income not listed therein is
necessarily from sources outside the Philippines.
Section 53 subjects to withholding tax various
specified income, among them, "premiums".
FINAL VERDICT: WHEREFORE, the judgment appealed from is
hereby affirmed with costs against appellants. It is so ordered.
5. PHILIPPINE AMERICAN LIFE INSURANCE COMPANY INC. v.
COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL
REVENUE
Petitioner PHILAMLIFE, a domestic corporation, entered into a
Management Services Agreement with American International
Reinsurance Co. (AIRCO eventually AIGI), a non-resident foreign
corporation, agreeing to conduct specific technical (i.e. analyze,
advice, recommend, etc.) services in favor of PHILAMLIFE on the
ground that AIGI, being a non-resident foreign corporation which
rendered such services abroad cannot be taxed under Philippine tax
laws. The court ruled that under Section 37 of NIRC, services
rendered by AIGI fall under the expanded definition of “Royalties”;
thus, making it fall under the purview Philippine tax laws.
Recit-ready
FACTS:
Petitioner PHILAMLIFE, a domestic corporation, entered into
a Management Services Agreement with American
International Reinsurance Co. (AIRCO), a non-resident
foreign corporation with principal place of business in
Pembroke, Bermuda.
AIRCO agreed to undertake, for a fee of not more than
$250,000.00 per annum, the following services:
o Reporting, analyzing, and recommending investment
opportunities
o Underwriting and Marketing
o Providing scholarship programs for PHILAMLIFE
personnel
o Providing seminars, training courses and other
educational programs for underwriters
o Assuming foreign currency obligations on behalf of
PHILAMLIFE personnel
o Etc.
30SEP1978: AIRCO merged with American International
Group Inc. (AIGI), with the latter as the successor-in-interest
in AIRCO’s Management Services Agreement with
PHILAMLIFE
08NOV1980: Respondent CIR, issued a tax credit memo in
favor of PHILAMLIFE in the amount of P643,125.00
representing excess withholding tax on remittances to AIGI
for services rendered abroad
On the basis of the said issuance, PHILAMLIFE now wishes
to make another claim for an amount exactly the same as
that awarded for the same reason of erroneous payment
Without waiting for a resolution from respondents,
PHILAMLIFE filed the same claim with the honorable Court
of Tax Appeals
During the pendency of the CTA case, respondent denied
the request for a refund for the amount of P643,125.00 and
cancelled the earlier issued tax credit memo for the same
amount; thus assessing the latter for a deficiency for the
same amount
Without protesting the assessment, PHILAMLIFE filed with
CTA another case, now seeking the annulment of the said
assessment
CTA ruled in favor of respondent; hence, the instant petition
ISSUES:
5. Whether or not compensation for advisory services
performed abroad by the personnel of a non-resident
foreign corporation not doing business in the
Philippines (AIGI) is subject to Philippine’s withholding
income tax.
6. Whether or not Commissioner is barred by prescription,
laches, estoppel, or equitable considerations in cancelling
the previous tax credit memo more than 5 years thereafter.
HELD & RATIO:
4. NO MERIT in this petition.
Section 37: Income from Services within the
Philippines:
o Gross Income from sources within the
Philippines
a. Rentals and Royalties – “…from
properties located in the Philippines or
from any interest in such property,
including:
i. The supply of scientific,
technical, industrial or
commercial knowledge or
information;
ii. Technical advice, assistance or
services rendered in
connection with the technical
management and
administration of any scientific,
industrial or commercial
undertaking, venture or
scheme
Scrutinizing the Management Services Agreement
undertaken by the petitioner, the services
enumerated therein could easily fall under the
expanded definition of royalties. Basically, the
services call for the supply by AIGI of technical
information and commercial information, knowledge,
advice or assistance in connection with technical
management or administration of an insurance
business – which constitutes as a commercial
undertaking. Therefore, the income derived from
such services under the management contract shall
be considered as income from services within the
Philippines and shall pay a tax of 35% of the gross
income received, AIGI being a non-resident foreign
corporation not engaged in trade or business in the
Philippines
In our jurisprudence, the test of taxability is “source”
and the source of an income is ‘that activity’ which
produced the income. It is not the presence of any
property from which one derives rentals and
royalties that is controlling, but rather that expanded
definition of “royalties” as hereinabove quoted.
With regard to the second issue raised, as ruled in
the case of Commissioner of Internal Revenue v.
Proctor and Gamble Philippine Manufacturing
Corporation, the errors or omissions of certain
administrative officers should never be allowed to
jeopardize the government’s financial position.
FINAL VERDICT: Petition is DENIED.
Notes/ Source:
6. COMMISSIONER OF INTERNAL REVENUE v. JULIANE BAIER-
NICKEL, as represented by Marina Q. Guzman (Attorney-in-fact)
G.R. No. 153793 August 29, 2006
Note: There seems to be a little problem with the facts in the PM
Reyes notes. It was actually the CIR’s contention (not
“A”/Baier-Nickel’s) that the source is the place of payment of
income. “A”/Baier-Nickel’s contention was actually correct but
was not granted refund because of lack of evidence.)
REYES NOTES:
Q: A, a non-resident citizen (note that in the actual case, “A”/Baier-
Nickel is a non-resident German, hence a non-resident alien), was
engaged by a domestic corporation as a commission agent. A will
receive a sales commission on all sales actually concluded. A argues
that the income is not taxable as A does not reside in the Philippines
and that the place of payment of the income is outside the
Philippines. Is A’s contention correct?
NO. The source of an income is the property, activity or service
that produced the income. With respect of rendition of labor or
personal service, as in the instant case, it is the place where the
labor or service is performed that determines the source of
income. There is therefore no merit in A’s interpretation which
equates source of income in labor or personal service with the
residence of the payor or the place of payment of the income.
CASE:
Juliane Baier-Nickel, a non-resident German citizen, is the
President of JUBANITEX, Inc., a domestic corporation. Incidentally,
she was also appointed by the corporation as a commission agent.
It was agreed that she will receive sales commission on all sales
actually concluded and collected through her efforts. Jubanitex
withheld the tax from her sales commission and remitted the same to
BIR. Baier-Nickel now claims for refund of the amount alleged to
have been mistakenly withheld and remitted by JUBANITEX to the
BIR. The issue here is whether respondent’s sales commission
income is taxable in the Philippines.
Note: Since Baier-Nickel is a non-resident alien, the sales
commission must be considered to be earned within the Philippines
to be subject to tax.
CIR: The commission is taxable in the Philippines because the
source thereof is JUBANITEX, a domestic corporation located in the
City of Makati.
Baier-Nickel: The services were rendered in Germany, hence an
income earned without/outside the Philippines.
SC held that "source of income" relates to the property, activity or
service that produced the income. With respect to rendition of
labor or personal service, as in the instant case, it is the place
where the labor or service was performed that determines the
source of the income. There is therefore no merit in CIR’s
interpretation which equates source of income in labor or personal
service with the residence of the payor or the place of payment of the
income. However, Baier-Nickel failed to prove with substantial
evidence that the sale transactions were actually consummated
in Germany or that her appointment as commission agent
is exclusively for Germany and other European markets. She
failed to discharge the burden of proving that her income was from
sources outside the Philippines and exempt from the application of
our income tax law. Hence, the claim for tax refund should be
denied.
FACTS:
Juliane Baier-Nickel, a non-resident German citizen, is the
President of JUBANITEX, Inc., a domestic corporation
engaged in "[m]anufacturing, marketing on wholesale only,
buying or otherwise acquiring, holding, importing and
exporting, selling and disposing embroidered textile
products."
The corporation appointed and engaged the services of
respondent as commission agent. It was agreed that
respondent will receive 10% sales commission on all sales
actually concluded and collected through her efforts.
In 1995, Baier-Nickel received the amount of P1,707,772.64,
representing her sales commission income from which
JUBANITEX withheld the corresponding 10% withholding tax
and remitted the same to the BIR.
Baier-Nickel filed a claim to refund the amount of
P170,777.26 alleged to have been mistakenly withheld and
remitted by JUBANITEX to the BIR.
Baier-Nickel contended that her sales commission income is
not taxable in the Philippines because the same was a
compensation for her services rendered in Germany and
therefore considered as income from sources outside the
Philippines.
ISSUE: Whether or not respondent’s sales commission income
is taxable in the Philippines.
HELD & RATIO:
Relevant Tax Code provisions:
Under the NIRC, non-resident aliens, whether or not engaged in
trade or business, are subject to Philippine income taxation on their
income received from all sources within the Philippines. Thus, the
keyword in determining the taxability of non-resident aliens is the
income’s "source."
SEC. 42. x x x
(A) Gross Income From Sources Within the Philippines. x x x
xxxx
(3) Services. – Compensation for labor or personal services
performed in the Philippines;
xxxx
(C) Gross Income From Sources Without the Philippines. x x x
xxxx
(3) Compensation for labor or personal services performed without
the Philippines;
CIR’s contention: The income earned by respondent is taxable in
the Philippines because the source thereof is JUBANITEX, a
domestic corporation located in the City of Makati. It thus implied that
source of income means the physical source where the income came
from. It further argued that since respondent is the President of
JUBANITEX, any remuneration she received from said corporation
should be construed as payment of her overall managerial services
to the company and should not be interpreted as a compensation for
a distinct and separate service as a sales commission agent.
Baier-Nickel’s contention: The income she received was payment
for her marketing services. She contended that income of
nonresident aliens like her is subject to tax only if the source of the
income is within the Philippines. Source, according to respondent is
the situs of the activity which produced the income. And since the
source of her income were her marketing activities in Germany, the
income she derived from said activities is not subject to Philippine
income taxation.
SC Ruling:
The "source of income" relates to the property, activity or
service that produced the income. With respect to
rendition of labor or personal service, as in the instant
case, it is the place where the labor or service was
performed that determines the source of the income.
There is therefore no merit in petitioner’s interpretation which
equates source of income in labor or personal service with
the residence of the payor or the place of payment of the
income.
Having disposed of the doctrine applicable in this case, the
Court will now determine whether respondent was able to
establish the factual circumstances showing that her income
is exempt from Philippine income taxation.
o What she presented as evidence to prove that she
performed income producing activities abroad, were
copies of documents she allegedly faxed to
JUBANITEX and bearing instructions as to the sizes
of, or designs and fabrics to be used in the finished
products as well as samples of sales orders
purportedly relayed to her by clients. However,
these documents do not show whether the
instructions or orders faxed ripened into
concluded or collected sales in Germany. At the
very least, these pieces of evidence show that while
respondent was in Germany, she sent
instructions/orders to JUBANITEX. As to whether
these instructions/orders gave rise to
consummated sales and whether these sales
were truly concluded in Germany, respondent
presented no such evidence.
o Baier-Nickel presented no contracts or orders signed
by the customers in Germany to prove the sale
transactions therein.
o Furthermore, Baier-Nickel presented no evidence to
prove that JUBANITEX does not sell embroidered
products in the Philippines and that her appointment
as commission agent is exclusively for Germany
and other European markets.
Baier-Nickel thus failed to discharge the burden of
proving that her income was from sources outside the
Philippines and exempt from the application of our
income tax law. Hence, the claim for tax refund should
be denied.
FINAL VERDICT: WHEREFORE, the petition is GRANTED.
Notes/ Source: Original Digest
7. A. SORIANO Y CIA v. COLLECTOR OF INTERNAL REVENUE
Source of Income Rules
CASE:
Petitioner was engaged in the business of selling surplus goods
acquired from the FLC. Part of the surplus goods consisted of
tractors which were in the various military bases or depots in the
Philippines. UAC’s representative, Gibson, contracted to buy tractors
from the petitioner, to be delivered f.a.s. (freight alongside ship)
Manila. The tractors were delivered by petitioner to the pier in Manila
by means of barges as soon as notice was received from the
representative of its foreign buyer that a carrying vessel was ready.
The PRC (affiliate of foreign buyer) shipped the 57 tractors acquired
from petitioner from the port of Manila UAC at Dares Salaem, East
Africa. The issue in this case is whether or not petitioner is liable
for the payment of percentage or sales tax on its gross sales of
the 57 tractors in question under the provisions of Sec. 186 of
the NIRC. The SC held that petitioner is liable for the payment of the
taxes. One who acquires title to surplus equipment found in U. S.
army bases or installations within the Philippines by purchase, and
then brings them out of those bases or depots, is an importer, and
sales made by him by such surplus goods to the general public are
taxable under sections 185 and 186 of the Tax Code.
Section 186. Percentage tax on sales of other articles.—There is
levied, assessed and collected once only on every original sale,
barter, exchange, and similar transaction intended to transfer
ownership of, or title to, the articles not enumerated in sections 184
and 185, a tax equivalent to five per centum of the gross selling price
or gross value in money of the articles so sold, bartered, exchanged,
or transferred, such tax to be paid by the manufacturer, producer, or
importer; . . .. (Emphasis supplied)
FACTS:
In 1947, petitioner was engaged in the business of selling
surplus goods acquired from the Foreign Liquidation
Commission (FLC)
o pursuant to an agreement with the US Government whereby
petitioner undertook to rehabilitate the Veterans
Administration Building for and in consideration of over a
million pesos worth of surplus goods
Part of the surplus goods consisted of tractors which were then
in the various U. S. military bases or depots in the Philippines.
Petitioner had yards in Manila (Sta. Mesa and Pieco), where
some of the surplus goods were stored, and those which were
defective reconditioned.
United Africa Co., Ltd. (UAC) sent its representative, Gibson, to
the Philippines to look into the availability of tractors for sale in
the Philippines.
Gibson contracted to buy tractors from the petitioner, to be
delivered f.a.s. Manila, in good working condition and capable of
running off lighters under their own power.
Taylor, a tractor expert, was employed by the foreign company to
select, inspect and test the tractors before delivery.
Taylor took the serial numbers of the tractors which he wanted,
and gave the list thereof to the petitioner, who then secured from
the FLC the purchase invoices and other documents for the
immediate release of the tractors.
The tractors were then removed by petitioner to its Pieco Yard,
where they were tested by Taylor.
Those found to be in good condition were approved by Taylor.
Petitioner presented to him the sales invoices for his signature,
stamping his approval thereon.
24 of the tractors were found defective and so were brought to
petitioner's Sta. Mesa Yard for reconditioning.
Upon approval of each invoice, the same was presented by
petitioner to the Philippine Refining Company, Inc., (PRC) an
affiliate of the foreign buyer, for payment of the purchase price.
The PRC would in turn notify the National City Bank of New York
and the Hongkong and Shanghai Banking Corporation, Manila,
 where the UAC had dollar deposits, to make payment of
petitioner's invoices.
The tractors were delivered by petitioner to the pier in Manila by
means of barges as soon as notice was received from the
representative of its foreign buyer that a carrying vessel was
ready.
The PRC shipped the 57 tractors acquired from petitioner from
the port of Manila UAC at Dares Salaem, East Africa.
The total value of the tractors was P757,000.
However, due to certain defects of some of them upon reaching
Africa, the sum of P4,959.19 was reimbursed by petitioner to its
foreign buyer by credit memo.
ISSUE: Whether or not petitioner is liable for the payment of
percentage or sales tax on its gross sales of the 57 tractors under
the provisions of Sec. 186 of the NIRC. (YES, petitioner is liable.)
HELD & RATIO:
Petitioner is liable for the payment of percentage or sales tax.
BIR’s theory: Petitioner imported the tractors from the army
bases; that they were subsequently sold to its foreign buyer
within the Philippines; and that title passed upon delivery to the
carrier f.a.s. Manila
Go Chen Tee vs. Meer and Saura Import and Export Co. vs.
Meer: One who acquires title to surplus equipment found in U. S.
army bases or installations within the Philippines by purchase,
and then brings them out of those bases or depots, is an
importer, and sales made by him by such surplus goods to the
general public are taxable under sections 185 and 186 of the Tax
Code.
Petitioner’s claim #1: it did not import the 57 tractors in
question for the FLC because title to the same passed to its
foreign buyer while the goods were still at the foreign bases, and
that they passed Philippine territory merely in transit to pier,
Manila, where they were delivered f.a.s.; hence its sale of the
tractors was not domestic and therefore not liable for the
payment of sales tax
o Not supported by the records
o Where the contract is to deliver goods f.a.s, the property
passes on delivery at the wharf or the dock. Otherwise
stated, delivery to the carrier is delivery to the buyer.
o True that this rule yields to evidence of a contrary intent
between the parties, but there is here no proof to show that
petitioner and its foreign buyer intended otherwise, that is,
that delivery and the passing of title to its buyer should take
place right in the army bases where the tractors were
located.
o Petitioner itself has admitted that Taylor has no power or
authority whatever to do so.
o Other undisputed facts in the record which force the
conclusion that title to the tractors in question passed to
petitioner's buyer not at the bases, but only at pier, Manila—
1. It was petitioner who paid for the delivery charges from
the different bases to the pier, pursuant to the tax in "fob"
or "f.a.s." sales that "the seller pays all charges and is
subject to risk until the goods are placed alongside the
'vessel'
2. The tractors were described in petitioner's invoices as
bearing certain numbers followed by the phrase "Our
Unit Sta. Mesa" or "Our Unit Pieco", showing that the
tractors were first brought to petitioner's yards and
numbered accordingly, in the same way that all goods
found and stored in these yards were numbered, and it
was only after they had passed petitioner's yards that
they were delivered to the buyer.
3. Two of petitioner's invoices stated that the tractors were
inspected and accepted at Pieco Yard and/or Sta. Mesa
Yard, which disproves petitioner's contention that Tex
Taylor tested and approved of them right in the bases.
4. Petitioner’s own witness Epimaco Gonzales admitted
that it was only at Pieco Yard that Taylor inspected and
tested the tractors
Petitioner’s claim #2: Goods in question did not acquire a
taxable situs in the Philippines because they merely passed
Philippine territory in transit and that they were not intended for
local use but for exportation to a foreign country.
o The tax in dispute is one on transaction (sales) and not a tax
on the property sold.
 o The sale of the tractors was consummated in the Philippines,
for title was transferred to the foreign buyer at the pier in
Manila; hence, the situs of the sale is Philippines and it is
taxable in this country.
Petitioner’s claim #3: The repeal of the consignment or "export
tax" under Sec. 187 of the Internal Revenue Code shows the
intention of the legislature to exempt all exports from tax.
o The consignment tax formerly imposed on exports by section
187 of the Tax Code is different from the sales tax imposed
by Art. 186, which has not been repealed.
Petitioner’s claim #4: To tax one who sells goods intended for
export would be to nullify the legislative intent behind the repeal
of the tax on consignments abroad, which is to encourage
exports.
o The law subjects to the payment of the sales tax not to the
buyer who intends to export what he buys, but the seller,
because such sale is domestic and therefore liable for the
payment of sales tax in this country.
o SolGen: it is only the exportation of locally produced or
manufactured products, and not every kind of exportation,
that Congress wanted to encourage and promote
o SolGen: our country needed then, and still needs now,
tractors for the development of our own agriculture, so that
the sale of such tractors to foreign buyers for a profit, thereby
depriving our own countrymen of their use in the
development of our own agriculture and increase of our
production, hardly justifies the tax exemption that petitioner
claims.
FINAL VERDICT: The decision appealed from is affirmed, with costs
against petitioner. So ordered.
8. QUILL CORP. vs. NORTH DAKOTA
Source of Income
REYES NOTES:
Quill Corp is an office supply retailer with no physical presence in
North Dakota but it has a licensed computer software program that
its customers in North Dakota use for checking Quill’s current
inventories and for placing orders directly. North Dakota attempted to
impose a “use tax” on Quill. Is Quill liable for the tax?
NO (But ‘YES’ in PM Reyes, which contradicts the ruling). In QUILL
CORP V. NORTH DAKOTA [504 US 298, MAY 26, 1992], the US
Supreme Court ruled that there must be physical presence in a state
for the corporation to be liable for sales and use taxes. It applied its
ruling in NATIONAL BELLAS HESS V. DEPARTMENT OF
REVENUE OF ILLINOIS [386 US 753] where it held that a seller
whose only connection with customers in the State is by common
carrier or the mail lacked the requisite minimum contacts with the
State. Thus, such vendors are free from state-imposed duties to
collect sales and use taxes. Nevertheless, the US Supreme Court
opined that if interstate commerce would be subject to intolerable or
undesirable burdens because of this, Congress has the power to
legislate make such vendors liable for sales and use taxes.
CASE:
Quill is a corporation engaged in selling office equipment and
supplies through mail-order. It did not have offices or warehouses in
North Dakota. North Dakota imposed a ‘use tax’ upon property
purchased within the state, requiring every retailer to collect tax from
the consumer and remit it to the State. Subsequently, the state
amended the statutory definition of “retailer” to include those who
regularly solicit a consumer market”. Thus, Quill, being a mail-order
company, was subjected to tax even if it did not maintain a property
or personnel in North Dakota. Quill contends that this would violate
the Federal Constitution’s Commerce Clause and the due process
clause provided by the Fourteenth Amendment.
Whether or not Quill is liable for the ‘use tax’.
NO, Quill is not liable. The Court ruled that a business must have a
physical presence in a state for that state to require it to collect sales
taxes. The due process clause did not bar the enforcement of the tax
against Quill BUT a vendor, whose only connection with customers in
a taxing state is by common carrier or the United States mail, is free
from state-imposed duties to collect sales and use taxes, because
such a vendor lacks the substantial nexus with the taxing state
required by the commerce clause. The Supreme Court, however,
conceded that Congress is free to disagree with the ruling and is in a
better position to decide whether, when, and to what extent the
states may burden interstate mail-order concerns with a duty to
collect use taxes. The Congress may legislate for this purpose
anytime.
FACTS:
Quill is a Delaware corporation. It is a mail-order house with
offices and warehouses in three other states, had no offices
or warehouses in North Dakota and no employees who
worked or resided in North Dakota.
Quill sells office equipment and supplies; it solicits business
through catalogs and flyers, advertisements in national
periodicals, and telephone calls. It delivers all of its
merchandise to its North Dakota customers by mail or
common carrier from out of state locations.
North Dakota imposes a use tax upon property purchased
for storage, use or consumption within the State. North
Dakota requires every "retailer maintaining a place of
business in" the State to collect the tax from the consumer
and remit it to the State.
In 1987 North Dakota amended the statutory definition of the
term "retailer" to include "every person who engages in
regular or systematic solicitation of a consumer market in the
state." Thus, mail order companies that engage in such
solicitation have been subject to the tax even if they maintain
no property or personnel in North Dakota.
The State, through its Tax Commissioner, filed this action to
require Quill to pay taxes (as well as interest and penalties)
on all such sales made after July 1, 1987.
Quill contends that the use tax statute, as applied to the
mail-order house, violated the Federal Constitution's
commerce clause (Art I, 8, cl 3) and the due process clause
as provided in the Fourteenth Amendment.
The district court, ruling in favor of Quill, found that North
Dakota had failed to establish a sufficient nexus between
Quill and the state because it was not shown that it had
spent tax revenues for the benefit of the mail order business.
The Supreme Court of North Dakota, reversing on appeal,
held that neither the commerce clause nor the due process
clause required a physical-presence nexus with the state as
a prerequisite to the legitimate exercise of state power over
an out-of-state retailer. Furthermore, Quill’s economic
presence in North Dakota depended on services and
benefits provided by the state and therefore generated a
constitutionally sufficient nexus to justify imposition of the
duty to collect the use tax
ISSUES:
7. Whether or not Quill is subject to ‘use tax’ despite no
physical presence in North Dakota.
HELD & RATIO
5. NO. A business must have a physical presence in a state
for that state to require it to collect sales taxes.
The due process clause did not bar enforcement of
the use tax against Quill, given that:
o (a) the mail-order house had purposefully
directed its activities at North Dakota
residents,
o (b) the magnitude of such contacts was
more than sufficient for due process
purposes, and
o (c) the use tax was re- lated to the benefits
that the mail-order house received from
access to the state
BUT a vendor whose only connection with
customers in a taxing state is by common carrier
or the United States mail is free from state-
imposed duties to collect sales and use taxes,
because such a vendor lacks the substantial
 nexus with the taxing state required by the
commerce clause.
Because Congress is free to disagree with the
Supreme Court's evaluation of the burdens that use
taxes impose on interstate commerce, Congress
remained free to decide whether, when, and to what
extent the states may burden interstate mail-order
concerns with a duty to collect use taxes.
o “This aspect of our decision is made easier
by the fact that the underlying issue is not
only one that Congress may be better
qualified to resolve, but also one that
Congress has the ultimate power to resolve.
No matter how we evaluate the burdens that
use taxes impose on interstate commerce,
Congress remains free to disagree with our
conclusions.”
FINAL VERDICT: The Supreme Court of North Dakota’s decision is
REVERSED and REMANDED for further proceedings.
Notes/ Source:
A use tax is a type of excised tax levied in the United States upon
otherwise "tax free" tangible personal property purchased by a
resident of the assessing state for use, storage or consumption of
goods in that state (not for resale), regardless of where the purchase
took place
Note that, as of this updated version, the BIR plans to impose a sales
tax on online retailers in the opinion that such sellers are no different
from merchants who sell their goods in physical stores. A RR on the
matter is forthcoming. (from PM Reyes reviewer, footnotes)
9. VODAFONE INTERNATIONAL HOLDINGS VS. UNION OF
INDIA
Supreme Court of India, Civil Appeal No. 733 of 2012,
January 20, 2012
(Source of Income Rules)
REYES NOTES:
Q18.7. Vodafone International Holdings (VIH), a corporation in
the Netherlands, acquired a controlling interest of CGP
holdings, a company in the Cayman Islands. By virtue of this
controlling interest, VIH acquired a 52% stake in Hutchinson
Essa Limited (HEL) in India from Hutchinson Telecom
International Limited (HTIL). Simply stated, VIH acquired control
over CGP and its subsidiaries, including HEL. The Indian tax
authorities contended that the transfer of shares was subject to
income tax. VIH argues that the transfer of shares took place
outside the Indian taxing jurisdiction, and, hence, is not taxable.
Which contention is correct?
The contention of VIH was held to be correct. In VODAFONE
INTERNATIONAL HOLDINGS B.V. V. UNION OF INDIA
(SUPREME COURT OF INDIA, CIVIL APPEAL NO. 733 OF 2012,
JANUARY 20, 2012), the Indian Supreme Court ruled that VIH had
no liability to withhold tax as the transaction was between two
nonresidents with no taxable presence in India.
Under Section 9(1) of the Income Tax Act of India, all income
accruing or arising, whether directly or indirectly through transfer of
capital assets situated in India shall be deemed to accrue or arise in
India.
The Supreme Court stated that the section clearly applied to a
transfer of capital asset situated in India and could not be expanded
to cover indirect transfers of capital assets or property situated in
India. The words ―directly or indirectly‖ go with the income and not
with the transfer of a capital asset.
FACTS:
 In February 2007, Vodafone International Holdings B.V
(Vodafone or VIH), a Dutch entity, had acquired 100 percent
shares in CGP (Holdings) Limited (CGP), a Cayman
Islands company for USD 11.1 billion from Hutchinson
Telecommunications International Limited (HTIL).
CGP, through various intermediate companies/ contractual
arrangements controlled 67 percent of Hutchison Essar
Limited (HEL), an Indian company.
The acquisition resulted in Vodafone acquiring control over
CGP and its downstream subsidiaries including, ultimately,
HEL.
HEL was a joint venture between the Hutchinson group and
the Essar group. It had obtained telecom licences to provide
cellular telephony in different circles in India from November
1994.
The India tax department issued a show-cause notice to
Vodafone to explain why tax was not withheld on payments
made to HTIL in relation to the above transaction. The tax
department contended that the transaction of transfer of
shares in CGP had the effect of indirect transfer of assets
situated in India.
ISSUE:
8. Whether or not the transfer of shares is taxable?
• In connection with the above, the Supreme Court
observed that:
existence of three elements, viz, transfer, existence of a capital asset
and situation of such asset in India.
t used the words ‘indirect transfer’ in Section
9(1)(i) of the Act. If the word ‘indirect’ is read into Section 9(1)(i) of
the Act, then the phrase ‘capital asset situate in India’ would be
rendered nugatory.
ok through’ provisions,
and it cannot be extended to cover indirect transfers of capital
assets/property situated in India.
taxation of off-shore share transactions indicate that indirect transfers
are not covered by Section 9(1)(i) of the Act.
giving purposive interpretation, particularly if the result of such
interpretation is to transform the concept of chargeability which is
also there in Section 9(1)(i) of the Act.
• Accordingly, the Supreme Court concluded that the transfer of the
share in CGP did not result in the transfer of a capital asset situated
in India, and gains from such transfer could not be subject to Indian
tax.

NO. The transaction was between two non-residents with no

taxable presence in India.

At the heart of the controversy was the interpretation of Section

9(1)(i) of the Act. As per the said section, inter alia, income accruing
or arising directly or indirectly from the transfer of a capital asset
situated in India is deemed to accrue/arise in India in the hands of a
non-resident.

5. Deductions
Sections 34-60, Tax Code
Business Expenses
RA 10028 (Sec. 3 & 14 only)
RA 8502
RA 8525 (Sec. 1 to 5 only)
RA 9999
10. CIR V. ISABELA CULTURAL CORPORATION
G.R. No. 172231 February 12, 2007
Deductions
REYES NOTES:
ABC Corp failed to claim expenses for professional services that
accrued in past years. May ABC Corp still claim these expenses as
deductions?
No. In CIR v Isabela Cultural Corp, Isabela Corp [Feb. 12, 2007]
failed to claim the expenses for professional services that accrued in
1984 and 1985 during the said years. Instead it sought to claim them
as deductions during the taxable year of 1986. The SC held that one
of the requisites for deductibility of a business expense is that it must
have been paid or incurred during the taxable year. Hence, the
professional fees should have been claimed as deductions during
the years where they were paid or incurred.
CASE:
ICC was assessed for deficiency income tax for the taxable
year 1986 due to BIR’s disallowance of ICC’s claimed expense
deductions for professional and security services billed to and paid
in 1986. CA held that although the professional services were
rendered to ICC in 1984 and 1985, the cost of the services was not
yet determinable at that time, hence, it could be considered as
deductible expenses only in 1986 when ICC received the billing
statements. CIR contended that since ICC uses the accrual method
of accounting, the professional fees expense that accrued in 1984
and 1985 should have been declared as deductions from income
during the said years, and the failure of ICC to do so bars it from
claiming said expenses as deduction for the taxable year 1986.
W/N CA correctly sustained the deduction of the expenses
for professional and security services from ICC’s gross income.
NO, ICC failed to discharge the burden of proving that the
claimed expense deductions for the professional services were
allowable deductions for the taxable year 1986.
Accounting methods for tax purposes comprise a set of rules
for determining when and how to report income and deductions. In
the instant case, ICC used the accrual method. A Revenue Audit
Memorandum Order provides that under the accrual method of
accounting, expenses not being claimed as deductions by a
taxpayer in the current year when they are incurred cannot be
claimed as deduction from income for the succeeding year.
Amounts of income accrue where the right to receive them
become fixed, where there is created an enforceable liability.
Similarly, liabilities are accrued when fixed and determinable in
amount, without regard to indeterminacy merely of time of payment. •
The propriety of an accrual must be judged by the facts that
a taxpayer knew, or could reasonably be expected to have known, at
the closing of its books for the taxable year. Taxpayer bears the
burden of proof of establishing the accrual of an item of income or
deduction.
ICC simply relied on the defense of delayed billing, which
under the circumstances, is not sufficient to exempt it from being
charged with knowledge of the reasonable amount of the
expenses for legal and auditing services.
FACTS:
Isabela Cultural Corp (ICC), a domestic corporation,
received an Assessment Notice for deficiency income tax
and deficiency expanded withholding tax both for the taxable
year 1986.
The deficiency income tax of P333,196.86 arose from:
o BIR’s disallowance of ICC’s claimed expense
deductions for professional and security services
billed to and paid by ICC in 1986, to wit:
Audit Expenses for 1985;
Legal Fees for 1984 and 1985
 Expenses for security services for April and
May 1986
CA affirmed the CTA decision and held that although the
professional services (legal and auditing services) were
rendered to ICC in 1984 and 1985, the cost of the services
was not yet determinable at that time, hence, it could be
considered as deductible expenses only in 1986 when ICC
received the billing statements for said services.
CIR contended that since ICC is using the accrual method of
accounting, the expenses for the professional services that
accrued in 1984 and 1985, should have been declared as
deductions from income during the said years, and the
failure of ICC to do so bars it from claiming said expenses as
deduction for the taxable year 1986.
ISSUE:
1. W/N CA correctly sustained the deduction of the
expenses for professional and security services from
ICC’s gross income for the taxable year 1986.
HELD & RATIO:
6. NO, ICC failed to discharge the burden of proving that
the claimed expense deductions for the professional
services were allowable deductions for the taxable year
1986.
The requisites for the deductibility of ordinary and
necessary trade, business, or professional
expenses, like expenses paid for legal and auditing
services, are:
o (a) the expense must be ordinary and
necessary;
o (b) it must have been paid or incurred during
the taxable year;
o (c) it must have been paid or incurred in
carrying on the trade or business of the
taxpayer; and
o (d) it must be supported by receipts, records
or other pertinent papers.
The requisite that it must have been paid or incurred
during the taxable year is further qualified by Sec 45
of the NIRC which states that: "the deduction …
shall be taken for the taxable year in which ‘paid or
accrued’ or ‘paid or incurred’, dependent upon the
method of accounting upon the basis of which
the net income is computed xxx".
Accounting methods for tax purposes comprise a set
of rules for determining when and how to report
income and deductions. In the instant case, ICC
used the accrual method.
Revenue Audit Memorandum Order No. 1-2000
(RAMO) provides that under the accrual method of
accounting, expenses not being claimed as
deductions by a taxpayer in the current year
when they are incurred cannot be claimed as
deduction from income for the succeeding year.
o Thus, a taxpayer who is authorized to
deduct certain expenses and other allowable
deductions for the current year but failed to
do so cannot deduct the same for the next
year.
The accrual method relies upon the taxpayer’s right
to receive amounts or its obligation to pay them, in
opposition to actual receipt or payment, which
characterizes the cash method of accounting.
o Amounts of income accrue where the right
to receive them become fixed, where there
is created an enforceable liability. Similarly,
liabilities are accrued when fixed and
determinable in amount, without regard
to indeterminacy merely of time of
payment.
The accrual of income and expense is permitted
when the all-events test has been met, to wit:
o (1) fixing of a right to income or liability to
pay; and
o (2) the availability of the reasonable
accurate determination of such income or
liability.
The all-events test requires the right to income or
liability be fixed, and the amount of such income or
liability be determined with reasonable accuracy.
However, the test does not demand that the
amount of income or liability be known
absolutely, only that a taxpayer has at his disposal
the information necessary to compute the amount
with reasonable accuracy.
The propriety of an accrual must be judged by the
facts that a taxpayer knew, or could reasonably be
expected to have known, at the closing of its books
for the taxable year. Taxpayer bears the burden of
proof of establishing the accrual of an item of
income or deduction.
Since a deduction for income tax purposes partakes
of the nature of a tax exemption, then it must be
strictly construed.
In this case, the expenses for professional fees
consist of expenses for legal and auditing services.
o Legal expenses pertain to the 1984 and
1985 legal and retainer fees of its counsel
since the 1960s.
o From the nature of the claimed
deductions and the span of time during
which the firm was retained, ICC can be
expected to have reasonably known the
retainer fees charged by the firm as well
as the compensation for its legal
services.
o ICC simply relied on the defense of delayed
billing by the firm and the company, which
under the circumstances, is not sufficient to
exempt it from being charged with
knowledge of the reasonable amount of the
expenses for legal and auditing services.
o As for the audit expenses for 1985 cannot
be validly claimed as expense
deductions in 1986 because ICC failed to
present evidence showing that even with
only "reasonable accuracy” it cannot
determine the professional fees that SGV &
Co. would charge for its services.
ICC thus failed to discharge the burden of
proving that the claimed expense deductions for
the professional services were allowable
deductions for the taxable year 1986. Hence, per
RAMO, they cannot be validly deducted from its
gross income for the said year and were
therefore properly disallowed by the BIR.
As to the expenses for security services, the records
show that these expenses were incurred by ICC in
1986 and could therefore be properly claimed as
deductions for the said year.
FINAL VERDICT: Petition is PARTIALLY GRANTED. The Decision
of the CA is AFFIRMED with the MODIFICATION that Assessment
Notice which disallowed the expense deduction of ICC for
professional and security services is declared valid only insofar as
the expenses for the professional fees are concerned.
11. CIR v. GENERAL FOODS (PHILS.), INC
Deductions; Business expenses;
Expenses paid to create goodwill and reputation are not business
expenses but capital expenditures.
CASE:
General Foods filed its income tax return and claimed as deduction
the amount of P9.4M for the media advertising for its product Tang.
CIR disallowed 50% or P4.7M of the deduction claimed by
respondent and assessed respondent for deficiency income taxes.
CTA affirmed CIR’s decision and held that the said expenses were
not business expenses but capital expenditures, hence, not
deductible under NIRC.
Conflict of the case: CA reversed CTA’s decision and ruled that
deduction should be allowed.
SC: The media advertising expense for TANG by respondent
corporation was a capital expenditure, paid in order to create
“goodwill and reputation” for respondent corporation and/or its
products. Thus, the same was not deductible.
A. To be deductible from gross income, the subject advertising
expense must comply with the requisites provided by the NIRC.
B. All requisites were satisfied except for the first one. Even if it
is necessary, the advertising expense cannot be considered an
ordinary expense deductible under NIRC because it failed the
two conditions: it was not reasonable and the amount was
incurred to create goodwill for the product of respondent.
C. Respondent corporation’s venture to protect its brand
franchise was tantamount to efforts to establish a reputation.
This was akin to the acquisition of capital assets and therefore
expenses related thereto were not to be considered as business
expenses but as capital expenditures.
FACTS:
General Foods (Respondent Corporation)
o engaged in the manufacture of beverages such as
TANG, CALUMET, and KOOL-AID
o filed its income tax return
o and claimed as deduction, among other business
expenses, the amount of P9.4M for media
advertising for TANG.
CIR:
o Disallowed 50% or P4.7M of the deduction claimed
by respondent
o And assessed respondent for deficiency income
taxes
General Foods filed a MR but was denied.
CTA dismissed respondent's appeal:
o Advertisement of a single product was unreasonable
considering the grave economic situation after the
Aquino assassination, strong deterioration of the
purchasing power of the Philippine peso, etc.
o Such expenditure was incurred to create or maintain
some form of good will for the taxpayer's trade or
business
o Good will is generally used to denote the benefit
arising from connection and reputation
o Efforts to establish reputation are akin to acquisition
of capital assets, therefore, expenses related thereto
are not business expenses but capital expenditures
o Hence, not deductible.
CA reversed CTA's decision. (CONFLICT)
o It has not been sufficiently established that the item
it claimed as deduction is excessive
o Thus, deduction should be allowed.
ISSUES:
Was the media advertising expense for TANG paid by respondent
corporation “necessary and ordinary,” hence, fully deductible under
the NIRC?
Or was it a capital expenditure, paid in order to create “goodwill and
reputation” for respondent corporation and/or its products, which
should have been amortized over a reasonable period?
HELD & RATIO:
The media advertising expense for TANG by respondent
corporation was a capital expenditure, paid in order to create
“goodwill and reputation” for respondent corporation and/or its
products. Thus, the same was not deductible.
Deductions from income tax purposes partake of the nature
of tax exemptions; hence, if tax exemptions are strictly
construed, then deductions must also be strictly construed.
Sec. 34(A)(1) of NIRC provides:
o “There shall be allowed as deduction from gross
income all ordinary and necessary expenses paid or
incurred during the taxable year in carrying on, or
which are directly attributable to, the development,
management, operation and/or conduct of the trade,
business or exercise of a profession.”
In other words, to be deductible from gross income, the
subject advertising expense must comply with the following
requisites:
o The expense must be ordinary and necessary;
o It must have been paid or incurred during the taxable
year;
o It must have been paid or incurred in carrying on the
trade or business of the taxpayer; and
o It must be supported by receipts, records or other
pertinent papers.
Note: To be deductible, an advertising expense should not
only be necessary but also ordinary. These two requirements
must be met.
All the parties agreed that all requisites were satisfied
except, whether or not it was ordinary.
CIR maintains:
o that the subject advertising expense was not
ordinary on the ground that it failed the two
conditions set by U.S. jurisprudence:
first, “reasonableness” of the amount
incurred
and second, the amount incurred must not
be a capital outlay to create “goodwill” for
the product and/or private respondent’s
business.
o Therefore, the expense must be considered a capital
expenditure.
In the case at bar, the P9.4M claimed as media advertising
expense for TANG alone was almost one-half of its total
claim for “marketing expenses.” The subject expense for the
advertisement of a single product was inordinately large.
Therefore, even if it is necessary, it cannot be
considered an ordinary expense deductible under the
NIRC.
Advertising is generally of two kinds:
(1) advertising to stimulate the current sale of merchandise
or use of services and
(2) advertising designed to stimulate the future sale of
merchandise or use of services.
The subject advertising expense was of the second kind.
o The second type involves expenditures incurred, in
whole or in part, to create or maintain some form of
goodwill for the taxpayer’s trade or business.
Not only was the amount staggering, respondent corporation
itself also admitted that the subject media expense was
incurred in order to protect respondent corporation’s brand
franchise.
Respondent corporation’s venture to protect its brand
franchise was tantamount to efforts to establish a
reputation. This was akin to the acquisition of capital
assets and therefore expenses related thereto were not
to be considered as business expenses but as capital
expenditures.
FINAL VERDICT: Petition granted. Decision of CA is reversed.
General Foods, Inc. is ordered to pay its deficiency income tax.
12. AGUINALDO INDUSTRIES CORPORATION VS
COMMISSIONER OF INTERNAL REVENUE
REYES NOTES:
Are bonuses to employees allowable deductions from gross income?
Aguinaldo Industries sought to claim as deductions the bonuses
given to its corporate officers from the sale of one of its properties.
The SC held that the said bonuses cannot be deducted because
there is no evidence that the said officers did any work which would
be the basis of the grant of the bonuses. One of the requisites for the
deductability of bonuses is that they are given for personal services
actually rendered.
CASE:
Aguinaldo Industries Corp sold its land in Muntinlupa. When AIC filed
it income tax return, BIR examiner found out that it deducted from its
gross income the remuneration paid to corporate officers (i.e
President, VP, Board Members, etc). Deductions were reported as
part of the selling expenses in connection with the Muntinlupa sale.
Examiner disallowed deduction. SC ruled that bonuses given to the
corporate officers should not be an allowable deduction since it has
not been shown that personal services have actually been rendered
by these corporate officers.
FACTS:
Aguinaldo Industries Corp is a domestic corporation
engaged in the manufacture of fish nets (handled by FISH
NETS DIVISION), which is a tax exempt industry, and
manufacture of furniture (handled by FURNITURE
DIVISION.
Each division has a separate set of books and the incomes
of both are computed separately.
AIC acquired land in Muntinlupa as a fish nets factory site. It
subsequently found a land in Marikina Heights, which was
 more suitable. So it decided to sell the Muntinlupa land. Sale
was entered into the books of Fish Nets Division as a
miscellaneous income, distinguishing it from the tax exempt
income.
AIC filed its income tax returns for 1957. Examiner of BIR
found that the Fish Nets division deducted from its gross
income remunerations paid to corporate officers, reported as
part of selling expenses (from profits of Muntinlupa land sale)
Examiner recommended that remunerations be disallowed
as a deduction
o AIC asserted that it should be allowed because the
bonuses given to the officers are part of its by-laws
which provides that 20% of net profits from business
both from Fish nets and Furniture divisions) go the
President, VP, Board members, Sec. Gen Manager
and Asst. Gen Manager.
CTA disallowed deduction. On MR, CTA imposed 5%
surcharge and 1% interest on the deficiency assessment.
ISSUES:
9. WON the bonuses given to the corporate officers from
the sale of the Muntinlupa property should be an
allowable deduction as business expense—NO.
HELD & RATIO:
Based on Sec 30 of the NIRC, the bonuses cannot be considered
deductible expenses. The sale was carried out through a broker who
was paid commission—actual services rendered. With respect to
such, BIR did not question that deduction.
Alhambra vs CIA: whenever a controversy arises on the deductibility
for the purpose of income tax, of certain items for alleged
compensation of officers of the tax taxpayer, two questions become
materials:
a. Have “personal services” been “actually rendered”
by said officers?
b. In the affirmative case, what is the “reasonable
allowance” therefor?
As for the corporate officers, there’s no evidence that they did any
work which would be the basis of the grant of the bonuses—neither a
selling expense nor reasonable or necessary
Such decision 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 the law since allowances, like exemptions, are
matters of legislative grace.
Notes/ Source: Copied a bit from Block A 2015 Digests
Section 30(a) of NIRC: In computing net income, there shall be
allowed as deductions---
(a) Expenses: (1) IN general—All the ordinary and necessary
expenses paid or incurred during the taxable year in
carrying on any trade or business, including a reasonable
allowance for personal services actually rendered.
13. ATLAS CONSOLIDATED MINING V. CIR
Business expenses
REYES NOTES/ CASE:
ABC Corporation paid a PR firm to campaign for the sale of
ABC’s additional capital stock. Is the compensation paid to the
PR firm deductible as a business expense?
No. In ATLAS CONSOLIDATED MINING & DEVELOPMENT
CORPORATION VS. COMMISSIONER OF INTERNAL REVENUE
(JANUARY 27, 1981), the Supreme Court held that this is not
deductible because it is a capital expenditure. Expenses relating to
the recapitalization and reorganization of the corporation, promotion
expenses and commission or fees for the sale of stock
reorganization are capital expenditures.
Are litigation expenses deductible as a business expense?
No. As held in ATLAS CONSOLIDATED MINING &
DEVELOPMENT CORPORATION VS. COMMISSIONER OF
INTERNAL REVENUE (JANUARY 27, 1981), litigation expenses
incurred in defense or protection of title are capital in nature and not
deductible.
Atlas and CIR appealed the CTA decision. The issue here is
Whether or not the expenses paid for the services rendered b a
public relations firm P.K MacKer & Co. labeled as stockholders
relation service fee is an allowable deduction as business expense
under Sec. 30 (a) (1) NIRC? No. 25k is not deductible from gross
income for the purpose of income tax. Not only must the taxpayer
meet the business test, he must substantially prove by evidence or
record the deductions claimed under the law, otherwise, the same
will be disallowed. We sustain the ruling of the tax court that the
expenditure of P25,523.14 paid to P.K. Macker & Co. as
compensation for services carrying on the selling campaign in an
effort to sell Atlas' additional capital stock of P3,325,000 is not an
ordinary expense. Additionally, it is well settled that litigation
expenses incurred in defense or protection of title are capital in
nature and not deductible.
FACTS:
2 petitions for review of the decisions of the CTA
Atlas is a corporation engaged in the mining industry
registered under the law of the Philippines.
CIR assessed Atlas for tax deficiency
o P 546,295 for 1957 – it was the opinion of the
Commissioner that Atlas is not entitled to exemption
from the income ta under Sec. 4 of RA 909 because
same cover only gold mines.
New mines, and old mines which resume
operation, when certified to as such by the
Secretary of Agriculture and Natural
Resources upon the recommendation of the
Director of Mines, shall be exempt from the
payment of income tax during the first three
(3) years of actual commercial production.
Provided that, any such mine and/or mines
making a complete return of its capital
investment at any time within the said
period, shall pay income tax from that year.
o P 215, 493.96 for 1958 – covers the disallowance of
items claimed by Atlas as deductible from gross
income.
Sec. of Finance ruled that the exemption provided in RA 909
embraces all new mines and old mines whether gold or other
minerals.
o Commissioner recomputed Atlas deficiency income
tax liabilities entirely eliminating the assessment of P
546, 295. 16 for the year 1957 and for 1958 the
amount was reduced from P 215 493.96 to P 39
646.82.
o Atlas appealed to the CTA, the disallowance of
certain items (transfer agent’s fee, stockholders
relation service fee, U.S. stock listing expenses, suit
expenses, provision for contingencies) amounting to
P 159,993.91, claimed as deductible from its gross
income for 1958.
CTA – deducted the items from Atlas’ gross income, except
those denominated by Atlas as stockholders relation service
fee and suit expenses.
o Stated that Atlas’ exemption from the payment of
corporate income tax under Sec. 4 RA 909 was
good only up to the 1st qtr of 1958, hence, only ¾ of
the net taxable income of petitioner is subject to
income tax.
o Upon computation, CTA still charged Atlas an
amount of P 25, 523.14 worth of ¾ promotion fees
Both Atlas and CIR appealed form the CTA decision
Atlas:
o The amount of 25k paid in 1958 as annual public
relations expenses is a deductible expense from
gross income under Sec. 30 (a) (1) NIRC
o It was paid for the services of a public relations firm,
P.K Macker &Co., a reputable public relations
consultant in New York, US. Hence, an ordinary and
necessary business expense in order to compete
with other corporations also interested in the
investment market in the US
 CIR:
o Under Sec. 30 (a) (1) NIRC it is a requirement for an
expense to be deductible from gross income that
Atlas must have been “paid or incurred during the
year” for which it is claimed
o That in the absence of convincing and satisfactory
evidence of payment, the deduction from gross
income for the year 1958 income tax return cannot
be sustained
o That the best evidence to proved payment, if at all
any has been made, would be the vouchers or
receipts issued therefor which Atlas failed to
represent.
ISSUES:
10. Whether or not the expenses paid for the services
rendered b a public relations firm P.K MacKer & Co.
labeled as stockholders relation service fee is an
allowable deduction as business expense under Sec. 30
(a) (1) NIRC?
11. Whether or not the expenses deducted by petitioner
form its gross income from 1958 are sanctioned by Sec.
30 (a) (1( NIRC?
HELD & RATIO:
1. No. 25k is not deductible from gross income for the purpose
of income tax.
a. An item of expenditure must fall squarely within its
language
b. Statutory test of deductibility – states that it is
axiomatic that to be deductible as a business
expenses, three conditions are imposed:
i. The expense must be ordinary and
necessary
ii. It must be paid or incurred within the taxable
year
iii. It must be paid or incurred in carrying in a
trade or business
c. Not only must the taxpayer meet the business test,
he must substantially prove by evidence or record
the deductions claimed under the law, otherwise, the
same will be disallowed.
d. The mere allegation of the taxpayer that an item of
expense is ordinary and necessary does not justify
its deduction
2. Interpretation of “ordinary and necessary”
a. An expense will be considered “necessary” where
the expenditure is appropriate and helpful in the
development of the taxpayer’s business.
b. It is “ordinary” when it connotes a payment which is
normal in relation to the business of the taxpayer
and the surrounding circumstances.
c. There is thus no hard and fast rule on the matter.
The right to a deduction depends in each case on
the particular facts and the relation of the payment to
the type of business in which the taxpayer is
engaged.
d. The intention of the taxpayer often may be the
controlling fact in making the determination.
e. We sustain the ruling of the tax court that the
expenditure of P25,523.14 paid to P.K. Macker &
Co. as compensation for services carrying on the
selling campaign in an effort to sell Atlas' additional
capital stock of P3,325,000 is not an ordinary
expense
3. Litigation expenses incurred in defense or protection of title
are capital in nature and not deductible
a. the litigation expenses under consideration were
incurred in defense of Atlas title to its mining
properties
b. it is well settled that litigation expenses incurred in
defense or protection of title are capital in nature and
not deductible
c. Surprisingly, however, the investigating revenue
examiner recommended a partial disallowance of
P13,333.30 instead of the entire amount of
P23,333.30, which, upon review, was further
reduced by the Commissioner of Internal Revenue.
Whether it was due to mistake, negligence or
omission of the officials concerned, the arithmetical
 error committed herein should not prejudice the
Government.
d. This Court will pass upon this particular question
since there is a clear error committed by officials
concerned in the computation of the deductible
amount.
FINAL VERDICT: WHEREFORE, judgment appealed from is hereby
affirmed with modification that the amount of P17,499.98 (3/4 of
P23,333.00) representing suit expenses be disallowed as deduction
instead of P6,666.65 only.
With this amount as part of the net income, the corresponding
income tax shall be paid thereon, with interest of 6% per annum from
June 20, 1959 to June 20,1962.
14. MARIANO ZAMORA v. COLLECTOR OF INTERNAL
REVENUE and COURT OF TAX APPEALS
Deductions
CASE: [I’m using the Reyes Notes as summary because it’s recit-
ready already.]
Zamora, a hotel owner, claimed as deduction promotion
expenses incurred by his wife for the promotion of said hotel. On
appeal, the CTA only allowed 50% of the promotional expenses as
deductions, because it was found in the Central dollar allocation
application of his wife that she went abroad on a combined business
and medical trip.
The Supreme Court stated that promotional expenses are
deductible but must be substantiated. When some of the
representation expenses claimed by the taxpayer were evidenced by
vouchers or documents, but other claims were not supported, it is not
possible to determine the actual amount covered by supporting
papers and the amount without supporting papers, the court should
determine from all available data the amount properly deductible as
representation expenses. In view of this, the SC held that CTA did
not commit error in allowing as promotion expenses Zamora’s
income tax returns at merely one-half.
FACTS:
Mariano Zamora, owner of the Bayview Hotel and Farmacia
Manila, filed his income tax returns for the years 1951 and 1952.
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 not allowable.
The CIR required him to pay the deficiency income tax.
Zamora appealed the case to the CTA, which modified the CIR’s
decision and ordered Zamora to pay the reduced total sum of
P30,258.00.
Having failed to obtain a reconsideration, Zamora appealed,
alleging, among others, that the CTA erred in disallowing
P10,478.50 as deduction promotion expenses incurred by
his wife for the promotion of the Bay View Hotel and
Farmacia Zamora (which is half of the P20,957.00 supposed
business expenses).
According to Zamora, the business expenses were used by his
wife during her travel to Japan and US for the purchase of new
machinery, and to observe hotel management in modern hotels.
The CTA found out that Zamora’s wife obtained only the sum of
P5,000 from the Central Bank, and that in her application for
dollar allocation, she stated that she was going abroad on a
combined medical and business trip, which were not denied
by Zamora himself. Also, the alleged expenses were not
supported by receipts.
ISSUES: [I only included the most relevant issue] W/N deduction for
Zamora’s alleged business expenses should be allowed
HELD & RATIO: No, the Court only allowed half of Zamora’s
deduction claim.
• The Tax Code provides that, in computing net income, there
shall be allowed deductions for the ordinary and necessary
expenses paid or incurred during the taxable year, in carrying on
any trade or business.
• Claim for the deduction of promotion expenses
must also be substantiated by record showing in detail the
amount and nature of expenses incurred.
• In this case, Zamora’s wife’s application for dollar
allocation shows that she went abroad on a combined
 medical and business trip, not all of her expenses came
under the category of ordinary and necessary expenses;
part thereof constituted her personal expenses.
• There was no way to ascertain which expense was
incurred by her in connection with business or for personal
benefit. So the CTA considered 50% of said amount as
business expenses, and the other as her personal
expenses.
FINAL VERDICT: Petition is dismissed.
Ree
15. CM HOSKINS & CO., INC. v. COMMISSIONER OF INTERNAL
REVENUE
Payment of supervision fees;
what are deductible ordinary and necessary expenses;
test for determining reasonableness of a given bonus as
compensation
REYES NOTES/CASE:
A, an experience realtor, was paid supervision fees in the
amount of P100,000 annually by XYZ Corporation for a three-
year project, an amount when combined with his salary and
bonuses is double the XYZ’s income. Are the supervision fees
deductible?
NO. In C.M. Hoskins & Co., Inc. v. Commissioner of Internal
Revenue [November 28, 1969], Hoskins & Co. claimed as
deductions the payment of P100,000 to its founder and controlling
stockholder, Hoskins representing 50% of the 8% supervision fees
the company received as managing agent for Paradise Farms. In this
case, the SC held that such was not deductible for failing to pass the
reasonableness test.
If allowed, Hoskin would be receiving on his salary, bonus, and
supervision fees a total of P185,000 which is double the company’s
reported net income. The SC stated that if it was a one-time
payment, it could have been deducted since Hoskin was an
experienced realtor. However, the P100,000 supervision fee was
being paid every year (for three (3) years) for the entire duration of
the company’s project with Paradise Farms.
CASE:
C.M. Hoskins & Co., Inc. (CMH&C) is a domestic corporation
engaged in real estate. Hoskins & Co. claimed as deductions the
payment of P100,000 to its founder and controlling stockholder,
Hoskins representing 50% of the 8% supervision fees the company
received as managing agent for Paradise Farms and Realty
Investment.
Whether or not the payment of supervision fees are deductible
ordinary and necessary expenses
SC held that such was not deductible for failing to pass the
reasonableness test. (No fixed test for determining reasonableness)
Conditions precedent to the deduction of bonuses to employees:
(1) Payments of the bonuses is in fact compensation
(2) Must be for personal services actually rendered
(3) When added to the salaries, are reasonable when measured to
the amount and quality of the services performed with relation to the
business of the particular taxpayer
The amounts received by Hoskins was inordinately large and could
not be accorded the treatment of ordinary and necessary expenses.
If allowed, Hoskin would be receiving on his salary, bonus, and
supervision fees a total of P185,000 which is double the company’s
reported net income. The SC stated that if it was a one-time
payment, it could have been deducted since Hoskin was an
experienced realtor. However, the P100,000 supervision fee was
being paid every year (for three (3) years) for the entire duration of
the company’s project with Paradise Farms and Realty Investment.
FACTS:
C.M. Hoskins & Co., Inc. (CMH&C) is a domestic corporation
engaged in real estate as brokers, managing agents, and
administrators.
They filed their income tax return for 1957 showing a net
income of P92,540.25, and a tax liability of P18,508.
CIR disallowed 4 items of deductions in CMH&C’s tax return.
 Court of Tax Appeals, upon review, upheld the disallowance
of almost P100K paid by CMH&C to C.M. Hoskins, its
founder and controlling stockholder, representing 50% of
supervision fees, It set aside CIR’s disallowance of 3 other
minor items.
Findings by the CTA:
o CMH&C has a capital stock of 1,000 shares, 996 of
which are owned by Mr. Hoskins.
o During the first 4 years of its existence, Hoskins was
President; after which he became the chairman of
the Board of Directors and also salesman-broker for
the company, for which he received P13,000 as
monthly salary and about P40,000 as yearly bonus.
o Hoskins also gets free use of the company car, and
enjoyed other similar benefits (other benefits not
stated in the case)
o Hoskins is familiar with the contract into by CMH&C
with Paradise Farms and with Realty Investments,
by the terms of which, CMH&C was to serve as
managing agent. This is the contract that gave rise
to the supervision fees in question. The amount
which almost totals P100K is 50% of the 8%
supervision fees CMH&C received as managing
agents for Paradise Farms and Realty Investments.
ISSUES:
1. Whether or not the payment of supervision fees are
deductible ordinary and necessary expenses
HELD & RATIO:
1. NO, Considering the amounts received by Hoskins as
observed by CTA, the P99,977.91 was inordinately large and
could not be accorded the treatment of ordinary and
necessary expenses allowed as deductible items within the
purview of Sec. 30(a)(i) of the Tax Code (Note: Not the same
as present Sec. 30a of the current Tax Code; text was not
cited in case.)
If such amount will be allowed as deductible item,
then Hoskins would receive on these 3 items alone
(salary, bonus, supervision fees) a total of P185K,
which would be double the company’s reported net
income of P92,540.25.
o If it was for a one-time thing paid to an
experienced realtor like Hoskins, its fairness
and deductibility by the taxpayer could be
conceded,
o BUT in this case, almost P100K fee was
being paid by the company to Hoskins every
year from 1955-1963, for the entire duration
of its project with Paradise Farms and
Realty Investment.
The case before us is similar to previous cases of
disallowances as deductible items, upheld by the SC
as not being within the purview of ordinary and
necessary expenses and not passing the TEST OF
REASONABLENESS.
In Kuenzie & Streiff v. CIR:
o SC held that it is a general rule that
“bonuses to employees made in good faith
and as an additional compensation for
services actually rendered by the employees
as deductible, provided such payments,
when added to the stipulated salaries, do
not exceed a reasonable compensation for
the services rendered.”
o Conditions precedent to the deduction of
bonuses to employees:
o (1) Payments of the bonuses is in fact
compensation
o (2) Must be for personal services actually
rendered
o (3) When added to the salaries, are
reasonable when measured to the amount
and quality of the services performed with
relation to the business of the particular
taxpayer
No fixed test for determining reasonableness.
Varying factors to consider, such as the ff. tests:
o “made in good faith”
 o “character of the taxpayers’ business,
volume and amount of its net earnings, size
and locality, type and extent of services
rendered, salary policy”
o “employees’ qualifications and contributions
to the business venture”
o “general economic conditions”
In a nutshell: situation must be considered as a
whole.
CMH&C’s case fails to pass the test.
Right of the employer versus Commissioner to fix
compensation of its employees: while the employer
has the right, it is subject to the determination of the
CIR.
For income tax purposes, the employer cannot
legally claim such bonuses as deductible expenses
unless shown to be reasonable. To hold otherwise
would open the gate to rampant tax evasion.
The right to determine deductible expenses cannot
be exercised for the purpose of evading payment of
taxes legitimately due to the State.
Finally, it is to be noted that CMH&C is practically a
sole proprietorship of C.M. Hoskins, who owns
99.6% of its shares.
o Having chosen to use the corporate form
with all its legal advantages of a separate
corporate personality, it is bound to follow
corporate norms and obligations.
o CMH&C may not be legally permitted, by
way of corporate resolutions authorizing
payment of inordinate large fees to its
controlling stockholder, to diminish its
corresponding tax liability.
And as for Hoskins’ invocation of the company’s
policy of sharing commissions with its salesmen, it is
untenable because what is involved here is not
Hoskins’ salesman’s share in the petitioner’s 12%
sales commission, which he presumably collected
also from the petitioner without respondent’s
questioning it, but a 50% share besides in
petitioner’s planning and supervision fee of 8% of
the gross sales, as mentioned above.
FINAL VERDICT: Decision is AFFIRMED.
Notes/ Source:
Taxation 1 Digests 2A-2015
16. CALANOC v. CIR
November 29, 1961
REYES NOTES:
Are police protection fees and gifts for an exhibition for
charitable purposes deductible as a business expense?
No. In CALANOC VS. COLLECTOR OF INTERNAL REVENUE
[NOVEMBER 29, 1961], at issue in this case is the deductibility of
the expenses incurred for police protection and for gifts and parties in
connection with the boxing and wrestling exhibition that Calanoc
financed and promoted whose proceeds would be given to the
orphans and destitute children of the Child Welfare Workers Club of
the Social Welfare Commission. The Supreme Court held that the
police protection fees were not deductible as they are illegal since it
was consideration for the performance of functions required of
policemen by law. As to the gifts and parties, they were deemed
excessive considering that the purpose of the exhibition was for
a charitable cause.
FACTS:
Calanoc was authorized by the Social Welfare Commission
to solicit and receive contributions for the orphans and
destitute children of the Child Welfare Workers Club of the
Commission.
Subsequently, Calanoc financed and promoted a boxing and
wrestling exhibition at the Rizal Memorial Stadium for the
said charitable purpose.
Before the prohibition took place, Calanoc applied for an
exemption on the amusement tax with the Collector of
Internal Revenue.
 After the exhibition, CIR agent discovered that the gross
sales amounted to P26,553. The expenditures incurred was
P25,157.62. Thus, P1,375.38 was the net profit which was
remitted to the said Commission.
The agent also found the following items of expenditures:
1. Police protection – P461.65
2. Gifts – P460.00
3. Parties – P1,880.05
4. Several items for representation
An amount of P7,378.57 was also assessed for the
amusement tax.
The Secretary of Finance authorized the denial of CIR of the
application for exemption on amusement tax in cases where
the net proceeds are not substantial or where the expenses
are exorbitant.
ISSUE:
12. Whether or not the assessment of P7,378.57 amusement
tax imposed was valid.
HELD & RATIO:
1. YES
Application for exemption from payment of
amusement tax will be denied where the net
proceeds of the exhibition conducted for
charitable purposes are not substantial or where
the expenses incurred by the taxpayer are
exorbitant.
Most of the items of expenditures contained in the
statement submitted to the agent are either
exorbitant or not supported by receipts.
SC agreed with the tax court that:
(1) The payment of P461.65 for police protection is
illegal as it is a consideration given by the
petitioner to the police for the performance by
the latter of the functions required of them to be
rendered by law.
(2) The expenditures of P460.00 for gifts, P1,880.05
for parties and other items for representation are
rather excessive, considering that the purpose of
the exhibition was for a charitable cause.
FINAL VERDICT: WHEREFORE, the decision sought herein to be
reviewed is hereby affirmed, with costs against the petitioner.
Notes:
In the case, main issue was the amusement tax. Read it along with
the Reyes notes for integration of the issue on deductibility as
business expense.
17. KUENZLE & STREIFF, INC. v. COLLECTOR OF INTERNAL
REVENUE
CASE:
Petitioner was assessed by the respondent to be liable for
deficiency income taxes for 1950 to 1952 because it deducted from
its gross income certain items representing salaries, directors' fees
and bonuses of its non-resident president and vice-president;
bonuses of its resident officers and employees; and interests on
earned but unpaid salaries and bonuses of its officers and
employees, which were disallowed by respondent. Respondent
modified its assessment by allowing as deductible all items
comprising directors' fees and salaries of the non-resident president
and vice-president, but disallowing the bonuses insofar as they
exceed the salaries of the recipients, as well as the interests on
earned but unpaid salaries and bonuses. CTA made a new
assessment but basically same items were the ones deducted and
not. Petitioner now disputes this ruling insofar as the resident
officers and employees are concerned contending that the same is
not in accordance with the usual pattern to be followed in
determining the reasonableness of a given compensation because it
ignores the nature, extent and quality of the services actually
rendered by its resident officers and employees. SC affirmed CTA’s
decision. It assailed the fact that resident officers and employees had
higher bonuses than non-resident ones even if they do basically the
same amount of service and contribution, which petitioner even
admitted. SC said the bonus for resident officers and employees was
not reasonable. "There is no special reason for granting greater
bonuses to such lower ranking officers than those given to Messrs.
Kuenzle and Streiff.”
FACTS:
Petitioner is a domestic corporation engaged in the
importation of textiles, hardware, sundries, chemicals,
pharmaceuticals, lumbers, groceries, wines and liquor; in
insurance and lumber; and in some exports.
In the income tax returns for the years 1950, 1951 and 1952
it filed with respondent, petitioner deducted from its gross
income certain items representing salaries, directors' fees
and bonuses of its non-resident president and vice-
president; bonuses of its resident officers and employees;
and interests on earned but unpaid salaries and bonuses of
its officers and employees. The income tax computed in
accordance with these returns was duly paid by petitioner.
July 2, 1953: After disallowing the deductions of the
aforementioned items, respondent CIR assessed and
demanded from petitioner the payment of deficiency income
taxes in the sums of P26,370.00, P53,865.00 and
P44,112.00 for the years 1950, 1951 and 1952, respectively.
Petitioner requested for a reexamination of the assessment.
June 8, 1955: Respondent modified it by allowing as
deductible all items comprising directors' fees and salaries of
the non-resident president and vice-president, but
disallowing the bonuses insofar as they exceed the salaries
of the recipients, as well as the interests on earned but
unpaid salaries and bonuses.
Hence, respondent made a new assessment and demanded
from petitioner as deficiency income taxes the amounts of
P10,147.00, P26,783.00 and P20,481.00, respectively.
Petitioner took this case on appeal to the CTA which
modified the assessment, declaring petitioner liable for the
total sum of P33,187.00 as deficiency income tax due for the
years 1950, 1951 and 1952.
From such decision, both parties appealed: petitioner on the
portion where it is still liable, respondent on the portion
where deductions were allowed.
o Petitioner: portion which holds that the measure of
the reasonableness of the bonuses paid to its non-
resident president and vice-president should be
applied to the bonuses given to resident officers and
employees in determining their deductibility and so
only so much of said bonuses as applied to the latter
should be allowed as deduction
o Respondent: portion of the decision which allows the
deduction of so much of the bonuses which is in
excess of the yearly salaries paid to the respective
recipients thereof
ISSUES: How much of said bonuses claimed by petitioner may
be considered reasonable in order that it may be allowed as
deduction.
HELD & RATIO:
1. Pertinent provision: Section 30 (a)(1) and (b)(1) of the
National Internal Revenue Code
SEC. 30. Deductions from gross income. — In computing net
income there shall be allowed as deductions —
(a) Expenses:
(1) In general. — All the ordinary and necessary
expenses paid or incurred during the taxable year in
carrying on any trade or business, including a
reasonable allowance for salaries or other
compensation for personal services actually
rendered;
(b) Interest:
(1) In general. — The amount of interest paid within
the taxable year on indebtedness, except on
indebtedness incurred or continued to purchase or
carry obligations the interest upon which is exempt
from taxation as income under this Title.
2. CTA Ruling disputed:
Petitioner gave to its non-resident president and vice
president for the years 1950 and 1951 bonuses
equal to 133-1/2% of their annual salaries and
bonuses equal to 125-2/3% for the year 1952,
whereas with regard to its resident officers and
employees it gave them much more on the alleged
reason that they deserved them because of their
valuable contribution to the business of the
corporation which has made it possible for it to
realize huge profits during the aforesaid years.
 And the Court of Tax Appeals ruled that while the
bonuses given to the non-resident officers are
reasonable considering their yearly salaries and the
services actually rendered by them, the bonuses
given to the resident officers and employees are,
however, quite excessive, the court saying on this
point that "there is no special reason for granting
greater bonuses to such lower ranking officers than
those given to Messrs. Kuenzle and Streiff.”
Petitioner now disputes this ruling insofar as the
resident officers and employees are concerned
contending that the same is not in accordance with
the usual pattern to be followed in determining the
reasonableness of a given compensation because it
ignores the nature, extent and quality of the services
actually rendered by its resident officers and
employees.
3. Supreme Court Ruling:
PETITIONER’S APPEAL
Bonuses
It is a general rule that bonuses to employees made
in good faith and as additional compensation for the
services actually rendered by the employees are
deductible, provided such payments, when added to
the stipulated salaries, do not exceed a reasonable
compensation for the services rendered.
Requisites for tax deductions in bonuses:
o The payment of the bonuses is in fact
compensation
o It must be for personal series actually
rendered
o 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.
There is no fixed test for determining the
reasonableness of a given bonus as compensation.
This depends upon many factors, one of them being
the amount and the quality of the services performed
with relation to the business. However, "in
determining whether the particular salary or
compensation payment is reasonable, the situation
must be considered as a whole.
The opinion of the management itself of the
corporation is that the non-resident officers had
rendered the same amount of efficient personal
service and contribution to deserve equal treatment
in compensation and other emoluments with the
particularity that their liberation yearly salaries had
been much smaller. Indeed, Indeed, the trial court
was justified in expressing the view that there is no
special reason for granting greater bonuses to such
lower ranking officers than those given to Messrs.
Kuenzle and Streiff. (petitioner kinda admitted that
bonuses should be equal, without meaning to, I
think)
Interests
As regards the amount of interests disallowed, we
also find the ruling of the trial court justified. There is
no dispute that these items accrued on unclaimed
salaries and bonus participation of shareholders and
employees.
Under the law, in order that interest may be
deductible, it must be paid "on indebtedness"
(Section 30, (b)(1) of the National Internal Revenue
Code).
It is therefore imperative to show that there is an
existing indebtedness which may be subjected to the
payment of interest. Here the items involved are
unclaimed salaries and bonus participation which in
our opinion cannot constitute 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.
It is well settled rule that the term indebtedness is
restricted to its usual import which "is the amount
 which one has contracted to pay the use of
borrowed money." Since the corporation had at all
times sufficient funds to pay the salaries of its
employees, whatever an employee may fail to collect
cannot be considered an indebtedness for it is the
concern of the employee to collect it in due time. The
willingness of the corporation to pay interest thereon
cannot be considered a justification to warrant
deduction.
RESPONDENT’S APPEAL
Its claim cannot be justified considering the factors
we have already mentioned that play in the
determination of the reasonableness of the bonuses
or additional compensation that may be given to an
officer or an employee which, if properly considered,
warrant the payment of the bonuses in question to
the extent allowed by the trial court.
This is specially so considering the post-war policy
of the corporation in giving salaries at 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
exchange which resulted in the diminution of the
amount of business and the consequent loss of
profits on the part of the corporation.
The payment of bonuses in amounts a little more
than the yearly salaries received considering the
prevailing circumstances is in our opinion
reasonable.
FINAL VERDICT: CTA’s decision is affirmed.
RR 10-2002 (July 10, 2002)
RR 1-2009 (December 9, 2009)
RR 7-2010 (July 20, 2010)
Interest (as amennded by RA 93337)
18. PAPER INDUSTRIES CORP. VS CA
CASE:
Picop received from the Commissioner of Internal Revenue ("CIR")
two (2) letters of assessment for: 1) deficiency transaction tax and for
documentary and science stamp tax; 2) deficiency income tax for an
aggregate amount of P88,763,255.00. However, in its 1977 Income
Tax Return, Picop claimed interest payments made in 1977,
amounting to P42,840,131.00, (on loans contracted for the purchase
of its machineries) as a deduction from its 1977 gross income. The
CIR disallowed the deductions, while the CA and CTA allowed the
same.
The SC held that the general rule is that interest expenses are
deductible against gross income and this includes interest paid under
loans incurred in connection with the carrying on of the business of
the taxpayer, which in this case was the interest on the loan
contracted for the purchase of the machineries.
FACTS:
The Paper Industries Corporation of the Philippines
("Picop"), which is petitioner in G.R. Nos. 106949-50 and
private respondent in G.R. Nos. 106984-85, is a Philippine
corporation registered with the Board of Investments ("BOI")
as a preferred pioneer enterprise with respect to its
integrated pulp and paper mill, and as a preferred non-
pioneer enterprise with respect to its integrated plywood and
veneer mills.
In 1969, 1972 and 1977, Picop obtained loans from foreign
creditors in order to finance the purchase of machinery and
equipment needed for its operations. In its 1977 Income
Tax Return, Picop claimed interest payments made in
1977, amounting to P42,840,131.00, on these loans as a
deduction from its 1977 gross income.
The CIR disallowed this deduction upon the ground that,
because the loans had been incurred for the purchase of
machinery and equipment, the interest payments on those
loans should have been capitalized instead and claimed as a
depreciation deduction taking into account the adjusted basis
of the machinery and equipment (original acquisition cost
plus interest charges) over the useful life of such assets.
On 21 April 1983, Picop received from the Commissioner of
Internal Revenue ("CIR") two (2) letters of assessment and
demand both dated 31 March 1983:
o (a) one for deficiency transaction tax and for
documentary and science stamp tax; and
o (b) the other for deficiency income tax for 1977,
o for an aggregate amount of P88,763,255.00.
On 26 April 1983, Picop protested the assessment of
deficiency transaction tax and documentary and science
stamp taxes. Picop also protested on 21 May 1983 the
deficiency income tax assessment for 1977.
o These protests were not formally acted upon by
respondent CIR. On 26 September 1984, the CIR
issued a warrant of distraint on personal property
and a warrant of levy on real property against Picop,
to enforce collection of the contested assessments;
in effect, the CIR denied Picop's protests.
Thereupon, Picop went before the Court of Tax Appeals
("CTA") appealing the assessments.
o After trial, the CTA rendered a decision dated 15
August 1989, modifying the findings of the CIR and
holding Picop liable for the reduced aggregate
amount of P20,133,762.33
Picop and the CIR both went to the Supreme Court on
separate Petitions for Review of the above decision of the
CTA. The Court referred the two (2) Petitions to the Court of
Appeals
o The Court of Appeals consolidated the two (2) cases
and rendered a decision, dated 31 August 1992,
which further reduced the liability of Picop to
P6,338,354.70.
CIR and Picop arguments before the SC:
Picop now maintains that it is not liable at all to pay any of
the assessments or any part thereof. It assails the propriety
of the thirty-five percent (35%) deficiency transaction tax
which the Court of Appeals held due from it in the amount of
P3,578,543.51. Picop also questions the imposition by the
Court of Appeals of the deficiency income tax of
P1,481,579.15, resulting from disallowance of certain
claimed financial guarantee expenses and claimed year-end
adjustments of sales and cost of sales figures by Picop's
external auditors
The CIR, upon the other hand, insists that the Court of
Appeals erred in finding Picop not liable for surcharge and
interest on unpaid transaction tax and for documentary and
science stamp taxes and in allowing Picop to claim as
deductible expenses:
(a) the net operating losses of another corporation
(i.e., Rustan Pulp and Paper Mills, Inc.); and
(b) interest payments on loans for the purchase
of machinery and equipment.
Both the CTA and the Court of Appeals sustained the
position of Picop and held that the interest deduction claimed
by Picop was proper and allowable. In the instant Petition,
the CIR insists on its original position.
ISSUE:
Whether Picop is entitled to deductions against income of interest
payments on loans for the purchase of machinery and equipment?
Yes. It is entitled to such deductions under Section 30 of the
1977 Tax Code
RATIO:
Interest payments on loans incurred by a taxpayer (whether
BOI-registered or not) are allowed by the NIRC as
deductions against the taxpayer's gross income. Section
30 of the 1977 Tax Code provided as follows:
Sec. 30. Deduction from Gross Income. — The following
may be deducted from gross income:
(a) Expenses:
xxx xxx xxx
(b) Interest:
(1) In general. — The amount of interest paid within
the taxable year on indebtedness, except on
indebtedness incurred or continued to purchase or
carry obligations the interest upon which is exempt
from taxation as income under this Title: . . .
(Emphasis supplied)
Thus, the general rule is that interest expenses are
deductible against gross income and this certainly includes
interest paid under loans incurred in connection with the
carrying on of the business of the taxpayer.
o In the instant case, the CIR does not dispute that the
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 of machinery and equipment actually
used in the registered operations of Picop. Neither
does the CIR deny that such interest payments were
legally due and demandable under the terms of such
loans, and in fact paid by Picop during the tax year
1977.
The CIR invokes Section 79 of Revenue Regulations No. 2
as amended which reads as follows:
Sec. 79. Interest on Capital. — Interest calculated for cost-keeping
or other purposes on account of capital or surplus invested in the
business, which does not represent a charge arising under an
interest-bearing obligation, is not allowable deduction from gross
income.
We read the above provision of Revenue Regulations No. 2
as referring to so called "theoretical interest," that is to say,
interest "calculated" or computed (and not incurred or paid)
for the purpose of determining the "opportunity cost" of
investing funds in a given business.
o Such "theoretical" or imputed interest does not
arise from a legally demandable interest-bearing
obligation incurred by the taxpayer who however
wishes to find out, e.g., whether he would have been
better off by lending out his funds and earning
interest rather than investing such funds in his
business. One thing that Section 79 quoted above
makes clear is that interest which does constitute a
charge arising under an interest-bearing obligation is
an allowable deduction from gross income.
The "carrying charges" which may be capitalized under the
above quoted provisions of the U.S. Internal Revenue Code
include, as the CIR has pointed out, interest on a loan "(but
not theoretical interest of a taxpayer using his own funds)."
What the CIR failed to point out is that such "carrying
charges" may, at the election of the taxpayer, either be
o (a) capitalized in which case the cost basis of the
capital assets, e.g., machinery and equipment, will
be adjusted by adding the amount of such interest
payments or alternatively,
o (b) deducted from gross income of the taxpayer.
o Should the taxpayer elect to deduct the interest
payments against its gross income, the taxpayer
cannot at the same time capitalize the interest
payments. In other words, the taxpayer is not
entitled to both the deduction from gross income and
the adjusted (increased) basis for determining gain
or loss and the allowable depreciation charge. The
U.S. Internal Revenue Code does not prohibit the
deduction of interest on a loan obtained for
purchasing machinery and equipment against gross
income, unless the taxpayer has also or previously
capitalized the same interest payments and thereby
adjusted the cost basis of such assets.
 Our 1977 NIRC does not prohibit the deduction of interest on
a loan incurred for acquiring machinery and equipment.
Neither does our 1977 NIRC compel the capitalization of
interest payments on such a loan. The 1977 Tax Code is
simply silent on a taxpayer's right to elect one or the other
tax treatment of such interest payments. Accordingly, the
general rule that interest payments on a legally
demandable loan are deductible from gross income
must be applied.
FINAL VERDICT: (Picop was still assessed to be liable for 35%
transaction tax and Deficiency income tax.)
WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is
hereby MODIFIED and Picop is hereby ORDERED to pay the CIR the
aggregate amount of P43,794,252.51 itemized as follows:
(1) Thirty-five percent (35%) transaction tax P 3,578,543.51
(2) Total Deficiency Income Tax Due 40,215,709.00
———————
Aggregate Amount Due and Payable P 43,794,252.51
19. CIR vs. VDA. DE PRIETO
Taxes are considered as debt. Payment by the debtor of interest on
tax delinquency is deductible from tax
RECIT READY:
“Do Tax obligations constitute indebtedness?” YES. Vda. De Prieto
conveyed real property by way of gifts to her four children. She was
assessed donor’s gift taxes including interests thereon. She claimed
as deduction the total interest on account of the delinquency. She
contends that the interests due from her tax obligations are
deductible from gross income. The Supreme Court held that although
the interest payment is not deductible as tax under the Tax Code, the
taxpayer is not precluded thereby from claiming said interest
payment as deduction under Section 30(b0 of the same code. It is
well-settled rule that tax obligations constitute indebtedness for the
purpose of deduction from gross income of the amount paid on
indebtedness.
FACTS
December 4, 1945, the De Prieto conveyed by way of gifts to
her four children, namely, Antonio, Benito, Carmen and
Mauro, all surnamed Prieto, real property with a total
assessed value of P892,497.50.
After the filing of the gift tax returns on 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 assessed the total sum of P117,706.50
as donor's gift tax, interest and compromises due thereon.
Of the total sum of P117,706.50 paid by respondent on April
29, 1954, the sum of P55,978.65 represents the total
interest on account of deliquency. This sum of
P55,978.65 was claimed as deduction, among others, by
respondent in her 1954 income tax return. (Since the
donation is on 1945 and binayaran lang nung 1954, may
delinquency!)
Petitioner, however, disallowed the claim and as a
consequence of such disallowance assessed respondent for
1954 the total sum of P21,410.38 as deficiency income tax
 due on the aforesaid P55,978.65, including interest up to
March 31, 1957, surcharge and compromise for the late
payment. (So may tax pa yung interest sa tax delinquency.
Taxception)
ISSUE:
Whether or not P55,978.65 paid in 1954 (representing interest on tax
delinquency) is considered an interest deductible from gross income,
thus should not be taxed and not be subject to taxception
HELD:
YES. The interest on tax delinquency is deductible from gross
income, being an indebtedness
For interest to be deductible, it must be shown that there
be an 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 conceded that the interest paid by respondent was
in consequence of the late payment of her donor's tax, and
the same was paid within the year it is sought to be declared.
Indebtedness within the contemplation of Section 30 (b) (1)
of the Tax Code:
SEC. 30 Deductions from gross income. — In computing net
income there shall be allowed as deductions —
(b) Interest:
(1) In general. — The amount of interest paid within the
taxable year on indebtedness, except on indebtedness
incurred or continued to purchase or carry obligations the
interest upon which is exempt from taxation as income
under this Title.
The term "indebtedness" has been defined as “an
unconditional and legally enforceable obligation for the
payment of money”. Within the meaning of that definition, it
is apparent that a tax may be considered an
indebtedness. Although taxes already due have not, strictly
speaking, the same concept as debts, they are, however,
obligations that may be considered as such.
The term "debt" is properly used in a comprehensive sense
as embracing not merely money due by contract but
whatever one is bound to render to another, either for
contract, or the requirement of the law. Where statute
imposes a personal liability for a tax, the tax becomes, at
least in a board sense, a debt.
It follows that the interest paid by herein respondent for the
late payment of her donor's tax is deductible from her gross
income under section 30(b) of the Tax Code above quoted.
To sustain the proposition that the interest payment in
question is not deductible for the purpose of computing
respondent's net income, petitioner relies heavily on section
80 of Revenue Regulation No. 2 promulgated by the
Department of Finance, which provides that "the word `taxes'
means taxes proper and no deductions should be allowed for
amounts representing interest, surcharge, or penalties
incident to delinquency." (hihirit pa). However, this is a mere
regulation only and must not run counter to the law, which is
Section 30(b) of the Tax Code.
BOTTOMLINE: TAXES ARE CONSIDERED AS DEBTS.
Interest on Delinquency is considered “interest” within the
meaning of Section 30(b) and therefore deductible and
exempt from taxation (considered as expenses on part of
debtor only. If on part of creditor, the interest is considered
an income from the loan, and thus, subject to taxation)
RR 13-2000 (November 20, 2000)
Interest arbitrage
20. BIR RULING NO. 006-00
January 5, 2000
PM REYES NOTES:
Q26. What is interest arbitrage?
Interest arbitrage results in the reduction of the interest expense
by a percentage of the interest income subject to final tax. It is also
defined as a circumstance which is presumed to exist because by
putting excess funds in deposits/securities subject to 20%
withholding, taxpayers are able to avoid the 32% tax which will
happen if the same funds are invested in revenue-generating
activities.
In BIR RULING NO. 006-00 [JANUARY 5, 2000], PNB requested
the BIR to exclude the interest income derived by it from treasury
bonds in the determination of the interest expense not allowable as
deduction as gross income. PNB argues that the said bonds were
given by the Government for payment for its liabilities to PNB and
hence, it has not engaged in a tax arbitrage scheme.
Although as a general rule, the amount of interest expense paid
or incurred by a taxpayer within a taxable year on indebtedness in
connection with his trade, business or exercise of profession shall be
allowed as a deduction from his gross income, the said interest
expense, however, shall be reduced if the taxpayer has derived
certain interest income which had been subject to final withholding
tax. The CIR ruled that this limitation on the deductibility of interest
expenses applies whether or not a tax arbitrage scheme was entered
into by the taxpayer.
CASE:
Section 34(B) of the Tax Reform Act of 1997 disallows as a
deduction a portion of Bank's interest expense representing 41% of
interest income subjected to final tax. PNB contends that such
provision was introduced to mitigate the effects of the so-called
tax arbitrage scheme. That since the treasury bonds were given by
the Government as payment for its liabilities to PNB, hence PNB is
not engaged in a tax arbitrage scheme. In line with this, PNB
requested BIR to exclude the interest income derived by it from the
treasury bonds in the determination of the interest expense not
allowable as a deduction from gross income.
The issue is whether or not the interest income derived by PNB
from the treasury bonds should be excluded in the determination of
the interest expense not allowable as deduction from gross income.
The Commissioner of Internal Revue ruled in the negative. CIR
denied the request of PNB that its interest income derived from the
said treasury bonds be excluded in the determination of the interest
expense not allowable as deduction from gross income. CIR stated
that although as a general rule, the amount of interest expense paid
or incurred by a taxpayer within a taxable year on indebtedness in
connection with his trade, business or exercise of profession shall be
allowed as a deduction from his gross income, the said interest
expense, however, shall be reduced if the taxpayer has derived
certain interest income which had been subject to final
withholding tax. The CIR ruled that this limitation on the
deductibility of interest expenses applies whether or not a tax
arbitrage scheme was entered into by the taxpayer.
FACTS:
Section 34(B) of the Tax Reform Act of 1997 disallows as a
deduction a portion of Bank's interest expense
representing 41% of interest income subjected to final tax.
PNB requests that interest income derived by it from the
treasury bonds be excluded in the determination of the
interest expense not allowable as deduction from gross
income.
PNB’s Contention:
o the said provision was introduced to mitigate the
effects of the so-called tax arbitrage scheme where
taxpayers save approximately 14% on taxes by placing
their excess funds in government securities and pay
only a 20% tax on the interest derived therefrom
instead of the 34% corporate tax that will be imposed
had such excess been used for other income-
generating activities not subject to final tax;
o that as a result of the Codal provision, taxpayers will
no longer enjoy the tax benefit/savings that
otherwise may be derived from the tax arbitrage;
o that the 12-year treasury bonds were given by the
Government as payment for its liabilities to PNB as
embodied in the Memorandum of Agreement (MOA)
dated August 14, 1995 executed between the National
Government, as represented by the Department of
Finance, and PNB; and
 o that PNB, therefore, has not engaged in a tax arbitrage
scheme.
ISSUE:
1. Whether or not interest income derived by PNB from the
treasury bonds should be excluded in the determination of
the interest expense not allowable as deduction from gross
income No.
RATIO:
1. CIR denied PNB’s request that its interest income derived
from the said treasury bonds be excluded in the
determination of the interest expense not allowable as
deduction from gross income.
Pursuant to Section 34(B) of the Tax Code of 1997:
o As a general rule, the amount of interest
expense paid or incurred by a taxpayer within a
taxable year on indebtedness in connection with
his trade, business or exercise of profession
shall be allowed as a deduction from his gross
income,
o However, the said interest expense shall be
reduced if the taxpayer has derived certain
interest income which had been subjected to
final withholding tax.
The said reduction shall be equal to the
following percentages of the interest
income earned depending on the year
when the interest income was earned, viz:
1. Forty-one percent (41%) beginning
January 1, 1998;
2. Thirty-nine percent (39%) beginning
January 1, 1999; and
3. Thirty-eight percent (38%) beginning
January 1, 2000 and thereafter.
This limitation shall apply regardless of whether or
not a tax arbitrage scheme was entered into by the
taxpayer or regardless of the date of the interest-
bearing loan and the date when the investment
was made, for as long as, during the taxable year,
there is an interest expense incurred on one side
and an interest income earned on the other side,
which interest income had been subjected to final
withholding tax.
FINAL RULING: request of PNB is DENIED.
Taxes
21. CIR V. LEDNICKY
PM REYES:
Q27.1. May a resident alien deduct from their gross income
taxes they paid to their government?
Generally, the answer is no. In COMMISSIONER OF INTERNAL
REVENUE VS. LEDNICKY [JULY 31, 1964], US citizens residing in
the Philippines who derives income wholly from sources within the
Philippines, sought to deduct from their gross income the income
taxes they have paid to the US government. The Supreme Court
held that to allow an alien resident to deduct from his gross income
whatever taxes he pays to his own government is incompatible with
the status of the Philippines as a sovereign state. This is because the
foreign government will have the power to reduce the tax income of
the Philippine government simply by increasing their tax rates.
Also important in this case is the statement made by the court on the
exception: a taxpayer may only be
allowed to deduct from his gross income, taxes paid to a foreign
country when such taxpayer is entitled to a foreign tax credit and he
does not choose to exercise such right. The right to deduct foreign
tax
paid is only an alternative to the taxpayer’s right to the foreign tax
credit.

(Note that at the time this case was decided, resident aliens were still
allowed to claim a tax credit. The present rule is that only resident
citizens and domestic corporations can claim a tax credit. Also, in
this case, their net income for foreign sources was zero and, thus,
there was no need to apply the tax credit.)
SUMMARY: The respondents, spouses Lednicky, are , both
American citizens residing in the Philippines, and have derived all
their income from Philippine sources. They filed three claims. The
first was a claim for reduction and refund for the year 1956. The
second was a refund as an alleged overpaid income tax for 1955.
The last case was a claim for deduction. Common to all three cases
was that the respondent spouses based these claims on tax
payments that they made to the US government. The CTA ruled in
favor of the respondents and granted their requests, which led to this
petition by the CIR. The issue is whether a citizen of the United
States residing in the Philippines, who derives income wholly from
sources within the Republic of the Philippines, may deduct from his
gross income the income taxes he has paid to the United States
government for the taxable year on the strength of section 30 (C-1)
of the Philippine Internal Revenue Code? Generally, the answer is
no. The exception: a taxpayer may only be allowed to deduct from
his gross income, taxes paid to a foreign country when such taxpayer
is entitled to a foreign tax credit and he does not choose to exercise
such right. The right to deduct foreign tax paid is only an alternative
to the taxpayer’s right to the foreign tax credit. (PM Reyes)
Specifically, the Court held that under this Section, the tax payer
should choose either deduction of gross income or tax credit. The
Construction and wording of Section 30 (c) (1) (B) of the Internal
Revenue Act shows the law's intent that the right to deduct income
taxes paid to foreign government from the taxpayer's gross income is
given only as an alternative or substitute to his right to claim a tax
credit for such foreign income taxes under Section 30 (c) (3) and (4).
So that unless the alien resident has a right to claim such tax credit if
he so chooses, he is precluded from deducting the foreign income
taxes from his gross income. Also, to allow an alien resident to
deduct from his gross income whatever taxes he pays to his own
government is incompatible with the status of the Philippines as a
sovereign state because in effect, this confers upon the foreign
government the power to reduce the tax income of the Philippine
government simply by increasing the tax rates on the alien resident
(because the more tax he pays there, the less tax he pays here)
FACTS:
These are consolidated petitions filed by the CIR to review
the decisions of the CTA. The parties and issues are the
same.
The respondents, V. E. Lednicky and Maria Valero Lednicky,
are husband and wife, respectively, both American citizens
residing in the Philippines, and have derived all their income
from Philippine sources for the taxable years in question
1st case- claim for deduction and refund for 1956
o respondent spouses paid the total amount of
P326,247.41, inclusive of the withheld taxes
o they then filed an amendment claiming a reduction
of P205,939.24 paid in 1956 to the United States
government as federal income tax for 1956.
2nd case- claim for refund in the amount as alleged overpaid
income tax for 1955
o respondents-spouses filed their domestic income tax
return
o they filed an amended income tax return, the
amendment upon the original being a lesser net
income (around P700k less)
o on the basis of this amended return, they paid
P570,252.00, inclusive of withholding taxes
o After audit, the petitioner determined a deficiency of
P16,116.00, which amount, the respondents paid
o Back in 1955, however, the Lednickys filed with the
U.S. Internal Revenue Agent in Manila their federal
income tax return for the years 1947, 1951, 1952,
1953, and 1954 on income from Philippine sources
on a cash basis.
Payment of these federal income taxes,
including penalties and delinquency interest
in the amount of P264,588.82, were made in
1955 to the U.S. Director of Internal
Revenue, Baltimore, Maryland
 3rd case- the facts are similar, but refer to respondents
spouses income tax return for 1957
o claiming a deduction representing taxes paid to the
U.S. Government on income derived wholly from
Philippine sources.
o On the strength thereof, respondents seek refund of
P90 520.75 as overpayment.
CTA granted these to respondent based on the undenied
fact that the spouses did not "signify" in their income tax
return a desire to avail of the benefits of section 30 (C-1) of
the Philippine Internal Revenue Code
ISSUE: Whether a citizen of the United States residing in the
Philippines, who derives income wholly from sources within the
Republic of the Philippines, may deduct from his gross income the
income taxes he has paid to the United States government for the
taxable year on the strength of section 30 (C-1) of the Philippine
Internal Revenue Code --NO
HELD & RATIO:
Tax payer should choose either deduction of gross income
or tax credit
o The Construction and wording of Section 30 (c) (1)
(B) of the Internal Revenue Act shows the law's
intent that the right to deduct income taxes paid to
foreign government from the taxpayer's gross
income is given only as an alternative or substitute
to his right to claim a tax credit for such foreign
income taxes under Section 30 (c) (3) and (4)
o So that unless the alien resident has a right to claim
such tax credit if he so chooses, he is precluded
from deducting the foreign income taxes from his
gross income
Purpose of the law
o To prevent a taxpayer from claiming twice the
benefits of his payment of foreign taxes, by
deduction of gross income (subsection c-1) and by
tax credit (subsection c-3)
o Aside from not conforming to the fundamental
doctrine of income taxation that the right of a
government to tax income emanates from its
partnership in the production of income, by providing
the protection, resources, incentive, and proper
climate for such production, the interpretation given
by the respondents to the revenue law provision in
question operates, in its application, to place a
resident alien with only domestic sources of income
in an equal, if not in a better, position than one who
has both domestic and foreign sources of income, a
situation which is manifestly unfair and short of logic.
To allow an alien resident to deduct from his gross income
whatever taxes he pays to his own government is
incompatible with the status of the Philippines as a sovereign
state
o To allow an alien resident to deduct from his gross
income whatever taxes he pays to his own
government amounts to conferring on the latter the
power to reduce the tax income of the Philippine
government simply by increasing the tax rates on the
alien resident.
o Everytime the rate of taxation imposed upon an
alien resident is increased by his own government,
his deduction from Philippine taxes would
correspondingly increase, and the proceeds for the
Philippines diminished, thereby subordinating our
own taxes to those levied by a foreign government.
Such a result is incompatible with the status of the
Philippines as an independent and sovereign state.
LAWS:
SEC. 30. Deduction from gross income. — In computing net income
there shall be allowed as deductions
(c) Taxes:
(1) In general. — Taxes paid or accrued within the taxable
year, except
(A) The income tax provided for under this Title;
(B) Income, war-profits, and excess profits taxes
imposed by the authority of any foreign country; but
this deduction shall be allowed in the case of a
taxpayer who does not signify in his return his desire
to have to any extent the benefits of paragraph (3) of
 this subsection (relating to credit for taxes of foreign
countries);
(C) Estate, inheritance and gift taxes; and
(D) Taxes assessed against local benefits of a kind
tending to increase the value of the property
assessed.
Par. (c) (3) Credits against tax for taxes of foreign countries. — If the
taxpayer signifies in his return his desire to have the benefits of this
paragraph, the tax imposed by this Title shall be credited with
B) Alien resident of the Philippines. — In the case of an alien
resident of the Philippines, the amount of any such taxes
paid or accrued during the taxable year to any foreign
country, if the foreign country of which such alien resident is
a citizen or subject, in imposing such taxes, allows a similar
credit to citizens of the Philippines residing in such country
Par. (c) (4) Limitation on credit. — The amount of the credit taken
under this section shall be subject to each of the following limitations:
(A) The amount of the credit in respect to the tax paid or
accrued to any country shall not exceed the same proportion
of the tax against which such credit is taken, which the
taxpayer's net income from sources within such country
taxable under this Title bears to his entire net income for the
same taxable year; and
(B) The total amount of the credit shall not exceed the same
proportion of the tax against which such credit is taken,
which the taxpayer's net income from sources without the
Philippines taxable under this Title bears to his entire net
income for the same taxable year.
Source: 2A 2015
22. BIR RULING 123-13
Cekas Development Corporation is a VAT REGISTERED company
engaged in ores, metals minerals and other chemicals. Considering
its nature of business, it often enters into VAT zero-rated
transactions where he obtains passed on input VAT. Since he does
not incur any output VAT liability, its input VAT from purchases has
remained unapplied and now has an accumulated amount of
P1,961,767.00 ( since December 2011). Cekas intended to avail of
the refund of the said amount but was not able to do so due to the
prescription of the 2 year period to file a claim. Cekas now wants to
have the unapplied input VAT treated as expense for income tax.
Can Cekas expense outright the unutilized input VAT after the
expiration of the two year period to file a claim for refund?
Ruling:
No. Under Section 112 (A) of the Tax Code, unutilized creditable
input taxes attributable to VAT zero-rated sales can only be
recovered through the application for refund or tax credit. Nowhere in
the Tax Code can a specific provision be found expressly providing
for another mode of recovery of unutilized input VAT, such as
through outright deduction or expense for income tax purposes.
Deductions from income tax partakes the nature of tax exemption
and must be construed in strictissimi juris against the taxpayer and
liberally in favor of the taxing authority.
Law :
, Section 112 (A) of the same Code states:
"(A) Zero-rated or Effectively Zero-rated Sales. — Any VAT-
registered person, whose sales are zero-rated or effectively zero-
rated may, within two (2) years after the close of the taxable quarter
when the sales were made, apply for the issuance of a tax credit
certificate or refund of creditable input tax due or paid attributable to
such sales, except transitional input tax, to the extent that such input
tax has not been applied against output tax: . . ."

Losses
Sec 38, Tax Code
23. TAMBUNTING PAWNSHOP V CIR
REYES NOTES/ CASE:
Tambunting Pawnshop was assessed for deficiency tax. It protested
saying that it was entitled to tax deductions on losses incurred on
auction sales, necessary and ordinary business expenses, and due
to a fire and theft.
The SC, in denying Tambunting’s petition, held that failure to submit
proper proof and to substantiate claims was fatal to the claim.
Tambunting submitted its “Subasata” and “Rematado” books to
prove losses on auction sales. These documents were not the
evidence required by law because they did not reflect the true
amounts of proceeds and capital respectively.
Also, to prove losses on ordinary and necessary business expenses,
Tambunting relied on withholding tax returns, cash vouchers, lessor’s
certifications, and the contracts of lease but the law requires official
receipts or invoices to substantiate such claims.
Finally, to prove Tambunting's claim for deductions due to losses
from fire and theft it submitted certifications from the police and fire
stations, an accounting of its losses, and a list of property lost but, in
this case, what was required was a sworn statement required by RR
12-77.
FACTS: Tambunting Pawnshop was assessed for deficiency
percentage tax, income tax and compromise penalties for taxable
year 1997. Tambunting instituted an administrative protest saying,
among others, that it was entitled to deductions because of losses
incurred on its auction sales, necessary and ordinary business
expenses, and due to a fire and theft.
Tambunting brought a petition for review in the CTA, citing the
inaction of the Commissioner of Internal Revenue.
CTA First Division rendered a decision ordering Tambunting pay
respondent.
To prove the loss on auction sale, petitioner submitted in evidence its
"Rematado" and "Subasta" books and the "Schedule of Losses on
Auction Sale". The "Rematado" book contained a record of items
foreclosed by the pawnshop while the "Subasta" book contained a
record of the auction sale of pawned items foreclosed.
ISSUES: W/N The petitioner was able to prove the grounds for a tax
deduction beyond doubt
HELD & RATIO: NO. The rule that tax deductions, being in the
nature of tax exemptions, are to be construed in strictissimi juris
against the taxpayer is well settled. Corollary to this rule is the
principle that when a taxpayer claims a deduction, he must point to
some specific provision of the statute in which that deduction is
authorized and must be able to prove that he is entitled to the
deduction which the law allows.
From Auction Sales
Tambunting did not properly prove that it had incurred losses. The
subasta books it presented were not the proper evidence of such
losses from the auctions because they did not reflect the true
amounts of the proceeds of the auctions due to certain items having
been left unsold after the auctions. The rematado books did not also
prove the amounts of capital because the figures reflected therein
were only the amounts given to the pawnees. It is interesting to note,
too, that the amounts received by the pawnees were not the actual
values of the pawned articles but were only fractions of the real
values.
From Ordinary and Necessary Business Expenses
The requisites for the deductibility of ordinary and necessary trade or
business expenses, are that: (a) the expenses must be ordinary and
necessary; (b) they must have been paid or incurred during the
taxable year; (c) they must have been paid or incurred in carrying on
the trade or business of the taxpayer; and (d) they must be
supported by receipts, records or other pertinent papers Notes/ Source: copy paste from the orig

Tambunting did not discharge its burden of substantiating its claim RR 12-77 (October 6, 1977)
for deductions due to the inadequacy of its documentary support of RMO 31-2009 (October 16, 2009)
its claim. Its reliance on withholding tax returns, cash vouchers,
lessor’s certifications, and the contracts of lease was futile because
such documents had scant probative value. As the CTA En Banc
succinctly put it, the law required Tambunting to support its claim for
deductions with the corresponding official receipts issued by the
service providers concerned.

The proper substantiation requirement for an expense to be allowed

is the official receipt or invoice. While the rental payments were
subjected to the applicable expanded withholding taxes, such returns
are not the documents required by law to substantiate the rental
expense. Petitioner should have submitted official receipts to support
its claim.

From Fire and Theft

The CTA En Banc aptly rejected Tambunting's claim for deductions

due to losses from fire and theft. The documents it had submitted to
support the claim, namely: (a) the certification from the Bureau of
Fire Protection in Malolos; (b) the certification from the Police Station
in Malolos; (c) the accounting entry for the losses; and (d) the list of
properties lost, were not enough. What were required were for
Tambunting to submit the sworn declaration of loss mandated by
Revenue Regulations 12-77. Its failure to do so was prejudicial to the
claim because the sworn declaration of loss was necessary to
forewarn the BIR that it had suffered a loss whose extent it would be
claiming as a deduction of its tax liability, and thus enable the BIR to
conduct its own investigation of the incident leading to the loss.
Indeed, the documents Tambunting submitted to the BIR could not
serve the purpose of their submission without the sworn declaration
of loss.

FINAL VERDICT: Petition is denied.

Forex losses
24. BIR RULING 260-90
CASE:
PMI is a corporation engaged in business involving handling of
US Dollars. The parties agreed to convert the said dollar
denominated loans into pesos. Lawyer is of the opinion that the
resultant loss of the conversion of US dollar denominated loans to
peso is more than a shrinkage in value of money. The signing of
the CB and the parties of the agreement to convert established
the loss, hence it became final and irrevocable.
WON the foreign exchange loss incurred by PMI is a deductible
loss.
NOT YET. Annual increase or decrease in value of property has
not yet been realized. Hence, not a gain or loss yet. The loss is
deductible only for the year it is actually sustained. It is sustained
during the year in which the loss occurs as evidenced by the
completed transaction and as fixed by identifiable occurring in
that year. No taxation event has as yet been consummated prior
to the remittance of the scheduled amortization.
FACTS:
PMI is a corporation established and organized under Philippine
laws
It has existing US dollar loans from Noritake Company, Limited
(Noritake) and Toyota Tsusho Corporation (Toyota) in the
aggregate amounts of US $7,636,679.17 and US $3,054,671.27,
respectively.
In 1989, the parties agreed to convert the said dollar
denominated loans into pesos at the exchange rate prevailing on
June 30, 1989; that in December 1989, both agreements were
approved by the Central Bank subject to the submission of a copy
each of the signed agreements incorporating the conversion; that
thereafter, drafts of the amended agreements were submitted to
the Central Bank for pre-approval; that on January 29, 1990, the
Central Bank advised your office on their findings and comments
on the said drafts which were considered and incorporated in the
final amended agreements; that in June 1990, the parties
submitted to the Central Bank the signed agreements;
That you, THE LAWYER, are of the opinion that in the case of
your client, the resultant loss on conversion of US dollar
denominated loans to peso is more than a shrinkage in value of
money; that the approval by the Central Bank and the signing by
the parties of the agreements covering the said conversion
established the loss, after which, the loss became final and
irrevocable, so that recoupment is reasonably impossible; and
that having been fixed and determinable, the loss is no longer
susceptible to change, hence, it could fairly be stated that such
has been sustained in a closed and completed transaction
ISSUES:
WON foreign exchange loss incurred by PMI is a deductible loss.
HELD & RATIO:
The annual increase in value of an asset is not taxable income
because such increase has not yet been realized. The increase in
value i.e., the gain, could only be taxed when a disposition of the
property occurred which was of such a nature as to constitute a
realization of such gain, that is, a severance of the gain from the
original capital invested in the property. The same conclusion
obtains as to losses. The annual decline in the value of property
is not normally allowable as a deduction. Hence, to be allowable
the loss must be realized
When foreign currency acquired in connection with a transaction
in the regular course of business is disposed ordinary gain or loss
results from the fluctuations. The loss is deductible only for the
year it is actually sustained. It is sustained during the year in
which the loss occurs as evidenced by the completed transaction
and as fixed by identifiable occurring in that year. No taxation
event has as yet been consummated prior to the remittance of the
scheduled amortization.
Accordingly, your request for confirmation of your aforesaid
opinion is hereby denied considering that foreign exchange
losses sustained as a result of conversion or devaluation of the
peso vis-a-vis the foreign currency or US dollar and vice versa
but which remittance of scheduled amortization consisting of
principal and interests payment on a foreign loan has not actually
been made are not deductible from gross income for income tax
purposes.
• Same also applies with losses. Losses are deductible only when
such loss are realized.
• The loss is only deductible on the year it is sustained and is
evidenced by a close and completed transaction and identifiable
event during that year.
• No taxable event has occurred prior to the remittance of a
scheduled amortization.
• Accordingly, foreign exchange losses sustained by virtue of foreign
currency devaluation, but which remittance of scheduled
amortization of foreign currency that has not been made are not
deductible from gross income for income tax purposes.

25. BIR Ruling 144-85

August 26, 1985

Notes:
Foreign exchange losses by reason of currency devaluations are not
deductible as losses unless they are realized, in as much as gain
arising from increase in value of an asset is not taxable unless such
gain is realized by a close and completed transaction.

Facts:
• This is a latter sent sent to the BIR dated July 1, 1985 asking if
foreign exchange losses by reason of devaluation are deductible
as losses.

Issues:
• Whether or not such losses are deductible
Ruling:
• No, they are deductible for the reason they ate not yet realized.
• The increase in value of a property is taxable only if such gain was
realized, that is when it is disposed of.