93-A CHINA BANKING CORPORATION V. COURT OF APPEALS (GIO) 3.
3. With the approval of the Bangko Sentral, China Bank wrote-off as being
19 July 2000 | Vitug, J. | Capital Loss
PETITIONER: China Banking Corporation
RESPONDENTS: Court of Appeals
SUMMARY: China Bank made an investment in First CBC. Subsequently, it was
found that First CBC had become insolvent. China Bank deducted from its gross
income the investment, treating the same as “worthless” or as a bad debt (an
ordinary loss). The CIR disallowed the deduction on the ground that the
investment was not worthless and that First CBC was still allowed to exercise
banking activities. The CIR held that the losses, if any, were to be regarded as
capital losses (non-deductible).
W/N the loss of investment are bad debts or ordinary losses deductible from
taxable gross income — NO.
An equity investment is a capital asset—not an ordinary asset—of the investor
the sale or exchange of which results in either a capital gain or a capital loss. The
gain or the loss is ordinary when the property sold or exchanged is not a capital
asset. Thus, shares of stock would be ordinary assets only to a dealer in securities
or a person engaged in the purchase and sale of, or an active trader (for his own
account) in, securities. First CBC, the investee corporation, is a subsidiary
corporation of China Bank whose shares in said investee corporation are not
intended for purchase or sale but as an investment. Therefore, any loss therefrom
would be a capital loss, not an ordinary loss, to the investor. The equity investment
is not an indebtedness, and it is a capital, not an ordinary, asset.
DOCTRINE: A capital gain or a capital loss normally requires the concurrence
of two conditions for it to result: (1) There is a sale or exchange; and (2) the thing
sold or exchanged is a capital asset. When securities become worthless, there is
strictly no sale or exchange, but the law deems the loss anyway to be “a loss from
the sale or exchange of capital assets.”
FACTS:
1. In 1980, China Banking Corporation (China Bank) made a 53% equity
investment in the First CBC Capital (First CBC) Ltd., a Hong Kong
subsidiary engaged in financing and investment with "deposit-taking"
function. The investment amounted to P16,227,851.80, consisting of 106,000
shares with a par value of P100 per share.
2. During the regular examination of China Bank’s financial books and
investment portfolios, it was found that First CBC had become insolvent.
1 The NIRC defines “capital assets” in the negative wise, thus — The term ‘capital assets’ means property
held by the taxpayer (whether or not connected with his trade or business), but does not include stock in
trade of the taxpayer or other property of a kind which would properly be included in the inventory of
worthless its investment in First CBC in its 1987 income tax return (ITR) and
treated the same as a bad debt or as an ordinary loss deductible from its gross
income.
4. The Commissioner of Internal Revenue (CIR) disallowed the deduction and
assessed China Bank for income tax deficiency. This was on the ground that
the investment should not be classified as being “worthless” and that,
although First CBC’s license as a “deposit-taking” company had been
revoked by the Hong Kong Banking Commissioner, First CBC was still able
to exercise its financing and investment activities.
a. Assuming that the securities had become worthless, the CIR held
that they should be classified as “capital loss” and not as a bad debt
since there was no indebtedness to speak of between China Bank
and First CBC.
5. The Court of Tax Appeals (CTA) and the Court of Appeals (CA) both
sustained the CIR’s holding.
6. Hence, this petition.
ISSUE:
1. W/N the shares of stock in question (the investment) are “bad debts” and,
hence, deductible from gross income — NO.
RULING: WHEREFORE, the Petition is DENIED. The decision of the Court of
Appeals disallowing the claimed deduction of P16,227,851.80 is AFFIRMED.
RATIO:
First Issue
1. The claim of China Bank is based on a Profit and Loss Account for the Year-
End 31 December 1987 and on the recommendation of Bangko Sentral that
the equity investment be written-off due to the insolvency of the subsidiary.
2. While the matter may not be unquestionable—since certain classes of
intangibles are not always given corresponding values in financial
statements—there is no need to go of length into the issue.
a. Assuming the worthlessness of the shares, the deductibility thereof
would still be nil in this case.
b. The Court is not prepared to hold that the lower courts are utterly
devoid of substantial bases for their own factual findings.
3. Subject to certain exceptions, the tax on income is imposed on the net income,
allowing certain specified deductions from gross income to be claimed by the
taxpayer. Among the deductible items allowed by the National Internal
Revenue Code (NIRC) are bad debts and losses.
4. An equity investment is a capital asset1 —not an ordinary asset—of the
the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for
sale to customers in the ordinary course of his trade or business, or property used in the trade or
 investor the sale or exchange of which results in either a capital gain or a
capital loss. The gain or the loss is ordinary when the property sold or
exchanged is not a capital asset.
5. Thus, shares of stock would be ordinary assets only to a dealer in securities
or a person engaged in the purchase and sale of, or an active trader (for his
own account) in, securities.2
6. In the hands, however, of another who holds the shares of stock by way of an
investment, the shares to him would be capital assets. When the shares held
by such investor become worthless, the loss is deemed to be a loss from the
sale or exchange of capital assets.
7. The NIRC provides that if securities become worthless during the tax year
and are capital assets, the loss resulting therefrom shall be considered a loss
from the sale or exchange of capital assets.
8. A capital gain or a capital loss normally requires the concurrence of two
conditions for it to result: (1) There is a sale or exchange; and (2) the thing
sold or exchanged is a capital asset.
9. When securities become worthless, there is strictly no sale or exchange, but
the law deems the loss anyway to be “a loss from the sale or exchange of
capital assets.”
10. Capital losses are allowed to be deducted only to the extent of capital gains,
i.e., gains derived from the sale or exchange of capital assets, and not from
any other income of the taxpayer.
11. Presently, First CBC, the investee corporation, is a subsidiary corporation of
China Bank whose shares in said investee corporation are not intended for
purchase or sale but as an investment. Unquestionably then, any loss
therefrom would be a capital loss, not an ordinary loss, to the investor.

business, of a character which is subject to the allowance for depreciation provided in subsection (f) of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to
section twenty-nine; or real property used in the trade or business of the taxpayer. customers with a view to the gains and profits that may be derived therefrom.
2 The term 'dealer in securities' means a merchant of stocks or securities, whether an individual,

partnership or corporation, with an established place of business, regularly engaged in the purchase of