Fernandez Hermanos, Inc. v.

CIR
G.R. No. L-21551 – September 30, 1969
En banc | J. Teehankee

Digest Author: Vito

Topic: Costs; Deductions and Exemptions > Allowable Deductions > Bad Debts

Case Summary: The CIR assessed petitioner Fernandez Hermanos, Inc., a domestic corporation engaged as an
investment company, with deficiency income taxes. One of the deductions that the Tax Court disallowed was
the losses in or bad debts of Palawan Manganese Mines, Inc. (1951).
The Court held that the Tax Court's disallowance of the write-off was proper. The advances made by
the taxpayer to its 100% subsidiary, Palawan Manganese Mines, Inc. amounting to P587,308,07 as of 1951
were investments and not loans. The evidence on record shows that the board of directors of the two
companies since August, 1945 were identical and that the only capital of Palawan Manganese Mines, Inc. is the
amount of P100,000.00 entered in the taxpayer's balance sheet as its investment in its subsidiary company. This
fact explains the liberality with which the taxpayer made such large advances to the subsidiary, despite the
latter's admittedly poor financial condition. The Tax Court held that the taxpayer's loss of its investment in its
subsidiary could not be deducted for the year 1951, as the subsidiary was still in operation in 1951 and 1952,
and the taxpayer continued to give it advances in those years. Therefore, the alleged debt or investment could
not properly be considered worthless and deductible in 1951, as claimed by the taxpayer. In fact, it was only on
January 1, 1956, that the subsidiary decided to cease operations.

Doctrines/Laws Involved: Such losses or bad debts must be ascertained to be so and written-off during the
taxable year and are therefore deductible in full or not at all, in the absence of any express provision in the
Tax Code authorizing partial deductions.

Cases L-21551 and L-21557

FACTS:

1. The CIR assessed petitioner Fernandez Hermanos, Inc., a domestic corporation engaged as an
investment company, with deficiency income taxes for years 1950-1954 (P13,414.00, P119,613.00,
P11,698.00, P6,887.00 and P14,451.00, respectively).
2. The Tax Court sustained the CIR’s disallowances of the:
a. Losses in or bad debts of Palawan Manganese Mines, Inc. for 1951, P353,134.25
b. Losses in Balamban Coal Mines for 1950 and 1951, P8,989.76 and P27,732.66
c. Excessive depreciation of Houses for 1950-1954
3. The Tax Court allowed the following claimed deductions, contrary to the CIR’s decision:
a. Losses in Mati Lumber Co. for 1950
b. Losses in Hacienda Dalupiri for 1950-1954
c. Losses in Hacienda Samal for 1951-52
d. Taxable increase in net worth for 1950-51
e. Gain realized from sale of real property in 1950
4. Both parties appealed before the Court.

ISSUES + HELD/RATIO:
1. Whether or not the losses in Mati Lumber Co. (1950) are allowable deductions – YES
a. The Tax Court found that the company ceased operations in 1949 when its manager and owner, a
certain Mr. Rocamora, left for Spain where he subsequently died.
b. When the company ceased to operate, it had no assets, in other words, completely insolvent. This
information as to the insolvency of the Company — reached the taxpayer in 1950, when it
properly claimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b)
or Section 30 (e) (3) of the NIRC.
c. There was adequate basis for the writing off of the stock as worthless securities.
2. Whether or not the losses in or bad debts of Palawan Manganese Mines, Inc. (1951) are allowable
deductions – NO
a. The Tax Court's disallowance of the write-off was proper.
b. The advances made by the taxpayer to its 100% subsidiary, Palawan Manganese Mines, Inc.
amounting to P587,308,07 as of 1951 were investments and not loans.
i. The evidence on record shows that the board of directors of the two companies since
August, 1945 were identical and that the only capital of Palawan Manganese Mines, Inc.
is the amount of P100,000.00 entered in the taxpayer's balance sheet as its investment in
its subsidiary company.
ii. This fact explains the liberality with which the taxpayer made such large advances to the
subsidiary, despite the latter's admittedly poor financial condition.
c. The Tax Court held that the taxpayer's loss of its investment in its subsidiary could not be
deducted for the year 1951, as the subsidiary was still in operation in 1951 and 1952, and the
taxpayer continued to give it advances in those years.
d. Therefore, the alleged debt or investment could not properly be considered worthless and
deductible in 1951, as claimed by the taxpayer. In fact, it was only on January 1, 1956, that the
subsidiary decided to cease operations.
e. Furthermore, neither under Section 30(d)(c) of our Tax Code providing for deduction by
corporations of losses actually sustained and charged off during the taxable year nor under
Section 30 (e)(1) thereof providing for deduction of bad debts actually ascertained to be
worthless and charged off within the taxable year, can there be a partial writing-off of a loss
or bad debt, as was sought to be done here by the taxpayer.
f. For such losses or bad debts must be ascertained to be so and written-off during the taxable year,
are therefore deductible in full or not at all, in the absence of any express provision in the Tax
Code authorizing partial deductions.
3. Whether or not the losses in Balamban Coal Mines (1950-51) are allowable deductions – NO
a. The Court sustains the Tax Court's disallowance of the sums of P8,989.76 and P27,732.66 spent
by the taxpayer for the operation of its Balamban coal mine in Cebu in 1950 and 1951,
respectively, and claimed as losses in the taxpayer's returns for said years.
b. The Tax Court correctly held that the losses are deductible in 1952, when the mines were
abandoned, and not in 1950 and 1951, when they were still in operation.
i. The taxpayer's claim that these expenditures should be allowed as losses for the
corresponding years that they were incurred, because it made no sales of coal during said
years, since the promised road or outlet through which the coal could be transported from
the mines to the provincial road was not constructed, cannot be sustained.
ii. Some definite event must fix the time when the loss is sustained, and there it was the
event of actual abandonment of the mines in 1952.
 4. Whether or not the losses in Hacienda Dalupiri (1950-54) and Hacienda Samal (1951-52) are allowable
deductions – YES
a. Sec. 100 of RR No. 2 authorizes farmers to determine their gross income on the basis of
inventories. Said regulations provide that if gross income is ascertained by inventories, no
deduction can be made for livestock or products lost during the year, whether purchased for
resale, produced on the farm, as such losses will be reflected in the inventory by reducing the
amount of livestock or products on hand at the close of the year.
b. As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in
its operation, which losses were determined by means of inventories authorized under Sec.
100 of RR No. 2, it was error for respondent to have disallowed the deduction of said losses.
The same is true with respect to losses sustained in the operation of the Hacienda Samal for the
years 1951 and 1952.
c. The Tax Court was satisfied with the method adopted by the taxpayer as a farmer breeding
livestock, reporting on the basis of receipts and disbursements. We find no compelling reason to
disturb its findings.
5. Whether or not the excessive depreciation of buildings (1950-52) are allowable deductions – NO
a. We sustain the Tax Court's finding that the taxpayer did not submit adequate proof of the
correctness of the taxpayer's claim that the depreciable assets or buildings in question had a
useful life only of 10 years so as to justify its 10% depreciation per annum claim, such finding
being supported by the record.
6. Whether or not the taxable increase in net worth (1950-51) are allowable deductions – YES
a. These increases in the taxpayer's net worth were not taxable increases in net worth, as they were
not the result of the receipt by it of unreported or unexplained taxable income.
b. They were shown to be merely the result of the correction of errors in its entries in its books
relating to its indebtedness to certain creditors, which had been erroneously overstated or listed
as outstanding when they had in fact been duly paid.
7. Whether or not the gain realized from sale of real property (1950) are allowable deductions – YES
a. As found by the Tax Court, the evidence shows that this property was acquired in 1926 for
P11,852.74, and was sold in 1950 for P60,000.00, apparently, resulting in a gain of P48,147.26.
b. The taxpayer reported in its return a gain of P37,000.00, or a discrepancy of P11,147.26.
c. It was sufficiently proved from the taxpayer's books that after acquiring the property, the
taxpayer had made improvements totalling P11,147.26, accounting for the apparent discrepancy
in the reported gain.
d. In other words. this figure added to the original acquisition cost of P11,852.74 results in a total
cost of P23,000.00, and the gain derived from the sale of the property for P60,000.00 was
correctly reported by the taxpayer at P37,000.00.

Cases L-24972 and L-24978

FACTS:

1. The CIR assessed petitioner Fernandez Hermanos, Inc. with deficiency income tax of P38,918.76 for
1957.
2. The CIR disallowed the claim for deductions of the net loss claimed on Hacienda Dalupiri, P89,547.33
and amortization of contractual right claimed as an expense under Mines Operations, P48,481.62.
 3. The Tax Court overruled the Commissioner's disallowance of the taxpayer's losses in the operation of its
Hacienda Dalupiri but sustained the disallowance of the other item.
4. Both parties appealed before the Court.

ISSUES + HELD/RATIO:
1. Whether or not the losses in Hacienda Dalupiri (1957) are allowable deductions – YES
a. The Tax Court cited its previous decision overruling the Commissioner's disallowance of losses
suffered by the taxpayer in the operation of its Hacienda Dalupiri, since it was convinced that
the hacienda was operated for business and not for pleasure.
b. It is true that petitioner followed the cash basis method of reporting income and expenses in the
operation of the Hacienda Dalupiri and used the accrual method with respect to its mine
operations. This method of accounting, otherwise known as the hybrid method, followed by
petitioner is not without justification.
i. The 1954 Code provisions permit the use of a hybrid method of accounting, combining a
cash and accrual method, under circumstances and requirements to be set out in
Regulations to be issued.
ii. Also, if a taxpayer is engaged in more than one trade or business he may use a different
method of accounting for each trade or business.
c. The Tax Court, having satisfied itself with the adequacy of the taxpayer's accounting method and
procedure as properly reflecting the taxpayer's income or losses, and the Commissioner having
failed to show the contrary, we find no compelling reason to disturb its findings.
2. Whether or not the amortization of alleged contractual rights are allowable deductions – NO
a. The alleged "capital investment" method invoked by the taxpayer is not a method of depletion,
but the Tax Code provision, prior to its amendment by Section 1, of Republic Act No. 2698,
which took effect on June 18, 1960, expressly provided that "when the allowances shall equal the
capital invested . . . no further allowances shall be made."
b. In other words, the "capital investment" was but the limitation of the amount of depletion that
could be claimed. The outright deduction by the taxpayer of 1/5 of the cost of the mines, as if it
were a "straight line" rate of depreciation, was correctly held by the Tax Court not to be
authorized by the Code.

DISPOSITIVE: ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the appeals in Case
Nos. L-21551 and L-21557, as modified by the crediting of the losses of P36,722.42 disallowed in 1951 and
1952 to the taxpayer for the year 1953 as directed in paragraph 1 (c) of this decision, is hereby affirmed. The
judgment of the Court of Tax Appeals appealed from in Case Nos. L-24972 and L-24978 is affirmed in toto. No
costs. So ordered.