Tax Deductions

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G.R. Nos. L-28508-9 July 7, 1989 ESSO STANDARD EASTERN, INC., (formerly, StandardVacuum Oil Company), petitioner, 
 vs.
 THE COMMISSIONER OF INTERNAL REVENUE, respondent.




TOPIC: Deductions

The applicable provision is Section 30(a) of the National Internal Revenue Code reading as follows:

FACTS: 


ESSO deducted from its gross income for 1959, as part of its ordinary and necessary business expenses, the amount it had spent for drilling and exploration of its petroleum concessions. The Commissioner disallowed the claim on the ground that the expenses should be capitalized and might be written off as a loss only when a “dry hole” should result. Hence, ESSO filed an amended return where it asked for the refund of P323,270 by reason of its abandonment, as dry holes, of several of its oil wells. It also claimed as ordinary and necessary expenses in the same return amount representing margin fees it had paid to the Central Bank on its profit remittances to its New York Head Office. It contends that the margin fees are considered taxes and hence deductible. Alternatively, ESSO prays that if margin fees are not taxes, they should nevertheless be considered necessary and ordinary business expenses and therefore still deductible from its gross income. 


ISSUE: Whether the margin fees may be considered ordinary and necessary expenses when paid.

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HELD: No. Margin fee was imposed by the State in the exercise of its police power and not the power of taxation. Hence, it is not considered as tax.

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; traveling expenses while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for the purpose of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity. (2)  Expenses allowable to non-resident alien individuals and foreign corporations. — In the case of a non-resident alien individual or a foreign corporation, the expenses deductible are the necessary expenses paid or incurred in carrying on any business or trade conducted within the Philippines exclusively.

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For an item to be deductible as a business expense, the expense must be ordinary and necessary; it must be paid or incurred within the taxable year; and it must be paid or incurred in carrying on a trade or business. In addition, the taxpayer must substantially prove by evidence or records the deductions claimed under law, otherwise, the same will be disallowed. There has been no attempt to define “ordinary and necessary” with precision. However, as guiding principle in the proper adjudication of conflicting claims, an expenses is considered necessary where the expenditure is appropriate and helpful in the development of the taxpayer’s business. It is ordinary when it connotes a payment which is normal in relation to the business of the taxpayer and the surrounding circumstances. Assuming that the expenditure is ordinary and necessary in the operation of the taxpayer’s business; the expenditure, to be an allowable deduction as a business expense, must be determined from the nature of the expenditure itself, and on the extent and permanency of the work accomplished by the expenditure. Herein, ESSO has not shown that the remittance to the head office of part of its profits was made in furtherance of its own trade or business. The petitioner merely presumed that all corporate expenses are necessary and appropriate in the absence of a showing that they are illegal or ultra vires; which is erroneous. Claims for deductions are a matter of legislative grace and do not turn on mere equitable considerations.

G.R. No. L-15290 May 31, 1963 MARIANO ZAMORA, petitioner, 
 vs.
 COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. TOPIC: Deductions FACTS: 


Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed his income tax returns the years 1951 and 1952. The Collector of Internal Revenue 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 collector required him to pay the sums of P43,758.50 and P7,625.00, as deficiency income tax for the years 1951 and 1952. 
 On appeal by Zamora, the Court of Tax Appeals modified the decision appealed from and ordered him to pay the reduced total sum of P30,258.00 (P22,980.00 and P7,278.00, as deficiency income tax for the years 1951 and 1952. 


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Having failed to obtain a reconsideration of the decision, Mariano Zamora appealed alleging that the Court of Tax Appeals erred in disallowing P10,478.50, as promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora (which is ½ of P20,957.00, supposed business expenses). – eto lang related sa topic 
 Note: He contends that the whole amount of P20,957.00 as

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promotion expenses in his 1951 income tax returns, should be allowed and not merely one-half of it or P10,478.50, on the ground that, while not all the itemized expenses are supported by receipts, the absence of some supporting receipts has been sufficiently and satisfactorily established. For, as alleged, the said amount of P20,957.00 was spent by Mrs. Esperanza A. Zamora (wife of Mariano), during her travel to Japan and the United States to purchase machinery for a new Tiki-Tiki plant, and to observe hotel management in modern hotels. The CTA, however, found that for said trip Mrs. Zamora obtained only the sum of P5,000.00 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 facts were not denied by Mariano Zamora. No evidence had been submitted as to where Mariano had obtained the amount in excess of P5,000.00 given to his wife which she spent abroad. No explanation had been made either that the statement contained in Mrs. Zamora's application for dollar allocation that she was going abroad on a combined medical and business trip, was not correct. The alleged expenses were not supported by receipts. Mrs. Zamora could not even remember how much money she had when she left abroad in 1951, and how the alleged amount of P20,957.00 was spent.   ISSUE: Whether or not the CTA erred in disallowing P10,478.50 as promotion expenses incurred by his wife for the promotion of

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the Bay View Hotel and Farmacia Zamora in the absence of receipts proving the same. 


HELD: NO 


Section 30, of the Tax Code, provides that in computing net income, there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year, in carrying on any trade or business. Since promotion expenses constitute one of the deductions in conducting a business, same must testify these requirements. Claim for the deduction of promotion expenses or entertainment expenses must also be substantiated or supported by record showing in detail the amount and nature of the expenses incurred (N.H. Van Socklan, Jr. v. Comm. of Int. Rev.; 33 BTA 544). Considering, as heretofore stated, that the application of Mrs. Zamora 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 having been no means by which to ascertain which expense was incurred by her in connection with the business of Mariano Zamora and which was incurred for her personal benefit, the Collector and the CTA in their decisions, considered 50% of the said amount of P20,957.00 as business expenses and the other 50%, as her personal expenses. We hold that said allocation is very fair to Mariano Zamora, there having been no receipt whatsoever, submitted to explain the alleged business expenses, or proof of the

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connection which said expenses had to the business or the reasonableness of the said amount of P20,957.00. While in situations like the present, absolute certainty is usually not possible, the CTA should make as close an approximation as it can, bearing heavily, if it chooses, upon the taxpayer whose inexactness is of his own making. 
 In the case of Visayan Cebu Terminal Co., Inc. v. Collector of Int. Rev, it was declared that representation expenses fall under the category of business expenses which are allowable deductions from gross income, if they meet the conditions prescribed by law, particularly section 30 (a) [1], of the Tax Code; that to be deductible, said business expenses must be ordinary and necessary expenses paid or incurred in carrying on any trade or business; that those expenses must also meet the further test of reasonableness in amount; that when some of the representation expenses claimed by the taxpayer were evidenced by vouchers or chits, but others were without vouchers or chits, documents or supporting papers; that there is no more than oral proof to the effect that payments have been made for representation expenses allegedly made by the taxpayer and about the general nature of such alleged expenses; that accordingly, 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 4 CHAPTER V: DEDUCTIONS properly deductible as representation expenses.

KUENZLE & STREIFF INC. V CIR
 Facts: 
 Kuenzle & Streiff for the years 1953, 1954 and 1955 filed its income tax return, declaring losses.
 CIR filed for deficiency of income taxes against Kuenzle & Streiff Inc. for the said years in the amounts of P40, 455.00, P11, 248.00 and P16, 228.00, respectively, arising from the disallowance, as deductible expenses, of the bonuses paid by the corporation to its officers, upon the ground that they were not ordinary, nor necessary, nor reasonable expenses within the purview of Section 30(a) (1) of the National Internal Revenue Code. The corporation filed with the Court of Tax Appeals a petition for review contesting the assessments. CTA favored the CIR, however lowered the tax due on 1954. The corporation moved for reconsideration, but still lost. The Corporation contends that the tax court, in arriving at its conclusion, acted "in a purely arbitrary manner", and erred in not considering individually the total compensation paid to each of petitioner's officers and staff members in determining the reasonableness of the bonuses in question, and that it erred likewise in holding that there was nothing in the record indicating that the actuation of the respondent was unreasonable or unjust.
 ISSUE: Whether or not the bonuses in question was reasonable and just to be allowed as a deduction?
 HELD: No.
 RATIO: It is a general rule that `Bonuses to employees made in

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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. The condition precedents to the deduction of bonuses to employees are: (1) the payment of the bonuses is in fact compensation; (2) it must be for personal services actually rendered; and (3) 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. Here it is admitted that the bonuses are in fact compensation and were paid for services actually rendered. The only question is whether the payment of said bonuses is reasonable. 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 quality of the services performed with relation to the business. Other tests suggested are: payment must be 'made in good faith'; the character of the taxpayer's business, the volume and amount of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation'; 'the size of the particular business'; 'the employees' qualifications and contributions to the business venture'; and 'general economic conditions. However, 'in determining whether the particular salary or compensation payment is reasonable, the situation must be considered as a whole.
 It seems clear from the record that, in arriving at its main conclusion, the tax court considered, inter alia, the following factors:
 1) The paid officers, in the absence of evidence to the contrary, that they were competent, on the other the record discloses no evidence nor has petitioner ever made the claim that all or some of them were gifted with some special talent, or had undergone some extraordinary training, or had accomplished any particular task,

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that contributed materially to the success of petitioner's business during the taxable years in question.
 2) All the other employees received no pay increase in the said years.
 3) The bonuses were paid despite the fact that it had suffered net losses for 3 years. Furthermore the corporation cannot use the excuse that it is 'salary paid' to an employee because the CIR does not question the basic salaries paid by petitioner to the officers and employees, but disallowed only the bonuses paid to petitioner's top officers at the end of the taxable years in question. ALTERNATIVE DIGEST FOR

G.R. No. L-18840 May 29, 1969 KUENZLE & STREIFF, INC., petitioner, 
 vs.
 THE COMMISSIONER OF INTERNAL REVENUE, respondent. Topic: Deductions FACTS: 


Kuenzle & Streiff for the years 1953, 1954 and 1955 filed its income tax return, declaring losses. 
 CIR filed for deficiency of income taxes against Kuenzle & Streiff Inc. for the said years in the amounts of P40,455.00, P11,248.00 and P16,228.00, respectively, arising from the disallowance, as deductible expenses, of the bonuses paid by the corporation to its officers, upon the ground that they were not ordinary, nor necessary, nor reasonable expenses

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within the purview of Section 30(a) (1) of the National Internal Revenue Code.   The corporation filed with the Court of Tax Appeals a petition for review contesting the assessments. CTA favored the CIR, however lowered the tax due on 1954. The corporation moved for reconsideration, but still lost.   The Corporation contends that the tax court, in arriving at its conclusion, acted "in a purely arbitrary manner", and erred in not considering individually the total compensation paid to each of petitioner's officers and staff members in determining the reasonableness of the bonuses in question, and that it erred likewise in holding that there was nothing in the record indicating that the actuation of the respondent was unreasonable or unjust.

rendered; and (3) 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. Here it is admitted that the bonuses are in fact compensation and were paid for services actually rendered. The only question is whether the payment of said bonuses is reasonable. 





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 quality of the services performed with relation to the business. Other tests suggested are: payment must be 'made in good faith'; the character of the taxpayer's business, the volume and amount of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation'; 'the size of the particular business'; 'the employees' qualifications and contributions to the business venture'; and 'general economic conditions. However, 'in determining whether the particular salary or compensation payment is reasonable, the situation must be considered as a whole.

ISSUE: Whether or not the bonuses in question was reasonable and just to be allowed as a deduction? 


HELD: No. 


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. 6 CHAPTER V: DEDUCTIONS The condition precedents to the deduction of bonuses to employees are: (1) the payment of the bonuses is in fact compensation; (2) it must be for personal services actually


 It seems clear from the record that, in arriving at its main conclusion, the tax court considered, inter alia, the following factors:
 1) The paid officers, in the absence of evidence to the contrary, that they were competent, on the other the record discloses no evidence nor has petitioner ever made the claim that all or some of them were gifted with some special

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talent, or had undergone some extraordinary training, or had accomplished any particular task, that contributed materially to the success of petitioner's business during the taxable years in question. 
 2) All the other employees received no pay increase in the said years. 
 3) The above salaries and bonuses were paid to petitioner's top officials mentioned heretofore, in spite of the fact that according to its income tax returns for the relevant years, it had suffered net losses. In fact, petitioner's financial statements further show that its gross assets suffered a gradual decrease for the same years.), and that a similar downward trend took place in its surplus and capital position during the same period of time. Petitioner admits that the amounts it paid to its top officers in 1953 as bonus or "additional remuneration" were taken either from operating funds, that is, funds from the year's business operations, or from its general reserve. Normally, the amounts taken from the first source should have constituted profits of the corporation distributable as dividends amongst its shareholders. Instead it would appear that they were diverted from this purpose and used to pay the bonuses for the year 1953. In the case of the amounts taken from the general reserve it seems clear that the company had to resort to the use of such reserve funds because the item of expense to be met could not be

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considered as ordinary or necessary — and was therefore beyond the purview of the provisions of Section 30(a) (1) of the National Internal Revenue Code. This being so, We cannot see our way clear to holding that the respondent acted arbitrarily in disallowing as deductible expenses the amounts thus paid as bonus or "additional remuneration". C. M. Hoskins & Co. Inc. v Commissioner of Internal Revenue

Facts: Petitioner, a domestic corporation engaged in the real estate business as brokers, managing agents and administrators, filed its income tax return for its fiscal year ending September 30, 1957 showing a net income of P92,540.25 and a tax liability due thereon of P18,508.00, which it paid in due course. Upon verification of its return, respondent Commissioner of Internal Revenue, disallowed four items of deduction in petitioner's tax returns and assessed against it an income tax deficiency in the amount of P28,054.00 plus interests. The Court of Tax Appeals upon reviewing the assessment at the taxpayer's petition, upheld respondent's disallowance of the principal item of petitioner's having paid to Mr. C. M. Hoskins, its founder and controlling stockholder the amount of P99,977.91 representing 50% of supervision fees earned by it and set aside respondent's disallowance of three other minor items. The Tax Court therefore determined petitioner's tax deficiency to be in the amount of P27,145.00 and on November 8, 1964 rendered judgment against it, as follows:

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WHEREFORE, premises considered, the decision of the respondent is hereby modified. Petitioner is ordered to pay to the latter or his representative the sum of P27,145.00, representing deficiency income tax for the year 1957, plus interest at 1/2% per month from June 20, 1959 to be computed in accordance with the provisions of Section 51(d) of the National Internal Revenue Code. If the deficiency tax is not paid within thirty (30) days from the date this decision becomes final, petitioner is also ordered to pay surcharge and interest as provided for in Section 51 (e) of the Tax Code, without costs. Issue: Whether or not the disallowance of the 4 items were proper. Held: NOT deductible.  It did not pass the test of reasonableness which is: General rule, bonuses to employees made in good faith and as additional compensation for services actually rendered by the employees are deductible, provided such payments, when added to the salaries do not exceed the compensation for services rendered. The conditions precedent to the deduction of bonuses to employees are:

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·         Payment of bonuses is in fact compensation

·         Must be for personal services actually rendered ·         Bonuses when added to salaries are reasonable when measured by the amount and quality of 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.

In the case, Hoskins fails to pass the test. CTA was correct in holding that the payment of the company to Mr. Hoskins of the sum P99,977.91 as 50% share of supervision fees received by the company was inordinately large and could not be treated as an ordinary and necessary expenses allowed for deduction. 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.
 The condition precedents to the deduction of bonuses to employees are: (1) the payment of the bonuses is in fact compensation; (2) it must be for personal services actually rendered; and (3) 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. Here it is admitted that the

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bonuses are in fact compensation and were paid for services actually rendered.

CIR vs. GENERAL FOODS PHILS. INC. (test of reasonableness) FACTS: In June 1985, GF, engaged in the manufacture of beverages filed its income tax return for the fiscal year ending February 28, 1985. In said tax return, respondent corporation claimed as deduction, among other business expenses, the amount of P9,461,246 for media advertising for Tang. CIR disallowed 50% or P4,730,623 of the deduction claimed by respondent corporation. Consequently, GR was assessed deficiency income taxes in the amount of P2,635, 141.42. The latter filed a motion for reconsideration but the same was denied. GR appealed to the Court of Tax Appeals but the appeal was dismissed: “With such a gargantuan expense for the advertisement of a singular product, which even excludes other advertising and promotions expenses, we are not prepared to accept that such amount is reasonable to stimulate the current sale of merchandise regardless of Petitioners explanation that such expense does not connote unreasonableness considering the grave economic situation taking place after the Aquino assassination characterized by capital fight, strong deterioration of the purchasing power of the Philippine peso and the slacking demand for consumer products”.

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CA however, set aside the ruling of the CTA: “Since it has not been sufficiently established that the item it claimed as a deduction is excessive, the same should be allowed.” Thus, this petition by CIR. ISSUE: W/N the media advertising expense for Tang incurred by respondent corporation was an ordinary and necessary expense fully deductible under the HELD: NO. We find the subject expense for the advertisement of a single product to be 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 second type involves expenditures incurred, in whole or in part, to create or maintain some form of goodwill for the taxpayers trade or business or for the industry or profession of which the taxpayer is a member. If the expenditures are for the advertising of the first kind, then, except as to the question of the reasonableness of amount, there is no doubt such expenditures are deductible as business expenses. If, however, the expenditures are for advertising of the second kind, then normally they should be spread out over a reasonable period of time. We agree with the CTA that the subject advertising expense was of the second kind. Not only was the amount staggering;

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the respondent corporation itself also admitted, in its letter protest to the Commissioner of Internal Revenues assessment, that the subject media expense was incurred in order to protect GR’s brand franchise, a critical point during the period under review. The protection of brand franchise is analogous to the maintenance of goodwill or title to one’s property. This is a capital expenditure which should be spread out over a reasonable period of time. Respondent corporations 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.

CIR vs. ISABELA CULTURAL CORPORATION (it must be paid or incurred during the taxable year) FACTS: In February 1990, ICC, a domestic corporation, received from the BIR an Assessment Notice for deficiency income tax in the amount of P333,196.86, and an Assessment Notice for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986. The deficiency expanded withholding tax was allegedly due 10 CHAPTER V: DEDUCTIONS to the failure of ICC to withhold 1% expanded withholding tax on its claimed P244,890.00 deduction for security services. The CTA held however that the claimed deductions for

professional and security services were properly claimed by ICC in 1986 because it was only in the said year when the bills demanding payment were sent to ICC. Hence, even if some of these professional services were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said years as the amount thereof could not be determined at that time. CIR appealed to the CA which upheld CTA holding 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. Hence, this case before the SC. ISSUE: W/N the deduction of the expenses for professional and security services from ICCs gross income was correct. HELD: NO. The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and auditing services, are: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers. The requisite that it must have been paid or incurred during the taxable year is further qualified by Section 45 of the

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National Internal Revenue Code (NIRC) which states that: [t]he deduction provided for in this Title 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 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. The failure to determine the exact amount of the expense during the taxable year when they could have been claimed as deductions cannot thus be attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could have inquired into the amount of their obligation to the firm, especially so that it is using the accrual method of accounting. For another, it could have reasonably determined the amount of legal and retainer fees owing to its familiarity with the rates charged by their long time legal consultant. CIR v CTA AND SMITH&FRENCH OVERSEAS

Facts: Smith Kline & French Overseas Company is a multinational firm domiciled in Philadelphia, licensed to do business in the

Philippines. It is engaged in the importation, manufacture, and sale of pharmaceutical drugs and chemicals. In 1971, it declared a net taxable income of P1.4 M and paid P511k as tax due. It claimed its share of the head office overhead expenses (P501k) as deduction from gross income. In its amended return, it claimed that there was an overpayment of tax (P324k) arising from under-deduction of the overhead expense. This was certified by international independent auditors, the allocation of the overhead expense made on the basis of the percentage of gross income in the Philippines to gross income of the corporation as a whole. In 1974, without waiting for the action of the CIR, Smith filed a petition for review with the CTA. CTA ordered CIR to refund the overpayment or grant Smith a tax credit. CIR appealed to the SC. Issue: Whether Smith is entitled to a refund – YES Ratio: The governing law is found in Sec. 37 (b).1 Revenue Regulation No. 2 of the DOF contains a similar provision, with the additional line that “the ratable part is based upon the ratio of gross income from sources within the Philippines to the total gross income” (Sec. 160). Hence, where an expense is clearly related to the production of Philippine-

Net income from sources in the Philippines. – From the items of gross income specified in subsection (a) of this section there shall be deducted expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the Philippines. 1

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derived income or to Philippine operations, that expense can be deducted from the gross income acquired in the Philippines without resorting to apportionment. However, the overhead expenses incurred by the parent company in connection with finance, administration, and research & development, all of which directly benefit its branches all over the world, fall under a different category. These are items which cannot be definitely allocated or identified with the operations of the Philippine branch. Smith can claim as its deductible share a ratable part of such expenses based upon the ration of the local branch’s gross income to the total gross income of the corporation worldwide. CIR’s Contention The CIR does not dispute the right of Smith to avail of Sec. 37 (b) of the Tax Code and Sec. 160 of the RR. But he maintains that such right is not absolute and that there exists a contract (service agreement) which Smith has entered into with its home office, prescribing the amount that a branch can deduct as its share of the main office’s overhead expenses. Since the share of the Philippine branch has been fixed, Smith cannot claim more than the said amount. Smith’s Contention Smith, on the other hand, submits that the contract between itself and its home office cannot amend tax laws and 12 CHAPTER V: DEDUCTIONS regulations. The matter of allocated expenses deductible under the law cannot be the subject of an agreement

between private parties nor can the CIR acquiesce in such an agreement. SC ruled for Smith Kline and said that its amended return conforms with the law and regulations. GUTIERREZ v COLLECTOR

Facts: Lino Gutierrez was primarily engaged in the business of leasing real property for which he paid real estate broker’s privilege tax. The Collector assessed against Gutierrez deficiency income tax amounting to P11,841. The deficiency tax came about by the disallowance of deductions from gross income representing depreciation expenses Gutierrez allegedly incurred in carrying on his business. The expenses consisted of: 1.       Transportation expenses incurred to attend the funeral of his friends, 2.       Procurement and installation of an iron door, 3.       Cost of furniture given by the taxpayer in furtherance of a business transaction, 4.       Membership fees in organizations established by those engaged in the real estate trade, 5.       Car expenses, salary of his driver and car depreciation, 6.       Repairing taxpayer’s rental apartments, 7.       Litigation expenses, 8.       Depreciation of Gutierrez’ residence, 9.       Fines and penalties for late payment of taxes, 10.   Alms given to in indigent family and a donation consisting of officer’s jewels and aprons to Biak-na-Bato Lodge No. 7.

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Issue: Whether or not claims for deduction are proper and allowable. Held: To be deductible, an expense must be: ·         Ordinary and necessary ·         Paid or incurred within the taxable year ·         Paid or incurred in carrying on a trade or business. 1. Transportation expenses which petitioner incurred to attend the funeral of his friends and the cost of admission tickets to operas - expenses relative to his personal and social activities rather than to his business of leasing real estate. 2. Procurement and installation of an iron door to - purely a personal expense. Personal, living, or family expenses are not deductible. 3. Cost of furniture given by the taxpayer as commission in furtherance of a business transaction - the expenses incurred in attending the National Convention of Filipino Businessmen, luncheon meeting and cruise to Corregidor of the Homeowners' Association were shown to have been made in the pursuit of his business. Commissions given in consideration for bringing about a profitable transaction are part of the cost of the business transaction and are deductible. 4. Membership and activities in connection therewith were solely to enhance his business -Gutierrez was an officer of the Junior Chamber of Commerce which sponsored the National Convention of Filipino Businessmen. He was also the president of the Homeowners' Association, an organization

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established by those engaged in the real estate trade. Having proved that his, the expenses incurred are deductible as ordinary and necessary business expenses. 5. Car expenses, salary of his driver and car depreciation – 1/3 of the same was disallowed by the Commissioner on the ground that the taxpayer used his car and driver both for personal and business purposes. There is no clear showing, however, that the car was devoted more for the taxpayer's business than for his personal and business needs. According to the evidence, the taxpayer's car was utilized both for personal and business needs. It is reasonable to allow as deduction 1/2 of the driver's salary, car expenses and depreciation. 6. Those used to repair the taxpayer's rental apartments - did not increase the value of such apartments, or prolong their life. They merely kept the apartments in an ordinary operating condition. Hence, the expenses incurred are deductible as necessary expenditures for the maintenance of the taxpayer's business. 7. Litigation expenses - defrayed by Gutierrez to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expenses in pursuing his business. It is routinary and necessary for one in the leasing business to collect rentals and to eject tenants who refuse to pay their accounts. 8. Depreciation of Gutierrez' residence - not deductible. A taxpayer may deduct from gross income a reasonable allowance for deterioration of property arising out of its use or employment in business or trade. Gutierrez' residence was not used in his trade or business. 9. Deduction the fines and penalties which he paid for late payment of taxes - while Section 30 allows taxes to be

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deducted from gross income, it does not specifically allow fines and penalties to be so deducted. Deductions from gross income are matters of legislative grace; what is not expressly granted by Congress is withheld. Moreover, when acts are condemned, by law and their commission is made punishable by fines or forfeitures, to allow them to be deducted from the wrongdoer's gross income, reduces, and so in part defeats, the prescribed punishment. 10. Alms to an indigent family and various individuals, contributions to Lydia Yamson and G. Trinidad and a donation consisting of officers' jewels and aprons to Biak-na-Bato Lodge No. 7 - not deductible from gross income inasmuch as their recipients have not been shown to be among those specified by law. Contributions are deductible when given to the Government of the Philippines, or any of its political subdivisions for exclusively public purposes, to domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, athletic, cultural or educational purposes, or for the rehabilitation of veterans, or to societies for the prevention of cruelty to children or animals, no part of the net income of which inures to the benefit of any private stockholder or individual.

GANGAYCO vs COLLECTOR FACTS: ▪ Respondent CIR issued a communication informing the petitioner that V: there was still due from him, a efficiency 14 CHAPTER DEDUCTIONS income tax for the year 1949, the sum of P29,554.05. Gancayco sought a reconsideration, which was part granted by respondent, who in a letter dated April 8, 1953,

informed petitioner that his income tax defendant efficiency for 1949 amounted to P16,860.31.  ▪ On April 15, 1956, respondent issued a warrant of distraint and levy against the properties of Gancayco for the satisfaction of his deficiency income tax liability, and accordingly, the municipal treasurer of Catanauan, Quezon issued on May 29, 1956, a notice of sale of said property at public auction on June 19, 1956. ▪ The question whether the sum of P16,860.31 is due from Gancayco as deficiency income tax for 1949 hinges on the validity of his claim for deduction of two (2) items, namely: (a) for farming expenses, P27,459.00; and (b) for representation expenses, P8,933.45. ISSUE: Whether or not the 2 claimed deductions are allowable. HELD: No. Section 30 of the Tax Code partly reads: (a) Expenses: (1) In General — All the  ordinary  and  necessary  expenses paid or incurred during the taxable year incarrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for the purposes of the trade or business, of property  to which the taxpayer has not taken or is not taking title or in which he has no equity.

[CHAPTER V: DEDUCTIONS] 15

In computing net income no deduction shall in  any  case be allowed in respect of —(1) Personal, living, or family expenses;(2) Any amount paid out for new buildings or for  permanent improvements, or  betterments  made to increase the value of any property or estate;(3) Any amount expended in  restoring  property or in  making good the exhaustion thereof  for which an allowance is or has been made; or (4) Premiums paid on any life insurance policy covering the life of any officer or employee, or any person financially interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such policy. The cost of farm machinery, equipment and farm building represents a capital investment and is  not  an allowable deduction as an item of expense. Amounts expended in the  development  of farms, orchards, and ranches  prior to the time when the productive state is reached  may be regarded as investments of capital. Accordingly, they are not deductible. As for Gangayco’s claim for representation expenses amounting to P31,753.97, of which P22,820.52 was allowed, and P8,933.45 disallowed. Such disallowance is justified by the record, for, apart from the absence of receipts, invoices or vouchers of the expenditures in question, petitioner could not specify the items constituting the same, or when or on whom or on what they were incurred.

3M Philippines vs. CIR FACTS: ▪ 3M Philippines, Inc. is a subsidiary of the Minnesota Mining and Manufacturing Company (or "3M-St. Paul") a nonresident foreign corporation with principal office in St. Paul, Minnesota, U.S.A. It is the exclusive importer,

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▪

▪

▪ ▪

manufacturer, wholesaler, and distributor in the Philippines of all products of 3M-St. Paul. To enable it to manufacture, package, promote, market, sell and install the highly specialized products of its parent company, and render the necessary post-sales service and maintenance to its customers, petitioner entered into a "Service Information and Technical Assistance Agreement" and a "Patent and Trademark License Agreement" with the latter under which the petitioner agreed to pay to 3M-St. Paul a technical service fee of 3% and a royalty of 2% of its net sales.  In its income tax return for the fiscal year ended October 31, 1974, the petitioner claimed the following deductions as business expenses:(a) royalties and technical service fees of P 3,050,646.00; and (b) pre-operational cost of tape coater of P97,485.08. The Commissioner did not allow the entire amount as deduction. Instead, respondent ordered petitioner to pay P840,540 as deficiency income tax on its 1974 return, plus P353,026.80 as 14% interest per annum from February 15, 1975 to February 15, 1976, or a total ofP1,193,566.80. Petitioner protested and argued that the law applicable to its case is only Section 29(a)(1) and not circular 393 of the central bank. CA upheld the commissioner’s ruling.

ISSUE: Whether or not the royalty payments are valid deductible payments. HELD: No.

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Although although the Tax Code allows payments of royalty to be deducted from gross income as business expenses, it is CB Circular No. 393 that defines what royalty payments are proper. Hence, improper payments of royalty are not deductible as legitimate business expenses. Section 3c of the circular provides that no royalty is payable on the wholesale price of finished products imported by the licensee from the licensor. Further, Circulars issued by the Central Bank in the exercise of its authority under the Central Bank Act, and which have been duly published in the Official Gazette, have the force and effect of law (People vs. Que Po Lay, 94 Phil. 640; Lim Hoa Ting vs. Central Bank, 104 Phil. 573). They are binding on everybody, the petitioner, as much as the public respondent.

OPTIONAL TREATMENT OF INTEREST EXPENSE COMMISSIONER OF INTERNAL REVENUE vs. CARLOS PALANCA, JR. (1966)

In 1950, Don Palanca Sr. donated in favor of his son (Respondent) shares of stock in La Tondeña, Inc. amounting to 12,500 shares. Respondent failed to file a return on the donation within the statutory period so BIR assessed the sums of P97,691.23, P24,442.81 and P47,868.70 as gift tax, 25% surcharge and interest, respectively, which he paid on June 22, 1955.

16 CHAPTER V: DEDUCTIONS

In 1956, respondent filed with BIR his income tax return for the calendar year 1955, claiming, among others, a deduction for interest. On the basis of this return, he was assessed the sum of P21,052.91, as income tax, which he paid. Subsequently, the respondent filed an amended return for the year 1955, claiming an additional deduction representing interest paid on the donee's gift tax. The claim for deduction was based on the provisions of Section 30(b) (1) of the Tax Code, which authorizes the deduction from gross income of interest paid within the taxable year on indebtedness. A claim for the refund of alleged overpaid income taxes for the year 1955 amounting to P17,885.01, which is the difference between the amount of P21,052.01 he paid as income taxes under his original return and of P3,167.00, was filed together with this amended return. The claim for refund was denied by the BIR.

In 1957, the respondent reiterated his claim for refund but was again denied. Then, he requested the case to be referred to the conference staff of the BIR. Later, he requested the respondent to hold his action on the case in abeyance until after the CTA renders its division on a similar case, and on November 7, 1957, BIR denied the claim for the refund.

Meanwhile, the BIR considered the transfer of 12,500 shares of stock of La Tondeña Inc. to be a transfer in contemplation of death pursuant to Section 88(b) of the NIRC. Consequently, the respondent assessed against the petitioner the sum of

[CHAPTER V: DEDUCTIONS] 17

P191,591.62 as estate and inheritance taxes on the transfer of said 12,500 shares of stock. The amount of P17,002.74 paid on June 22, 1955 by the petitioner as gift tax, including interest and surcharge, was applied to his estate and inheritance tax liability. On the tax liability of P191,591.62, the petitioner paid the amount of P60,581.80 as interest for delinquency.

In 1958, the respondent once more filed an amended income tax return for the year 1955, claiming, in addition to the interest deduction of P9,076.45 appearing in his original return, a deduction in the amount of P60,581.80, representing interest on the estate and inheritance taxes on the 12,500 shares of stock, thereby reporting a net taxable income for 1955 in the amount of P5,400.32 and an income tax due thereon in the sum of P428.00. He attached a letter requesting the refund of P20,624.01 which is the difference between the amounts of P21,052.01 he paid as income tax under his original return and of P428.00. Without waiting for the CIR's decision on this claim for refund, he filed his petition for review before the CTA. CIR then denied the request for refund. CTA ordered CIR to refund to the respondent the amount representing alleged over-payment of income taxes for the calendar year 1955.

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ISSUE: WON the amount paid by Palanca for interest on his delinquent estate and inheritance tax is deductible from the gross income for that year under Section 30 (b) (1) of the Revenue Code.

HELD: Yes. While "taxes" and "debts" are distinguishable legal concepts, in certain cases as in the suit at bar, on account of their nature, the distinction becomes inconsequential. This qualification is recognized even in the United States. Thus, 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 requirements of the law. (Camden vs. Fink Coule and Coke Co., 61 ALR 584). Where statutes impose a personal liability for a tax, the tax becomes at least in a broad sense, a debt. (Idem.) Some American authorities hold that, especially for remedial purposes, Federal taxes are debts. (Tax Commission vs. National Malleable Castings Co., 35 ALR 1448)

In our jurisdiction, the rule is settled that although taxes already due have not, strictly speaking, the same concept as debts, they are, however obligations that may be considered as such. (Sambrano vs. Court of Tax Appeals, G.R. no. L-8652, March 30, 1957). In a more recent case Commissioner of Internal Revenue vs. Prieto, G.R. No. L-13912, September 30,

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1960, we explicitly announced that while the distinction between "taxes" and "debts" was recognized in this jurisdiction, the variance in their legal conception does not extend to the interests paid on them, at least insofar as Section 30 (b) (1) of the National Internal Revenue Code is concerned.

We do not see any element in this case which can justify a departure from or abandonment of the doctrine in the Prieto case above. In both this and the said case, the taxpayer sought the allowance as deductible items from the gross income of the amounts paid by them as interests on delinquent tax liabilities. Of course, what was involved in the cited case was the donor's tax while the present suit pertains to interest paid on the estate and inheritance tax. This difference, however, submits no appreciable consequence to the rationale of this Court's previous determination that interests on taxes should be considered as interests on indebtedness within the meaning of Section 30(b) (1) of the Tax Code. The interpretation we have placed upon the said section was predicated on the congressional intent, not on the nature of the tax for which the interest was paid. PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP) vs. CA, CIR, and CTA (1995)

18 is CHAPTER V: DEDUCTIONS Picop 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 1983, Picop received from the CIR 2 letters of assessment and demand: (a) one for deficiency transaction tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate amount of P88,763,255.00. Picop protested the assessment of deficiency transaction tax and documentary and science stamp taxes. It also protested the deficiency income tax assessment for 1977. These protests were not formally acted upon by CIR. In 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.

PICOP appealed the assessments to CTA, which modified the CIR’s findings and held 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. Both petitions were referred by SC to the CA. Cases were consolidated.

CA: further reduced the liability of Picop.

[CHAPTER V: DEDUCTIONS] 19

Elevated the case again to SC, alleged: Picop: not liable at all to pay any of the assessments or any part thereof. CIR: 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 and that Picop should be held liable for interest at 14% per annum for 3 years, and interest at 20% per annum for a maximum of 3 years; and for a surcharge of 10%, on Picop's deficiency income tax. Finally, the CIR contends that Picop is liable for the corporate development tax equivalent to five percent (5%) of its correct 1977 net income.

ISSUE: Whether Picop is entitled to deductions against income of interest payments on loans for the purchase of machinery and equipment. HELD: YES. 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. The basis is 1977 Tax Code Sec. 30 (b). Thus, the general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under loans incurred

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in connection with the carrying on of the business of the taxpayer. 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 contention of CIR does not spring of the 1977 Tax Code but from Revenue Regulations 2 Sec. 79. However, the Court said that the term “interest” here should be construed as the 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. Such "theoretical" or imputed interest does not arise from a legally demandable interestbearing 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. CIR V LEDNICKY FACTS:

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Resp spouses V.E. Lednicky and Maria Valero Lednicky are American Citizens residing in the Philippines and derived their income from Philippine sources for the taxable years in question. 1957 – Sps filed their ITR for 1956 reporting a gross income P1,017,287.65 and a net income of P733,809.44 on which P317,395.40 was assessed after deducting P4,805.59 as withholding tax. Sps paid 326,247.41 on April 1957 March 1959 – Sps filed an amended ITR for 1956. They claimed a deduction of P205,939.24 paid in 1956 to US gov’t. Respondents requested refund of 112,437.90 CIR failed to answer the claim for refund, resps filed their petition with the Tax Court G.R. No. L-18169 formerly CTA case 570[different case/year] is also a claim for refund in the amount of P150,269.00 as alleged overpaid income tax for 1955 Facts: In Feb 1956 Sps filed ITR for 1955 = gross income of P1,7771,124.63 and net income of P1,052,550.67 1956 – sps filed an amended ITR. Back in 1955, sps filed with the US Internal Revenue Agent in Manila their federal ITR for the years 1947,1951-54 on income from Phil sources on a cash basis. 1958 – Sps amended their Phil ITR for 1955 to include the deductions of US Federal income taxes, interest accrued up to May 15, 1955, and exchange and bank charges. CTA case 570 was filed. 20 No. CHAPTER V: DEDUCTIONS G.R. 21434 formerly CTA Case No. 783, facts are similar but refer to Lednickys’ OTR for 1957 filed in Feb 1958. In

1959 sps filed amended return for 1957 claiming deductions representing taxes paid to US Gov’t. * Tax court held that the taxes may be deducted because the Sps did not signify in their ITR a desire to avail themselves of the benefits of paragraph 3(B) of Sec. 30 COMMON ISSUE: WON a citizen of the US residing in Phils who derives income wholly from sources within the Phils may deduct from his gross income the income taxes he has paid to US gov’t for the taxable year? HELD/RATIO: •

•

SC: CIR correct that the construction and wording of Sec. 30c(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 o (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 any extent the benefits of paragraph (3) of this subsection (relating to credit for foreign countries) 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.

[CHAPTER V: DEDUCTIONS] 21

•

•

•

For it is obvious that in prescribing that such deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have any extent benefits of paragraph 3, the statute assumes that the taxpayer in question may signify his desire to claim a tax credit and waive the deduction; otherwise, the foreign taxes would always be deductible and their mention in the list on nondeductible items in Sec. 30c might as well have been omitted or at least expressly limited to taxes on income from sources outside the Philippine Islands Had the law intended that foreign income taxes could be deducted from gross income in any event, regardless of the taxpayer’s right to claim a tax credit, it is the latter right that should be conditioned upon the taxpayer’s waiving the deduction No danger of double credit/taxation. o Double taxation becomes obnoxious only where the taxpayer is taxed twice for the benefit of the same governmental entity o The Philippine government only receives the proceeds of one tax o Justice and equity demand that the tax on the income should accrue to the benefit of the Philippines o Any relief from the alleged double taxation should come from the US since the former’s right to burden the taxpayer is solely predicated in is citizenship, without

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o

contributing to the production of wealth that is being taxed 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 t h e Ph i li p p i n e gove rn m e n t si m p ly b y increasing the tax rates on the alien resident.

MARCELO STEEL CORPORATION vs. COLLECTOR OF INTERNAL REVENUE Facts: The petitioner is a corporation duly organized and existing under and by virtue of the laws of the Philippines, with offices at Malabon, Rizal. It is engaged in three (3) industrial activities, namely, (1) manufacture of wire fence, (2) manufacture of nails, and (3) manufacture of steel bars, rods and other allied steel products. enjoined the benefits of the tax exemption under Republic Act No. 35. On May 21, 1953, the petitioner filed an income tax return for the year 1952, reflecting a net income of P34,386.58 realized solely from its business of manufacturing wire fence, an activity which is not tax exempt, and on March 31, 1954, it filed its income tax return for the year 1953, showing a net income of P58,329.00 realized from the same sources, i.e., the manufacture of wire fence.

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On basis of the said income tax return filed by the petitioner for the year 1952 and 1953 which did not reflect the financial of its tax exempt business activities, the respondent assessed the total sum of P12,750. On October 1, 1954, the petitioner filed amended income tax returns for taxable years 1952 and 1953, showing that bit suffered a net loss of P871,407.37 in 1952, and P10,956.29 in 1953. The said losses were arrived at by consolidating the gross income and expenses and/or deductions of the petitioner in all its business activities. On October 1, 1954, the petitioner, claiming that instead of earning the net income shown in its original income tax returns for 1952 and 1953, it sustained the losses shown in its amended income tax returns for refund of the income taxes for the said years amounting to P12,750.00 which it allegedly paid to the respondent. After more than ten months of waiting without any action being taken by the respondent on the claim for refund, and in order to protect its right under Section 306 of the National Internal Revenue Code, the petitioner, on August 13, 1955, filed with this Court the instant petition for review. The Court of Tax Appeals held that "petitioner cannot deduct from the profits realized from its taxable industries, the 22 CHAPTER V:its DEDUCTIONS losses sustained by tax exempt business activities, . . ." Issue:

1) whether or not the petitioner may be allowed to deduct from the profits realized from its taxable business activities, the losses sustained by its tax except industries, an 2) whether or not the action for refund, with regard to the sum of P3,458.50 which was of the Tax Code. Held: No. The fact that the petitioner is a corporate organized with a single capital that answer for all its financial obligations including those incurred in the tax exempt industries is of no moment. The intent of the law is to treat taxable or nonexempt industries as separate and distinct from new and necessary industries which are tax-exempt for purposes of taxation. Section 7, Executive Order No. 341, series of 1950, issued by the President of the Philippines pursuant to section 2, Republic Act No. 35, provides: Any industry granted tax exemption under the provisions of Republic Act No. 35 shall report to the Secretary of Finance at the end of every fiscal rear a complete list and a correct valuation of all real and personal property of its industrial plant of factory: shall file a separate income tax return; shall keep separetely the accounting records relative to the industry declared exempt; shall keep such records and submit such sworn statements as may be prescribed from time to time by the Secretary of Finance;1 (Emphasis supplied.)

[CHAPTER V: DEDUCTIONS] 23

And when Congress revised the provision of Republic Act No. 35 by enacting onto law Republic Act No. 901 it incorporate similar provisions and provided that "Any industry granted tax exemption under of Republic Act No. 35" shall "file a separate income tax return."2 The petitioner states that it is not liable to pay income tax on its industries of manufacturing nails and steel bars, ros and other allied steel product for the reason that it had incurred loss in their operation and not because it is exempt under the provision of Republic Act No. 35. It argues that by being allowed to deduct its gains derived from the operation of its taxable or non-exempt industry of manufacturing wire fence, from the losses incurred in the operation of its taxexempt industries of manufacturing nails and steels bars, rod and other allied steel products, it would not receive the benefit of double exemption under Republic Act No. 35 is to lighten the onerous financial burden and reduce the losses of the entrepeneur, yet it is not designed to assure him of a return on his capital invested. As already stated, the law intended to treat to treat taxable or non-excempt industry as separate and distinct from new and necessary industry, which is tax exempt, and did not mean to grant an entrepreneur, engaged at the same time in a taxable or non-exempt industry and a new and necessary industry, the benefit or privilege of deducting his gains or profit derived from the operation of the first from the losses incurred in the operation of the second. Moreover, aside from

Taxation 1- SY 2015-2016 (Zarate)

its exemption from the payment of income tax on its profits derived from the operation of new and necessary industries, the petitioner is exempt from the payment of other internal revenue taxes directly payable by it, such as the fixed and privilege tax on business, the percentage tax on the fixed and privilege tax on business, the percentage tax on the sales of manufactured products, in respect to which exemption is granted, the compensating tax on the articles, goods or material exclusively used in the new and necessary industry, and the documentary stamp tax (Exhibits 6 and 7). These exemption alone are enough to lighten its onerous financial burden and reduce losses. The petitioner claims that unlike the United States Internal Revenue Code which expressly forbids the deduction of — Any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not only any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this chapter [(Section 24 (a) (5)]. Our National Internal Revenue Code does not contain a similar prohibition. When in 1939 Commonwealth Act No. 466, the National Internal Revenue Code, was enacted into law, the idea of granting tax exemption to new and necessary industries in the Philippines had not yet been thought of because there were no new and necessary industries being established or exploited. It was only in 1946, after the last World War, and after the Philippines became sovereign

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nation, that the establishment or exploitation of new and necessary industries was stimulated. Hence the absence of a similar provision in out National Internal Revenue Code. This absence, however, cannot be capitalized upon by the petitioner in support of its theory. For, as already stated, when Congress enacted Republic Act No. 35 into law, it intended to segregate income derived from the operation of new and necessary industries from that derived from the operation of taxable or non-exempt industries.

contractual obligation to produce and supply logs to the latter.

*Losses (Requisites for Deductibility)

San Jose later failed to deliver the logs to Galang Machinery and the latter sued on the performance bond.

To afford itself adequate protection against loss or damage on the performance bond, petitioner required San Jose and one Ramon Cuervo to execute an indemnity agreement obligating themselves, solidarily, to indemnify petitioner for whatever liability it may incur by reason of said performance bond. Accordingly, San Jose constituted a chattel mortgage on logging machineries and other movables in petitioner's favor while Ramon Cuervo executed a real estate mortgage.

G.R. No. L-21520      December 11, 1967 PLARIDEL SURETY and INSURANCE COMPANY, petitioner,

CFI: San Jose and petitioner = liable.

vs.

CA and SC affirmed.

COMMISSIONER OF INTERNAL REVENUE, respondent.

FACTS: Petitioner Plaridel Surety & Insurance Co., is a domestic corporation engaged in the bonding business. On November 9, 1950, petitioner, as surety, and Constancio San Jose, as 24 CHAPTER V: DEDUCTIONS principal, solidarily executed a performance bond in the penal sum of P30,600.00 in favor of the P. L. Galang Machinery Co., Inc., to secure the performance of San Jose's

In its income tax return for the year 1957, petitioner claimed the amount of P44,490.00 (paid to Galang machinery) as deductible loss from its gross income and, accordingly, paid the amount of P136.00 as its income tax for 1957. CIR disallowed deduction. Petitioner filed protest but was denied.

[CHAPTER V: DEDUCTIONS] 25

ISSUE: WON the amount of interest bond is an interest deduction.

The alleged interest deduction not having been properly litigated as an issue before the Tax Court, it is now too late to raise and assert it before this Court.

HELD: NO. Loss is deductible only in the taxable year it actually happens or is sustained. However, if it is compensable by insurance or otherwise, deduction for the loss suffered is postponed to a subsequent year, which, to be precise, is that year in which it appears that no compensation at all can be had, or that there is a remaining or net loss, i.e., no full compensation. There is no question that the year in which the petitioner Insurance Co. effected payment to Galang Machinery pursuant to a final decision occurred in 1957. However, under the same court decision, San Jose and Cuervo were obligated to reimburse petitioner for whatever payments it would make to Galang Machinery. Clearly, petitioner's loss is compensable otherwise (than by insurance).itc-al It should follow, then, that the loss deduction can not be claimed in 1957. The rule is that loss deduction will be denied if there is a measurable right to compensation for the loss, with ultimate collection reasonably clear. So where there is reasonable ground for reimbursement, the taxpayer must seek his redress and may not secure a loss deduction until he establishes that no recovery may be had.

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*Losses (Requisites for Deductibility) G.R. No. L-18282             May 29, 1964 COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. PRISCILA ESTATE, INC., and THE COURT OF APPEALS, respondents. FACTS: The corporation duly filed its income tax returns for the years 1949, 1950 and 1951. On 13 June 1952, however, it amended its income tax returns for 1951 and paid the tax corresponding to the assessment made by the petitioner on the basis of the returns, as amended; and on 13 September 1952, the company claimed a refund of P4,941.00 as overpaid income tax for the year 1950 for having deducted from gross income only the sum of P6,013.85 instead of P39,673.25 as its loss in the sale of a lot and building. Thereupon, the Commissioner of Internal Revenue conducted an investigation of the company's income tax returns for 1949 through 1951 and, thereafter, granted a tax credit of P1,443.00 for 1950 but assessed on 3 November 1953 deficiency income taxes of P3,575.49 for 1949 and P22,166.10 for 1951.

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The Priscila Estate, Inc., contested the deficiency assessments and when the Commissioner of Internal Revenue refused to reconsider them, the former brought suit to the tax court which after trial, rendered the decision that, in 1961, the Commissioner elevated to this Supreme Court for review.

G.R. No. 125508               July 19, 2000 CHINA BANKING CORPORATION, petitioner, 
 vs.
 COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. Topic: Ordinary Losses v Capital Losses Decisions:

ISSUE: WON the cost of the barong-barong is an allowable deduction. (The petitioner claims that the value of the demolished building should not be deducted from gross income but added to the cost of the building replacing it because its demolition or removal was to make way for the erection of another in its place.) 1äwphï1.ñët) HELD: NO. Tax court found that the removal of the "barong-barong", instead of being voluntary, was forced upon the corporation by the city engineer because the structure was a fire hazard; that the rental income of the old building was about P3,730.00 per month, and that the corporation had no funds but had to borrow, in order to construct a new building. All these facts, taken together, belie any intention on the part of the corporation to demolish the old building merely for the purpose of erecting another in its place. Since the demolished building was not compensated for by insurance or otherwise, its loss should be charged off as deduction 26 gross CHAPTER V: DEDUCTIONS from income.

CTA:

Denied in the inclusion for deductions valued worthless securities.

CA:

Affirmed CTA decision..

SC:

Petition denied. Affirmed CTA decision.

Facts: 1.

Sometime in 1980, petitioner China Banking Corporation made a 53% equity investment in the First CBC Capital (Asia) Ltd., a Hongkong 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.

In 1986, it was shown that First CBC Capital (Asia), Ltd., has become insolvent. With the approval of Bangko Sentral, petitioner wrote-off as being worthless its investment in First CBC Capital (Asia), Ltd., in its 1987 Income Tax Return and treated it as a bad debt or as an ordinary loss deductible from its gross income. This was denied by the BIR stating among other things that they should then be classified as "capital loss," and not as a bad

[CHAPTER V: DEDUCTIONS] 27

debt expense there being no indebtedness to speak of between petitioner and its subsidiary. Issue: WoN CA is correct in affirming CTA and BIR’s decision that such worthless securities should be treated as capital loss and not as bad debts? Basis of SC Decision: 1.

No error on the CA ruling > In the case at bar, First CBC Capital (Asia), Ltd., the investee corporation, is a subsidiary corporation of petitioner 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. Therefore, following Section 29(d)(4)(B) of the NIRC which states "(B) Securities becoming worthless. - If securities as defined in Section 20 become worthless during the tax" year and are capital assets, the loss resulting therefrom shall, for the purposes of his Title, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets

Note: In sum (a) The equity investment in shares of stock held by CBC of approximately 53% in its Hongkong subsidiary, the First CBC Capital (Asia), Ltd., is not an indebtedness, and it is a capital, not an ordinary, asset.91âwphi1 (b) Assuming that the equity investment of CBC has indeed become "worthless," the loss sustained is a capital, not an ordinary, loss.10 (c) The capital loss sustained by CBC can only be deducted from capital gains if any derived by it during the same taxable year that the securities have become "worthless."

Taxation 1- SY 2015-2016 (Zarate)

G.R. Nos. 106949-50 December 1, 1995 PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner, 
 vs.
 COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. G.R. Nos. 106984-85 December 1, 1995 COMMISSIONER INTERNAL REVENUE, petitioner, 
 vs.
 PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT OF APPEALS and THE COURT OF TAX APPEALS, respondents.. Facts: Petitioner is registered with the 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. It received from the CIR two (2) letters of assessment and demand (a) one for deficiency transaction tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate amount of P88,763,255.00. Picop protested the assessment of deficiency transaction tax and documentary and science stamp taxes. 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 CTA.

28

[CHAPTER V: DEDUCTIONS]

Picop and the CIR both went to the Supreme Court on separate Petitions for Review of the above decision of the CTA. In two (2) Resolutions dated 7 February 1990 and 19 February 1990, respectively, the Court referred the two (2) Petitions to the Court of Appeals. 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. 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. 3 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. ISSUE: Whether Picop is entitled to deduct against current income net operating losses incurred by Rustan Pulp and Paper Mills, Inc;.

registered with the BOI as a preferred pioneer enterprise — is that net operating losses cannot be carried over. Under our Tax Code, both in 1977 and at present, losses may be deducted from gross income only if such losses were actually sustained in the same year that they are deducted or charged off. Thus it is that R.A. No. 5186 introduced the carry-over of net operating losses as a very special incentive to be granted only to registered pioneer enterprises and only with respect to their registered operations. In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. In effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated operating losses. We consider and so hold that there is nothing in Section 7 (c) of R.A. No. 5186 which either requires or permits such a result. Indeed, that result makes non-sense of the legislative purpose which may be seen clearly to be projected by Section 7 (c), R.A. No. 5186. We conclude that the deduction claimed by Picop in the amount of P44,196,106.00 in its 1977 Income Tax Return must be disallowed.

HELD: After prolonged consideration and analysis of this matter, the Court is unable to agree with the CTA and Court of Appeals on the deductibility of RPPM's accumulated losses against Picop's 1977 28 CHAPTER V: DEDUCTIONS gross income. It is important to note at the outset that in our jurisdiction, the ordinary rule — that is, the rule applicable in respect of corporations not

BAD DEBTS G.R. No. L-22265

December 22, 1967

COLLECTOR OF INTERNAL REVENUE, petitioner, 
 vs.
 GOODRICH INTERNATIONAL RUBBER CO., respondent.

[CHAPTER V: DEDUCTIONS] 29

TOPIC: Bad Debts FACTS: Respondent was assessed by the CIR for Taxable Years 1951-1952. These assessments were based on disallowed deductions, claimed by Goodrich, consisting of several alleged bad debts, in the aggregate sum of P50,455.41, for the year 1951, and the sum of P30,138.88, as representation expenses allegedly incurred in the year 1952. Goodrich had appealed from said assessments to the Court of Tax Appeals, which, after appropriate proceedings, rendered, on June 8, 1963, a decision allowing the deduction for bad debts, but disallowing the alleged representation expenses, hence, this appeal. ISSUE: Whether or not the bad debts had been properly deducted for the year 1951. RULING: Some but not all. The requirement of ascertainment of worthlessness requires proof of two facts: (1) that the taxpayer did in fact ascertain the debt to be worthlessness, in the year for which the deduction is sought; and (2) that, in so doing, he acted in good faith. Good faith on the part of the taxpayer is not enough. He must show, also, that he had reasonably investigated the relevant facts and had drawn a reasonable inference from the information thus obtained by him. The payments made, some in full, after some of the foregoing accounts had been characterized as bad debts, merely stresses the undue haste with which the same had been written off. At any rate, respondent has not proven that said debts were worthless. There is no evidence that the debtors can not pay them.lawphil.net It should be noted also that, in violation of Revenue Regulations No. 2, Section 102,

Taxation 1- SY 2015-2016 (Zarate)

respondent had not attached to its income tax returns a statement showing the propriety of the deductions therein made for alleged bad debts. Below are the accounts claimed by Goodrich as Bad Debts: Disallowed by SC: Portillo's Auto Seat Cover (P730.00): This debt was incurred in 1950. In 1951, the debtor paid P70.00, leaving a balance of P630.31. That same year, the account was written off as bad debt (Exhibit 3-C-4). Counsel for Goodrich had merely sent two (2) letters of demand in 1951 (Exh. B-14). In 1952, the debtor paid the full balance (Exhibit A). Visayan Rapid Transit (P17,810.26): This debt was, also, incurred in 1950. In 1951, it was charged off as bad debt, after the debtor had paid P275.21. No other payment had been made.lawphil Taxpayer's Accountant testified that, according to its branch manager in Cebu, he had been unable to collect the balance. The debtor had merely promised and kept on promising to pay. Taxpayer's counsel stated that the debtor had gone out of business and became insolvent, but no proof to this effect. was introduced. Bataan Auto Seat Cover (P373.13): This is the balance of a debt of P474.13 contracted in 1949. In 1951, the debtor paid P100.00. That same year, the balance of P373.13 was charged off as bad debt. The next year, the debtor paid the additional sum of P50.00. Tres Amigos Auto Supply (P1,370.31):

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[CHAPTER V: DEDUCTIONS]

This account had been outstanding since 1949. Counsel for the taxpayer had merely sent demand letters (Exh. B-13) without success. P. C. Teodoro (P650.00): In 1949, the account was P751.91. In 1951, the debtor paid P101.91, thus leaving a balance of P650.00, which the taxpayer charged off as bad debt in the same year. In 1952, the debtor made another payment of P150.00.

The original account was P2,705.87, when, in 1950, it was turned over for collection to counsel for Goodrich (p. 156, CTA Records). Counsel began sending letters of collection in April 1950. Interior Caltex made partial payments, so that as of December, 1951, the balance outstanding was P1,505.87.lawphil.net The debtor paid P200, in 1952; P113.20, in 1954; P750.00, in 1961; and P300.00.00 in 1962. The account had been written off as bad debt in 1951.

Ordinance Service, P.A. (P386.42): In 1949, the outstanding account of this government agency was P817.55. Goodrich's counsel sent demand letters (Exh. B-8). In 1951, it paid Goodrich P431.13. The balance of P386.42 was written off as bad debt that same year. Ordinance Service, P.C. (P796.26): In 1950, the account was P796.26.lawphil It was referred to counsel for collection. In 1951, the account was written off as a debt. In 1952, the debtor paid it in full. National Land Settlement Administration (P3,020.76): The outstanding account in 1949 was P7,041.51. Collection letters were sent (Exh. B-7). In 1951, the debtor paid P4,020.75, leaving a balance of P3,020.76, which was written off, that same year, as a bad debt. This office was under liquidation, and its Board of Liquidators promised to pay when funds shall become available. National Coconut Corporation (P644.74): This account had been outstanding since 1949. Collection letters were sent (Exh. B-12) without success. It was written off as bad debt in 1951, while the corporation was under a 30 CHAPTER V: DEDUCTIONS Board of Liquidators, which promised to pay upon availability of funds. In 1961, the debt was fully paid. Interior Caltex Service Station (P1,505.87):

Allowed by SC: San Juan Auto Supply (P4,530.64): This account was contracted in 1950. Referred, for collection, to respondent's counsel, the latter secured no payment. In November, 1950, the corresponding suit for collection was filed (Exh. C). The debtor's counsel was allowed to withdraw, as such, the debtor having failed to meet him. In fact, the debtor did not appear at the hearing of the case.lawphil.net Judgment was rendered in 1951 for the creditor (Exh. C-2). The corresponding writ of execution (Exh. C-3) was returned unsatisfied, for no properties could be attached or levied upon. PACSA

(P45.36),

Philippine Naval Patrol

(P14.18),

Surplus Property Commission (P277.68), Alvarez Auto Supply

(P285.62):

These four (4) accounts were 2 or 3 years old in 1951. After the collectors of the creditor had failed to collect the same, its counsel wrote letters of demand (Exhs. B-10, B-11, B-6 and B-2) to no avail. Considering the small amounts involved

[CHAPTER V: DEDUCTIONS] 31

in these accounts, the taxpayer was justified in feeling that the unsuccessful efforts therefore exerted to collect the same sufficed to warrant their being written off.3 Lion Shoe Store

(P11,686.93),

Ruiz Highway Transit

(P2,350.00), and

Esquire Auto Seat Cover

(P3,536.94):

These three (3) accounts were among those referred to counsel for Goodrich for collection. Up to 1951, when they were written off, counsel had sent 17 Letters of demand to Lion Shoe Store (Exh. B); 16 demand letters to Ruiz Highway Transit (Exh. B-1); and 6 letters of demand to Esquire Auto Seat Cover (Exit. B-5) In 1951, Lion Shoe Store, Ruiz Highway Transit, and Esquire Auto Seat Cover had made partial payments in the sums of P1,050.00, P400.00, and P300.00 respectively. Subsequent to the write-off, additional small payments were made and accounted for as income of Goodrich. Counsel interviewed the debtors, investigated their ability to pay and threatened law suits. He found that the debtors were in strained financial condition and had no attachable or leviable property. Moreover, Lion Shoe Store was burned twice, in 1948 and 1949. Thereafter, it continued to do business on limited scale. Later; it went out of business. Ruiz Highway Transit, had more debts than assets. Counsel, therefore, advised respondent to write off these accounts as bad debts without going to court, for it would be "foolish to spend good money after bad." PHILIPPINE REFINING CO ( UNILEVER COMPANY) v CA FACTS:Philippine Refining Corp (PRC) was assessed deficiency tax payments for the year 1985 in the amount of around 1.8M. This figure was computed based on the disallowance of the claim of bad

Taxation 1- SY 2015-2016 (Zarate)

debts by PRC. PRC duly protested the assessment claiming that under the law, bad debts and interest expense are allowable deductions. When the BIR subsequently garnished some of PRC’s properties, the latter considered the protest as being denied and filed an appeal to the CTA which set aside the disallowance of the interest expense and modified the disallowance of the bad debts by allowing 3 accounts to be claimed as deductions. However, 13 supposed “bad debts” were disallowed as the CTA claimed that these were not substantiated and did not satisfy the jurisprudential requirement of “worthlessness of a debt” The CA denied the petition for review. ISSUE: Whether or not the CA was correct in disallowing the 13 accounts as bad debts. RULING:YES. Both the CTA and CA relied on the case of Collector vs. Goodrich International, which laid down the requisites for “worthlessness of a debt” to wit: In said case, we held that for debts to be considered as "worthless," and thereby qualify as "bad debts" making them deductible, the taxpayer should show that (1) there is a valid and subsisting debt. (2) the debt must be actually ascertained to be worthless and uncollectible during the taxable year; (3) the debt must be charged off during the taxable year; and (4) the debt must arise from the business or trade of the taxpayer. Additionally, before a debt can be considered worthless, the taxpayer must also show that it is indeed uncollectible even in the future. Furthermore, there are steps outlined to be undertaken by the taxpayer to prove that he exerted diligent efforts to collect the debts, viz.: (1) sending of statement of accounts; (2) sending of collection letters; (3) giving the account to a lawyer for collection; and (4) filing a collection case in court.

32

[CHAPTER V: DEDUCTIONS]

PRC only used the testimony of its accountant Ms. Masagana in order to prove that these accounts were bad debts. This was considered by all 3 courts to be self-serving. The SC said that PRC failed to exercise due diligence in order to ascertain that these debts were uncollectible. In fact, PRC did not even show the demand letters they allegedly gave to some of their debtors.

BASILAN ESTATES INC. vs. CIR and CTA (depreciation) FACTS: CIR, per examiners' report of February 19, 1959, assessed Basilan Estates, Inc., a deficiency income tax of P3,912 for 1953 and P86,876.85 as 25% surtax on unreasonably accumulated profits as of 1953 pursuant to Section 25 of the Tax Code. Basilan Estates, Inc. filed before the CTA a petition for review of the Commissioner's assessment, alleging prescription of the period for assessment and collection; error in disallowing claimed depreciations, travelling and miscellaneous expenses; and error in finding the existence of unreasonably accumulated profits and the imposition of 25% surtax thereon. BEI claimed deductions for the depreciation of its assets up to 1949 on the basis of their acquisition cost. As of January 1, 1950 it changed the depreciable value of said assets by increasing it to conform with the increase in cost for their replacement. Accordingly, from 1950 to 1953 it deducted from gross income the value of depreciation computed on the reappraised value. 32 CHAPTER V: DEDUCTIONS

Upon investigation and examination of taxpayer's books and papers, the CIR found that the reappraised assets depreciated in 1953 were the same ones upon which depreciation was claimed in 1952. And for the year 1952, the Commissioner had already determined, with taxpayer's concurrence, the depreciation allowable on said assets to be P36,842.04, computed on their acquisition cost at rates fixed by the taxpayer. Hence, the Commissioner pegged the deductible depreciation for 1953 on the same old assets at P36,842.04 and disallowed the excess thereof in the amount of P10,500.49. ISSUE: W/N depreciation shall be determined on the acquisition cost or on the reappraised value of the assets. HELD: It shall be determined on the acquisition cost. Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and normal obsolescense. The term is also applied to amortization of the value of intangible assets, the use of which in the trade or business is definitely limited in duration. Depreciation commences with the acquisition of the property and its owner is not bound to see his property gradually waste, without making provision out of earnings for its replacement. The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is that deductions from gross income are privileges, not matters of right. They are not created by implication but upon clear expression in the law.

[CHAPTER V: DEDUCTIONS] 33

Moreover, the recovery, free of income tax, of an amount more than the invested capital in an asset will transgress the underlying purpose of a depreciation allowance. For then what the taxpayer would recover will be, not only the acquisition cost, but also some profit. Recovery in due time thru depreciation of investment made is the philosophy behind depreciation allowance; the idea of profit on the investment made has never been the underlying reason for the allowance of a deduction for depreciation. Accordingly, the claim for depreciation beyond P36,842.04 or in the amount of P10,500.49 has no justification in the law. The determination, therefore, of the Commissioner of Internal Revenue disallowing said amount, affirmed by the Court of Tax Appeals, is sustained. ZAMORA v CIR

Mariano Zamora and his deceased sister Felicidad Zamora, bought a piece of land located in Manila on May 16, 1944, for P132,000.00 and sold it for P75,000.00 on March 5, 1951. They also purchased a lot located in Quezon City for P68,959.00 on January 19, 1944, which they sold for P94,000 on February 9, 1951. The CTA ordered the estate of the late Felicidad Zamora (represented by Esperanza A. Zamora, as special administratrix of her estate), to pay the sum of P235.50, representing alleged deficiency income tax and surcharge due from said estate.

Petitioner Mariano Zamora alleges that the CTA erred in disallowing 3-½% per annum as the rate of depreciation of the Bay View Hotel Building but only 2-½%. In justifying depreciation deduction of 3-½ %, Mariano Zamora contends that (1) the Ermita District, where the Bay View Hotel is located, is now becoming a commercial district; (2) the hotel has no room for improvement; and (3) the changing modes in architecture, styles of furniture and decorative designs, "must meet the taste of a fickle public".

FACTS: ISSUE: w/n the depreciation rate 2-1/2% is correct? YES Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, filed his income tax returns. The CIR found that he failed to file his return of the capital gains derived from the sale of certain real properties and claimed deductions which were not allowable. The collector required him to pay deficiency income tax. On appeal by Zamora, the CTA reduced the amount of deficiency income tax.

Cases Nos. L-15289 and L-15281

Taxation 1- SY 2015-2016 (Zarate)

HELD: Section 30, of the Tax Code, provides that in computing net income, there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year, in carrying on any trade or business. Since promotion expenses constitute one of the deductions in conducting a business, same must satisfy these requirements. Claim for the deduction of promotion expenses or entertainment expenses must also be

34

[CHAPTER V: DEDUCTIONS]

substantiated or supported by record showing in detail the amount and nature of the expenses incurred.

It is a fact, however, that the CTA, in estimating the reasonable rate of depreciation allowance for hotels made of concrete and steel at 2-½%, the three factors just mentioned had been taken into account already. Said the CTA— Normally, an average hotel building is estimated to have a useful life of 50 years, but inasmuch as the useful life of the building for business purposes depends to a large extent on the suitability of the structure to its use and location, its architectural quality, the rate of change in population, the shifting of land values, as well as the extent and maintenance and rehabilitation. It is allowed a depreciation rate of 2-½% corresponding to a normal useful life of only 40 years (1955 PH Federal Taxes, Par 14 160-K). Consequently, the stand of the petitioners can not be sustained. As the lower court based its findings on Bulletin F, petitioner Zamora, argues that the same should have been first proved as a law, to be subject to judicial notice. Bulletin F, is a publication of the US Federal Internal Revenue Service, which was made after a study of the lives of the properties. In the words of the lower court: "It contains the list of depreciable assets, the estimated average useful lives thereof and the rates of depreciation allowable for each kind of property. (See 1955 PH Federal Taxes, Par. 14, 160 to Par. 14, 163-0)

It is true that Bulletin F has no binding force, but it has a strong persuasive effect considering that the same has been the result of 34 CHAPTER V: DEDUCTIONS scientific studies and observation for a long period in the United States after whose Income Tax Law ours is patterned." Verily, courts are permitted to look into and investigate the antecedents or the

legislative history of the statutes involved (Director of Lands v. Abaya, et al., 63 Phil. 559). Zamora also contends that his basis for applying the 3-½% rate is the testimony of its witness Mariano Katipunan, who cited a book entitled "Hotel Management — Principles and Practice" by Lucius Boomer, President, Hotel Waldorf Astoria Corporation. As well commented by the Solicitor General, "while the petitioner would deny us the right to use Bulletin F, he would insist on using as authority, a book in Hotel management written by a man who knew more about hotels than about taxation. All that the witness did (Katipunan) . . . is to read excerpts from the said book (t.s.n. pp. 99-101), which admittedly were based on the decision of the U.S. Tax Courts, made in 1928 (t.s.n. p. 106)". The 2-½% rate of depreciation of the Bay View Hotel building, is approximately correct.

US vs LUDLEY FACTS: ▪ Ludey brought this suit in the Court of Claims to recover an amount exacted as additional taxes for 1917. The tax was assessed on the alleged gain from a sale in 1917 of oil mining properties which had been owned and operated by him for several years. The Commissioner of Internal Revenue determined that there was a gain on the sale of $26,904.15. Ludey insists that there was a loss of $14,777.33. The amount sued for is the tax assessed on the difference. ▪ The aggregate original cost of the properties was $95,977.33. Of this amount, $30,977.33 was the cost of th equipment used in the business; $65,000 the cost of the oil reserves. The 1917 sale price was $81,200. ▪ CIR: Gain/Loss computed after deduction the depreciation/depletion expenses.– the Commissioner deducted from the original cost $10,465.16 on account of depreciation of the equipment through wear and tear, and $32,258.81 on account of depletion of the reserves through the taking out of oil by the plaintiff, after March 1, 1913. In operating the properties,

[CHAPTER V: DEDUCTIONS] 35

Ludey disposed, in the form of oil, of part of his capital assets; that, in the extraction of the oil, he consumed so much of the equipment as was represented by the depreciation, and disposed of so much of the oil reserves as was represented by the depletion; that the sale of the properties made by him in 1917 was not a sale of all of the property represented by the original cost of $95,977.33, since physical equipment to the amount of the depreciation and oil reserves to the amount of the depletion had been taken from it during the preceding years, and that, for this reason, the cost to plaintiff of the net property sold in 1917 was not $95,977.33, but $53,258.36.

was the gain or the loss depends primarily upon whether deductions for depletion and depreciation are to be made from the original cost in determining gain or loss on sale of oil mining properties. The question is one of statutory construction or application. The Court of Claims entered judgment for the plaintiff.

▪ COURT OF CLAIMS: No deduction should be made – It held that no deduction from original cost should be made here, because of the nature of oil mining properties. It held that the depreciation was not deductible, because wear and tear of equipment was an expense or incident of the business.

ISSUE: Whether or not depreciation of the mining e-uipment should be deducted on the cost of the same to determine whether there was a gain or loss on the sale of the said equipment.

US vs. LUDLEY DOCTRINE Depreciation should be taken into account in determining whether there is a loss or gain in sale of properties for purposes of income taxation. FACTS Ludey brought this suit in the Court of Claims to recover an amount exacted as additional taxes for 1917. The tax was assessed on the alleged gain from a sale in 1917 of oil mining properties which had been owned and operated by him for several years. The Commissioner of Internal Revenue determined that there was a gain on the sale of $26, 904.15. Ludey insists that there was a loss of $14,777.33. The amount sued for is the tax assessed on the difference. ,hether there

Taxation 1- SY 2015-2016 (Zarate)

RULING: YES Until 1924, none of the revenue Acts provided in terms that in computing the gain from a sale of  any property' a deduction shall be made from the original cost on account of depreciation and depletion during the period of operation. But ever since March 1,1913, the revenue acts have required that gains from sales made within the tax year shall be included in the taxable income of the year' and that losses on sales may be deducted from gross income. We are of opinion that the revenue acts should be construed as requiring deductions for both depreciation and depletion when determining the original cost of oil properties sold. The depreciation charge permitted as a deduction from the gross income in determining the taxable income of a business for any year represents the reduction during the year' of the

36

[CHAPTER V: DEDUCTIONS]

capital assets through wear and tear of the plant used. The amount of the allowance for depreciation is the sum which should be set aside for the taxable year' in order that at the end of the useful life of the plant in the business the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost. The theory underlying this allowance for depreciation is that by using up the plant a gradual sale is made of it. The depreciation charged is the measure of the cost of the part which has been sold. When the plant is disposed of after years of use' the thing then sold is not the whole thing originally acquired. The amount of the depreciation must be deducted from the original cost of the whole in order to determine the cost of that disposed of in the final sale of properties. Any other construction would permit a double deduction for the loss of the same capital assets. DISPOSITIVE The decision of the Court of Claims is reversed and the case is remanded for further proceeding to determine the right amount of depreciation. 
 Roxas vs. CTA GR No. L-25043 | April 26, 1968 Facts: · 36 CHAPTER Don Pedro and Dona Carmen Ayala, both Spanish, V:Roxas DEDUCTIONS transmitted to their grandchildren by hereditary succession the following properties:

a. Agricultural lands with a total area of 19,000 hectares in Nasugbu, Batangas Tenants who have been tilling the lands expressed their desire to purchase from Roxas y Cia, the parcels which they actually occupied The govt, in line with the constitutional mandate to acquire big landed estates and apportion them among landless tenants-farmers, persuaded the Roxas brothers to part with their landholdings The brothers agreed to sell 13,500 hec to the govt for P2.079Mn, plus 300K survey and subdivision expenses Unfortunately, the govt did not have funds A special arrangement was made with the Rehabilitation Finance Corporation to advance to Roxas y Cia the amount of P1.5Mn as loan Under the arrangement, Roxas y Cia. allowed the farmers to buy the lands for the same price but by installment, and contracted with the RFC to pay its loan from the proceeds of the yearly amortizations paid by the farmers In 1953 and 1955, Roxas y Cia. derived from said installment payments a net gain of P42,480.83 and P29,500.71. 50% of said net gain was reported for income tax purposes as gain on the sale of capital asset held for more than one year pursuant to Sec. 34 of the Tax Code

b. Residential house and lot at Wright St., Malate, Manila After the marriage of Antonio and Eduardo, Jose lived in the house where he paid rentals of 8K/year to Roxas y Cia c.

Shares of stocks in different corporations

[CHAPTER V: DEDUCTIONS] 37

To manage the properties, Antonio Roxas, Eduardo Roxas and Jose Roxas, the children, formed a partnership called Roxas y Compania On 1958, CIR demanded from Roxas y Cia the payment of real estate dealer's tax for 1952 amtg to P150.00 plus P10.00 compromise penalty for late payment, and P150.00 tax for dealers of securities plus P10.00 compromise penalty for late payment. Basis: house rentals received from Jose, pursuant to Art. 194 of the Tax Code stating that an owner of a real estate who derives a yearly rental income therefrom in the amount of P3,000.00 or more is considered a real estate dealer and is liable to pay the corresponding fixed tax The Commissioner further assessed deficiency income taxes against the brothers for 1953 and 1955, resulting from the inclusion as income of Roxas y Cia of the unreported 50% of the net profits derived from the sale of the Nasugbu farm lands to the tenants, and the disallowance of deductions from gross income of various business expenses and contributions claimed by Roxas y Cia and the Roxas brothers The brothers protested the assessment but was denied, thus appealing to the CTA · CTA decision: sustained the assessment except the demand for the payment of the fixed tax on dealer of securities and the disallowance of the deductions for contributions to the Philippine Air Force Chapel and Hijas de Jesus' Retiro de Manresa Issue: Should Roxas y Cia be considered a real estate dealer because it engaged in the business of selling real estate Ruling: NO, being an isolated transaction

Taxation 1- SY 2015-2016 (Zarate)

Real estate dealer: any person engaged in the business of buying, selling, exchanging, leasing or renting property on his own account as principal and holding himself out as a full or part-time dealer in real estate or as an owner of rental property or properties rented or offered to rent for an aggregate amount of three thousand pesos or more a year: Section 194 of the Tax Code, in considering as real estate dealers owners of real estate receiving rentals of at least P3,000.00 a year, does not provide any qualification as to the persons paying the rentals The fact that there were hundreds of vendees and them being paid for their respective holdings in installment for a period of ten years, it would nevertheless not make the vendor Roxas y Cia. a real estate dealer during the 10-year amortization period The sale of the Nasugbu farm lands to the very farmers who tilled them for generations was not only in consonance with, but more in obedience to the request and pursuant to the policy of our Government to allocate lands to the landless It was the duty of the Government to pay the agreed compensation after it had persuaded Roxas y Cia. to sell its haciendas, and to subsequently subdivide them among the farmers at very reasonable terms and prices. But due to the lack of funds, Roxas y Cia. shouldered the Government's burden, went out of its way and sold lands directly to the farmers in the same way and under the same terms as would have been the case had the Government done it itself. The power of taxation is sometimes called also the power to destroy. Therefore it should be exercised with caution to minimize injury to the proprietary rights of a taxpayer. It must be exercised fairly, equally and uniformly

38

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Therefore, Roxas y Cia. cannot be considered a real estate dealer for the sale in question. Hence, pursuant to Section 34 of the Tax Code the lands sold to the farmers are capital assets, and the gain derived from the sale thereof is capital gain, taxable only to the extent of 50% As to the deductions a. P40 tickets to a banquet given in honor of Sergio Osmena and P28 San Miguel beer given as gifts to various persons – representation expenses · Representation expenses: deductible from gross income as expenditures incurred in carrying on a trade or business · In this case, the evidence does not show such link between the expenses and the business of Roxas y Cia b. Contributions to the Pasay police and fire department and other police departments as Christmas funds · Contributions to the Christmas funds are not deductible for the reason that the Christmas funds were not spent for public purposes but as Christmas gifts to the families of the members of said entities · Under Section 39(h), a contribution to a government entity is deductible when used exclusively for public purposes · As to the contribution to the Manila Police trust fund, such is an allowable deduction for said trust fund belongs to the Manila Police, a government entity, intended to be used exclusively for its public functions. c. Contributions to the Philippines Herald's fund for Manila's neediest families CHAPTER V: DEDUCTIONS · 38 The contributions were not made to the Philippines Herald but to a group of civic spirited citizens organized by the Philippines Herald solely for charitable purposes

· There is no question that the members of this group of citizens do not receive profits, for all the funds they raised were for Manila's neediest families. Such a group of citizens may be classified as an association organized exclusively for charitable purposes mentioned in Section 30(h) of the Tax Code d. Contribution to Our Lady of Fatima chapel at the FEU · University gives dividends to its stockholders · Located within the premises of the university, the chapel in question has not been shown to belong to the Catholic Church or any religious organization · The contributions belongs to the Far Eastern University, contributions to which are not deductible under Section 30(h) of the Tax Code for the reason that the net income of said university injures to the benefit of its stockholders No deficiency income tax is due for 1953 from Antonio Roxas, Eduardo Roxas and Jose Roxas. For 1955 they are liable to pay deficiency income tax in the sum of P109.00, P91.00 and P49.00, respectively

*Items not Deductible G.R. No. L-26911 January 27, 1981 AT L A S C O N S O L I D AT E D M I N I N G & D E V E L O P M E N T CORPORATION, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent.

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G.R. No. L-26924 January 27, 1981 COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. AT L A S C O N S O L I D AT E D M I N I N G & D E V E L O P M E N T CORPORATION and COURT OF TAX APPEALS, respondents.

FACTS: This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income tax assessments made by the Commissioner of Internal Revenue, where the Atlas Consolidated Mining and Development Corporation, was assessed P546,295.16 for 1957 and P215,493.96 for 1958 deficiency income taxes. Atlas is a corporation engaged in the mining industry registered under the laws of the Philippines. On August 20, 1962, the Commissioner assessed against Atlas the sum of P546,295.16 and P215,493.96 or a total of P761,789.12 as deficiency income taxes for the years 1957 and 1958. For the year 1957, it was the opinion of the Commissioner that Atlas is not entitled to exemption from the income tax under Section 4 of Republic Act 909 because same covers only gold mines.

Taxation 1- SY 2015-2016 (Zarate)

For the year 1958, the assessment of deficiency income tax of P761,789.12 covers the disallowance of items claimed by Atlas as deductible from gross income. On October 25, 1962, the Secretary of Finance ruled that the exemption provided in Republic Act 909 embraces all new mines and old mines whether gold or other minerals. Commissioner recomputed Atlas deficiency income tax liabilities in the light of the ruling of the Secretary of Finance. On June 9, 1964, the Commissioner issued a revised assessment entirely eliminating the assessment of P546,295.16 for the year 1957. The assessment for 1958 was reduced from P215,493.96 to P39,646.82 from which Atlas appealed to the Court of Tax Appeals, assailing the disallowance of the following items claimed as deductible from its gross income for 1958.

CTA: allowed the ff as deductions: Transfer agent's fee, U.S. stock listing expenses, Provision for contingencies EXCEPT Stockholders relation service fee and suit expenses.

ISSUE: WON the expenses paid for the services rendered by a public relations firm P.K MacKer & Co. labelled as stockholders relation service fee is an allowable deduction as business expense under Section 30 (a) (1) of the National Internal Revenue Code.

40

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HELD: NO. The principle is recognized 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. As previously adverted to, the law allowing expenses as deduction from gross income for purposes of the income tax is Section 30 (a) (1) of the National Internal Revenue which allows a deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." An item of expenditure, in order to be deductible under this section of the statute, must fall squarely within its language.

To be deductible as a business expense, three conditions are imposed, namely: (1) the expense must be ordinary and necessary, (2) it must be paid or incurred within the taxable year, and (3) it must be paid or incurred in carrying in a trade or business. In addition, not only must the taxpayer meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise, the same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction.

40 CHAPTER V: DEDUCTIONS

SC sustained 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 in line with the decision of U.S. Board of Tax Appeals in the case of Harrisburg Hospital Inc. vs. Commissioner of Internal Revenue.

As held in the case of Vera vs. Fernandez, 30 this Court emphatically said that taxes are the lifeblood of the Government and their prompt and certain availability are imperious need. Upon taxation depends the Government's ability to serve the people for whose benefit taxes are collected. To safeguard such interest, neglect or omission of government officials entrusted with the collection of taxes should not be allowed to bring harm or detriment to the people, in the same manner as private persons may be made to suffer individually on account of his own negligence, the presumption being that they take good care of their personal affair. This should not hold true to government officials with respect to matters not of their own personal concern. This is the philosophy behind the government's exception, as a general rule, from the operation of the principle of estoppel.

G.R. No. L-13325             April 20, 1961 SANTIAGO GANCAYCO, petitioner, 
 vs.
 THE COLLECTOR OF INTERNAL REVENUE, respondent.. Facts:

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Gancayco filed his Income tax Return (ITR) for 1949. Ø CIR notified him that his liability is Php 9.793.62, which he paid 1950 Ø CIR after a year wrote to Gancayco saying that there was tax due from him for a total of Php 29,554.05 Ø Gancayco asked for reconsideration and the tax assessed wasreduced Ø CIR issued a warrant of distraint for the deficient liability Ø Gancayco filed petition with CTA CTA: Required Gancayco to pay Php 16, 860.31 for tax deficiency in1949 Gancayco: the right to collect the deficiency income tax is barred by the statute of limitations. The 5 yr period for judicial action should be counted from May 12 50, the date of original assessment SC: Section 316 provides: The civil remedies for the collection of internal revenue taxes, fees, or charges, and any increment thereto resulting from delinquency shall be (a) by distraint of goods, chattels, or effects, and other personal property of whatever character, including stocks and other securities, debts, credits, bank accounts, and interest in and rights to personal property, and by levy upon real property; and (b) by judicial action. Either of these remedies or both simultaneously may be pursued in the discretion of the authorities charged with the collection of such taxes. No exemption shall be allowed against the internal revenue taxes in any case.

Taxation 1- SY 2015-2016 (Zarate)

Deduction for expenses may be allowed, however in this case, Gancayco was not able to prove any expense as there were no receipts or other proofs. CTA AFFIRMED