G.R. No. 96016. October 17, 1991.

* The issue to be resolved in this petition for review on

certiorari is whether or not terminal leave pay received by a
COMMISSIONER OF INTERNAL REVENUE,
government official or employee on the occasion of his
petitioner, vs. THE COURT OF APPEALS and EFREN P.
compulsory
CASTANEDA, respondents.
retirement from the government service is subject to
Taxation; Withholding tax; Terminal leave pay; Terminal leave
withholding (income) tax.
pay received by a government official or employee is not
subject to withholding tax.The Court has already ruled that We resolve the issue in the negative.
the terminal leave pay received by a government official or
Private respondent Efren P. Castaneda retired from the
employee is not subject to withholding (income) tax. In the
government service as Revenue Attache in the Philippine
recent case of Jesus N. Borromeo vs. The Hon. Civil Service
Embassy in London, England, on 10 December 1982 under
Commission, et al., G.R. No. 96032, 31 July 1991, the Court
the provisions of Section 12 (c) of Commonwealth Act 186, as
explained the rationale behind the employees entitlement to
amended. Upon retirement, he received, among other
an exemption from withholding (income) tax on his terminal
benefits, terminal leave pay from which petitioner
leave pay as follows: x x x commutation of leave credits,
Commissioner of Internal Revenue withheld P12,557.13
more commonly known as terminal leave, is applied for by an
allegedly representing income tax thereon.
officer or employee who retires, resigns or is separated from
the service through no fault of his own. (Manual on Leave Castaneda filed a formal written claim with petitioner for a
Administration Course for Effectiveness published by the Civil refund of the P12,557.13, contending that the cash
Service Commission, pages 16-17). In the exercise of sound equivalent of his terminal leave is exempt from income tax.
personnel policy, the Government encourages unused leaves To comply with the two-year prescriptive period within which
to be accumulated. The Government recognizes that for most claims for refund may be filed, Castaneda filed on 16 July
public servants, retirement pay is always less than generous 1984 with the Court of Tax Appeals a Petition for Review,
if not meager and scrimpy. A modest nest egg which the seeking the refund of income tax withheld from his terminal
senior citizen may look forward to is thus avoided. Terminal leave pay.
leave payments are given not only at the same time but also
for the same policy considerations governing retirement The Court of Tax Appeals found for private respondent
benefits. Castaneda and ordered the Commissioner of Internal
Revenue to refund Castaneda the sum of P12,557.13
PETITION for certiorari to review the decision of the Court of withheld as income tax. (Annex C, petition).
Appeals.
Petitioner appealed the above-mentioned Court of Tax
The facts are stated in the resolution of the Court. Appeals decision to this Court, which was docketed as G.R.
No. 80320. In turn, we referred the case to the Court of
Leovigildo Monasterial for private respondent.
Appeals for resolution. The case was docketed in the Court of
RESOLUTION Appeals as CA-G.R. SP No. 20482.
PADILLA, J.: On 26 September 1990, the Court of Appeals dismissed the
petition for review and affirmed the decision of the Court of
Tax Appeals. Hence, the present recourse by the given not only at the same time but also for the same policy
Commissioner of Internal Revenue. considerations governing retirement benefits.
The Solicitor General, acting on behalf of the Commissioner In fine, not being part of the gross salary or income of a
of Internal Revenue, contends that the terminal leave pay is government official or employee but a retirement benefit,
income derived from employer-employee relationship, citing terminal leave pay is not subject to income tax.
in support of his stand Section 28 of the National Internal
ACCORDINGLY, the petition for review is hereby DENIED.
Revenue Code; that as part of the compensation for services
rendered, terminal leave pay is actually part of gross income SO ORDERED.
of the recipient. Thus
x x x. It (terminal leave pay) cannot be viewed as salary for
purposes which would reduce it. x x x there can thus be no
commutation of salary when a government retiree applies
for terminal leave because he is not receiving it as salary.
What he applies for is a commutation of leave credits. It is
an accumulation of credits intended for old age or separation
from service. x x x.
The Court has already ruled that the terminal leave pay
received by a government official or employee is not subject
to withholding (income) tax. In the recent case of Jesus N.
Borromeo vs. The Hon. Civil Service Commission, et al.,G.R.
No. 96032, 31 July 1991, the Court explained
the rationale behind the employees entitlement to an
exemption from withholding (income) tax on his terminal
leave pay as follows:
x x x commutation of leave credits, more commonly known
as terminal leave, is applied for by an officer or employee
who retires, resigns or is separated from the service through
no fault of his own. (Manual on Leave Administration Course
for Effectiveness published by the Civil Service Commission,
pages 16-17). In the exercise of sound personnel policy, the
Government encourages unused leaves to be accumulated.
The Government recognizes that for most public servants,
retirement pay is always less than generous if not meager
and scrimpy. A modest nest egg which the senior citizen may
look forward to is thus avoided. Terminal leave payments are
 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. On motion for
reconsideration and new trial, filed by Goodrich, on
November 19, 1963, the Court of Tax Appeals amended its
aforementioned decision and allowed said deductions for
representation expenses. Hence, this appeal by the
Government.
The alleged representation expenses are:

1. Expenses at Elks Club P10,959.

21

2. Manila Polo Club 4,947.35

G.R. No. L-22265 December 22, 1967 3. Army and Navy Club 2,812.95
COLLECTOR OF INTERNAL REVENUE, petitioner,
vs. 4. Manila Golf Club 4,478.45
GOODRICH INTERNATIONAL RUBBER CO., respondent.
5. Wack Wack Golf Club, Casino 6,940.92
Manuel O. Chan for respondent.
Espaol, etc.
Manuel O. Chan for respondent.
CONCEPCION, C.J.: TOTAL P30,138.
Appeal by the Government from a decision of the Court of Tax 88
Appeals, setting aside the assessments made by the
The claim for deduction thereof is based upon receipts
Commissioner of Internal Revenue, in the sums of P14,128.00
issued, not by the entities in which the alleged expenses had
and P8,439.00, as deficiency income taxes allegedly due
been incurred, but by the officers of Goodrich who allegedly
from respondent Goodrich International Rubber Company
paid them.
hereinafter referred to as Goodrich for the years 1951 and
1952, respectively. The claim must be rejected. If the expenses had really been
incurred, receipts or chits would have been issued by the
These assessments were based on disallowed deductions,
entities to which the payments had been made, and it would
claimed by Goodrich, consisting of several alleged bad debts,
have been easy for Goodrich or its officers to produce such
in the aggregate sum of P50,455.41, for the year 1951, and
receipts.lawphil These issued by said officers merely attest to
their claim that they had incurred and paid said expenses.
They do not establish payment of said alleged expenses to
the entities in which the same are said to have been 14. Surplus Property Commission 277.68
incurred. The Court of Tax Appeals erred, therefore, in
allowing the deduction thereof. 15. Alverez Auto Supply 285.62

The alleged bad debts are:

16. Lion Shoe Store 1,686.93
1. Portillo's Auto Seat Cover P630.31
17. Ruiz Highway Transit 2,350.00
2. Visayan Rapid Transit 17,810.2
6 18. Esquire Auto Seat Cover 3,536.94

3. Bataan Auto Seat Cover 373.13 TOTAL P50,455.4

1*
4. Tres Amigos Auto Supply 1,370.31
The issue, in connection with these debts is whether or not
the same had been properly deducted as bad debts for the
5. P. C. Teodorolawphil 650.00 year 1951. In this connection, we find:
Portillo's Auto Seat Cover (P730.00):
6. Ordnance Service, P.A. 386.42
This debt was incurred in 1950. In 1951, the debtor paid
7. Ordnance Service, P.C. 796.26 P70.00, leaving a balance of P630.31. That same year, the
account was written off as bad debt (Exhibit 3-C-4). Counsel
8. National land Settlement 3,020.76 for Goodrich had merely sent two (2) letters of demand in
Administration 1951 (Exh. B-14). In 1952, the debtor paid the full balance
(Exhibit A).

9. National Coconut Corporation 644.74 Visayan Rapid Transit (P17,810.26):

This debt was, also, incurred in 1950. In 1951, it was charged
10. Interior Caltex Service Station 1,505.87 off as bad debt, after the debtor had paid P275.21. No other
payment had been made.lawphil Taxpayer's Accountant
11. San Juan Auto Supply 4,530.64 testified that, according to its branch manager in Cebu, he
had been unable to collect the balance. The debtor had
12. P A C S A 45.36 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.
13. Philippine Naval Patrol 14.18
Bataan Auto Seat Cover (P373.13): This account had been outstanding since 1949. Collection
letters were sent (Exh. B-12) without success. It was written
This is the balance of a debt of P474.13 contracted in 1949.
off as bad debt in 1951, while the corporation was under a
In 1951, the debtor paid P100.00. That same year, the
Board of Liquidators, which promised to pay upon availability
balance of P373.13 was charged off as bad debt. The next
of funds. In 1961, the debt was fully paid.
year, the debtor paid the additional sum of P50.00.
Interior Caltex Service Station (P1,505.87):
Tres Amigos Auto Supply (P1,370.31):
The original account was P2,705.87, when, in 1950, it was
This account had been outstanding since 1949. Counsel for
turned over for collection to counsel for Goodrich (p. 156, CTA
the taxpayer had merely sent demand letters (Exh. B-13)
Records). Counsel began sending letters of collection in April
without success.
1950. Interior Caltex made partial payments, so that as of
P. C. Teodoro (P650.00): December, 1951, the balance outstanding was
P1,505.87.lawphil.net The debtor paid P200, in 1952;
In 1949, the account was P751.91. In 1951, the debtor paid P113.20, in 1954; P750.00, in 1961; and P300.00.00 in 1962.
P101.91, thus leaving a balance of P650.00, which the The account had been written off as bad debt in 1951.
taxpayer charged off as bad debt in the same year. In 1952,
the debtor made another payment of P150.00. The claim for deduction of these ten (10) debts should be
rejected. Goodrich has not established either that the debts
Ordinance Service, P.A. (P386.42): are actually worthless or that it had reasonable grounds to
In 1949, the outstanding account of this government agency believe them to be so in 1951. Our statute permits the
was P817.55. Goodrich's counsel sent demand letters (Exh. deduction of debts "actually ascertained to be worthless
B-8). In 1951, it paid Goodrich P431.13. The balance of within the taxable year," obviously to prevent arbitrary action
P386.42 was written off as bad debt that same year. by the taxpayer, to unduly avoid tax liability.

Ordinance Service, P.C. (P796.26): The requirement of ascertainment of worthlessness requires

proof of two facts: (1) that the taxpayer did in fact ascertain
In 1950, the account was P796.26.lawphil It was referred to the debt to be worthlessness, in the year for which the
counsel for collection. In 1951, the account was written off as deduction is sought; and (2) that, in so doing, he acted in
a debt. In 1952, the debtor paid it in full. good faith.1
National Land Settlement Administration (P3,020.76): Good faith on the part of the taxpayer is not enough. He
must show, also, that he had reasonably investigated the
The outstanding account in 1949 was P7,041.51. Collection
relevant facts and had drawn a reasonable inference from the
letters were sent (Exh. B-7). In 1951, the debtor paid
information thus obtained by him.2 Respondent herein has
P4,020.75, leaving a balance of P3,020.76, which was written
not adequately made such showing.
off, that same year, as a bad debt. This office was under
liquidation, and its Board of Liquidators promised to pay The payments made, some in full, after some of the
when funds shall become available. foregoing accounts had been characterized as bad debts,
merely stresses the undue haste with which the same had
National Coconut Corporation (P644.74):
been written off. At any rate, respondent has not proven that
said debts were worthless. There is no evidence that the Lion Shoe Store (P11,686.93),
debtors can not pay them.lawphil.net It should be noted also
that, in violation of Revenue Regulations No. 2, Section 102,
respondent had not attached to its income tax returns a Ruiz Highway Transit (P2,350.00),
statement showing the propriety of the deductions therein and
made for alleged bad debts.
Esquire Auto Seat Cover (P3,536.94):
Upon the other hand, we find that the following accounts
were properly written off: These three (3) accounts were among those referred to
San Juan Auto Supply (P4,530.64): counsel for Goodrich for collection. Up to 1951, when they
were written off, counsel had sent 17 Letters of demand to
This account was contracted in 1950. Referred, for collection, Lion Shoe Store (Exh. B); 16 demand letters to Ruiz Highway
to respondent's counsel, the latter secured no payment. In Transit (Exh. B-1); and 6 letters of demand to Esquire Auto
November, 1950, the corresponding suit for collection was Seat Cover (Exit. B-5) In 1951, Lion Shoe Store, Ruiz Highway
filed (Exh. C). The debtor's counsel was allowed to withdraw, Transit, and Esquire Auto Seat Cover had made partial
as such, the debtor having failed to meet him. In fact, the payments in the sums of P1,050.00, P400.00, and P300.00
debtor did not appear at the hearing of the respectively. Subsequent to the write-off, additional small
case.lawphil.net Judgment was rendered in 1951 for the payments were made and accounted for as income of
creditor (Exh. C-2). The corresponding writ of execution (Exh. Goodrich. Counsel interviewed the debtors, investigated their
C-3) was returned unsatisfied, for no properties could be ability to pay and threatened law suits. He found that the
attached or levied upon. debtors were in strained financial condition and had no
attachable or leviable property. Moreover, Lion Shoe Store
PACSA (P45.36), was burned twice, in 1948 and 1949. Thereafter, it continued
to do business on limited scale. Later; it went out of business.
Philippine Naval Patrol (P14.18), 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
Surplus Property (P277.68),
spend good money after bad."
Commission
The deduction of these eight (8) accounts, aggregating
Alvarez Auto Supply (P285.62): P22,627.35, as bad debts should be allowed.
WHEREFORE, the decision appealed from should be, as it is
These four (4) accounts were 2 or 3 years old in 1951. After
hereby, modified, in the sense that respondent's alleged
the collectors of the creditor had failed to collect the same,
representation expenses are totally disallowed, and its claim
its counsel wrote letters of demand (Exhs. B-10, B-11, B-6
for bad debts allowed up to the sum of P22,627.35 only.
and B-2) to no avail. Considering the small amounts involved
Without special pronouncement as to costs. It is so ordered.
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