4 - China Banking Corporation v. CA - CIR - CTA

[SP Bus] Capital Gains and Losses – 04
JRRB
China Banking Corporation v. CA W/N the respondent courts erred in their ruling in
G.R. No. 125508 | July 19, 2000| Vitug, J. classifying the loss as a capital loss - NO
Petitioners: China Banking Corporation RULING

Respondents: CA, CIR and CTA
Subject to certain exceptions, such as the compensation
FACTS income of individuals and passive income subject to final
tax, as well as income of non-resident aliens and foreign
PETITIONER CHINA BANKING CORPORATION MADE A corporations not engaged in trade or business in the
53% EQUITY INVESTMENT IN THE FIRST CBC CAPITAL Philippines, the tax on income is imposed on the net
(ASIA) LTD., A HONGKONG SUBSIDIARY ENGAGED IN income allowing certain specified deductions from gross
FINANCING AND INVESTMENT WITH "DEPOSIT- income to be claimed by the taxpayer. Among the
TAKING" FUNCTION. FIRST CBC CAPITAL (ASIA), LTD. deductible items allowed by the National Internal
BECAME INSOLVENT. WITH THE APPROVAL OF Revenue Code ("NIRC") are bad debts and losses.
BANGKO SENTRAL, PETITIONER WROTE-OFF AS BEING
WORTHLESS ITS INVESTMENT IN FIRST CBC CAPITAL An equity investment is a capital, not ordinary, asset of the
(ASIA), LTD., IN ITS 1987 INCOME TAX RETURN AND investor the sale or exchange of which results in either a
TREATED IT AS A BAD DEBT OR AS AN ORDINARY LOSS capital gain or a capital loss. The gain or the loss is
DEDUCTIBLE FROM ITS GROSS INCOME. ordinary when the property sold or exchanged is not a
capital asset. 3 A capital asset is defined negatively in
RESPONDENT COMMISSIONER OF INTERNAL REVENUE Section 33(1) of the NIRC1.
DISALLOWED THE DEDUCTION. THE COMMISSIONER
HELD THE VIEW THAT THE SHARES SHOULD BE Thus, shares of stock, like the other securities defined in
CLASSIFIED AS "CAPITAL LOSS," AND NOT AS A BAD Section 20(t) 4 of the NIRC, would be ordinary assets only
DEBT EXPENSE THERE BEING NO INDEBTEDNESS TO to a dealer in securities or a person engaged in the
SPEAK OF BETWEEN PETITIONER AND ITS SUBSIDIARY. purchase and sale of, or an active trader (for his own
Respondent Commissioner of Internal Revenue account) in, securities.
disallowed the deduction and assessed petitioner for
income tax deficiency in the amount of P8,533,328.04, In the hands, however, of another who holds the shares
inclusive of surcharge, interest and compromise penalty. of stock by way of an investment, the shares to him would
The disallowance of the deduction was made on the be capital assets. When the shares held by such investor
ground that the investment should not be classified as become worthless, the loss is deemed to be a loss from
being "worthless" and that, although the Hongkong the sale or exchange of capital assets.
Banking Commissioner had revoked the license of First
CBC Capital as a "deposit-taking" company, the latter Section 29(d)(4)(B) of the NIRC states:
could still exercise, however, its financing and investment "(B) Securities becoming worthless. — If securities as
activities. Assuming that the securities had indeed defined in Section 20 become worthless during the
become worthless, respondent Commissioner of Internal taxable" year and are capital assets, the loss resulting
Revenue held the view that they should then be classified therefrom shall, for the purposes of this Title, be
as "capital loss," and not as a bad debt expense there considered as a loss from the sale or exchange, on the last
being no indebtedness to speak of between petitioner and day of such taxable year, of capital assets."
its subsidiary.
The above provision conveys that the loss sustained by the
holder of the securities, which are capital assets (to him),
PETITIONER CONTESTED THE RULING OF RESPONDENT is to be treated as a capital loss as if incurred from a sale
COMMISSIONER BEFORE THE COURT OF TAX APPEALS or exchange transaction. A capital gain or a capital loss
(CTA). THE TAX COURT SUSTAINED THE normally requires the concurrence of two conditions for it
COMMISSIONER. WHEN THE DECISION WAS APPEALED to result: (1) There is a sale or exchange; and (2) the thing
TO THE COURT OF APPEALS, THE LATTER UPHELD THE sold or exchanged is a capital asset. When securities
CTA. HENCE, THE PRESENT PETITION. PETITIONER become worthless, there is strictly no sale or exchange but
BANK ASSAILED THE APPELLATE COURT IN AFFIRMING the law deems the loss anyway to be "a loss from the sale
THE CTA'S DECISION. or exchange of capital assets. " 5 A similar kind of
treatment is given, by the NIRC on the retirement of
ISSUE(S) certificates of indebtedness with interest coupons or in
1
Capital assets. — The term 'capital assets' means property primarily for sale to customers in the ordinary course of his
held by the taxpayer (whether or not connected with his trade trade or business, or property used in the trade or business, of
or business), but does not include stock in trade of the a character which is subject to the allowance for depreciation
taxpayer or other property of a kind which would properly be provided in subsection (f) of section twenty-nine; or real
included in the inventory of the taxpayer if on hand at the property used in the trade or business of the taxpayer.
close of the taxable year, or property held by the taxpayer
[SP Bus] Capital Gains and Losses – 04
JRRB
registered form, short sales and options to buy or sell One other item. Section 34(c)(1) of the NIRC states that the
property where no sale or exchange strictly exists. 6 In entire amount of the gain or loss upon the sale or
these cases, the NIRC dispenses, in effect, with the exchange of property, as the case may be, shall be
standard requirement of a sale or exchange for the recognized.
application of the capital gain and loss provisions of the
code. The above law should be taken within context on the
general subject of the determination and recognition of
In the case at bar, First CBC Capital (Asia), Ltd., the gain or loss; it is not preclusive of, let alone renders
investee corporation, is a subsidiary corporation of completely inconsequential, the more specific provisions
petitioner bank whose shares in said investee corporation of the code. Thus, pursuant, to the same section of the
are not intended for purchase or sale but as an law, no such recognition shall be made if the sale or
investment. Unquestionably then, any loss therefrom exchange is made in pursuance of a plan of corporate
would be a capital loss, not an ordinary loss, to the merger or consolidation or, if as a result of an exchange
investor. of property for stocks, the exchanger, alone or together
with others not exceeding four, gains control of the
Section 29(d)(4)(A), of the NIRC expresses: corporation. 7 Then, too, how the resulting gain might be
taxed, or whether or not the loss would be deductible and
"(A) Limitations. — Losses from sales or exchanges of how, are matters properly dealt with elsewhere in various
capital assets shall be allowed only to the extent provided other sections of the NIRC. 8 At all events, it may not be
in Section 33." amiss to once again stress that the basic rule is still that
any capital loss can be deducted only from capital gains
The pertinent provisions of Section 33 of the NIRC under Section 33(c) of the NIRC.
referred to in the aforesaid Section 29(d)(4)(A), read:
In sum —
"SECTION 33. Capital gains and losses. —
(a) The equity investment in shares of stock held by CBC
"xxx xxx xxx of approximately 53% in its Hongkong subsidiary, the First
CBC Capital (Asia), Ltd., is not an indebtedness, and it is a
"(c) Limitation on capital losses. — Losses from sales or capital, not an ordinary, asset. 9
exchange of capital assets shall be allowed only to the
extent of the gains from such sales or exchanges. If a bank (b) Assuming that the equity investment of CBC has
or trust company incorporated under the laws of the indeed become "worthless," the loss sustained is a capital,
Philippines, a substantial part of whose business is the not an ordinary, loss. 10
receipt of deposits, sells any bond, debenture, note, or
certificate or other evidence of indebtedness issued by (c) The capital loss sustained by CBC can only be deducted
any corporation (including one issued by a government or from capital gains if any derived by it during the same
political subdivision thereof), with interest coupons or in taxable year that the securities have become "worthless."
registered form, any loss resulting from such sale shall not
be subject to the foregoing limitation and shall not be
included in determining the applicability of such limitation DISPOSITIVE PORTION
to other losses." ITADaE WHEREFORE, the petition is DENIED.
The exclusionary clause found in the foregoing text of the

law does not include all forms of securities but specifically
covers only bonds, debentures, notes, certificates or other
evidence of indebtedness, with interest coupons or in
registered form, which are the instruments of credit
normally dealt with in the usual lending operations of a
financial institution. Equity holdings cannot come close to
being, within the purview of "evidence of indebtedness"
under the second sentence of the aforequoted paragraph.
Verily, it is for a like thesis that the loss of petitioner bank
in its equity investment in the Hongkong subsidiary
cannot also be deductible as a bad debt. The shares of
stock in question do not constitute a loan extended by it
to its subsidiary (First CBC Capital) or a debt subject to
obligatory repayment by the latter, essential elements to
constitute a bad debt, but a long term investment made
by CBC.

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[SP Bus] Capital Gains and Losses – 04

Petitioners: China Banking Corporation RULING

The exclusionary clause found in the foregoing text of the

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