Compiled Tax Digests For May 8

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Section 34 (as amended by TRAIN and CREATE)

Calanoc v. CIR (November 29, 1961)

Payment for police protection – illegal as it is compensation given by the petitioner to the police for the performance by the latter of
the functions required of them to be rendered by law

Requirements for deductible claims:

1. Sufficient evidence (official receipts or other adequate records)

2. Direct connection of the expense to the development, management, operation, and/or conduct of the trade, business or
profession

Payment of bribes and kickbacks, whether given to the government or a private person are not deductible.

FACTS: Calanoc held a boxing and wrestling exhibition on Dec. 3, 1949 at the Rizal Memorial Stadium. The Collector of Internal
Revenue made an assessment of P7.3k as amusement tax and surcharge. Before the exhibition took place, Calanoc applied with the
CIR for exemption from payment of the amusement tax, as Calanoc was authorized to solicit and receive contributions for the
orphans and destitute children of the Child Welfare Workers Club of the Commission. Upon examination of the receipts, the CIR
found the following items of expenditures: P461.65 for police protection; P460.00 for gifts; P1,880.05 for parties; and several items
for representation. Out of the proceeds of the exhibition, only ~P1.3k was remitted to the Social Welfare Commission for the said
charitable purpose. Upon examination of the Secretary of Finance, authorizing denial of application for exemption from payment of
amusement tax in cases where the net proceeds are not substantial or where the expenses are exorbitant.

ISSUE: W/N the assessment of amusement tax against Calanoc is valid – YES

HELD/RATIO: Calanoc admitted that he could not justify the other expenses, such as those for police protection and gifts. He claims
further that the accountant who prepared the statement of receipts is already dead and could no longer be questioned on the items
contained in said statement. The SC agrees with the CTA that most of the items of expenditures contained in the statement
submitted to the agent are either exorbitant or not supported by receipts. The expenditures of P460 for gifts, P1,880.05 for parties
and other items for representation are rather excessive, considering that the purpose of the exhibition was for a charitable cause.
Moreover, the payment for police protection is illegal as it is compensation given by the petitioner to the police for the performance
by the latter of the functions required of them to be rendered by law.

CIR v. Isabela Cultural (February 12, 2007)

Requirements with the following requisites for the deductibility of ordinary and necessary trade, business, or professional expenses:

1. Expense must be ordinary and necessary

2. Must have been paid or incurred during the taxable year -- qualified by Section 45 of the National Internal Revenue Code
'paid or accrued' or 'paid or incurred', dependent upon the method of accounting upon the basis of which the net
income is computed
3. Must have been paid or incurred in carrying on the trade/business

4. Must be supported by receipts, records or other pertinent papers

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not
being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction
from income for the succeeding year
The accrual of income and expense is permitted when the all-events test has been met.
(1) fixing of a right to income or liability to pay; and -- Amounts of income accrue where the right to receive them
become fixed. Similarly, liabilities are accrued when fixed and determinable in amount.
(2) the availability of the reasonable accurate determination of such income or liability. The amount of liability does not
have to be determined exactly; it must be determined with "reasonable accuracy."; implies something less than an exact
or completely accurate amount.
FACTS:
Isabela Cultural Corporation (ICC), a domestic corporation, received from the BIR two Assessment Notices for the taxable year 1986.
One of the notices was for deficiency income tax in the amount of ~P300k. The deficiency income tax arose from BIR’s disallowance
of ICC’s claimed expense deductions for professional and security services billed to and paid by ICC in 1986, namely:

(1) Expenses for the auditing services for the year 1985;

(2) Expenses for the legal services of the law firm for the years 1984 and 1985; and

(3) Expense for security services for the months of April and May 1986.

ICC brought the case to the CTA which held that the petition is premature because the final notice of assessment cannot be
considered as a final decision appealable to the tax court. However, this was reversed by the CA, whose decision was sustained by
the SC. The case was remanded to the CTA. The CTA rendered a decision canceling and setting aside the assessment notices issued
against ICC. According to the CTA , 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. The CA affirmed the CTA decision. The
CIR filed the instant petition contending that since ICC is using the accrual method of accounting, the expenses for the professional
services that accrued in 1984 and 1985, should have been declared as deductions from income during the said years and the failure
of ICC to do so bars it from claiming said expenses as deduction for the taxable year 1986.

ISSUE: W/N the CA correctly sustained the deduction of the expenses for professional and security services from ICC’s gross income –
NO for professional services; YES for security services

HELD/RATIO: The requisite that it must have been paid or incurred during the taxable year is further qualified by Sec. 45 of the NIRC:
the 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. ICC is using the accrual method. Revenue Audit
Memorandum Order No. 1-2000 provides that under the accrual method of accounting, expenses not being claimed as deductions
by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year.

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at the
closing of its books for the taxable year. Accrual method of accounting presents largely a question of fact; such that the taxpayer
bears the burden of proof of establishing the accrual of an item of income or deduction. The expenses for professional fees consist of
expenses for legal and auditing services.

LEGAL EXPENSES: From the nature of the claimed deductions and the span of time during which the law firm was retained (the firm
was ICC’s counsel since 1960’s), ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the
compensation for its legal services. ICC could have inquired into the amount of their obligation to the firm, especially so that it is
using the accrual method of accounting. • 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.

AUDITING FEES: The professional fees of SGV & Co. for auditing the financial statements of ICC for the year 1985 cannot be validly
claimed as expense deductions in 1986 since ICC failed to present evidence showing that even with only "reasonable accuracy" as
the standard to ascertain its liability to SGV & Co. in 1985, it cannot determine the professional fees which said company would
charge for its services.

SECURITY SERVICES: As to the expenses for security services, the records show that these expenses were incurred by ICC in 1986 and
could therefore be properly claimed as deductions for the said year.

CIR v. General Foods (April 24, 2003)

Expenses must be ordinary and necessary.

Advertising is two kinds:

1. To stimulate the current sale of merchandise or use of services -- it is definitely deductible as a business expense, the only question
to be answered is if it is reasonable or not

2. To stimulate the future sale of merchandise or use of services --- involves expenditures incurred, in whole or in part, to create or
maintain some form of goodwill for the taxpayer’s trade or business or for the industry or profession of which the taxpayer is a
member --- normally they should be spread out over a reasonable

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. 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.
FACTS:

General Foods Inc., in its ITR, claimed the amount of P9.4M for media advertising of “ Tang” as a deduction. The CIR disallowed 50%
of this and assessed them to have a deficiency income tax of P2.6M. General Foods appealed to the CTA, but the CTA dismiss it on
the ground that the amount was so large that it cannot be considered a reasonable amount. It was instead incurred to create or
maintain good will for their trade or business, which is considered as acquisition of capital assets. Thus, the same cannot be seen as a
business expense. The CA reversed this ruling as the amount was not proven to be excessive.

ISSUES: W/N the subject media advertising expense for "Tang" incurred by General Foods was an ordinary and necessary expense
fully deductible under the NIRC – NO

HELD/RATIO: To be deductible from gross income, the subject advertising expense must comply with the following requisites: 1.
expense must be ordinary and necessary 2. it must have been paid or incurred during the taxable year 3. it must have been paid or
incurred in carrying on the trade/business 4. it must be supported by receipts, records or other pertinent papers

While the parties agreed that the advertising expenses were incurred in carrying on a trade or business, making it necessary, the SC
held that the same was not ordinary. • The P9,461,246 claimed as media advertising expense for "Tang" alone was almost one-half of
its total claim for "marketing expenses." • The media advertising expense for "Tang" was almost double the amount of the
corporation’s P4,640,636 general and administrative expenses. • The amount was inordinately large. Therefore, even if it was
necessary, it cannot be considered ordinary. Advertising designed to stimulate the future sale of merchandise or use of services
involves expenditures incurred, in whole or in part, to create or maintain some form of goodwill for the taxpayer’s trade or business
or for the industry or profession of which the taxpayer is a member. normally they should be spread out over a reasonable period of
time. The subject advertising expense was of the 2nd kind. Not only was the amount staggering, but G eneral Foods themselves
admitted that the expense was incurred in order to protect their brand franchise. The protection of brand franchise is analogous to
the maintenance of goodwill or title to one’s property. Its venture to protect its brand franchise was tantamount to efforts to
establish a reputation. This was akin to the acquisition of capital assets and thus expenses related thereto were not to be considered
as business expenses but as capital expenditures.

Atlas Consolidated Mining v. CIR (January 27, 1981)

Expenses paid to advertising firms to promote sale of capital stock for acquisition of additional capital is not deductible from taxable
income. Efforts to establish reputation are akin to acquisition of capital assets, and therefore, expenses related thereto are NOT
business expense but capital expenditures.

Mere allegation of the taxpayer that an item of expense is ordinary and necessary is not enough. There is no hard and fast rule on
what is considered ordinary and necessary. An expense may be considered necessary if it is appropriate and helpful in the
development of the taxpayer’s business. ○ It is ordinary when it connotes payment which is normal in relation to the business of the
taxpayer. Ordinary does not require that payments be habitual or normal in the sense that the taxpayer will have to make them
often. The right to a deduction depends on each case. The intention of the taxpayer often may be the controlling factor in making the
determination. Assuming that the expenditure is ordinary and necessary in the operation of the business, the answer to whether it is
deductible as a business expense must be determined from the nature of the expense itself, which in turn depends on the extent and
permanency of the work accomplished by the expenditure

Litigation expenses incurred in defense of title to property – are capital in nature and NOT deductible

FACTS:

Atlas was assessed by the CIR for deficiencies for the years 1957-1958. Atlas contested the assessment for 1958 as it disallowed the
items claimed by Atlas as deductible from its gross income. Atlas claimed that the following items are deductible: transfer agent’s
fee, stockholders relation service fee, US stock listing expenses and suit expenses. According to Atlas, the stockholders’ relations fee
must be allowed as a deduction as it was used to hire a PR company to create a favorable image and goodwill to gain or maintain
their patronage. The stockholders’ relation service fee was paid to the public relations firm PK Macker & Company to help Atlas sell
its capital stock. Meanwhile, the suit expenses were incurred in defense or protection of title to Atlas’ mining properties.

ISSUE: W/N the deduction should be allowed – NO

HELD/RATIO: The Court ruled that compensation for the services of the PR company to campaign to sell Atlas’ additional capital stock
is not an ordinary expense. Expenses relating to recapitalization and reorganization of the corporation, the cost of obtaining stock
subscription, promotion expenses and commission or fees paid for the sale of stock organization are capital expenditures. The fact
that the expense was incurred to improve the goodwill of the corporation does not make it a deductible business expense. As held in
Welch v Helvering, efforts to establish reputation are akin to acquisition of capital assets. • Expenses paid to advertising firms to
promote sale of capital stock for acquisition of additional capital → NOT deductible from taxable income
In another case, the CIR questioned the decision of the CTA where it disallowed only 6666.65 as suit expenses and where it allowed
listing expenses to be deducted from Atlas’ gross income. CIR claims that listing expenses are not ordinary and necessary and cited
the case of Domes where it was held that expenses for listing capital stock in the stock exchange are not ordinary and necessary
expenses which were gold mining and selling, which business is similar to Atlas. The SC ruled that the case of Chesapeake v CIR was
controlling with the facts and circumstances of the present case. In Dome Mines, the stock listing fee was disallowed as a deduction
because the same was paid only once and the benefit acquired continued indefinitely, whereas, in Chesapeake, the fee paid to the
stock exchange was annual and recurring, in order to maintain the corporation’s stock exchange listing. In the present case, payments
were made annually by Atlas. Hence, the listing fee is an ordinary and necessary business expense.

With regard to the suit expenses, the Court ruled that the litigation expenses incurred by Atlas in the defense of title to the Toledo
Mining properties purchased by Atlas from Mindanao Lode are capital in nature and not deductible as it constitutes part of the cost
of the property.

Kuenzle v, CIR (May 29, 1969)

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 – MUST BE REASONABLE

FACTS: Kuenzle & Streiff, Inc., a domestic corporation, filed its income tax returns for the taxable years 1953, 1954 and 1955,
declaring net losses. The CIR assessed it for deficiency income taxes, by disallowing, as deductible expenses, the bonuses paid by the
corporation to its officers, upon the ground that these were not ordinary nor necessary and were not reasonable expenses within the
scope of Sec. 30(a) (1) of the NIRC. Kuenzle Inc. filed with the CTA a petition for review contesting the assessments, but the CTA ruled
in favor of the CIR. Kuenzle & Streiff, Inc. argues that the CA acted in a purely arbitrary manner and that it erred in not considering
individually the total compensation paid to each of the corporation’s officers and staff members in determining the reasonableness
of the bonuses.

ISSUE: W/N the bonuses were reasonable and thus to be allowed as deductions – NO

HELD/RATIO: Petitioner contends that, as employer, it has the right to fix the compensation of its officers and employees and that it
was in the exercise of such right that it deemed proper to pay the bonuses. To this, the Court said that that right may be conceded,
but for income tax purposes, the employer cannot legally claim such bonuses as deductible expenses unless they are shown to be
reasonable. To hold otherwise would open the gate to rampant tax evasion. Jurisprudence provides 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. In this case,
the bonuses were compensation and paid for services actually rendered; however, they were NOT reasonable and just to be allowed
as a deduction. • First, petitioner paid to its top officers substantial amounts as salaries and bonuses ranging from P9k to P50k yearly.
While it may be assumed that they were competent, there is no evidence on record that all or some of them were gifted with some
special 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. • Second, all other employees received no pay increase at
all during said years. • Third, the bonuses were paid to the top officials in spite of the fact that the corporation suffered net losses for
3 years. o 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 further
claims that the amounts disallowed by the CIR should be considered as legitimate business expenses as the payment was made in
good faith. The Court said that petitioner treads on dangerous ground because of two reasons: • In the first place, good faith cannot
decide whether a business expense is reasonable or unreasonable for purposes of income tax deduction. • In the second place,
petitioner's good faith in the matter is not overly manifest, considering that the bonuses were fixed and paid at the end of the years
in question — at a time, therefore, when petitioner fully knew that it was going to suffer a net loss in its business operations.

Aguinaldo Industries v. CIR (February 25, 1982)

Bonuses given to corporate officers out of the sale of corporate land are NOT deductible as an ordinary business expense in the
absence of showing what role said officers performed to effectuate said sale. The taxpayer must show that personal services had
been rendered and that the amount was reasonable.

Whenever a controversy arises on the deductibility, for purposes of income tax, of certain items for alleged compensation of officers
of the taxpayer, two (2) questions become material, namely: (a) Have 'personal services' been 'actually rendered' by said officers? (b)
In the affirmative case, what is the 'reasonable allowance' thereof? ● Deductions can only be allowed for income tax purposes when
such is an ordinary and necessary business expenses --- includes a reasonable allowance for personal services actually rendered.

FACTS: Aguinaldo is engaged in the manufacture of fish nets (tax exempt industry) and manufacture of furniture. Later on, a piece of
land (Muntinlupa land) recorded under the Fish Nets Division was sold. Aguinaldo declared the profit from the sale of land as
miscellaneous income of the Fish Nets Division to distinguish it from its tax-exempt income. In relation to this sale, a portion of the
proceeds were given to its corporate officers as bonuses (officer’s remuneration), which was later on declared as a deduction for
income tax purposes. The BIR contends that the amount given as Officer’s remuneration should be disallowed as deduction from
gross income. On the other hand, Aguinaldo argues that the said amount should be allowed as deduction because it was paid to its
officers as allowance or bonus pursuant to its by-laws.

ISSUE: W/N the bonus given to officers from the proceeds of sale of land is deductible – NO

HELD/RATIO: Sec. 30(a)(1) provides that all ordinary and necessary expenses paid or incurred during the taxable year including a
reasonable allowance for personal services actually rendered shall be allowed as deductions in computing for net income. Bonuses
given to corporate officers out of the sale of corporate land are NOT deductible as an ordinary business expense in the absence of
showing what role said officers performed to effectuate said sale. The taxpayer must show that personal services had been rendered
and that the amount was reasonable.

The bonuses given to the officers of the Aguinaldo as their share of the profit realized from the sale of the Muntinlupa land cannot
be deemed a deductible expense for tax purposes, even if the aforesaid sale could be considered as a transaction for carrying on the
trade or business of the petitioner and even if the grant of the bonus to the corporate officers is pursuant to petitioner's by-laws. •
First, the sale itself was done through a broker who was paid commission. • Furthermore, there is absolutely no evidence of any
service actually rendered by Aguinaldo’s officers which could be the basis of the granting of a bonus to them, said bonus being paid
by the profit derived from the sale. In this case, the Officer’s remuneration are extraordinary and unusual amounts paid by petitioner
to directors in the guise and form of compensation for their supposed services as such, without any relation to the measure of their
actual services, and thus cannot be regarded as ordinary and necessary expenses.

CM Hoskins v, CIR (November 28, 1969)

For income tax purposes, the employer cannot legally claim bonuses as deductible expenses unless they are shown to be reasonable.
The conditions precedent to the deduction of bonuses are: ▪ The payment of bonuses is in fact compensation; ▪ It must be for
personal services actually rendered; and ▪ The bonuses, when added to the salaries, are reasonable when measured by the amount
and quality of the services performed with relation the business of the taxpayer.

FACTS:

CM Hoskins, a domestic corporation engaged in the real estate business as brokers, managing agents and administrators, filed its
income tax return 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, CIR disallowed 4 items of deduction in petitioner's tax returns and assessed against it an income tax
deficiency in the amount of P28,054 plus interests. The CTA upheld the CIR’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. Petitioner questions the Tax Court’s findings that
the disallowed payment to Hoskins was an inordinately large one, which bore a close relationship to the recipient’s dominant
stockholdings and therefore amounted in law to a distribution of its earnings and profits.

ISSUE: W/N the payment of the company to Mr. Hoskins of the sum P99,977.91 as 50% share of supervision fees can be treated as an
ordinary and necessary expenses allowed for deduction – NO

HELD/RATIO: For income tax purposes, the employer cannot legally claim bonuses as deductible expenses unless they are shown to
be reasonable. The conditions precedent to the deduction of bonuses are: 1. The payment of bonuses is in fact compensation; 2. It
must be for personal services actually rendered; and 3. The bonuses, when added to the salaries, are reasonable when measured by
the amount and quality of the services performed with relation the business of the taxpayer There is no fixed test for determining
the reasonableness of a given bonus as compensation. This depends upon many factors. However, in determining whether the
particular salary or compensation payment is reasonable, the situation must be considered as whole.

Hoskins was the Chairman of the BOD of the corporation. He owned 99.6% of its total authorized capital stock, and was also
salesman-broker for his company. He was also receiving a 50% share of the sales commissions earned by his company as well as his
monthly salary of P3,750, plus an annual salary bonus of P40,000, plus free use of the company car and receipt of other similar
allowances and benefits. The Tax Court correctly ruled that the payment by petitioner to Hoskins of the additional sum of P99,977.91
as his equal or 50% share of the 8% supervision fees received by the company as managing agents of the real estate, subdivision
projects of Paradise Farms, Inc. and Realty Investments, Inc. was inordinately large and could not be accorded the treatment of
ordinary and necessary expenses allowed as deductible items within the purview of Sec. 30(a)(i) of the Tax Code.

CIR v. Vda. de Prieto (September 30, 1960)


Late payment of tax is considered a debt, and therefore interest on taxes is interest on indebtedness and is thus deductible. The
amount of interest paid within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry
obligations the interest upon which is exempt from taxation as income under this Title – considered deductions under NIRC.

FACTS: Respondent Consuelo conveyed by way of gifts to her 4 children real property with a total assessed value of P892,497.50.
After the filing of the gift tax returns, the CIR appraised the real property donated for gift tax purposes and assessed the total sum of
P117,706.50 as donor’s gift tax, interest and compromises due thereon. Of the total sum of P117,706.50 paid by Consuelo, the sum
of P55,978.65 represents the total interest on account of delinquency. This sum of P55,978.65 was claimed as deduction, among
others, by Consuelo in her 1954 income tax return. The CIR, however, disallowed the claim.

ISSUE: W/N the interest paid by Consuelo, in consequence of the late payment of her donor’s tax, was paid upon an indebtedness
within the contemplation of Sec. 30 (b) (1) of the Tax Code – YES

HELD/RATIO: Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should be
interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within the year. • It is here
conceded that the interest paid by Consuelo was in consequence of the late payment of her donor’s tax, and the same was paid
within the year it is sought to be declared. “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 requirement of the law.

Although taxes already due have not, strictly speaking, the same concept as debts, they are, however, obligations that may be
considered as such. Where a statute imposes a personal liability for a tax, the tax becomes, at least in a broad sense, a debt. It
follows that the interest paid by Consuelo for the late payment of her donor’s tax is deductible from her gross income under Sec.
30(b) of the Tax Code. The CIR insists that the interest payment is not deductible for the purpose of computing respondent's net
income relying heavily on Sec. 80 of Revenue Regulation No. 2 (known as Income Tax Regulation) promulgated by the Department of
Finance, which provides that "the word ‘taxes’ means taxes proper and no deductions should be allowed for amounts representing
interest, surcharge, or penalties incident to delinquency." The Court, however, held Sec. 80 as inapplicable to the instant case because
while it implements Sec. 30(c) of the Tax Code governing deduction of taxes, the respondent taxpayer seeks to come under Sec. 30(b)
of the same Code providing for deduction of interest on indebtedness. • In conclusion, the Court held that although interest payment
for delinquent taxes is not deductible as tax under Sec. 30(c) of the Tax Code and Sec. 80 of the Income Tax Regulations, the taxpayer
can claim said interest payment as deduction under Sec. 30(b) of the same Code.

Paper Industries v. CA (December 1, 1995)

Congress decided to limit the transfer of NOLCO because to allow the indiscriminate transfer thereof would allow corporations to
simply buy and benefit from the operating losses of another corporation

FACTS: Picop is a corporation registered with the Board of Investments. It received two letters of assessments and demand for certain
types of taxes. Upon proceedings with the CTA and the CA, the amount was eventually lowered. Both the CIR and Picop now go
before the SC. Part of the deductions claimed for Picop was for the accumulated losses of Rustan Pulp and Paper Mills, Inc. (RPPM).
Picop entered into a merger with RPPM and Rustan Manufacturing Corporation (RMC), where Picop was the surviving corporation
and obtained all of the rights and properties of the two corporations. RPPM was also a BOI registered company. In its 1977 ITR, Picop
claimed P44,196,106 of RPPM’s accumulated losses as a deduction against its gross income. Picop relied on the Investments
Incentives Act for claiming the deduction. The provision on Net Operating Loss Carry-over (NOLCO) allowed losses from the first 10
years of BOI-registered enterprises to be carried over and deducted from taxable income for the 6 years immediately following the
year of such loss. The CIR disallowed the deductions claimed because the previous losses were incurred by another taxpayer, as
RPPM and RMC were merged only upon the approval of the merger in 1978 so during the taxable year 1977, they still had their
separate juridical personalities.

ISSUE: W/N Picop is entitled to deductions against income of net operating losses incurred by Rustan Pulp and Paper Mills, Inc – NO

HELD/RATIO: The ordinary rule is that NOLCO cannot be carried over. Losses must be deducted against current income in the taxable
year where the losses were incurred. The Investments Incentives Act introduced NOLCO carry-over only to registered pioneer
enterprises with respect to their registered operations as an encouragement and incentive. Through the carry-over, the State defers
taxing the income of the pioneer enterprise until that enterprise has recovered or offset earlier losses. Thus, the statutory purpose
can be served only if the accumulated operating losses are carried over and charged off against income subsequently
earned/accumulated by the SAME enterprise in the same registered operations. • Congress decided to limit the transfer of NOLCO
because to allow the indiscriminate transfer thereof would allow corporations to simply buy and benefit from the operating losses of
another corporation. Thus, of Picop will be allowed to claim the deduction, it means Picop benefits from the operating losses
accumulated by another enterprise. RPPM is not benefited at all. To grant Picop’s claimed deduction would be to permit Picop to
shelter its otherwise taxable income which had not been earned by the registered enterprise which had suffered the accumulated
losses. 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. Picop’s claim for deduction is not only bereft of statutory basis; it does violence to the legislative
intent which animates the tax incentive granted by RA 5186 or the Investment Incentives Act.

Philex Mining v. CIR (April 16, 2008)

Bad debts are deductible, provided that there is an existing indebtedness due to the taxpayer which is valid and legally demandable,
and not losses from investments as in this case. Deductions for income tax purposes partake of the nature of tax exemptions and are
strictly construed against the taxpayer, who must prove by convincing evidence that he is entitled to the deduction claimed.

FACTS: Philex Mining Corporation entered into an Agreement with Baguio Gold Mining Company which stated that Philex was to
manage and operate Baguio Gold’s mining claim, known as the Sto. Niño mine, located in Atok and Tublay, Benguet Province. The
Agreement was that Baguio Gold was to make available to Philex up to P11M in such amounts as from time to time may be required
by Philex Mining within a 3 year period, for the use and management of the Sto. Nino Mine. Also, the compensation of Philex for this
undertaking shall be 50% of the net profit of Sto Niño project before income tax. It is understood that Philex shall pay income tax on
their compensation, while Baguio Gold shall pay income tax on the net profit of the Sto. Nino project after deduction therefrom of
Philex’s compensation. In the course of managing and operating the project, Philex Mining made advances of cash and property in
accordance with the agreement. Philex then withdrew as manager of the mine due to the mine’s continuing losses over the years;
then, the mine ceased operations. The parties executed 2 Compromise Agreements (a Compromise with Dation in Payment and an
Amendment to Compromise with Dation in Payment) wherein the parties determined that Baguio Gold had an outstanding
indebtedness to Philex in the amount of P114,996,768. In its 1982 annual income tax return, Philex deducted from its gross income
the amount of P112,136,000 as loss on settlement of receivables from Baguio Gold against reserves and allowances. However, the
BIR disallowed the amount as deduction for bad debt and assessed Philex a deficiency income tax. Philex contended that the
deduction must be allowed since all requisites for a bad debt deduction were satisfied, namely: (a) there was a valid and existing
debt; (b) the debt was ascertained to be worthless; (c) it was charged off within the taxable year when it was determined to be
worthless.

ISSUE: W/N the outstanding balance can be treated as bad debt and thus be deducted from Philex’ gross income – NO

HELD/RATIO: And here, Philex failed to substantiate its assertion that the advances were subsisting debts of Baguio Gold that could
be deducted. CONSEQUENTLY, it could not claim the advances as a valid bad debt deduction. As the primary contract, the Power of
Attorney is the material instrument to determine the true nature of the business relationship between Philex and Baguio Gold.
Resort may be had on the two Compromise Agreements after the parties’ intent is ascertained via the Power of Attorney. As per the
Power of Attorney, a partnership or joint venture was indeed intended by the parties:

1. The parties undertook to contribute money, property and industry to the common fund known as the Sto. Niño mine. The parties
were to contribute equally to the joint venture assets under their respective accounts.

2. They also had a joint interest in the profits of the business as shown by a 50-50 sharing in the income of the mine.

3. Baguio Gold was not unconditionally obligated to return the advances made by Philex. Philex was merely entitled to a
proportionate return of the mine’s assets upon dissolution of the parties’ business relations. -There was nothing that required Baguio
Gold to make payments of the advances to Philex as would be recognized as an item of obligation or "accounts payable" for Baguio
Gold.

4. It is unlikely that a business corporation would lend hundreds of millions of pesos to another corporation with neither security, or
collateral, nor a specific deed evidencing the terms and conditions of such loans. The parties also did not provide a specific maturity
date for the advances to become due and demandable, and the manner of payment was unclear. - Thus, the advances were NOT
loans but capital contributions to a partnership.

5. Philex would receive 50% of the net profits as "compensation" under par. 12.

This “compensation” was actually its share in the income of the joint venture. Clearly, then, the advances were NOT debts of Baguio
Gold to Philex. As for the amounts that Philex paid as guarantor to Baguio Gold’s creditors, these debts were not yet due and
demandable at the time Philex paid. Therefore, Philex cannot claim the advances as a bad debt deduction from its gross income.

Phil Refining v. CTA (May 8, 1996)

The rule in determining the worthlessness of a debt requires the taxpayer to 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;
4. the debt must arise from the business or trade of the taxpayer. In addition, the taxpayer must show that it is uncollectible even in
the future.
To prove that he exerted diligent efforts to collect the debts: (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

FACTS: The CIR assessed Phil. Refining Co. for deficiency taxes, as it disallowed bad debts and interest expenses claimed by PRC as
deductions. PRC asserted that the accounts of 16 debtors are bad debts and tried to prove the same through the explanations made
by its financial adviser or accountant. When the case was elevated to the CA, the appellate court opined that out of the 16 accounts
alleged as bad debts, only 3 met the requirements of the worthlessness of the accounts, hence were properly written off as bad
debts. The accounts of the 13 remaining debtors amounting to P395,324.27 have not satisfied the requirements of the
“worthlessness of a debt,” as, according to the CTA, mere testimony of the accountant explaining the worthlessness of the said debts
is not enough to prove its worthlessness.

ISSUE: W/N the 13 accounts should be considered as bad debts and so are deductible – NO

HELD/RATIO: As correctly ruled by the CA and CTA, PRC did not satisfy the requirements of worthlessness of a debt as to the thirteen
accounts disallowed as deductions. It appears that the only evidentiary support given by PRC for its claimed deductions was the
explanation posited by its financial adviser or accountant, which was not substantiated by any documentary evidence. PRC tried to
prove that some of its debtors couldn’t pay for various reasons, including: that the debtor’s store burned down, or that the owner of
the store was murdered, or the debtor was missing, and left no assets which it could garnish; that the debtor is insolvent; and other
such reasons. In all of these explanations, they failed to show documentary evidence to prove these circumstances, and also to
prove their efforts to collect the debt, as they also failed to show a single demand letter. PRC tried to argue that despite the delay in
tax payment, nothing is lost on the part of the Government in case the debts are collected in the future, since the same will be
returned as taxes on the year of the recovery of the debts. The SC rejected this argument, saying that even if the Government
eventually recovers the revenues, the delay caused by non-payment of taxes will still have a disastrous effect on the revenue
collections necessary for the government’s operations during the period that the “bad debts” were claimed as deductions

Hermanos v. CIR (September 30, 1969)

Losses or bad debts must be ascertained to be so and written off during the taxable year. They are therefore deductible in full or not
at all. There’s no partial deductions. The Tax Code does not provide for a partial writing off of a loss or bad debt, as was sought to be
done here by the taxpayer. For such losses or bad debts must be ascertained to be so and written off during the taxable year, are
therefore deductible in full or not at all, in the absence of any express provision in the Tax Code authorizing partial deductions.

FACTS: The CIR assessed petitioner investment company, Fernandez Hermanos, deficiency income taxes for the years 1950-1954 and
1957 in the total amount of P166,063, which resulted from alleged discrepancies found upon the examination of Fernandez
Hermanos’ income tax returns for the years concerned. The Tax Court sustained the CIR’s disallowance of the losses listed by the
corporation concerning Balamban Coal Mines as well as the losses or bad debts of Palawan Manganese Mines (Item #1, b and c). It
likewise sustained the disallowance of the depreciation of houses (Item #2), resulting in a modified deficiency income tax assessment
of P123,436 for the subject taxable years. Both Fernandez Hermanos and the CIR appealed the Tax Court decision, questioning the
correctness of its rulings on the disputed items for allowance/disallowance.

Issue: W/N the Tax Court correctly ruled on the disputed disallowances – YES

Held/Ratio: The disallowance of the claimed losses or bad debts of Palawan Manganese Mines was warranted, given that the amount
represents advances made by Fernandez Hermanos to Palawan Manganese without expectation of repayment. In order to fund its
mining operations in Coron Island, Palawan Manganese loaned from the latter and undertook to pay it back with 15% of its net
profits. However, despite the yearly advances given by Fernandez to Palawan Manganese, the latter continued to suffer losses,
thereby yielding no profits to pay Fernandez with. Even so, Fernandez cannot write the amount off as loss or bad debt as Palawan
Managese’s undertaking was to pay 15% of its net profits; not advances. No bad debt can arise where there is no valid or subsisting
debt. The Court also considered the advances made as investments rather than loans, given that both corporations share the same
controlling stockholders. The only capital of Palawan Manganese was the amount entered into Fernandez Hermanos’ balance sheet
as its investment in its subsidiary company. As for the losses concerning Balamban Coal Mines, the Court ruled that only the amount
listed in 1952 can be considered losses, as this was the period when the mines were abandoned. The amounts claimed in 1950-1951
cannot be considered deductions since the mines were still in operation during such time. As for Item #2 concerning the depreciation
of houses pegged by Fernandez Hermanos at 10%, the Court sustained the CTA’s disallowance of the amounts listed since Fernandez
did not submit adequate proof to show that the depreciable assets in question had a useful life only of 10 years so as to justify its
10% depreciation per annum claim. Said depreciation rate was ruled to be excessive. DOCTRINE: Losses or bad debts must be
ascertained to be so and written off during the taxable year. They are therefore deductible in full or not at all. There’s no partial
deductions.

Basilan Estates v. CIR (September 5, 1967)


A company has the right to claim depreciation, but the law does NOT allow depreciation beyond its acquisition cost. The law permits
the taxpayer to recover gradually his capital investment in wasting assets free from income tax. ● Section 30 (f) (1) allows a
deduction from gross income for depreciation but limits the recovery to the capital invested in the asset being depreciated. ● Hence,
a deduction over and above the acquisition cost cannot be claimed and allowed since deductions from gross income are privileges,
not matters of right

FACTS: Basilan Estates, Inc. filed its ITR for 1953 and paid its income tax. It 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. However, the CIR found that the reappraised assets depreciated in 1953 were the
same ones upon which depreciation was claimed in 1952. For the year 1952, the depreciation of P36,842.04 was based on their
acquisition cost. Hence, the Commissioner pegged the deductible depreciation for 1953 on the same old assets at P36,842.04 and
disallowed the excess thereof, resulting in a deficiency income tax of P3,912. Basilan Estates, Inc. filed before the CTA a petition for
review of the CIR’s assessment, alleging, among others, error in disallowing claimed depreciation. The CTA affirmed the deficiency
assessment in toto.

ISSUE: Whether depreciation shall be determined on the acquisition cost or on the reappraised value of the assets – Acquisition cost

HELD/RATIO: Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and normal
obsolescence. 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. It is entitled to see that from earnings the
value of the property invested is kept unimpaired, so that at the end of any given term of years, the original investment remains as it
was in the beginning. It is not only the right of a company to make such a provision, but it is its duty to its bond and stockholders,
and, in the case of a public service corporation, at least, its plain duty to the public. Accordingly, the law permits the taxpayer to
gradually recover his capital investment in wasting assets free from income tax (see Sec. 30(f)(1)) A company has the right to claim
depreciation, but the law does not allow depreciation 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, created by
expression in the law. In this case, Basilan used the reappraised value as basis for its depreciation, hence, the over depreciation.
Moreover, the recovery, free of income tax, of an amount more than the invested capital in an asset will transgress the purpose of a
depreciation allowance. For then what the taxpayer would recover will be, not only the acquisition cost, but also some profit. - The
philosophy behind depreciation allowance is the recovery in due time through depreciation of investment made; 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.

Roxas v. CTA (April 26, 1968)

Deductions to the ff are partially deductible: 1. To the government, exclusively for public purposes Contributions to a government
entity is deductible when used exclusively for public purposes. Hence, the contributions to the Christmas funds of the various city
police were held not to be deductible because the Christmas funds were not spent for public purposes but as Christmas gifts to the
families of the members of the different police.

FACTS: Don Pedro Roxas and Dona Carmen Ayala, Spanish subjects, transmitted to their grandchildren by hereditary succession
several properties. To manage the properties, said children, namely, Antonio, Eduardo and Jose, formed a partnership called Roxas y
Compania. At the conclusion of WW2, the tenants who have all been tilling the lands in Nasugbu for generations expressed their
desire to purchase from Roxas y Cia. the parcels which they actually occupied. The Government, in consonance 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. Conferences were held with the farmers in the early part of 1948, and finally the Roxas
brothers agreed to sell 13,500 hectares to the Government for distribution to actual occupants for a price of P2,079,048.47 plus
P300,000 for survey and subdivision expenses. It turned out however that the Government did not have funds to cover the purchase
price, and so a special arrangement was made for the Rehabilitation Finance Corporation to advance to Roxas y Cia. the amount of
P1.5M as loan. Roxas y Cia. allowed the farmers to buy the lands for the same price but by installment, and contracted with the
Rehabilitation Finance Corp. to pay its loan from the proceeds of the yearly amortizations paid by the farmers. The CIR demanded
from Roxas y Cia the payment of deficiency income taxes resulting from the inclusion as income of Roxas y Cia. of the unreported
50% of the net profits for 1953 and 1955 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. For
the reason that Roxas y Cia. subdivided its Nasugbu farm lands and sold them to the farmers on installment, the Commissioner
considered the partnership as engaged in the business of real estate; hence, 100% of the profits derived therefrom was taxed. The
Roxas brothers protested the assessment.

ISSUE: W/N the deductions for business expenses and contributions are deductible – SOME ARE (see below)
HELD/RATIO: Xmas funds of the Pasay City Police – NOT DEDUCTIBLE: Under Sec. 39(h), a contribution to a government entity is
deductible only when used exclusively for public purposes. For this reason, the disallowance must be sustained. Hence, the
contributions to the Christmas funds of the various city police were held not to be deductible because the Christmas funds were NOT
spent for public purposes but as Christmas gifts to the families of the members of the police. Contribution to the Manila Police Trust
Fund – DEDUCTIBLE: The contribution to the Manila Police trust fund 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. Contribution to the PH Herald –
DEDUCTIBLE: 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. Contribution to Our Lady of Fatima Chapel – NOT DEDUCTIBLE: The contribution to Our
Lady of Fatima chapel at the Far Eastern University is not deductible on the ground that the said university gives dividends to its
stockholders.

RR 6-2018 (deductions when no withholding)

Again, individuals (except nonresident aliens) can elect a standard deduction not exceeding 40% of gross sales or gross receipts.
Corporations (except nonresident foreign corps.) can elect a standard deduction not exceeding 40% of its gross income. • The OSD
may be availed of by: o A citizen, whether resident or nonresident o Resident alien o Domestic corporation o Resident foreign
corporation o Partnerships o Taxable estate and trust • The OSD allowed to individual taxpayer shall be a minimum of 40% of gross
sales or gross receipts during the taxable year a. If one uses the accrual basis of accounting for his income and deductions: the OSD
shall be based on the gross sales during the taxable year b. If one uses the cash basis: the OSD shall be based on his gross receipts
during the taxable year o The law is specific that for individual taxpayers, the basis of the OSD shall be gross sales or gross receipts,
not gross income → for which reason the “cost of sales” and the “cost of services” are not allowed to be deducted for purposes of
determining the basis of the OSD o For other individual taxpayers allowed by law to report their income and deductions under a
different method of accounting, the gross sales or receipts shall be determined in accordance with the said acceptable mode of
accounting (R.R. 16-2008)

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