TAXATION 2 ATTY.

PADILLA

reversed the board, holding that there had been no

Gregory v. Helvering, 293 U.S. "reorganization" within the meaning of the statute.
465 (1935) Petitioner applied to this Court for a writ of certiorari,
which the government, considering the question one
FACTS: Petitioner, in 1928, was the owner of all the of importance, did not oppose. We granted the writ.
stock of United Mortgage Corporation. That
corporation held among its assets 1,000 shares of ISSUE: W/N petitioner is liable for a larger tax
the Monitor Securities Corporation. For the sole because said “reorganization” is ineffective?
purpose of procuring a transfer of these shares to
herself in order to sell them for her individual profit, HELD: YES. There was no reorganization within the
and at the same time, diminish the amount of intent of the statute; thus, she is liable to a higher
income tax which would result from a direct transfer tax.
by way of dividend, she sought to bring about a
"reorganization" under § 112(g) of the Revenue Act Section 112 of the Revenue Act of 1928 deals with
of 1928, c. 852, 45 Stat. 791, 816, 818, set forth later the subject of gain or loss resulting from the sale or
in this opinion. To that end, she caused the Averill exchange of property. Such gain or loss is to be
Corporation to be organized under the laws of recognized in computing the tax, except as provided
Delaware on September 18, 1928. Three days later, in that section. The provisions of the section, so far
the United Mortgage Corporation transferred to the as they are pertinent to the question here presented,
Averill Corporation the 1,000 shares of Monitor follow:
stock, for which all the shares of the Averill
Corporation were issued to the petitioner. On "Sec. 112. (g) Distribution of Stock on Reorganization. If there is
distributed, in pursuance of a plan of reorganization, to a
September 24, the Averill Corporation was
shareholder in a corporation a party to the reorganization, stock or
dissolved, and liquidated by distributing all its assets, securities in such corporation or in another corporation a party to
namely, the Monitor shares, to the petitioner. No the reorganization, without the surrender by such shareholder of
other business was ever transacted, or intended to stock or securities in such a corporation, no gain to the distributee
from the receipt of such stock of securities shall be recognized.
be transacted, by that company. Petitioner
..."
immediately sold the Monitor shares for
$133,333.33. She returned for taxation, as capital "(i) Definition of Reorganization. -- As used in this section . . ."
net gain, the sum of $76,007.88, based upon an
apportioned cost of $57,325.45. Further details are "(1) The term 'reorganization' means . . . (B) a transfer by a
unnecessary. It is not disputed that, if the corporation of all or a part of its assets to another corporation if
interposition of the so-called reorganization was immediately after the transfer the transferor or its stockholders or
both are in control of the corporation to which the assets are
ineffective, petitioner became liable for a much transferred. . . ."
larger tax as a result of the transaction.
It is earnestly contended on behalf of the taxpayer
The Commissioner of Internal Revenue, being of that, since every element required by the foregoing
opinion that the reorganization attempted was subdivision (B) is to be found in what was done, a
without substance and must be disregarded, held statutory reorganization was effected, and that the
that petitioner was liable for a tax as though the motive of the taxpayer thereby to escape payment of
United corporation had paid her a dividend a tax will not alter the result or make unlawful what
consisting of the amount realized from the sale of the statute allows. It is quite true that, if a
the Monitor shares. In a proceeding before the reorganization in reality was effected within the
meaning of subdivision (B), the ulterior purpose
Board of Tax Appeals, that body rejected the mentioned will be disregarded. The legal right of a
commissioner's view and upheld that of petitioner. taxpayer to decrease the amount of what otherwise
Upon a review of the latter decision, the Circuit Court would be his taxes, or altogether avoid them, by
of Appeals sustained the commissioner and means which the law permits, cannot be

1
 TAXATION 2 ATTY. PADILLA

doubted. But the question for determination is

whether what was done, apart from the tax motive,
C. F. CALANOC vs. CIR
was the thing which the statute intended. The
reasoning of the court below in justification of a LABRADOR, J : p

negative answer leaves little to be said.

G.R. No. L-15922, November 29, 1961, 113 PHIL 499-502
When subdivision (B) speaks of a transfer of assets
FACTS: By authority of a solicitation permit issued
by one corporation to another, it means a transfer
by the Social Welfare Commission, whereby the
made "in pursuance of a plan of reorganization" [§
petitioner was authorized to solicit and receive
112(g)] of corporate business, and not a transfer of
contributions for the orphans and destitute children
assets by one corporation to another in pursuance of
of the Child Welfare Workers Club of the
a plan having no relation to the business of either, as
Commission, the petitioner on December 3, 1949
plainly is the case here. Putting aside, then, the
financed and promoted a boxing and wrestling
question of motive in respect of taxation altogether,
exhibition at the Rizal Memorial Stadium for the said
and fixing the character of the proceeding by what
charitable purpose. Before the exhibition took place,
actually occurred, what do we find? Simply an
the petitioner applied with the respondent CIR
operation having no business or corporate purpose -
exemption from payment of the amusement tax,
- a mere device which put on the form of a corporate
relying on the provisions of Sec 260 of the NIRC to
reorganization as a disguise for concealing its real
which the respondent answered that the exemption
character, and the sole object and accomplishment
depended upon petitioner's compliance with the
of which was the consummation of a preconceived
requirements of law.
plan, not to reorganize a business or any part of a
business, but to transfer a parcel of corporate shares After said exhibition, the respondent, investigated
to the petitioner. No doubt, a new and valid the tax case of the petitioner, and from the statement
corporation was created. But that corporation was of receipts which was furnished the agent, the latter
nothing more than a contrivance to the end last found that the gross sales amounted to P26,553.00;
described. It was brought into existence for no other the expenditures incurred was P25,157.62; and the
purpose; it performed, as it was intended from the net profit was only P1,375.38. Upon examination of
beginning it should perform, no other function. the said receipts, the agent also found the following
items of expenditures: (a) P461.65 for police
When that limited function had been exercised, it protection; (b) P460.00 for gifts; (c) P1,880.05 for
immediately was put to death. parties; and (d) several items for representation.
Out of the proceeds of the exhibition, only P1,375.38
In these circumstances, the facts speak for was remitted to the Social Welfare Commission for
themselves, and are susceptible of but one the said charitable purpose for which the permit was
interpretation. The whole undertaking, though issued.
conducted according to the terms of subdivision (B),
was in fact an elaborate and devious form of Thereafter, the CIR demanded from the petitioner
conveyance masquerading as a corporate payment of the amount of P7,378.57 as the
reorganization, and nothing else. The rule which amusement tax for the exhibition. Authority for this
excludes from consideration the motive of tax demand for payment is an opinion of the Secretary
avoidance is not pertinent to the situation, because of Finance dated June 15, 1948, authorizing denial
the transaction, upon its face, lies outside the plain of application for exemption from payment of
intent of the statute. To hold otherwise would be to amusement tax in cases where the net proceeds are
exalt artifice above reality and to deprive the not substantial or where the expenses are
statutory provision in question of all serious purpose. exorbitant. Petitioner then brought this case to the
CTA for review, which the decision sought herein to be
Judgment affirmed. reviewed. Hence, this petition.

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 TAXATION 2 ATTY. PADILLA

ISSUE: W/N the assessment of P7,378.57 imposed G.R. Nos. L-12010 & L-12113. October 20, 1959
upon is valid?
BAUTISTA ANGELO, J
HELD: YES, it was valid. Application for exemption
FACTS: Petitioner is a domestic corporation
from payment of amusement tax will be denied
engaged in the importation of textiles, hardware,
where the net proceeds of the exhibition conducted
sundries, chemicals, pharmaceuticals, lumbers,
for charitable purposes are not substantial or where
groceries, wines and liquor; in insurance and lumber;
the expenses incurred by the taxpayer are
and in some exports. In the income tax returns for
exorbitant. Petitioner denies having received the
the years 1950, 1951 and 1952 it filed with
stadium fee of P1,000, which is not included in the
respondent, petitioner deducted from its gross
receipts, and claims that if he did, he can not be
income certain items representing salaries, directors'
made to pay almost seven times the amount as
fees and bonuses of its non-resident president and
amusement tax. But evidence was submitted that
vice-president; bonuses of some of its resident
while he did not receive said stadium fee of P1,000,
officers and employees; and interests on earned but
said amount was paid by the O-SO Beverages
unpaid salaries and bonuses of its officers and
directly to the stadium for advertisement privileges in
employees. The income tax computed in accordance
the evening of the entertainments. As the fee was
with these returns was duly paid by petitioner.
paid by said concessionaire, petitioner had no right
to include the P1,000 stadium fee among the items
of his expenses. It results, therefore, that P1,000 After disallowing the deductions of the items
went into petitioner's pocket which is not accounted representing directors' fees, salaries and bonuses of
for. petitioner's non-resident president and vice
Furthermore petitioner admitted that he could not president; the bonus participation of certain resident
justify the other expenses, such as those for police officers and employees; and the interests on earned
protection and gifts. He claims further that the but unpaid salaries and bonuses, respondent
accountant who prepared the statement of receipts assessed and demanded from petitioner the
is already dead and could no longer be questioned payment of deficiency income taxes in the sums of
on the items contained in said statement. P26,370.00, P53,865.00 and P44,112.00 for the
years 1950, 1951 and 1952, respectively.
We have examined the records of the case and we
Respondent modified the same by allowing as
agree with the lower court that most of the items of
deductible all items comprising directors' fees and
expenditures contained in the statement submitted
salaries of the non-resident president and vice
to the agent are either exorbitant or not supported by
president, but disallowing the bonuses insofar as
receipts. We agree with the tax court that the
they exceed the salaries of the recipients, as well as
payment of P461.65 for police protection is illegal as
the interests on earned but unpaid salaries and
it is a consideration given by the petitioner to the
bonuses. Hence, for the years 1950, 1951 and 1952,
police for the performance by the latter of the
respondent made a new assessment and demanded
functions required of them to be rendered by law.
from petitioner as deficiency income taxes the
The expenditures of P460.00 for gifts, P1,880.05 for
amounts of P10,147.00, P26,783.00 and
parties and other items for representation are rather
P20,481.00, respectively.
excessive, considering that the purpose of the
exhibition was for a charitable cause. ISSUE: W/N the bonuses in question were
reasonable and just to be allowed as a deduction?
WHEREFORE, the decision sought herein to be
reviewed is hereby affirmed, with costs against the HELD: NO. It is a general rule that "Bonuses to
petitioner. employees made in good faith and as additional
compensation for the services actually rendered by
the employees are deductible, provided such
KUENZLE & STREIFF vs. CIR payments, when added to the stipulated salaries, do

3
 TAXATION 2 ATTY. PADILLA

not exceed a reasonable compensation for the While it may be admitted that the resident officers
services rendered" and employees had performed their duty well and
rendered efficient service and for that reason were
The condition precedents to the deduction of
given greater compensation than the non-resident
bonuses to employees are: (1) the payment of the
officers, it does not necessarily follow that they
bonuses is in fact compensation; (2) it must be for
should be given greater amount of additional
personal services actually rendered; and (3) the
compensation in the form of bonuses than what was
bonuses, when added to the salaries, are
given to the non-resident officers. The reason for this
"reasonable . . . when measured by the amount and
is that, in the opinion of the management itself of the
quality of the services performed with relation to the
corporation, said non-resident officers had rendered
business of the particular taxpayer" Here it is
the same amount of efficient personal service and
admitted that the bonuses are in fact compensation
contribution to deserve equal treatment in
and were paid for services actually rendered. The
compensation and other emoluments with the
only question is whether the payment of said
particularity that their liberation yearly salaries had
bonuses is reasonable.
been much smaller.
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 trial court was justified in expressing the view
"the amount and quality of the services performed that "there is no special reason for granting greater
with relation to the business." Other tests suggested bonuses to such lower ranking officers than those
are: payment must be "made in good faith"; "the given to Messrs. Kuenzle and Streiff." The Court
character of the taxpayer's business, the volume and concurs in this observation.
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 contention of respondent that the trial court
"the employees' qualifications and contributions to erred also in allowing as deduction bonuses in
the business venture"; and 'general economic excess of the yearly salaries of their respective
conditions" (4 Mertens, Law of Federal Income recipients predicated upon his own decision that the
Taxation, Sec. 25.44, 25.49, 25.50, 25.51, pp. 407- deductible amount of said bonuses should be only
412). However, "in determining whether the equal to their respective yearly salaries cannot also
particular salary or compensation payment is be sustained. This claim cannot be justified
reasonable, the situation must be considered as a considering the factors we have already mentioned
whole. Ordinarily, no single factor is decisive. . . . it is that play in the determination of the reasonableness
important to keep in mind that it seldom happens of the bonuses or additional compensation that may
that the application of one test can give satisfactory be given to an officer or an employee which, if
answer, and that ordinarily it is the interplay of properly considered, warrant the payment of the
several factors, properly weighted for the particular bonuses in question to the extent allowed by the trial
case, which must furnish the final answer". court. This is specially so considering the post-war
policy of the corporation in giving salaries at low
levels because of the unsettled conditions resulting
Considering the different tests formulated above, from war and the imposition of government controls
was the trial court justified in holding that the on imports and exports and on the use of foreign
reasonableness of the amount of bonuses given to exchange which resulted in the diminution of the
resident officers and employees should follow the amount of business and the consequent loss of
same pattern for determining the reasonableness of profits on the part of the corporation. The payment of
the amount of bonuses given to non-resident bonuses in amounts a little more than the yearly
officers? salaries received considering the prevailing
circumstances is in our opinion reasonable.

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 TAXATION 2 ATTY. PADILLA

Wherefore, the decision appealed from is affirmed, P300.00; 20% interest per annum on the deficiency
without pronouncement as to costs. income tax of P1,481,579.15, for a period of three
(3) years from, or in the total amount of
P888,947.49, and a surcharge of 10% on the latter
PAPER INDUSTRIES amount, or P88,984.75).
CORPORATION OF THE The CIR, insists that the CA erred in finding Picop
PHILIPPINES (PICOP) vs CTA not liable for surcharge and interest on unpaid
transaction tax and for documentary and science
stamp taxes and in allowing Picop to claim as
G.R. Nos. 106949-50, 106984-85, December 1,
1995], 321 PHIL 1-63 deductible expenses:

FACTS: The Paper Industries Corporation of the (a) the net operating losses of another corporation
Philippines ("Picop") is a Philippine corporation (i.e., Rustan Pulp and Paper Mills, Inc.); and (b)
registered with the Board of Investments ("BOI") as interest payments on loans for the purchase of
a preferred pioneer enterprise with respect to its machinery and equipment.
integrated pulp and paper mill, and as a preferred ISSUE:
non-pioneer enterprise with respect to its integrated
plywood and veneer mills. Whether Picop is entitled to deductions against
income of:
Picop received from the Commissioner of Internal
Revenue ("CIR") two letters of assessment and (1) interest payments on loans for the purchase
demand both dated 31 March 1983: (a) one for of machinery and equipment;
deficiency transaction tax and for documentary and (2) net operating losses incurred by the Rustan
science stamp tax; and (b) the other for deficiency Pulp and Paper Mills, Inc.; and
income tax for 1977, for an aggregate amount of
(3) certain claimed financial guarantee
P88,763,255.00.
expenses
Picop protested the assessment of deficiency
transaction tax and documentary and science stamp HELD:
taxes, and the deficiency income tax assessment for
1977. The CIR issued a warrant of distraint on (1) Whether Picop is entitled to deduct against
personal property and a warrant of levy on real current income interest payments on loans for
property against Picop, to enforce collection of the the purchase of machinery and equipment? YES
contested assessments; in effect, the CIR denied
Picop's protests. In 1969, 1972 and 1977, Picop obtained loans from
foreign creditors in order to finance the purchase of
Picop went before the CTA appealing the machinery and equipment needed for its operations.
assessments. In its 1977 Income Tax Return, Picop claimed
interest payments made in 1977, amounting to
CTA: Rendered a decision modifying the findings of P42,840,131.00, on these loans as a deduction from
the CIR and holding Picop liable for the reduced its 1977 gross income.
aggregate amount of P20,133,762.33 (35%
Transaction Tax P16,020,113.20, Documentary & The CIR disallowed this deduction upon the ground
Science Stamp Tax P300,300.00, Deficiency Income that, because the loans had been incurred for the
Tax Due P3,813,349.33) purchase of machinery and equipment, the interest
payments on those loans should have been
CA: Rendered a decision which further reduced the capitalized instead and claimed as a depreciation
liability of Picop to P6,338,354.70 (35% transaction deduction taking into account the adjusted basis of
tax in the amount of P3,578,543.51; absolved from the machinery and equipment (original acquisition
the payment of documentary and science stamp tax cost plus interest charges) over the useful life of
such assets.
of P300,000.00 and the compromise penalty of

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 TAXATION 2 ATTY. PADILLA

Both the CTA and the Court of Appeals sustained (2) Whether Picop is entitled to deduct against
the position of Picop and held that the interest current income net operating losses incurred by
deduction claimed by Picop was proper and Rustan Pulp and Paper Mills, Inc? NO
allowable. In the instant Petition, the CIR insists on
its original position. On 18 January 1977, Picop entered into a merger
agreement with the Rustan Pulp and Paper Mills,
We begin by noting that interest payments on loans Inc. ("RPPM") and Rustan Manufacturing
incurred by a taxpayer (whether BOI-registered or Corporation ("RMC"). Under this agreement, the
not) are allowed by the NIRC as deductions against rights, properties, privileges, powers and franchises
the taxpayer's gross income. Section 30 of the 1977 of RPPM and RMC were to be transferred, assigned
Tax Code provided as follows: and conveyed to Picop as the surviving corporation.
The entire subscribed and outstanding capital stock
Sec. 30. Deduction from Gross Income. — The following may be of RPPM and RMC would be exchanged for
deducted from gross income: 2,891,476 fully paid up Class "A" common stock of
Picop (with a par value of P10.00) and 149,848
(b) Interest: shares of preferred stock of Picop (with a par value
of P10.00), to be issued by Picop, the result being
(1) In general. — The amount of interest paid within the taxable that Picop would wholly own both RPPM and RMC
year on indebtedness, except on indebtedness incurred or while the stockholders of RPPM and RMC would join
continued to purchase or carry obligations the interest upon which
is exempt from taxation as income under this Title: . . . the ranks of Picop's shareholders. In addition, Picop
paid off the obligations of RPPM to the Development
Bank of the Philippines ("DBP") in the amount of
Thus, the general rule is that interest expenses are
P68,240,340.00, by issuing 6,824,034 shares of
deductible against gross income and this certainly
preferred stock (with a par value of P10.00) to the
includes interest paid under loans incurred in
DBP. The merger agreement was approved in 1977
connection with the carrying on of the business of
by the creditors and stockholders of Picop, RPPM
the taxpayer. Tha CIR does not dispute that the
and RMC and by the Securities and Exchange
interest payments were made by Picop on
Commission. Thereupon, on 30 November 1977,
loans incurred in connection with the carrying on of
apparently the effective date of merger, RPPM and
the registered operations of Picop, i.e., the financing
RMC were dissolved. The Board of Investments
of the purchase of machinery and equipment
approved the merger agreement.
actually used in the registered operations of Picop.
Neither does the CIR deny that such interest
payments were legally due and demandable under It appears that RPPM and RMC were, like Picop,
the terms of such loans, and in fact paid by Picop BOI-registered companies. Immediately before
during the tax year 1977. merger effective date, RPPM had over preceding
years accumulated losses in the total amount of
P81,159,904.00. In its 1977 Income Tax Return,
We have already noted that our 1977 NIRC
Picop claimed P44,196,106.00 of RPPM's
does not prohibit the deduction of interest on a loan
accumulated losses as a deduction against Picop's
incurred for acquiring machinery and equipment.
1977 gross income. 24
Neither does our 1977 NIRC compel the
capitalization of interest payments on such a loan.
The 1977 Tax Code is simply silent on a taxpayer's Even before the effective date of merger, on 30
right to elect one or the other tax treatment of such August 1977, Picop sold all the outstanding shares
interest payments. Accordingly, the general rule that of RMC stock to San Miguel Corporation for the sum
interest payments on a legally demandable loan are of P38,900,000.00, and reported a gain of
deductible from gross income must be applied. P9,294,849.00 from this transaction. 25

We conclude that the CTA and the Court of CIR: Disallowed all the deductions claimed on the
Appeals did not err in allowing the deductions of basis of RPPM's losses, apparently on two (2)
Picop's 1977 interest payments on its loans for grounds. Firstly, the previous losses were incurred
capital equipment against its gross income for by "another taxpayer," RPPM, and not by Picop in
1977. connection with Picop's own registered operations.
The CIR took the view that Picop, RPPM and RMC
were merged into one (1) corporate personality only
on 12 January 1978, upon approval of the merger

6
 TAXATION 2 ATTY. PADILLA

agreement by the BOI. Thus, during the taxable year (d) Losses:
1977, Picop on the one hand and RPPM and RMC
on the other, still had their separate juridical (2) By Corporations. — In a case of a corporation, all
personalities. Secondly, the CIR alleged that these losses actually sustained and charged off within the taxable
year and not compensated for by insurance or otherwise.
losses had been incurred by RPPM "from the
borrowing of funds" and not from carrying out of
(3) By Non-resident Aliens or Foreign Corporations. — In the case
RPPM's registered operations. We focus on the first of a non-resident alien individual or a foreign corporation, the
ground. losses deductible are those actually sustained during the
year incurred in business or trade conducted within the
Philippines, . . .
CTA: Upheld the deduction claimed by Picop. The
CTA said:
Section 76 of the Philippine Income Tax Regulations
(Revenue Regulation No. 2, as amended) is even
We disagree with respondent. The purpose of the more explicit and detailed:
merger was to rationalize the container board
industry and not to take advantage of the net losses
Sec. 76. When charges are deductible. — Each year's return, so
incurred by RPPMI prior to the stock swap. Thus, far as practicable, both as to gross income and deductions
when stock of a corporation is purchased in order to therefrom should be complete in itself, and taxpayers are
take advantage of the corporation's net operating expected to make every reasonable effort to ascertain the facts
loss incurred in years prior to the purchase, the necessary to make a correct return. The expenses, liabilities, or
deficit of one year cannot be used to reduce the income of a
corporation thereafter entering into a trade or subsequent year. A taxpayer has the right to deduct all authorized
business different from that in which it was allowances and it follows that if he does not within any year
previously engaged, the net operating loss carry- deduct certain of his expenses, losses, interests, taxes, or other
over may be entirely lost. Furthermore, once the BOI charges,
he can not deduct them from the income of the next or any
approved the merger agreement, the registered succeeding year. . . .
capacity of Rustan shall be transferred to PICOP,
and the previous losses of Rustan may be carried
It is thus clear that under our law, and outside
over by PICOP by operation of law. It is clear
the special realm of BOI-registered enterprises,
therefrom, that the deduction availed of under
there is no such thing as a carry-over of net
Section 7(c) of R.A. No. 5186 was only proper
operating loss. To the contrary, losses must be
deducted against current income in the taxable
CA: Affirmed the CTA. The Court of Appeals, year when such losses were incurred. Moreover,
concluded that since RPPM was dissolved on 30 such losses may be charged off only against
November 1977, its accumulated losses were income earned in the same taxable year when
appropriately carried over by Picop in the latter's the losses were incurred.
1977 Income Tax Return "because by that time
RPPMI and Picop were no longer separate and
Thus it is that R.A. No. 5186 introduced the carry-
different taxpayers."
over of net operating losses as a very special
incentive to be granted only to registered pioneer
SC: Unable to agree with the CTA and Court of enterprises and only with respect to their registered
Appeals on the deductibility of RPPM's accumulated operations. The statutory purpose here may be seen
losses against Picop's 1977 gross income. to be the encouragement of the establishment and
continued operation of pioneer industries by allowing
It is important to note at the outset that in our the registered enterprise to accumulate its operating
jurisdiction, the ordinary rule — that is, the rule losses which may be expected during the early
applicable in respect of corporations not registered years of the enterprise and to permit the enterprise
with the BOI as a preferred pioneer enterprise — is to offset such losses against income earned by it in
that net operating losses cannot be carried over. later years after successful establishment and
Under our Tax Code, both in 1977 and at present, regular operations. To promote its economic
losses may be deducted from gross income only if development goals, the Republic foregoes or defers
such losses were actually sustained in the same taxing the income of the pioneer enterprise until after
year that they are deducted or charged off. Section that enterprise has recovered or offset its earlier
30 of the 1977 Tax Code provides: losses. We consider that the statutory purpose can
be served only if the accumulated operating losses
Sec. 30. Deductions from Gross Income. — In computing net are carried over and charged off against income
income, there shall be allowed as deduction — subsequently earned and accumulated by the same

7
 TAXATION 2 ATTY. PADILLA

enterprise engaged in the same registered (3) Whether Picop is entitled to deduct against
operations. current income certain claimed financial
guarantee expenses? NO
In the instant case, to allow the deduction claimed by
Picop would be to permit one corporation or In its Income Tax Return for 1977, Picop also
enterprise, Picop, to benefit from the operating claimed a deduction in the amount of P1,237,421.00
losses accumulated by another corporation or as financial guarantee expenses.
enterprise, RPPM. RPPM far from benefiting from
the tax incentive granted by the BOI statute, in fact This deduction is said to relate to chattel and real
gave up the struggle and went out of existence and estate mortgages required from Picop by the
its former stockholders joined the much larger group Philippine National Bank ("PNB") and DBP as
of Picop's stockholders. To grant Picop's claimed guarantors of loans incurred by Picop from foreign
deduction would be to permit Picop to shelter its creditors. According to Picop, the claimed deduction
otherwise taxable income (an objective which Picop represents registration fees and other expenses
had from the very beginning) which had not been incidental to registration of mortgages in favor of
earned by the registered enterprise which had DBP and PNB.
suffered the accumulated losses. In effect, to grant
Picop's claimed deduction would be to permit Picop
In support of this claimed deduction, Picop allegedly
to purchase a tax deduction and RPPM to peddle its showed its own vouchers to BIR Examiners to prove
accumulated operating losses. Under the CTA and disbursements to the Register of Deeds of Tandag,
Court of Appeals decisions, Picop would benefit by
Surigao del Sur, of particular amounts. In the
immunizing P44,196,106.00 of its income from
proceedings before the CTA, however, Picop did not
taxation thereof although Picop had not run the risks
submit in evidence such vouchers and instead
and incurred the losses which had been
presented one of its employees to testify that the
encountered and suffered by RPPM. Conversely, the amount claimed had been disbursed for the
income that would be shielded from taxation is not
registration of chattel and real estate mortgages.
income that was, after much effort, eventually
generated by the same registered operations which
earlier had sustained losses. We consider and so The CIR disallowed this claimed deduction upon the
hold that there is nothing in Section 7 (c) of R.A. No. ground of insufficiency of evidence. This
5186 which either requires or permits such a result. disallowance was sustained by the CTA and the
Indeed, that result makes non-sense of the Court of Appeals. The CTA said:
legislative purpose which may be seen clearly to be
projected by Section 7 (c), R.A. No. 5186. No records are available to support the abovementioned
expenses. The vouchers merely showed that the amounts were
paid to the Register of Deeds and simply cash account. Without
Both the CTA and the Court of Appeals appeared the supporting papers such as the invoices or official receipts of
much impressed not only with corporate the Register of Deeds, these vouchers standing alone cannot
prove that the payments made were for the accrued expenses in
technicalities but also with the U.S. tax law on this question. The best evidence of payment is the official receipts
matter. It should suffice, however, simply to note that issued by the Register of Deeds. The testimony of petitioner's
in U.S. tax law, the availability to companies witness that the official receipts and cash vouchers were shown to
generally of operating loss carry-overs and of the Bureau of Internal Revenue will not suffice if no records could
be presented in court for proper marking and identification.
operating loss carry-backs is expressly provided and
regulated in great detail by statute. In our
jurisdiction, save for Section 7 (c) of R.A. No. 5186, We must support the CTA and the Court of Appeals
no statute recognizes or permits loss carry-overs in their foregoing rulings. A taxpayer has the burden
and loss carry-backs. Indeed, as already noted, our of proving entitlement to a claimed deduction. 36 In
tax law expressly rejects the very notion of loss the instant case, even Picop's own vouchers were
carry-overs and carry-backs. not submitted in evidence and the BIR Examiners
denied that such vouchers and other documents had
been exhibited to them. Moreover, cash vouchers
We conclude that the deduction claimed by
can only confirm the fact of disbursement but not
Picop in the amount of P44,196,106.00 in its 1977
necessarily the purpose thereof. 37 The best
Income Tax Return must be disallowed.
evidence that Picop should have presented to
support its claimed deduction were the invoices and
official receipts issued by the Register of Deeds.
Picop not only failed to present such documents; it

8
 TAXATION 2 ATTY. PADILLA

also failed to explain the loss thereof, assuming they P55,978.65, including interest up to March 31, 1957,
had existed before. 38 Under the best evidence surcharge and compromise for the late payment.
rule, 39 therefore, the testimony of Picop's employee
was inadmissible and was in any case entitled to
very little, if any, credence.
Under the law, for interest to be deductible, it must
be shown that there be an indebtedness, that there
We consider that entitlement to Picop's claimed
deduction of P1,237,421.00 was not adequately should be interest upon it, and that what is claimed
shown and that such deduction must be as an interest deduction should have been paid or
disallowed. accrued within the year. It is here conceded that the
interest paid by respondent was in consequence of
the late payment of her donor's tax, and the same
CIR vs. CONSUELO L. VDA. was paid within the year it is sought to be deducted.
DE PRIETO The only question to be determined, as stated by the
parties, is whether or not such interest was paid
G.R. No. L-13912, [September 30, 1960], 109 PHIL upon an indebtedness within the contemplation of
592-598 section 30(b) (1) of the Tax Code, the pertinent part
of which reads:
GUTIERREZ DAVID, J
"Sec. 30 Deductions from gross income. — In computing net
income there shall be allowed as deductions —

FACTS: This is an appeal from a decision of the "(b) Interest:

Court of Tax Appeals reversing the decision of the "(1) In general. — The amount of interest paid within the taxable
Commissioner of Internal Revenue which held year on indebtedness, except on indebtedness incurred or
continued to purchase or carry obligations the interest upon which
herein respondent Consuelo L. Vda. de Prieto liable is exempt from taxation as income under this Title."
for the payment of the sum of P21,410.38 as
deficiency income tax, plus penalties and monthly
interest. The term "indebtedness" as used in the Tax Code of
the United States containing similar provisions as in
the above-quoted section has been defined as an
On December 4, 1945, the respondent conveyed by unconditional and legally enforceable obligation for
way of gifts to her four children, namely, Antonio, the payment of money.
Benito, Carmen and Mauro, all surnamed Prieto, real
property with a total assessed value of P892,497.50. Within the meaning of that definition, it is apparent
After the filing of the gift tax returns on or about that a tax may be considered an indebtedness. As
February 1, 1954, the petitioner CIR appraised the stated by this Court in the case of Santiago
real property donated for gift tax purposes at Sambrano vs. Court of Tax Appeals and Collector of
P1,231,268.00 and assessed the total sum of Internal Revenue (101 Phil., 1; 53 Off. Gaz., 4839)
P117,706.50 as donor's gift tax, interests and "Although taxes already due have not, strictly
compromises due thereon. Of the total sum of speaking, the same concept as debts, they are,
P117,706.50 paid by respondent on April 29, 1954, however, obligations that may be considered as
the sum of P55,978.65 represents the total interest such.
on account of delinquency. This sum of P55,978.65
was claimed as deduction, among others, by
respondent in her 1954 income tax return. Petitioner, "'The term "debt" is properly used in a
however, disallowed the claim and as a comprehensive sense as embracing not merely
consequence of such disallowance assessed money due by contract but whatever one is bound to
respondent for 1954 the total sum of P21,410.38 as render to another, either for contract, or the
deficiency income tax due on the aforesaid requirement of the law. (Camben vs. Fink Coule &
Coke Co. 61 LRA 584).

9
 TAXATION 2 ATTY. PADILLA

"Where statute imposes a personal liability for a tax, same Code providing for deduction of interest on
the tax becomes, at least in a board sense, a debt. indebtedness. We find the lower court's ruling to be
correct. Contrary to petitioner's belief, the portion of
"'A tax is a debt for which a creditor's bill may be
section 80 of Revenue Regulation No. 2 under
brought in a proper case.'
consideration has been part and parcel of the
development to the law on deduction of taxes in the
It follows that the interest paid by herein respondent United States. (See Capital Bldg. & Loan Assn. vs.
for the late payment of her donor's tax is deductible Comm., 23 BTA 848. Thus, Mertens in his treatise
from her gross income under section 30 (b) of the says: "Penalties are to be distinguished from taxes
Tax Code above quoted. and they are not deductible under the heading of
taxes." . . . Interest on state taxes is not deductible
ISSUE: W/N the interest paid by herein respondent as taxes." (Vol. 5, Law on Federal income Taxation,
for the late payment of her donor's tax is deductible pp. 22-23, sec. 27.06, citing cases.) This
from her gross income? notwithstanding, courts in that jurisdiction, however,
HELD: YES. Although interest payment for have invariably held that interest on deficiency taxes
delinquent taxes is not deductible as tax under are deductible, not as taxes, but as interest. (U.S.
Section 30(c) of the Tax Code and section 80 of the vs. Jaffray, et al., supra; see also Mertens, sec.
Income Tax Regulations, the taxpayer is not 26.09, Vol. 4, p. 552, and cases cited therein.)
precluded thereby from claiming said interest Section 80 of Revenue Regulation No. 2, therefore,
payment as deduction under section 30(b) of the merely incorporated the established application of
same Code. the tax deduction statute in the United States, where
deduction of "taxes" has always been limited to
taxes proper and has never included interest on
The above conclusion finds support in the delinquent taxes, penalties and surcharges.
established jurisprudence in the United States after
whose laws our Income Tax Law has been
patterned. Thus, under sec. 23(b) of the Internal To give to the quoted portion of section 80 of our
Revenue Code of 1939, as amended 1, which Income Tax Regulations the meaning that the
contains similarly worded provisions as sec. 30(b) of petitioner gives it would run counter to the provision
our Tax Code, the uniform ruling is that interest on of section 30(b) of the Tax Code and the
taxes is interest on indebtedness and is construction given to it by courts in the United
deductible. The rule applies even though the tax is States. Such effect would thus make the regulation
nondeductible. invalid for a "regulation which operates to create a
rule out of harmony with the statute, is a mere
nullity." (Lynch vs. Tilden Produce Co., 265 U.S.
To sustain the proposition that the interest payment 315; Miller vs. U.S., 294 U.S. 435.) As already
in question is not deductible for the purpose of stated, section 80 implements only section 30(c) of
computing respondent's net income, petitioner relies the Tax Code, or the provision allowing deduction of
heavily on section 80 of Revenue Regulation No. 2 taxes, while herein respondent seeks to be allowed
(known as Income Tax Regulation) promulgated by deduction under section 30(b), which provides for
the Department of Finance, which provides that "the deduction of interest on indebtedness.
word 'taxes' means taxes proper and no deductions
should be allowed for amounts representing interest,
surcharge, or penalties incident to delinquency." The In conclusion, we are of the opinion and so hold that
court below, however, held section 80 as although interest payment for delinquent taxes is not
inapplicable to the instant case because while it deductible as tax under Section 30(c) of the Tax
implements sections 30(c) of the Tax Code Code and section 80 of the Income Tax Regulations,
governing deduction of taxes, the respondent the taxpayer is not precluded thereby from claiming
taxpayer seeks to come under section 30(b) of the

10
 TAXATION 2 ATTY. PADILLA

said interest payment as deduction under section income of P1,012,554.51, and, on the basis of this
30(b) of the same Code. amended return, they paid P570,252.00, inclusive of
withholding taxes. After audit, the petitioner
determined a deficiency of P16,116.00, which
amount the respondents paid on 5 December 1956.
CIR vs. V. E. LEDNICKY and
MARIA VALERO LEDNICKY Back in 1955, however, the Lednickys filed with the
U.S. Internal Revenue Agent in Manila their Federal
G.R. Nos. L-18169, L-18286, & L-21434, [July 31, income tax return for the years 1947, 1951, 1952,
1964], 120 PHIL 586-594 1953 and 1954 on income from Philippine sources
REYES, J.B.L., J p: on a cash basis. Payment of these federal income
taxes, including penalties and delinquency interest in
the amount of $264,588.82, were made in 1955 to
FACTS: Respondents, V. E. Lednicky and Maria the U. S. Director of Internal Revenue, Baltimore,
Valero Lednicky, are husband and wife, respectively, Maryland, through the National City Bank of New
both American citizens residing in the Philippines, York, Manila Branch. Exchange and bank charges in
and have derived all their income from Philippine remitting payment totaled P4,143.91.
sources for the taxable years under question.

On 11 August 1958 the said respondents amended

In compliance with local law, respondents filed their their Philippines income tax return for 1955 to a total
income tax return for 1956, the amount of of P516,345.15 and therewith filed a claim for refund
P317,395.41 was assessed after deducting of the sum of P150,269.00.
P4,805.59 as withholding tax. Pursuant to the
petitioner's assessment notice, the respondents paid
the total amount of P326,247.41, inclusive of the Lednickys income tax returns for 1957, filed on
withheld taxes, on 15 April 1957. February 28, 1958, and for which respondents paid
a total sum of P196,799.65. In 1959, they filed an
The respondents Lednickys then filed an amended amended return for 1957, claiming deduction of
income tax return for 1956. The amendment consists P190,755.80, representing taxes paid to the U.S.
in a claimed deduction of P205,939.24 paid in 1956 Government on income derived wholly from
to the United States government as federal income Philippine sources. On the strength thereof,
tax for 1956. Simultaneously with the filing of the respondents seek refund of P90,520.75 as
amended return, the respondents requested the overpayment. The Tax Court again decided for
refund of P112,437.90. respondents.

They are also claiming for refund in the amount of ISSUE: W/N a citizen of the United States residing in
P150,269.00, as alleged overpaid income tax for the Philippines, who derives income wholly from
1955, the facts of which are as follows: sources within the Republic of the Philippines, may
deduct from his gross income the income taxes he
has paid to the United States government?
On 28 February 1956, the same respondents-
spouses filed their domestic income tax return for HELD: NO, an alien resident who derives income
1955, reporting a gross income of P1,771,124.63 wholly from sources within the Philippines may not
and a net income of P1,052,550.67. On 19 April deduct from gross income the income taxes he paid
1956, they filed an amended income tax return, the to his home country for the taxable year.
amendment upon the original being a lesser net

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 TAXATION 2 ATTY. PADILLA

An alien resident's right to deduct from gross income Philippine sources), or the option to deduct from
the income taxes he paid to a foreign government is gross income disappears altogether.
given only as an alternative to his right to claim a tax
Double taxation becomes obnoxious only where the
credit for such foreign income taxes; so that unless
taxpayer is taxed twice for the benefit of the same
he has a right to claim such tax credit if he chooses,
governmental entity. In the present case, although
he is precluded from said deduction.
the taxpayer would have to pay two taxes on the
"SEC. 30. Deduction from gross income. — In computing net same income but the Philippine government only
income there shall be allowed as deductions —
receives the proceeds of one tax, there is no
(c) Taxes: obnoxious double taxation. As between the
"(1) In general. — Taxes paid or accrued within the taxable year, Philippines, where the income was earned and
except —…"(B) Income, war-profits, and excess profits taxes where the taxpayer is domiciled, and the United
imposed by the authority of any foreign country; but this deduction States, where that income was not earned and
shall be allowed in the case of a taxpayer who does not signify in
his return his desire to have to any extent the benefits of
where the taxpayer did not reside, it is indisputable
paragraph (3) of this subsection (relating to credit for taxes of that justice and equity demand that the tax on the
foreign countries); income should accrue to the benefit of the
The construction and wording of Section 30 (c) (1) Philippines. Any relief from the alleged double
(B) of the Internal Revenue Act shows the law's taxation should come from the United States, and
intent that the right to deduct income taxes paid to not from the Philippines, since the former's right to
foreign government from the taxpayer's gross burden the taxpayer is solely predicated on his
income is given only as an alternative or substitute citizenship, without contributing to the production of
to his right to claim a tax credit for such foreign the wealth that is being taxed.
income taxes under section 30 (c) (3) and (4); so
that unless the alien resident has a right to claim
Aside from not conforming to the fundamental
such tax credit if he so chooses, he is precluded
doctrine of income taxation that the right of a
from deducting the foreign income taxes from his
government to tax income emanates from its
gross income.
partnership in the production of income, by providing
Had the law intended that foreign income taxes the protection, resources, incentives, and proper
could be deducted from gross income in any event, climate for such production, the interpretation given
regardless of the taxpayer's right to claim a tax by the respondents to the revenue law provision in
credit, it is the latter right that should be conditioned question operates, in its application, to place a
upon the taxpayer's waiving the deduction; in which resident alien with only domestic sources of income
case the right to reduction under subsection would in an equal, if not in a better, position than one who
have been made absolute or unconditional (by has both domestic and foreign sources of income, a
omitting foreign taxes from the enumeration of non- situation which is manifestly unfair and short of logic.
deductions), while the right to a tax credit under
IN VIEW OF THE FOREGOING, the decisions of the
subsection would have been expressly conditioned
Court of Tax Appeals are reversed, and the
upon the taxpayer's not claiming any deduction
disallowance of the refunds claimed by the
under subsection.
respondents Lednicky is affirmed, with costs against
Petitioners admit in their brief that the purpose of the said respondents-appellees.
law is to prevent the taxpayer from claiming twice
the benefits of his payment of foreign taxes, by
deduction from gross income and by tax credit. This
danger of double credit certainly can not exist if the PHILIPPINE REFINING
taxpayer can not claim benefit under either of these
headings at his option, so that he must be entitled to
COMPany vs. CA, CTA, and
a tax credit (respondent taxpayers admittedly are not CIR
so entitled because all their income is derived from

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 TAXATION 2 ATTY. PADILLA

G.R. No. 118794, [May 8, 1996], 326 PHIL 680-692 is seen by this Court as nothing more than a self-
serving exercise which lacks probative value. There
REGALADO, J.
was no iota of documentary evidence (e.g.,
collection letters sent, report from investigating
FACTS: This is an appeal by certiorari from the fieldmen, letter of referral to their legal department,
decision of respondent Court of Appeals affirming police report/affidavit that the owners were bankrupt
the decision of the Court of Tax Appeals which due to fire that engulfed their stores or that the
disallowed petitioner's claim for deduction as bad owner has been murdered etc.), to give support to
debts of several accounts in the total sum of the testimony of an employee of the Petitioner. Mere
P395,324,27, and imposing a 25% surcharge and allegations cannot prove the worthlessness of such
20% annual delinquency interest on the alleged debts in 1985. Hence, the claim for deduction of
deficiency income tax liability of petitioner. these thirteen (13) debts should be rejected.

Petitioner Philippine Refining Company (PRC) was ISSUE: W/N the disallowance of bad debts by CTA
assessed by respondent Commissioner of Internal and CA is valid?
Revenue (Commissioner) to pay a deficiency tax for HELD: YES.
the year 1985 in the amount of P1,892,584.00.
Rule in determining the "worthlessness of a debt" as
The assessment was timely protested by petitioner held in Collector vs. Goodrich International Rubber
on April 26, 1989, on the ground that it was based Co: For debts to be considered as "worthless," and
on the erroneous disallowances of "bad debts" and thereby qualify as "bad debts" making them
"interest expense" although the same are both deductible, the taxpayer should show that
allowable and legal deductions. Respondent
(1) there is a valid and subsisting debt;
Commissioner, however, issued a warrant of
garnishment against the deposits of petitioner at a (2) the debt must be actually ascertained to be
branch of City Trust Bank, in Makati, Metro Manila, worthless and uncollectible during the taxable year;
which action the latter considered as a denial of its (3) the debt must be charged off during the taxable
protest. year; and
Petitioner accordingly filed a petition for review with (4) the debt must arise from the business or trade of
the Court of Tax Appeals (CTA) on the same the taxpayer. Additionally, before a debt can be
assignment of error, that is, that the "bad debts" and considered worthless, the taxpayer must also show
"interest expense" are legal and allowable that it is indeed uncollectible even in the future.
deductions.
Furthermore, there are steps outlined to be
CTA: set aside the Commissioner's disallowance of undertaken by the taxpayer to prove that he exerted
the interest expense of P2,666,545.19 but diligent efforts to collect the debts, viz: (1) sending of
maintained the disallowance of the bad debts of statement of accounts; (2) sending of collection
thirteen (13) debtors in the total sum of P395,324.27. letters; (3) giving the account to a lawyer for
collection; and (4) filing a collection case in court.

CA: affirmed CTA decision. Out of the sixteen (16)

accounts alleged as bad debts, We find that only On the foregoing considerations, respondent Court
three (3) accounts have met the requirements of the of Appeals held that petitioner did not satisfy the
worthlessness of the accounts, hence were properly requirements of "worthlessness of a debt" as to the
written off as bad debts thirteen (13) accounts disallowed as deductions.
We find that said accounts have not satisfied the
requirements of the 'worthlessness of a debt'. Mere
It appears that the only evidentiary support given by
testimony of the Financial Accountant of the
PRC for its aforesaid claimed deductions was the
Petitioner explaining the worthlessness of said debts
explanation or justification posited by its financial

13
 TAXATION 2 ATTY. PADILLA

adviser or accountant, Guia D. Masagana. Her them only in their country of incorporation; and since
allegations were not supported by any documentary this will entail expenses more than the amounts of
evidence, hence, both the Court of Appeals and the the debts to be collected, petitioner did not file any
CTA ruled that said contentions per se cannot prove collection suit but opted to write them off as bad
that the debts were indeed uncollectible and can be debts. Petitioner was unable to show proof of its
considered as bad debts as to make them efforts to collect the debts, even by a single demand
deductible. That both lower courts are correct is letter therefor. While it is not required to file suit, it is
shown by petitioner's own submission and the at least expected by the law to produce reasonable
discussion thereof which we have taken time and proof that the debts are uncollectible although
patience to cull from the antecedent proceedings in diligent efforts were exerted to collect the same.
this case, albeit bordering on factual settings.
The contentions of PRC that nobody is in a better
position to determine when an obligation becomes a
bad debt than the creditor itself, and that its
The accounts of Remoblas Store in the amount of
judgment should not be substituted by that of
P11,961.00 and CM Variety Store in the amount of
respondent court as it is PRC which has the facilities
P10,895.82 are uncollectible, according to petitioner,
in ascertaining the collectibility or uncollectibility of
since the stores were burned in November, 1984
these debts, are presumptuous and uncalled for.
and in early 1985, respectively, and there are no
The Court of Tax Appeals is a highly specialized
assets belonging to the debtors that can be
body specifically created for the purpose of
garnished by PRC. However, PRC failed to show
reviewing tax cases. Through its expertise, it is
any documentary evidence for said allegations. Not
undeniably competent to determine the issue of
a single document was offered to show that the
whether or not the debt is deductible through the
stores were burned, even just a police report or an
evidence presented before it. (they mentioned other
affidavit attesting to such loss by fire. In fact,
transactions where they failed to prove that it was a
petitioner did not send even a single demand letter
bad debt, almost all the same namaaan hehe)
to the owners of said stores.
The account of Tomas Store in the amount of
P16,842.79 is uncollectible, claims petitioner PRC, Because of this recognized expertise, the findings of
since the owner thereof was murdered and left no the CTA will not ordinarily be reviewed absent a
visible assets which could satisfy the debt. Withal, showing of gross error or abuse on its part. The
just like the accounts of the two other stores just findings of fact of the CTA are binding on this Court
mentioned, petitioner again failed to present proof of and in the absence of strong reasons for this Court
the efforts exerted to collect the debt, other than the to delve into facts, only questions of law are open for
aforestated asseverations of its financial adviser. determination. Were it not, therefore, due to the
desire of this Court to satisfy petitioner's calls for
The amount of P13,772.00 corresponding to the
clarification and to use this case as a vehicle for
debt of Lucito Sta. Maria is allegedly due to the loss
exemplification, this appeal could very well have
of his stocks through robbery and the account is
been summarily dismissed.
uncollectible due to his insolvency. Petitioner
likewise failed to submit documentary evidence, not
even the written reports of the alleged investigation
The Court vehemently rejects the absurd thesis of
conducted by its agents as testified to by its
petitioner that despite the supervening delay in the
aforenamed financial adviser.
tax payment, nothing is lost on the part of the
Regarding the accounts of C. Itoh in the amount of Government because in the event that these debts
P19,272.22, Crocklaan B.V. in the sum of are collected, the same will be returned as taxes to it
P77,690.00, and Craig, Mostyn Pty. Ltd. with a in the year of the recovery. This is an irresponsible
balance of P23,738.00, petitioner contends that statement which deliberately ignores the fact that
these debtors being foreign corporations, it can sue while the Government may eventually recover

14
 TAXATION 2 ATTY. PADILLA

revenues under that hypothesis, the delay caused by

the non-payment of taxes under such a contingency
will obviously have a disastrous effect on the
revenue collections necessary for governmental
operations during the period concerned.

ACCORDINGLY, the petition at bar is DENIED and

the judgment of respondent Court of Appeals is
hereby AFFIRMED, with treble costs against
petitioner.

15