TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
become fixed, where there is created an enforceable liability. Similarly,
EXPENSES
G.R. No. 172231. February 12, 2007.*
COMMISSIONER OF INTERNAL REVENUE,
petitioner, vs. ISABELA CULTURAL CORPORATION, respondent.
Taxation; Tax Deductions; The requisites for the deductibility of
ordinary and necessary trade, business, or professional expenses, like
expenses paid for legal and auditing services, are: a) the expense must be
ordinary and necessary; b) it must have been paid or incurred during the
taxable year; c) it must have been paid or incurred in carrying on the trade
or business of the taxpayer; and d) it must be supported by receipts, records
or other pertinent papers.—The requisites for the deductibility of ordinary
and necessary trade, business, or professional expenses, like expenses paid
for legal and auditing services, are: (a) the expense must be ordinary and
necessary; (b) it must have been paid or incurred during the taxable year; (c)
it must have been paid or incurred in carrying on the trade or business of the
taxpayer; and (d) it must be supported by receipts, records or other pertinent
papers. The requisite that it must have been paid or incurred during the
taxable year is further qualified by Section 45 of the National Internal
Revenue Code (NIRC) which states that: “[t]he deduction provided for in this
Title shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or
incurred,’ dependent upon the method of accounting upon the basis of which
the net income is computed x x x.”
Same; Same; A taxpayer who is authorized to deduct certain expenses
and other allowable deductions for the current year but failed to do so
cannot deduct the same for the next year.—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. Thus, a taxpayer who is authorized to deduct certain
expenses and other allowable deductions for the current year but failed to do
so cannot deduct the same for the next year. The accrual method relies upon
the taxpayer’s right to receive amounts or its obligation to pay them, in
opposition to actual receipt or payment, which characterizes the cash method
of accounting. Amounts of income accrue where the right to receive them
1
liabilities are accrued when fixed and determinable in amount, without regard
to indeterminacy merely of time of payment.
Same; Same; The propriety of an accrual must be judged by the fact
that a taxpayer knew, or could reasonably be expected to have known, at the
closing of its books for the taxable year.—The all-events test requires the
right to income or liability be fixed, and the amount of such income or
liability be determined with reasonable accuracy. However, the test does not
demand that the amount of income or liability be known absolutely, only that
a taxpayer has at his disposal the information necessary to compute the
amount with reasonable accuracy. The all-events test is satisfied where
computation remains uncertain, if its basis is unchangeable; the test is
satisfied where a computation may be unknown, but is not as much as
unknowable, within the taxable year. The amount of liability does not have to
be determined exactly; it must be determined with “reasonable accuracy.”
Accordingly, the term “reasonable accuracy” implies something less than an
exact or completely accurate amount. The propriety of an accrual must be
judged by the fact 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.
Same; Same; An exemption from the common burden cannot be
permitted to exist upon vague implications. And since a deduction for income
tax purposes partakes of the nature of tax exemption, then it must also be
strictly construed.—Corollarily, it is a governing principle in taxation that
tax exemptions must be construed in strictissimi juris against the taxpayer
and liberally in favor of the taxing authority; and one who claims an
exemption must be able to justify the same by the clearest grant of organic or
statute law. An exemption from the common burden cannot be permitted to
exist upon vague implications. And since a deduction for income tax
purposes partakes of the nature of a tax exemption, then it must also be
strictly construed.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Same; Same; It simply relied on the defense of delayed billing by the
firm and the company, which under the circumstances, is not sufficient to
exempt it from being charged with knowledge of the reasonable amount of
the expenses for legal and auditing services.—As previously stated, the
accrual method presents largely a question of fact and that the taxpayer bears
the burden of establishing the accrual of an expense or income. However,
ICC failed to discharge this burden. As to when the firm’s performance of its
services in connection with the 1984 tax problems were completed, or
whether ICC exercised reasonable diligence to inquire about the amount of
its liability, or whether it does or does not possess the information necessary
to compute the amount of said liability with reasonable accuracy, are
questions of fact which ICC never established. It simply relied on the defense
of delayed billing by the firm and the company, which under the
circumstances, is not sufficient to exempt it from being charged with
knowledge of the reasonable amount of the expenses for legal and auditing
services.
Same; Same; Isabela Cultural Corporation (ICC) thus failed to
discharge the burden of proving that the claimed expense deductions for the
professional services were allowable deductions for the taxable year 1986.
Hence, per Revenue Audit Memorandum Order No. 12000, they cannot be
validly deducted from its gross income for the said year and were therefore
properly disallowed by the BIR.—ICC thus failed to discharge the burden of
proving that the claimed expense deductions for the professional services
were allowable deductions for the taxable year 1986. Hence, per Revenue
Audit Memorandum Order No. 1-2000, they cannot be validly deducted from
its gross income for the said year and were therefore properly disallowed by
the BIR.
PETITION for review on certiorari of a decision of the Court of Appeals.
The facts are stated in the opinion of the Court.
The Solicitor General for petitioner.
Narciso, Jimenez, Gonzales, Liwanag, Bello, Valdez, Caluya and
Fernandez for respondent.
2
Petitioner Commissioner of Internal Revenue (CIR) assails the September
30, 2005 Decision1 of the Court of Appeals in CA-G.R. SP No. 78426
affirming the February 26, 2003 Decision2 of the Court of Tax Appeals
(CTA) in CTA Case No. 5211, which cancelled and set aside the Assessment
Notices for deficiency income tax and expanded withholding tax issued by
the Bureau of Internal Revenue (BIR) against respondent Isabela Cultural
Corporation (ICC).
The facts show that on February 23, 1990, ICC, a domestic corporation,
received from the BIR Assessment Notice No. FAS-1-86-90-000680 for
deficiency income tax in the amount of P333,196.86, and Assessment Notice
No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the
amount of P4,897.79, inclusive of surcharges and interest, both for the
taxable year 1986.
The deficiency income tax of P333,196.86, arose from:
(1) The BIR’s disallowance of ICC’s claimed expense deductions for
professional and security services billed to and paid by ICC in 1986,
to wit:
(a) Expenses for the auditing services of SGV & Co.,3 for the
year ending December 31, 1985;4
(b) Expenses for the legal services [inclusive of retainer fees]
of the law firm Bengzon Zarraga Narciso Cudala Pecson
Azcuna & Bengson for the years 1984 and 1985.5
(c) Expense for security services of El Tigre Security &
Investigation Agency for the months of April and May
1986.6
(2) The alleged understatement of ICC’s interest income on the three
promissory notes due from Realty Investment, Inc.
The deficiency expanded withholding tax of P4,897.79 (inclusive of interest
and surcharge) was allegedly due to the failure of ICC to withhold 1%
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
expanded withholding tax on its claimed P244,890.00 deduction for security
services.7
On March 23, 1990, ICC sought a reconsideration of the subject assessments.
On February 9, 1995, however, it received a final notice before seizure
demanding payment of the amounts stated in the said notices. Hence, it
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. This was reversed by the Court of
Appeals holding that a demand letter of the BIR reiterating the payment of
deficiency tax, amounts to a final decision on the protested assessment and
may therefore be questioned before the CTA. This conclusion was sustained
by this Court on July 1, 2001, in G.R. No. 135210.8 The case was thus
remanded to the CTA for further proceedings.
On February 26, 2003, the CTA rendered a decision canceling and setting
aside the assessment notices issued against ICC. It held that the claimed
deductions for professional and security services were properly claimed by
ICC in 1986 because it was only in the said year when the bills demanding
payment were sent to ICC. Hence, even if some of these professional
services were rendered to ICC in 1984 or 1985, it could not declare the same
as deduction for the said years as the amount thereof could not be determined
at that time.
The CTA also held that ICC did not understate its interest income on the
subject promissory notes. It found that it was the BIR which made an
overstatement of said income when it compounded the interest income
receivable by ICC from the promissory notes of Realty Investment, Inc.,
despite the absence of a stipulation in the contract providing for a
compounded interest; nor of a circumstance, like delay in payment or breach
of contract, that would justify the application of compounded interest.
Likewise, the CTA found that ICC in fact withheld 1% expanded
withholding tax on its claimed deduction for security services as shown by
the various payment orders and confirmation receipts it presented as
evidence. The dispositive portion of the CTA’s Decision, reads:
WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-
86-90-000680 for deficiency income tax in the amount of P333,196.86, and
3
Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded
withholding tax in the amount of P4,897.79, inclusive of surcharges and
interest, both for the taxable year 1986, are hereby CANCELLED and SET
ASIDE.
SO ORDERED.9
Petitioner filed a petition for review with the Court of Appeals, which
affirmed the CTA decision,10 holding that although the professional services
(legal and auditing services) were rendered to ICC in 1984 and 1985, the cost
of the services was not yet determinable at that time, hence, it could be
considered as deductible expenses only in 1986 when ICC received the
billing statements for said services. It further ruled that ICC did not
understate its interest income from the promissory notes of Realty
Investment, Inc., and that ICC properly withheld and remitted taxes on the
payments for security services for the taxable year 1986.
Hence, petitioner, through the Office of the Solicitor General, 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. As to the alleged deficiency interest
income and failure to withhold expanded withholding tax assessment,
petitioner invoked the presumption that the assessment notices issued by the
BIR are valid.
The issue for resolution is whether the Court of Appeals correctly: (1)
sustained the deduction of the expenses for professional and security services
from ICC’s gross income; and (2) held that ICC did not understate its interest
income from the promissory notes of Realty Investment, Inc; and that ICC
withheld the required 1% withholding tax from the deductions for security
services.
The requisites for the deductibility of ordinary and necessary trade, business,
or professional expenses, like expenses paid for legal and auditing services,
are: (a) the expense must be ordinary and necessary; (b) it must have been
paid or incurred during the taxable year; (c) it must have been paid or
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
incurred in carrying on the trade or business of the taxpayer; and (d) it must
be supported by receipts, records or other pertinent papers.11
The requisite that it must have been paid or incurred during the taxable year
is further qualified by Section 45 of the National Internal Revenue Code
(NIRC) which states that: "[t]he deduction provided for in this Title shall be
taken for the taxable year in which ‘paid or accrued’ or ‘paid or incurred’,
dependent upon the method of accounting upon the basis of which the net
income is computed x x x".
Accounting methods for tax purposes comprise a set of rules for determining
when and how to report income and deductions.12 In the instant case, the
accounting method used by ICC is 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. Thus, a taxpayer who is
authorized to deduct certain expenses and other allowable deductions for the
current year but failed to do so cannot deduct the same for the next year.13
The accrual method relies upon the taxpayer’s right to receive amounts or its
obligation to pay them, in opposition to actual receipt or payment, which
characterizes the cash method of accounting. Amounts of income accrue
where the right to receive them become fixed, where there is created an
enforceable liability. Similarly, liabilities are accrued when fixed and
determinable in amount, without regard to indeterminacy merely of time of
payment.14
For a taxpayer using the accrual method, the determinative question is, when
do the facts present themselves in such a manner that the taxpayer must
recognize income or expense? The accrual of income and expense is
permitted when the all-events test has been met. This test requires: (1) fixing
of a right to income or liability to pay; and (2) the availability of the
reasonable accurate determination of such income or liability.
The all-events test requires the right to income or liability be fixed, and the
amount of such income or liability be determined with reasonable accuracy.
4
However, the test does not demand that the amount of income or liability be
known absolutely, only that a taxpayer has at his disposal the information
necessary to compute the amount with reasonable accuracy. The all-events
test is satisfied where computation remains uncertain, if its basis is
unchangeable; the test is satisfied where a computation may be unknown, but
is not as much as unknowable, within the taxable year. The amount of
liability does not have to be determined exactly; it must be determined
with "reasonable accuracy." Accordingly, the term "reasonable
accuracy" implies something less than an exact or completely accurate
amount.[15]
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.[16] 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.17
Corollarily, it is a governing principle in taxation that tax exemptions must
be construed in strictissimi juris against the taxpayer and liberally in favor of
the taxing authority; and one who claims an exemption must be able to
justify the same by the clearest grant of organic or statute law. An exemption
from the common burden cannot be permitted to exist upon vague
implications. And since a deduction for income tax purposes partakes of the
nature of a tax exemption, then it must also be strictly construed.18
In the instant case, the expenses for professional fees consist of expenses for
legal and auditing services. The expenses for legal services pertain to the
1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga
Narciso Cudala Pecson Azcuna & Bengson, and for reimbursement of the
expenses of said firm in connection with ICC’s tax problems for the year
1984. As testified by the Treasurer of ICC, the firm has been its counsel
since the 1960’s.19 From the nature of the claimed deductions and the span of
time during which the firm was retained, ICC can be expected to have
reasonably known the retainer fees charged by the firm as well as the
compensation for its legal services. The failure to determine the exact
amount of the expense during the taxable year when they could have been
claimed as deductions cannot thus be attributed solely to the delayed billing
of these liabilities by the firm. For one, ICC, in the exercise of due diligence
could have inquired into the amount of their obligation to the firm, especially
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
so that it is using the accrual method of accounting. For another, it could
have reasonably determined the amount of legal and retainer fees owing to its
familiarity with the rates charged by their long time legal consultant.
As previously stated, the accrual method presents largely a question of fact
and that the taxpayer bears the burden of establishing the accrual of an
expense or income. However, ICC failed to discharge this burden. As to
when the firm’s performance of its services in connection with the 1984 tax
problems were completed, or whether ICC exercised reasonable diligence to
inquire about the amount of its liability, or whether it does or does not
possess the information necessary to compute the amount of said liability
with reasonable accuracy, are questions of fact which ICC never established.
It simply relied on the defense of delayed billing by the firm and the
company, which under the circumstances, is not sufficient to exempt it from
being charged with knowledge of the reasonable amount of the expenses for
legal and auditing services.
In the same vein, 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. This is so because ICC failed to present
evidence showing that even with only "reasonable accuracy," as the standard
to ascertain its liability to SGV & Co. in the year 1985, it cannot determine
the professional fees which said company would charge for its services.
ICC thus failed to discharge the burden of proving that the claimed expense
deductions for the professional services were allowable deductions for the
taxable year 1986. Hence, per Revenue Audit Memorandum Order No. 1-
2000, they cannot be validly deducted from its gross income for the said year
and were therefore properly disallowed by the BIR.
As to the expenses for security services, the records show that these expenses
were incurred by ICC in 198620 and could therefore be properly claimed as
deductions for the said year.
Anent the purported understatement of interest income from the promissory
notes of Realty Investment, Inc., we sustain the findings of the CTA and the
Court of Appeals that no such understatement exists and that only simple
interest computation and not a compounded one should have been applied by
the BIR. There is indeed no stipulation between the latter and ICC on the
5
application of compounded interest.21 Under Article 1959 of the Civil Code,
unless there is a stipulation to the contrary, interest due should not further
earn interest.
Likewise, the findings of the CTA and the Court of Appeals that ICC truly
withheld the required withholding tax from its claimed deductions for
security services and remitted the same to the BIR is supported by payment
order and confirmation receipts.22 Hence, the Assessment Notice for
deficiency expanded withholding tax was properly cancelled and set aside.
In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of
P333,196.86 for deficiency income tax should be cancelled and set aside but
only insofar as the claimed deductions of ICC for security services. Said
Assessment is valid as to the BIR’s disallowance of ICC’s expenses for
professional services. The Court of Appeal’s cancellation of Assessment
Notice No. FAS-1-86-90-000681 in the amount of P4,897.79 for deficiency
expanded withholding tax, is sustained.
WHEREFORE, the petition is PARTIALLY GRANTED. The September 30,
2005 Decision of the Court of Appeals in CA-G.R. SP No. 78426, is
AFFIRMED with the MODIFICATION that Assessment Notice No. FAS-1-
86-90-000680, which disallowed the expense deduction of Isabela Cultural
Corporation for professional and security services, is declared valid only
insofar as the expenses for the professional fees of SGV & Co. and of the law
firm, Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, are
concerned. The decision is affirmed in all other respects.
The case is remanded to the BIR for the computation of Isabela Cultural
Corporation’s liability under Assessment Notice No. FAS-1-86-90-000680.
SO ORDERED.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
EXPENSES
G.R. No. 143672. April 24, 2003.*
COMMISSIONER OF INTERNAL REVENUE,
petitioner, vs. GENERAL FOODS (PHILS.), INC. respondent.
Taxation; Statutory Construction; It is a governing principle in taxation
that tax exemptions must be construed in strictissimi juris against the
taxpayer and liberally in favor of the taxing authority; Deductions for
income tax purposes partake of the nature of tax exemptions, hence strictly
construed.—It is a governing principle in taxation that tax exemptions must
be construed in strictissimi juris against the taxpayer and liberally in favor of
the taxing authority; and he who claims an exemption must be able to justify
his claim by the clearest grant of organic or statute law. An exemption from
the common burden cannot be permitted to exist upon vague implications.
Deductions for income tax purposes partake of the nature of tax exemptions;
hence, if tax exemptions are strictly construed, then deductions must also be
strictly construed.
Same; Income Taxation; Advertising Expenses; Requisites for
Deductions from Gross Income for Advertising Expense.—Simply put, to be
deductible from gross income, the subject advertising expense must comply
with the following requisites: (a) the expense must be ordinary and
necessary; (b) it must have been paid or incurred during the taxable year; (c)
it must have been paid or incurred in carrying on the trade or business of the
taxpayer; and (d) it must be supported by receipts, records or other pertinent
papers.
Same; Same; Same; There is yet to be a clear-cut criteria or fixed test
for determining the reasonableness of an advertising expense.—There is yet
to be a clear-cut criteria or fixed test for determining the reasonableness of an
advertising expense. There being no hard and fast rule on the matter, the right
to a deduction depends on a number of factors such as but not limited to: the
type and size of business in which the taxpayer is engaged; the volume and
amount of its net earnings; the nature of the expenditure itself; the intention
of the taxpayer and the general economic conditions. It is the interplay of
these, among other factors and properly weighed, that will yield a proper
evaluation.
6
Same; Same; Same; Words and Phrases; Advertising is generally of
two kinds—(1) advertising to stimulate the current sale of merchandise or
use of services and (2) advertising designed to stimulate the future sale of
merchandise or use of services.—Advertising is generally of two kinds: (1)
advertising to stimulate the current sale of merchandise or use of services
and (2) advertising designed to stimulate the future sale of merchandise or
use of services. The second type involves expenditures incurred, in whole or
in part, to create or maintain some form of goodwill for the taxpayer’s trade
or business or for the industry or profession of which the taxpayer is a
member. If the expenditures are for the advertising of the first kind, then,
except as to the question of the reasonableness of amount, there is no doubt
such expenditures are deductible as business expenses. If, however, the
expenditures are for advertising of the second kind, then normally they
should be spread out over a reasonable period of time.
Same; Same; Same; Protection of brand franchise is analogous to the
maintenance of goodwill or title to one’s property, a capital expenditure
which should be spread out over a reasonable period of time.—We agree
with the Court of Tax Appeals that the subject advertising expense was of the
second kind. Not only was the amount staggering; the respondent corporation
itself also admitted, in its letter protest to the Commissioner of Internal
Revenue’s assessment, that the subject media expense was incurred in order
to protect respondent corporation’s brand franchise, a critical point during the
period under review. The protection of brand franchise is analogous to the
maintenance of goodwill or title to one’s property. This is a capital
expenditure which should be spread out over a reasonable period of time.
Respondent corporation’s venture to protect its brand franchise was
tantamount to efforts to establish a reputation. This was akin to the
acquisition of capital assets and therefore expenses related thereto were not
to be considered as business expenses but as capital expenditures.
Same; Same; Same; The taxpayer’s prerogative to determine the
amount of advertising expenses it will incur and where to apply them is
subject to certain considerations, one of which relates to the extent to which
the expenditures are actually capital outlays, and the second relates to
whether the expenditures are ordinary and necessary; For an expense to be
considered ordinary, it must be reasonable in amount.—True, it is the
taxpayer’s prerogative to determine the amount of advertising expenses it
will incur and where to apply them. Said prerogative, however, is subject to
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
certain considerations. The first relates to the extent to which the
expenditures are actually capital outlays; this necessitates an inquiry into the
nature or purpose of such expenditures. The second, which must be applied
in harmony with the first, relates to whether the expenditures are ordinary
and necessary. Concomitantly, for an expense to be considered ordinary, it
must be reasonable in amount. The Court of Tax Appeals ruled that
respondent corporation failed to meet the two foregoing limitations.
Same; Same; Same; Administrative Law; Court of Tax Appeals; It has
been a long standing policy and practice of the Court to respect the
conclusions of quasi-judicial agencies such as the Court of Tax Appeals, a
highly specialized body specifically created for the purpose of reviewing tax
cases.—It has been a long standing policy and practice of the Court to
respect the conclusions of quasi-judicial agencies such as the Court of Tax
Appeals, a highly specialized body specifically created for the purpose of
reviewing tax cases. The CTA, by the nature of its functions, is dedicated
exclusively to the study and consideration of tax problems. It has necessarily
developed an expertise on the subject. We extend due consideration to its
opinion unless there is an abuse or improvident exercise of authority. Since
there is none in the case at bar, the Court adheres to the findings of the CTA.
Same; Same; Same; Burden of Proof; It is not incumbent upon the
taxing authority to prove that the amount of items being claimed is
unreasonable—the burden of proof to establish the validity of claimed
deductions is on the taxpayer.—Accordingly, we find that the Court of
Appeals committed reversible error when it declared the subject media
advertising expense to be deductible as an ordinary and necessary expense on
the ground that “it has not been established that the item being claimed as
deduction is excessive.” It is not incumbent upon the taxing authority to
prove that the amount of items being claimed is unreasonable. The burden of
proof to establish the validity of claimed deductions is on the taxpayer. In the
present case, that burden was not discharged satisfactorily.
PETITION for review on certiorari of a decision of the Court of Appeals.
The facts are stated in the opinion of the Court.
Rhodora J. Corcuera-Menzon for petitioner.
Ortega, Del Castillo, Bacorro, Odulio, Calma & Carbonell for
respondent.
7
CORONA, J.:
Petitioner Commissioner of Internal Revenue (Commissioner) assails the
resolution1 of the Court of Appeals reversing the decision2 of the Court of
Tax Appeals which in turn denied the protest filed by respondent General
Foods (Phils.), Inc., regarding the assessment made against the latter for
deficiency taxes.
The records reveal that, on June 14, 1985, respondent corporation, which is
engaged in the manufacture of beverages such as "Tang," "Calumet" and
"Kool-Aid," filed its income tax return for the fiscal year ending February 28,
1985. In said tax return, respondent corporation claimed as deduction, among
other business expenses, the amount of P9,461,246 for media advertising for
"Tang."
On May 31, 1988, the Commissioner disallowed 50% or P4,730,623 of the
deduction claimed by respondent corporation. Consequently, respondent
corporation was assessed deficiency income taxes in the amount of P2,635,
141.42. The latter filed a motion for reconsideration but the same was denied.
On September 29, 1989, respondent corporation appealed to the Court of Tax
Appeals but the appeal was dismissed:
With such a gargantuan expense for the advertisement of a singular
product, which even excludes "other advertising and promotions"
expenses, we are not prepared to accept that such amount is
reasonable "to stimulate the current sale of merchandise" regardless
of Petitioner’s explanation that such expense "does not connote
unreasonableness considering the grave economic situation taking
place after the Aquino assassination characterized by capital fight,
strong deterioration of the purchasing power of the Philippine peso
and the slacking demand for consumer products" (Petitioner’s
Memorandum, CTA Records, p. 273). We are not convinced with
such an explanation. The staggering expense led us to believe that
such expenditure was incurred "to create or maintain some form of
good will for the taxpayer’s trade or business or for the industry or
profession of which the taxpayer is a member." The term "good will"
can hardly be said to have any precise signification; it is generally
used to denote the benefit arising from connection and reputation
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
(Words and Phrases, Vol. 18, p. 556 citing Douhart vs. Loagan, 86
III. App. 294). As held in the case of Welch vs. Helvering, efforts to
establish reputation are akin to acquisition of capital assets and,
therefore, expenses related thereto are not business expenses but
capital expenditures. (Atlas Mining and Development Corp. vs.
Commissioner of Internal Revenue, supra). For sure such
expenditure was meant not only to generate present sales but more
for future and prospective benefits. Hence, "abnormally large
expenditures for advertising are usually to be spread over the period
of years during which the benefits of the expenditures are received"
(Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).
WHEREFORE, in all the foregoing, and finding no error in the case
appealed from, we hereby RESOLVE to DISMISS the instant
petition for lack of merit and ORDER the Petitioner to pay the
respondent Commissioner the assessed amount of P2,635,141.42
representing its deficiency income tax liability for the fiscal year
ended February 28, 1985."3
Aggrieved, respondent corporation filed a petition for review at the Court of
Appeals which rendered a decision reversing and setting aside the decision of
the Court of Tax Appeals:
Since it has not been sufficiently established that the item it claimed
as a deduction is excessive, the same should be allowed.
WHEREFORE, the petition of petitioner General Foods
(Philippines), Inc. is hereby GRANTED. Accordingly, the Decision,
dated 8 February 1994 of respondent Court of Tax Appeals is
REVERSED and SET ASIDE and the letter, dated 31 May 1988 of
respondent Commissioner of Internal Revenue is CANCELLED.
SO ORDERED.4
Thus, the instant petition, wherein the Commissioner presents for the Court’s
consideration a lone issue: whether or not the subject media advertising
expense for "Tang" incurred by respondent corporation was an ordinary and
8
necessary expense fully deductible under the National Internal Revenue Code
(NIRC).
It is a governing principle in taxation that tax exemptions must be
construed in strictissimi juris against the taxpayer and liberally in favor of
the taxing authority;5 and he who claims an exemption must be able to justify
his claim by the clearest grant of organic or statute law. An exemption from
the common burden cannot be permitted to exist upon vague implications.6
Deductions for income tax purposes partake of the nature of tax exemptions;
hence, if tax exemptions are strictly construed, then deductions must also be
strictly construed.
We then proceed to resolve the singular issue in the case at bar. Was the
media advertising expense for "Tang" paid or incurred by respondent
corporation for the fiscal year ending February 28, 1985 "necessary and
ordinary," hence, fully deductible under the NIRC? Or was it a capital
expenditure, paid in order to create "goodwill and reputation" for respondent
corporation and/or its products, which should have been amortized over a
reasonable period?
Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:
(A) Expenses.-
(1) Ordinary and necessary trade, business or professional
expenses.-
(a) In general.- There shall be allowed as deduction from
gross income all ordinary and necessary expenses paid or
incurred during the taxable year in carrying on, or which are
directly attributable to, the development, management,
operation and/or conduct of the trade, business or exercise of
a profession.
Simply put, to be deductible from gross income, the subject advertising
expense must comply with the following requisites: (a) the expense must be
ordinary and necessary; (b) it must have been paid or incurred during the
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
taxable year; (c) it must have been paid or incurred in carrying on the trade or
business of the taxpayer; and (d) it must be supported by receipts, records or
other pertinent papers.7
The parties are in agreement that the subject advertising expense was paid or
incurred within the corresponding taxable year and was incurred in carrying
on a trade or business. Hence, it was necessary. However, their views
conflict as to whether or not it was ordinary. To be deductible, an advertising
expense should not only be necessary but also ordinary. These two
requirements must be met.
The Commissioner maintains that the subject advertising expense was not
ordinary on the ground that it failed the two conditions set by U.S.
jurisprudence: first, "reasonableness" of the amount incurred and second, the
amount incurred must not be a capital outlay to create "goodwill" for the
product and/or private respondent’s business. Otherwise, the expense must be
considered a capital expenditure to be spread out over a reasonable time.
We agree.
There is yet to be a clear-cut criteria or fixed test for determining the
reasonableness of an advertising expense. There being no hard and fast rule
on the matter, the right to a deduction depends on a number of factors such as
but not limited to: the type and size of business in which the taxpayer is
engaged; the volume and amount of its net earnings; the nature of the
expenditure itself; the intention of the taxpayer and the general economic
conditions. It is the interplay of these, among other factors and properly
weighed, that will yield a proper evaluation.
In the case at bar, the P9,461,246 claimed as media advertising expense for
"Tang" alone was almost one-half of its total claim for "marketing expenses."
Aside from that, respondent-corporation also claimed P2,678,328 as "other
advertising and promotions expense" and another P1,548,614, for consumer
promotion.
Furthermore, the subject P9,461,246 media advertising expense for "Tang"
was almost double the amount of respondent corporation’s P4,640,636
general and administrative expenses.
9
We find the subject expense for the advertisement of a single product to be
inordinately large. Therefore, even if it is necessary, it cannot be considered
an ordinary expense deductible under then Section 29 (a) (1) (A) of the
NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate
the current sale of merchandise or use of services and (2) advertising
designed to stimulate the future sale of merchandise or use of services. The
second type involves expenditures incurred, in whole or in part, to create or
maintain some form of goodwill for the taxpayer’s trade or business or for
the industry or profession of which the taxpayer is a member. If the
expenditures are for the advertising of the first kind, then, except as to the
question of the reasonableness of amount, there is no doubt such
expenditures are deductible as business expenses. If, however, the
expenditures are for advertising of the second kind, then normally they
should be spread out over a reasonable period of time.
We agree with the Court of Tax Appeals that the subject advertising expense
was of the second kind. Not only was the amount staggering; the respondent
corporation itself also admitted, in its letter protest8 to the Commissioner of
Internal Revenue’s assessment, that the subject media expense was incurred
in order to protect respondent corporation’s brand franchise, a critical point
during the period under review.
The protection of brand franchise is analogous to the maintenance of
goodwill or title to one’s property. This is a capital expenditure which should
be spread out over a reasonable period of time.9
Respondent corporation’s venture to protect its brand franchise was
tantamount to efforts to establish a reputation. This was akin to the
acquisition of capital assets and therefore expenses related thereto were not
to be considered as business expenses but as capital expenditures.10
True, it is the taxpayer’s prerogative to determine the amount of advertising
expenses it will incur and where to apply them.11 Said prerogative, however,
is subject to certain considerations. The first relates to the extent to which the
expenditures are actually capital outlays; this necessitates an inquiry into the
nature or purpose of such expenditures.12 The second, which must be applied
in harmony with the first, relates to whether the expenditures are ordinary
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

and necessary. Concomitantly, for an expense to be considered ordinary, it SO ORDERED.

must be reasonable in amount. The Court of Tax Appeals ruled that
respondent corporation failed to meet the two foregoing limitations.

We find said ruling to be well founded. Respondent corporation incurred the

subject advertising expense in order to protect its brand franchise. We
consider this as a capital outlay since it created goodwill for its business
and/or product. The P9,461,246 media advertising expense for the promotion
of a single product, almost one-half of petitioner corporation’s entire claim
for marketing expenses for that year under review, inclusive of other
advertising and promotion expenses of P2,678,328 and P1,548,614 for
consumer promotion, is doubtlessly unreasonable.

It has been a long standing policy and practice of the Court to respect the
conclusions of quasi-judicial agencies such as the Court of Tax Appeals, a
highly specialized body specifically created for the purpose of reviewing tax
cases. The CTA, by the nature of its functions, is dedicated exclusively to the
study and consideration of tax problems. It has necessarily developed an
expertise on the subject. We extend due consideration to its opinion unless
there is an abuse or improvident exercise of authority.13 Since there is none in
the case at bar, the Court adheres to the findings of the CTA.

Accordingly, we find that the Court of Appeals committed reversible error

when it declared the subject media advertising expense to be deductible as an
ordinary and necessary expense on the ground that "it has not been
established that the item being claimed as deduction is excessive." It is not
incumbent upon the taxing authority to prove that the amount of items being
claimed is unreasonable. The burden of proof to establish the validity of
claimed deductions is on the taxpayer.14 In the present case, that burden was
not discharged satisfactorily.

WHEREFORE, premises considered, the instant petition is GRANTED.

The assailed decision of the Court of Appeals is hereby REVERSED and
SET ASIDE. Pursuant to Sections 248 and 249 of the Tax Code, respondent
General Foods (Phils.), Inc. is hereby ordered to pay its deficiency income
tax in the amount of P2,635,141.42, plus 25% surcharge for late payment and
20% annual interest computed from August 25, 1989, the date of the denial
of its protest, until the same is fully paid.

10
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
EXPENSES
G.R. No. L-26911 January 27, 1981
ATLAS CONSOLIDATED MINING & DEVELOPMENT
CORPORATION, petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
G.R. No. L-26924 January 27, 1981
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
ATLAS CONSOLIDATED MINING & DEVELOPMENT
CORPORATION and COURT OF TAX APPEALS, respondents.
DE CASTRO, J.:
These are two (2) petitions for review from the decision of the Court of Tax
Appeals of October 25, 1966 in CTA Case No. 1312 entitled "Atlas
Consolidated Mining and Development Corporation vs. Commissioner of
Internal Revenue." One (L-26911) was filed by the Atlas Consolidated
Mining & Development Corporation, and in the other L-26924), the
Commissioner of Internal Revenue is the petitioner.
This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency
income tax assessments made by the Commissioner of Internal Revenue,
hereinafter referred to as Commissioner, where the Atlas Consolidated
Mining and Development Corporation, hereinafter referred to as Atlas, was
assessed P546,295.16 for 1957 and P215,493.96 for 1958 deficiency income
taxes.
Atlas is a corporation engaged in the mining industry registered under the
laws of the Philippines. On August 20, 1962, the Commissioner assessed
against Atlas the sum of P546,295.16 and P215,493.96 or a total of
P761,789.12 as deficiency income taxes for the years 1957 and 1958. For the
year 1957, it was the opinion of the Commissioner that Atlas is not entitled to
11
exemption from the income tax under Section 4 of Republic Act
909 1 because same covers only gold mines, the provision of which reads:
New mines, and old mines which resume operation, when
certified to as such by the Secretary of Agriculture and
Natural Resources upon the recommendation of the Director
of Mines, shall be exempt from the payment of income tax
during the first three (3) years of actual commercial
production. Provided that, any such mine and/or mines
making a complete return of its capital investment at any
time within the said period, shall pay income tax from that
year.
For the year 1958, the assessment of deficiency income tax of P761,789.12
covers the disallowance of items claimed by Atlas as deductible from gross
income.
On October 9, 1962, Atlas protested the assessment asking for its
reconsideration and cancellation. 2 Acting on the protest, the Commissioner
conducted a reinvestigation of the case.
On October 25, 1962, the Secretary of Finance ruled that the exemption
provided in Republic Act 909 embraces all new mines and old mines whether
gold or other minerals. 3 Accordingly, the Commissioner recomputed Atlas
deficiency income tax liabilities in the light of the ruling of the Secretary of
Finance. On June 9, 1964, the Commissioner issued a revised assessment
entirely eliminating the assessment of P546,295.16 for the year 1957. The
assessment for 1958 was reduced from P215,493.96 to P39,646.82 from
which Atlas appealed to the Court of Tax Appeals, assailing the disallowance
of the following items claimed as deductible from its gross income for 1958:
Transfer agent's
fee.........................................................P59,477.42
Stockholders relation service
fee....................................25,523.14
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

U.S. stock listing 1958

expenses..................................................8,326.70
Total net income for 1958.................................P1,968,898.27
Suit
expenses..........................................................................6,666 Net income corresponding to taxable period April 1 to
.65
Dec. 31, 1958, 3/4 of
Provision for contingencies.....................................
.........60,000.00 P1,968,898.27..........................................................1,476,673
.70
Total...............................................................
.....P159,993.91 Add: 3/4 of promotion fees

After hearing, the Court of Tax Appeals rendered a decision on October 25, of
1966 allowing the above mentioned disallowed items, except the items P25,523.14..............................................................P19,142.3
denominated by Atlas as stockholders relation service fee and suit 5
expenses. 4 Pertinent portions of the decision of the Court of Tax Appeals
read as follows: Litigation

Under the facts, circumstances and applicable law in this expenses.........................................................................6,

case, the unallowable deduction from petitioner's gross 666.65
income in 1958 amounted to P32,189.79.
Net income per decision..........................................11, 02,4
Stockholders relation service fee.................................... 2.70
P25,523.14
Tax due
Suit and litigation thereon.........................................................412,695.00
expenses................................................ 6,666.65
Less: Amount already assessed .............................405,468.00
Total...................................................................................
P32,189.79 DEFICIENCY INCOME TAX
DUE............................P7,227.00
As the exemption of petitioner from the payment of
corporate income tax under Section 4, Republic Act 909, Add: 1/2 % monthly interest
was good only up to the Ist quarter of 1958 ending on March
31 of the same year, only three-fourth (3/4) of the net taxable
from 6-20-59 to 6-20-62
income of petitioner is subject to income tax, computed as
(18%)....................................P1,300.89
follows:

12
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
TOTAL AMOUNT DUE &
COLLECTIBLE............P8,526.22
From the Court of Tax Appeals' decision of October 25, 1966, both parties
appealed to this Court by way of two (2) separate petitions for review
docketed as G. R. No. L-26911 (Atlas, petitioner) and G. R. No. L-29924
(Commissioner, petitioner).
G. R. No. L-26911—Atlas appealed only that portion of the Court of Tax
Appeals' decision disallowing the deduction from gross income of the so-
called stockholders relation service fee amounting to P25,523.14, making a
lone assignment of error that —
THE COURT OF TAX APPEALS ERRED IN ITS
CONCLUSION THAT THE EXPENSE IN THE AMOUNT
OF P25,523.14 PAID BY PETITIONER IN 1958 AS
ANNUAL PUBLIC RELATIONS EXPENSES WAS
INCURRED FOR ACQUISITION OF ADDITIONAL
CAPITAL, THE SAME NOT BEING SUPPORTED BY
THE EVIDENCE.
It is the contention of Atlas that the amount of P25,523.14 paid in 1958 as
annual public relations expenses is a deductible expense from gross income
under Section 30 (a) (1) of the National Internal Revenue Code. Atlas
claimed that it was paid for services of a public relations firm, P.K Macker &
Co., a reputable public relations consultant in New York City, U.S.A., hence,
an ordinary and necessary business expense in order to compete with other
corporations also interested in the investment market in the United States. 5 It
is the stand of Atlas that information given out to the public in general and to
the stockholder in particular by the P.K MacKer & Co. concerning the
operation of the Atlas was aimed at creating a favorable image and goodwill
to gain or maintain their patronage.
The decisive question, therefore, in this particular appeal taken by Atlas to
this Court is whether or not the expenses paid for the services rendered by a
public relations firm P.K MacKer & Co. labelled as stockholders relation
service fee is an allowable deduction as business expense under Section 30
(a) (1) of the National Internal Revenue Code.
13
The principle is recognized that when a taxpayer claims a deduction, he must
point to some specific provision of the statute in which that deduction is
authorized and must be able to prove that he is entitled to the deduction
which the law allows. As previously adverted to, the law allowing expenses
as deduction from gross income for purposes of the income tax is Section 30
(a) (1) of the National Internal Revenue which allows a deduction of "all the
ordinary and necessary expenses paid or incurred during the taxable year in
carrying on any trade or business." An item of expenditure, in order to be
deductible under this section of the statute, must fall squarely within its
language.
We come, then, to the statutory test of deductibility where it is axiomatic that
to be deductible as a business expense, three conditions are imposed, namely:
(1) the expense must be ordinary and necessary, (2) it must be paid or
incurred within the taxable year, and (3) it must be paid or incurred in
carrying in a trade or business. 6 In addition, not only must the taxpayer meet
the business test, he must substantially prove by evidence or records the
deductions claimed under the law, otherwise, the same will be disallowed.
The mere allegation of the taxpayer that an item of expense is ordinary and
necessary does not justify its deduction. 7
While it is true that there is a number of decisions in the United States
delving on the interpretation of the terms "ordinary and necessary" as used in
the federal tax laws, no adequate or satisfactory definition of those terms is
possible. Similarly, this Court has never attempted to define with precision
the terms "ordinary and necessary." There are however, certain guiding
principles worthy of serious consideration in the proper adjudication of
conflicting claims. Ordinarily, an expense will be considered "necessary"
where the expenditure is appropriate and helpful in the development of the
taxpayer's business. 8 It is "ordinary" when it connotes a payment which is
normal in relation to the business of the taxpayer and the surrounding
circumstances. 9 The term "ordinary" does not require that the payments be
habitual or normal in the sense that the same taxpayer will have to make
them often; the payment may be unique or non-recurring to the particular
taxpayer affected. 10
There is thus no hard and fast rule on the matter. The right to a deduction
depends in each case on the particular facts and the relation of the payment to
the type of business in which the taxpayer is engaged. The intention of the
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

taxpayer often may be the controlling fact in making the acquisition of capital assets and, therefore, expenses related thereto are not
determination. 11 Assuming that the expenditure is ordinary and necessary in business expense but capital expenditures.
the operation of the taxpayer's business, the answer to the question as to
whether the expenditure is an allowable deduction as a business expense We do not agree with the contention of Atlas that the conclusion of the Court
must be determined from the nature of the expenditure itself, which in turn of Tax Appeals in holding that the expense of P25,523.14 was incurred for
depends on the extent and permanency of the work accomplished by the acquisition of additional capital is not supported by the evidence. The burden
expenditure. 12 of proof that the expenses incurred are ordinary and necessary is on the
taxpayer 16 and does not rest upon the Government. To avail of the claimed
It appears that on December 27, 1957, Atlas increased its capital stock from deduction under Section 30(a) (1) of the National Internal Revenue Code, it
P15,000,000 to P18,325,000. 13 It was claimed by Atlas that its shares of is incumbent upon the taxpayer to adduce substantial evidence to establish a
stock worth P3,325,000 were sold in the United States because of the reasonably proximate relation petition between the expenses to the ordinary
services rendered by the public relations firm, P. K. Macker & Company. conduct of the business of the taxpayer. A logical link or nexus between the
The Court of Tax Appeals ruled that the information about Atlas given out expense and the taxpayer's business must be established by the taxpayer.
and played up in the mass communication media resulted in full subscription
of the additional shares issued by Atlas; consequently, the questioned item, G. R. No. L-26924-In his petition for review, the Commissioner of Internal
stockholders relation service fee, was in effect spent for the acquisition of Revenue assigned as errors the following:
additional capital, ergo, a capital expenditure.
I
We sustain the ruling of the tax court that the expenditure of P25,523.14 paid
to P.K. Macker & Co. as compensation for services carrying on the selling THE COURT OF TAX APPEALS ERRED IN ALLOWING
campaign in an effort to sell Atlas' additional capital stock of P3,325,000 is THE DEDUCTION FROM GROSS INCOME OF THE SO-
not an ordinary expense in line with the decision of U.S. Board of Tax CALLED TRANSFER AGENT'S FEES ALLEGEDLY
Appeals in the case of Harrisburg Hospital Inc. vs. Commissioner of Internal PAID BY RESPONDENT;
Revenue. 14 Accordingly, as found by the Court of Tax Appeals, the said
expense is not deductible from Atlas gross income in 1958 because expenses II
relating to recapitalization and reorganization of the corporation (Missouri-
Kansas Pipe Line vs. Commissioner of Internal Revenue, 148 F. (2d), THE COURT OF TAX APPEALS ERRED IN ALLOWING
460; Skenandos Rayon Corp. vs. Commissioner of Internal Revenue, 122 F. THE DEDUCTION FROM GROSS INCOME OF LISTING
(2d) 268, Cert. denied 314 U.S. 6961), the cost of obtaining stock EXPENSES ALLEGEDLY INCURRED BY
subscription (Simons Co., 8 BTA 631), promotion expenses (Beneficial RESPONDENT;
Industrial Loan Corp. vs. Handy, 92 F. (2d) 74), and commission or fees paid
for the sale of stock reorganization (Protective Finance Corp., 23 BTA 308)
III
are capital expenditures.
THE COURT OF TAX APPEALS ERRED IN HOLDING
That the expense in question was incurred to create a favorable image of the
THAT THE AMOUNT OF P60,000 REPRESENTED BY
corporation in order to gain or maintain the public's and its stockholders'
RESPONDENT AS "PROVISION FOR
patronage, does not make it deductible as business expense. As held in the
CONTINGENCIES" WAS ADDED BACK BY
case of Welch vs. Helvering, 15 efforts to establish reputation are akin to
RESPONDENT TO ITS GROSS INCOME IN

14
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
COMPUTING THE INCOME TAX DUE FROM IT FOR
1958;
IV
THE COURT OF TAX APPEALS ERRED IN
DISALLOWING ONLY THE AMOUNT OF P6,666.65 AS
SUIT EXPENSES, THE CORRECT AMOUNT THAT
SHOULD HAVE BEEN DISALLOWED BEING
P17,499.98.
It is well to note that only in the Court of Tax Appeals did the Commissioner
raise for the first time (in his memorandum) the question of whether or not
the business expenses deducted from Atlas gross income in 1958 may be
allowed in the absence of proof of payments. 17 Before this Court, the
Commissioner reiterated the same as ground against deductibility when he
claimed that the Court of Tax Appeals erred in allowing the deduction of
transfer agent's fee and stock listing fee from gross income in the absence of
proof of payment thereof.
The Commissioner contended that under Section 30 (a) (1) of the National
Internal Revenue Code, it is a requirement for an expense to be deductible
from gross income that it must have been "paid or incurred during the year"
for which it is claimed; that in the absence of convincing and satisfactory
evidence of payment, the deduction from gross income for the year 1958
income tax return cannot be sustained; and that the best evidence to prove
payment, if at all any has been made, would be the vouchers or receipts
issued therefor which ATLAS failed to present.
Atlas admitted that it failed to adduce evidence of payment of the deduction
claimed in its 1958 income tax return, but explains the failure with the
allegation that the Commissioner did not raise that question of fact in his
pleadings, or even in the report of the investigating examiner and/or letters of
demand and assessment notices of ATLAS which gave rise to its appeal to
the Court of Tax Appeal. 18 It was emphasized by Atlas that it went to trial
and finally submitted this case for decision on the assumption that inasmuch
as the fact of payment was never raised as a vital issue by the Commissioner
in his answer to the petition for review in the Court of Tax Appeal, the issues
is limited only to pure question of law—whether or not the expenses
15
deducted by petitioner from its gross income for 1958 are sanctioned by
Section 30 (a) (1) of the National Internal Revenue Code.
On this issue of whether or not the Commissioner can raise the fact of
payment for the first time on appeal in its memorandum in the Court of Tax
Appeal, we fully agree with the ruling of the tax court that the Commissioner
on appeal cannot be allowed to adopt a theory distinct and different from that
he has previously pursued, as shown by the BIR records and the answer to
the amended petition for review. 19 As this Court said in the case of
Commissioner of Customs vs. Valencia 20 such change in the nature of the
case may not be made on appeal, specially when the purpose of the latter is
to seek a review of the action taken by an administrative body, forming part
of a coordinate branch of the Government, such as the Executive department.
In the case at bar, the Court of Tax Appeal found that the fact of payment of
the claimed deduction from gross income was never controverted by the
Commissioner even during the initial stages of routinary administrative
scrutiny conducted by BIR examiners. 21 Specifically, in his answer to the
amended petition for review in the Court of Tax Appeal, the Commissioner
did not deny the fact of payment, merely contesting the legitimacy of the
deduction on the ground that same was not ordinary and necessary business
expenses. 22
As consistently ruled by this Court, the findings of facts by the Court of Tax
Appeal will not be reviewed in the absence of showing of gross error or
abuse. 23 We, therefore, hold that it was too late for the Commissioner to
raise the issue of fact of payment for the first time in his memorandum in the
Court of Tax Appeals and in this instant appeal to the Supreme Court. If
raised earlier, the matter ought to have been seriously delved into by the
Court of Tax Appeals. On this ground, we are of the opinion that under all
the attendant circumstances of the case, substantial justice would be served if
the Commissioner be held as precluded from now attempting to raise an issue
to disallow deduction of the item in question at this stage. Failure to assert a
question within a reasonable time warrants a presumption that the party
entitled to assert it either has abandoned or declined to assert it.
On the second assignment of error, aside from alleging lack of proof of
payment of the expense deducted, the Commissioner contended that such
expense should be disallowed for not being ordinary and necessary and not
incurred in trade or business, as required under Section 30 (a) (1) of the
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
National Internal Revenue Code. He asserted that said fees were therefore
incurred not for the production of income but for the acquisition petition of
capital in view of the definition that an expense is deemed to be incurred in
trade or business if it was incurred for the production of income, or in the
expectation of producing income for the business. In support of his
contention, the Commissioner cited the ruling in Dome Mines, Ltd vs.
Commisioner of Internal Revenue 24 involving the same issue as in the case at
bar where the U.S. Board of Tax Appeal ruled that expenses for listing
capital stock in the stock exchange are not ordinary and necessary expenses
incurred in carrying on the taxpayer's business which was gold mining and
selling, which business is strikingly similar to Atlas.
On the other hand, the Court of Tax Appeal relied on the ruling in the case
of Chesapeake Corporation of Virginia vs. Commissioner of Internal
Revenue 25 where the Tax Court allowed the deduction of stock exchange fee
in dispute, which is an annually recurring cost for the annual maintenance of
the listing.
We find the Chesapeake decision controlling with the facts and
circumstances of the instant case. In Dome Mines, Ltd case the stock listing
fee was disallowed as a deduction not only because the expenditure did not
meet the statutory test but also because the same was paid only once, and the
benefit acquired thereby continued indefinitely, whereas, in the Chesapeake
Corporation case, fee paid to the stock exchange was annual and recurring.
In the instant case, we deal with the stock listing fee paid annually to a stock
exchange for the privilege of having its stock listed. It must be noted that the
Court of Tax Appeal rejected the Dome Mines case because it involves a
payment made only once, hence, it was held therein that the single payment
made to the stock exchange was a capital expenditure, as distinguished from
the instant case, where payments were made annually. For this reason, we
hold that said listing fee is an ordinary and necessary business expense
On the third assignment of error, the Commissioner con- tended that the
Court of Tax Appeal erred when it held that the amount of P60,000 as
"provisions for contingencies" was in effect added back to Atlas income.
On this issue, this Court has consistently ruled in several cases adverted to
earlier, that in the absence of grave abuse of discretion or error on the part of
the tax court its findings of facts may not be disturbed by the Supreme
16
Court. 26 It is not within the province of this Court to resolve whether or not
the P60,000 representing "provision for contingencies" was in fact added to
or deducted from the taxable income. As ruled by the Court of Tax Appeals,
the said amount was in effect added to Atlas taxable income. 27 The same
being factual in nature and supported by substantial evidence, such findings
should not be disturbed in this appeal.
Finally, in its fourth assignment of error, the Commissioner contended that
the CTA erred in disallowing only the amount of P6,666.65 as suit expenses
instead of P17,499.98.
It appears that petitioner deducted from its 1958 gross income the amount of
P23,333.30 as attorney's fees and litigation expenses in the defense of title to
the Toledo Mining properties purchased by Atlas from Mindanao Lode
Mines Inc. in Civil Case No. 30566 of the Court of First Instance of Manila
for annulment of the sale of said mining properties. On the ground that the
litigation expense was a capital expenditure under Section 121 of the
Revenue Regulation No. 2, the investigating revenue examiner recommended
the disallowance of P13,333.30. The Commissioner, however, reduced this
amount of P6,666.65 which latter amount was affirmed by the respondent
Court of Tax Appeals on appeal.
There is no question that, as held by the Court of Tax Ap- peals, the litigation
expenses under consideration were incurred in defense of Atlas title to its
mining properties. In line with the decision of the U.S. Tax Court in the case
of Safety Tube Corp. vs. Commissioner of Internal Revenue, 28 it is well
settled that litigation expenses incurred in defense or protection of title are
capital in nature and not deductible. Likewise, it was ruled by the U.S. Tax
Court that expenditures in defense of title of property constitute a part of the
cost of the property, and are not deductible as expense. 29
Surprisingly, however, the investigating revenue examiner recommended a
partial disallowance of P13,333.30 instead of the entire amount of
P23,333.30, which, upon review, was further reduced by the Commissioner
of Internal Revenue. Whether it was due to mistake, negligence or omission
of the officials concerned, the arithmetical error committed herein should not
prejudice the Government. This Court will pass upon this particular question
since there is a clear error committed by officials concerned in the
computation of the deductible amount. As held in the case of Vera vs.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

Fernandez, 30 this Court emphatically said that taxes are the lifeblood of the
Government and their prompt and certain availability are imperious need.
Upon taxation depends the Government's ability to serve the people for
whose benefit taxes are collected. To safeguard such interest, neglect or
omission of government officials entrusted with the collection of taxes
should not be allowed to bring harm or detriment to the people, in the same
manner as private persons may be made to suffer individually on account of
his own negligence, the presumption being that they take good care of their
personal affair. This should not hold true to government officials with respect
to matters not of their own personal concern. This is the philosophy behind
the government's exception, as a general rule, from the operation of the
principle of estoppel. 31

WHEREFORE, judgment appealed from is hereby affirmed with

modification that the amount of P17,499.98 (3/4 of P23,333.00) representing
suit expenses be disallowed as deduction instead of P6,666.65 only. With this
amount as part of the net income, the corresponding income tax shall be paid
thereon, with interest of 6% per annum from June 20, 1959 to June 20,1962.

SO ORDERED.

17
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
EXPENSES
G.R. No. 173373. July 29, 2013.*
H. TAMBUNTING PAWNSHOP, INC., petitioner, vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
Taxation; Tax Deductions; The rule that tax deductions, being in the
nature of tax exemptions, are to be construed in strictissimi juris against the
taxpayer is well settled.―The rule that tax deductions, being in the nature of
tax exemptions, are to be construed in strictissimi juris against the taxpayer is
well settled. Corollary to this rule is the principle that when a taxpayer claims
a deduction, he must point to some specific provision of the statute in which
that deduction is authorized and must be able to prove that he is entitled to
the deduction which the law allows. An item of expenditure, therefore, must
fall squarely within the language of the law in order to be deductible. A mere
averment that the taxpayer has incurred a loss does not automatically warrant
a deduction from its gross income.
Same; Same; Requisites for the Deductibility of Ordinary and
Necessary Trade or Business Expenses, Like Those Paid for Security and
Janitorial Services, Management and Professional Fees, and Rental
Expenses.―The requisites for the deductibility of ordinary and necessary
trade or business expenses, like those paid for security and janitorial services,
management and professional fees, and rental expenses, are that: (a) the
expenses must be ordinary and necessary; (b) they must have been paid or
incurred during the taxable year; (c) they must have been paid or incurred in
carrying on the trade or business of the taxpayer; and (d) they must be
supported by receipts, records or other pertinent papers.
Same; Same; The law required Tambunting to support its claim for
deduction with the corresponding official receipts issued by the service
providers concerned.―To reiterate, 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. Tambunting did not discharge its burden of substantiating
its claim for deductions due to the inadequacy of its documentary support of
its claim. Its reliance on withholding tax returns, cash vouchers, lessor’s
18
certifications, and the contracts of lease was futile because such documents
had scant probative value. As the CTA En Banc succinctly put it, the law
required Tambunting to support its claim for deductions with the
corresponding official receipts issued by the service providers concerned.
PETITION for review on certiorari of the decision and resolution of the
Court of Appeals.
The facts are stated in the opinion of the Court.
Siguion Reyna, Montecillo & Ongsiako for petitioner.
The Solicitor General for respondent.
To be entitled to claim a tax deduction, the taxpayer must competently
establish the factual and documentary bases of its claim.
Antecedents
H. Tambunting Pawnshop, Inc. (petitioner), a domestic corporation duly
licensed and authorized to engage in the pawnshop business, appeals the
adverse decision promulgated on April 24, 2006,1 whereby the Court of Tax
Appeals En Bane (CTA En Bane) affirmed the decision of the CTA First
Division ordering it to pay deficiency income taxes in the amount of
₱4,536,687.15 for taxable yaar 1997, plus 20% delinquency interest
computed from August 29, 2000 until full payment, but cancelling the
compromise penalties for lack of basis.
On June 26, 2000, the Bureau of Internal Revenue (BIR), through then
Acting Regional Director Lucien E. Sayuno of Revenue Region No. 6 in
Manila, issued assessment notices and demand letters, all numbered 32-1-97,
assessing Tambunting for deficiency percentage tax, income tax and
compromise penalties for taxable year 1997,2 as follows:
Deficiency Percentage Tax
Taxable Sales/Receipts ₱12,749,135.25
============
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

Percentage Tax due (5%) P 637,456.76 Disallowed Loss on Fire & Theft 906,560.00
--------------------
Add: 20% Interest up to 7-26-00 320,513.24
-------------------- Taxable Net Income per Investigation P 11,344,295.43
============
Total Percentage Tax Due P 957,970.00
============ Income Tax Due (35%) P 3,970,503.40

Deficiency Income Tax Less Income Tax Paid 18,937.57

---------------------
Taxable Net Income per Return P 54,107.36
Deficiency Income Tax 3,951,565.83
Adjustments per investigation Section 28
Add: 20% Interest to 7-26-00 1,799,938.23
Overstatement of gain/loss on auction sales ---------------------
Gain/Loss per F/S P 4,914,967.50 Total Income Tax Due 5,751,504.06
Gain/Loss per Audit 133,057.40 4,781,910.00 Compromise Penalties
--------------------
Late Payment of Income Tax 25,000.00
Unsupported Security/Janitorial Expenses
Late Payment of Percentage Tax 20,000.00
Per F/S 2,183,573.02
Failure to Pay Withholding Tax Return for
Per Audit 358,800.00 1,824,773.02
-------------------- the Months of April and May 24,000.00
-----------------
Unsupported Rent Expenses
69,000.00
Per F/S 2,293,631.13 ==========
Per Audit 434,406.77 1,859,224.35
-------------------- On July 26, 2000, Tambunting instituted an administrative protest against the
assessment notices and demand letters with the Commissioner of Internal
Unsupported Interest Expenses 1,155,154.28 Revenue.3
Unsupported Management & Professional Fees 96,761.00
On February 21, 2001, Tambunting brought a petition for review in the CTA,
Unsupported Repairs & Maintenance 348,074.68 pursuant to Section 228 of the National Internal Revenue Code of
1997,4 citing the inaction of the Commissioner of Internal Revenue on its
Unsupported 13th Month Pay & Bonus 317,730.73 protest within the 180-day period prescribed by law.

19
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Per Petitioner's
Financial Per BIR's Per Court's On ------------------
Particulars Statement Examination Verification Octob
er 8, Unsupported Security/Janitorial Services
Loss on Auction
Sale P 4,914,967.50 P 133,057.40 P 133,057.40 2004,
the Security, Janitorial Services per F/S ₱2,183,573.02
Security & Janitorial CTA
Services 2,183,573.02 358,800.00 736,044.26 Security, Janitorial Services
First
Rent Expense 2,293,631.13 434,406.77 642,619.10 Divisi per Court’s Verification 736,044.26 1,447,528.76
on
Interest Expense 1,155,154.28 - 1,155,154.28
render ------------------
Professional & ed a Unsupported Rent Expenses
Management Fees 96,761.00 - - decisi
Repairs &
on, Rent Expenses per F/S ₱2,293,631.13
Maintenance 348,074.68 - 329,399.18 the
pertin Rent Expenses per Court’s
13th
Month pay & ent Verification 642,619.10 1,651,012.03
Bonuses 317,730.73 - 317,730.73 portio
n of ------------------
Loss on Fire 906,560.00 - -
which
Unsupported Management & Professional Fees 96,761.00
-------------------- -------------------- -------------------- is
Total P 12,216,452.34 P 926,264.17 P 3,314,004.95 hereu
============= ============= ============= Unsupported Repairs & Maintenance
nder
quoted, to wit: (₱348,074.68 - ₱329,399.18) 18,675.50

In view of all the foregoing verification, petitioner’s allowable deductions are Disallowed Loss on Fire & Theft 906,560.00
summarized below: ---------------

Apparently, petitioner is still liable for deficiency income tax in the reduced
Net Income P 8,956,554.65
amount of ₱4,536,687.15, computed as follows:
=============

Net Income Per Return ₱54,107.36 Income Tax Due Thereon P 3,134,794.13

Add: Overstatement of Gain/Loss on Auction Sales Less: Amount Paid 18,937.57

Gain/Loss on Auction Sales per F/S ₱4,914,967.50 ------------------

Gain/Loss on Auction Sales per Court’s Balance P 3,115,856.56

Verification 133,057.40 4,781,910.00
Add: 20% Interest until 7-26-00 1,420,830.59

20
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
------------------
TOTAL INCOME TAX DUE ₱4,536,687.15
=============
WHEREFORE, petitioner is ORDERED to PAY the respondent the amount
of ₱4,536,687.15 representing deficiency income tax for the year 1997, plus
20% delinquency interest computed from August 29, 2000 until full payment
thereof pursuant to Section 249 (C) of the National Internal Revenue Code.
However, the compromise penalties in the sum of ₱49,000.00 is hereby
CANCELLED for lack of legal basis.
SO ORDERED.5
After its motion for reconsideration was denied for lack of merit on February
18, 2005,6 Tambunting filed a petition for review in the CTA En Banc,
arguing that the First Division erred in disallowing its deductions on the
ground that it had not substantiated them by sufficient evidence.
On April 24, 2006, the CTA En Banc denied Tambunting’s petition for
review,7 disposing:
WHEREFORE, the Court en banc finds no reversible error to warrant the
reversal of the assailed Decision and Resolution promulgated on October 8,
2004 and February 11, 2005, respectively, the instant Petition for Review is
hereby DISMISSED. Accordingly, the aforesaid Decision and Resolution are
hereby AFFIRMED in toto.
SO ORDERED.
On June 29, 2006, the CTA En Banc also denied Tambunting’s motion for
reconsideration for its lack of merit.8
Issues
Hence, this appeal by petition for review on certiorari.
21
Tambunting argues that the CTA should have allowed its deductions because
it had been able to point out the provisions of law authorizing the deductions;
that it proved its entitlement to the deductions through all the documentary
and testimonial evidence presented in court;9 that the provisions of Section
34 (A)(1)(b) of the 1997 National Internal Revenue Code, governing the
types of evidence to prove a claim for deduction of expenses, were applicable
because the law took effect during the pendency of the case in the
CTA;10 that the CTA had allowed deductions for ordinary and necessary
expenses on the basis of cash vouchers issued by the taxpayer or
certifications issued by the payees evidencing receipt of interest on loans as
well as agreements relating to the imposition of interest;11 that it had thus
shown beyond doubt that it had incurred the losses in its auction sales; 12 and
that it substantially complied with the requirements of Revenue Regulations
No. 12-77 on the deductibility of its losses.13
On December 5, 2006, the Commissioner of Internal Revenue filed a
comment,14 stating that the conclusions of the CTA were entitled to
respect,15 due to its being a highly specialized body specifically created for
the purpose of reviewing tax cases;16 and that the petition involved factual
and evidentiary matters not reviewable by the Court in an appeal by
certiorari.17
On March 22, 2007, Tambunting reiterated its arguments in its reply.18
Ruling
The petition has no merit.
At the outset, the Court agrees with the CTA En Banc that because this case
involved assessments relating to transactions incurred by Tambunting prior
to the effectivity of Republic Act No. 8424 (National Internal Revenue Code
of 1997, or NIRC of 1997), the provisions governing the propriety of the
deductions was Presidential Decree 1158 (NIRC of 1977). In that regard, the
pertinent provisions of Section 29 (d) (2) & (3)of the NIRC of 1977 state:
xxxx
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
(2) By corporation. — In the case of a corporation, all losses actually
sustained and charged off within the taxable year and not
compensated for by insurance or otherwise.
(3) Proof of loss. — In the case of a non-resident alien individual or
foreign corporation, the losses deductible are those actually sustained
during the year incurred in business or trade conducted within the
Philippines, and losses actually sustained during the year in
transactions
entered into for profit in the Philippines although not connected with their
business or trade, when such losses are not compensated for by insurance or
otherwise. The Secretary of Finance, upon recommendation of the
Commissioner of Internal Revenue, is hereby authorized to promulgate rules
and regulations prescribing, among other things, the time and manner by
which the taxpayer shall submit a declaration of loss sustained from casualty
or from robbery, theft, or embezzlement during the taxable year: Provided,
That the time to be so prescribed in the regulations shall not be less than 30
days nor more than 90 days from the date of the occurrence of the casualty or
robbery, theft, or embezzlement giving rise to the loss.
The CTA En Banc ruled thusly:
To prove the loss on auction sale, petitioner submitted in evidence its
"Rematado" and "Subasta" books and the "Schedule of Losses on Auction
Sale". The "Rematado" book contained a record of items foreclosed by the
pawnshop while the "Subasta" book contained a record of the auction sale of
pawned items foreclosed.
However, as elucidated by the petitioner, the gain or loss on auction sale
represents the difference between the capital (the amount loaned to the
pawnee, the unpaid interest and other expenses incurred in connection with
such loan) and the price for which the pawned articles were sold, as reflected
in the "Subasta" Book. Furthermore, it explained that the amounts appearing
in the "Rematado" book do not reflect the total capital of petitioner as it
merely reflected the amounts loaned to the pawnee. Likewise, the amounts
appearing in the "Subasta" book, are not representative of the amount of sale
made during the "subastas" since not all articles are eventually sold and
disposed of by petitioner.
22
Petitioner submits that based on the evidence presented, it was able to show
beyond doubt that it incurred the amount of losses on auction sale claimed as
deduction from its gross income for the taxable year 1997. And that the
documents/records submitted in evidence as well as the facts contained
therein were neither contested nor controverted by the respondent, hence,
admitted.
xxxx
In this case, petitioner's reliance on the entries made in the "Subasta" book
were not sufficient to substantiate the claimed deduction of loss on auction
sale. As admitted by the petitioner, the contents in the "Rematado" and
"Subasta" books do not reflect the true amounts of the total capital and the
auction sale, respectively. Be that as it may, petitioner still failed to adduce
evidence to substantiate the other expenses alleged to have been incurred in
connection with the sale of pawned items.
As correctly held by the Court's Division in the assailed decision, and We
quote:
x x x The remaining evidence is neither conclusive to sustain its claim of loss
on auction sale in the aggregate amount of ₱4,915,967.50. While it appears
that the basis of respondent is not strong, petitioner, nevertheless, should not
rely on the weakness of such evidence but on the strength of its own
documents. The facts essential for the proper disposition of the said
controversy were available to the petitioner. Petitioner should have
endeavored to make the facts clear to this court. Sad to say, it failed to
dispute the same with clear and convincing proof. x x x19
We affirm the aforequoted ruling of the CTA En Banc.
The rule that tax deductions, being in the nature of tax exemptions, are to be
construed in strictissimi juris against the taxpayer is well settled.20 Corollary
to this rule is the principle that when a taxpayer claims a deduction, he must
point to some specific provision of the statute in which that deduction is
authorized and must be able to prove that he is entitled to the deduction
which the law allows.21 An item of expenditure, therefore, must fall squarely
within the language of the law in order to be deductible.22 A mere averment
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
that the taxpayer has incurred a loss does not automatically warrant a
deduction from its gross income.
As the CTA En Banc held, Tambunting did not properly prove that it had
incurred losses. The subasta books it presented were not the proper evidence
of such losses from the auctions because they did not reflect the true amounts
of the proceeds of the auctions due to certain items having been left unsold
after the auctions. The rematado books did not also prove the amounts of
capital because the figures reflected therein were only the amounts given to
the pawnees. It is interesting to note, too, that the amounts received by the
pawnees were not the actual values of the pawned articles but were only
fractions of the real values.
As to business expenses, Section 29 (a) (1) (A) of the NIRC of 1977
provides:
(a) Expenses. — (1) Business expenses.— (A) In general. — All ordinary
and necessary expenses paid or incurred during the taxable year in carrying
on any trade or business, including a reasonable allowance for salaries or
other compensation for personal services actually rendered; traveling
expenses while away from home in the pursuit of a trade, profession or
business, rentals or other payments required to be made as a condition to the
continued use or possession, for the purpose of the trade, profession or
business, of property to which the taxpayer has not taken or is not taking title
or in which he has no equity.
The requisites for the deductibility of ordinary and necessary trade or
business expenses, like those paid for security and janitorial services,
management and professional fees, and rental expenses, are that: (a) the
expenses must be ordinary and necessary; (b) they must have been paid or
incurred during the taxable year; (c) they must have been paid or incurred in
carrying on the trade or business of the taxpayer; and (d) they must be
supported by receipts, records or other pertinent papers.23
In denying Tambunting’s claim for deduction of its security and janitorial
expenses, management and professional fees, and its rental expenses, the
CTA En Banc explained:
23
Contrary to petitioner’s contention, the security/janitorial expenses paid to
Pathfinder Investigation were not duly substantiated. The certification issued
by Mr. Balisado was not the proper document required by law to substantiate
its expenses. Petitioner should have presented the official receipts or invoices
to prove its claim as provided for under Section 238 of the National Internal
Revenue Code of 1977, as amended, to wit:
"SEC. 238. Issuance of receipts or sales or commercial invoices. — All
persons subject to an internal revenue tax shall for each sale or transfer of
merchandise or for services rendered valued at ₱25.00 or more, issue receipts
or sales or commercial invoices, prepared at least in duplicate, showing the
date of transaction, quantity, unit cost and description of merchandise or
nature of service; Provided, That in the case of sales, receipts or transfers in
the amount of ₱100.00 or more, or, regardless of amount, where the sale or
transfer is made by persons subject to value-added tax to other persons also
subject to value-added tax; or, where the receipts is issued to cover payment
made as rentals, commissions, compensation or fees, receipts or invoices
shall be issued which shall show the name, business style, if any, and address
of the purchaser, customer, or client. The original of each receipt or invoice
shall be issued to the purchases, customer or client at the time the transaction
is effected, who, if engaged in business or in the exercise of profession, shall
keep and preserve the same in his place of business for a period of 3 years
from the close of the taxable year in which such invoice or receipt was
issued, while the duplicate shall be kept and preserved by the issuer, also in
his place of business, for a like period.
With regard to the misclassified items of expenses, petitioner's statements
were self-serving, likewise it failed to substantiate its allegations by clear and
convincing evidence as provided under the foregoing provision of law.
Bearing in mind the principle in taxation that deductions from gross income
partake the nature of tax exemptions which are construed in strictissimi juris
against the taxpayer, the Court en banc is not inclined to believe the self-
serving statements of petitioner regarding the misclassified items of office
supplies, advertising and rent expenses.
Among the expenses allegedly incurred, courts may consider only those
supported by credible evidence and which appear to have been genuinely
incurred in connection with the trade or business of the taxpayer.24
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
xxxx
As previously discussed, the proper substantiation requirement for an
expense to be allowed is the official receipt or invoice. While the rental
payments were subjected to the applicable expanded withholding taxes, such
returns are not the documents required by law to substantiate the rental
expense. Petitioner should have submitted official receipts to support its
claim.
Moreover, the issue on the submission of cash vouchers as evidence to prove
expenses incurred has been addressed by this Court in the assailed
Resolution, to wit:
"The trend then was to allow deductions based on cash vouchers which are
signed by the payees. It bears to note that the cases cited by petitioner are
pronouncements by this Court in 1980, 1982 and 1989.
However, latest jurisprudence has deviated from such interpretation of the
law. Thus, this Court held in the case of Pilmico-Mauri Foods Corporation
vs. Commissioner of Internal Revenue C.T.A. Case No. 6151, December 15,
2004;
[P]etitioner’s contention that the NIRC of 1977 did not impose substantiation
requirements on deductions from gross income is bereft of merit. Section 238
of the 1977 Tax Code [now Section 237] provides:
xxxx
From the foregoing provision of law, a person who is subject to an internal
revenue tax shall issue receipts, sales or commercial invoices, prepared at
least in duplicate. The provision likewise imposed a responsibility upon the
purchaser to keep and preserve the original copy of the invoice or receipt for
a period of three years from the close of the taxable year in which the invoice
or receipt was issued. The rationale behind the latter requirement is the duty
of the taxpayer to keep adequate records of each and every transaction
entered into in the conduct of its business. So that when their books of
accounts are subjected to a tax audit examination, all entries therein could be
shown as adequately supported and proven as legitimate business
24
transactions. Hence, petitioner’s claim that the NIRC of 1977 did not require
substantiation requirements is erroneous."
In order that the cash vouchers may be given probative value, these must be
validated with official receipts.25
xxxx
Petitioner’s management and professional fees were disallowed as these were
supported merely by cash vouchers, which the Court’s Division correctly
found to have little probative value.26
Again, we affirm the foregoing holding of the CTA En Banc for the reasons
therein stated. To reiterate, 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.27 Tambunting did not discharge its burden of substantiating its
claim for deductions due to the inadequacy of its documentary support of its
claim. Its reliance on withholding tax returns, cash vouchers, lessor’s
certifications, and the contracts of lease was futile because such documents
had scant probative value. As the CTA En Banc succinctly put it, the law
required Tambunting to support its claim for deductions with the
corresponding official receipts issued by the service providers concerned.
Regarding proof of loss due to fire, the text of Section 29(d) (2) & (3) of P.D.
1158 (NIRC of 1977) then in effect, is clear enough, to wit:
(2) By corporation. — In the case of a corporation, all losses actually
sustained and charged off within the taxable year and not
compensated for by insurance or otherwise.
(3) Proof of loss. — In the case of a non-resident alien individual or
foreign corporation, the losses deductible are those actually sustained
during the year incurred in business or trade conducted within the
Philippines, and losses actually sustained during the year in
transactions entered into for profit in the Philippines although not
connected with their business or trade, when such losses are not
compensated for by insurance or otherwise. The Secretary of
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Finance, upon recommendation of the Commissioner of Internal
Revenue, is hereby authorized to promulgate rules and regulations
prescribing, among other things, the time and manner by which the
taxpayer shall submit a declaration of loss sustained from casualty or
from robbery, theft, or embezzlement during the taxable year:
Provided, That the time to be so prescribed in the regulations shall
not be less than 30 days nor more than 90 days from the date of the
occurrence of the casualty or robbery, theft, or embezzlement giving
rise to the loss.
The implementing rules for deductible losses are found in Revenue
Regulations No. 12-77, as follows:
SECTION 1. Nature of deductible losses.— Any loss arising from fires,
storms or other casualty, and from robbery, theft or embezzlement, is
allowable as a deduction under Section 30 (d) for the taxable year in which
the loss is sustained. The term "casualty" is the complete or partial
destruction of property resulting from an identifiable event of a sudden,
unexpected, or unusual nature. It denotes accident, some sudden invasion by
hostile agency, and excludes progressive deterioration through steadily
operating cause. Generally, theft is the criminal appropriation of another’s
property for the use of the taker. Embezzlement is the fraudulent
appropriation of another's property by a person to whom it has been entrusted
or into whose hands it has lawfully come.
SECTION 2. Requirements of substantiation. — The taxpayer bears the
burden of proving and substantiating his claim for deduction for losses
allowed under Section 30 (d) and should comply with the following
substantiation requirements:
(a) A declaration of loss which must be filed with the Commissioner
of Internal Revenue or his deputies within a certain period prescribed
in these regulations after the occurrence of the casualty, robbery,
theft or embezzlement.
(b) Proof of the elements of the loss claimed, such as the actual
nature and occurrence of the event and amount of the loss.
25
SECTION 3. Declaration of loss. — Within forty-five days after the date of
the occurrence of casualty or robbery, theft or embezzlement, a taxpayer who
sustained loss therefrom and who intends to claim the loss as a deduction for
the taxable year in which the loss was sustained shall file a sworn declaration
of loss with the nearest Revenue District Officer. The sworn declaration of
loss shall contain, among other things, the following information:
(a) The nature of the event giving rise to the loss and the time of its
occurrence;
(b) A description of the damaged property and its location;
(c) The items needed to compute the loss such as cost or other basis
of the property; depreciation allowed or allowable if any; value of
property before and after the event; cost of repair;
(d) Amount of insurance or other compensation received or
receivable.
Evidence to support these items should be furnished, if available. Examples
are purchase contracts and deeds, receipted bills for improvements, and
pictures and competent appraisals of the property before and after the
casualty.
SECTION 4. Proof of loss.— (a) In general. — The declaration of loss, being
one of the essential requirements of substantiation of a claim for a loss
deduction, is subject to verification and does not constitute sufficient proof of
the loss that will justify its deductibility for income tax purposes. Therefore,
the mere filing of a declaration of loss does not automatically entitle the
taxpayer to deduct the alleged loss from gross income. The failure, however,
to submit the said declaration of loss within the period prescribed in these
regulations will result in the disallowance of the casualty loss claimed in the
taxpayer's income tax return. The taxpayer should therefore file a declaration
of loss and should be prepared to support and substantiate the information
reported in the said declaration with evidence which he should gather
immediately or as soon as possible after the occurrence of the casualty or
event causing the loss.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

xxxx Tambunting to submit the sworn declaration of loss mandated by Revenue

(b) Casualty loss. — Photographs of the property as it existed before it was
damaged will be helpful in showing the condition and value of the property
prior to the casualty. Photographs taken after the casualty which show the
extent of damage will be helpful in establishing the condition and value of
the property after it was damaged. Photographs showing the condition and
value of the property after it was repaired, restored or replaced may also be
helpful.
Furthermore, since the valuation of the property is of extreme importance in
determining the amount of loss sustained, the taxpayer should be prepared to
come forward with documentary proofs, such as cancelled checks, vouchers,
receipts and other evidence of cost.
Regulations 12-77. Its failure to do so was prejudicial to the claim because
the sworn declaration of loss was necessary to forewarn the BIR that it had
suffered a loss whose extent it would be claiming as a deduction of its tax
liability, and thus enable the BIR to conduct its own investigation of the
incident leading to the loss. Indeed, the documents Tambunting submitted to
the BIR could not serve the purpose of their submission without the sworn
declaration of loss.
WHEREFORE, the Court AFFIRMS the decision promulgated on April 24,
2006; and ORDERS petitioner to pay the costs of suit.
SO ORDERED.

The foregoing evidence should be kept by the taxpayer as part of his tax
records and be made available to a revenue examiner, upon audit of his
income tax return and the declaration of loss.

(c) Robbery, theft or embezzlement losses. - To support the deduction for

losses arising from robbery, theft or embezzlement, the taxpayer must prove
by credible. evidence all the elements of the loss, the amount of the loss, and
the proper year of the deduction. The taxpayer bears the burden of proof, and
no deduction will be allowed unless he shows the property was stolen, rather
than misplaced or lost. A mere disappearance of property is not enough, nor
is a mere error or shortage in accounts.

Failure to report theft or robbery to the police may be a factor against the
taxpayer. On the other hand, a mere report of alleged theft or robbery to the
police authorities is not a conclusive proof of the loss arising therefrom.
(Bold underscoring supplied for emphasis)

In the context of the foregoing rules, the CT A En Bane aptly rejected Tam
bunting's claim for deductions due to losses from fire and theft. The
documents it had submitted to support the claim, namely: (a) the certification
from the Bureau of Fire Protection in Malolos; (b) the certification from the
Police Station in Malolos; (c) the accounting entry for the losses; and (d) the
list of properties lost, were not enough. What were required were for

26
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
INTEREST
G.R. No. L-13912 September 30, 1960
THE COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
CONSUELO L. VDA. DE PRIETO, respondent.
Office of the Solicitor General Edilberto Barot, Solicitor F.R. Rosete and
Special Atty. B. Gatdula, Jr. for petitioner.
Formilleza and Latorre for respondent.
GUTIERREZ DAVID, J.:
This is an appeal from a decision of the Court of tax Appeals reversing the
decision of the Commissioner of Internal Revenue which held herein
respondent Consuelo L. Vda. de Prieto liable for the payment of the sum of
P21,410.38 as deficiency income tax, plus penalties and monthly interest.
The case was submitted for decision in the court below upon a stipulation of
facts, which for brevity is summarized as follows: On December 4, 1945, the
respondent conveyed by way of gifts to her four children, namely, Antonio,
Benito, Carmen and Mauro, all surnamed Prieto, real property with a total
assessed value of P892,497.50. After the filing of the gift tax returns on or
about February 1, 1954, the petitioner Commissioner of Internal Revenue
appraised the real property donated for gift tax purposes at P1,231,268.00,
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
respondent on April 29, 1954, the sum of P55,978.65 represents the total
interest on account of deliquency. This sum of P55,978.65 was claimed as
deduction, among others, by respondent in her 1954 income tax return.
Petitioner, however, disallowed the claim and as a consequence of such
disallowance assessed respondent for 1954 the total sum of P21,410.38 as
deficiency income tax due on the aforesaid P55,978.65, including interest up
to March 31, 1957, surcharge and compromise for the late payment.
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
27
an interest deduction should have been paid or 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 was paid within the year it is
sought to be declared. The only question to be determined, as stated by the
parties, is whether or not such interest was paid upon an indebtedness within
the contemplation of section 30 (b) (1) of the Tax Code, the pertinent part of
which reads:
SEC. 30 Deductions from gross income. — In computing net income
there shall be allowed as deductions —
xxx xxx xxx
(b) Interest:
(1) In general. — 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.
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 unconditional and legally enforceable obligation for the payment of
money.1awphîl.nèt (Federal Taxes Vol. 2, p. 13,019, Prentice-Hall, Inc.;
Merten's Law of Federal Income Taxation, Vol. 4, p. 542.) Within the
meaning of that definition, it is apparent that a tax may be considered an
indebtedness. As stated by this Court in the case of Santiago
Sambrano vs. Court of Tax Appeals and Collector of Internal Revenue (101
Phil., 1; 53 Off. Gaz., 4839) —
Although taxes already due have not, strictly speaking, the same
concept as debts, they are, however, obligations that may be
considered as such.
The term "debt" is properly used in a comprehensive sense as
embracing not merely money due by contract but whatever one is
bound to render to another, either for contract, or the requirement of
the law. (Camben vs. Fink Coule and Coke Co. 61 LRA 584)
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Where statute imposes a personal liability for a tax, the tax becomes,
at least in a board sense, a debt. (Idem).
A tax is a debt for which a creditor's bill may be brought in a proper
case. (State vs. Georgia Co., 19 LRA 485).
It follows that the interest paid by herein respondent for the late payment of
her donor's tax is deductible from her gross income under section 30(b) of the
Tax Code above quoted.
The above conclusion finds support in the established jurisprudence in the
United States after whose laws our Income Tax Law has been patterned.
Thus, under sec. 23(b) of the Internal Revenue Code of 1939, as amended 1 ,
which contains similarly worded provisions as sec. 30(b) of our Tax Code,
the uniform ruling is that interest on taxes is interest on indebtedness and is
deductible. (U.S. vs. Jaffray, 306 U.S. 276. See also Lustig vs. U.S., 138 F.
Supp. 870; Commissioner of Internal Revenue vs. Bryer, 151 F. 2d 267, 34
AFTR 151; Penrose vs. U.S. 18 F. Supp. 413, 18 AFTR 1289; Max Thomas
Davis, et al. vs. Commissioner of Internal Revenue, 46 U.S. Boared of Tax
Appeals Reports, p. 663, citing U.S. vs. Jaffray, 6 Tax Court of United States
Reports, p. 255; Armour vs. Commissioner of Internal Revenue, 6 Tax Court
of the United States Reports, p. 359; The Koppers Coal
Co. vs. Commissioner of Internal Revenue, 7 Tax Court of United States
Reports, p. 1209; Toy vs. Commissioner of Internal Revenue;
Lucas vs. Comm., 34 U.S. Board of Tax Appeals Reports, 877; Evens and
Howard Fire Brick Co. vs. Commissioner of Internal Revenue, 3 Tax Court
of United States Reports, p. 62). The rule applies even though the tax is
nondeductible. (Federal Taxes, Vol. 2, Prentice Hall, sec. 163, 13,022; see
also Merten's Law of Federal Income Taxation, Vol. 5, pp. 23-24.)
To sustain the proposition that the interest payment in question is not
deductible for the purpose of computing respondent's net income, petitioner
relies heavily on section 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 below, however, held section 80 as inapplicable to
the instant case because while it implements sections 30(c) of the Tax Code
governing deduction of taxes, the respondent taxpayer seeks to come under
28
section 30(b) of the same Code providing for deduction of interest on
indebtedness. We find the lower court's ruling to be correct. Contrary to
petitioner's belief, the portion of section 80 of Revenue Regulation No. 2
under consideration has been part and parcel of the development to the law
on deduction of taxes in the United States. (See Capital Bldg. and Loan
Assn. vs. Comm., 23 BTA 848. Thus, Mertens in his treatise says: "Penalties
are to be distinguished from taxes and they are not deductible under the
heading of taxs." . . . Interest on state taxes is not deductible as taxes." (Vol.
5, Law on Federal Income Taxation, pp. 22-23, sec. 27.06, citing cases.) This
notwithstanding, courts in that jurisdiction, however, have invariably held
that interest on deficiency taxes are deductible, not as taxes, but as interest.
(U.S. vs. Jaffray, et al., supra; see also Mertens, sec. 26.09, Vol. 4, p. 552,
and cases cited therein.) Section 80 of Revenue Regulation No. 2, therefore,
merely incorporated the established application of 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 delinquent taxes, penalties
and surcharges.
To give to the quoted portion of section 80 of our Income Tax Regulations
the meaning that the petitioner gives it would run counter to the provision of
section 30(b) of the Tax Code and the construction given to it by courts in the
United States. Such effect would thus make the regulation 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. 315;
Miller vs. U.S., 294 U.S. 435.) As already stated, section 80 implements only
section 30(c) of the Tax Code, or the provision allowing deduction of taxes,
while herein respondent seeks to be allowed deduction under section 30(b),
which provides for deduction of interest on indebtedness.
In conclusion, we are of the opinion and so hold that although interest
payment for delinquent taxes is not deductible as tax under Section 30(c) of
the Tax Code and section 80 of the Income Tax Regulations, the taxpayer is
not precluded thereby from claiming said interest payment as deduction
under section 30(b) of the same Code.
In view of the foregoing, the decision sought to be reviewed is affirmed,
without pronouncement as to costs.
INTEREST
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
G.R. Nos. 106949-50. December 1, 1995.*
PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES
(PICOP), petitioner, vs. COURT OF APPEALS, COMMISSIONER OF
INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.
G.R. Nos. 106984-85. December 1, 1995.*
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. PAPER
INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT
OF APPEALS AND THE COURT OF TAX APPEALS, respondents.
Taxation; Picop’s tax exemption under R.A. No. 5186, as amended,
does not include exemption from the thirty-five (35%) percent transaction
tax.—We agree with the CTA and the Court of Appeals that Picop’s tax
exemption under R.A. No. 5186, as amended, does not include exemption
from the thirty-five percent (35%) transaction tax. In the first place, the
thirty-five percent (35%) transaction tax is an income tax, that is, it is a tax
on the interest income of the lenders or creditors.
Same; Transaction tax is an income tax and as such falls outside the
scope of the tax exemption granted to registered pioneer enterprises by
Section 8 of R.A. 5186, as amended.—It is thus clear that the transaction tax
is an income tax and as such, in any event, falls outside the scope of the tax
exemption granted to registered pioneer enterprises by Section 8 of R.A. No.
5186, as amended Picop was the withholding agent, obliged to withhold
thirty-five percent (35%) of the interest payable to its lenders and to remit the
amounts so withheld to the Bureau of Internal Revenue (“BIR”). As a
withholding agent, Picop is made personally liable for the thirty-five percent
(35%) transaction tax and if it did not actually withhold thirty-five percent
(35%) of the interest monies it had paid to its lenders, Picop had only itself to
blame.
Same; P.D. No. 1154 is not to be given retroactive effect by imposing
the thirty five percent transaction tax in respect of interest earnings which
accrued before the effectivity date of P.D. No. 1154.—P.D. No. 1154 is not,
in other words, to be given retroactive effect by imposing the thirty-five
percent (35%) transaction tax in respect of interest earnings which accrued
before the effectivity date of P.D. No. 1154, there being nothing in the statute
29
to suggest that the legislative authority intended to bring about such
retroactive imposition of the tax.
Same; P.D. No. 1154 did not itself impose nor did it expressly authorize
the imposition of a surcharge and penalty interest in case of failure to pay
the thirty-five percent transaction tax when due.—P.D. No 1154 did not itself
impose, nor did it expressly authorize the imposition of, a surcharge and
penalty interest in case of failure to pay the thirtyfive percent (35%)
transaction tax when due Neither did Section 210 (b) of the 1977 Tax Code
which re-enacted Section 195-C inserted into the Tax Code by P.D. No.
1154.
Same; The thirty-five percent transaction tax is not one of the taxes in
respect of which Section 51(e) authorized the imposition of surcharge and
interest and Section 71 the imposition of a fraud surcharge.—It will be seen
that Section 51 (c)(1) and (e)(1) and (3), of the 1977 Tax Code, authorize the
imposition of surcharge and interest only in respect of a “tax imposed by this
Title,” that is to say, Title II on “Income Tax.” It will also be seen that
Section 72 of the 1977 Tax Code imposes a surcharge only in case of failure
to file a return or list “required by this Title,” that is,Title II on “Income
Tax.” The thirty-five percent (35%) transaction tax is, however, imposed in
the 1977 Tax Code by Section 210 (b) thereof which Section is embraced in
Title V on “Taxes on Business” of that Code. Thus, while the thirty-five
percent (35%) transaction tax is in truth a tax imposed
on interest income earned by lenders or creditors purchasing commercial
paper on the money market, the relevant provisions, i.e., Section 210 (b),
were not inserted in Title II of the 1977 Tax Code. The end result is that the
thirty-five percent (35%) transaction tax is not one of the taxes in respect of
which Section 51 (e) authorized the imposition of surcharge and interest and
Section 72 the imposition of a fraud surcharge.
Same; Tax Exemptions; Tax exemptions are strictly construed.—Tax
exemptions are, to be sure, to be “strictly construed,” that is, they are not to
be extended beyond the ordinary and reasonable intendment of the language
actually used by the legislative authority in granting the exemption. The
issuance of debenture bonds is certainly conceptually distinct from pulping
and paper manufacturing operations. But no one contends that issuance of
bonds was a principal or regular business activity of Picop; only banks or
other financial institutions are in the regular business of raising money by
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

issuing bonds or other instruments to the general public. We consider that the
actual dedication of the proceeds of the bonds to the carrying out of Picop’s
registered operations constituted a sufficient nexus with such registered PETITIONS for review of a decision of the Court of Appeals.
operations so as to exempt Picop from stamp taxes ordinarily imposed upon
or in connection with issuance of such bonds. We agree, therefore, with the The facts are stated in the opinion of the Court.
Court of Appeals on this matter that the CTA and the CIR had erred in Ma. Lourdes A. Gadioma for Paper Industries Corporation of the
rejecting Picop’s claim for exemption from stamp taxes. Philippines.

Same; Same; The rule in respect of corporations not registered with the FELICIANO, J.:
BOI as a preferred pioneer enterprise is that net operating losses cannot be
carried over.—It is important to note at the outset that in our jurisdiction, the The Paper Industries Corporation of the Philippines ("Picop"), which is
ordinary rule—that is, the rule applicable in respect of petitioner in G.R. Nos. 106949-50 and private respondent in G.R. Nos.
corporations not registered with the BOI as a preferred pioneer enterprise—is 106984-85, is a Philippine corporation registered with the Board of
that net operating losses cannot be carried over. Under our Tax Code, both Investments ("BOI") as a preferred pioneer enterprise with respect to its
in 1977 and at present, losses may be deducted from gross income only if integrated pulp and paper mill, and as a preferred non-pioneer enterprise with
such losses were actually sustained in the same year that they are deducted or respect to its integrated plywood and veneer mills.
charged off.
On 21 April 1983, Picop received from the Commissioner of Internal
Same; Same; Losses must be deducted against current income in the
Revenue ("CIR") two (2) letters of assessment and demand both dated 31
taxable year when such losses were incurred.—It is thus clear that under our
March 1983: (a) one for deficiency transaction tax and for documentary and
law, and outside the special realm of BOI-registered enterprises, there is no
science stamp tax; and (b) the other for deficiency income tax for 1977, for
such thing as a carry-over of net operating loss. To the contrary, losses must
an aggregate amount of P88,763,255.00. These assessments were computed
be deducted against current income in the taxable year when such losses
as follows:
were incurred. Moreover, such losses may be charged off only against
income earned in the same taxable year when the losses were incurred.
Transaction Tax
Same; Same; A taxpayer has the burden of proving entitlement to a
claimed deduction.—A taxpayer has the burden of proving entitlement to a Interest payments on
claimed deduction. In the instant case, even Picop’s own vouchers were not
submitted in evidence and the BIR Examiners denied that such vouchers and money market
other documents had been exhibited to them. Moreover, cash vouchers can
only confirm the fact of disbursement but not necessarily the purpose thereof. borrowings P 45,771,849.00
The best 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 also failed to 35% Transaction tax due
explain the loss thereof, assuming they had existed before. Under the best
evidence rule, therefore, the testimony of Picop’s employee was inadmissible thereon 16,020,147.00
and was in any case entitled to very little, if any, credence.
Add: 25% surcharge 4,005,036.75
30
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

—————— ( P200 ) P 150,000.00

T o t a l P 20,025,183.75 Science Stamps Tax Due

Add: (P0.30 x P100,000,000 )

14% int. fr. ( P200 ) P 150,000.00

1-20-78 to ——————

7-31-80 P 7,093,302.57 T o t a l P 300,000.00

20% int, fr. Add: Compromise for

8-1-80 to non-affixture 300.00

3-31-83 10,675,523.58 ——————

—————— 300,300.00

17,768,826.15 ——————

—————— TOTAL AMOUNT DUE AND COLLECTIBLE P

38,094,309.90
P 37,794,009.90
===========
Documentary and Science Stamps Tax
Deficiency Income Tax for 1977
Total face value of
Net income per return P 258,166.00
debentures P100,000,000.00
Add: Unallowable deductions
Documentary Stamps
1) Disallowed deductions
Tax Due
availed of under
(P0.30 x P100,000.000 )

31
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

R.A. No. 5186 P 44,332,980.00 Add:

2) Capitalized interest 14% int. fr.

expenses on funds 4-15-78 to

used for acquisition 7-31-81 P 11,128,503.56

of machinery & other 20% int. fr.

equipment 42,840,131.00 8-1-80 to

3) Unexplained financial 4-15-81 4,886,242.34

guarantee expense 1,237,421.00 ——————

4) Understatement P16,014,745.90

of sales 2,391,644.00 ——————

5) Overstatement of TOTAL AMOUNT DUE AND COLLECTIBLE P

50,668,946.90 1
cost of sales 604,018.00
===========
——————
On 26 April 1983, Picop protested the assessment of deficiency transaction
P91,406,194.00 tax and documentary and science stamp taxes. Picop also protested on 21
May 1983 the deficiency income tax assessment for 1977. These protests
Net income per investigation P91,664,360.00 were not formally acted upon by respondent CIR. On 26 September 1984, the
CIR issued a warrant of distraint on personal property and a warrant of levy
Income tax due thereon 34,734,559.00 on real property against Picop, to enforce collection of the contested
assessments; in effect, the CIR denied Picop's protests.
Less: Tax already assessed per return 80,358.00
Thereupon, Picop went before the Court of Tax Appeals ("CTA") appealing
—————— the assessments. After trial, the CTA rendered a decision dated 15 August
1989, modifying the findings of the CIR and holding Picop liable for the
reduced aggregate amount of P20,133,762.33, which was itemized in the
Deficiency P34,654,201.00
dispositive portion of the decision as follows:
32
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
35% Transaction Tax P 16,020,113.20
Documentary & Science
Stamp Tax 300,300.00
Deficiency Income Tax Due 3,813,349.33
——————
TOTAL AMOUNT DUE AND PAYABLE P
20,133,762.53 2
===========
Picop and the CIR both went to the Supreme Court on separate Petitions for
Review of the above decision of the CTA. In two (2) Resolutions dated 7
February 1990 and 19 February 1990, respectively, the Court referred the
two (2) Petitions to the Court of Appeals. The Court of Appeals consolidated
the two (2) cases and rendered a decision, dated 31 August 1992, which
further reduced the liability of Picop to P6,338,354.70. The dispositive
portion of the Court of Appeals decision reads as follows:
WHEREFORE, the appeal of the Commissioner of Internal
Revenue is denied for lack of merit. The judgment against
PICOP is modified, as follows:
1. PICOP is declared liable for the 35% transaction tax in the
amount of P3,578,543.51;
2. PICOP is absolved from the payment of documentary and
science stamp tax of P300,000.00 and the compromise
penalty of P300.00;
3. PICOP shall pay 20% interest per annum on the
deficiency income tax of P1,481,579.15, for a period of three
(3) years from 21 May 1983, or in the total amount of
33
P888,947.49, and a surcharge of 10% on the latter amount,
or P88,984.75.
No pronouncement as to costs.
SO ORDERED.
Picop and the CIR once more filed separate Petitions for Review before the
Supreme Court. These cases were consolidated and, on 23 August 1993, the
Court resolved to give due course to both Petitions in G.R. Nos. 106949-50
and 106984-85 and required the parties to file their Memoranda.
Picop now maintains that it is not liable at all to pay any of the assessments
or any part thereof. It assails the propriety of the thirty-five percent (35%)
deficiency transaction tax which the Court of Appeals held due from it in the
amount of P3,578,543.51. Picop also questions the imposition by the Court
of Appeals of the deficiency income tax of P1,481,579.15, resulting from
disallowance of certain claimed financial guarantee expenses and claimed
year-end adjustments of sales and cost of sales figures by Picop's external
auditors. 3
The CIR, upon the other hand, insists that the Court of Appeals erred in
finding Picop not liable for surcharge and interest on unpaid transaction tax
and for documentary and science stamp taxes and in allowing Picop to claim
as deductible expenses:
(a) the net operating losses of another corporation (i.e.,
Rustan Pulp and Paper Mills, Inc.); and
(b) interest payments on loans for the purchase of machinery
and equipment.
The CIR also claims that Picop should be held liable for interest at
fourteen percent (14%) per annum from 15 April 1978 for three (3)
years, and interest at twenty percent (20%) per annum for a
maximum of three (3) years; and for a surcharge of ten percent
(10%), on Picop's deficiency income tax. Finally, the CIR contends
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
that Picop is liable for the corporate development tax equivalent to
five percent (5%) of its correct 1977 net income.
The issues which we must here address may be sorted out and grouped in the
following manner:
I. Whether Picop is liable for:
(1) the thirty-five percent (35%) transaction tax;
(2) interest and surcharge on unpaid transaction tax; and
(3) documentary and science stamp taxes;
II. Whether Picop is entitled to deductions against income
of:
(1) interest payments on
loans for the purchase of
machinery and equipment;
(2) net operating losses
incurred by the Rustan Pulp
and Paper Mills, Inc.; and
(3) certain claimed financial guarantee expenses; and
III. (1) Whether Picop had understated its
sales and overstated its cost of sales for
1977; and
(2) Whether Picop is liable
for the corporate
development tax of five
percent (5%) of its net
income for 1977.
We will consider these issues in the foregoing sequence.
34
I.
(1) Whether Picop is liable
for the thirty-five percent
(35%) transaction tax.
With the authorization of the Securities and Exchange Commission, Picop
issued commercial paper consisting of serially numbered promissory notes
with the total face value of P229,864,000.00 and a maturity period of one (1)
year, i.e., from 24 December 1977 to 23 December 1978. These promissory
notes were purchased by various commercial banks and financial institutions.
On these promissory notes, Picop paid interest in the aggregate amount of
P45,771,849.00. In respect of these interest payments, the CIR required
Picop to pay the thirty-five percent (35%) transaction tax.
The CIR based this assessment on Presidential Decree No. 1154 dated 3 June
1977, which reads in part as follows:
Sec. 1. The National Internal Revenue Code, as amended, is
hereby further amended by adding a new section thereto to
read as follows:
Sec. 195-C. Tax on certain interest. — There shall be levied,
assessed, collected and paid on every commercial paper
issued in the primary market as principal instrument, a
transaction tax equivalent to thirty-five percent (35%) based
on the gross amount of interest thereto as defined hereunder,
which shall be paid by the borrower/issuer: Provided,
however, that in the case of a long-term commercial paper
whose maturity exceeds more than one year, the borrower
shall pay the tax based on the amount of interest
corresponding to one year, and thereafter shall pay the tax
upon accrual or actual payment (whichever is earlier) of the
untaxed portion of the interest which corresponds to a period
not exceeding one year.
The transaction tax imposed in this section shall be a final
tax to be paid by the borrower and shall be allowed as a
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
deductible item for purposes of computing the borrower's
taxable income.
For purposes of this tax —
(a) "Commercial paper" shall be defined as an instrument
evidencing indebtedness of any person or entity, including
banks and non-banks performing quasi-banking functions,
which is issued, endorsed, sold, transferred or in any manner
conveyed to another person or entity, either with or without
recourse and irrespective of
maturity. Principally, commercial papers are promissory
notes and/or similar instruments issued in the primary
market and shall not include repurchase agreements,
certificates of assignments, certificates of participations, and
such other debt instruments issued in the secondary market.
(b) The term "interest" shall mean the difference between
what the principal borrower received and the amount it paid
upon maturity of the commercial paper which shall, in no
case, be lower than the interest rate prevailing at the time of
the issuance or renewal of the commercial paper. Interest
shall be deemed synonymous with discount and shall include
all fees, commissions, premiums and other payments which
form integral parts of the charges imposed as a consequence
of the use of money.
In all cases, where no interest rate is stated or if the rate
stated is lower than the prevailing interest rate at the time of
the issuance or renewal of commercial paper, the
Commissioner of Internal Revenue, upon consultation with
the Monetary Board of the Central Bank of the Philippines,
shall adjust the interest rate in accordance herewith, and
assess the tax on the basis thereof.
The tax herein imposed shall be remitted by the borrower to
the Commissioner of Internal Revenue or his Collection
Agent in the municipality where such borrower has its
principal place of business within five (5) working days from
35
the issuance of the commercial paper. In the case of long
term commercial paper, the tax upon the untaxed portion of
the interest which corresponds to a period not exceeding one
year shall be paid upon accrual payment, whichever is
earlier. (Emphasis supplied)
Both the CTA and the Court of Appeals sustained the assessment of
transaction tax.
In the instant Petition, Picop reiterates its claim that it is exempt from the
payment of the transaction tax by virtue of its tax exemption under R.A. No.
5186, as amended, known as the Investment Incentives Act, which in the
form it existed in 1977-1978, read in relevant part as follows:
Sec. 8. Incentives to a Pioneer Enterprise. In addition to the
incentives provided in the preceding section, pioneer
enterprises shall be granted the following incentive benefits:
(a) Tax Exemption. Exemption from all taxes under the
National Internal Revenue Code, except income tax, from
the date the area of investment is included in the Investment
Priorities Plan to the following extent:
(1) One hundred per cent (100%) for the first five years;
(2) Seventy-five per cent (75%) for the sixth through the
eighth years;
(3) Fifty per cent (50%) for the ninth and tenth years;
(4) Twenty per cent (20%) for the eleventh and twelfth
years; and
(5) Ten per cent (10%) for the thirteenth through the
fifteenth year.
xxx xxx xxx 4
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
We agree with the CTA and the Court of Appeals that Picop's tax exemption
under R.A. No. 5186, as amended, does not include exemption from the
thirty-five percent (35%) transaction tax. In the first place, the thirty-five
percent (35%) transaction tax 5 is an income tax, that is, it is a tax on the
interest income of the lenders or creditors. In Western Minolco
Corporation v. Commissioner of Internal Revenue, 6 the petitioner
corporation borrowed funds from several financial institutions from June
1977 to October 1977 and paid the corresponding thirty-five (35%)
transaction tax thereon in the amount of P1,317,801.03, pursuant to Section
210 (b) of the 1977 Tax Code. Western Minolco applied for refund of that
amount alleging it was exempt from the thirty-five (35%) transaction tax by
reason of Section 79-A of C.A. No. 137, as amended, which granted new
mines and old mines resuming operation "five (5) years complete tax
exemptions, except income tax, from the time of its actual bonafide orders
for equipment for commercial production." In denying the claim for refund,
this Court held:
The petitioner's contentions deserve scant consideration. The
35% transaction tax is imposed on interest income from
commercial papers issued in the primary money
market. Being a tax on interest, it is a tax on income.
As correctly ruled by the respondent Court of Tax Appeals:
Accordingly, we need not and do not think it
necessary to discuss further the nature of the
transaction tax more than to say that the
incipient scheme in the issuance of Letter of
Instructions No. 340 on November 24, 1975
(O.G. Dec. 15, 1975), i.e., to achieve
operational simplicity and effective
administration in capturing the interest-
income "windfall" from money market
operations as a new source of revenue, has
lost none of its animating principle in
parturition of amendatory Presidential
Decree No. 1154, now Section 210 (b) of the
Tax Code. The tax thus imposed is actually
a tax on interest earnings of the lenders or
36
placers who are actually the taxpayers in
whose income is imposed. Thus "the
borrower withholds the tax of 35% from the
interest he would have to pay the lender so
that he (borrower) can pay the 35% of the
interest to the Government." (Citation
omitted) . . . . Suffice it to state that the
broad consensus of fiscal and monetary
authorities is that "even if nominally, the
borrower is made to pay the tax, actually,
the tax is on the interest earning of the
immediate and all prior lenders/placers of
the money. . . ." (Rollo, pp. 36-37)
The 35% transaction tax is an income tax on interest
earnings to the lenders or placers. The latter are actually the
taxpayers. Therefore, the tax cannot be a tax imposed upon
the petitioner. In other words, the petitioner who borrowed
funds from several financial institutions by issuing
commercial papers merely withheld the 35% transaction tax
before paying to the financial institutions the interests
earned by them and later remitted the same to the
respondent Commissioner of Internal Revenue. The tax
could have been collected by a different procedure but the
statute chose this method. Whatever collecting procedure is
adopted does not change the nature of the tax.
xxx xxx xxx 7
(Emphasis supplied)
Much the same issue was passed upon in Marinduque Mining
Industrial Corporation v. Commissioner of Internal Revenue 8 and
resolved in the same way:
It is very obvious that the transaction tax, which is a tax on
interest derived from commercial paper issued in the money
market, is not a tax contemplated in the above-quoted legal
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
provisions. The petitioner admits that it is subject to income
tax. Its tax exemption should be strictly construed.
We hold that petitioner's claim for refund was justifiably
denied. The transaction tax, although nominally categorized
as a business tax, is in reality a withholding tax as positively
stated in LOI No. 340. The petitioner could have shifted the
tax to the lenders or recipients of the interest. It did not
choose to do so. It cannot be heard now to complain about
the tax. LOI No. 340 is an extraneous or extrinsic aid to the
construction of section 210 (b).
xxx xxx xxx 9
(Emphasis supplied)
It is thus clear that the transaction tax is an income tax and as such, in any
event, falls outside the scope of the tax exemption granted to registered
pioneer enterprises by Section 8 of R.A. No. 5186, as amended. Picop was
the withholding agent, obliged to withhold thirty-five percent (35%) of the
interest payable to its lenders and to remit the amounts so withheld to the
Bureau of Internal Revenue ("BIR"). As a withholding agent, Picop is
made personally liable for the thirty-five percent (35%) transaction
tax 10 and if it did not actually withhold thirty-five percent (35%) of the
interest monies it had paid to its lenders, Picop had only itself to blame.
Picop claims that it had relied on a ruling, dated 6 October 1977, issued by
the CIR, which held that Picop was not liable for the thirty-five (35%)
transaction tax in respect of debenture bonds issued by Picop. Prior to the
issuance of the promissory notes involved in the instant case, Picop had also
issued debenture bonds P100,000,000.00 in aggregate face value. The
managing underwriter of this debenture bond issue, Bancom Development
Corporation, requested a formal ruling from the Bureau of Internal Revenue
on the liability of Picop for the thirty-five percent (35%) transaction tax in
respect of such bonds. The ruling rendered by the then Acting Commissioner
of Internal Revenue, Efren I. Plana, stated in relevant part:
37
It is represented that PICOP will be offering to the public
primary bonds in the aggregate principal sum of one hundred
million pesos (P100,000,000.00); that the bonds will be
issued as debentures in denominations of one thousand pesos
(P1,000.00) or multiples, to mature in ten (10) years at 14%
interest per annum payable semi-annually; that the bonds are
convertible into common stock of the issuer at the option of
the bond holder at an agreed conversion price; that the issue
will be covered by a "Trust Indenture" with a duly
authorized trust corporation as required by the Securities and
Exchange Commission, which trustee will act for and in
behalf of the debenture bond holders as beneficiaries; that
once issued, the bonds cannot be preterminated by the
holder and cannot be redeemed by the issuer until after eight
(8) years from date of issue; that the debenture bonds will
be subordinated to present and future debts of PICOP; and
that said bonds are intended to be listed in the stock
exchanges, which will place them alongside listed equity
issues.
In reply, I have the honor to inform you that although the
bonds hereinabove described are commercial papers which
will be issued in the primary market, however, it is clear
from the abovestated facts that said bonds will not be issued
as money market instruments. Such being the case, and
considering that the purposes of Presidential Decree No.
1154, as can be gleaned from Letter of Instruction No. 340,
dated November 21, 1975, are (a) to regulate money market
transactions and (b) to ensure the collection of the tax on
interest derived from money market transactions by
imposing a withholding tax thereon, said bonds do not come
within the purview of the "commercial papers" intended to
be subjected to the 35% transaction tax prescribed in
Presidential Decree No. 1154, as implemented by Revenue
Regulations No. 7-77. (See Section 2 of said Regulation)
Accordingly, PICOP is not subject to 35% transaction tax
on its issues of the aforesaid bonds. However, those
investing in said bonds should be made aware of the fact that
the transaction tax is not being imposed on the issuer of said
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
bonds by printing or stamping thereon, in bold letters, the
following statement: "ISSUER NOT SUBJECT TO
TRANSACTION TAX UNDER P.D. 1154.
BONDHOLDER SHOULD DECLARE INTEREST
EARNING FOR INCOME TAX." 11 (Emphases supplied)
In the above quoted ruling, the CIR basically held that Picop's debenture
bonds did not constitute "commercial papers" within the meaning of P.D. No.
1154, and that, as such, those bonds were not subject to the thirty-five
percent (35%) transaction tax imposed by P.D. No. 1154.
The above ruling, however, is not applicable in respect of the promissory
notes which are the subject matter of the instant case. It must be noted that
the debenture bonds which were the subject matter of Commissioner Plana's
ruling were long-term bonds maturing in ten (10) years and which could not
be pre-terminated and could not be redeemed by Picop until after eight (8)
years from date of issue; the bonds were moreover subordinated to present
and future debts of Picop and convertible into common stock of Picop at the
option of the bondholder. In contrast, the promissory notes involved in the
instant case are short-term instruments bearing a one-year maturity period.
These promissory notes constitute the very archtype of money market
instruments. For money market instruments are precisely, by custom and
usage of the financial markets, short-term instruments with a tenor of one (1)
year or less. 12 Assuming, therefore, (without passing upon) the correctness
of the 6 October 1977 BIR ruling, Picop's short-term promissory notes must
be distinguished, and treated differently, from Picop's long-term debenture
bonds.
We conclude that Picop was properly held liable for the thirty-five percent
(35%) transaction tax due in respect of interest payments on its money
market borrowings.
At the same time, we agree with the Court of Appeals that the transaction tax
may be levied only in respect of the interest earnings of Picop's money
market lenders accruing after P.D. No. 1154 went into effect, and not in
respect of all the 1977 interest earnings of such lenders. The Court of
Appeals pointed out that:
38
PICOP, however contends that even if the tax has to be paid,
it should be imposed only for the interests earned after 20
September 1977 when PD 1154 creating the tax became
effective. We find merit in this contention. It appears that
the tax was levied on interest earnings from January to
October, 1977. However, as found by the lower court, PD
1154 was published in the Official Gazette only on 5
September 1977, and became effective only fifteen (15) days
after the publication, or on 20 September 1977, no other
effectivity date having been provided by the PD. Based on
the Worksheet prepared by the Commissioner's office, the
interests earned from 20 September to October 1977 was
P10,224,410.03. Thirty-five (35%) per cent of this is
P3,578,543.51 which is all PICOP should pay as transaction
tax. 13 (Emphasis supplied)
P.D. No. 1154 is not, in other words, to be given retroactive effect by
imposing the thirty-five percent (35%) transaction tax in respect of interest
earnings which accrued before the effectivity date of P.D. No. 1154, there
being nothing in the statute to suggest that the legislative authority intended
to bring about such retroactive imposition of the tax.
(2) Whether Picop is liable
for interest and surcharge
on unpaid transaction tax.
With respect to the transaction tax due, the CIR prays that Picop be held
liable for a twenty-five percent (25%) surcharge and for interest at the rate of
fourteen percent (14%) per annum from the date prescribed for its payment.
In so praying, the CIR relies upon Section 10 of Revenue Regulation 7-77
dated 3 June 1977, 14 issued by the Secretary of Finance. This Section reads:
Sec. 10. Penalties. — Where the amount shown by the
taxpayer to be due on its return or part of such payment is
not paid on or before the date prescribed for its payment, the
amount of the tax shall be increased by twenty-five (25%)
per centum, the increment to be a part of the tax and
the entire amount shall be subject to interest at the rate of
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
fourteen (14%) per centum per annum from the date
prescribed for its payment.
In the case of willful neglect to file the return within the
period prescribed herein or in case a false or fraudulent
return is willfully made, there shall be added to the tax or to
the deficiency tax in case any payment has been made on the
basis of such return before the discovery of the falsity or
fraud, a surcharge of fifty (50%) per centum of its amount.
The amount so added to any tax shall be collected at the
same time and in the same manner and as part of the tax
unless the tax has been paid before the discovery of the
falsity or fraud, in which case the amount so added shall be
collected in the same manner as the tax.
In addition to the above administrative penalties,
the criminal and civil penalties as provided for under Section
337 of the Tax Code of 1977 shall be imposed for violation
of any provision of Presidential Decree No.
1154. 15 (Emphases supplied)
The 1977 Tax Code itself, in Section 326 in relation to Section 4 of
the same Code, invoked by the Secretary of Finance in issuing
Revenue Regulation 7-77, set out, in comprehensive terms, the rule-
making authority of the Secretary of Finance:
Sec. 326. Authority of Secretary of Finance to Promulgate
Rules and Regulations. — The Secretary of Finance, upon
recommendation of the Commissioner of Internal Revenue,
shall promulgate all needful rules and regulations for the
effective enforcement of the provisions of this Code.
(Emphasis supplied)
Section 4 of the same Code contains a list of subjects or areas to be
dealt with by the Secretary of Finance through the medium of an
exercise of his quasi-legislative or rule-making authority. This list,
however, while it purports to be open-ended, does not include the
imposition of administrative or civil penalties such as the payment of
amounts additional to the tax due. Thus, in order that it may be held
39
to be legally effective in respect of Picop in the present case, Section
10 of Revenue Regulation 7-77 must embody or rest upon some
provision in the Tax Code itself which imposes surcharge and
penalty interest for failure to make a transaction tax payment when
due.
P.D. No. 1154 did not itself impose, nor did it expressly authorize the
imposition of, a surcharge and penalty interest in case of failure to pay the
thirty-five percent (35%) transaction tax when due. Neither did Section 210
(b) of the 1977 Tax Code which re-enacted Section 195-C inserted into the
Tax Code by P.D. No. 1154.
The CIR, both in its petition before the Court of Appeals and its Petition in
the instant case, points to Section 51 (e) of the 1977 Tax Code as its source
of authority for assessing a surcharge and penalty interest in respect of the
thirty-five percent (35%) transaction tax due from Picop. This Section needs
to be quoted in extenso:
Sec. 51. Payment and Assessment of Income Tax. —
(c) Definition of deficiency. — As used in this Chapter in
respect of a tax imposed by this Title, the term "deficiency"
means:
(1) The amount by which the tax imposed by this
Title exceeds the amount shown as the tax by the taxpayer
upon his return; but the amount so shown on the return shall
first be increased by the amounts previously assessed (or
collected without assessment) as a deficiency, and decreased
by the amount previously abated, credited, returned, or
otherwise in respect of such tax; . . .
xxx xxx xxx
(e) Additions to the tax in case of non-payment. —
(1) Tax shown on the return. — Where the amount
determined by the taxpayer as the tax imposed by this
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Title or any installment thereof, or any part of such amount
or installment is not paid on or before the date prescribed for
its payment, there shall be collected as a part of the tax,
interest upon such unpaid amount at the rate of fourteen per
centum per annum from the date prescribed for its payment
until it is paid: Provided, That the maximum amount that
may be collected as interest on deficiency shall in no case
exceed the amount corresponding to a period of three years,
the present provisions regarding prescription to the contrary
notwithstanding.
(2) Deficiency. — Where a deficiency, or any interest
assessed in connection therewith under paragraph (d) of this
section, or any addition to the taxes provided for in Section
seventy-two of this Code is not paid in full within thirty days
from the date of notice and demand from the Commissioner
of Internal Revenue, there shall be collected upon the unpaid
amount as part of the tax, interest at the rate of fourteen per
centum per annum from the date of such notice and demand
until it is paid: Provided, That the maximum amount that
may be collected as interest on deficiency shall in no case
exceed the amount corresponding to a period of three years,
the present provisions regarding prescription to the contrary
notwithstanding.
(3) Surcharge. — If any amount of tax included in the notice
and demand from the Commissioner of Internal Revenue is
not paid in full within thirty days after such notice and
demand, there shall be collected in addition to the interest
prescribed herein and in paragraph (d) above and as part of
the tax a surcharge of five per centum of the amount of tax
unpaid. (Emphases supplied)
Section 72 of the 1977 Tax Code referred to in Section 51 (e) (2)
above, provides:
Sec. 72. Surcharges for failure to render returns and for
rendering false and fraudulent returns. — In case of willful
neglect to file the return or list required by this Title within
40
the time prescribed by law, or in case a false or fraudulent
return or list is wilfully made, the Commissioner of Internal
Revenue shall add to the tax or to the deficiency tax, in case
any payment has been made on the basis of such return
before the discovery of the falsity or fraud, as surcharge of
fifty per centum of the amount of such tax or deficiency tax.
In case of any failure to make and file a return or list within
the time prescribed by law or by the Commissioner or other
Internal Revenue Officer, not due to willful neglect, the
Commissioner of Internal Revenue shall add to the
tax twenty-five per centum of its amount, except that, when a
return is voluntarily and without notice from the
Commissioner or other officer filed after such time, and it is
shown that the failure to file it was due to a reasonable
cause, no such addition shall be made to the tax. The amount
so added to any tax shall be collected at the same time, in the
same manner and as part of the tax unless the tax has been
paid before the discovery of the neglect, falsity, or fraud, in
which case the amount so added shall be collected in the
same manner as the tax. (Emphases supplied)
It will be seen that Section 51 (c) (1) and (e) (1) and (3), of the 1977 Tax
Code, authorize the imposition of surcharge and interest only in respect of a
"tax imposed by this Title," that is to say, Title II on "Income Tax." It will
also be seen that Section 72 of the 1977 Tax Code imposes a surcharge only
in case of failure to file a return or list "required by this Title," that is, Title II
on "Income Tax." The thirty-five percent (35%) transaction tax is, however,
imposed in the 1977 Tax Code by Section 210 (b) thereof which Section is
embraced in Title V on "Taxes on Business" of that Code. Thus, while the
thirty-five percent (35%) transaction tax is in truth a tax
imposed on interest income earned by lenders or creditors purchasing
commercial paper on the money market, the relevant provisions, i.e., Section
210 (b), were not inserted in Title II of the 1977 Tax Code. The end result is
that the thirty-five percent (35%) transaction tax is not one of the taxes in
respect of which Section 51 (e) authorized the imposition of surcharge and
interest and Section 72 the imposition of a fraud surcharge.
It is not without reluctance that we reach the above conclusion on the basis of
what may well have been an inadvertent error in legislative draftsmanship, a
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
type of error common enough during the period of Martial Law in our
country. Nevertheless, we are compelled to adopt this conclusion. We
consider that the authority to impose what the present Tax Code calls (in
Section 248) civil penalties consisting of additions to the tax due, must be
expressly given in the enabling statute, in language too clear to be mistaken.
The grant of that authority is not lightly to be assumed to have been made to
administrative officials, even to one as highly placed as the Secretary of
Finance.
The state of the present law tends to reinforce our conclusion that Section 51
(c) and (e) of the 1977 Tax Code did not authorize the imposition of a
surcharge and penalty interest for failure to pay the thirty-five percent (35%)
transaction tax imposed under Section 210 (b) of the same Code. The
corresponding provision in the current Tax Code very clearly embraces
failure to pay all taxes imposed in the Tax Code, without any regard to the
Title of the Code where provisions imposing particular taxes are textually
located. Section 247 (a) of the NIRC, as amended, reads:
Title X
Statutory Offenses and Penalties
Chapter I
Additions to the Tax
Sec. 247. General Provisions. — (a) The additions to the tax
or deficiency tax prescribed in this Chapter shall apply to all
taxes, fees and charges imposed in this Code. The amount so
added to the tax shall be collected at the same time, in the
same manner and as part of the tax. . . .
Sec. 248. Civil Penalties. — (a) There shall be imposed, in
addition to the tax required to be paid, penalty equivalent to
twenty-five percent (25%) of the amount due, in the
following cases:
xxx xxx xxx
41
(3) failure to pay the tax within the time
prescribed for its payment; or
xxx xxx xxx
(c) the penalties imposed hereunder shall form part of the tax
and the entire amount shall be subject to the interest
prescribed in Section 249.
Sec. 249. Interest. — (a) In General. — There shall be
assessed and collected on any unpaid amount of
tax, interest at the rate of twenty percent (20%) per
annum or such higher rate as may be prescribed by
regulations, from the date prescribed for payment until the
amount is fully paid. . . . (Emphases supplied)
In other words, Section 247 (a) of the current NIRC supplies what
did not exist back in 1977 when Picop's liability for the thirty-five
percent (35%) transaction tax became fixed. We do not believe we
can fill that legislative lacuna by judicial fiat. There is nothing to
suggest that Section 247 (a) of the present Tax Code, which was
inserted in 1985, was intended to be given retroactive application by
the legislative authority. 16
(3) Whether Picop is Liable
for Documentary and
Science Stamp Taxes.
As noted earlier, Picop issued sometime in 1977 long-term subordinated
convertible debenture bonds with an aggregate face value of
P100,000,000.00. Picop stated, and this was not disputed by the CIR, that the
proceeds of the debenture bonds were in fact utilized to finance the BOI-
registered operations of Picop. The CIR assessed documentary and science
stamp taxes, amounting to P300,000.00, on the issuance of Picop's debenture
bonds. It is claimed by Picop that its tax exemption — "exemption from all
taxes under the National Internal Revenue Code, except income tax" on a
declining basis over a certain period of time — includes exemption from the
documentary and science stamp taxes imposed under the NIRC.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
The CIR, upon the other hand, stresses that the tax exemption under the
Investment Incentives Act may be granted or recognized only to the extent
that the claimant Picop was engaged in registered operations, i.e., operations
forming part of its integrated pulp and paper project. 17 The borrowing of
funds from the public, in the submission of the CIR, was not an activity
included in Picop's registered operations. The CTA adopted the view of the
CIR and held that "the issuance of convertible debenture bonds [was] not
synonymous [with] the manufactur[ing] operations of an integrated pulp and
paper mill." 18
The Court of Appeals took a less rigid view of the ambit of the tax exemption
granted to registered pioneer enterprises. Said the Court of Appeals:
. . . PICOP's explanation that the debenture bonds were
issued to finance its registered operation is logical and is
unrebutted. We are aware that tax exemptions must be
applied strictly against the beneficiary in order to deter their
abuse. It would indeed be altogether a different matter if
there is a showing that the issuance of the debenture bonds
had no bearing whatsoever on the registered operations
PICOP and that they were issued in connection with a totally
different business undertaking of PICOP other than its
registered operation. There is, however, a dearth of evidence
in this regard. It cannot be denied that PICOP needed funds
for its operations. One of the means it used to raise said
funds was to issue debenture bonds. Since the money raised
thereby was to be used in its registered operation, PICOP
should enjoy the incentives granted to it by R.A. 5186, one
of which is the exemption from payment of all taxes under
the National Internal Revenue Code, except income
taxes, otherwise the purpose of the incentives would be
defeated. Documentary and science stamp taxes on
debenture bonds are certainly not income
taxes. 19 (Emphasis supplied)
Tax exemptions are, to be sure, to be "strictly construed," that is, they are not
to be extended beyond the ordinary and reasonable intendment of the
language actually used by the legislative authority in granting the exemption.
The issuance of debenture bonds is certainly conceptually distinct from
42
pulping and paper manufacturing operations. But no one contends that
issuance of bonds was a principal or regular business activity of Picop; only
banks or other financial institutions are in the regular business of raising
money by issuing bonds or other instruments to the general public. We
consider that the actual dedication of the proceeds of the bonds to the
carrying out of Picop's registered operations constituted a sufficient nexus
with such registered operations so as to exempt Picop from stamp taxes
ordinarily imposed upon or in connection with issuance of such bonds. We
agree, therefore, with the Court of Appeals on this matter that the CTA and
the CIR had erred in rejecting Picop's claim for exemption from stamp taxes.
It remains only to note that after commencement of the present litigation
before the CTA, the BIR took the position that the tax exemption granted by
R.A. No. 5186, as amended, does include exemption from documentary
stamp taxes on transactions entered into by BOI-registered enterprises. BIR
Ruling No. 088, dated 28 April 1989, for instance, held that a registered
preferred pioneer enterprise engaged in the manufacture of integrated
circuits, magnetic heads, printed circuit boards, etc., is exempt from the
payment of documentary stamp taxes. The Commissioner said:
You now request a ruling that as a preferred pioneer
enterprise, you are exempt from the payment of
Documentary Stamp Tax (DST).
In reply, please be informed that your request is hereby
granted. Pursuant to Section 46 (a) of Presidential Decree
No. 1789, pioneer enterprises registered with the BOI are
exempt from all taxes under the National Internal Revenue
Code, except from all taxes under the National Internal
Revenue Code, except income tax, from the date the area of
investment is included in the Investment Priorities Plan to
the following extent:
xxx xxx xxx
Accordingly, your company is exempt from the payment of
documentary stamp tax to the extent of the percentage
aforestated on transactions connected with the registered
business activity. (BIR Ruling No. 111-81) However, if said
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
transactions conducted by you require the execution of a
taxable document with other parties, said parties who are not
exempt shall be the one directly liable for the tax. (Sec. 173,
Tax Code, as amended; BIR Ruling No. 236-87) In other
words, said parties shall be liable to the same percentage
corresponding to your tax exemption. (Emphasis supplied)
Similarly, in BIR Ruling No. 013, dated 6 February 1989, the
Commissioner held that a registered pioneer enterprise producing
polyester filament yarn was entitled to exemption "from the
documentary stamp tax on [its] sale of real property in Makati up to
December 31, 1989." It appears clear to the Court that the CIR,
administratively at least, no longer insists on the position it originally
took in the instant case before the CTA.
II
(1) Whether Picop is entitled
to deduct against current
income interest payments
on loans for the purchase
of machinery and equipment.
In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in order
to finance the purchase of machinery and equipment needed for its
operations. In its 1977 Income Tax Return, Picop claimed interest payments
made in 1977, amounting to P42,840,131.00, on these loans as a deduction
from its 1977 gross income.
The CIR disallowed this deduction upon the ground that, because the loans
had been incurred for the purchase of machinery and equipment, the interest
payments on those loans should have been capitalized instead and claimed as
a depreciation deduction taking into account the adjusted basis of the
machinery and equipment (original acquisition cost plus interest charges)
over the useful life of such assets.
43
Both the CTA and the Court of Appeals sustained the position of Picop and
held that the interest deduction claimed by Picop was proper and allowable.
In the instant Petition, the CIR insists on its original position.
We begin by noting that interest payments on loans incurred by a taxpayer
(whether BOI-registered or not) are allowed by the NIRC as deductions
against the taxpayer's gross income. Section 30 of the 1977 Tax Code
provided as follows:
Sec. 30. Deduction from Gross Income. — The following
may be deducted from gross income:
(a) Expenses:
xxx xxx xxx
(b) Interest:
(1) In general. — 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: . . . (Emphasis supplied)
Thus, the general rule is that interest expenses are deductible against
gross income and this certainly includes interest paid under loans
incurred in connection with the carrying on of the business of the
taxpayer. 20 In the instant case, the CIR does not dispute that the
interest payments were made by Picop on loans incurred in
connection with the carrying on of the registered operations of
Picop, i.e., the financing of the purchase of machinery and
equipment actually used in the registered operations of Picop.
Neither does the CIR deny that such interest payments were legally
due and demandable under the terms of such loans, and in fact paid
by Picop during the tax year 1977.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
The CIR has been unable to point to any provision of the 1977 Tax Code or
any other Statute that requires the disallowance of the interest payments
made by Picop. The CIR invokes Section 79 of Revenue Regulations No. 2
as amended which reads as follows:
Sec. 79. Interest on Capital. — Interest calculated for cost-
keeping or other purposes on account of capital or surplus
invested in the business, which does not represent a charge
arising under an interest-bearing obligation,
is not allowable deduction from gross income. (Emphases
supplied)
We read the above provision of Revenue Regulations No. 2 as
referring to so called "theoretical interest," that is to say, interest
"calculated" or computed (and not incurred or paid) for the purpose
of determining the "opportunity cost" of investing funds in a given
business. Such "theoretical" or imputed interest does not arise from a
legally demandable interest-bearing obligation incurred by the
taxpayer who however wishes to find out, e.g., whether he would
have been better off by lending out his funds and earning interest
rather than investing such funds in his business. One thing that
Section 79 quoted above makes clear is that interest which does
constitute a charge arising under an interest-bearing obligation is an
allowable deduction from gross income.
It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was
"patterned after" paragraph 1.266-1 (b), entitled "Taxes and Carrying
Charges Chargeable to Capital Account and Treated as Capital Items" of the
U.S. Income Tax Regulations, which paragraph reads as follows:
(B) Taxes and Carrying Charges. — The items thus
chargeable to capital accounts are —
(11) In the case of real property, whether improved or
unimproved and whether productive or nonproductive.
(a) Interest on a loan (but not theoretical interest of a
taxpayer using his own funds). 21
44
The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR
needs to be related to the relevant provisions of the U.S. Internal Revenue
Code, which provisions deal with the general topic of adjusted basis for
determining allowable gain or loss on sales or exchanges of property and
allowable depreciation and depletion of capital assets of the taxpayer:
Present Rule. The Internal Revenue Code, and the
Regulations promulgated thereunder provide that "No
deduction shall be allowed for amounts paid or
accrued for such taxes and carrying charges as, under
regulations prescribed by the Secretary or his delegate, are
chargeable to capital account with respect to property, if the
taxpayer elects, in accordance with such regulations, to treat
such taxes or charges as so chargeable."
At the same time, under the adjustment of basis provisions
which have just been discussed, it is provided that
adjustment shall be made for all "expenditures, receipts,
losses, or other items" properly chargeable to a capital
account, thus including taxes and carrying charges;
however, an exception exists, in which event such adjustment
to the capital account is not made, with respect to taxes and
carrying charges which the taxpayer has not elected to
capitalize but for which a deduction instead has been
taken. 22 (Emphasis supplied)
The "carrying charges" which may be capitalized under the above
quoted provisions of the U.S. Internal Revenue Code include, as the
CIR has pointed out, interest on a loan "(but not theoretical interest
of a taxpayer using his own funds)." What the CIR failed to point out
is that such "carrying charges" may, at the election of the
taxpayer, either be (a) capitalized in which case the cost basis of the
capital assets, e.g., machinery and equipment, will be adjusted by
adding the amount of such interest payments or alternatively, be (b)
deducted from gross income of the taxpayer. Should the taxpayer
elect to deduct the interest payments against its gross income, the
taxpayer cannot at the same time capitalize the interest payments. In
other words, the taxpayer is not entitled to both the deduction from
gross income and the adjusted (increased) basis for determining gain
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
or loss and the allowable depreciation charge. The U.S. Internal
Revenue Code does not prohibit the deduction of interest on a
loan obtained for purchasing machinery and equipment against gross
income, unless the taxpayer has also or previously capitalized the
same interest payments and thereby adjusted the cost basis of such
assets.
We have already noted that our 1977 NIRC does not prohibit the deduction
of interest on a loan incurred for acquiring machinery and equipment.
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 right to
elect one or the other tax treatment of such interest payments. Accordingly,
the general rule that interest payments on a legally demandable loan are
deductible from gross income must be applied.
The CIR argues finally that to allow Picop to deduct its interest payments
against its gross income would be to encourage fraudulent claims to double
deductions from gross income:
[t]o allow a deduction of incidental expense/cost incurred in
the purchase of fixed asset in the year it was incurred
would invite tax evasion through fraudulent application of
double deductions from gross income. 23 (Emphases
supplied)
The Court is not persuaded. So far as the records of the instant cases
show, Picop has not claimed to be entitled to double deduction of its
1977 interest payments. The CIR has neither alleged nor proved that
Picop had previously adjusted its cost basis for the machinery and
equipment purchased with the loan proceeds by capitalizing the
interest payments here involved. The Court will not assume that the
CIR would be unable or unwilling to disallow "a double deduction"
should Picop, having deducted its interest cost from its gross income,
also attempt subsequently to adjust upward the cost basis of the
machinery and equipment purchased and claim, e.g., increased
deductions for depreciation.
45
We conclude that the CTA and the Court of Appeals did not err in allowing
the deductions of Picop's 1977 interest payments on its loans for capital
equipment against its gross income for 1977.
(2) Whether Picop is entitled
to deduct against current
income net operating losses
incurred by Rustan Pulp
and Paper Mills, Inc.
On 18 January 1977, Picop entered into a merger agreement with the Rustan
Pulp and Paper Mills, Inc. ("RPPM") and Rustan Manufacturing Corporation
("RMC"). Under this agreement, the rights, properties, privileges, powers and
franchises of RPPM and RMC were to be transferred, assigned and conveyed
to Picop as the surviving corporation. The entire subscribed and outstanding
capital stock of RPPM and RMC would be exchanged for 2,891,476 fully
paid up Class "A" common stock of Picop (with a par value of P10.00) and
149,848 shares of preferred stock of Picop (with a par value of P10.00), to be
issued by Picop, the result being that Picop would wholly own both RPPM
and RMC while the stockholders of RPPM and RMC would join 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
P68,240,340.00, by issuing 6,824,034 shares of preferred stock (with a par
value of P10.00) to the DBP. The merger agreement was approved in 1977
by the creditors and stockholders of Picop, RPPM and RMC and by the
Securities and Exchange Commission. Thereupon, on 30 November 1977,
apparently the effective date of merger, RPPM and RMC were dissolved.
The Board of Investments approved the merger agreement on 12 January
1978.
It appears that RPPM and RMC were, like Picop, BOI-registered companies.
Immediately before 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, Picop claimed P44,196,106.00 of RPPM's accumulated
losses as a deduction against Picop's 1977 gross income. 24
Upon the other hand, even before the effective date of merger, on 30 August
1977, Picop sold all the outstanding shares of RMC stock to San Miguel
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Corporation for the sum of P38,900,000.00, and reported a gain of
P9,294,849.00 from this transaction. 25
In claiming such deduction, Picop relies on section 7 (c) of R.A. No. 5186
which provides as follows:
Sec. 7. Incentives to Registered Enterprise. — A registered
enterprise, to the extent engaged in a preferred area of
investment, shall be granted the following incentive benefits:
xxx xxx xxx
(c) Net Operating Loss Carry-over. — A net operating loss
incurred in any of the first ten years of operations may be
carried over as a deduction from taxable income for the six
years immediately following the year of such loss. The entire
amount of the loss shall be carried over to the first of the six
taxable years following the loss, and any portion of such loss
which exceeds the taxable income of such first year shall be
deducted in like manner from the taxable income of the next
remaining five years. The net operating loss shall be
computed in accordance with the provisions of the National
Internal Revenue Code, any provision of this Act to the
contrary notwithstanding, except that income not taxable
either in whole or in part under this or other laws shall be
included in gross income. (Emphasis supplied)
Picop had secured a letter-opinion from the BOI dated 21 February
1977 — that is, after the date of the agreement of merger but before
the merger became effective — relating to the deductibility of the
previous losses of RPPM under Section 7 (c) of R.A. No. 5186 as
amended. The pertinent portions of this BOI opinion, signed by BOI
Governor Cesar Lanuza, read as follows:
2) PICOP will not be allowed to carry over the losses of
Rustan prior to the legal dissolution of the latter because at
that time the two (2) companies still had separate legal
personalities;
46
3) After BOI approval of the merger, PICOP can no longer
apply for the registration of the registered capacity of Rustan
because with the approved merger, such registered capacity
of Rustan transferred to PICOP will have the same
registration date as that of Rustan. In this case, the previous
losses of Rustan may be carried over by PICOP, because
with the merger, PICOP assumes all the rights and
obligations of Rustan subject, however, to the period
prescribed for carrying over of such
losses. 26 (Emphasis supplied)
Curiously enough, Picop did not also seek a ruling on this matter,
clearly a matter of tax law, from the Bureau of Internal Revenue.
Picop chose to rely solely on the BOI letter-opinion.
The CIR disallowed all the deductions claimed on the basis of RPPM's
losses, apparently on two (2) grounds. Firstly, the previous losses were
incurred by "another taxpayer," RPPM, and not by Picop in 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 agreement by the BOI. Thus, during the
taxable year 1977, Picop on the one hand and RPPM and RMC on the other,
still had their separate juridical personalities. Secondly, the CIR alleged that
these losses had been incurred by RPPM "from the borrowing of funds" and
not from carrying out of RPPM's registered operations. We focus on the first
ground. 27
The CTA upheld the deduction claimed by Picop; its reasoning, however, is
less than crystal clear, especially in respect of its view of what the U.S. tax
law was on this matter. In any event, the CTA apparently fell back on the
BOI opinion of 21 February 1977 referred to above. The CTA said:
Respondent further averred that the incentives granted under
Section 7 of R.A. No. 5186 shall be available only to the
extent in which they are engaged in registered
operations, citing Section 1 of Rule IX of the Basic Rules
and Regulations to Implement the Intent and Provisions of
the Investment Incentives Act, R.A. No. 5186.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
We disagree with respondent. The purpose of the merger
was to rationalize the container board industry and not to
take advantage of the net losses incurred by RPPMI prior to
the stock swap. Thus, when stock of a corporation is
purchased in order to take advantage of the corporation's net
operating loss incurred in years prior to the purchase, the
corporation thereafter entering into a trade or business
different from that in which it was previously engaged, the
net operating loss carry-over may be entirely lost. [IRC
(1954), Sec. 382(a), Vol. 5, Mertens, Law of Federal Income
Taxation, Chap. 29.11a, p. 103]. 28 Furthermore, once the
BOI approved the merger agreement, the registered capacity
of Rustan shall be transferred to PICOP, and the previous
losses of Rustan may be carried over by PICOP by operation
of law. [BOI ruling dated February 21, 1977 (Exh. J-1)] It is
clear therefrom, that the deduction availed of under Section
7(c) of R.A. No. 5186 was only proper." (pp. 38-43, Rollo of
SP No. 20070) 29 (Emphasis supplied)
In respect of the above underscored portion of the CTA decision, we
must note that the CTA in fact overlooked the statement made by
petitioner's counsel before the CTA that:
Among the attractions of the merger to Picop was the
accumulated net operating loss carry-over of RMC that it
might possibly use to relieve it (Picop) from its income taxes,
under Section 7 (c) of R.A. 5186. Said section provides:
xxx xxx xxx
With this benefit in mind, Picop addressed three (3) questions
to the BOI in a letter dated November 25, 1976. The BOI
replied on February 21, 1977 directly answering the three (3)
queries. 30 (Emphasis supplied)
The size of RPPM's accumulated losses as of the date of the merger
— more than P81,000,000.00 — must have constituted a powerful
attraction indeed for Picop.
47
The Court of Appeals followed the result reached by the CTA. The Court of
Appeals, much like the CTA, concluded that since RPPM was dissolved on
30 November 1977, its accumulated losses were appropriately carried over
by Picop in the latter's 1977 Income Tax Return "because by that time
RPPMI and Picop were no longer separate and different taxpayers." 31
After prolonged consideration and analysis of this matter, the Court is unable
to agree with the CTA and Court of Appeals on the deductibility of RPPM's
accumulated losses against Picop's 1977 gross income.
It is important to note at the outset that in our jurisdiction, the ordinary rule
— that is, the rule applicable in respect of corporations not registered with
the BOI as a preferred pioneer enterprise — is that net operating losses
cannot be carried over. Under our Tax Code, both in 1977 and at present,
losses may be deducted from gross income only if such losses were actually
sustained in the same year that they are deducted or charged off. Section 30
of the 1977 Tax Code provides:
Sec. 30. Deductions from Gross Income. — In computing
net income, there shall be allowed as deduction —
xxx xxx xxx
(d) Losses:
(1) By Individuals. — In the case of an individual,
losses actually sustained during the taxable year and not
compensated for by an insurance or otherwise —
(A) If incurred in trade or business;
xxx xxx xxx
(2) By Corporations. — In a case of a corporation, all
losses actually sustained and charged off within the taxable
year and not compensated for by insurance or otherwise.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
(3) By Non-resident Aliens or Foreign Corporations. — In
the case of a non-resident alien individual or a foreign
corporation, the losses deductible are those actually
sustained during the year incurred in business or trade
conducted within the Philippines, . . . 32 (Emphasis supplied)
Section 76 of the Philippine Income Tax Regulations (Revenue
Regulation No. 2, as amended) is even more explicit and detailed:
Sec. 76. When charges are deductible. — Each year's return,
so far as practicable, both as to gross income and deductions
therefrom should be complete in itself, and taxpayers are
expected to make every reasonable effort to ascertain the
facts necessary to make a correct return. The expenses,
liabilities, or deficit of one year cannot be used to reduce the
income of a subsequent year. A taxpayer has the right to
deduct all authorized allowances and it follows that if he
does not within any year deduct certain of his
expenses, losses, interests, taxes, or other charges,
he can not deduct them from the income of the next or any
succeeding year. . . .
xxx xxx xxx
. . . . If subsequent to its occurrence, however, a taxpayer
first ascertains the amount of a loss sustained during a prior
taxable year which has not been deducted from gross
income, he may render an amended return for such
preceding taxable year including such amount of loss in the
deduction from gross income and may in proper cases file
a claim for refund of the excess paid by reason of the failure
to deduct such loss in the original return. A loss from theft
or embezzlement occurring in one year and discovered in
another is ordinarily deductible for the year in which
sustained. (Emphases supplied)
It is thus clear that under our law, and outside the special realm of
BOI-registered enterprises, there is no such thing as a carry-over of
net operating loss. To the contrary, losses must be deducted against
48
current income in the taxable year when such losses were incurred.
Moreover, such losses may be charged off only against income
earned in the same taxable year when the losses were incurred.
Thus it is that R.A. No. 5186 introduced the carry-over of net operating
losses as a very special incentive to be granted only to registered pioneer
enterprises and only with respect to their registered operations. The statutory
purpose here may be seen to be the encouragement of the establishment and
continued operation of pioneer industries by allowing the registered
enterprise to accumulate its operating losses which may be expected during
the early years of the enterprise and to permit the enterprise to offset such
losses against income earned by it in later years after successful
establishment and regular operations. To promote its economic development
goals, the Republic foregoes or defers taxing the income of the pioneer
enterprise until after that enterprise has recovered or offset its earlier losses.
We consider that the statutory purpose can be served only if the accumulated
operating losses are carried over and charged off against income
subsequently earned and accumulated by the same enterprise engaged in the
same registered operations.
In the instant case, to allow the deduction claimed by Picop would be to
permit one corporation or enterprise, Picop, to benefit from the operating
losses accumulated by another corporation or enterprise, RPPM. RPPM far
from benefiting from the tax incentive granted by the BOI statute, in fact
gave up the struggle and went out of existence and its former stockholders
joined the much larger group of Picop's stockholders. To grant Picop's
claimed deduction would be to permit Picop to shelter its otherwise taxable
income (an objective which Picop had from the very beginning) 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. Under the CTA and Court of Appeals
decisions, Picop would benefit by immunizing P44,196,106.00 of its income
from taxation thereof although Picop had not run the risks and incurred the
losses which had been encountered and suffered by RPPM. Conversely, the
income that would be shielded from taxation is not income that was, after
much effort, eventually generated by the same registered operations which
earlier had sustained losses. We consider and so hold that there is nothing in
Section 7 (c) of R.A. No. 5186 which either requires or permits such a result.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Indeed, that result makes non-sense of the legislative purpose which may be
seen clearly to be projected by Section 7 (c), R.A. No. 5186.
The CTA and the Court of Appeals allowed the offsetting of RPPM's
accumulated operating losses against Picop's 1977 gross income, basically
because towards the end of the taxable year 1977, upon the arrival of the
effective date of merger, only one (1) corporation, Picop, remained. The
losses suffered by RPPM's registered operations and the gross income
generated by Picop's own registered operations now came under one and the
same corporate roof. We consider that this circumstance relates much more
to form than to substance. We do not believe that that single purely technical
factor is enough to authorize and justify the deduction claimed by Picop.
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
Section 7 (c) of R.A. No. 5186. In granting the extraordinary privilege and
incentive of a net operating loss carry-over to BOI-registered pioneer
enterprises, the legislature could not have intended to require the Republic to
forego tax revenues in order to benefit a corporation which had run no risks
and suffered no losses, but had merely purchased another's losses.
Both the CTA and the Court of Appeals appeared much impressed not only
with corporate technicalities but also with the U.S. tax law on this matter. It
should suffice, however, simply to note that in U.S. tax law, the availability
to companies generally of operating loss carry-overs and of operating loss
carry-backs is expressly provided and regulated in great detail by
statute. 33 In our jurisdiction, save for Section 7 (c) of R.A. No. 5186, no
statute recognizes or permits loss carry-overs and loss carry-backs. Indeed, as
already noted, our tax law expressly rejects the very notion of loss carry-
overs and carry-backs.
We conclude that the deduction claimed by Picop in the amount of
P44,196,106.00 in its 1977 Income Tax Return must be disallowed.
(3) Whether Picop is entitled
to deduct against current
income certain claimed
financial guarantee expenses.
49
In its Income Tax Return for 1977, Picop also claimed a deduction in the
amount of P1,237,421.00 as financial guarantee expenses.
This deduction is said to relate to chattel and real estate mortgages required
from Picop by the Philippine National Bank ("PNB") and DBP as guarantors
of loans incurred by Picop from foreign creditors. According to Picop, the
claimed deduction represents registration fees and other expenses incidental
to registration of mortgages in favor of DBP and PNB.
In support of this claimed deduction, Picop allegedly showed its own
vouchers to BIR Examiners to prove disbursements to the Register of Deeds
of Tandag, Surigao del Sur, of particular amounts. In the proceedings before
the CTA, however, Picop did not submit in evidence such vouchers and
instead presented one of its employees to testify that the amount claimed had
been disbursed for the registration of chattel and real estate mortgages.
The CIR disallowed this claimed deduction upon the ground of insufficiency
of evidence. This disallowance was sustained by the CTA and the Court of
Appeals. The CTA said:
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 the supporting papers such as the invoices
or official receipts of the Register of Deeds, these vouchers
standing alone cannot prove that the payments made were
for the accrued expenses in question. The best evidence of
payment is the official receipts issued by the Register of
Deeds. The testimony of petitioner's witness that the official
receipts and cash vouchers were shown to the Bureau of
Internal Revenue will not suffice if no records could be
presented in court for proper marking and
identification. 34 Emphasis supplied)
The Court of Appeals added:
The mere testimony of a witness for PICOP and the cash
vouchers do not suffice to establish its claim that registration
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

fees were paid to the Register of Deeds for the registration of overstated its cost of sales by P604,018.00. Thereupon, the CIR added back
real estate and chattel mortgages in favor of Development both sums to Picop's net income figure per its own return.
Bank of the Philippines and the Philippine National Bank as
guarantors of PICOP's loans. The witness could very well The 1977 Income Tax Return of Picop set forth the following figures:
have been merely repeating what he was instructed to say
regardless of the truth, while the cash vouchers, which we do Sales (per Picop's Income Tax Return):
not find on file, are not said to provide the necessary details
regarding the nature and purpose of the expenses reflected Paper P 537,656,719.00
therein. PICOP should have presented, through the
guarantors, its owner's copy of the registered titles with the Timber P 263,158,132.00
lien inscribed thereon as well as an official receipt from the
Register of Deeds evidencing payment of the registration
———————
fee. 35 (Emphasis supplied)
Total Sales P 800,814,851.00
We must support the CTA and the Court of Appeals in their foregoing
rulings. A taxpayer has the burden of proving entitlement to a claimed
deduction. 36 In the instant case, even Picop's own vouchers were not ============
submitted in evidence and the BIR Examiners denied that such vouchers and
other documents had been exhibited to them. Moreover, cash vouchers can Upon the other hand, Picop's Books of Accounts reflected higher
only confirm the fact of disbursement but not necessarily the purpose sales figures:
thereof. 37 The best evidence that Picop should have presented to support its
claimed deduction were the invoices and official receipts issued by the Sales (per Picop's Books of Accounts):
Register of Deeds. Picop not only failed to present such documents; it also
failed to explain the loss thereof, assuming they had existed before. 38 Under Paper P 537,656,719.00
the best evidence rule, 39 therefore, the testimony of Picop's employee was
inadmissible and was in any case entitled to very little, if any, credence. Timber P 265,549,776.00

We consider that entitlement to Picop's claimed deduction of P1,237,421.00 ———————

was not adequately shown and that such deduction must be disallowed.
Total Sales P 803,206,495.00
III
============
(1) Whether Picop had understated
its sales and overstated its The above figures thus show a discrepancy between the sales figures
cost of sales for 1977. reflected in Picop's Books of Accounts and the sales figures reported
in its 1977 Income Tax Return, amounting to: P2,391,644.00.
In its assessment for deficiency income tax for 1977, the CIR claimed that
Picop had understated its sales by P2,391,644.00 and, upon the other hand,

50
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
The CIR also contended that Picop's cost of sales set out in its 1977 Income
Tax Return, when compared with the cost figures in its Books of Accounts,
was overstated:
Cost of Sales
(per Income Tax Return) P607,246,084.00
Cost of Sales
(per Books of Accounts) P606,642,066.00
———————
Discrepancy P 604,018.00
============
Picop did not deny the existence of the above noted discrepancies. In the
proceedings before the CTA, Picop presented one of its officials to explain
the foregoing discrepancies. That explanation is perhaps best presented in
Picop's own words as set forth in its Memorandum before this Court:
. . . that the adjustment discussed in the testimony of the
witness, represent the best and most objective method of
determining in pesos the amount of the correct and actual
export sales during the year. It was this correct and actual
export sales and costs of sales that were reflected in the
income tax return and in the audited financial statements.
These corrections did not result in realization of income and
should not give rise to any deficiency tax.
xxx xxx xxx
What are the facts of this case on this matter? Why were
adjustments necessary at the year-end?
Because of PICOP's procedure of recording its export sales
(reckoned in U.S. dollars) on the basis of a fixed rate, day to
day and month to month, regardless of the actual exchange
rate and without waiting when the actual proceeds are
received. In other words, PICOP recorded its export sales at
51
a pre-determined fixed exchange rate. That pre-determined
rate was decided upon at the beginning of the year and
continued to be used throughout the year.
At the end of the year, the external auditors made an
examination. In that examination, the auditors determined
with accuracy the actual dollar proceeds of the export sales
received. What exchange rate was used by the auditors to
convert these actual dollar proceeds into Philippine pesos?
They used the average of the differences between (a) the
recorded fixed exchange rate and (b) the exchange rate at the
time the proceeds were actually received. It was this rate at
time of receipt of the proceeds that determined the amount of
pesos credited by the Central Bank (through the agent banks)
in favor of PICOP. These accumulated differences were
averaged by the external auditors and this was what was
used at the year-end for income tax and other government-
report purposes. (T.s.n., Oct. 17/85, pp. 20-25) 40
The above explanation, unfortunately, at least to the mind of the Court, raises
more questions than it resolves. Firstly, the explanation assumes that all of
Picop's sales were export sales for which U.S. dollars (or other foreign
exchange) were received. It also assumes that the expenses summed up as
"cost of sales" were all dollar expenses and that no peso expenses had been
incurred. Picop's explanation further assumes that a substantial part of
Picop's dollar proceeds for its export sales were not actually surrendered to
the domestic banking system and seasonably converted into pesos; had all
such dollar proceeds been converted into pesos, then the peso figures could
have been simply added up to reflect the actual peso value of Picop's export
sales. Picop offered no evidence in respect of these assumptions, no
explanation why and how a "pre-determined fixed exchange rate" was chosen
at the beginning of the year and maintained throughout. Perhaps more
importantly, Picop was unable to explain why its Books of Accounts did not
pick up the same adjustments that Picop's External Auditors were alleged to
have made for purposes of Picop's Income Tax Return. Picop attempted to
explain away the failure of its Books of Accounts to reflect the same
adjustments (no correcting entries, apparently) simply by quoting a passage
from a case where this Court refused to ascribe much probative value to the
Books of Accounts of a corporate taxpayer in a tax case. 41 What appears to
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
have eluded Picop, however, is that its Books of Accounts, which are kept by
its own employees and are prepared under its control and supervision, reflect
what may be deemed to be admissions against interest in the instant case. For
Picop's Books of Accounts precisely show higher sales figures
and lower cost of sales figures than Picop's Income Tax Return.
It is insisted by Picop that its Auditors' adjustments simply present the "best
and most objective" method of reflecting in pesos the "correct
and ACTUAL export sales" 42 and that the adjustments or "corrections" "did
not result in realization of [additional] income and should not give rise to any
deficiency tax." The correctness of this contention is not self-evident. So far
as the record of this case shows, Picop did not submit in evidence the
aggregate amount of its U.S. dollar proceeds of its export sales; neither did it
show the Philippine pesos it had actually received or been credited for such
U.S. dollar proceeds. It is clear to this Court that the testimonial evidence
submitted by Picop fell far short of demonstrating the correctness of its
explanation.
Upon the other hand, the CIR has made out at least a prima facie case that
Picop had understated its sales and overstated its cost of sales as set out in its
Income Tax Return. For the CIR has a right to assume that Picop's Books of
Accounts speak the truth in this case since, as already noted, they embody
what must appear to be admissions against Picop's own interest.
Accordingly, we must affirm the findings of the Court of Appeals and the
CTA.
(2) Whether Picop is liable for
the corporate development
tax of five percent (5%)
of its income for 1977.
The five percent (5%) corporate development tax is an additional corporate
income tax imposed in Section 24 (e) of the 1977 Tax Code which reads in
relevant part as follows:
(e) Corporate development tax. — In addition to the tax
imposed in subsection (a) of this section, an additional tax in
52
an amount equivalent to 5 per cent of the same taxable net
income shall be paid by a domestic or a resident foreign
corporation; Provided, That this additional tax shall be
imposed only if the net income exceeds 10 per cent of the
net worth, in case of a domestic corporation, or net assets in
the Philippines in case of a resident foreign corporation: . . . .
The additional corporate income tax imposed in this
subsection shall be collected and paid at the same time and
in the same manner as the tax imposed in subsection (a) of
this section.
Since this five percent (5%) corporate development tax is
an income tax, Picop is not exempted from it under the provisions of
Section 8 (a) of R.A. No. 5186.
For purposes of determining whether the net income of a corporation exceeds
ten percent (10%) of its net worth, the term "net worth" means the
stockholders' equity represented by the excess of the total assets over
liabilities as reflected in the corporation's balance sheet provided such
balance sheet has been prepared in accordance with generally accepted
accounting principles employed in keeping the books of the corporation. 43
The adjusted net income of Picop for 1977, as will be seen below, is
P48,687,355.00. Its net worth figure or total stockholders' equity as reflected
in its Audited Financial Statements for 1977 is P464,749,528.00. Since its
adjusted net income for 1977 thus exceeded ten percent (10%) of its net
worth, Picop must be held liable for the five percent (5%) corporate
development tax in the amount of P2,434,367.75.
Recapitulating, we hold:
(1) Picop is liable for the thirty-five percent (35%) transaction tax in the
amount of P3,578,543.51.
(2) Picop is not liable for interest and surcharge on unpaid transaction tax.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

(3) Picop is exempt from payment of documentary and science stamp taxes (2) Unexplained financial
in the amount of P300,000.00 and the compromise penalty of P300.00. guarantee expenses P 1,237,421.00

(4) Picop is entitled to its claimed deduction of P42,840,131.00 for interest (3) Understatement of
payments on loans for, among other things, the purchase of machinery and Sales P 2,391,644.00
equipment.
(4) Overstatement of
(5) Picop's claimed deduction in the amount of P44,196,106.00 for the Cost of Sales P 604,018.00
operating losses previously incurred by RPPM, is disallowed for lack of
merit. ——————

(6) Picop's claimed deduction for certain financial guarantee expenses in the Total P 48,429,189.00
amount P1,237,421.00 is disallowed for failure adequately to prove such
expenses. ——————

(7) Picop has understated its sales by P2,391,644.00 and overstated its cost of Net Income as Adjusted P 48,687,355.00
sales by P604,018.00, for 1977.
===========
(8) Picop is liable for the corporate development tax of five percent (5%) of
its adjusted net income for 1977 in the amount of P2,434,367.75. Income Tax Due Thereon 44 P 17,030,574.00

Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled to hold Less:

Picop liable for deficiency income tax for the year 1977 computed as
follows: Tax Already Assessed per
Return 80,358.00
Deficiency Income Tax
——————
Net Income Per Return P 258,166.00
Deficiency Income Tax P 16,560,216.00
Add:
Add:
Unallowable Deductions
Five percent (5%) Corporate
(1) Deduction of net Development Tax P 2,434,367.00
operating losses
incurred by RPPM P 44,196,106.00 Total Deficiency Income Tax P 18,994,583.00

53
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

=========== (1) Thirty-five percent (35%)

Add: transaction tax P 3,578,543.51

Five percent (5%) surcharge 45 P 949,729.15 (2) Total Deficiency Income

—————— Tax Due 40,215,709.00

Total Deficiency Income Tax ———————

with surcharge P 19,944,312.15 Aggregate Amount Due and Payable P 43,794,252.51

Add: ============

Fourteen percent (14%) No pronouncement as to costs.

interest from 15 April SO ORDERED.

1978 to 14 April 1981 46 P 8,376,610.80 Narvasa, C.J., Regalado, Davide, Jr., Romero, Bellosillo, Melo, Puno,
Kapunan, Mendoza, Francisco, Hermosisima, Jr. and Panganiban, JJ.,
Fourteen percent (14%) concur.

interest from 21 April Padilla, J., took no part.

1983 to 20 April 1986 47 P 11,894,787.00

Separate Opinions
——————
VITUG, J., concurring and dissenting:
Total Deficiency Income Tax
In usual erudite manner, Mr. Justice Florentino P. Feliciano has written for
Due and Payable P 40,215,709.00 the Court the ponencia that presents in clear and logical sequence the issues,
the facts and the law involved. While I share, in most part, the conclusions
=========== expressed in the opinion, I regrettably find it difficult, nevertheless, not to
propose a re-examination of the Court's holding in Western Minolco
WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is Corporation vs. Commissioner of Internal Revenue (124 SCRA 121),
hereby MODIFIED and Picop is hereby ORDERED to pay the CIR the reiterated in Marinduque Mining and Industrial Corporation
aggregate amount of P43,794,252.51 itemized as follows: vs. Commissioner of Internal Revenue (137 SCRA 88), that has taken the
35% transaction tax on commercial papers issued in the primary market
54
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
under the 1977 Revenue Code, in relation to Republic Act ("R.A.") 5186, to
be an income tax.
R.A. No. 5186, also known as the Investment Incentives Act, has provided
for incentives by, among other things, granting to registered pioneer
enterprises an exemption from all taxes, except income tax, under the
National Internal Revenue Code. The income tax, referred to, in my view, is
that imposed in Title II, entitled "Income Tax," of the Revenue Code.
Nowhere under that title is there a 35% transaction tax.
There was, to be sure, a 35% transaction tax still in effect in 1977 but it was a
tax not on the investor-lender in whose favor the interest income on the
commercial paper accrues. The tax was, instead, levied on the borrower-
issuer of commercial papers transacted in the primary market. Being the
principal taxpayer, the borrower-issuer could not have been likewise
contemplated to be a mere tax withholding agent. The tax was conceived as a
tax on business transaction, and so it was rightly incorporated in Title V,
entitled "Privilege Taxes on Business and Occupation" of the Tax Code.
The fact that a taxpayer on whom the tax is imposed can shift, characteristic
of indirect taxes, the burden thereof to another does not make the latter the
taxpayer and the former the withholding agent. Indeed, the facility of shifting
the burden of the tax is opposed to the idea of a direct tax to which class the
income tax actually belongs.
Accordingly, I vote to so reduce the tax liability of petitioners as adjudged by
the amount corresponding to the 35% transaction tax. In all other respects, I
concur with the majority in the judgment.
Separate Opinions
VITUG, J., concurring and dissenting:
In usual erudite manner, Mr. Justice Florentino P. Feliciano has written for
the Court the ponencia that presents in clear and logical sequence the issues,
the facts and the law involved. While I share, in most part, the conclusions
expressed in the opinion, I regrettably find it difficult, nevertheless, not to
propose a re-examination of the Court's holding in Western Minolco
55
Corporation vs. Commissioner of Internal Revenue (124 SCRA 121),
reiterated in Marinduque Mining and Industrial Corporation
vs. Commissioner of Internal Revenue (137 SCRA 88), that has taken the
35% transaction tax on commercial papers issued in the primary market
under the 1977 Revenue Code, in relation to Republic Act ("R.A.") 5186, to
be an income tax.
R.A. No. 5186, also known as the Investment Incentives Act, has provided
for incentives by, among other things, granting to registered pioneer
enterprises an exemption from all taxes, except income tax, under the
National Internal Revenue Code. The income tax, referred to, in my view, is
that imposed in Title II, entitled "Income Tax," of the Revenue Code.
Nowhere under that title is there a 35% transaction tax.
There was, to be sure, a 35% transaction tax still in effect in 1977 but it was a
tax not on the investor-lender in whose favor the interest income on the
commercial paper accrues. The tax was, instead, levied on the borrower-
issuer of commercial papers transacted in the primary market. Being the
principal taxpayer, the borrower-issuer could not have been likewise
contemplated to be a mere tax withholding agent. The tax was conceived as a
tax on business transaction, and so it was rightly incorporated in Title V,
entitled "Privilege Taxes on Business and Occupation" of the Tax Code.
The fact that a taxpayer on whom the tax is imposed can shift, characteristic
of indirect taxes, the burden thereof to another does not make the latter the
taxpayer and the former the withholding agent. Indeed, the facility of shifting
the burden of the tax is opposed to the idea of a direct tax to which class the
income tax actually belongs.
Accordingly, I vote to so reduce the tax liability of petitioners as adjudged by
the amount corresponding to the 35% transaction tax. In all other respects, I
concur with the majority in the judgment.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
G.R. No. L-13912 September 30, 1960
THE COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
CONSUELO L. VDA. DE PRIETO, respondent.
Office of the Solicitor General Edilberto Barot, Solicitor F.R. Rosete and
Special Atty. B. Gatdula, Jr. for petitioner.
Formilleza and Latorre for respondent.
GUTIERREZ DAVID, J.:
This is an appeal from a decision of the Court of tax Appeals reversing the
decision of the Commissioner of Internal Revenue which held herein
respondent Consuelo L. Vda. de Prieto liable for the payment of the sum of
P21,410.38 as deficiency income tax, plus penalties and monthly interest.
The case was submitted for decision in the court below upon a stipulation of
facts, which for brevity is summarized as follows: On December 4, 1945, the
respondent conveyed by way of gifts to her four children, namely, Antonio,
Benito, Carmen and Mauro, all surnamed Prieto, real property with a total
assessed value of P892,497.50. After the filing of the gift tax returns on or
about February 1, 1954, the petitioner Commissioner of Internal Revenue
appraised the real property donated for gift tax purposes at P1,231,268.00,
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
respondent on April 29, 1954, the sum of P55,978.65 represents the total
interest on account of deliquency. This sum of P55,978.65 was claimed as
deduction, among others, by respondent in her 1954 income tax return.
Petitioner, however, disallowed the claim and as a consequence of such
disallowance assessed respondent for 1954 the total sum of P21,410.38 as
deficiency income tax due on the aforesaid P55,978.65, including interest up
to March 31, 1957, surcharge and compromise for the late payment.
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 respondent was in consequence of the
56
late payment of her donor's tax, and the same was paid within the year it is
sought to be declared. The only question to be determined, as stated by the
parties, is whether or not such interest was paid upon an indebtedness within
the contemplation of section 30 (b) (1) of the Tax Code, the pertinent part of
which reads:
SEC. 30 Deductions from gross income. — In computing net income
there shall be allowed as deductions —
xxx xxx xxx
(b) Interest:
(1) In general. — 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.
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 unconditional and legally enforceable obligation for the payment of
money.1awphîl.nèt (Federal Taxes Vol. 2, p. 13,019, Prentice-Hall, Inc.;
Merten's Law of Federal Income Taxation, Vol. 4, p. 542.) Within the
meaning of that definition, it is apparent that a tax may be considered an
indebtedness. As stated by this Court in the case of Santiago
Sambrano vs. Court of Tax Appeals and Collector of Internal Revenue (101
Phil., 1; 53 Off. Gaz., 4839) —
Although taxes already due have not, strictly speaking, the same
concept as debts, they are, however, obligations that may be
considered as such.
The term "debt" is properly used in a comprehensive sense as
embracing not merely money due by contract but whatever one is
bound to render to another, either for contract, or the requirement of
the law. (Camben vs. Fink Coule and Coke Co. 61 LRA 584)
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Where statute imposes a personal liability for a tax, the tax becomes,
at least in a board sense, a debt. (Idem).
A tax is a debt for which a creditor's bill may be brought in a proper
case. (State vs. Georgia Co., 19 LRA 485).
It follows that the interest paid by herein respondent for the late payment of
her donor's tax is deductible from her gross income under section 30(b) of the
Tax Code above quoted.
The above conclusion finds support in the established jurisprudence in the
United States after whose laws our Income Tax Law has been patterned.
Thus, under sec. 23(b) of the Internal Revenue Code of 1939, as amended 1 ,
which contains similarly worded provisions as sec. 30(b) of our Tax Code,
the uniform ruling is that interest on taxes is interest on indebtedness and is
deductible. (U.S. vs. Jaffray, 306 U.S. 276. See also Lustig vs. U.S., 138 F.
Supp. 870; Commissioner of Internal Revenue vs. Bryer, 151 F. 2d 267, 34
AFTR 151; Penrose vs. U.S. 18 F. Supp. 413, 18 AFTR 1289; Max Thomas
Davis, et al. vs. Commissioner of Internal Revenue, 46 U.S. Boared of Tax
Appeals Reports, p. 663, citing U.S. vs. Jaffray, 6 Tax Court of United States
Reports, p. 255; Armour vs. Commissioner of Internal Revenue, 6 Tax Court
of the United States Reports, p. 359; The Koppers Coal
Co. vs. Commissioner of Internal Revenue, 7 Tax Court of United States
Reports, p. 1209; Toy vs. Commissioner of Internal Revenue;
Lucas vs. Comm., 34 U.S. Board of Tax Appeals Reports, 877; Evens and
Howard Fire Brick Co. vs. Commissioner of Internal Revenue, 3 Tax Court
of United States Reports, p. 62). The rule applies even though the tax is
nondeductible. (Federal Taxes, Vol. 2, Prentice Hall, sec. 163, 13,022; see
also Merten's Law of Federal Income Taxation, Vol. 5, pp. 23-24.)
To sustain the proposition that the interest payment in question is not
deductible for the purpose of computing respondent's net income, petitioner
relies heavily on section 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 below, however, held section 80 as inapplicable to
the instant case because while it implements sections 30(c) of the Tax Code
governing deduction of taxes, the respondent taxpayer seeks to come under
57
section 30(b) of the same Code providing for deduction of interest on
indebtedness. We find the lower court's ruling to be correct. Contrary to
petitioner's belief, the portion of section 80 of Revenue Regulation No. 2
under consideration has been part and parcel of the development to the law
on deduction of taxes in the United States. (See Capital Bldg. and Loan
Assn. vs. Comm., 23 BTA 848. Thus, Mertens in his treatise says: "Penalties
are to be distinguished from taxes and they are not deductible under the
heading of taxs." . . . Interest on state taxes is not deductible as taxes." (Vol.
5, Law on Federal Income Taxation, pp. 22-23, sec. 27.06, citing cases.) This
notwithstanding, courts in that jurisdiction, however, have invariably held
that interest on deficiency taxes are deductible, not as taxes, but as interest.
(U.S. vs. Jaffray, et al., supra; see also Mertens, sec. 26.09, Vol. 4, p. 552,
and cases cited therein.) Section 80 of Revenue Regulation No. 2, therefore,
merely incorporated the established application of 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 delinquent taxes, penalties
and surcharges.
To give to the quoted portion of section 80 of our Income Tax Regulations
the meaning that the petitioner gives it would run counter to the provision of
section 30(b) of the Tax Code and the construction given to it by courts in the
United States. Such effect would thus make the regulation 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. 315;
Miller vs. U.S., 294 U.S. 435.) As already stated, section 80 implements only
section 30(c) of the Tax Code, or the provision allowing deduction of taxes,
while herein respondent seeks to be allowed deduction under section 30(b),
which provides for deduction of interest on indebtedness.
In conclusion, we are of the opinion and so hold that although interest
payment for delinquent taxes is not deductible as tax under Section 30(c) of
the Tax Code and section 80 of the Income Tax Regulations, the taxpayer is
not precluded thereby from claiming said interest payment as deduction
under section 30(b) of the same Code.
In view of the foregoing, the decision sought to be reviewed is affirmed,
without pronouncement as to costs.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
G.R. No. 118794. May 8, 1996.*
PHILIPPINE REFINING COMPANY (now known as “UNILEVER
PHILIPPINES [PRC], INC.”), petitioner, vs. COURT OF APPEALS,
COURT OF TAX APPEALS, and THE COMMISSIONER OF
INTERNAL REVENUE, respondents.
Taxation; ”Bad Debts”; Conditions before debts could be considered
as ”worthless.”—This pronouncement of respondent Court of Appeals relied
on the ruling of this Court in Collector vs. Goodrich International Rubber
Co., which established the rule in determining the “worthlessness of a debt.”
In said case, we held that for debts to be considered as “worthless,” and
thereby qualify as “bad debts” making them deductible, the taxpayer should
show that: (1) there is a valid and subsisting debt; (2) the debt must be
actually ascertained to be worthless and uncollectible during the taxable year;
(3) the debt must be charged off during the taxable year; and (4) the debt
must arise from the business or trade of the taxpayer. Additionally, before a
debt can be considered worthless, the taxpayer must also show that it is
indeed uncollectible even in the future.
Same; Same; Evidence; While a creditor is not required to file suit
against foreign debtors which could only be sued in their country, it is at
least expected by the law to produce reasonable proof that the debts are
uncollectible although diligent efforts were exerted to collect the same.—
Regarding the accounts of C. Itoh in the amount of P19,272.22, Crocklaan
B.V. in the sum of P77,690.00, and Craig, Mostyn Pty. Ltd. with a balance of
P23,738.00, petitioner contends that these debtors being foreign corporations,
it can sue them only in their country of incorporation; and since this will
entail expenses more than the amounts of the debts to be collected, petitioner
did not file any collection suit but opted to write them off as bad debts.
Petitioner was unable to show proof of its efforts to collect the debts, even by
a single demand letter therefor. While it is not required to file suit, it is at
least expected by the law to produce reasonable proof that the debts are
uncollectible although diligent efforts were exerted to collect the same.
Same; Same; State Immunity; The mere fact that AFPCES is a
government agency does not preclude the creditor from filing suit since said
agency, while discharging proprietary functions, does not enjoy immunity
from suit.—With regard to the account of AFPCES for unpaid supplies in the
58
amount of P13,833.62, petitioner asserts that since the debtor is an agency of
the government, PRC did not file a collection suit therefor. Yet, the mere fact
that AFPCES is a government agency does not preclude PRC from filing suit
since said agency, while discharging proprietary functions, does not enjoy
immunity from suit. Such pretension of petitioner cannot pass judicial
muster.
Same; Same; Administrative Law; The Court of Tax Appeals is a highly
specialized body specifically created for the purpose of reviewing tax cases
and, through its expertise, it is undeniably competent to determine the issue
of whether or not the debt is deductible through the evidence presented
before it.—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 judgment should not be substituted by that of respondent court as it is
PRC which has the facilities in ascertaining the collectibility or
uncollectibility of these debts, are presumptuous and uncalled for. The Court
of Tax Appeals is a highly specialized body specifically created for the
purpose of reviewing tax cases. Through its expertise, it is undeniably
competent to determine the issue of whether or not the debt is deductible
through the evidence presented before it.
Same; Same; Same; The findings of the CTA will not ordinarily be
reviewed absent a showing of gross error or abuse on its part.—Because of
this recognized expertise, the findings of the CTA will not ordinarily be
reviewed absent a showing of gross error or abuse on its part. The findings of
fact of the CTA are binding on this Court and in the absence of strong
reasons for this Court to delve into facts, only questions of law are open for
determination. Were it not, therefore, due to the desire of this Court to satisfy
petitioner’s calls for clarification and to use this case as a vehicle for
exemplification, this appeal could very well have been summarily dismissed.
Same; Same; The fact that a taxpayer appealed the assessment to the
CTA and that the same was modified does not relieve it of the penalties
incident to delinquency.—As correctly pointed out by the Solicitor General,
the deficiency tax assessment in this case, which was the subject of the
demand letter of respondent Commissioner dated April 11, 1989, should
have been paid within thirty (30) days from receipt thereof. By reason of
petitioner’s default thereon, the delinquency penalties of 25% surcharge and
interest of 20% accrued from April 11, 1989. The fact that petitioner
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

appealed the assessment to the CTA and that the same was modified does not in the total sum of P395,324.27, and imposing a 25% surcharge and 20%
relieve petitioner of the penalties incident to delinquency. The reduced annual delinquency interest on the alleged deficiency income tax liability of
amount of P237,381.25 is but a part of the original assessment of petitioner.
P1,892,584.00.
Petitioner Philippine Refining Company (PRC) was assessed by respondent
Same; Same; Tax laws imposing penalties for delinquencies are Commissioner of Internal Revenue (Commissioner) to pay a deficiency tax
intended to hasten tax payments by punishing evasions or neglect of duty in for the year 1985 in the amount of P1,892,584.00, computed as follows:
respect thereof.—Our attention has also been called to two of our previous
rulings and these we set out here for the benefit of petitioner and whosoever Deficiency Income Tax
may be minded to take the same stance it has adopted in this case. Tax laws
imposing penalties for delinquencies, so we have long held, are intended to Net Income per investigation P197,502,568.00
hasten tax payments by punishing evasions or neglect of duty in respect Add: Disallowances
thereof. If penalties could be condoned for flimsy reasons, the law imposing Bad Debts P 713,070.93
penalties for delinquencies would be rendered nugatory, and the maintenance Interest Expense P 2,666,545.49
of the Government and its multifarious activities will be adversely affected. —————— ——————
P3,379,616.00
Same; Same; It is mandatory to collect penalty and interest at the stated
rate in case of delinquency.—We have likewise explained that it is
Net Taxable Income 200,882,184.00
mandatory to collect penalty and interest at the stated rate in case of
delinquency. The intention of the law is to discourage delay in the payment
of taxes due the Government and, in this sense, the penalty and interest are Tax Due Thereon 70,298,764.00
not penal but compensatory for the concomitant use of the funds by the Less: Tax Paid 69,115,899.00
taxpayer beyond the date when he is supposed to have paid them to the Deficiency Income Tax 1,182,865.00
Government. Unquestionably, petitioner chose to turn a deaf ear to these Add: 20% Interest (60% max.) 709,719.00
injunctions. ——————

Total Amount Due and Collectible P1,892,584.002

The assessment was timely protested by petitioner on April 26, 1989, on the
PETITION for review of a decision of the Court of Appeals. ground that it was based on the erroneous disallowances of "bad debts" and
"interest expense" although the same are both allowable and legal
The facts are stated in the opinion of the Court. deductions. Respondent Commissioner, however, issued a warrant of
Antonio H. Garces for petitioner. garnishment against the deposits of petitioner at a branch of City Trust Bank,
in Makati, Metro Manila, which action the latter considered as a denial of its
REGALADO, J.: protest.

This is an appeal by certiorari from the decision of respondent Court of Petitioner accordingly filed a petition for review with the Court of Tax
Appeals1 affirming the decision of the Court of Tax Appeals which Appeals (CTA) on the same assignment of error, that is, that the "bad debts"
disallowed petitioner’s claim for deduction as bad debts of several accounts and "interest expense" are legal and allowable deductions. In its decision3 of

59
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
February 3, 1993 in C.T.A. Case No. 4408, the CTA modified the findings of
the Commissioner by reducing the deficiency income tax assessment to
P237,381.26, with surcharge and interest incident to delinquency. In said
decision, the Tax Court reversed and set aside the Commissioner's
disallowance of the interest expense of P2,666,545.19 but maintained the
disallowance of the supposed bad debts of thirteen (13) debtors in the total
sum of P395,324.27.
Petitioner then elevated the case to respondent Court of Appeals which, as
earlier stated, denied due course to the petition for review and dismissed the
same on August 24, 1994 in CA-G.R. SP No. 31190,4 on the following
ratiocination:
We agree with respondent Court of Tax Appeals:
Out of the sixteen (16) accounts alleged as
bad debts, We find that only three (3)
accounts have met the requirements of the
worthlessness of the accounts, hence were
properly written off as: bad debts, namely:
1. Petronila Catap P
29,098.30
(Pet Mini Grocery)
2. Esther Guinto 254,375.54
(Esther Sari-sari Store)
3. Manuel Orea 34,272.82
(Elman Gen. Mdsg.)
—————
TOTAL P 317,746.66
xxx xxx xxx
1. This pronouncement of respondent Court of Appeals relied on the ruling of
this Court in Collector vs. Goodrich International Rubber Co.,6 which
With regard to the other accounts, namely:
established the rule in determining the "worthlessness of a debt." In said case,
60
1. Remoblas Store P 11,961.00
2. Tomas Store 16,842.79
3. AFPCES 13,833.62
4. CM Variety Store 10,895.82
5. U' Ren Mart Enterprise 10,487.08
6. Aboitiz Shipping Corp. 89,483.40
7. J. Ruiz Trucking 69,640.34
8. Renato Alejandro 13,550.00
9. Craig, Mostyn Pty. Ltd.
23,738.00
10. C. Itoh 19,272.22
11. Crocklaan B.V. 77,690.00
12. Enriched Food Corp. 24,158.00
13. Lucito Sta. Maria 13,772.00
—————
TOTAL P 395,324.27
We find that said accounts have not satisfied the
requirements of the "worthlessness of a debt". Mere
testimony of the Financial Accountant of the Petitioner
explaining the worthlessness of said debts is seen by this
Court as nothing more than a self-serving exercise which
lacks probative value. There was no iota of documentary
evidence (e.g., collection letters sent, report from
investigating fieldmen, letter of referral to their legal
department, police report/affidavit that the owners were
bankrupt due to fire that engulfed their stores or that the
owner has been murdered. etc.), to give support to the
testimony of an employee of the Petitioner. Mere allegations
cannot prove the worthlessness of such debts in 1985.
Hence, the claim for deduction of these thirteen (13) debts
should be rejected.5
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
we held that for debts to be considered as "worthless," and thereby qualify as
"bad debts" making them deductible, the taxpayer should show that (1) there
is a valid and subsisting debt. (2) the debt must be actually ascertained to be
worthless and uncollectible during the taxable year; (3) the debt must be
charged off during the taxable year; and (4) the debt must arise from the
business or trade of the taxpayer. Additionally, before a debt can be
considered worthless, the taxpayer must also show that it is indeed
uncollectible even in the future.
Furthermore, there are steps outlined to be undertaken by the taxpayer to
prove that he exerted diligent efforts to collect the debts, viz.: (1) sending of
statement of accounts; (2) sending of collection letters; (3) giving the account
to a lawyer for collection; and (4) filing a collection case in court.
On the foregoing considerations, respondent Court of Appeals held that
petitioner did not satisfy the requirements of "worthlessness of a debt" as to
the thirteen (13) accounts disallowed as deductions.
It appears that the only evidentiary support given by PRC for its aforesaid
claimed deductions was the explanation or justification posited by its
financial adviser or accountant, Guia D. Masagana. Her allegations were not
supported by any documentary evidence, hence both the Court of Appeals
and the CTA ruled that said contentions per se cannot prove that the debts
were indeed uncollectible and can be considered as bad debts as to make
them deductible. That both lower courts are correct is shown by petitioner's
own submission and the discussion thereof which we have taken time and
patience to cull from the antecedent proceedings in this case, albeit bordering
on factual settings.
The accounts of Remoblas Store in the amount of P11,961.00 and CM
Variety Store in the amount of P10,895.82 are uncollectible, according to
petitioner, since the stores were burned in November, 1984 and in early
1985, respectively, and there are no assets belonging to the debtors that can
be garnished by PRC.7 However, PRC failed to show any documentary
evidence for said allegations. Not a single document was offered to show that
the stores were burned, even just a police report or an affidavit attesting to
such loss by fire. In fact, petitioner did not send even a single demand letter
to the owners of said stores.
61
The account of Tomas Store in the amount of P16,842.79 is uncollectible,
claims petitioner PRC, since the owner thereof was murdered and left no
visible assets which could satisfy the debt. Withal, just like the accounts of
the two other stores just mentioned, petitioner again failed to present proof of
the efforts exerted to collect the debt, other than the aforestated asseverations
of its financial adviser.
The accounts of Aboitiz Shipping Corporation and J. Ruiz Trucking in the
amounts of P89,483.40 and P69,640.34, respectively, both of which allegedly
arose from the hijacking of their cargo and for which they were given 30%
rebates by PRC, are claimed to be uncollectible. Again, petitioner failed to
present an iota of proof, not even a copy of the supposed policy regulation of
PRC that it gives rebates to clients in case of loss arising from fortuitous
events or force majeure, which rebates it now passes off as uncollectible
debts.
As to the account of P13,550.00 representing the balance collectible from
Renato Alejandro, a former employee who failed to pay the judgment against
him, it is petitioner's theory that the same can no longer be collected since his
whereabouts are unknown and he has no known property which can be
garnished or levied upon. Once again, petitioner failed to prove the existence
of the said case against that debtor or to submit any documentation to show
that Alejandro was indeed bound to pay any judgment obligation.
The amount of P13,772.00 corresponding to the debt of Lucito Sta. Maria is
allegedly due to the loss of his stocks through robbery and the account is
uncollectible due to his insolvency. Petitioner likewise failed to submit
documentary evidence, not even the written reports of the alleged
investigation conducted by its agents as testified to by its aforenamed
financial adviser.
Regarding the accounts of C. Itoh in the amount of P19,272.22, Crocklaan
B.V. in the sum of P77,690.00, and Craig, Mostyn Pty. Ltd. with a balance of
P23,738.00, petitioner contends that these debtors being foreign corporations,
it can sue them only in their country of incorporation; and since this will
entail expenses more than the amounts of the debts to be collected, petitioner
did not file any collection suit but opted to write them off as bad debts.
Petitioner was unable to show proof of its efforts to collect the debts, even by
a single demand letter therefor. While it is not required to file suit, it is at
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
least expected by the law to produce reasonable proof that the debts are
uncollectible although diligent efforts were exerted to collect the same.
The account of Enriched Food Corporation in the amount of P24,158.00
remains unpaid, although petitioner claims that it sent several letters. This is
not sufficient to sustain its position. even if true, but even smacks of
insouciance on its part. On top of that, it was unable to show a single copy of
the alleged demand letters sent to the said corporation or any of its corporate
officers.
With regard to the account of AFPCES for unpaid supplies in the amount of
P13,833.62, petitioner asserts that since the debtor is an agency of the
government, PRC did not file a collection suit therefor. Yet, the mere fact
that AFPCES is a government agency does not preclude PRC from filing suit
since said agency, while discharging proprietary functions, does not enjoy
immunity from suit. Such pretension of petitioner cannot pass judicial
muster.
No explanation is offered by petitioner as to why the unpaid account of U'
Ren Mart Enterprise in the amount of P10,487.08 was written off as a bad
debt. However, the decision of the CTA includes this debtor in its findings on
the lack of documentary evidence to justify the deductions claimed, since the
worthlessness of the debts involved are sought to be established by the mere
self-serving testimony of its financial consultant.
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
judgment should not be substituted by that of respondent court as it is PRC
which has the facilities in ascertaining the collectibility or uncollectibility of
these debts, are presumptuous and uncalled for. The Court of Tax Appeals is
a highly specialized body specifically created for the purpose of reviewing
tax cases. Through its expertise, it is undeniably competent to determine the
issue of whether or not the debt is deductible through the evidence presented
before it.8
Because of this recognized expertise, the findings of the CTA will not
ordinarily be reviewed absent a showing of gross error or abuse on its
part.9 The findings of fact of the CTA are binding on this Court and in the
absence of strong reasons for this Court to delve into facts, only questions of
62
law are open for determination. 10 Were it not, therefore, due to the desire of
this Court to satisfy petitioner's calls for clarification and to use this case as a
vehicle for exemplification, this appeal could very well have been summarily
dismissed.
The Court vehemently rejects the absurd thesis of petitioner that despite the
supervening delay in the tax payment, nothing is lost on the part of the
Government because in the event that these debts are collected, the same will
be returned as taxes to it in the year of the recovery. This is an irresponsible
statement which deliberately ignores the fact that while the Government may
eventually recover 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.
2. We need not tarry at length on the second issue raised by petitioner. It
argues that the imposition of the 25% surcharge and the 20% delinquency
interest due to delay in its payment of the tax assessed is improper and
unwarranted, considering that the assessment of the Commissioner was
modified by the CTA and the decision of said court has not yet become final
and executory.
Regarding the 25% surcharge penalty, Section 248 of the Tax Code provides:
Sec. 248. Civil Penalties. — (a) There shall be imposed, in
addition to the tax required to be paid, a penalty equivalent
to twenty-five percent (25%) of the amount due, in the
following cases:
xxx xxx xxx
(3) Failure to pay the tax within the time prescribed for its
payment.
With respect to the penalty of 20% interest, the relevant provision is found in
Section 249 of the same Code, as follows:
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

Sec. 249. Interest. — (a) In general. — There shall be
assessed and collected on any unpaid amount of tax, interest
at the rate of twenty percent (20%) per annum, or such
higher rate as may be prescribed by regulations, from the
date prescribed for payment until the amount is fully paid.
xxx xxx xxx
(c) Delinquency interest. — In case of failure pay:
(1) The amount of the tax due on any return required to be
filed, or
(2) The amount of the tax due for which no return is
required, or
(3) A deficiency tax, or any surcharge or interest thereon, on
the due date appearing in the notice and demand of the
Commissioner,
there shall be assessed and collected, on the unpaid amount,
interest at the rate prescribed in paragraph (a) hereof until the
amount is fully paid, which interest shall form part of the
tax. (emphasis supplied)
Our attention has also been called to two of our previous rulings and these
we set out here for the benefit of petitioner and whosoever may be minded to
take the same stance it has adopted in this case. Tax laws imposing penalties
for delinquencies, so we have long held, are intended to hasten tax payments
by punishing evasions or neglect of duty in respect thereof. If penalties could
be condoned for flimsy reasons, the law imposing penalties for delinquencies
would be rendered nugatory, and the maintenance of the Government and its
multifarious activities will be adversely affected. 11
We have likewise explained that it is mandatory to collect penalty and
interest at the stated rate in case of delinquency. The intention of the law is to
discourage delay in the payment of taxes due the Government and, in this
sense, the penalty and interest are not penal but compensatory for the
concomitant use of the funds by the taxpayer beyond the date when he is
supposed to have paid them to the Government. 12 Unquestionably, petitioner
chose to turn a deaf ear to these injunctions.
ACCORDINGLY, the petition at bar is DENIED and the judgment of
respondent Court of Appeals is hereby AFFIRMED, with treble costs against
petitioner.
SO ORDERED.

xxx xxx xxx

As correctly pointed out by the Solicitor General, the deficiency tax

assessment in this case, which was the subject of the demand letter of
respondent Commissioner dated April 11,1989, should have been paid within
thirty (30) days from receipt thereof. By reason of petitioner's default
thereon, the delinquency penalties of 25% surcharge and interest of 20%
accrued from April 11, 1989. The fact that petitioner appealed the assessment
to the CTA and that the same was modified does not relieve petitioner of the
penalties incident to delinquency. The reduced amount of P237,381.25 is but
a part of the original assessment of P1,892,584.00.

63
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

G.R. No. L-21551 September 30, 1969 Rafael Dinglasan for petitioner.
Office of the Solicitor General Arturo A. Alafriz, Solicitor Alejandro B.
FERNANDEZ HERMANOS, INC., petitioner, Afurong and Special Attorney Virgilio G. Saldajeno for respondent.
vs.
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX L-21557:
APPEALS, respondents.
Office of the Solicitor General for petitioner.
----------------------------- Rafael Dinglasan for respondent Fernandez Hermanos, Inc.

G.R. No. L-21557 September 30, 1969 L-24972:

COMMISSIONER OF INTERNAL REVENUE, petitioner, Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor
vs. General Felicisimo R. Rosete and Special Attorney Virgilio G. Saldajeno for
FERNANDEZ HERMANOS, INC., and COURT OF TAX petitioner.
APPEALS, respondents. Rafael Dinglasan for respondent Fernandez Hermanos, Inc.

----------------------------- L-24978:

G.R. No. L-24972 September 30, 1969 Rafael Dinglasan for petitioner.
Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor
COMMISSIONER OF INTERNAL REVENUE, petitioner, General Antonio G. Ibarra and Special Attorney Virgilio G. Saldajeno for
vs. respondent.
FERNANDEZ HERMANOS INC., and the COURT OF TAX
APPEALS, respondents.

-----------------------------
TEEHANKEE, J.:
G.R. No. L-24978 September 30, 1969
These four appears involve two decisions of the Court of Tax Appeals
FERNANDEZ HERMANOS, INC., petitioner, determining the taxpayer's income tax liability for the years 1950 to 1954 and
vs. for the year 1957. Both the taxpayer and the Commissioner of Internal
THE COMMISSIONER OF INTERNAL REVENUE, and HON. Revenue, as petitioner and respondent in the cases a quo respectively,
ROMAN A. UMALI, COURT OF TAX APPEALS, respondents. appealed from the Tax Court's decisions, insofar as their respective
contentions on particular tax items were therein resolved against them. Since
L-21551: the issues raised are interrelated, the Court resolves the four appeals in this
joint decision.

Cases L-21551 and L-21557

64
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized 2. Excessive depreciation of Houses —
for the principal purpose of engaging in business as an "investment
company" with main office at Manila. Upon verification of the taxpayer's 1950 P 8,180.40
income tax returns for the period in question, the Commissioner of Internal
1951 8,768.11
Revenue assessed against the taxpayer the sums of P13,414.00, P119,613.00,
P11,698.00, P6,887.00 and P14,451.00 as alleged deficiency income taxes 1952 18,002.16
for the years 1950, 1951, 1952, 1953 and 1954, respectively. Said 1953 13,655.25
assessments were the result of alleged discrepancies found upon the 1954 29,314.98
examination and verification of the taxpayer's income tax returns for the said
years, summarized by the Tax Court in its decision of June 10, 1963 in CTA
3. Taxable increase in net worth —
Case No. 787, as follows:

1. Losses — 1950 P 30,050.00

1951 1,382.85
a. Losses in Mati Lumber Co. (1950) P 8,050.00
4. Gain realized from sale of real property in 1950 P
b. Losses in or bad debts of Palawan Manganese Mines, Inc. 11,147.2611
(1951) 353,134.25
The Tax Court sustained the Commissioner's disallowances of Item
c. Losses in Balamban Coal Mines — 1, sub-items (b) and (e) and Item 2 of the above summary, but
overruled the Commissioner's disallowances of all the remaining
1950 8,989.76 items. It therefore modified the deficiency assessments accordingly,
found the total deficiency income taxes due from the taxpayer for the
1951 27,732.66
years under review to amount to P123,436.00 instead of P166,063.00
as originally assessed by the Commissioner, and rendered the
d. Losses in Hacienda Dalupiri — following judgment:

1950 17,418.95 RESUME

1951 29,125.82
1952 26,744.81 1950 P2,748.00
1953 21,932.62 1951 108,724.00
1954 42,938.56 1952 3,600.00
1953 2,501.00
e. Losses in Hacienda Samal — 1954 5,863.00

1951 8,380.25 Total P123,436.00

1952 7,621.73
65
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
WHEREFORE, the decision appealed from is hereby modified, and
petitioner is ordered to pay the sum of P123,436.00 within 30 days
from the date this decision becomes final. If the said amount, or any
part thereof, is not paid within said period, there shall be added to the
unpaid amount as surcharge of 5%, plus interest as provided in
Section 51 of the National Internal Revenue Code, as amended. With
costs against petitioner. (Pp. 75, 76, Taxpayer's Brief as appellant)
Both parties have appealed from the respective adverse rulings against them
in the Tax Court's decision. Two main issues are raised by the parties: first,
the correctness of the Tax Court's rulings with respect to the disputed items
of disallowances enumerated in the Tax Court's summary reproduced above,
and second, whether or not the government's right to collect the deficiency
income taxes in question has already prescribed.
On the first issue, we will discuss the disputed items of
disallowances seriatim.
1. Re allowances/disallowances of losses.
(a) Allowance of losses in Mati Lumber Co. (1950). — The Commissioner of
Internal Revenue questions the Tax Court's allowance of the taxpayer's
writing off as worthless securities in its 1950 return the sum of P8,050.00
representing the cost of shares of stock of Mati Lumber Co. acquired by the
taxpayer on January 1, 1948, on the ground that the worthlessness of said
stock in the year 1950 had not been clearly established. The Commissioner
contends that although the said Company was no longer in operation in 1950,
it still had its sawmill and equipment which must be of considerable value.
The Court, however, found that "the company ceased operations in 1949
when its Manager and owner, a certain Mr. Rocamora, left for Spain ,where
he subsequently died. When the company eased to operate, it had no assets,
in other words, completely insolvent. This information as to the insolvency
of the Company — reached (the taxpayer) in 1950," when it properly
claimed the loss as a deduction in its 1950 tax return, pursuant to Section
30(d) (4) (b) or Section 30 (e) (3) of the National Internal Revenue Code. 2
We find no reason to disturb this finding of the Tax Court. There was
adequate basis for the writing off of the stock as worthless securities.
Assuming that the Company would later somehow realize some proceeds
66
from its sawmill and equipment, which were still existing as claimed by the
Commissioner, and that such proceeds would later be distributed to its
stockholders such as the taxpayer, the amount so received by the taxpayer
would then properly be reportable as income of the taxpayer in the year it is
received.
(b) Disallowance of losses in or bad debts of Palawan Manganese Mines,
Inc. (1951). — The taxpayer appeals from the Tax Court's disallowance of its
writing off in 1951 as a loss or bad debt the sum of P353,134.25, which it
had advanced or loaned to Palawan Manganese Mines, Inc. The Tax Court's
findings on this item follow:
Sometime in 1945, Palawan Manganese Mines, Inc., the controlling
stockholders of which are also the controlling stockholders of
petitioner corporation, requested financial help from petitioner to
enable it to resume it mining operations in Coron, Palawan. The
request for financial assistance was readily and unanimously
approved by the Board of Directors of petitioner, and thereafter a
memorandum agreement was executed on August 12, 1945,
embodying the terms and conditions under which the financial
assistance was to be extended, the pertinent provisions of which are
as follows:
"WHEREAS, the FIRST PARTY, by virtue of its resolution
adopted on August 10, 1945, has agreed to extend to the
SECOND PARTY the requested financial help by way of
accommodation advances and for this purpose has
authorized its President, Mr. Ramon J. Fernandez to cause
the release of funds to the SECOND PARTY.
"WHEREAS, to compensate the FIRST PARTY for the
advances that it has agreed to extend to the SECOND
PARTY, the latter has agreed to pay to the former fifteen per
centum (15%) of its net profits.
"NOW THEREFORE, for and in consideration of the above
premises, the parties hereto have agreed and covenanted that
in consideration of the financial help to be extended by the
FIRST PARTY to the SECOND PARTY to enable the latter
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
to resume its mining operations in Coron, Palawan, the
SECOND PARTY has agreed and undertaken as it hereby
agrees and undertakes to pay to the FIRST PARTY fifteen
per centum (15%) of its net profits." (Exh. H-2)
Pursuant to the agreement mentioned above, petitioner gave to Palawan
Manganese Mines, Inc. yearly advances starting from 1945, which advances
amounted to P587,308.07 by the end of 1951. Despite these advances and the
resumption of operations by Palawan Manganese Mines, Inc., it continued to
suffer losses. By 1951, petitioner became convinced that those advances
could no longer be recovered. While it continued to give advances, it decided
to write off as worthless the sum of P353,134.25. This amount "was arrived
at on the basis of the total of advances made from 1945 to 1949 in the sum of
P438,981.39, from which amount the sum of P85,647.14 had to be deducted,
the latter sum representing its pre-war assets. (t.s.n., pp. 136-139, Id)." (Page
4, Memorandum for Petitioner.) Petitioner decided to maintain the advances
given in 1950 and 1951 in the hope that it might be able to recover the same,
as in fact it continued to give advances up to 1952. From these facts, and as
admitted by petitioner itself, Palawan Manganese Mines, Inc., was still in
operation when the advances corresponding to the years 1945 to 1949 were
written off the books of petitioner. Under the circumstances, was the sum of
P353,134.25 properly claimed by petitioner as deduction in its income tax
return for 1951, either as losses or bad debts?
It will be noted that in giving advances to Palawan Manganese Mine Inc.,
petitioner did not expect to be repaid. It is true that some testimonial
evidence was presented to show that there was some agreement that the
advances would be repaid, but no documentary evidence was presented to
this effect. The memorandum agreement signed by the parties appears to be
very clear that the consideration for the advances made by petitioner was
15% of the net profits of Palawan Manganese Mines, Inc. In other words, if
there were no earnings or profits, there was no obligation to repay those
advances. It has been held that the voluntary advances made without
expectation of repayment do not result in deductible losses. 1955 PH Fed.
Taxes, Par. 13, 329, citing W. F. Young, Inc. v. Comm., 120 F 2d. 159, 27
AFTR 395; George B. Markle, 17 TC. 1593.
Is the said amount deductible as a bad debt? As already stated, petitioner
gave advances to Palawan Manganese Mines, Inc., without expectation of
67
repayment. Petitioner could not sue for recovery under the memorandum
agreement because the obligation of Palawan Manganese Mines, Inc. was to
pay petitioner 15% of its net profits, not the advances. No bad debt could
arise where there is no valid and subsisting debt.
Again, assuming that in this case there was a valid and subsisting debt and
that the debtor was incapable of paying the debt in 1951, when petitioner
wrote off the advances and deducted the amount in its return for said year,
yet the debt is not deductible in 1951 as a worthless debt. It appears that the
debtor was still in operation in 1951 and 1952, as petitioner continued to give
advances in those years. It has been held that if the debtor corporation,
although losing money or insolvent, was still operating at the end of the
taxable year, the debt is not considered worthless and therefore not
deductible. 3
The Tax Court's disallowance of the write-off was proper. The Solicitor
General has rightly pointed out that the taxpayer has taken an "ambiguous
position " and "has not definitely taken a stand on whether the amount
involved is claimed as losses or as bad debts but insists that it is either a loss
or a bad debt." 4 We sustain the government's position that the advances made
by the taxpayer to its 100% subsidiary, Palawan Manganese Mines, Inc.
amounting to P587,308,07 as of 1951 were investments and not loans. 5 The
evidence on record shows that the board of directors of the two companies
since August, 1945, were identical and that the only capital of Palawan
Manganese Mines, Inc. is the amount of P100,000.00 entered in the
taxpayer's balance sheet as its investment in its subsidiary company. 6 This
fact explains the liberality with which the taxpayer made such large advances
to the subsidiary, despite the latter's admittedly poor financial condition.
The taxpayer's contention that its advances were loans to its subsidiary as
against the Tax Court's finding that under their memorandum agreement, the
taxpayer did not expect to be repaid, since if the subsidiary had no earnings,
there was no obligation to repay those advances, becomes immaterial, in the
light of our resolution of the question. The Tax Court correctly held that the
subsidiary company was still in operation in 1951 and 1952 and the taxpayer
continued to give it advances in those years, and, therefore, the alleged debt
or investment could not properly be considered worthless and deductible in
1951, as claimed by the taxpayer. Furthermore, neither under Section 30 (d)
(2) of our Tax Code providing for deduction by corporations of losses
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
actually sustained and charged off during the taxable year nor under Section
30 (e) (1) thereof providing for deduction of bad debts actually ascertained to
be worthless and charged off within the taxable year, can there be 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.
The Tax Court held that the taxpayer's loss of its investment in its subsidiary
could not be deducted for the year 1951, as the subsidiary was still in
operation in 1951 and 1952. The taxpayer, on the other hand, claims that its
advances were irretrievably lost because of the staggering losses suffered by
its subsidiary in 1951 and that its advances after 1949 were "only limited to
the purpose of salvaging whatever ore was already available, and for the
purpose of paying the wages of the laborers who needed help." 7 The
correctness of the Tax Court's ruling in sustaining the disallowance of the
write-off in 1951 of the taxpayer's claimed losses is borne out by subsequent
events shown in Cases L-24972 and L-24978 involving the taxpayer's 1957
income tax liability. (Infra, paragraph 6.) It will there be seen that by 1956,
the obligation of the taxpayer's subsidiary to it had been reduced from
P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on January
1, 1956 that the subsidiary decided to cease operations. 8
(c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). — The
Court sustains the Tax Court's disallowance of the sums of P8,989.76 and
P27,732.66 spent by the taxpayer for the operation of its Balamban coal
mines in Cebu in 1950 and 1951, respectively, and claimed as losses in the
taxpayer's returns for said years. The Tax Court correctly held that the losses
"are deductible in 1952, when the mines were abandoned, and not in 1950
and 1951, when they were still in operation." 9 The taxpayer's claim that these
expeditions should be allowed as losses for the corresponding years that they
were incurred, because it made no sales of coal during said years, since the
promised road or outlet through which the coal could be transported from the
mines to the provincial road was not constructed, cannot be sustained. Some
definite event must fix the time when the loss is sustained, and here it was
the event of actual abandonment of the mines in 1952. The Tax Court held
that the losses, totalling P36,722.42 were properly deductible in 1952, but the
appealed judgment does not show that the taxpayer was credited therefor in
68
the determination of its tax liability for said year. This additional deduction
of P36,722.42 from the taxpayer's taxable income in 1952 would result in the
elimination of the deficiency tax liability for said year in the sum of
P3,600.00 as determined by the Tax Court in the appealed judgment.
(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and
Hacienda Samal (1951-1952). — The Tax Court overruled the
Commissioner's disallowance of these items of losses thus:
Petitioner deducted losses in the operation of its Hacienda Dalupiri
the sums of P17,418.95 in 1950, P29,125.82 in 1951, P26,744.81 in
1952, P21,932.62 in 1953, and P42,938.56 in 1954. These
deductions were disallowed by respondent on the ground that the
farm was operated solely for pleasure or as a hobby and not for
profit. This conclusion is based on the fact that the farm was
operated continuously at a loss.1awphîl.nèt
From the evidence, we are convinced that the Hacienda Dalupiri was
operated by petitioner for business and not pleasure. It was mainly a
cattle farm, although a few race horses were also raised. It does not
appear that the farm was used by petitioner for entertainment, social
activities, or other non-business purposes. Therefore, it is entitled to
deduct expenses and losses in connection with the operation of said
farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103,
CB 1939-1, p.164)
Section 100 of Revenue Regulations No. 2, otherwise known as the
Income Tax Regulations, authorizes farmers to determine their gross
income on the basis of inventories. Said regulations provide:
"If gross income is ascertained by inventories, no deduction
can be made for livestock or products lost during the year,
whether purchased for resale, produced on the farm, as such
losses will be reflected in the inventory by reducing the
amount of livestock or products on hand at the close of the
year."
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
Evidently, petitioner determined its income or losses in the operation
of said farm on the basis of inventories. We quote from the
memorandum of counsel for petitioner:
"The Taxpayer deducted from its income tax returns for the
years from 1950 to 1954 inclusive, the corresponding yearly
losses sustained in the operation of Hacienda Dalupiri, which
losses represent the excess of its yearly expenditures over the
receipts; that is, the losses represent the difference between
the sales of livestock and the actual cash disbursements or
expenses." (Pages 21-22, Memorandum for Petitioner.)
As the Hacienda Dalupiri was operated by petitioner for business and
since it sustained losses in its operation, which losses were
determined by means of inventories authorized under Section 100 of
Revenue Regulations No. 2, it was error for respondent to have
disallowed the deduction of said losses. The same is true with respect
to loss sustained in the operation of the Hacienda Samal for the years
1951 and 1952. 10
The Commissioner questions that the losses sustained by the taxpayer were
properly based on the inventory method of accounting. He concedes,
however, "that the regulations referred to does not specify how the
inventories are to be made. The Tax Court, however, felt satisfied with the
evidence presented by the taxpayer ... which merely consisted of an alleged
physical count of the number of the livestock in Hacienda Dalupiri for the
years involved." 11 The Tax Court was satisfied with the method adopted by
the taxpayer as a farmer breeding livestock, reporting on the basis of receipts
and disbursements. We find no Compelling reason to disturb its findings.
2. Disallowance of excessive depreciation of buildings (1950-1954). —
During the years 1950 to 1954, the taxpayer claimed a depreciation
allowance for its buildings at the annual rate of 10%. The Commissioner
claimed that the reasonable depreciation rate is only 3% per annum, and,
hence, disallowed as excessive the amount claimed as depreciation allowance
in excess of 3% annually. We sustain the Tax Court's finding that the
taxpayer did not submit adequate proof of the correctness of the taxpayer's
claim that the depreciable assets or buildings in question had a useful life
only of 10 years so as to justify its 10% depreciation per annum claim, such
69
finding being supported by the record. The taxpayer's contention that it has
many zero or one-peso assets, 12 representing very old and fully depreciated
assets serves but to support the Commissioner's position that a 10% annual
depreciation rate was excessive.
3. Taxable increase in net worth (1950-1951). — The Tax Court set aside the
Commissioner's treatment as taxable income of certain increases in the
taxpayer's net worth. It found that:
For the year 1950, respondent determined that petitioner had an
increase in net worth in the sum of P30,050.00, and for the year
1951, the sum of P1,382.85. These amounts were treated by
respondent as taxable income of petitioner for said years.
It appears that petitioner had an account with the Manila Insurance
Company, the records bearing on which were lost. When its records
were reconstituted the amount of P349,800.00 was set up as its
liability to the Manila Insurance Company. It was discovered later
that the correct liability was only 319,750.00, or a difference of
P30,050.00, so that the records were adjusted so as to show the
correct liability. The correction or adjustment was made in 1950.
Respondent contends that the reduction of petitioner's liability to
Manila Insurance Company resulted in the increase of petitioner's net
worth to the extent of P30,050.00 which is taxable. This is erroneous.
The principle underlying the taxability of an increase in the net worth
of a taxpayer rests on the theory that such an increase in net worth, if
unreported and not explained by the taxpayer, comes from income
derived from a taxable source. (See Perez v. Araneta, G.R. No. L-
9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 & L-
11558, Nov. 25, 1958.) In this case, the increase in the net worth of
petitioner for 1950 to the extent of P30,050.00 was not the result of
the receipt by it of taxable income. It was merely the outcome of the
correction of an error in the entry in its books relating to its
indebtedness to the Manila Insurance Company. The Income Tax
Law imposes a tax on income; it does not tax any or every increase
in net worth whether or not derived from income. Surely, the said
sum of P30,050.00 was not income to petitioner, and it was error for
respondent to assess a deficiency income tax on said amount.
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

The same holds true in the case of the alleged increase in net worth of of first instance, or where the assessment is appealed to the Court of Tax
petitioner for the year 1951 in the sum of P1,382.85. It appears that certain Appeals, by filing an answer to the taxpayer's petition for review wherein
items (all amounting to P1,382.85) remained in petitioner's books as payment of the tax is prayed for." 17 This is but logical for where the taxpayer
outstanding liabilities of trade creditors. These accounts were discovered in avails of the right to appeal the tax assessment to the Court of Tax Appeals,
1951 as having been paid in prior years, so that the necessary adjustments the said Court is vested with the authority to pronounce judgment as to the
were made to correct the errors. If there was an increase in net worth of the taxpayer's liability to the exclusion of any other court. In the present case,
petitioner, the increase in net worth was not the result of receipt by petitioner regardless of whether the assessments were made on February 24 and 27,
of taxable income." 13 The Commissioner advances no valid grounds in his 1956, as claimed by the Commissioner, or on December 27, 1955 as claimed
brief for contesting the Tax Court's findings. Certainly, these increases in the by the taxpayer, the government's right to collect the taxes due has clearly
taxpayer's net worth were not taxable increases in net worth, as they were not not prescribed, as the taxpayer's appeal or petition for review was filed with
the result of the receipt by it of unreported or unexplained taxable income, the Tax Court on May 4, 1960, with the Commissioner filing on May 20,
but were shown to be merely the result of the correction of errors in its 1960 his Answer with a prayer for payment of the taxes due, long before the
entries in its books relating to its indebtednesses to certain creditors, which expiration of the five-year period to effect collection by judicial action
had been erroneously overstated or listed as outstanding when they had in counted from the date of assessment.
fact been duly paid. The Tax Court's action must be affirmed.
Cases L-24972 and L-24978
4. Gain realized from sale of real property (1950). — We likewise sustain as
being in accordance with the evidence the Tax Court's reversal of the These cases refer to the taxpayer's income tax liability for the year 1957.
Commissioner's assessment on all alleged unreported gain in the sum of Upon examination of its corresponding income tax return, the Commissioner
P11,147.26 in the sale of a certain real property of the taxpayer in 1950. As assessed it for deficiency income tax in the amount of P38,918.76, computed
found by the Tax Court, the evidence shows that this property was acquired as follows:
in 1926 for P11,852.74, and was sold in 1950 for P60,000.00, apparently,
resulting in a gain of P48,147.26. 14 The taxpayer reported in its return a gain
of P37,000.00, or a discrepancy of P11,147.26. 15 It was sufficiently proved Net income per return P29,178.70
from the taxpayer's books that after acquiring the property, the taxpayer had Add: Unallowable deductions:
made improvements totalling P11,147.26, 16 accounting for the apparent (1) Net loss claimed on Ha. Dalupiri 89,547.33
discrepancy in the reported gain. In other words, this figure added to the
(2) Amortization of Contractual right claimed as an
original acquisition cost of P11,852.74 results in a total cost of P23,000.00,
expense under Mines Operations 48,481.62
and the gain derived from the sale of the property for P60,000.00 was
correctly reported by the taxpayer at P37,000.00.
Net income per investigation P167,297.65
On the second issue of prescription, the taxpayer's contention that the Tax due thereon 38,818.00
Commissioner's action to recover its tax liability should be deemed to have
prescribed for failure on the part of the Commissioner to file a complaint for Less: Amount already assessed 5,836.00
collection against it in an appropriate civil action, as contradistinguished Balance P32,982.00
from the answer filed by the Commissioner to its petition for review of the
questioned assessments in the case a quo has long been rejected by this Add: 1/2% monthly interest from 6-20-59 to 6-
Court. This Court has consistently held that "a judicial action for the 20-62 5,936.76 1
8
collection of a tax is begun by the filing of a complaint with the proper court TOTAL AMOUNT DUE AND COLLECTIBLE
70
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
P38,918.76
The Tax Court overruled the Commissioner's disallowance of the taxpayer's
losses in the operation of its Hacienda Dalupiri in the sum of P89,547.33 but
sustained the disallowance of the sum of P48,481.62, which allegedly
represented 1/5 of the cost of the "contractual right" over the mines of its
subsidiary, Palawan Manganese Mines, Inc. which the taxpayer had acquired.
It found the taxpayer liable for deficiency income tax for the year 1957 in the
amount of P9,696.00, instead of P32,982.00 as originally assessed, and
rendered the following judgment:
WHEREFORE, the assessment appealed from is hereby modified.
Petitioner is hereby ordered to pay to respondent the amount of
P9,696.00 as deficiency income tax for the year 1957, plus the
corresponding interest provided in Section 51 of the Revenue Code.
If the deficiency tax is not paid in full within thirty (30) days from
the date this decision becomes final and executory, petitioner shall
pay a surcharge of five per cent (5%) of the unpaid amount, plus
interest at the rate of one per cent (1%) a month, computed from the
date this decision becomes final until paid, provided that the
maximum amount that may be collected as interest shall not exceed
the amount corresponding to a period of three (3) years. Without
6. Disallowance of amortization of alleged "contractual rights." — The
pronouncement as to costs. 19
reasons for sustaining this disallowance are thus given by the Tax Court:
Both parties again appealed from the respective adverse rulings against them
in the Tax Court's decision.
5. Allowance of losses in Hacienda Dalupiri (1957). — The Tax Court cited
its previous decision overruling the Commissioner's disallowance of losses
suffered by the taxpayer in the operation of its Hacienda Dalupiri, since it
was convinced that the hacienda was operated for business and not for
pleasure. And in this appeal, the Commissioner cites his arguments in his
appellant's brief in Case No. L-21557. The Tax Court, in setting aside the
Commissioner's principal objections, which were directed to the accounting
method used by the taxpayer found that:
It is true that petitioner followed the cash basis method of reporting
income and expenses in the operation of the Hacienda Dalupiri and
71
used the accrual method with respect to its mine operations. This
method of accounting, otherwise known as the hybrid method,
followed by petitioner is not without justification.
... A taxpayer may not, ordinarily, combine the cash and
accrual bases. The 1954 Code provisions permit, however,
the use of a hybrid method of accounting, combining a cash
and accrual method, under circumstances and requirements
to be set out in Regulations to be issued. Also, if a taxpayer
is engaged in more than one trade or business he may use a
different method of accounting for each trade or business.
And a taxpayer may report income from a business on
accrual basis and his personal income on the cash basis.' (See
Mertens, Law of Federal Income Taxation, Zimet & Stanley
Revision, Vol. 2, Sec. 12.08, p. 26.) 20
The Tax Court, having satisfied itself with the adequacy of the
taxpayer's accounting method and procedure as properly reflecting
the taxpayer's income or losses, and the Commissioner having failed
to show the contrary, we reiterate our ruling [supra, paragraph 1 (d)
and (e)] that we find no compelling reason to disturb its findings.
It appears that the Palawan Manganese Mines, Inc., during a special
meeting of its Board of Directors on January 19, 1956, approved a
resolution, the pertinent portions of which read as follows:
"RESOLVED, as it is hereby resolved, that the corporation's
current assets composed of ores, fuel, and oil, materials and
supplies, spare parts and canteen supplies appearing in the
inventory and balance sheet of the Corporation as of
December 31, 1955, with an aggregate value of P97,636.98,
contractual rights for the operation of various mining claims
in Palawan with a value of P100,000.00, its title on various
mining claims in Palawan with a value of P142,408.10 or a
total value of P340,045.02 be, as they are hereby ceded and
transferred to Fernandez Hermanos, Inc., as partial
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME
settlement of the indebtedness of the corporation to said
Fernandez Hermanos Inc. in the amount of P442,895.23."
(Exh. E, p. 17, CTA rec.)
On March 29, 1956, petitioner's corporation accepted the above offer
of transfer, thus:
"WHEREAS, the Palawan Manganese Mines, Inc., due to its
yearly substantial losses has decided to cease operation on
January 1, 1956 and in order to satisfy at least a part of its
indebtedness to the Corporation, it has proposed to transfer
its current assets in the amount of NINETY SEVEN
THOUSAND SIX HUNDRED THIRTY SIX PESOS &
98/100 (P97,636.98) as per its balance sheet as of December
31, 1955, its contractual rights valued at ONE HUNDRED
THOUSAND PESOS (P100,000.00) and its title over
various mining claims valued at ONE HUNDRED FORTY
TWO THOUSAND FOUR HUNDRED EIGHT PESOS &
10/100 (P142,408.10) or a total evaluation of THREE
HUNDRED FORTY THOUSAND FORTY FIVE PESOS &
08/100 (P340,045.08) which shall be applied in partial
settlement of its obligation to the Corporation in the amount
of FOUR HUNDRED FORTY TWO THOUSAND EIGHT
HUNDRED EIGHTY FIVE PESOS & 23/100
(P442,885.23)," (Exh. E-1, p. 18, CTA rec.)
Petitioner determined the cost of the mines at P242,408.10 by adding
the value of the contractual rights (P100,000.00) and the value of its
mining claims (P142,408.10). Respondent disallowed the deduction
on the following grounds: (1) that the Palawan Manganese Mines,
Inc. could not transfer P242,408.10 worth of assets to petitioner
because the balance sheet of the said corporation for 1955 shows that
it had only current as worth P97,636.96; and (2) that the alleged
amortization of "contractual rights" is not allowed by the Revenue
Code.
The law in point is Section 30(g) (1) (B) of the Revenue Code,
before its amendment by Republic Act No. 2698, which provided in
part:
72
"(g) Depletion of oil and gas wells and mines.:
"(1) In general. — ... (B) in the case of mines, a reasonable
allowance for depletion thereof not to exceed the market
value in the mine of the product thereof, which has been
mined and sold during the year for which the return and
computation are made. The allowances shall be made under
rules and regulations to be prescribed by the Secretary of
Finance: Provided, That when the allowances shall equal the
capital invested, ... no further allowance shall be made."
Assuming, arguendo, that the Palawan Manganese Mines, Inc. had
assets worth P242,408.10 which it actually transferred to the
petitioner in 1956, the latter cannot just deduct one-fifth (1/5) of said
amount from its gross income for the year 1957 because such
deduction in the form of depletion charge was not sanctioned by
Section 30(g) (1) (B) of the Revenue Code, as above-quoted.
xxx xxx xxx
The sole basis of petitioner in claiming the amount of P48,481.62 as
a deduction was the memorandum of its mining engineer (Exh. 1, pp.
31-32, CTA rec.), who stated that the ore reserves of the Busuange
Mines (Mines transferred by the Palawan Manganese Mines, Inc. to
the petitioner) would be exhausted in five (5) years, hence, the claim
for P48,481.62 or one-fifth (1/5) of the alleged cost of the mines
corresponding to the year 1957 and every year thereafter for a period
of 5 years. The said memorandum merely showed the estimated ore
reserves of the mines and it probable selling price. No evidence
whatsoever was presented to show the produced mine and for how
much they were sold during the year for which the return and
computation were made. This is necessary in order to determine the
amount of depletion that can be legally deducted from petitioner's
gross income. The method employed by petitioner in making an
outright deduction of 1/5 of the cost of the mines is not authorized
under Section 30(g) (1) (B) of the Revenue Code. Respondent's
disallowance of the alleged "contractual rights" amounting to
P48,481.62 must therefore be sustained. 21
 TAX CASES BATCH 6: DEDUCTIONS FROM GROSS INCOME

The taxpayer insists in this appeal that it could use as a method for depletion
under the pertinent provision of the Tax Code its "capital investment,"
representing the alleged value of its contractual rights and titles to mining
claims in the sum of P242,408.10 and thus deduct outright one-fifth (1/5) of
this "capital investment" every year. regardless of whether it had actually
mined the product and sold the products. The very authorities cited in its
brief give the correct concept of depletion charges that they "allow for the
exhaustion of the capital value of the deposits by production"; thus, "as the
cost of the raw materials must be deducted from the gross income before the
net income can be determined, so the estimated cost of the reserve used up is
allowed." 22 The alleged "capital investment" method invoked by the
taxpayer is not a method of depletion, but the Tax Code provision, prior to its
amendment by Section 1, of Republic Act No. 2698, which took effect on
June 18, 1960, expressly provided that "when the allowances shall equal the
capital invested ... no further allowances shall be made;" in other words, the
"capital investment" was but the limitation of the amount of depletion that
could be claimed. The outright deduction by the taxpayer of 1/5 of the cost of
the mines, as if it were a "straight line" rate of depreciation, was correctly
held by the Tax Court not to be authorized by the Tax Code.

ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the

appeals in Cases Nos. L-21551 and L-21557, as modified by the crediting of
the losses of P36,722.42 disallowed in 1951 and 1952 to the taxpayer for the
year 1953 as directed in paragraph 1 (c) of this decision, is hereby affirmed.
The judgment of the Court of Tax Appeals appealed from in Cases Nos. L-
24972 and L-24978 is affirmed in toto. No costs. So ordered.

Concepcion, C.J., Dizon, Makalintal, Zaldivar, Sanchez, Castro, Fernando,

Capistrano and Barredo, JJ., concur.

73