42 54

[G.R. No. L-18840. May 29, 1969.
KUENZLE & STREIFF, INC., Petitioner, v. THE COMMISSIONER OF INTERNAL REVENUE, Respondent. Angel S. Gamboa
for Petitioner.
Solicitor General Arturo A. Alafriz, Assistant Solicitor General Jose P. Alejandro and Special Attorney Virgilio C .
Saldajeno for Respondent.
SYLLABUS
1. TAXATION; INCOME TAXATION; DEDUCTIBLE EXPENSES; BONUSES TO EMPLOYEES; DEDUCTION NOT

ALLOWABLE IN CASE AT BAR. — Where the bonuses to petitioner’s top officials were paid in spite of the fact
that according to its income tax returns for the years 1953, 1954, and 1955, it suffered net losses and in fact, its
gross assets suffered a gradual decrease for the same years, and that a similar downward trend took place in its
surplus and capital position during the same period of time, the respondent Commissioner of Internal Revenue
did not act arbitrarily in disallowing as deductible expenses the amounts thus paid by the company as bonus or
"additional remuneration" in accordance with Section 30(a) (1) of the National Internal Revenue Code.
2. ID.; ID.; ID.; ID.; COMPANY’S POLICY OF LOW SALARY BUT WITH SUBSTANTIAL BONUSES NOT A
JUSTIFICATION. — Petitioner justifies payment of the bonuses in question to its top officials by saying that its
general salary policy was to give a low salary but to grant substantial bonuses at the end of each year, so that its
officers may receive considerable lump sums with which to purchase whatever expensive objects or items they
might need. While the Court is not prepared to hold that such policy is unreasonable, still its application should
not result in producing a net loss for the employer at the end of the year, for if that were to be the case, the
scheme may be utilized to freely achieve some other purpose-evade payment of taxes.
3. ID.; ID.; ID.; ID.; QUESTION OF ALLOWANCE EXCLUSIVELY LODGED IN COMMISSIONER OF INTERNAL REVENUE.
— The question of allowing or disallowing as deductible expenses the amounts paid to corporate officers by way
of bonus is determined by the Commissioner of Internal Revenue exclusively for income tax purposes.
Concededly, he has no authority to fix the amounts to be paid to corporate officers by way of basic salary, bonus
or additional remuneration - a matter that lies more or less exclusively within the sound discretion of the
corporation itself. But this right of the corporation is, of course, not absolute. It cannot exercise it for the
purpose of evading payment of taxes legitimately due to the State.
DECISION
DIZON, J.:
Petition filed by Kuenzle & Streiff, Inc. for the review of the decision of the Court of Tax Appeals in C.T.A. Case No. 551
sustaining the assessments of the respondent issued against it, for deficiency income taxes for the years 1953, 1954 and
1955 in the amounts of P40,455.00, P11,248.00 and P16,228.00, respectively, arising from the disallowance, as
deductible expenses, of the bonuses paid by petitioner to its officers, upon the ground that they were not ordinary, nor
necessary, nor reasonable expenses within the purview of Section 30(a) (1) of the National Internal Revenue Code .
Petitioner, a domestic corporation, filed its income tax returns for the taxable years 1953, 1954 and 1955, declaring net
losses of P2,085.84, P4,953.91 and P9,246.07, respectively. Upon a verification thereof, the respondent, on September
9, 1957, assessed against it the deficiency income taxes in question, arrived at as follows:
For the year 1953, by disallowing as deductions all amounts paid that year by the petitioner as bonus to its officers and
staff-members in the aggregate sum of P175,140.00, this resulting in a net taxable income of petitioner amounting to
P173,054.16; for the taxable years 1954 and 1955, the similar disallowance as deductions of a portion of the bonuses
paid by petitioner in said years to its officers and staff-members in the aggregate sums of P88,193.33 for 1954 and
P90,385.00 for 1955, resulted likewise in a net taxable income for petitioner in the sum of P83,239.42 for 1954 and
P81,138.93 for 1955.
On July 9, 1958 petitioner filed with the Court of Tax Appeals a petition for review contesting the aforementioned
assessments (C.T.A. Case No. 551), and on April 28, 1961, said Court rendered judgment as follows:
"FOR THE FOREGOING CONSIDERATIONS, the decision appealed from is hereby affirmed with respect to the deficiency
assessment for the years 1953 and 1955. As regards the deficiency assessment for the year 1954, the same is hereby
modified in the sense that the amount due from petitioner is P11,248.00, instead of P16,648.00. Accordingly, petitioner
is ordered to pay within thirty days from the date this decision becomes final the sums of P40,455.00 and P16,228.00,
plus 5% surcharge and 1% monthly interest from October 1, 1957 until paid. It is likewise ordered to pay the sum of
P11,248.00 within the same period, and, if not so paid, there shall be added thereto 5% surcharge and 1% monthly
interest from the date of delinquency to the date of payment. With costs against petitioner."
Petitioner moved for a reconsideration of the above quoted decision, and on August 21, 1961, the court amended the
same to include the following at the end thereof:
". . . In both cases, the maximum amount of interest shall not exceed the amount corresponding to a period of three
years, pursuant to Section 51(e) (2) of the National Internal Revenue Code, as amended by Section 8 of Republic Act No.
2343. With costs against petitioner."
Having found that the bonuses in question were paid for services actually rendered by the recipients thereof, the tax
court proceeded to consider the question of "whether or not they are reasonable." In this connection it construed
Section 30(a) (1) of the Revenue Code as allowing the deduction from gross income of all the ordinary and necessary
expenses incurred during the taxable year in carrying on the trade or business of the taxpayer, including a reasonable
allowance for salaries or other compensation for personal services actually rendered. We agree with the view thus
expressed, as well as with said court’s conclusion that the bonuses in question were not reasonable considering all
material and relevant factors.
Petitioner contends that the tax court, in arriving at its conclusion, acted "in a purely arbitrary manner," and erred in not
considering individually the total compensation paid to each of petitioner’s officers and staff members in determining
the reasonableness of the bonuses in question, and that it erred likewise in holding that there was nothing in the record
indicating that the actuation of the respondent was unreasonable or unjust.
It is not true, as petitioner claims to support its view, that the respondent and the tax court based their ruling
exclusively upon the fact that petitioner had suffered net losses in its business operations during the years when the
bonuses in question were paid. The truth appears to be that, in arriving at such conclusion, the respondent and the tax
court gave due consideration to all the material factors that led this Court to decide an earliest case of petitioner itself
involving the same issue and where the test for determining the reasonableness of bonuses and additional
compensation for services actually rendered were laid down by Us as follows:
"It is a general rule that ‘Bonuses to employees made in good faith and as additional compensation for the services
actually rendered by the employees are deductible provided such payments, when added to the stipulated salaries, do
not exceed a reasonable compensation for the services rendered’ (4 Mertens, Law of Federal Income Taxation, Sec. 25-
50, p. 410). The condition precedents to the deduction of bonuses to employees are: (1) the payment of the bonuses is
in fact compensation; (2) it must be for personal services actually rendered; and (3) bonuses, when added to the
salaries, are ‘reasonable . . . when measured by the amount and quality of the services performed with relation to the
business of the particular taxpayer’ (Idem., Sec. 25.44, p. 395). Here it is admitted that the bonuses are in fact
compensation and were paid for services actually rendered. The only question is whether the payment of said bonuses is
reasonable.
"There is no fixed test for determining the reasonableness of a given bonus as compensation. This depends upon many
factors, one of them being ‘the amount and quality of the services performed with relation to the business’. Other tests
suggested are: payment must be ‘made in good faith’; ‘the character of the taxpayer’s business, the volume and amount
of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation’; ‘the
size of the particular business’; ‘the employees’ qualifications and contributions to the business venture’; and ‘general
economic conditions’ (4 Mertens Law of Federal Income Taxation, Secs. 25.44, 25.49, 25.50, 25.51, pp. 407-412).
However, ‘in determining whether the particular salary or compensation payment is reasonable, the situation must be
considered as a whole.’ Ordinarily, no single factor is decisive . . . it is important to keep in mind that it seldom happens
that the application of one test can give a satisfactory answer, and that ordinarily it is the interplay of several factors,
properly weighted for the particular case, which must furnish the final answer (Idem.)." (Kuenzle & Streiff v. Coll. of Int.
Rev., G.R. Nos. L-12010 & L-12113, Oct. 20, 1959.)
Making a distinction between petitioner’s previous case and the present, the tax court said that while it is true that in
the former (C.T.A. No. 169, December 29, 1956, G.R. Nos. L-12010 and L-12113, October 20, 1959, involving taxable
years 1950 to 1952) We allowed—and considered deductible—bonuses in amounts bigger than the ones allowed by
respondent in the case at bar, that was due to the fact that petitioner had earned huge profits during the years 1950-
52. So much so that, the payment of such bonuses notwithstanding, petitioner still had substantial net profits
distributable as dividends among its stockholders. In the present case, on the other hand, it is clear that the ultimate
and inevitable result of the payment of the questioned bonuses would be net losses for petitioner during the taxable
years in which they were paid.
It seems clear from the record that, in arriving at its main conclusion, the tax court considered, inter alia, the following
factors:
In the first place, for the years 1953, 1954 and 1955 the petitioner paid to its following top officers: A.P. Kuenzle, H.A.
Streiff, A. Jung, G. Cattaneo, A. Schatzmann, F.E. Rein, M. Klingler, A. Huber, S. Meili, M. Triaca, J. Ortiz, H. Vogt, W.
Ramp, W. Strehler, H.R. Jung, K. Schedler, P.C. Curtis, R. Oefeli, substantial amounts as salaries and bonuses ranging from
P9,000.00 yearly as a minimum (except in one case) and P50,000.00 as maximum. All these officials headed various
departments of petitioner’s business. While it must be assumed, on the one hand, in the absence of evidence to the
contrary, that they were competent, on the other the record discloses no evidence nor has petitioner ever made the
claim that all or some of them were gifted with some special talent, or had undergone some extraordinary training, or
had accomplished any particular task, that contributed materially to the success of petitioner’s business during the
taxable years in question.
In the second place, working under the abovenamed officials and constituting what we might call the staff of petitioner’s
working personnel, were a good number of other employees—mostly Filipinos (T.s.n., pp. 222-223)—all of whom,
according to the record (Idem, 223), received no pay increase at all during the same years.
In the third place, the above salaries and bonuses were paid to petitioner’s top officials mentioned heretofore, in spite
of the fact that according to its income tax returns for the relevant years, it has suffered net losses as follows;
P2,085.84, P4,953.91, P9,246.07 for the years 1953, 1954 and 1955, respectively. In fact, petitioner’s financial
statements further show that its gross assets suffered a gradual decrease for the same years (Exh. B-1, p. 58, B.I.R.
records, Exh. D-1, p. 36 id., Exh. F-1, p. 14 id.), and that a similar downward trend took place in its surplus and capital
position during the same period of time.
That the charge of arbitrariness against respondent is without merit is further shown by the following considerations:
Petitioner admits that the amounts it paid to its top officers in 1953 as bonus or "additional remuneration" were taken
either from operating funds, that is, funds from the year’s business operations, or from its general reserve. Normally, the
amounts taken from the first source should have constituted profits of the corporation distributable as dividends
amongst its shareholders. Instead it would appear that they were diverted from this purpose and used to pay the
bonuses for the year 1953. In the case of the amounts taken from the general reserve it seems clear that the company
had to resort to the use of such reserve funds because the item of expense to be met could not be considered as
ordinary or necessary—and was therefore beyond the purview of the provisions of Section 30(a) (1) of the National
Internal Revenue Code. This being so, We can not see our way clear to holding that the respondent acted arbitrarily in
disallowing as deductible expenses the amounts thus paid as bonus or "additional remuneration."
Neither does the total disallowance of the bonuses paid to some officers and the partial disallowance of those paid to
others show that respondent acted unjustly and unreasonably. The record sufficiently shows that the total disallowance
was more or less due to the fact that the affected officers had previously received substantial increases in their basic
salaries.
Petitioner justifies payment of these bonuses to its top officials by saying that its general salary policy was to give a low
salary but to grant substantial bonuses at the end of each year, so that its officers may receive considerable lump sums
with which to purchase whatever expensive objects or items they might need. While We are not prepared to hold that
such policy is unreasonable, still We believe that its application should not result in producing a net loss for the
employer at the end of the year, for if that were to be the case, the scheme may be utilized to freely achieve some other
purpose — evade payment of taxes.
The authority relied upon by petitioner (Mertens Law of Federal Income Taxation, Vol. IV, p. 418) does not apply to the
present case, because it refers to the salary paid to an employee, which may be claimed as a deductible amount. In the
case before Us the respondent does not question the basic salaries paid by petitioner to its officers and employees, but
disallowed only the bonuses paid to petitioner’s top officers at the end of the taxable years in question.
In further support of its appeal petitioner claims that the amounts disallowed by the respondent should be considered
as legitimate business expenses as their payment was made in good faith. In bringing up this point, petitioner treads on
dangerous ground. In the first place, good faith can not decide whether a business expense is reasonable or
unreasonable for purposes of income tax deduction. In the second place, petitioner’s good faith in the matter at issue is
not overly manifest, considering that the questioned bonuses were fixed and paid at the end of the years m question —
at a time, therefore, when petitioner fully knew that it was going to suffer a net loss in its business operations.
As far as petitioner’s contention that as employer it has the right to fix the compensation of its officers and employees
and that it was in the exercise of such right that it deemed proper to pay the bonuses in question, all that We need say is
this: that right may be conceded, but for income tax purposes the employer can not legally claim such bonuses as
deductible expenses unless they are shown to be reasonable. To hold otherwise would open the gate to rampant tax
evasion.
Lastly, We must not lose sight of the fact that the question of allowing or disallowing as deductible expenses the
amounts paid to corporate officers by way of bonus is determined by respondent exclusively for income tax purposes.
Concededly, he has no authority to fix the amounts to be paid to corporate officers by way of basic salary, bonus or
additional remuneration—a matter that lies more or less exclusively within the sound discretion of the corporation itself.
But this right of the corporation is, of course, not absolute. It can not exercise it for the purpose of evading payment of
taxes legitimately due to the State.
WHEREFORE, the appealed decision being in accordance with law, the same is hereby affirmed, with costs.
Reyes, J.B.L., Actg. C . J., Makalintal, Zaldivar, Sanchez, Fernando, Capistrano, Teehankee and Barredo, JJ., concur.
Concepcion, C.J. and Castro, J., are on official leave of absence.
G.R. No. L-24059 November 28, 1969
C. M. HOSKINS & CO., INC., petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
Ross, Salcedo, Del Rosario, Bito and Misa for petitioner.

Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felicisimo R. Rosete and Special Attorney
Michaelina R. Balasbas for respondent.
TEEHANKEE, J.:
We uphold in this taxpayer's appeal the Tax Court's ruling that payment by the taxpayer to its controlling stockholder
of 50% of its supervision fees or the amount of P99,977.91 is not a deductible ordinary and necessary expense and
should be treated as a distribution of earnings and profits of the taxpayer.
Petitioner, a domestic corporation engaged in the real estate business as brokers, managing agents and
administrators, filed its income tax return for its fiscal year ending September 30, 1957 showing a net income of
P92,540.25 and a tax liability due thereon of P18,508.00, which it paid in due course. Upon verification of its return,
respondent Commissioner of Internal Revenue, disallowed four items of deduction in petitioner's tax returns and
assessed against it an income tax deficiency in the amount of P28,054.00 plus interests. The Court of Tax Appeals
upon reviewing the assessment at the taxpayer's petition, upheld respondent's disallowance of the principal item of
petitioner's having paid to Mr. C. M. Hoskins, its founder and controlling stockholder the amount of P99,977.91
representing 50% of supervision fees earned by it and set aside respondent's disallowance of three other minor items.
The Tax Court therefore determined petitioner's tax deficiency to be in the amount of P27,145.00 and on November 8,
1964 rendered judgment against it, as follows:
WHEREFORE, premises considered, the decision of the respondent is hereby modified. Petitioner is ordered to pay to
the latter or his representative the sum of P27,145.00, representing deficiency income tax for the year 1957, plus
interest at 1/2% per month from June 20, 1959 to be computed in accordance with the provisions of Section 51(d) of the
National Internal Revenue Code. If the deficiency tax is not paid within thirty (30) days from the date this decision
becomes final, petitioner is also ordered to pay surcharge and interest as provided for in Section 51 (e) of the Tax Code,
without costs.
Petitioner questions in this appeal the Tax Court's findings that the disallowed payment to Hoskins was an inordinately
large one, which bore a close relationship to the recipient's dominant stockholdings and therefore amounted in law to
a distribution of its earnings and profits.
We find no merit in petitioner's appeal.
As found by the Tax Court, "petitioner was founded by Mr. C. M. Hoskins in 1937, with a capital stock of 1,000 shares at
a par value of P1.00 each share; that of these 1,000 shares, Mr. C. M. Hoskins owns 996 shares (the other 4 shares being
held by the other four officers of the corporation), which constitute exactly 99.6% of the total authorized capital stock
(p. 92, t.s.n.); that during the first four years of its existence, Mr. C. M. Hoskins was the President, but during the taxable
period in question, that is, from October 1, 1956 to September 30, 1957, he was the chairman of the Board of Directors
and salesman-broker for the company (p. 93, t.s.n.); that as chairman of the Board of Directors, he received a salary of
P3,750.00 a month, plus a salary bonus of about P40,000.00 a year (p. 94, t.s.n.); that he was also a stockholder and
officer of the Paradise Farms, Inc. and Realty Investments, Inc., from which petitioner derived a large portion of its
income in the form of supervision fees and commissions earned on sales of lots (pp. 97-99, t.s.n.; Financial Statements,
attached to Exhibit '1', p. 11, BIR rec.); that as chairman of the Board of Directors of petitioner, his duties were: "To act
as a salesman; as a director, preside over meetings and to get all of the real estate business I could for the company by
negotiating sales, purchases, making appraisals, raising funds to finance real estate operations where that was
necessary' (p. 96, t.s.n.); that he was familiar with the contract entered into by the petitioner with the Paradise Farms,
Inc. and the Realty Investments, Inc. by the terms of which petitioner was 'to program the development, arrange
financing, plan the proposed subdivision as outlined in the prospectus of Paradise Farms, Inc., arrange contract for road
constructions, with the provision of water supply to all of the lots and in general to serve as managing agents for the
Paradise Farms, Inc. and subsequently for the Realty Investment, Inc." (pp. 96-97. t.s.n.)
Considering that in addition to being Chairman of the board of directors of petitioner corporation, which bears his name,
Hoskins, who owned 99.6% of its total authorized capital stock while the four other officers-stockholders of the firm
owned a total of four-tenths of 1%, or one-tenth of 1% each, with their respective nominal shareholdings of one share
each was also salesman-broker for his company, receiving a 50% share of the sales commissions earned by petitioner,
besides his monthly salary of P3,750.00 amounting to an annual compensation of P45,000.00 and an annual salary
bonus of P40,000.00, plus free use of the company car and receipt of other similar allowances and benefits, the Tax
Court correctly ruled that the payment by petitioner to Hoskins of the additional sum of P99,977.91 as his equal or 50%
share of the 8% supervision fees received by petitioner as managing agents of the real estate, subdivision projects of
Paradise Farms, Inc. and Realty Investments, Inc. was inordinately large and could not be accorded the treatment of
ordinary and necessary expenses allowed as deductible items within the purview of Section 30 (a) (i) of the Tax Code.
If such payment of P99,977.91 were to be allowed as a deductible item, then Hoskins would receive on these three
items alone (salary, bonus and supervision fee) a total of P184,977.91, which would be double the petitioner's reported
net income for the year of P92,540.25. As correctly observed by respondent. If independently, a one-time P100,000.00-
fee to plan and lay down the rules for supervision of a subdivision project were to be paid to an experienced realtor such
as Hoskins, its fairness and deductibility by the taxpayer could be conceded; but here 50% of the supervision fee of
petitioner was being paid by it to Hoskins every year since 1955 up to 1963 and for as long as its contract with the
subdivision owner subsisted, regardless of whether services were actually rendered by Hoskins, since his services to
petitioner included such planning and supervision and were already handsomely paid for by petitioner.
The fact that such payment was authorized by a standing resolution of petitioner's board of directors, since "Hoskins had
personally conceived and planned the project" cannot change the picture. There could be no question that as Chairman
of the board and practically an absolutely controlling stockholder of petitioner, holding 99.6% of its stock, Hoskins
wielded tremendous power and influence in the formulation and making of the company's policies and decisions. Even
just as board chairman, going by petitioner's own enumeration of the powers of the office, Hoskins, could exercise
great power and influence within the corporation, such as directing the policy of the corporation, delegating powers
to the president and advising the corporation in determining executive salaries, bonus plans and pensions, dividend
policies, etc.1
Petitioner's invoking of its policy since its incorporation of sharing equally sales commissions with its salesmen, in
accordance with its board resolution of June 18, 1946, is equally untenable. Petitioner's Sales Regulations provide:
Compensation of Salesmen
8. Schedule I — In the case of sales to prospects discovered and worked by a salesman, even though the closing is done
by or with the help of the Sales Manager or other members of the staff, the salesmen get one-half (1/2) of the total
commission received by the Company, but not exceeding five percent (5%). In the case of subdivisions, when the office
commission covers general supervision, the 1/2-rule does not apply, the salesman's share being stipulated in the case of
each subdivision. In most cases the salesman's share is 4%. (Exh. "N-1").2
It will be readily seen therefrom that when the petitioner's commission covers general supervision, it is provided that
the 1/2 rule of equal sharing of the sales commissions does not apply and that the salesman's share is stipulated in the
case of each subdivision. Furthermore, what is involved here is not Hoskins' salesman's share in the petitioner's 12%
sales commission, which he presumably collected also from petitioner without respondent's questioning it, but a 50%
share besides in petitioner's planning and supervision fee of 8% of the gross sales, as mentioned above. This is evident
from petitioner's board's resolution of July 14, 1953 (Exhibit 7), wherein it is recited that in addition to petitioner's sales
commission of 12% of gross sales, the subdivision owners were paying to petitioner 8% of gross sales as supervision fee,
and a collection fee of 5% of gross collections, or total fees of 25% of gross sales.
The case before us is similar to previous cases of disallowances as deductible items of officers' extra fees, bonuses and
commissions, upheld by this Court as not being within the purview of ordinary and necessary expenses and not
passing the test of reasonable compensation.3 In Kuenzle & Streiff, Inc. vs. Commissioner of Internal Revenue decided by
this Court on May 29, 1969,4 we reaffirmed the test of reasonableness, enunciated in the earlier 1967 case involving the
same parties, that: "It is a general rule that 'Bonuses to employees made in good faith and as additional compensation
for the services actually rendered by the employees are deductible, provided such payments, when added to the
stipulated salaries, do not exceed a reasonable compensation for the services rendered' (4 Mertens Law of Federal
Income Taxation, Sec. 25.50, p. 410). The conditions precedent to the deduction of bonuses to employees are: (1) the
payment of the bonuses is in fact compensation; (2) it must be for personal services actually rendered; and (3) the
bonuses, when added to the salaries, are 'reasonable . . . when measured by the amount and quality of the services
performed with relation to the business of the particular taxpayer' (Idem., Sec. 25, 44, p. 395).
"There is no fixed test for determining the reasonableness of a given bonus as compensation. This depends upon many
factors, one of them being 'the amount and quality of the services performed with relation to the business.' Other tests
suggested are: payment must be 'made in good faith'; 'the character of the taxpayer's business, the volume and amount
of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation'; 'the
size of the particular business'; 'the employees' qualifications and contributions to the business venture'; and 'general
economic conditions' (4 Mertens, Law of Federal Income Taxation, Secs. 25.44, 25.49, 25.50, 25.51, pp. 407-412).
However, 'in determining whether the particular salary or compensation payment is reasonable, the situation must be
considered as whole. Ordinarily, no single factor is decisive. . . . it is important to keep in mind that it seldom happens
that the application of one test can give satisfactory answer, and that ordinarily it is the interplay of several factors,
properly weighted for the particular case, which must furnish the final answer."
Petitioner's case fails to pass the test. On the right of the employer as against respondent Commissioner to fix the
compensation of its officers and employees, we there held further that while the employer's right may be conceded,
the question of the allowance or disallowance thereof as deductible expenses for income tax purposes is subject to
determination by respondent Commissioner of Internal Revenue. Thus: "As far as petitioner's contention that as
employer it has the right to fix the compensation of its officers and employees and that it was in the exercise of such
right that it deemed proper to pay the bonuses in question, all that We need say is this: that right may be conceded, but
for income tax purposes the employer cannot legally claim such bonuses as deductible expenses unless they are shown
to be reasonable. To hold otherwise would open the gate of rampant tax evasion.
"Lastly, We must not lose sight of the fact that the question of allowing or disallowing as deductible expenses the
amounts paid to corporate officers by way of bonus is determined by respondent exclusively for income tax purposes.
Concededly, he has no authority to fix the amounts to be paid to corporate officers by way of basic salary, bonus or
additional remuneration — a matter that lies more or less exclusively within the sound discretion of the corporation
itself. But this right of the corporation is, of course, not absolute. It cannot exercise it for the purpose of evading
payment of taxes legitimately due to the State."
Finally, it should be noted that we have here a case practically of a sole proprietorship of C. M. Hoskins, who however
chose to incorporate his business with himself holding virtually absolute control thereof with 99.6% of its stock with four
other nominal shareholders holding one share each. Having chosen to use the corporate form with its legal advantages
of a separate corporate personality as distinguished from his individual personality, the corporation so created, i.e.,
petitioner, is bound to comport itself in accordance with corporate norms and comply with its corporate obligations.
Specifically, it is bound to pay the income tax imposed by law on corporations and may not legally be permitted, by way
of corporate resolutions authorizing payment of inordinately large commissions and fees to its controlling stockholder,
to dilute and diminish its corresponding corporate tax liability.
ACCORDINGLY, the decision appealed from is hereby affirmed, with costs in both instances against petitioner
G.R. No. L-54108 January 17, 1984
COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
COURT OF TAX APPEALS and SMITH KLINE & FRENCH OVERSEAS CO. (PHILIPPINE BRANCH), respondents.
The Solicitor General for petitioner.
Siguion Reyna, Montecillo & Ongsiako and J.C. Castañeda, Jr. and E.C. Alcantara for respondents.
AQUINO, J.:
This case is about the refund of a 1971 income tax amounting to P324,255. Smith Kline and French Overseas Company, a
multinational firm domiciled in Philadelphia, Pennsylvania, is licensed to do business in the Philippines. It is engaged in
the importation, manufacture and sale of pharmaceuticals drugs and chemicals.
In its 1971 original income tax return, Smith Kline declared a net taxable income of P1,489,277 (Exh. A) and paid
P511,247 as tax due. Among the deductions claimed from gross income was P501,040 ($77,060) as its share of the
head office overhead expenses. However, in its amended return filed on March 1, 1973, there was an overpayment of
P324,255 "arising from underdeduction of home office overhead" (Exh. E). It made a formal claim for the refund of
the alleged overpayment.
It appears that sometime in October, 1972, Smith Kline received from its international independent auditors, Peat,
Marwick, Mitchell and Company, an authenticated certification to the effect that the Philippine share in the unallocated
overhead expenses of the main office for the year ended December 31, 1971 was actually $219,547 (P1,427,484). It
further stated in the certification that the allocation was made on the basis of the percentage of gross income in the
Philippines to gross income of the corporation as a whole. By reason of the new adjustment, Smith Kline's tax liability
was greatly reduced from P511,247 to P186,992 resulting in an overpayment of P324,255.
On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on its claim Smith Kline filed a
petition for review with the Court of Tax Appeals.
In its decision of March 21, 1980, the Tax Court ordered the Commissioner to refund the overpayment or grant a tax
credit to Smith Kline. The Commissioner appealed to this Court.
The governing law is found in section 37 of the old National Internal Revenue Code, Commonwealth Act No. 466, which
is reproduced in Presidential Decree No. 1158, the National Internal Revenue Code of 1977 and which reads:
SEC. 37. Income form sources within the Philippines. —
xxx xxx xxx
(b) Net income from sources in the Philippines. — From the items of gross income specified in subsection (a) of this
section there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated
thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some
item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the
Philippines.
xxx xxx xxx
Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to be
made to determine the net income from Philippine sources:
SEC. 160. Apportionment of deductions. — From the items specified in section 37(a), as being derived specifically from
sources within the Philippines there shall be deducted the expenses, losses, and other deductions properly apportioned
or allocated thereto and a ratable part of any other expenses, losses or deductions which can not definitely be allocated
to some item or class of gross income. The remainder shall be included in full as net income from sources within the
Philippines. The ratable part is based upon the ratio of gross income from sources within the Philippines to the total
gross income.
Example: A non-resident alien individual whose taxable year is the calendar year, derived gross income from all sources
for 1939 of P180,000, including therein:
Interest on bonds of a domestic corporation P9,000
Dividends on stock of a domestic corporation 4,000
Royalty for the use of patents within the Philippines 12,000
Gain from sale of real property located within the Philippines 11,000
Total P36,000
that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of the gross income
was from sources without the Philippines, determined under section 37(c).
The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount of P8,000 is properly
allocated to income from sources within the Philippines and the amount of P40,000 is properly allocated to income from
sources without the Philippines.
The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A ratable part thereof,
based upon the relation of gross income from sources within the Philippines to the total gross income, shall be deducted
in computing net income from sources within the Philippines. Thus, these are deducted from the P36,000 of gross
income from sources within the Philippines expenses amounting to P14,000 [representing P8,000 properly apportioned
to the income from sources within the Philippines and P6,000, a ratable part (one-fifth) of the expenses which could not
be allocated to any item or class of gross income.] The remainder, P22,000, is the net income from sources within the
Philippines.
From the foregoing provisions, it is manifest that where an expense is clearly related to the production of Philippine-
derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building in the
Philippines), that expense can be deducted from the gross income acquired in the Philippines without resorting to
apportionment.
The overhead expenses incurred by the parent company in connection with finance, administration, and research and
development, all of which direct benefit its branches all over the world, including the Philippines, fall under a different
category however. These are items which cannot be definitely allocated or Identified with the operations of the
Philippine branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under section 37(b) of the Revenue
Code and section 160 of the regulations, Smith Kline can claim as its deductible share a ratable part of such expenses
based upon the ratio of the local branch's gross income to the total gross income, worldwide, of the multinational
corporation.
In his petition for review, the Commissioner does not dispute the right of Smith Kline to avail itself of section 37(b) of the
Tax Code and section 160 of the regulations. But the Commissioner maintains that such right is not absolute and that as
there exists a contract (in this case a service agreement) which Smith Kline has entered into with its home office,
prescribing the amount that a branch can deduct as its share of the main office's overhead expenses, that contract is
binding.
The Commissioner contends that since the share of the Philippine branch has been fixed at $77,060, Smith Kline itself
cannot claim more than the said amount. To allow Smith Kline to deduct more than what was expressly provided in the
agreement would be to ignore its existence. It is a cardinal rule that a contract is the law between the contracting parties
and the stipulations therein must be respected unless these are proved to be contrary to law, morals, good customs and
public policy. There being allegedly no showing to the contrary, the provisions thereof must be followed.
The Commissioner also argues that the Tax Court erred in relying on the certification of Peat, Marwick, Mitchell and
Company that Smith Kline is entitled to deduct P1,427,484 ($219,547) as its allotted share and that Smith Kline has not
presented any evidence to show that the home office expenses chargeable to Philippine operations exceeded $77,060.
On the other hand, Smith Kline submits that the contract between itself and its home office cannot amend tax laws and
regulations. The matter of allocated expenses which are deductible under the law cannot be the subject of an
agreement between private parties nor can the Commissioner acquiesce in such an agreement.
Smith Kline had to amend its return because it is of common knowledge that audited financial statements are generally
completed three or four months after the close of the accounting period. There being no financial statements yet when
the certification of January 11, 1972 was made the treasurer could not have correctly computed Smith Kline's share in
the home office overhead expenses in accordance with the gross income formula prescribed in section 160 of the
Revenue Regulations. What the treasurer certified was a mere estimate.
Smith Kline likewise submits that it has presented ample evidence to support its claim for refund. To this end, it has
presented before the Tax Court the authenticated statement of Peat, Marwick, Mitchell and Company to show that
since the gross income of the Philippine branch was P7,143,155 ($1,098,617) for 1971 as per audit report prepared by
Sycip, Gorres, Velayo and Company, and the gross income of the corporation as a whole was $6,891,052, Smith Kline's
share at 15.94% of the home office overhead expenses was P1,427,484 ($219,547) (Exh. G to G-2, BIR Records, 4-5).
Clearly, the weight of evidence bolsters its position that the amount of P1,427,484 represents the correct ratable share,
the same having been computed pursuant to section 37(b) and section 160.
In a manifestation dated July 19, 1983, Smith Kline declared that with respect to its share of the head office overhead
expenses in its income tax returns for the years 1973 to 1981, it deducted its ratable share of the total overhead
expenses of its head office for those years as computed by the independent auditors hired by the parent company in
Philadelphia, Pennsylvania U.S.A., as soon as said computations were made available to it.
We hold that Smith Kline's amended 1971 return is in conformity with the law and regulations. The Tax Court correctly
held that the refund or credit of the resulting overpayment is in order.
WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs.
SO ORDERED
G.R. No. L-19537 May 20, 1965
The late LINO GUTIERREZ substituted by ANDREA C. VDA. DE GUTIERREZ, ANTONIO D. GUTIERREZ, GUILLERMO D.
GUTIERREZ, SANTIAGO D. GUTIERREZ and TOMAS D. GUTIERREZ,petitioners,
vs.
COLLECTOR (now COMMISSIONER) OF INTERNAL REVENUE, respondent.
Rosendo J. Tansinsin, Sr., Rosendo Tansinsin, Jr. and Juan C. Nabong, Jr.for petitioners.
Office of the Solicitor General for respondent.
BENGZON, J.P., J.:
Lino Gutierrez was primarily engaged in the business of leasing real property for which he paid estate broker's
privilege tax. He filed his income tax returns for the years 1951, 1952, 1953 and 1954 on the following dates:
Year Date Filed
1951 March 1, 1952
1952 February 28, 1953
1953 February 22, 1954
1954 February 23, 1955
and paid the corresponding tax declared therein.
On July 10, 1956 the Commissioner (formerly Collector) of Internal Revenue assessed against Gutierrez the following
defiency income tax:
1951 . . . . . . . . . . . . . . P 1,400.00
1952 . . . . . . . . . . . . . . 672.00
1953 . . . . . . . . . . . . . . 5,161.00
1954 . . . . . . . . . . . . . . 4,608.00
Total . . . . . . . . . . . . . . P 11,841.00
==========
The above defiency tax came about by the disallowance of deductions from gross income representing depreciation,
expenses Gutierrez allegely incurred in carrying on his business, and the addition to gross income of receipts which he
did not report in his income tax returns. The disallowed business expenses which were considered by the Commissioner
either as personal or capital expenditures consisted of:
1951
Personal expenses:
Transportation expenses to attend funeral of various persons P 96.50

Repair of car and salary of driver 59.80
Expenses in attending National Convention of Filipino

Businessmen in Baguio 121.35
Alms to indigent family 15.00
Capital expenditures:
Electrical fixtures and supplies 100.00
Transportation and other expenses to watch laborers in

construction work 516.00
Realty tax not paid by former owner of property acquired by

350.00
Gutierrez
Litigation expenses to collect rental and eject lessee 702.65
Other disallowed deductions:
Fines and penalties for late payment of taxes 64.48
1952
Personal expenses:
Car expenses, salary of driver and car depreciation P1,454.37
Contribution to Lydia Samson and G. Trinidad 52.00
Officers' jewels and aprons donated to Biak-na-Bato Lodge

No. 7, Free Masons 280.00
Luncheon of Homeowners' Association 5.50
Ticket to opera "Aida" 15.00
1953
Personal expenses:
Car expenses, salary of driver, car depreciation P 1,409.24
Cruise to Corregidor with Homeowners' Association 43.00
Contribution to alms to various individuals 70.00
Tickets to operas 28.00
Cost of one set of Comments on the Rules of Court by Moran P 145.00
1954
Personal expenses:
Car expenses, salary of driver and car depreciation P 1,413.67
Furniture given as commission in connection with business

transaction 115.00
Cost of iron door of Gutierrez' residence 55.00
Painting of rental apartments P 908.00
Carpentry and lumber for rental apartments 335.83
Tinsmith and plumbing for rental apartments 605.25
Cement, tiles, gravel, sand and masonry for rental apartments 199.48
Iron bars, venetian blind, water pumps for rental apartments 1,340.00
Relocation and registration of property used in taxpayer's

1,758.12
business
He also claimed the depreciation of his residence as follows:
1952 . . . . . . P 992.22
1953 . . . . . . 942.61
1954 . . . . . . 895.45
The following are the items of income which Gutierrez did not declare in his
income tax returns:
1951
Income of wife (admitted by Gutierrez) P 2,749.90.
1953
Overstatement of purchase price of real estate P 8,476.92
Understatement of profits from sale of real estate 5,803.74
1954
Understatement of profits from sale of real estate P 5,444.24

The overstatement of purchase price of real estate refers to the sale of two pieces of property in 1953. In 1943 Gutierrez
bought a parcel of land situated along Padre Faura St. in Manila for P35,000.00. Sometime in 1953, he sold the same for
P30,400.00. Expenses of sale amounted to P631.80. In his return he claimed a loss of P5,231.80. 1 However, the
Commissioner, including the said property was bought in Japanese military notes, converting the buying price to its
equivalent in PhilippineCommonwealth peso by the use of the Ballantyne Scale of Values. At P1.30 Japanese military
notes per Commonwealth peso, the acquisition cost of P35,000.00 Japanese military notes was valued at P26,923.00
PhilippineCommonwealth peso. Accordingly, the Commissioner determined a profit of P3,476.92 after restoring to
Gutierrez' gross income the P5,231.80 deductionfor loss.
In another transaction, Gutierrez sold a piece of land for P1,200.00. Alleging the said property was purchased for
P1,200.00, he reported no profit hereunder. However, after verifying the deed of acquisition, the Commissioner
discovered the purchase price to be only P800.00. Consequently, he determined a profit of P400.00 which was added
to the gross income for 1953.1äwphï1.ñët
The understatement of profit from the sale of real estate may be explained thus: In 1953 and 1954 Gutierrez sold four
other properties upon which he made substantial profits. 2Convinced that said properties were capital assets, he
declared only 50% of the profits from their sale. However, treating said properties as ordinary assets (as property held
and used byGutierrez in his business), the Commissioner taxed 100% of the profits from their disposition pursuant to
Section 35 of the Tax Code.
Having unsuccessfully questioned the legality and correctness of the aforesaid assessment, Gutierrez instituted on
February 17, 1958, the Commissioner issued a warrant of distraint and levy on one of Gutierrez' real properties but
desisted from enforcing the same when Gutierrez filed a bond to assure payment of his tax liability.
In a decision dated January 28, 1962, the Court of Tax Appeals upheld in toto the assessment of the Commissioner of
Internal Revenue. Hence, this appeal.
On October 18, 1962, Lino Guttierrez died and he was substituted by Andrea C. Vda. de Gutierrez, Antonio D. Gutierrez,
Santiago D. Gutierrez, Guillermo D. Gutierrez and Tomas D. Gutierrez, his heirs,as party petitioners.
The issues are: (1) Are the taxpayer's aforementioned claims for deduction proper and allowable? (2) May the
Ballantyne Scale of Values be applied indetermining the acquisition cost in 1943 of a real property sold in 1953, for
income tax purposes? (3) Are real properties used in the trade or business of the taxpayer capital or ordinary assets? (4)
Has the right of the Commissioner of Internal Revenue to collect the deficiency income tax for the years 1951 and 1952
prescribed? (5) Has the right of the Commissioner of Internal Revenue to collect by distraint and levy the deficiency
income tax for 1953 prescribed? If not, may the taxpayer's rea lproperty be distrained and levied upon without first
exhausting his personal property?
We come first to question whether or not the deductions claimed by Gutierrez are allowable. Section 30(a) of the Tax
Code allows business expenses tobe deducted from gross income. We quote:
SEC. 30. Deductions from gross income. — In computing net income there shall be allowed as deductions —
(a) Expenses:
(1) In general. — All the 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; travelling expenses while away from home in the pursuit of a trade or business; and rentals or other
payments required to be made as a condition to be continued use of possession, for the purposes of the trade or
business, or property to which the taxpayer has not taken or is not taking title or in which he has no equity.
To be deductible, therefore, an expense must be (1) ordinary and necessary;(2) paid or incurred within the taxable year;
and, (3) paid or incurred in carrying on a trade or business. 3
The transportation expenses which petitioner incurred to attend the funeral of his friends and the cost of admission
tickets to operas were expenses relative to his personal and social activities rather than to his business of leasing real
estate. Likewise, the procurement and installation of an iron door to is residence is purely a personal expense. Personal,
living, or family expenses are not deductible. 4
On the other hand, the cost of furniture given by the taxpayer as commission in furtherance of a business transaction,
the expenses incurred in attending the National Convention of Filipino Businessmen, luncheon meeting and cruise to
Corregidor of the Homeowners' Association were shown to have been made in the pursuit of his business. Commissions
given in consideration for bringing about a profitable transaction are part of the cost of the business transaction and are
deductible.
The record shows that Gutierrez was an officer of the Junior Chamber of Commerce which sponsored the National
Convention of Filipino Businessmen. He was also the president of the Homeowners' Association, an organization
established by those engaged in the real estate trade. Having proved that his membership thereof and activities in
connection therewith were solely to enhance his business, the expenses incurred thereunder are deductible as ordinary
and necessary business expenses.
With respect to the taxpayer's claim for deduction for car expenses, salary of his driver and car depreciation, one-third
of the same was disallowed by the Commissioner on the ground that the taxpayer used his car and driver both for
personal and business purposes. There is no clear showing, however, that the car was devoted more for the taxpayer's
business than for his personal and business needs. 5 According to the evidence, the taxpayer's car was utilized both for
personal and business needs. We therefore find it reasonable to allow as deduction one-half of the driver's salary, car
expenses and depreciation.
The electrical supplies, paint, lumber, plumbing, cement, tiles, gravel, masonry and labor used to repair the taxpayer's
rental apartments did not increase the value of such apartments, or prolong their life. They merely kept the apartments
in an ordinary operating condition. Hence, the expenses incurred therefor are deductible as necessary expenditures for
the maintenance of the taxpayer's business.
Similarly, the litigation expenses defrayed by Gutierrez to collect apartment rentals and to eject delinquent tenants are
ordinary and necessary expenses in pursuing his business. It is routinary and necessary for one in the leasing business to
collect rentals and to eject tenants who refuse to pay their accounts.
The following are not deductible business expenses but should be integrated into the cost of the capital assets for which
they were incurred and depreciated yearly: (1) Expenses in watching over laborers in construction work. Watching over
laborers is an activity more akin to the construction work than to running the taxpayer's business. Hence, the expenses
incurred therefor should form part of the construction cost. (2) Real estate tax which remained unpaid by the former
owner of Gutierrez' rental property but which the latter paid, is an additional cost to acquire such property and ought
therefore to be treated as part of the property's purchase price. (3) The iron bars, venetian blind and water pump
augmented the value of the, apartments where they were installed. Their cost is not a maintenance charge, 6 hence, not
deductible.. 7 (4) Expenses for the relocation, survey and registration of property tend to strengthen title over the
property, hence, they should be considered as addition to the costs of such property. (5) The set of "Comments on the
Rules of Court" having a life span of more than one year should be depreciated ratably during its whole life span instead
of its total cost being deducted in one year.
Coming to the claim for depreciation of Gutierrez' residence, we find the same not deductible. A taxpayer may deduct
from gross income a reasonable allowance for deterioration of property arising out of its use or employment in business
or trade. 8 Gutierrez' residence was not used in his trade or business.
Gutierrez also claimed for deduction the fines and penalties which he paid for late payment of taxes. While Section 30
allows taxes to be deducted from gross income, it does not specifically allow fines and penalties to be so deducted.
Deductions from gross income are matters of legislative grace; what is not expressly granted by Congress is withheld.
Moreover, when acts are condemned, by law and their commission is made punishable by fines or forfeitures, to allow
them to be deducted from the wrongdoer's gross income, reduces, and so in part defeats, the prescribed punishment. .9
As regards the alms to an indigent family and various individuals, contributions to Lydia Yamson and G. Trinidad and a
donation consisting of officers' jewels and aprons to Biak-na-Bato Lodge No. 7, the same are not deductible from gross
income inasmuch as their recipients have not been shown to be among those specified by law. Contributions are
deductible when given to the Government of the Philippines, or any of its political subdivisions for exclusively public
purposes, to domestic corporations or associations organized and operated exclusively for religious, charitable,
scientific, athletic, cultural or educational purposes, or for the rehabilitation of veterans, or to societies for the
prevention of cruelty to children or animals, no part of the net income of which inures to the benefit of any private
stockholder or individual. 10
We come to the question of whether or not the Ballantyne Scale of Values can be applied to tax cases.
Sometime in 1943 Gutierrez bought a piece of real estate in Manila for a price of P35,000.00. In 1953 he sold said
property for P30,400.00, thereby incurring a loss which he claimed as deduction in his income tax return for 1953. The
Commissioner of Internal Revenue, convinced that the purchase price of the property in 1943 was in Japanese military
notes, converted said purchase price into Philippine Commonwealth pesos by the use of the Ballantyne Scale of Values.
As a result, the Commissioner found Gutierrez to have profited, instead of lost in the sale.
Firstly, Gutierrez maintains that the purchase price was paid for in Commonwealth pesos. On the other hand the
Commissioner insists that inasmuch as the prevailing currency in the City of Manila in 1943 was the Japanese military
issue, the transaction could have been in said military notes. The evidence offered by Gutierrez, consisting of the
testimony of his son to the effect that it was he who carried the bundle of Commonwealth pesos and Japanese military
notes when his father purchased the property, did not convince the Tax Court. No cogent reason to alter the court a
quo's finding of fact in this regard has been given. There is no definite showing that Gutierrez paid for the property in
Commonwealth pesos. Considering that in 1943 the medium of exchange in Manila was the Japanese military notes, the
use of which the Japanese Military Government enforced with stringent measures, we are inclined to concur with the
finding that the purchase price was in Japanese military notes. We are specifically mindful of the fact that Gutierrez sold
the property in 1953 for only P30,400.00 at a time when the price of real estate in the City of Manila was much greater
than in 1943.
It is further contended by Gutierrez that the money he used to pay for the purchase of the property in question came
from the proceeds of merchandise acquired prior to World War II but which he sold after Manila was occupied by the
Japanese military forces, hence, the purchase price should be deemed to have been made in Commonwealth pesos
inasmuch as the aforesaid merchandise was purchased in Commonwealth pesos. This contention, if true, strengthens
our conclusion that the real estate in question was bought in Japanese military notes. For, at the time Gutierrez sold his
merchandise, the prevailing currency in the City of Manila was the Japanese military money. Consequently, the proceeds
therefrom, which were used to buy the real estate in question, were Japanese military notes.
Gutierrez assails the use of the Ballantyne Scale of Values in converting the purchase price of the real estate in question
from Japanese military notes to Philippine Commonwealth pesos on the ground that (1) the Ballantyne Scale of Values
was intended only for transactions entered into by parties voluntarily during the Japanese occupation, wherein a portion
of the contract was left unperformed until liberation of the Philippines by the Americans; (2) that such Scale of Values
cannot be the basis of a tax, for it is not a law.
In determining the gain or loss from the sale of property the purchase price and the selling price ought to be in the same
currency. Since in this case the purchase price was in Japanese military notes and the selling price was in our present
legal tender, the Japanese military notes should be converted to the present currency. Since the only standard scale
recognized by courts for the purpose is the Ballantyne Scale of Values, we find it compelling to use such table of values
rather than adopt an arbitrary scale. It may not be amiss to state in this connection that the Ballantyne Scale of Values is
not being used herein as the authority to impose the tax, but only as a medium of computing the tax base upon which
the tax is to be imposed.
It is furthermore proffered by the taxpayer that in determining gain or loss, the real value of the Commonwealth peso at
the time the property was purchased and the value of the Republic peso at the time. the same property was sold should
be considered. The Commonwealth peso and the Republic peso are the same currency, with the same intrinsic value,
sanctioned by the same authorities. Both are legal tender and accepted at face value regardless of fluctuation in their
buying power. The 1941 Commonwealth peso when used to buy in 1963 or in 1965 is accorded the same value: one
peso.
In his income tax returns for 1953 and 1954, Gutierrez reported only 50% of profits he realized from the sale of real
properties during the years 1953 and 1954 on the ground that said properties were capital assets. Profits from the sale
of capital assets are taxable to the extent of 50% thereof pursuant to Section 34 of the Tax Code.
Section 34 provides:
SEC. 34. Capital gains and losses. — (a) Definitions. — As used in this title —
(1) Capital assets. — The term "capital assets" means property held by the taxpayer (whether or not connected with his
trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly
be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer
primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business,
of a character which is subject to the allowance for depreciation provided in subsection (f) of section thirty; or real
property used in the trade or business of the taxpayer.
xxx xxx xxx
(b) Percentage taken into account. — In the case of a taxpayer, other than a corporation, only the following percentages
of the gain or loss recognized upon the sale or exchange of capital asset hall be taken into account in computing net
capital gain, net capital loss, and net income:
(1) One hundred per centum if the capital asset has been held for not more than twelve months;
(2) Fifty per centum if the capital asset has been held for not more than twelve months.
Section 34, before it was amended by Republic Act 82 in 1947, considered as capital assets real property used in the
trade or business of a taxpayer. However, with the passage of Republic Act 82, Congress classified "real property used in
the trade or business of the taxpayer" is ordinary asset. The explanatory note to Republic Act 82 says — "... the words
"or real property used in the trade or business of the taxpayer" have been included among the non-capital assets. This
has the effect of withdrawing the gain or loss from the sale or exchange of real property used in the trade or business of
the taxpayer from the operation of the capital gains and losses provisions. As such real property is used in the trade or
business of the taxpayer, it is logical that the gain or loss from the sale or exchange thereof should be treated as
ordinary income or loss. 11 Accordingly, the real estate, admittedly used by Gutierrez in his business, which he sold in
1953 and 1954 should be treated as ordinary assets and the gain from the sale thereof, as ordinary gain, hence, fully
taxable. 12
With regard to the issue of the prescription of the Commissioner's right to collect deficiency tax for 1951 and 1952,
Gutierrez claims that the counting of the 5-year period to collect income tax should start from the time the income tax
returns were filed. He, therefore, urges us to declare the Commissioner's right to collect the deficiency tax for 1951 and
1952 to have prescribed, the income tax returns for 1951 and 1952 having been filed in March 1952 and on February 28,
1953, respectively, and the action to collect the tax having been instituted on March 5, 1958 when the Commissioner
filed his answer to the petition for review in C.T.A. Case No. 504. On the other hand, the Commissioner argues that the
running of the prescriptive period to collect commences from the time of assessment. Inasmuch as the tax for 1951 and
1952 were assessed only on July 10, 1956, less than five years lapsed when he filed his answer on March 5, 1958.
The period of limitation to collect income tax is counted from the assessment of the tax as provided for in paragraph (c)
of Section 332 quoted below:
SEC. 332(c). Where the assessment of any internal revenue tax has been made within the period of limitation above
prescribed such tax may be collected by distraint or levy or by a proceeding in court, but only if begun (1) within five
years after the assessment of the tax, or (2) prior to the expiration of any period for collection agreed upon in writing by
the Collector of Internal Revenue and the taxpayer before the expiration of such five-year period. The period so agreed
upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed
upon.
Inasmuch as the assessment for deficiency income tax was made on July 10, 1956 which is 7 months and 25 days prior to
the action for collection, the right of the Commissioner to collect such tax has not prescribed.
The next issue relates to the prescription of the right of the Commissioner of Internal Revenue to collect the deficiency
tax for 1954 by distraint and levy.
The pertinent provision of the Tax Code states:
SEC. 51(d). Refusal or neglect to make returns; fraudulent returns, etc. — In cases of refusal or neglect to make a return
and in cases of erroneous, false, or fraudulent returns, the Collector of Internal Revenue shall, upon the discovery
thereof, at any time within three years after said return is due or has been made, make a return upon information
obtained as provided for in this code or by existing law, or require the necessary corrections to be made, and the
assessment made by the Collector of Internal Revenue thereon shall be paid by such person or corporation immediately
upon notification of the amount of such assessment.
On February 23, 1955 Gutierrez filed his income tax return for 1954 and on February 24, 1958 the Commissioner of
Internal Revenue issued a warrant of distraint and levy to collect the tax due thereunder. Gutierrez contends that the
Commissioner's right to issue said warrant is barred, for the same was issued more than 3 years from the time he filed
his income tax return. On the other hand, the Commissioner of Internal Revenue maintains that his right did not lapse
inasmuch as from the last day prescribed by law for the filing of the 1954 return to the date when he issued the warrant
of distraint and levy, less than 3 years passed. The question now is: should the counting of the prescriptive period
commence from the actual filing of the return or from the last day prescribed by law for the filing thereof?
We observe that Section 51(d) speaks of erroneous, false or fraudulent returns, and refusal or neglect of the taxpayer to
file a return. It also provides for two dates from which to count the three-year prescriptive period, namely, the date
when the return is due and the date the return has been made. We are inclined to conclude that the date when
the return is due refers to cases where the taxpayer refused or neglected to file a return, and the date when the return
has been made refers to instances where the taxpayer filed erroneous, false or fraudulent returns. Since Gutierrez filed
an income tax return, the three-year prescriptive period should be counted from the time he filed such return. From
February 23, 1955 when the income tax return for 1954 was filed, to February 24, 1958, when the warrant of distraint
and levy was issued, 3 years and 2 days elapsed. The right of the Commissioner to issue said warrant of distraint and levy
having lapsed by two days, the warrant issued is null and void.
The above finding has made academic the question of whether or not the warrant of distraint and levy can be enforced
against the taxpayer's real property without first exhausting his personal properties.
In resume the tax liability of Lino Gutierrez for 1951, 1952, 1953 and 1954 may be computed as follows:
1951
Net income per investigation P29,471.81
Add: Disallowed deductions for salary of 29.90

driver and car expenses
P29,501.81
Less: Allowable deductions:
Expenses in attending National

Convention of Filipino Businessmen P 121.35
Repair of rental apartments 802.65 924.00
Net income P30,425.71
Less: Personal exemption 3,600.00
Amount subject to tax P26,825.71
Tax due thereon P 5,668.00
Less tax already paid 3,981.00
Deficiency income tax due P 1,687.00

==========
1952
Add: Disallowed deductions:
Salary of driver P 260.67
Car expenses 401.51
Car depreciation 65.00 727.18
P22,359.40
Less Allowable deduction:
Luncheon, Homeowners' Association 5.50
Amount subject to tax

P18,764.90
Deficiency income tax due 848.00

==========
1953
Car expenses 406.00
P69,785.40
Less: Allowable deduction:
Cruise to Corregidor with Homeowners'

Association 42.00
Net Income P69,828 40
Tax due thereon P15,179.00

==========
1954

Car expenses 414.18
P44,508.75
Less: Allowable deductions:
Furniture given in connection with

business transaction P 115.00
Repairs of rental apartments 2,048.56 2,163.56

==========
SUMMARY
1951 . . . . . . . . . . . . . . . . P 1,687.00
1952 . . . . . . . . . . . . . . . . 848.00
1953 . . . . . . . . . . . . . . . . 5,374.00
1954 . . . . . . . . . . . . . . . . 4,020.00
TOTAL . . . . . . . . . . P 11,929.00
=========
WHEREFORE, the decision appealed from is modified and Lino Gutierrez and/or his heirs, namely, Andrea C. Vda. de
Gutierrez, Antonio D. Gutierrez, Santiago D. Gutierrez, Guillermo D. Gutierrez and Tomas D. Gutierrez, are ordered to
pay the sums of P1,687.00, P848.00, P5,374.00, and P4,020.00, as deficiency income tax for the years 1951, 1952, 1953
and 1954, respectively, or a total of P11,929.00, plus the statutory penalties in case of delinquency. No costs. So
ordered.
. G.R. No. L-13325 April 20, 1961
SANTIAGO GANCAYCO, petitioner,
vs.
THE COLLECTOR OF INTERNAL REVENUE, respondent.
Benjamin J. Molina for petitioner.

Office of the Solicitor General and Special Attorney Antonio A. Garces for respondent.
CONCEPCION, J.:
Petitioner Santiago Gancayco seeks the review of a decision of the Court of Tax Appeals, requiring him to pay
P16,860.31, plus surcharge and interest, by way of deficiency income tax for the year 1949.
On May 10, 1950, Gancayco filed his income tax return for the year 1949. Two (2) days later, respondent Collector of
Internal Revenue issued the corresponding notice advising him that his income tax liability for that year amounted
P9,793.62, which he paid on May 15, 1950. A year later, on May 14, 1951, respondent wrote the communication Exhibit
C, notifying Gancayco, inter alia, that, upon investigation, there was still due from him, an efficiency income tax for the
year 1949, the sum of P29,554.05. Gancayco sought a reconsideration, which was part granted by respondent, who in a
letter dated April 8, 1953 (Exhibit D), informed petitioner that his income tax defendant efficiency for 1949 amounted to
P16,860.31. Gancayco urged another reconsideration (Exhibit O), but no action taken on this request, although he had
sent several communications calling respondent's attention thereto.
On April 15, 1956, respondent issued a warrant of distraint and levy against the properties of Gancayco for the
satisfaction of his deficiency income tax liability, and accordingly, the municipal treasurer of Catanauan, Quezon issued
on May 29, 1956, a notice of sale of said property at public auction on June 19, 1956. Upon petition of Gancayco filed on
June 16, 1956, the Court of Tax Appeal issued a resolution ordering the cancellation of the sale and directing that the
same be readvertised at a future date, in accordance with the procedure established by the National Internal Revenue
Code. Subsequently, or on June 22, 1956, Gancayco filed an amended petition praying that said Court:
(a) Issue a writ of preliminary injunction, enjoining the respondents from enforcing the collection of the alleged tax
liability due from the petitioner through summary proceeding pending determination of the present case;
(b) After a review of the present case adjudge that the right of the government to enforce collection of any liability due
on this account had already prescribed;
(c) That even assuming that prescription had not set in the objections of petitioner to the disallowance of the
entertainment, representation and farming expenses be allowed;
xxx xxx xxx
In his answer respondent admitted some allegations the amended petition, denied other allegations thereof and set up
some special defenses. Thereafter Gancayco received from the municipal treasurer of Catanauan, Quezon, another
notice of auction sale of his properties, to take place on August 29, 1956. On motion of Gancayco, the Court of Tax
Appeals, by resolution dated August 27, 1956, "cancelled" the aforementioned sale and enjoined respondent and the
municipal treasurer of Catanauan, Quezon, from proceeding with the same. After appropriate proceedings, the Court of
Tax Appeals rendered, on November 14, 1957, the decision adverted to above.
Gancayco maintains that the right to collect the deficiency income tax in question is barred by the statute of
limitations. In this connection, it should be noted, however, that there are two (2) civil remedies for the collection of
internal revenue taxes, namely: (a) by distraint of personal property and levy upon real property; and (b) by "judicial
action" (Commonwealth Act 456, section 316). The first may not be availed of except within three (3) years after the
"return is due or has been made ..." (Tax Code, section 51 [d] ). After the expiration of said Period, income taxes may not
be legally and validly collected by distraint and/or levy (Collector of Internal Revenue v. Avelino, L-9202, November 19,
1956; Collector of Internal Revenue v. Reyes, L-8685, January 31, 1957; Collector of Internal Revenue v. Zulueta, L-8840,
February 8, 1957; Sambrano v. Court of Tax Appeals, L-8652, March 30, 1957). Gancayco's income tax return for 1949
was filed on May 10, 1950; so that the warrant of distraint and levy issued on May 15, 1956, long after the expiration
of said three-year period, was illegal and void, and so was the attempt to sell his properties in pursuance of said
warrant.
The "judicial action" mentioned in the Tax Code may be resorted to within five (5) years from the date the return has
been filed, if there has been no assessment, or within five (5) years from the date of the assessment made within the
statutory period, or within the period agreed upon, in writing, by the Collector of Internal Revenue and the taxpayer.
before the expiration of said five-year period, or within such extension of said stipulated period as may have been
agreed upon, in writing, made before the expiration of the period previously situated, except that in the case of a false
or fraudulent return with intent to evade tax or of a failure to file a return, the judicial action may be begun at any time
within ten (10) years after the discovery of the falsity, fraud or omission (Sections 331 and 332 of the Tax Code ). In the
case at bar, respondent made three (3) assessments: (a) the original assessment of P9,793.62, made on May 12, 1950;
(b) the first deficiency income tax assessment of May 14, 1951, for P29,554.05; and (c) the amended deficiency
income tax assessment of April 8, 1953, for P16,860.31.
Gancayco argues that the five-year period for the judicial action should be counted from May 12, 1950, the date of the
original assessment, because the income tax for 1949, he says, could have been collected from him since then. Said
assessment was, however, not for the deficiency income tax involved in this proceedings, but for P9,793.62, which he
paid forthwith. Hence, there never had been any cause for a judicial action against him, and, per force, no statute of
limitations to speak of, in connection with said sum of P9,793.62.
Neither could said statute have begun to run from May 14, 1951, the date of the first deficiency income tax assessment
or P29,554.05, because the same was, upon Gancayco's request, reconsidered or modified by the assessment made on
April 8, 1953, for P16,860.31. Indeed, this last assessment is what Gancayco contested in the amended petition filed by
him with the Court of Tax Appeals. The amount involved in such assessment which Gancayco refused to pay and
respondent tried to collect by warrant of distraint and/or levy, is the one in issue between the parties. Hence, the five-
year period aforementioned should be counted from April 8, 1953, so that the statute of limitations does not bar the
present proceedings, instituted on April 12, 1956, if the same is a judicial action, as contemplated in section 316 of the
Tax Code, which petitioner denies, upon the ground that
a. "The Court of Tax Appeals does not have original jurisdiction to entertain an action for the collection of the tax due;
b. "The proper party to commence the judicial action to collect the tax due is the government, and
c. "The remedies provided by law for the collection of the tax are exclusive."
Said Section 316 provides:
The civil remedies for the collection of internal revenue taxes, fees, or charges, and any increment thereto resulting
from delinquency shall be (a) by distraint of goods, chattels, or effects, and other personal property of whatever
character, including stocks and other securities, debts, credits, bank accounts, and interest in and rights to personal
property, and by levy upon real property; and (b) by judicial action. Either of these remedies or both simultaneously
may be pursued in the discretion of the authorities charged with the collection of such taxes.
No exemption shall be allowed against the internal revenue taxes in any case.
Petitioner contends that the judicial action referred to in this provision is commenced by filing, with a court of first
instance, of a complaint for the collection of taxes. This was true at the time of the approval of Commonwealth Act No.
456, on June 15, 1939. However, Republic Act No. 1125 has vested the Court of Tax Appeals, not only with exclusive
appellate jurisdiction to review decisions of the Collector (now Commissioner) of Internal Revenue in cases involving
disputed assessments, like the one at bar, but, also, with authority to decide "all cases involving disputed assessments of
Internal Revenue taxes or customs duties pending determination before the court of first instance" at the time of the
approval of said Act, on June 16, 1954 (Section 22, Republic Act No. 1125). Moreover, this jurisdiction to decide all cases
involving disputed assessments of internal revenue taxes and customs duties necessarily implies the power to authorize
and sanction the collection of the taxes and duties involved in such assessments as may be upheld by the Court of Tax
Appeals. At any rate, the same now has the authority formerly vested in courts of first instance to hear and decide cases
involving disputed assessments of internal revenue taxes and customs duties. Inasmuch as those cases filed with courts
of first instance constituted judicial actions, such is, likewise, the nature of the proceedings before the Court of Tax
Appeals, insofar as sections 316 and 332 of the Tax Code are concerned.
The question whether the sum of P16,860.31 is due from Gancayco as deficiency income tax for 1949 hinges on the
validity of his claim for deduction of two (2) items, namely: (a) for farming expenses, P27,459.00; and (b) for
representation expenses, P8,933.45.
Section 30 of the Tax Code partly reads:
(a) Expenses:
(1) In General — All the 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 or business; and rentals or other payments
required to be made as a condition to the continued use or possession, for the purposes of the trade or business, of
property to which the taxpayer has not taken or is not taking title or in which he has no equity. (Emphasis supplied.)
Referring to the item of P27,459, for farming expenses allegedly incurred by Gancayco, the decision appealed from has
the following to say:
No evidence has been presented as to the nature of the said "farming expenses" other than the bare statement of
petitioner that they were spent for the "development and cultivation of (his) property". No specification has been made
as to the actual amount spent for purchase of tools, equipment or materials, or the amount spent for improvement.
Respondent claims that the entire amount was spent exclusively for clearing and developing the farm which
were necessary to place it in a productive state. It is not, therefore, an ordinary expense but a capitol expenditure .
Accordingly, it is not deductible but it may be amortized, in accordance with section 75 of Revenue Regulations No. 2,
cited above. See also, section 31 of the Revenue Code which provides that in computing net income, no deduction shall
in any case be allowed in respect of any amount paid out for new buildings or for permanent improvements,
or betterments made to increase the value of any property or estate. (Emphasis supplied.)
We concur in this view, which is a necessary consequence of section 31 of the Tax Code, pursuant to which:
(a) General Rule — In computing net income no deduction shall in any case be allowed in respect of —
(1) Personal, living, or family expenses;
(2) Any amount paid out for new buildings or for permanent improvements, or betterments made to increase the
value of any property or estate;
(3) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or
has been made; or
(4) Premiums paid on any life insurance policy covering the life of any officer or employee, or any person financially
interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly or
indirectly a beneficiary under such policy. (Emphasis supplied.)
Said view is, likewise, in accord with the consensus of the authorities on the subject.
Expenses incident to the acquisition of property follow the same rule as applied to payments made as direct
consideration for the property. For example, commission paid in acquiring property are considered as representing part
of the cost of the property acquired. The same treatment is to be accorded to amounts expended for maps, abstracts,
legal opinions on titles, recording fees and surveys. Other non-deductible expenses include amounts paid in connection
with geological explorations, development and subdividing of real estate; clearing and grading; restoration of soil,
drilling wells, architects's fees and similar types of expenditures. (4 Merten's Law of Federal Income Taxation, Sec. 25.20,
pp. 348-349; see also sec. 75 of the income Regulation of the B.I.R.; Emphasis supplied.)
The cost of farm machinery, equipment and farm building represents a capital investment and is not an allowable
deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches prior to the
time when the productive state is reached may be regarded as investments of capital. (Merten's Law of Federal Income
Taxation, supra, sec. 25.108, p. 525.)
Expenses for clearing off and grading lots acquired is a capital expenditure, representing part of the cost of the land and
was not deductible as an expense. (Liberty Banking Co. v. Heiner 37 F [2d] 703 [8AFTR 100111] [CCA 3rd]; The B.L.
Marble Chair Company v. U.S., 15 AFTR 746).
An item of expenditure, in order to be deductible under this section of the statute providing for the deduction
of ordinary and necessary business expenses, must fall squarely within the language of the statutory provision. This
section is intended primarily, although not always necessarily, to cover expenditures of a recurring nature where the
benefit derived from the payment is realized and exhausted within the taxable year. Accordingly, if the result of the
expenditure is the acquisition of an asset which has an economically useful life beyond the taxable year, no deduction of
such payment may be obtained under the provisions of the statute. In such cases, to the extent that a deduction is
allowable, it must be obtained under the provisions of the statute which permit deductions for amortization,
depreciation, depletion or loss. (W.B. Harbeson Co. 24 BTA, 542; Clark Thread Co., 28 BTA 1128 aff'd 100 F [2d] 257 [CCA
3rd, 1938]; 4 Merten's Law of Federal Income Taxation, Sec. 25.17, pp. 337-338.)
Gancayco's claim for representation expenses aggregated P31,753.97, of which P22,820.52 was allowed, and P8,933.45
disallowed. Such disallowance is justified by the record, for, apart from the absence of receipts, invoices or vouchers of
the expenditures in question, petitioner could not specify the items constituting the same, or when or on whom or on
what they were incurred. The case of Cohan v. Commissioner, 39 F (2d) 540, cited by petitioner is not in point, because
in that case there was evidence on the amounts spent and the persons entertained and the necessity of entertaining
them, although there were no receipts an vouchers of the expenditures involved therein. Such is not the case of
petitioner herein.
Being in accordance with the facts and law, the decision of the Court of Tax Appeals is hereby affirmed therefore, with
costs against petitioner Santiago Cancayco. It is so ordered.
3M PHILIPPINES, INC., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
Bito, Misa & Lozada for Petitioner.
The Office of the Solicitor General for Respondent.
SYLLABUS
1. TAXATION; DEFICIENCY INCOME TAX ASSESSMENT; ROYALTY PAYMENTS CLAIMED AS DEDUCTIONS FOR BUSINESS
EXPENSES IN INCOME TAX RETURN DISALLOWED. — Section 3-c of CB Circular No. 393 provides for payment of royalties
only on commodities manufactured by the licensee under the royalty agreement not on the wholesale price of finished
products imported by the licensee from the licensor.
2. ID.; CENTRAL BANK CIRCULAR NO. 393 NOT THE TAX CODE, DEFINES PROPER PAYMENTS OF ROYALTY. — Although the
Tax Code allows payments of royalty to be deducted from gross income as business expenses, it is CB Circular No. 393
that defines what royalty payments are proper. Improper payments of royalty are not deductible as legitimate business
expenses.
3. STATUTES; CIRCULAR ISSUED BY THE CENTRAL BANK IN THE EXERCISE OF ITS AUTHORITY AND DULY PUBLISHED IN
THE OFFICIAL GAZETTE, CONSIDERED AS LAW. — Central Bank Circulars, like CB Circular No. 393 (dated December 7,
1973, published in the Official Gazette issue of December 17, 1973 [69 O.G. No. 51, p. 11737] issued by the Central Bank
in the exercise of fits authority under the Central Bank Act, duly published in the Official Gazette, have the force and
effect of law (Cases cited) and binding on everybody.
DECISION
GRIÑO-AQUINO, J.:
This is a petition for review of the decision of the Court of Tax Appeals which affirmed the assessment of deficiency
income tax on the petitioner’s 1974 income tax return, for deductions of "business expenses" in the form of royalty
payments to its foreign licensor which the respondent Commissioner of Internal Revenue disallowed. This case hinges on
the propriety or impropriety of the deductions.
3M Philippines, Inc. is a subsidiary of the Minnesota Mining and Manufacturing Company (or "3M-St. Paul") a non-
resident foreign corporation with principal office in St. Paul, Minnesota, U.S.A. It is the exclusive importer,
manufacturer, wholesaler, and distributor in the Philippines of all products of 3M-St. Paul. To enable it to
manufacture, package, promote, market, sell and install the highly specialized products of its parent company, and
render the necessary post-sales service and maintenance to its customers, petitioner entered into a "Service
Information and Technical Assistance Agreement" and a "Patent and Trademark License Agreement" with the latter
under which the petitioner agreed to pay to 3M-St. Paul a technical service fee of 3% and a royalty of 2% of its net
sales. Both agreements were submitted to, and approved by, the Central Bank of the Philippines.
In its income tax return for the fiscal year ended October 31, 1974, the petitioner claimed the following deductions as
business expenses:
(a) royalties and technical service fees of P3,050,646.00; and
(b) pre-operational cost of tape coater of P97,485.08.
On the first item, the respondent Commissioner of Internal Revenue allowed a deduction of P797,046.09 only as
technical service fee and royalty for locally manufactured products, but disallowed the sum of P2,323,599.02 alleged
to have been paid by the petitioner to 3M-St. Paul as technical service fee and royalty on P46,471,998.00 worth of
finished products imported by the petitioner from the parent company, on the ground that the fee and royalty should
be based only on locally manufactured goods. The improper deduction was treated by respondent as a disguised
dividend or income.
On the second item, respondent allowed P19,544.77 or one-fifth (1/5) of petitioner’s capital expenditure of P97,046.09
for its tape coater which was installed in 1973 because such expenditure should be amortized for a period of five (5)
years, hence, payment of the disallowed balance of P77,740.38 should be spread over the next four (4) years .
Respondent ordered petitioner to pay P840,540 as deficiency income tax on its 1974 return, plus P353,026.80 as 14%
interest per annum from February 15, 1975 to February 15, 1976, or a total of P1,193,566.80.
Petitioner protested the assessment in a letter dated March 7, 1980. The respondent Commissioner did not answer the
protest. Instead, he issued warrants of distraint and levy on October 1, 1984. On October 23, 1984, petitioner appealed
to the Court of Tax Appeals by petition for review with a prayer for the issuance of a writ of preliminary injunction to
stop the enforcement of the warrants of distraint and levy. The writ was issued upon petitioner posting a P1,850,000
bond.
After the respondent had filed his answer to the petition for review and hearings were held, the Tax Court rendered a
decision on August 14, 1987 upholding the Commissioner’s ruling. Petitioner’s motion for reconsideration of the
decision was denied by the Tax Court on April 6, 1988. A copy of the resolution was received by petitioner on April 21,
1988.
On April 25, 1988, petitioner sought a review in this Court of the Tax Court’s decision.
The pertinent legal provisions in this case are Section 29(a)(1) of the Internal Revenue Code and Circular No. 393 of the
Central Bank.
Because remittances to foreign licensors of technical service fees and royalties are made in foreign exchange, CB Circular
No. 393 (Regulations Governing Royalties/Rentals) dated December 7, 1973 was promulgated by the Central Bank as an
exchange control regulation to conserve foreign exchange and avoid unnecessary drain on the country’s international
reserves (69 O.G. No. 51, pp. 11737-38). Section 3-C of the circular provides that royalties shall be paid only on
commodities manufactured by the licensee under the royalty agreement:
"Section 3. Requirements for Approval and Registration. — The requirements for approval and registration as provided
for in Section 2 above include, but are not limited to the following:
"a. . . .
"b. . . .
"c. The royalty/rental contracts involving manufacturing’ royalty, e.g., actual transfers of technological services such as
secret formula/processes, technical know-how and the like shall not exceed five (5) per cent of the wholesale price of
the commodity/ties manufactured under the royalty agreement. For contracts involving ‘marketing’ services such as the
use of foreign brands or trade names or trademarks, the royalty/rental rate shall not exceed two (2) per cent of the
wholesale price of the commodity/ties manufactured under the royalty agreement. The producer’s or foreign licensor’s
share in the proceeds from the distribution/exhibition of the films shall not exceed sixty (60) per cent of the net
proceeds (gross proceeds less local expenses) from the exhibition/distribution of the films. . . . ( Emphasis supplied.)" (p.
27, Rollo.)
Clearly, no royalty is payable on the wholesale price of finished products imported by the licensee from the licensor.
However, petitioner argues that the law applicable to its case is only Section 29(a)(1) of the Tax Code which 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; travelling 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, for property to which the taxpayer has not taken or is
not taking title or in which he has no equity."
Petitioner points out that the Central bank "has no say in the assessment and collection of internal revenue taxes as
such power is lodged in the Bureau of Internal Revenue," that the Tax Code "never mentions Circular 393 and there is no
law or regulation governing deduction of business expenses that refers to said circular." (p. 9, Petition.)
The argument is specious, for, although the Tax Code allows payments of royalty to be deducted from gross income as
business expenses, it is CB Circular No. 393 that defines what royalty payments are proper. Hence, improper payments
of royalty are not deductible as legitimate business expenses.
CB Circular No. 393 dated December 7, 1983 was published in the Official Gazette issue of December 17, 1973 (69 O.G.
No. 51, p. 11737). Circulars issued by the Central Bank in the exercise of its authority under the Central Bank Act, and
which have been duly published in the Official Gazette, have the force and effect of law (People v. Que Po Lay, 94 Phil.
640; Lim Hoa Ting v. Central Bank, 104 Phil. 573). They are binding on everybody, the petitioner, as much as the
public Respondent.
WHEREFORE, finding no reversible error in the decision of the Court of Tax Appeals, the petition for review is denied.
Costs against the petitioner.
SO ORDERED.
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 INTERNAL REVENUE, petitioner,

vs.
PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT OF APPEALS and THE COURT OF TAX
APPEALS, respondents.
FELICIANO, J.:
The Paper Industries Corporation of the Philippines ("Picop"), which is petitioner in G.R. Nos. 106949-50 and private
respondent in G.R. Nos. 106984-85, is a Philippine corporation registered with the Board of Investments ("BOI") as a
preferred pioneer enterprise with respect to its integrated pulp and paper mill, and as a preferred non-
pioneer enterprise with respect to its integrated plywood and veneer mills.
On 21 April 1983, Picop received from the Commissioner of Internal Revenue ("CIR") two (2) letters of assessment and
demand both dated 31 March 1983: (a) one for deficiency transaction tax and for documentary and science stamp tax;
and (b) the other for deficiency income tax for 1977, for an aggregate amount of P88,763,255.00. These assessments
were computed as follows:
Transaction Tax
Interest payments on
money market
borrowings P 45,771,849.00
———————
35% Transaction tax due
thereon 16,020,147.00
Add: 25% surcharge 4,005,036.75
——————
T o t a l P 20,025,183.75
Add:
14% int. fr.
1-20-78 to
7-31-80 P 7,093,302.57
20% int, fr.
8-1-80 to
3-31-83 10,675,523.58
——————
17,768,826.15
——————
P 37,794,009.90
Documentary and Science Stamps Tax
Total face value of
debentures P100,000,000.00
Documentary Stamps
Tax Due
(P0.30 x P100,000.000 )
( P200 ) P 150,000.00
Science Stamps Tax Due

(P0.30 x P100,000,000 )
( P200 ) P 150,000.00
——————
T o t a l P 300,000.00
Add: Compromise for
non-affixture 300.00
——————
300,300.00
——————
TOTAL AMOUNT DUE AND COLLECTIBLE P 38,094,309.90
===========
Deficiency Income Tax for 1977
Net income per return P 258,166.00
Add: Unallowable deductions
1) Disallowed deductions
availed of under
R.A. No. 5186 P 44,332,980.00
2) Capitalized interest
expenses on funds
used for acquisition
of machinery & other
equipment 42,840,131.00
3) Unexplained financial
guarantee expense 1,237,421.00
4) Understatement
of sales 2,391,644.00
5) Overstatement of
cost of sales 604,018.00
——————
P91,406,194.00
Net income per investigation P91,664,360.00
Income tax due thereon 34,734,559.00

Less: Tax already assessed per return 80,358.00
——————
Deficiency P34,654,201.00
Add:
14% int. fr.
4-15-78 to
7-31-81 P 11,128,503.56
20% int. fr.
8-1-80 to
4-15-81 4,886,242.34
——————
P16,014,745.90
——————
TOTAL AMOUNT DUE AND COLLECTIBLE P 50,668,946.90 1
===========
On 26 April 1983, Picop protested the assessment of deficiency transaction tax and documentary and science stamp
taxes. Picop also protested on 21 May 1983 the deficiency income tax assessment for 1977. These protests 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 on real property against Picop, to enforce collection of the contested assessments; in
effect, the CIR denied Picop's protests.
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 dispositive portion of the decision as follows:
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 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 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.
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
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 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
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 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 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:
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 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:
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 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 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 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 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 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:
x x x x x x x x x
(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.
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 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
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.
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.
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
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 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.
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.

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 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;
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
26
losses. (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.
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.
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.
(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 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. 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.

income certain claimed
financial guarantee expenses.
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
fees were paid to the Register of Deeds for the registration of real estate and chattel mortgages in favor of Development
Bank of the Philippines and the Philippine National Bank as guarantors of PICOP's loans. The witness could very well
have been merely repeating what he was instructed to say regardless of the truth, while the cash vouchers, which we do
not find on file, are not said to provide the necessary details regarding the nature and purpose of the expenses reflected
therein. PICOP should have presented, through the guarantors, its owner's copy of the registered titles with the lien
inscribed thereon as well as an official receipt from the Register of Deeds evidencing payment of the registration
fee. 35 (Emphasis supplied)
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 only confirm the fact of disbursement but not necessarily the purpose thereof. 37 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 explain the loss thereof, assuming
they had existed before. 38 Under 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.
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.
III
(1) Whether Picop had understated

its sales and overstated its
cost of sales for 1977.
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, overstated its cost of sales by P604,018.00. Thereupon, the CIR added back
both sums to Picop's net income figure per its own return.
The 1977 Income Tax Return of Picop set forth the following figures:
Sales (per Picop's Income Tax Return):
Paper P 537,656,719.00
Timber P 263,158,132.00
———————
Total Sales P 800,814,851.00
============
Upon the other hand, Picop's Books of Accounts reflected higher sales figures:
Sales (per Picop's Books of Accounts):
Paper P 537,656,719.00
Timber P 265,549,776.00
———————
Total Sales P 803,206,495.00
============
The above figures thus show a discrepancy between the sales figures reflected in Picop's Books of Accounts and the
sales figures reported in its 1977 Income Tax Return, amounting to: P2,391,644.00.
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 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 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 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.
(3) Picop is exempt from payment of documentary and science stamp taxes in the amount of P300,000.00 and the
compromise penalty of P300.00.
(4) Picop is entitled to its claimed deduction of P42,840,131.00 for interest payments on loans for, among other things,
the purchase of machinery and equipment.
(5) Picop's claimed deduction in the amount of P44,196,106.00 for the operating losses previously incurred by RPPM, is
disallowed for lack of merit.
(6) Picop's claimed deduction for certain financial guarantee expenses in the 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 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.
Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled to hold Picop liable for deficiency income tax for the
year 1977 computed as follows:
Deficiency Income Tax
Net Income Per Return P 258,166.00
Add:
Unallowable Deductions
(1) Deduction of net

operating losses
incurred by RPPM P 44,196,106.00
(2) Unexplained financial
guarantee expenses P 1,237,421.00
(3) Understatement of
Sales P 2,391,644.00
(4) Overstatement of
Cost of Sales P 604,018.00
——————
Total P 48,429,189.00
——————
Net Income as Adjusted P 48,687,355.00
===========
Income Tax Due Thereon 44 P 17,030,574.00
Less:
Tax Already Assessed per

Return 80,358.00
——————
Deficiency Income Tax P 16,560,216.00
Add:
Five percent (5%) Corporate

Development Tax P 2,434,367.00
Total Deficiency Income Tax P 18,994,583.00
===========
Add:
Five percent (5%) surcharge 45 P 949,729.15
——————
Total Deficiency Income Tax
with surcharge P 19,944,312.15
Add:
Fourteen percent (14%)
interest from 15 April
1978 to 14 April 1981 46 P 8,376,610.80
Fourteen percent (14%)
interest from 21 April
1983 to 20 April 1986 47 P 11,894,787.00

——————
Total Deficiency Income Tax
Due and Payable P 40,215,709.00
===========
WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is hereby MODIFIED and Picop is hereby
ORDERED to pay the CIR the aggregate amount of P43,794,252.51 itemized as follows:
(1) Thirty-five percent (35%)
transaction tax P 3,578,543.51
(2) Total Deficiency Income
Tax Due 40,215,709.00
———————
Aggregate Amount Due and Payable P 43,794,252.51
============
No pronouncement as to costs.
SO ORDERED.
G.R. No. L-21520 December 11, 1967
PLARIDEL SURETY and INSURANCE COMPANY, petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
Gil R. Carlos and Associates for petitioner.

Office of the Solicitor General for respondent.
BENGZON, J.P., J.:
Petitioner Plaridel Surety & Insurance Co., is a domestic corporation engaged in the bonding business. On November 9,
1950, petitioner, as surety, and Constancio San Jose, as principal, solidarily executed a performance bond in the penal
sum of P30,600.00 in favor of the P. L. Galang Machinery Co., Inc., to secure the performance of San Jose's contractual
obligation to produce and supply logs to the latter.
To afford itself adequate protection against loss or damage on the performance bond, petitioner required San Jose and
one Ramon Cuervo to execute an indemnity agreement obligating themselves, solidarily, to indemnify petitioner for
whatever liability it may incur by reason of said performance bond. Accordingly, San Jose constituted a chattel mortgage
on logging machineries and other movables in petitioner's favor 1 while Ramon Cuervo executed a real estate mortgage. 2
San Jose later failed to deliver the logs to Galang Machinery 3 and the latter sued on the performance bond. On October
1, 1952, the Court of First Instance adjudged San Jose and petitioner liable; it also directed San Jose and Cuervo to
reimburse petitioner for whatever amount it would pay Galang Machinery. The Court of Appeals, on June 17, 1955,
affirmed the judgment of the lower court. The same judgment was likewise affirmed by this Court 4 on January 11, 1957
except for a slight modification apropos the award of attorney's fees.
On February 19 and March 20, 1957, petitioner effected payment in favor of Galang Machinery in the total sum of
P44,490.00 pursuant to the final decision.
In its income tax return for the year 1957, petitioner claimed the said amount of P44,490.00 as deductible loss from its
gross income and, accordingly, paid the amount of P136.00 as its income tax for 1957.
The Commissioner of Internal Revenue disallowed the claimed deduction of P44,490.00 and assessed against petitioner
the sum of P8,898.00, plus interest, as deficiency income tax for the year 1957. Petitioner filed its protest which was
denied. Whereupon, appeal was taken to the Tax Court, petitioner insisting that the P44,490.00 which it paid to Galang
Machinery was a deductible loss.
The Tax Court dismissed the appeal, ruling that petitioner was duly compensated for otherwise than by insurance — thru
the mortgages in its favor executed by San Jose and Cuervo — and it had not yet exhausted all its available remedies,
especially as against Cuervo, to minimize its loss. When its motion to reconsider was denied, petitioner elevated the
present appeal.
Of the sum of P44,490.00, the amount of P30,600.00 — which is the principal sum stipulated in the performance bond
— is being claimed as loss deduction under Sec. 30 (d) (2) of the Tax Code and P10,000.00 — which is the interest that
had accrued on the principal sum — is now being claimed as interest deduction under Sec. 30 (b) (1).
Loss is deductible only in the taxable year it actually happens or is sustained. However, if it is compensable by insurance
or otherwise, deduction for the loss suffered is postponed to a subsequent year, which, to be precise, is that year in
which it appears that no compensation at all can be had, or that there is a remaining or net loss, i.e., no full
compensation.5
There is no question that the year in which the petitioner Insurance Co. effected payment to Galang Machinery pursuant
to a final decision occurred in 1957. However, under the same court decision, San Jose and Cuervo were obligated to
reimburse petitioner for whatever payments it would make to Galang Machinery. Clearly, petitioner's loss
is compensable otherwise (than by insurance).itc-alf It should follow, then, that the loss deduction can not be claimed in
1957.
Now, petitioner's submission is that its case is an exception. Citing Cu Unjieng Sons, Inc. v. Board of Tax Appeals,6 and
American cases also, petitioner argues that even if there is a right to compensation by insurance or otherwise, the
deduction can be taken in the year of actual loss where the possibility of recovery is remote. The pronouncement,
however to this effect in the Cu Unjieng case is not as authoritative as petitioner would have it since it was there found
that the taxpayer had no legal right to compensation either by insurance or otherwise.7 And the American cases
cited8 are not in point. None of them involved a taxpayer who had, as in the present case, obtained a final judgment
against third persons for reimbursement of payments made. In those cases, there was either no legally enforceable right
at all or such claimed right was still to be, or being, litigated.
On the other hand, the rule is that loss deduction will be denied if there is a measurable right to compensation for the
loss, with ultimate collection reasonably clear. So where there is reasonable ground for reimbursement, the taxpayer
must seek his redress and may not secure a loss deduction until he establishes that no recovery may be had.9 In other
words, as the Tax Court put it, the taxpayer (petitioner) must exhaust his remedies first to recover or reduce his loss.
It is on record that petitioner had not exhausted its remedies, especially against Ramon Cuervo who was solidarily liable
with San Jose for reimbursement to it. Upon being prodded by the Tax Court to go after Cuervo, Hermogenes
Dimaguiba, president of petitioner corporation, said that they would 10 but no evidence was submitted that anything was
really done on the matter. Moreover, petitioner's evidence on remote possibility of recovery is fatally wanting. Its right
to reimbursement is not only secured by the mortgages executed by San Jose and Cuervo but also by a final and
executory judgment in the civil case itself. Thus, other properties of San Jose and Cuervo were subject to levy and
execution. But no writ of execution, satisfied or unsatisfied, was ever submitted. Neither has it been established that
Cuervo was insolvent. The only evidence on record on the point is Dimaguiba's testimony that he does not really know if
Cuervo has other properties. 11 This is not substantial proof of insolvency.itc-alf Thus, it was too premature for petitioner
to claim a loss deduction.
But assuming that there was no reasonable expectation of recovery, still no loss deduction can be had. Sec. 30 (d) (2) of
the Tax Code requires a charge-off as one of the conditions for loss deduction:
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. (Emphasis supplied)
Mertens12 states only four (4) requisites because the United States Internal Revenue Code of 1939 13 has no charge-off
requirement.itc-alf Sec. 23(f) thereof provides merely:
In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or
otherwise.
Petitioner, who had the burden of proof 14 failed to adduce evidence that there was a charge-off in connection with the
P44,490.00—or P30,600.00 — which it paid to Galang Machinery.
In connection with the claimed interest deduction of P10,000.00, the Solicitor General correctly points out that this
question was never raised before the Tax Court. Petitioner, thru counsel, had admitted before said court 15 and in the
memorandum it filed16 that the only issue in the case was whether the entire P44,490.00 paid by it was or was not a
deductible loss under Sec. 30 (d) (2) of the Tax Code. Even in petitioner's return, the P44,490.00 was claimed wholly as
losses on its bond.17 The alleged interest deduction not having been properly litigated as an issue before the Tax Court, it
is now too late to raise and assert it before this Court.
WHEREFORE, the appealed decision is, as it is hereby, affirmed. Costs against petitioner Plaridel Surety & Insurance Co.
So ordered.
G.R. No. L-18282 May 29, 1964
COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
PRISCILA ESTATE, INC., and THE COURT OF APPEALS, respondents.
Office of the Solicitor General for petitioner.

Sison, Dominguez and Mijares for respondents.
REYES, J.B.L., J.:
Review of the decision of the Court of Tax Appeals in its case No. 334 ordering the petitioner, Commissioner of Internal
Revenue to refund to the respondent, Priscila Estate, Inc., a domestic corporation engaged in the business of leasing real
estate, the sum of P3,045.19, as overpaid income tax for 1950.
The corporation duly filed its income tax returns for the years 1949, 1950 and 1951. On 13 June 1952, however, it
amended its income tax returns for 1951 and paid the tax corresponding to the assessment made by the petitioner on
the basis of the returns, as amended; and on 13 September 1952, the company claimed a refund of P4,941.00 as
overpaid income tax for the year 1950 for having deducted from gross income only the sum of P6,013.85 instead of
P39,673.25 as its loss in the sale of a lot and building. Thereupon, the Commissioner of Internal Revenue conducted an
investigation of the company's income tax returns for 1949 through 1951 and, thereafter, granted a tax credit of
P1,443.00 for 1950 but assessed on 3 November 1953 deficiency income taxes of P3,575.49 for 1949 and P22,166.10 for
1951.
The Priscila Estate, Inc., contested the deficiency assessments and when the Commissioner of Internal Revenue refused
to reconsider them, the former brought suit to the tax court which after trial, rendered the decision that, in 1961, the
Commissioner elevated to this Supreme Court for review.
The first assignment of error refers to the allowance of a deduction in the 1949 income tax returns of the respondent
corporation the amount of P11,237.35 representing the cost of a "barong-barong" (a make-shift building), situated at
the corner of Azcarraga Street and Rizal Avenue, Manila, which was demolished on 31 December 1949 and a new one
built in its place. The petitioner claims that the value of the demolished building should not be deducted from gross
income but added to the cost of the building replacing it because its demolition or removal was to make way for the
erection of another in its place. 1äwphï1.ñët
The foregoing argument is erroneous inasmuch as the tax court found that the removal of the "barong-barong", instead
of being voluntary, was forced upon the corporation by the city engineer because the structure was a fire hazard; that
the rental income of the old building was about P3,730.00 per month, and that the corporation had no funds but had to
borrow, in order to construct a new building. All these facts, taken together, belie any intention on the part of the
corporation to demolish the old building merely for the purpose of erecting another in its place. Since the demolished
building was not compensated for by insurance or otherwise, its loss should be charged off as deduction from gross
income. (Sec. 30[2], Internal Revenue Code.)
The second to the fifth assignments of error pertain to depreciation.
Particularly contested by the petitioner is the basis for depreciation of Building Priscila No. 3. This building, with an
assessed value of P70,343.00 but with a construction cost of P110,600.00, was acquired by the respondent corporation
from the spouses, Carlos Moran Sison and Priscila F. Sison, in exchange for shares of stock. According to the petitioner,
the basis for commuting the depreciation of this building should be limited to the capital invested, which is the assessed
value. On the other hand, the respondent based its computation on its construction cost, revaluing the property on this
basis by a board resolution in order to "give justice to the Sison spouse Since this revaluation would import an obligation
of the corporation to pay the Sison spouses, as vendors, the difference between the assessed value and the revalued
construction cost, as provided in resolution Exhibit F-1 (otherwise the revaluation would make no sense), the corporate
investment would ultimately be the construction cost which is undisputed), and depreciation logically had to be on that
basis. That the revaluation may import additional profit to the vendor spouses is a matter related to their own income
tax, and not to that of respondent corporation.
The Collector also questions the rates of depreciation which the tax court applied to the other properties, consisting of
store and office building, houses, a garage, library books, furniture and fixtures and transportation equipment.
Depreciation is a question of fact,1 and is "not measured by a theoretical yardstick, but should be determined by a
consideration of the actual facts ... ." (Landon vs. CIR of State of Kansas, 260 Fed. 433 [1920]], quoted in Sec. 23.32,
Mertens, Federal Income Taxation). The petitioner himself on page 26 of his appeal brief, asserts that "what consist of
the depreciable amount (sic) is elusive and is a question of fact."
Since the petitioner does not claim that the tax court, in applying certain rates and basis to arrive at the allowed
amounts of depreciation of the various properties, was, arbitrary or had abused its discretion, and since the Supreme
Court, before the Revised Rules, limited its review of decisions of the Court of Tax Appeals to questions of law only
(Sanchez v. Commissioner of Customs, L-8556, 30 Sept. 1957; Gutierrez v. Court of Tax Appeals, L-9738 & L-9771, 31 May
1957), the findings of the tax court on the depreciation of the several assets should not be disturbed.
In the sixth and last assignment of error, the petitioner argues that the refund to the respondent is barred by the two-
year prescriptive period under Section 306 of the Internal Revenue Code because the action for refund was filed on 5
December 1956 while the respondent's 1950 income tax was paid on 15 August 1951. The petitioner's argument would
have been tenable but for his failure to plead prescription in a motion to dismiss or as a defense in his answer, said
failure is deemed a waiver of the defense of prescription (Sec. 10, Rule 9, Rules of Court).
Finding no reversible error in the decision under review, the same is hereby affirmed. No costs.
[G.R. No. 125508. July 19, 2000.]

CHINA BANKING CORPORATION, Petitioner, v. COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and
COURT OF TAX APPEALS, Respondents.
DECISION
VITUG, J.:
The Commissioner of Internal Revenue denied the deduction from gross income of "securities becoming worthless"
claimed by China Banking Corporation ("CBC"). The Commissioner’s disallowance was sustained by the Court of Tax
Appeals ("CTA"). When the ruling was appealed to the Court of Appeals ("CA"), the appellate court upheld the CTA. The
case is now before us on a Petition for Review on Certiorari.
Sometime in 1980, petitioner China Banking Corporation made a 53% equity investment in the First CBC Capital (Asia)
Ltd., a Hongkong subsidiary engaged in financing and investment with "deposit-taking" function. The investment
amounted to P16,227,851.80, consisting of 106,000 shares with a par value of P100 per share.
In the course of the regular examination of the financial books and investment portfolios of petitioner conducted by
Bangko Sentral in 1986, it was shown that First CBC Capital (Asia), Ltd., has become insolvent. With the approval of
Bangko Sentral, petitioner wrote-off as being worthless its investment in First CBC Capital (Asia), Ltd., in its 1987 Income
Tax Return and treated it as a bad debt or as an ordinary loss deductible from its gross income.
Respondent Commissioner of Internal Revenue disallowed the deduction and assessed petitioner for income tax
deficiency in the amount of P8,533,328.04, inclusive of surcharge, interest and compromise penalty. The disallowance of
the deduction was made on the ground that the investment should not be classified as being "worthless" and that,
although the Hongkong Banking Commissioner had revoked the license of First CBC Capital as a "deposit-taking"
company, the latter could still exercise, however, its financing and investment activities. Assuming that the securities
had indeed become worthless, respondent Commissioner of Internal Revenue held the view that they should then be
classified as "capital loss," and not as a bad debt expense there being no indebtedness to speak of between petitioner
and its subsidiary.
Petitioner contested the ruling of respondent Commissioner before the CTA. The tax court sustained the Commissioner,
holding that the securities had not indeed become worthless and ordered petitioner to pay its deficiency income tax for
1987 of P8,533,328.04 plus 20% interest per annum until fully paid. When the decision was appealed to the Court of
Appeals, the latter upheld the CTA. In its instant petition for review on certiorari, petitioner bank assails the CA decision.
The petition must fail.
The claim of petitioner that the shares of stock in question have become worthless is based on a Profit and Loss Account
for the Year-End 31 December 1987, and the recommendation of Bangko Sentral that the equity investment be written-
off due to the insolvency of the subsidiary. While the matter may not be indubitable (considering that certain classes of
intangibles, like franchises and goodwill, are not always given corresponding values in financial statements 1), there may
really be no need, however, to go at length into this issue since, even to assume the worthlessness of the shares, the
deductibility thereof would still be nil in this particular case. At all events, the Court is not prepared to hold that both the
tax court and the appellate court are utterly devoid of substantial basis for their own factual findings.
Subject to certain exceptions, such as the compensation income of individuals and passive income subject to final tax, as
well as income of non-resident aliens and foreign corporations not engaged in trade or business in the Philippines, the
tax on income is imposed on the net income allowing certain specified deductions from gross income to be claimed by
the taxpayer. Among the deductible items allowed by the National Internal Revenue Code ("NIRC") are bad debts and
losses. 2
An equity investment is a capital, not ordinary, asset of the investor the sale or exchange of which results in either a
capital gain or a capital loss. The gain or the loss is ordinary when the property sold or exchanged is not a capital asset . 3
A capital asset is defined negatively in Section 33(1) of the NIRC; viz:
"(1) Capital assets. — The term ‘capital assets’ means property held by the taxpayer (whether or not connected with his
trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly
be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer
primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business,
of a character which is subject to the allowance for depreciation provided in subsection (f) of section twenty-nine; or
real property used in the trade or business of the taxpayer."
Thus, shares of stock, like the other securities defined in Section 20(t) 4 of the NIRC, would be ordinary assets only to a
dealer in securities or a person engaged in the purchase and sale of, or an active trader (for his own account) in,
securities. Section 20(u) of the NIRC defines a dealer in securities thus:
"(u) The term ‘dealer in securities’ means a merchant of stocks or securities, whether an individual, partnership or
corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to
customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and
profits that may be derived therefrom."
In the hands, however, of another who holds the shares of stock by way of an investment, the shares to him would be
capital assets. When the shares held by such investor become worthless, the loss is deemed to be a loss from the sale
or exchange of capital assets. Section 29(d)(4)(B) of the NIRC states:
"(B) Securities becoming worthless. — If securities as defined in Section 20 become worthless during the taxable year
and are capital assets, the loss resulting therefrom shall, for the purposes of this Title, be considered as a loss from the
sale or exchange, on the last day of such taxable year, of capital assets."
The above provision conveys that the loss sustained by the holder of the securities, which are capital assets (to him), is
to be treated as a capital loss as if incurred from a sale or exchange transaction. A capital gain or a capital loss normally
requires the concurrence of two conditions for it to result: (1) There is a sale or exchange; and (2) the thing sold or
exchanged is a capital asset. When securities become worthless, there is strictly no sale or exchange but the law deems
the loss anyway to be "a loss from the sale or exchange of capital assets." A similar kind of treatment is given by the
NIRC on the retirement of certificates of indebtedness with interest coupons or in registered form, short sales and
options to buy or sell property where no sale or exchange strictly exists. 6 In these cases, the NIRC dispenses, in effect,
with the standard requirement of a sale or exchange for the application of the capital gain and loss provisions of the
code.
Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains derived from the sale or exchange
of capital assets, and not from any other income of the taxpayer.
In the case at bar, First CBC Capital (Asia), Ltd., the investee corporation, is a subsidiary corporation of petitioner bank
whose shares in said investee corporation are not intended for purchase or sale but as an investment. Unquestionably
then, any loss therefrom would be a capital loss, not an ordinary loss, to the investor.
Section 29(d)(4)(A), of the NIRC expresses:
"(A) Limitations. — Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in
Section 33."
The pertinent provisions of Section 33 of the NIRC referred to in the aforesaid Section 29(d)(4)(A), read:
"SECTION 33. Capital gains and losses. —
"x x x
"(c) Limitation on capital losses. — Losses from sales or exchange of capital assets shall be allowed only to the extent of
the gains from such sales or exchanges. If a bank or trust company incorporated under the laws of the Philippines, a
substantial part of whose business is the receipt of deposits, sells any bond, debenture, note, or certificate or other
evidence of indebtedness issued by any corporation (including one issued by a government or political subdivision
thereof), with interest coupons or in registered form, any loss resulting from such sale shall not be subject to the
foregoing limitation and shall not be included in determining the applicability of such limitation to other losses."
The exclusionary clause found in the foregoing text of the law does not include all forms of securities but specifically
covers only bonds, debentures, notes, certificates or other evidence of indebtedness, with interest coupons or in
registered form, which are the instruments of credit normally dealt with in the usual lending operations of a financial
institution. Equity holdings cannot come close to being within the purview of "evidence of indebtedness" under the
second sentence of the aforequoted paragraph. Verily, it is for a like thesis that the loss of petitioner bank in its equity
investment in the Hongkong subsidiary cannot also be deductible as a bad debt. The shares of stock in question do not
constitute a loan extended by it to its subsidiary (First CBC Capital) or a debt subject to obligatory repayment by the
latter, essential elements to constitute a bad debt, but a long term investment made by CBC.
One other item. Section 34(c)(1) of the NIRC states that the entire amount of the gain or loss upon the sale or exchange
of property, as the case may be, shall be recognized. The complete text reads:
"SECTION 34. Determination of amount of and recognition of gain or loss. —
"(a) Computation of gain or loss. — The gain from the sale or other disposition of property shall be the excess of the
amount realized therefrom over the basis or adjusted basis for determining gain and the loss shall be the excess of the
basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other
disposition of property shall be the sum of money received plus the fair market value of the property (other than
money) received. (As amended by E.O. No. 37)
"(b) Basis for determining gain or loss from sale or disposition of property. — The basis of property shall be — (1) The
cost thereof in the cases of property acquired on or before March 1, 1913, if such property was acquired by purchase; or
"(2) The fair market price or value as of the date of acquisition if the same was acquired by inheritance; or
"(3) If the property was acquired by gift the basis shall be the same as if it would be in the hands of the donor or the last
preceding owner by whom it was not acquired by gift, except that if such basis is greater than the fair market value of
the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value; or
"(4) If the property, other than capital asset referred to in Section 21 (e), was acquired for less than an adequate
consideration in money or money’s worth, the basis of such property is (i) the amount paid by the transferee for the
property or (ii) the transferor’s adjusted basis at the time of the transfer whichever is greater.
"(5) The basis as defined in paragraph (c) (5) of this section if the property was acquired in a transaction where gain or
loss is not recognized under paragraph (c) (2) of this section. (As amended by E.O. No. 37)
"(c) Exchange of property.
"(1) General rule. — Except as herein provided, upon the sale or exchange of property, the entire amount of the gain or
loss, as the case may be, shall be recognized.
"(2) Exception. — No gain or loss shall be recognized if in pursuance of a plan of merger or consolidation (a) a
corporation which is a party to a merger or consolidation exchanges property solely for stock in a corporation which is, a
party to the merger or consolidation, (b) a shareholder exchanges stock in a corporation which is a party to the merger
or consolidation solely for the stock in another corporation also a party to the merger or consolidation, or (c) a security
holder of a corporation which is a party to the merger or consolidation exchanges his securities in such corporation
solely for stock or securities in another corporation, a party to the merger or consolidation.
"No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for stock in
such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four
persons, gains control of said corporation: Provided, That stocks issued for services shall not be considered as issued in
return of property."
The above law should be taken within context on the general subject of the determination and recognition of gain or
loss; it is not preclusive of, let alone renders completely inconsequential, the more specific provisions of the code. Thus,
pursuant to the same section of the law, no such recognition shall be made if the sale or exchange is made in pursuance
of a plan of corporate merger or consolidation or, if as a result of an exchange of property for stocks, the exchanger,
alone or together with others not exceeding four, gains control of the corporation. 7 Then, too, how the resulting gain
might be taxed, or whether or not the loss would be deductible and how, are matters properly dealt with elsewhere in
various other sections of the NIRC. 8 At all events, it may not be amiss to once again stress that the basic rule is still that
any capital loss can be deducted only from capital gains under Section 33(c) of the NIRC.
In sum —
(a) The equity investment in shares of stock held by CBC of approximately 53% in its Hongkong subsidiary, the First CBC
Capital (Asia), Ltd., is not an indebtedness, and it is a capital, not an ordinary, asset. 9
(b) Assuming that the equity investment of CBC has indeed become "worthless," the loss sustained is a capital, not an
ordinary, loss. 10
(c) The capital loss sustained by CBC can only be deducted from capital gains if any derived by it during the same taxable
year that the securities have become "worthless." 11
WHEREFORE, the Petition is DENIED. The decision of the Court of Appeals disallowing the claimed deduction of
P16,227,851.80 is AFFIRMED.
SO ORDERED

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[G.R. No. L-18840. May 29, 1969.

1. TAXATION; INCOME TAXATION; DEDUCTIBLE EXPENSES; BONUSES TO EMPLOYEES; DEDUCTION NOT

Concepcion, C.J. and Castro, J., are on official leave of absence.

G.R. No. L-24059 November 28, 1969

C. M. HOSKINS & CO., INC., petitioner,

Ross, Salcedo, Del Rosario, Bito and Misa for petitioner.

We find no merit in petitioner's appeal.

G.R. No. L-54108 January 17, 1984

COMMISSIONER OF INTERNAL REVENUE, petitioner,

The Solicitor General for petitioner.

xxx xxx xxx

xxx xxx xxx

Interest on bonds of a domestic corporation P9,000

Dividends on stock of a domestic corporation 4,000

Royalty for the use of patents within the Philippines 12,000

Gain from sale of real property located within the Philippines 11,000

WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs.

Year Date Filed

1951 March 1, 1952

1952 February 28, 1953

1953 February 22, 1954

1954 February 23, 1955

and paid the corresponding tax declared therein.

Transportation expenses to attend funeral of various persons P 96.50

Expenses in attending National Convention of Filipino

Alms to indigent family 15.00

Electrical fixtures and supplies 100.00

Transportation and other expenses to watch laborers in

Realty tax not paid by former owner of property acquired by

Litigation expenses to collect rental and eject lessee 702.65

Other disallowed deductions:

Fines and penalties for late payment of taxes 64.48

Car expenses, salary of driver and car depreciation P1,454.37

Contribution to Lydia Samson and G. Trinidad 52.00

Officers' jewels and aprons donated to Biak-na-Bato Lodge

Luncheon of Homeowners' Association 5.50

Ticket to opera "Aida" 15.00

Car expenses, salary of driver, car depreciation P 1,409.24

Cruise to Corregidor with Homeowners' Association 43.00

Contribution to alms to various individuals 70.00

Tickets to operas 28.00

Car expenses, salary of driver and car depreciation P 1,413.67

Furniture given as commission in connection with business

Cost of iron door of Gutierrez' residence 55.00

Painting of rental apartments P 908.00

Carpentry and lumber for rental apartments 335.83

Tinsmith and plumbing for rental apartments 605.25

Relocation and registration of property used in taxpayer's

He also claimed the depreciation of his residence as follows:

Income of wife (admitted by Gutierrez) P 2,749.90.

Overstatement of purchase price of real estate P 8,476.92

Understatement of profits from sale of real estate 5,803.74

Understatement of profits from sale of real estate P 5,444.24

SEC. 34. Capital gains and losses. — (a) Definitions. — As used in this title —

The pertinent provision of the Tax Code states:

Net income per investigation P29,471.81

Add: Disallowed deductions for salary of 29.90

Less: Allowable deductions:

Expenses in attending National

Repair of rental apartments 802.65 924.00

Net income P30,425.71

Less: Personal exemption 3,600.00