L.
Deductions from Gross Income
Deduction- refer to the amounts which the law
allows to be stubtracted from gross income in order
to arrive at net income
1. Expenses
i. Sec 34 (A) of the NIRC
What are the deductible expenses?
a. Necessary Expenses- appropriate and helpful in
the development of taxpayers business and are
intended to minimize losses or to increase profits
(day to day expenses)
b. Ordinary Expenses- normal or usual in relation
to the taxpayers business in the surrounding
circumstances
ie. Of Expenses
a. Salaries, wages, compensation including fringe
benefits
b. travel expenses
c. entertainment expenses
d. rentals on properties
e. Depreciation of assets in case of private
educational institutions
Which are not considered expenses?
a. Bribes and kickbacks directly or indirectly paid to
govt officials
b. Capital Expenditures except for depreciables of
private educational institutions
1. RR No. 10-02 dated July 10, 2002
Requisites of Business Expenses to be
deductible?
1. Ordinary and Necessary
2. Pair or incurred within taxable year
3. Substantiated with official receipts or
adequate records
4. paid or incurred in carrying trade or business
5. if subject to withholding taxes proof of
payment to the Bureau of Internal Revenue must
be shown.
6. must be reasonable (not too lavish)
Ceiling on Entertainment Expense is
imposed upon the ffg:
1. IND engaged in Business
2. IND engaged in practice of profession
3. Domestic Coporations
4. Resident Corporations
5. GPP including its members
Ceiling: Actual amount but not more than .50%
of net sales for those engaged in sale of goods or
properties; 1% of net revenue for those engaged
in sale of services and exercise of profession or
lease of properties
Requirement: Must be substantiated for audit
purposes
Entertainment expenses not deductible:
1. Those treated as fringe benefits for services
under empl-emp relationship
2. expenses for charitable or fund raising events
3. Meeting of SH, partners or directors
4.Sponsorship on an employees business league
or professional org meeting
5. expenses for events organized for promotion
and marketing
ii. Sec. 36(A) of the NIRC
Not deductible in computing net income:
a. personal,living, family expenses
b. payment for new buildings, permanent
improvements etc
that will increase value of property
c. payment for restoration of property
d. premiums paid on life insurance policy of any
officer or employee when taxpayer is direct or
indirect beneficiary
iii. Sec. 45 of the NIRC
-Deductible when pair or accrued or paid or
incurred unless to clearly reflect the income, it
should be deducted at a diff period
-in case of death of tax payer-> deductions falling on
date of his death
CASES:
CIR vs. Isabela Cultural Corporation
FACTS:
Isabela Cultural Corp.(ICC for brevity) , a domestic
corporation received from BIR assessment notice no.
FAS-1-86-90000680 (680 for brevity) for deficiency
income tax in the amount of PhP 333,196.86 and
assessment notice no. FAS-1-86-90-000681 (681 for
brevity) for deficiency expanded withholding tax in
the amount of PhP 4,897.79, inclusive of surcharge
and interest both for the taxable year 1986. The
deficiency income tax of PhP 333,196 arose from BIR
disallowance of ICC claimed expenses deductions for
professional and security services billed to and paid
by ICC in 1986.
The deficiency expanded withholding tax of
PhP4,897.79 was allegedly due to the failure of ICC to
withhold 1% expanded withholding tax on its claimed
PhP244,890 deduction for security services.
Court of Tax Appeal and Court of Appeal affirmed that
the professional services were rendered to ICC in
1984 and 1985, the cost of the service was not yet
determinable at that time, hence, it could be
considered as deductible expenses only in 1986
when ICC received the billing statement for said
service. It further ruled that ICC did not state its
interest income from the promissory notes of Realty
Investment and that ICC properly withheld the
remitted taxes on the payment for security services
for the taxable year 1986.
Petitioner contend that since ICC is using the accrual
method of accounting, the expenses for the
professional services that accrued in 1984 and 9185
should have been declared as deductions from
income during the said years and the failure of ICC to
do so bars it from claiming said expenses as
deduction for the taxable year 1986.
ISSUE (1): WON CA is correct in sustaining the
deduction of the expenses for professionals and
security services form ICC gross income?
ISSUE (2): WON CA correctly held that ICC did not
understate its interest income from the promissory
notes of Realty Investment, Inc; that ICC withheld the
required 1% withholding tax from the deduction for
security services.
HELD(1): NO
Revenue Audit Memorandum Order No.1-2000
provides that under the accrual method of
accounting, expenses not being claimed as
deductions by a tax payer in the current year when
they are incurred cannot be claimed as deductions
from the income for the succeeding year.
HELD(2):
Sustaining the finding of the CTA and CA that no such
understatement exist and that only simple interest
computation and not a compounded one should have
been applied by the BIR. There is no indeed no
stipulation between the latter and ICC on the
application of compound interest.
Under Article 1959 of the Civil Code, unless there is a
stipulation to the contrary, interest due should not
further earn interest.
CIR vs. Isabela Cultural Corporation
FACTS:
Isabela Cultural Corporation (ICC), a domestic
corporation received an assessment notice for
deficiency income tax and expanded withholding tax
from BIR. It arose from the disallowance of ICCs
claimed expense for professional and security
services paid by ICC; as well as the alleged
understatement of interest income on the three
promissory notes due from Realty Investment Inc.
The deficiency expanded withholding tax was
allegedly due to the failure of ICC to withhold 1% e-
withholding tax on its claimed deduction for security
services.
ICC sought a reconsideration of the assessments.
Having received a final notice of assessment, it
brought the case to CTA, which held that it is
unappealable, since the final notice is not a decision.
CTAs ruling was reversed by CA, which was
sustained by SC, and case was remanded to CTA. CTA
rendered a decision in favor of ICC. It ruled that the
deductions for professional and security services
were properly claimed, it said that even if services
were rendered in 1984 or 1985, the amount is not
yet determined at that time. Hence it is a proper
deduction in 1986. It likewise found that it is the BIR
which overstate the interest income, when it applied
compounding absent any stipulation.
Petitioner appealed to CA, which affirmed CTA, hence
the petition.
ISSUE: Whether or not the expenses for professional
and security services are deductible.
HELD:
No. One of the requisites for the deductibility of
ordinary and necessary expenses is that it must have
been paid or incurred during the taxable year. This
requisite is dependent on the method of accounting
of the taxpayer. In the case at bar, ICC is using the
accrual method of accounting. Hence, under this
method, an expense is recognized when it is
incurred. Under a Revenue Audit Memorandum, when
the method of accounting is accrual, expenses not
being claimed as deductions by a taxpayer in the
current year when they are incurred cannot be
claimed in the succeeding year.
The accrual of income and expense is permitted
when the all-events test has been met. This test
requires: 1) fixing of a right to income or liability to
pay; and 2) the availability of the reasonable
accurate determination of such income or liability.
The test does not demand that the amount of income
or liability be known absolutely, only that a taxpayer
has at its disposal the information necessary to
compute the amount with reasonable accuracy.
From the nature of the claimed deductions and the
span of time during which the firm was retained, ICC
can be expected to have reasonably known the
retainer fees charged by the firm. They cannot give
as an excuse the delayed billing, since it could have
inquired into the amount of their obligation and
reasonably determine the amount.
CIR v General Foods, Inc. GR No. 172231
FACTS:
Respondent corporation General Foods (Phils), which
is engaged in the manufacture of Tang, Calumet
and Kool-Aid, filed its income tax return for the
fiscal year ending February 1985 and claimed as
deduction, among other business expenses,
P9,461,246 for media advertising for Tang. The
Commissioner disallowed 50% of the deduction
claimed and assessed deficiency income taxes of
P2,635,141.42 against General Foods, prompting the
latter to file an MR which was denied. General Foods
later on filed a petition for review at CA, which
reversed and set aside an earlier decision by CTA
dismissing the companys appeal.
ISSUE: W/N the subject media advertising expense
for Tang was ordinary and necessary expense fully
deductible under the NIRC
HELD: No.
Tax exemptions must be construed in stricissimi juris
against the taxpayer and liberally in favor of the
taxing authority, and he who claims an exemption
must be able to justify his claim by the clearest grant
of organic or statute law. Deductions for income
taxes partake of the nature of tax exemptions;
hence, if tax exemptions are strictly construed, then
deductions must also be strictly construed.
To be deductible from gross income, the subject
advertising expense must comply with the following
requisites: (a) the expense must be ordinary and
necessary; (b) it must have been paid or incurred
during the taxable year; (c) it must have been paid
or incurred in carrying on the trade or business of the
taxpayer; and (d) it must be supported by receipts,
records or other pertinent papers.
While the subject advertising expense was paid or
incurred within the corresponding taxable year and
was incurred in carrying on a trade or business,
hence necessary, the parties views conflict as to
whether or not it was ordinary. To be deductible, an
advertising expense should not only be necessary
but also ordinary.
The Commissioner maintains that the subject
advertising expense was not ordinary on the ground
that it failed the two conditions set by U.S.
jurisprudence: first, reasonableness of the amount
incurred and second, the amount incurred must not
be a capital outlay to create goodwill for the
product and/or private respondents business.
Otherwise, the expense must be considered a capital
expenditure to be spread out over a reasonable time.
There is yet to be a clear-cut criteria or fixed test for
determining the reasonableness of an advertising
expense. There being no hard and fast rule on the
matter, the right to a deduction depends on a
number of factors such as but not limited to: the type
and size of business in which the taxpayer is
engaged; the volume and amount of its net earnings;
the nature of the expenditure itself; the intention of
the taxpayer and the general economic conditions. It
is the interplay of these, among other factors and
properly weighed, that will yield a proper evaluation.
The Court finds the subject expense for the
advertisement of a single product to be inordinately
large. Therefore, even if it is necessary, it cannot be
considered an ordinary expense deductible under
then Section 29 (a) (1) (A) of the NIRC.
Advertising is generally of two kinds: (1) advertising
to stimulate the current sale of merchandise or use
of services and (2) advertising designed to stimulate
the future sale of merchandise or use of services.
The second type involves expenditures incurred, in
whole or in part, to create or maintain some form of
goodwill for the taxpayers trade or business or for
the industry or profession of which the taxpayer is a
member. If the expenditures are for the advertising
of the first kind, then, except as to the question of
the reasonableness of amount, there is no doubt
such expenditures are deductible as business
expenses. If, however, the expenditures are for
advertising of the second kind, then normally they
should be spread out over a reasonable period of
time.
The companys media advertising expense for the
promotion of a single product is doubtlessly
unreasonable considering it comprises almost one-
half of the companys entire claim for marketing
expenses for that year under review. Petition
granted, judgment reversed and set aside.
CIR v General Foods, Inc. GR No. 172231
FACTS:
In its income tax return, respondent corporation
claimed as deduction, among other business
expenses, the amount for media advertising for
Tang, one of its products.
ISSUE:
WON the subject media advertising expense for
Tang incurred by respondent was an ordinary and
necessary expense fully deductible under the NIRC
HELD: Not deductible.
Deductions for income tax purposes partake of the
nature of tax exemptions; hence, must be strictly
construed. To be deductible from gross income, the
subject advertising expense must be ordinary and
necessary. There being no hard and fast rule on the
reasonableness of an advertising expense, the right
to a deduction depends on a number of factors such
as but not limited to: the type and size of business in
which the taxpayer is engaged; the volume and
amount of its net earnings; the nature of the
expenditure itself; the
intention of the taxpayer and the general economic
conditions. The amount claimed as media advertising
expense for Tang alone was almost one-half of its
total claim for marketing expenses. Furthermore, it
was almost double the amount of respondent
corporation's general and administrative expenses.
The subject expense for the advertisement of a
single product is inordinately large. Said venture of
respondent to protect its brand franchise was
tantamount to efforts to establish a reputation, and
should not, therefore, be considered as business
expense but as capital expenditure, which normally
should be spread out over a reasonable period of
time.
ATLAS CONSOLIDATED MINING & DEVT CORP VS
COMMISSIONER OF INTERNAL REVENUE
FACTS:
Atlas Consolidated Mining & Devt Corp is a
corporation engaged in the mining industry. It was
assessed deficiency income tax for the year 1958 as
a result of the disallowance of certain items claimed
by the company as deductions from its gross income.
Atlas claimed the following items as deductible from
its gross income: (1) transfer agents fee, (2)
stockholders relation service fee, (3) US stock listing
expenses, (4) suit expenses, (5) provision for
contingencies. The
Commissioner of Internal Revenue disallowed all
these items. Atlas elevated the issue to the Court of
Tax Appeals. The CTA rendered a decision allowing
the said items, except for the stockholders relation
service fee and the suit expenses. Both Atlas and the
CIR went to the Supreme Court to appeal the CTA
decision. In GR No. L-26911, Atlas argues that the
CTA should not have disallowed the stockholders
relation service fee. The corporation contends that
such fee constitutes an ordinary and necessary
business expense, and should, therefore, be allowed
as a deductible expense from the companys gross
income. In GR No. L-26924, the CIR argues that the
transfer agents fee and the US stock listing fee
should not have been allowed as deductions from
gross income in the absence of proof of payment for
such expenses. The CIR also argues that the US stock
listing expenses should be disallowed for not being
ordinary and necessary and not incurred in trade or
business, as required under Sec 30 (a) (1) of the
National Internal Revenue Code. The CIR also
contends that the correct amount of disallowance for
suit expenses should be PhP 17,499.98 and not PhP
6,666.65.
ISSUE:
In GR No. L-26911, whether or not the expenses paid
for the services rendered by a public relations firm, P.
K. Macker & Co., labeled as stockholders relation
service fee is an allowable deduction as business
expense. In GR No. L-26924, whether or not the
transfer agents fee and the US stock listing fee
should have been allowed as deduction in the
absence of proof of payments. Whether or not the US
stock listing expenses should be disallowed for not
being ordinary and necessary and not incurred in
trade or business. Whether PhP 17,499.98 or PhP
6,666.65 is the correct amount of disallowance for
suit expenses.
HELD:
GR No. L-26911. Under Sec 30 (a) (1) of the Tax
Code, three conditions have to be complied with
before a business expense is allowed as a deduction
from gross income: (1) the expense must be ordinary
and necessary, (2) it must be paid or incurred within
the taxable year, and (3) it must be paid or incurred
in carrying a trade or business. The Court sustained
the ruling of the CTA that the expenditure paid to P.
K. Macker & Co. denominated as stockholders
relation service fee is not an ordinary expense. The
fee was paid to the PR firm as ompensation
for services carrying on the selling campaign in an
effort to sell Atlas additional capital stock. Such is
not an ordinary expense because, according to the
Court, expenses relating to the recapitalization and
reorganization of a corporation, the cost of obtaining
stock subscription,
promotion expenses, and commission or fees paid for
the sale of stock reorganization are capital
expenditures. The stockholders relation service fee
is not deductible from Atlas gross income.
GR No. L-26924. The Court agreed with the CTA that
the CIR cannot raise the issue of payment for the first
time on appeal. The fact of payment was never
controverted by the CIR during the proceedings.
Failure to assert a question within a reasonable time
warrants a presumption that the party entitled to
assert it either has abandoned or declined to assert
it. The Court held that the US stock listing fee is an
ordinary and necessary business expense and was
correctly allowed by the CTA as a deduction. The
stock listing fee is paid annually to a stock exchange
for the privilege of having Atlas stock listed. A single
payment made to the stock exchange is considered a
capital expenditure (Domes Mines case). However,
payments to the stock exchange made annually or in
a recurring manner are considered ordinary and
necessary business expenses (Chesapeake
Corporation case). The fees paid by Atlas partake of
the latter. The Court reiterated that it is well-settled
that litigation expenses incurred in defense or
protection of title are capital in nature and not
deductible. The Court sustained the CIR that the
correct amount of disallowance for litigation or suit
expenses is PhP 17,499.98.
ATLAS CONSOLIDATED MINING & DEVT CORP VS
COMMISSIONER OF INTERNAL REVENUE
FACTS:
Atlas is a corporation engaged in the mining industry
registered. On August 1962, CIR assessed against
Atlas for deficiency income taxes for the years 1957
and 1958. For the year 1957, it was the opinion of
the CIR that Atlas is not entitled to exemption from
the income tax under RA 909 because same covers
only gold mines. For the year 1958, the deficiency
income tax covers the disallowance of items claimed
by Atlas as deductible from gross income. Atlas
protested for reconsideration and cancellation, thus
the CIR conducted a reinvestigation of the case.
On October 1962, the Secretary of Finance ruled that
the exemption provided in RA 909 embraces all new
mines and old mines whether gold or other minerals.
Accordingly, the CIR recomputed Atlas deficiency
income tax liabilities in the light of said ruling. On
June 1964, the CIR issued a revised assessment
entirely eliminating the assessment for the year
1957. The assessment for 1958 was reduced from
which Atlas appealed to the CTA, assailing the
disallowance of the following items claimed as
deductible from its gross income for 1958: Transfer
agent's fee, Stockholders relation service fee, U.S.
stock listing expenses, Suit expenses, and Provision
for contingencies. The CTA allowed said items as
deduction except those denominated by Atlas as
stockholders relation service fee and suit expenses.
Both parties appealed the CTA decision to the SC by
way of two (2) separate petitions for review. Atlas
appealed only the disallowance of the deduction from
gross income of the so-called stockholders relation
service fee.
ISSUE/HELD: W/N the annual public relations
expense (aka stockholders relation service fee) paid
to a public relations consultant is a deductible
expense from gross income
RATIO: Section 30 (a) (1) of the Tax Code allows a
deduction of "all the ordinary and necessary
expenses paid or incurred during the taxable year in
carrying on any trade or business." An item of
expenditure, in order to be deductible under this
section of the statute, must fall squarely within its
language. To be deductible as a business expense,
three conditions are imposed, namely: (1) the
expense must be ordinary and necessary, (2) it must
be paid or incurred within the taxable year, and (3) it
must be paid or incurred in carrying in a trade or
business. In addition, not only must the taxpayer
meet the business test, he must substantially prove
by evidence or records the deductions claimed under
the law, otherwise, the same will be disallowed. The
mere allegation of the taxpayer that an item of
expense is ordinary and necessary does not justify its
deduction.
The SC has never attempted to define with precision
the terms "ordinary and necessary." As a guiding
principle, ordinarily, an expense will be considered
"necessary" where the expenditure is appropriate
and helpful in the development of the taxpayer's
business. It is "ordinary" when it connotes a payment
which is normal in relation to the business of the
taxpayer and the surrounding circumstances. The
term "ordinary" does not require that the payments
be habitual or normal in the sense that the same
taxpayer will have to make them often; the payment
may be unique or non-recurring to the particular
taxpayer affected.
There is thus no hard and fast rule on the matter. The
right to a deduction depends in each case on the
particular facts and the relation of the payment to
the type of business in which the taxpayer is
engaged. The intention of the taxpayer often may be
the controlling fact in making the determination.
Assuming that the expenditure is ordinary and
necessary in the operation of the taxpayer's
business, the answer to the question as to whether
the expenditure is an allowable deduction as a
business expense must be determined from the
nature of the expenditure itself, which in turn
depends on the extent and permanency of the work
accomplished by the expenditure.
It appears that on December 1957, Atlas increased
its capital stock. It claimed that its shares of stock
were sold in the United States because of the
services rendered by the public relations firm. The
information about Atlas given out and played up in
the mass communication media resulted in full
subscription of the additional shares issued by Atlas;
consequently, the stockholders relation service fee,
the compensation for services carrying on the selling
campaign, was in effect spent for the acquisition of
additional capital, ergo, a capital expenditure, and
not an ordinary expense. It is not deductible from
Atlas gross income in 1958 because expenses
relating to recapitalization and reorganization of the
corporation, the cost of obtaining stock subscription,
promotion expenses, and commission or fees paid for
the sale of stock reorganization are capital
expenditures. That the expense in question was
incurred to create a favorable image of the
corporation in order to gain or maintain the public's
and its stockholders' patronage, does not make it
deductible as business expense. As held in a US
case, efforts to establish reputation are akin to
acquisition of capital assets and, therefore, expenses
related thereto are not business expense but capital
expenditures.
Note: The burden of proof that the expenses incurred
are ordinary and necessary is on the taxpayer and
does not rest upon the Government. To avail of the
claimed deduction, it is incumbent upon the taxpayer
to adduce substantial evidence to establish a
reasonably proximate relation petition between the
expenses to the ordinary conduct of the business of
the taxpayer. A logical link or nexus between the
expense and the taxpayer's business must be
established by the taxpayer.
TAMBUNTING PAWNSHOP v CIR
DOCTRINE: To be entitled to claim a tax deduction,
the taxpayer must competently establish the factual
and documentary bases of its claim.
FACTS:
H. Tambunting Pawnshop, Inc. (petitioner), a
domestic corporation duly licensed and authorized to
engage in the pawnshop business, appeals the
adverse decision promulgated on April 24, 2006,
whereby the Court of Tax Appeals En Bane (CTA En
Bane) affirmed the decision of the CTA First Division
ordering it to pay deficiency income taxes in the
amount of P4,536,687.15 for taxable year 1997, plus
20% delinquency interest computed from August 29,
2000 until full payment, but cancelling the
compromise penalties for lack of basis.
BIR through then Acting Regional Director Lucien E.
Sayuno of Revenue Region No. 6 in Manila, issued
assessment notices and demand letters, all
numbered 32-1-97, assessing Tambunting for
deficiency percentage tax, income tax and
compromise penalties for taxable year 1997
amounting to 69K.
Tambunting instituted an administrative protest
against the assessment notices and demand letters
with the Commissioner of Internal Revenue.
Tambunting brought a petition for review in the CTA,
pursuant to Section 228 of the National Internal
Revenue Code of 1997, citing the inaction of the
Commissioner of Internal Revenue on its protest
within the 180-day period prescribed by law.
CTA: Tambunting is still liable for deficiency income
tax in the reduced amount of P4,536,687.15.
However, the compromise penalties in the sum of
P49,000.00 is hereby CANCELLED for lack of legal
basis.
Tambunting filed a petition for review in the CTA En
Banc, arguing that the First Division erred in
disallowing its deductions on the ground that it had
not substantiated them by sufficient evidence.
CTA En Banc denied.
ISSUE:
WON CTA should have allowed its deductions
because it had been able to prove its entitlement to
the deductions through all the documentary and
testimonial evidence presented in court.
WON Tambunting had thus shown beyond doubt that
it had incurred the losses in its auction sales; and
that it substantially complied with the requirements
of Revenue Regulations No. 12-77 on the
deductibility of its losses.
HELD:
CTA EN Banc is correct. Because this case involved
assessments relating to transactions incurred by
Tambunting prior to the effectivity of Republic Act No.
8424 (National Internal Revenue Code of 1997, or
NIRC of 1997), the provisions governing the propriety
of the deductions was Presidential Decree 1158 (NIRC
of 1977). In that regard, the pertinent provisions here
are of Section 29 (d) (2) & (3)of the NIRC of 1977.
In this case, petitioner's reliance on the entries made
in the "Subasta" book were not sufficient to
substantiate the claimed deduction of loss on auction
sale. As admitted by the petitioner, the contents in
the "Rematado" and "Subasta" books do not reflect
the true amounts of the total capital and the auction
sale, respectively. Be that as it may, petitioner still
failed to adduce evidence to substantiate the other
expenses alleged to have been incurred in
connection with the sale of pawned items.
Among the expenses allegedly incurred, courts may
consider only those supported by credible evidence
and which appear to have been genuinely incurred in
connection with the trade or business of the
taxpayer.
As previously discussed, the proper substantiation
requirement for an expense to be allowed is the
official receipt or invoice. While the rental payments
were subjected to the applicable expanded
withholding taxes, such returns are not the
documents required by law to substantiate the rental
expense. Petitioner should have submitted official
receipts to support its claim.
Moreover, the issue on the submission of cash
vouchers as evidence to prove expenses incurred has
been addressed by this Court in the assailed
Resolution, to wit:
In order that the cash vouchers may be given
probative value, these must be validated with official
receipts. In order that the cash vouchers may be
given probative value, these must be validated with
official receipts.
CT A En Bane aptly rejected Tam bunting's claim for
deductions due to losses from fire and theft. The
documents it had submitted to support the claim,
namely: (a) the certification from the Bureau of Fire
Protection in Malolos; (b) the certification from the
Police Station in Malolos; (c) the accounting entry for
the losses; and (d) the list of properties lost, were not
enough. What were required were for Tambunting to
submit the sworn declaration of loss mandated by
Revenue Regulations 12-77. Its failure to do so was
prejudicial to the claim because the sworn
declaration of loss was necessary to forewarn the BIR
that it had suffered a loss whose extent it would be
claiming as a deduction of its tax liability, and thus
enable the BIR to conduct its own investigation of the
incident leading to the loss. Indeed, the documents
Tambunting submitted to the BIR could not serve the
purpose of their submission without the sworn
declaration of loss.
2. INTERESTS
i. Sec. 34(B) of the NIRC
ii. Sec. 36 of the NIRC
Not deductible in computing net
income:
a. personal,living, family expenses
b. payment for new buildings, permanent
improvements etc
that will increase value of property
c. payment for restoration of property
d. premiums paid on life insurance policy of
any officer or employee when taxpayer is
direct or indirect beneficiary
e. Losses from sales or exchange of property
when:
1. between members of family (includes
bro and sis)
2.individuals with more than 50% of
shares of corp except during liquidation
3. bet 2 corp with more than 50% shares
4. between grantor and a fiduciary trust
5. between 2 fiduciaries with same
grantor
6. between fiduciary of trust and
beneficiary
iii. RR No. 13-00 dated November 20, 2000
 Requirements for deductibility of
interest expense
1. There must be an indebtedness;
2. There should be an interest expense paid
or incurred upon such indebtedness;
3. The indebtedness must be that of the
taxpayer,
4. The indebtedness must be connected with
the taxpayers trade, business or exercise
of profession.
5. The interest expense must have been paid
or incurred during the taxable year;
6. The interest must have been stipulated in
writing;
7. The interest must be legally due;
8. The interest payment arrangement must
not be between related taxpayers as
mandated in Sec. 34(B)(2)(b), in relation
to Sec. 36(B), both of the Tax Code of
1997;
9. The interest must not be incurred to
finance petroleum operations; and
10. In case of interest incurred to acquire
property used in trade, business or
exercise of profession, the same was not
treated as a capital expenditure.
SEC. 3. TAX INCENTIVES ACCRUING TO THE
ADOPTING PRIVATE ENTITY. A pre-qualified
adopting private entity, which enters into an
Agreement with a public school, shall be
entitled to the following tax incentives:
(a) Deduction from the gross income of the
amount of contribution/donation that were
actually, directly and exclusively incurred for
the Program, subject to limitations,
conditions and rules set forth in Section
34(H) of the Tax Code, plus an additional
amount equivalent to fifty percent (50%) of
such contribution/donation subject to the
following conditions:
(1) That the deduction shall be availed of in
the taxable year in which the expenses have
been paid or incurred;
(2) That the taxpayer can substantiate the
deduction with sufficient evidence, such as
official receipts or delivery receipt and other
adequate records
(2.1) The amount of expenses being claimed
as deduction;
(2.2) The direct connection or relation of the
expenses to the adopting private entitys
participation in the Adopt-a-School Program.
The adopting private entity shall also provide
a list of projects and/or activities undertaken
and the cost of each undertaking, indicating
in particular where and how the assistance
has been utilized as supported by the
Agreement; and
(2.3) Proof or acknowledgment of receipt of
the contributed/donated property by the
recipient public school.
(3) That the application, together with the
approved Agreement endorsed by the
National Secretariat, shall be filed with the
Revenue District Office (RDO) having
jurisdiction over the place of business of the
donor/adopting private entity, copy furnished
the RDO having jurisdiction over the
property, if the contribution/donation is in the
form of real property.
(b) Exemption of the Assistance made by the
donor from payment of donors tax pursuant
to Sections 101 (A)(2) and (B)(1) of the Tax
Code of 1997.
iv. Tax Arbitrage Rule/ Scheme
taxpayer would secure a loan simply to
generate interest expense thereby reducing
the taxable income and enjoying a tax
benefit thereto. The funds loaned will then be
deposited with the bank to yield interest
income that is subject to a final withholding
tax (e.g. 20%) less than the normal income
tax rate (e.g. 30% starting 2009). In effect,
the taxpayer enjoys a double tax benefit
tax benefit on deduction of interest expense,
and tax benefit on lower tax rate for income.
To neutralize the impact of such scheme,
deductible interest expense in the Philippines
is reduced by 33% (starting 2009) of such
interest income subjected to final withholding
tax. Nevertheless, interest expense on
unpaid taxes is not covered by this limitation
on interest expenses in the Philippines.
CASES:
Commissioner of Internal Revenue vs. Vda. De
Prieto (1960)
FACTS:
On December 4, 1945, Consuelo L. Vda. De Prieto
conveyed by way of gifts to her four children
(Antonio, Benito, Carmen and Mauro), real property
with total assessed value of 892,497.50.
CIR appraised the real property donated for gift tax
purposes at 1,231.268.00, and assessed the total
sum of 117,706.50 as donors gift tax, interests
and compromises due thereon.
Of the total sum of 117,706.50 paid by Consuelo, the
sum of 55,978.65 represents the total
interest on account of delinquency. Said sum
of the total interest was claimed as
deduction by Consuelo in her 1954 income
tax return.
CIR disallowed the claim and as a consequence,
assessed Consuelo the total sum of 21,410.38 as
deficiency income tax due on the aforesaid
 55,978.65, including interest up to March 1957,
surcharge and compromise for the late payment.
Under the law, for interest to be deductible, it must
be shown that there be an indebtedness, that there
should be interest upon it, and that what is claimed
as an interest deduction should have been paid or
accrued within the year. It is here conceded that
the interest paid by Consuelo was in consequence
of the late payment of her donors tax, and the
same was paid within the year it is sought to be
deducted.
To sustain the proposition that the interest payment
is not deductible, CIR relies heavily on section 80 of
the Revenue Regulation No. 2( Income Tax
Regulation) promulgated by the Department of
Finance, which provides that the word taxes
means taxes proper and no deductions should be
allowed for amounts representing interest,
surcharge, or penalties incident to delinquency.
CTA reversed the decision of CIR.
ISSUES:
1. WON such interest was paid upon indebtedness
within the contemplation of section 30(b) (1) of the
Tax Code.
2. WON the interest paid for the late payment of the
donors tax is deductible from the gross income
under section 30(b) of the Tax Code.
3. WON section 80 of the Revenue Regulation No. 2 is
applicable in this case, thus the deduction should
not be allowed.
HELD:
1.Yes, the donors tax may be considered as
indebtedness within the contemplation of the Tax
Code.
2.Yes, given that the donors tax may be considered as
indebtedness, the interest paid for the late
payment of the donors tax is deductible from the
gross income under section 30(b) of the Tax Code.
3.No, section 80 of RR2 is not applicable in this case
because the said section of RR2 pertains to or
implements section 30(c) of the Tax Code,
governing deduction of taxes, and not section 30
(b) on deduction of interest on indebtedness, which
is the provision invoked by Consuelo.
RATIO:
1.The term indebtedness as used in the US Tax Code
containing similar provisions as in the Phil Tax Code
has been defined as an unconditional and legally
enforceable obligation for the payment of money.
Within the meaning of that definition, it is apparent
that a tax may be considered an indebtedness. As
stated by the SC in the case of Santiago Sambrano
vs. CTA and CIR: Although taxes already due have
not, strictly speaking, the same concept as debts,
they are, however, obligations that may be
considered as such.
2.This conclusion finds support in the established
jurisprudence in the US. Under section 23(b) of the
Internal Revenue Code of 1939, as amended, which
contains similarly worded provisions as section
30(b) of Phil Tax Code, the uniform ruling in the US
jurisprudence is that interest on taxes is interest
on indebtedness and is deductible. This rule
applies even though the tax is nondeductible, like
the donors tax.
3. Section 80 is inapplicable to the instant case
because while it implements section 30(c) of the
Tax Code governing deduction of taxes, Consuelo
seeks to come under section 30(b) providing for
deduction of interest on indebtedness.
In conclusion, the SC is of the opinion that although
interest payment for delinquent taxes is not
deductible as tax under section 30(c) of the Tax
Code and Section 80 of RR2, the taxpayer is not
precluded thereby from claiming said interest
payment as deduction under section (b) of the same
code.
Commissioner of Internal Revenue vs. Vda. De
Prieto (1960)
FACTS:
Respondent Vda. de Prieto conveyed by way
of gifts a real property to her children. The
Commissioner of Internal Revenue appraised the
property donated at P1,231,268.00, and assessed
the total sum of P117,706.50 as donor's gift tax,
interest and compromises due thereon. Of the total
sum of P117,706.50 paid by respondent on April 29,
1954, the sum of P55,978.65 represents the total
interest on account of deliquency. Said sum was
claimed as deduction, among others, by respondent
in her 1954 income tax return. Petitioner disallowed
the claim and as a consequence of such disallowance
assessed respondent for 1954 deficiency income tax
due on the aforesaid P55,978.65, including interest
1957, surcharge and compromise for the late
payment.
ISSUE:
Whether or not interest paid for the late
payment of tax is deductible from gross income.
HELD:
YES. For interest to be deductible, it must be
shown that: (1) there be an indebtedness, (2) there
should be interest upon it, and (3) what is claimed as
an interest deduction should have been paid or
accrued within the year. In this case, the last two
requirements are undisputed. The only question is if
interest on account of late payments of taxes be
considered as indebtedness. Indebtedness has been
defined as an unconditional and legally enforceable
obligation for the payment of money. Within the
meaning of that definition, it is apparent that a tax
may be considered indebtedness. Although taxes
already due have not, strictly speaking, the same
concept as debts, they are, however, obligations that
may be considered as such. Where statute imposes a
personal liability for a tax, the tax becomes, at least
in a board sense, a debt. It follows that the interest
paid by herein respondent for the late payment of
her donor's tax is deductible from her gross income.
In conclusion, interest payment for delinquent taxes
is not deductible as tax but the taxpayer is not
precluded thereby from claiming said payment as
deduction on account of interest.
SUMMARY:
Respondent donated real property to her children.
She paid the assessed donors gift tax, which
assessment included interest on account of
delinquency. The following year, in her income tax
return, respondent claimed the interest as a
deduction. The CIR disallowed the deduction, but the
CTA reversed and allowed it. The SC affirmed the CTA
decision. Interest on tax is interest on
indebtedness and is thus deductible. US Tax
Code (which our provisions are based on)
contemplates tax as an indebtedness. Jurisprudence
has also held the same; although taxes arent
conceptually the same as debts, they may be
considered as such.
FACTS:
Respondent conveyed as gifts to her four children
Antonio, Benito, Carmen, and Mauro (like, so
conyo names) real property with total assessed
value of P892,497.50.
The gift tax returns was filed. The CIR appraised
respondents real property donation for gift tax
purposes at P1,231,268, and assessed
P117,706.50 as donors gift tax, interest and
compromises due. The assessment was duly paid
by respondent. Take note that P55,978.65 of the
assessed P117,706.50 represented the total
interest on account of delinquency.
That sum of P55,978.65 (total interest on account
of delinquency) was then claimed as a deduction
by respondent in her 1954 income tax return.
The CIR, however, disallowed the deduction claim
and assessed respondent for 1954 the sum of
P21,410.38 as deficiency income tax on the
aforesaid P55,978.65. It included interest,
surcharge, and compromise for the late payment.
The CTA reversed the the CIR decision.
ISSUE:
WON the interest paid by respondent (the P55K++)
was paid upon an indebtedness within the
contemplation of Sec 30(B)(1)1 of the Tax Code.
1 SEC. 30 Deductions from gross income. In computing net
income there shall be allowed as deductions x x x 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.
HELD: YES. CTA affirmed.
[Dispositive] In conclusion, we are of the opinion
and so hold that although interest payment for
delinquent taxes is not deductible as tax under
Section 30(c) of the Tax Code and section 80 of the
Income Tax Regulations, the taxpayer is not
precluded thereby from claiming said interest
payment as deduction under section 30(b) of the
same Code.
In view of the foregoing, the decision sought to be
reviewed is affirmed, without pronouncement as to
costs.
RATIO:
Under the law, for interest to be deductible, it
must be shown that (1) there be an indebtedness, (2)
there should be interest upon it, (3) and that what is
claimed as an interest deduction should have been
paid or accrued within the year. In this case, ALL
three are present and admitted by both parties. It is
just the interpretation of the interest paid that is in
issue here and WON it falls within the contemplation
of the law.
Interest on tax, such as that paid by respondent
for the late payment of donors tax, is interest on
indebtedness and is thus deductible.
o Meaning of indebtedness in the US Tax Code
(which contains similar provisions as ours)
an unconditional and legally enforceable
obligation for the payment of money.
Within that definition, it is apparent that
a tax may be considered an
indebtedness.
o Sambrano vs CTA&CIR
Although taxes already due arent the
same concept as debts, they are
however, obligations which may be
considered as such.
Debt" is properly used in a
comprehensive sense as embracing not
merely money due by contract but
whatever one is bound to render to
another, either for contract, or the
requirement of the law.
Where statute imposes a personal
liability for a tax, the tax becomes, at
least in a board sense, a debt.
A tax is a debt for which a creditor's bill
may be brought in a proper case.
[Argument of CIR] Look at Sec. 80 of Revenue
Regulation #2 of the DOF!! the word `taxes'
means taxes proper and no deductions should be
allowed for amounts representing interest, surcharge,
or penalties incident to delinquency."
SC Nope. That revenue regulation merely
incorporates the established application of the
 tax deduction statute in the US, where deduction
of "taxes" has always been limited to taxes
proper and has never included interest on
delinquent taxes, penalties and surcharges.
o In any case, lower court was correct when it
held that Sec. 80 is inapplicable to the
instant case. Sec. 80 implements sections
30(c) of the Tax Code governing deduction of
taxes; here, respondent seeks to come under
section 30(b) providing for deduction of
interest on indebtedness.
o To follow the interpretation of the CIR of Sec.
80 would contravene Sec. 30(B) of the Tax
Code and the construction of said law by US
Courts. A regulation which operates to create
a rule not in harmony with the statute is a
mere nullity.
Commissioner of Internal Revenue vs. Vda. De
Prieto (1960)
FACTS:
On December 4, 1945, the respondent conveyed by
way of gifts to her four children, namely, Antonio,
Benito, Carmen and Mauro, all surnamed Prieto, real
property with a total assessed value of P892,497.50.
After the filing of the gift tax returns on or about
February 1, 1954, the petitioner Commissioner of
Internal Revenue appraised the real property
donated for gift tax purposes at P1,231,268.00, and
assessed the total sum of P117,706.50 as donor's gift
tax, interest and compromises due thereon. Of the
total sum of P117,706.50 paid by respondent on April
29, 1954, the sum of P55,978.65 represents the total
interest on account of deliquency. This sum of
P55,978.65 was claimed as deduction, among others,
by respondent in her 1954 income tax return.
Petitioner, however, disallowed the claim and as a
consequence of such disallowance assessed
respondent for 1954 the total sum of P21,410.38 as
deficiency income tax due on the aforesaid
P55,978.65, including interest up to March 31, 1957,
surcharge and compromise for the late payment.
Under the law, for interest to be deductible, it must
be shown that there be an indebtedness, that there
should be interest upon it, and that what is claimed
as an interest deduction should have been paid or
accrued within the year. It is here conceded that the
interest paid by respondent was in consequence of
the late payment of her donor's tax, and the same
was paid within the year it is sought to be declared.
To sustain the proposition that the interest payment
in question is not deductible for the purpose of
computing respondent's net income, petitioner relies
heavily on section 80 of Revenue Regulation No. 2
(known as Income Tax Regulation) promulgated by
the Department of Finance, which provides that "the
word `taxes' means taxes proper and no deductions
should be allowed for amounts representing interest,
surcharge, or penalties incident to delinquency." The
court below, however, held section 80 as inapplicable
to the instant case because while it implements
sections 30(c) of the Tax Code governing deduction
of taxes, the respondent taxpayer seeks to come
under section 30(b) of the same Code providing for
deduction of interest on indebtedness.
ISSUE:
Whether or not such interest was paid upon an
indebtedness within the contemplation of section 30
(b) (1) of the Tax Code?
RULING:
Yes. According to the Supreme Court, although
interest payment for delinquent taxes is not
deductible as tax under Section 30(c) of the Tax Code
and section 80 of the Income Tax Regulations, the
taxpayer is not precluded thereby from claiming said
interest payment as deduction under section 30(b) of
the same Code.
SEC. 30 Deductions from gross income. In
computing net income there shall be allowed as
deductions
(b) Interest:
(1) In general. The amount of interest paid
within the taxable year on indebtedness,
except on indebtedness incurred or
continued to purchase or carry obligations
the interest upon which is exempt from
taxation as income under this Title.
The term "indebtedness" as used in the Tax Code of
the United States containing similar provisions as in
the above-quoted section has been defined as an
unconditional and legally enforceable obligation for
the payment of money.
To give to the quoted portion of section 80 of our
Income Tax Regulations the meaning that the
petitioner gives it would run counter to the provision
of section 30(b) of the Tax Code and the construction
given to it by courts in the United States. Such effect
would thus make the regulation invalid for a
"regulation which operates to create a rule out of
harmony with the statute, is a mere nullity." As
already stated, section 80 implements only section
30(c) of the Tax Code, or the provision allowing
deduction of taxes, while herein respondent seeks to
be allowed deduction under section 30(b), which
provides for deduction of interest on indebtedness.
PAPER INDUSTRIES v CA ( Dec. 1, 1995)
FACTS:
On various years (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.
ISSUE: Whether Picop is entitled to deductions
against income of interest payments on loans for the
purchase of machinery and equipment.
HELD: YES.
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. The basis is 1977 Tax Code Sec. 30 (b). 2
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. 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 contention of CIR does not spring of the 1977 Tax
Code but from Revenue Regulations 2 Sec. 79.3
However, the Court said that the term interest here
should be construed as the so-called "theoretical
2 Sec. 30. Deduction from Gross Income. The following may be
deducted from gross income: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)
3 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)
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.
Only if sir asks: (For further discussion of CIRs
contention)
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).
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 orcharges 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.
3. TAXES
i. Sec. 34(C) of the NIRC
(1) In General. - Taxes paid or incurred within the
taxable year in connection with the taxpayer's
profession, trade or business, shall be allowed as
deduction, except
(a) The income tax provided for under this Title;
(b) Income taxes imposed by authority of any foreign
country; but this deduction shall be allowed in the
case of a taxpayer who does not signify in his return
his desire to have to any extent the benefits of
paragraph (3) of this subsection (relating to credits
for taxes of foreign countries);
(c) Estate and donor's taxes; and
(d) Taxes assessed against local benefits of a kind
tending to increase the value of the property
assessed.
Provided, That taxes allowed under this Subsection,
when refunded or credited, shall be included as part
of gross income in the year of receipt to the extent of
the income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a
nonresident alien individual engaged in trade or
business in the Philippines and a resident foreign
corporation, the deductions for taxes provided in
paragraph (1) of this Subsection (C) shall be allowed
only if and to the extent that they are connected with
income from sources within the Philippines.
(3) Credit Against Tax for Taxes of Foreign Countries. -
If the taxpayer signifies in his return his desire to
have the benefits of this paragraph, the tax imposed
by this Title shall be credited with:
(a) Citizen and Domestic Corporation. - In the case of
a citizen of the Philippines and of a domestic
corporation, the amount of income taxes paid or
incurred during the taxable year to any foreign
country; and
(b) Partnerships and Estates. - In the case of any
such individual who is a member of a general
professional partnership or a beneficiary of an estate
or trust, his proportionate share of such taxes of the
general professional partnership or the estate or
trust paid or incurred during the taxable year to a
foreign country, if his distributive share of the income
of such partnership or trust is reported for taxation
under this Title.
An alien individual and a foreign corporation shall not
be allowed the credits against the tax for the taxes of
foreign countries allowed under this paragraph.
(4) Limitations on Credit. - The amount of the credit
taken under this Section shall be subject to each of
the following limitations:
(a) The amount of the credit in respect to the tax
paid or incurred to any country shall not exceed the
same proportion of the tax against which such credit
is taken, which the taxpayer's taxable income from
sources within such country under this Title bears to
his entire taxable income for the same taxable year;
and
(b) The total amount of the credit shall not exceed
the same proportion of the tax against which such
credit is taken, which the taxpayer's taxable income
from sources without the Philippines taxable under
this Title bears to his entire taxable income for the
same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If
accrued taxes when paid differ from the amounts
claimed as credits by the taxpayer, or if any tax paid
is refunded in whole or in part, the taxpayer shall
notify the Commissioner; who shall redetermine the
amount of the tax for the year or years affected, and
the amount of tax due upon such redetermination, if
any, shall be paid by the taxpayer upon notice and
demand by the Commissioner, or the amount of tax
overpaid, if any, shall be credited or refunded to the
taxpayer. In the case of such a tax incurred but not refund in the amount of P150,269.00 as
paid, the Commissioner as a condition precedent to alleged overpaid income tax for 1955
the allowance of this credit may require the taxpayer o Facts:
to give a bond with sureties satisfactory to and to be In Feb 1956 Sps filed ITR for 1955 =
approved by the Commissioner in such sum as he gross income of P1,7771,124.63 and net
may require, conditioned upon the payment by the income of P1,052,550.67
taxpayer of any amount of tax found due upon any 1956 sps filed an amended ITR
such redetermination. The bond herein prescribed Back in 1955, sps filed with the US
shall contain such further conditions as the Internal Revenue Agent in Manila their
Commissioner may require. federal ITR for the years 1947,1951-54
(6) Year in Which Credit Taken. - The credits provided on income from Phil sources on a cash
for in Subsection (C)(3) of this Section may, at the basis
option of the taxpayer and irrespective of the method 1958 Sps amended their Phil ITR for
of accounting employed in keeping his books, be 1955 to include the deductions of US
taken in the year which the taxes of the foreign Federal income taxes, interest accrued
country were incurred, subject, however, to the up to May 15, 1955, and exchange and
conditions prescribed in Subsection (C)(5) of this bank charges
Section. If the taxpayer elects to take such credits in CTA case 570 was filed
the year in which the taxes of the foreign country
G.R. No. 21434 formerly CTA Case No. 783,
accrued, the credits for all subsequent years shall be
facts are similar but refer to Lednickys OTR
taken upon the same basis and no portion of any
for 1957 filed in Feb 1958
such taxes shall be allowed as a deduction in the
o In 1959 sps filed amended return for
same or any succeeding year.
1957 claiming deductions
(7) Proof of Credits. - The credits provided in
representing taxes paid to US Govt.
Subsection (C)(3) hereof shall be allowed only if the
* Tac xourt held that the taxes may be deducted
taxpayer establishes to the satisfaction of the
because the Sps did not signify in their ITRa desire
Commissioner the following:
to avail themselves of the benefits of paragraph 3(B)
(a) The total amount of income derived from sources
of Sec. 30
without the Philippines;
COMMON ISSUE: WON a citizen of the US residing in
(b) The amount of income derived from each country,
Phils who derives income wholly from sources within
the tax paid or incurred to which is claimed as a
the Phils may deduct from his gross income the
credit under said paragraph, such amount to be
income taxes he has paid to US govt for the taxable
determined under rules and regulations prescribed
year?
by the Secretary of Finance; and
HELD/RATIO:
(c) All other information necessary for the verification
and computation of such credits. SC: CIR correct that the construction and
wording of Sec. 30c(1)B of the Internal
CASES: Revenue Act shows the laws intent that the
right to deduct income taxes paid to foreign
CIR V LEDNICKY government from the taxpayers gross
income is given only as an alternative or
FACTS: substitute to his right to claim a tax credit for
Resp spouses V.E. Lednicky and Maria Valero such foreign income taxes
o (B) Income, war-profits, and excess
Lednicky are American Citizens residing in
the Philippines and derived their income from profits taxes imposed by the
Philippine sources for the taxable years in authority of any foreign country; but
question this deduction shall be allowed in the
case of a taxpayer who does not
1957 Sps filed their ITR for 1956 reporting a
signify in his return his desire to have
gross income P1,017,287.65 and a net
any extent the benefits of paragraph
income of P733,809.44 on which
(3) of this subsection (relating to
P317,395.40 was assessed after deducting
credit for foreign countries)
P4,805.59 as withholding tax.
So that unless the alien resident has a right
Sps paid 326,247.41 on April 1957
to claim such tax credit if he so chooses, he
March 1959 Sps filed an amended ITR for is precluded from deducting the foreign
1956. They claimed a deduction of income taxes from his gross income.
P205,939.24 paid in 1956 to US govt.
For it is obvious that in prescribing that such
Respondents requested refund of 112,437.90
deduction shall be allowed in the case of a
CIR failed to answer the claim for refund, taxpayer who does not signify in his return
resps filed their petition with the Tax Court his desire to have any extent benefits of
G.R. No. L-18169 formerly CTA case paragraph 3, the statute assumes that the
570[different case/year] is also a claim for
 taxpayer in question may signify his desire to
claim a tax credit and waive the deduction;
otherwise, the foreign taxes would always be
deductible and their mention in the list on
non-deductible items in Sec. 30c might as
well have been omitted or at least expressly
limited to taxes on income from sources
outside the Philippine Islands
Had the law intended that foreign income
taxes could be deducted from gross income
in any event, regardless of the taxpayers
right to claim a tax credit, it is the latter right
that should be conditioned upon the
taxpayers waiving the deduction
No danger of double credit/taxation.
o Double taxation becomes obnoxious only
where the taxpayer is taxed twice for the
benefit of the same governmental entity
o The Philippine government only receives
the proceeds of one tax
o Justice and equity demand that the tax
on the income should accrue to the
benefit of the Philippines
o Any relief from the alleged double
taxation should come from the US since
the formers right to burden the taxpayer
is solely predicated in is citizenship,
without contributing to the production of
wealth that is being taxed
o To allow an alien resident to deduct from
his gross income whatever taxes he pays
to his own government amounts to
conferring on the latter the power to
reduce the tax income of the Philippine
government simply by increasing the tax
rates on the alien resident.
CIR vs. Lednicky [G.R. Nos. L-18169, L-18286, &
L-21434. July 31, 1964.]
FACTS:
V. E. Lednicky and Maria Valero Lednicky, are
husband and wife, both American citizens residing in
the Philippines, and have derived all their income
from Philippine sources for the taxable years under
question. [GR L-18286] In compliance with local law,
the spouses, on 27 March 1957, filed their income
tax return for 1956, reporting therein a gross income
of P1,017,287.65 and a net income of P733,809.44
on which the amount of P317,395.41 was assessed
after deducting P4,805.59 as withholding tax.
Pursuant to the Commissioner of Internal Revenues
assessment notice, the spouses paid the total
amount of P326,247.41, inclusive of the withheld
taxes, on 15 April 1957. On 17 March 1959, the
spouses filed an amended income tax return for
1956. The amendment consists in a claimed
deduction of P205,939.24 paid in 1956 to the US
government as federal income tax for 1956.
Simultaneously with the filing of the amended return,
the spouses requested the refund of P112,437.90.
When the Commissioner of Internal Revenue failed to
answer the claim for refund, the spouses filed their
petition with the tax court on 11 April 1959 as CTA
Case 646. [GR L- 18165] On 28 February 1956, the
spouses filed their domestic income tax return for
1955, reporting a gross income of P1,771,124.63 and
a net income of P1,052,550.67. On 19 April 1956,
they filed an amended income tax return, the
amendment upon the original being a lesser net
income of P1,012,554.51, and, on the basis of this
amended return, they paid P570,252.00, inclusive of
withholding taxes. After audit, the Commissioner
determined a deficiency of P16,116.00, which
amount the spouses paid on 5 December 1956. Back
in 1955, however, the spouses filed with the US
Internal Revenue Agent in Manila their Federal
income tax return for the years 1947, 1951, 1952,
1953 and 1954 on income from Philippine sources on
a cash basis. Payment of these federal income taxes,
including penalties and delinquency interest in the
amount of $264,588.82, were made in 1955 to the
US Director of Internal Revenue, Baltimore, Maryland,
through the National City Bank of New York, Manila
Branch. Exchange and bank charges in remitting
payment totaled P4,143.91. On 11 August 1958 the
said respondents amended their Philippines income
tax return for 1955 to including US Federal income
taxes, interest accruing up to 15 May 1955, and
exchange and bank charges, totaling P516,345.15
and therewith filed a claim for refund of the sum of
P166,384.00, which was later reduced to
P150,269.00. The spouses brought suit in the Tax
Court, which was docketed therein as CTA Case 570.
[GR 21434] The facts are similar to above cases but
refer to the spouses income tax returns for 1957,
filed on 28 February 1958, and for which the spouses
paid a total sum of P196,799.65. In 1959, they filed
an amended return for 1957, claiming deduction of
P190,755.80, representing taxes paid to the US
Government on income derived wholly from
Philippine sources. On the strength thereof, spouses
seek refund of P90,520.75 as overpayment (CTA
Case 783). The Tax Court decide for the spouses. The
Commissioner thus elevated under separate petitions
for review of the corresponding decisions of the Court
of Tax Appeals to the Supreme Court. Since these
cases involve the same parties and issues akin to
each case presented, the Court decided them jointly.
HELD:
The Supreme Court reversed the decisions of the
Court of Tax Appeals, and affirmed the disallowance
of the refunds claimed by the spouses, with costs
against said spouses.
1. Section 30 (c-1) of the Philippine Internal Revenue
Code Section 30 (c) (1) (Deduction from gross
income) provides that in computing net income
there shall be allowed as deductions: (c) Taxes: (1) In
general. Taxes paid or accrued within the taxable
year, except (A) The income tax provided for under
this Title; (B) Income, war-profits, and excess profits
taxes imposed by the authority of any foreign
country; but this deduction shall be allowed in the
case of a taxpayer who does not signify in his return
his desire to have to any extent the benefits of
paragraph (3) of this subsection (relating to credit for
taxes of foreign countries); (C) Estate, inheritance
and gift taxes; and (D) Taxes assessed against local
benefits of a kind tending to increase the value of the
property assessed.
2. Paragraph (c) (3) (b) of the Tax Code; Credits
against tax for taxes of foreign countries Paragraph 3
(B) of the subsection (Credits against tax for taxes of
foreign countries), reads: If the taxpayer signifies in
his return his desire to have the benefits of this
paragraph, the tax imposed by this Title shall be
credited with (B) Alien resident of the Philippines.
In the case of an alien resident of the Philippines, the
amount of any such taxes paid or accrued during the
taxable year to any foreign country, if the foreign
country of which such alien resident is a citizen or
subject, in imposing such taxes, allows a similar
credit to citizens of the Philippines residing in such
country;
3. Paragraph (c) (4) of the Tax Code; Limitation on
credit The tax credit so authorized is limited under
paragraph 4 (A and B) of the same subsection, in the
following terms: Par. (c) (4) Limitation on credit.
The amount of the credit taken under this section
shall be subject to each of the following limitations:
(A) The amount of the credit in respect to the tax
paid or accrued to any country shall not exceed the
same proportion of the tax against which such credit
is taken, which the taxpayers net income from
sources within such country taxable under this Title
bears to his entire net income for the same taxable
year; and (B) The total amount of the credit shall not
exceed the same proportion of the tax against which
such credit is taken, which the taxpayers net income
from sources without the Philippines taxable under
this Title bears to his entire net income for the same
taxable year.
4. Laws intent that right to deduct income taxes paid
to foreign government taken as an alternative or
substitute to claim of tax credit for such foreign
income tax Construction and wording of Section 30
(c) (1) (B) of the Internal Revenue Act shows the
laws intent that the right to deduct income taxes
paid to foreign government from the taxpayers gross
income is given only as an alternative or substitute
to his right to claim a tax credit for such foreign
income taxes under section 30 (c) (3) and (4); so that
unless the alien resident has a right to claim such tax
credit if he so chooses, he is precluded from
deducting the foreign income taxes from his gross
income. For it is obvious that in prescribing that such
deduction shall be allowed in the case of a taxpayer
who does not signify in his return his desire to have
to any extent the benefits of paragraph (3) (relating
to credits for taxes paid to foreign countries), the
statute assumes that the taxpayer in question also
may signify his desire, to claim a tax credit and waive
the deduction; otherwise, the foreign taxes would
always be deductible, and their mention in the list of
non-deductible items in Section 30 (c) might as well
have been omitted, or at least expressly limited to
taxes on income from sources outside the Philippine
Islands. Had the law intended that foreign income
taxes could be deducted from gross income in any
event, regardless of the taxpayers right to claim a
tax credit, it is the latter right that should be
conditioned upon the taxpayers waiving the
deduction; in which case the right to reduction under
subsection (c-1-B) would have been made absolute
or unconditional (by omitting foreign taxes from the
enumeration of non- deductions), while the right to a
tax credit under subsection (c-3) would have been
expressly conditioned upon the taxpayers not
claiming any deduction under subsection (c-1).
5. Danger of double credit does not exist if taxpayer
cannot claim benefit from either headings at his
option The purpose of the law is to prevent the
taxpayer from claiming twice the benefits of his
payment of foreign taxes, by deduction from gross
income (subs. c-1) and by tax credit (subs. c-3). This
danger of double credit certainly can not exist if the
taxpayer can not claim benefit under either of these
headings at his option, so that he must be entitled to
a tax credit (the spouses admittedly are not so
entitled because all their income is derived from
Philippine sources), or the option to deduct from
gross income disappears altogether.
6. When double taxation; Tax income should accrue
to benefit of the Philippines Double taxation becomes
obnoxious only where the taxpayer is taxed twice for
the benefit of the same governmental entity (cf.
Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579,
Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the
present case, while the taxpayers would have to pay
two taxes on the same income, the Philippine
government only receives the proceeds of one tax.
As between the Philippines, where the income was
earned and where the taxpayer is domiciled, and the
United States, where that income was not earned
and where the taxpayer did not reside, it is
indisputable that justice and equity demand that the
tax on the income should accrue to the benefit of the
Philippines. Any relief from the alleged double
taxation should come from the United States, and not
from the Philippines, since the formers right to
burden the taxpayer is solely predicated on his
citizenship, without contributing to the production of
the wealth that is being taxed.
7. Fundamental doctrine of income taxation The
fundamental doctrine of income taxation provides
that the right of a government to tax income
emanates from its partnership in the production of
income, by providing the protection, resources,
incentives, and proper climate for such production.
8. Interpretation cannot result to an absurd situation
The interpretation given by the spouses to the
revenue law provision in question operates, in its
application, to place a resident alien with only
domestic sources of income in an equal, if not in a
better, position than one who has both domestic and
foreign sources of income, a situation which is
manifestly unfair and short of logic.
9. Erroneous interpretation would subrogate
Philippine taxes to those levied by a foreign
government To allow an alien resident to deduct from
his gross income whatever taxes he pays to his own
government amounts to conferring on the latter
power to reduce the tax income of the Philippine
government simply by increasing the tax rates on the
alien resident. Everytime the rate of taxation
imposed upon an alien resident is increased by his
own government, his deduction from Philippine taxes
would correspondingly increase, and the proceeds for
the Philippines diminished, thereby subordinating our
own taxes to those levied by a foreign government.
Such a result is incompatible with the status of the
Philippines as an independent and sovereign state.
Commissioner of Internal Revenue vs W.E.
Lednicky and Maria Lednicky
GR Nos. L-18262 and L-21434, 1964
FACTS:
Spouses are both American citizens residing in the
Philippines and have derived all their income from
Philippine sources for taxable years in question.
On March, 1957, filed their ITR for 1956, reporting
gross income of P1,017,287.65 and a net income of P
733,809.44. On March 1959, file an amended
claimed deduction of P 205,939.24 paid in 1956 to
the United States government as federal income tax
of 1956.
ISSUE:
Whether a citizen of the United States residing in the
Philippines, who derives wholly from sources within
the Philippines, may deduct his gross income from
the income taxes he has paid to the United States
government for the said taxable year?
HELD:
An alien resident who derives income wholly from
sources within the Philippines may not deduct from
gross income the income taxes he paid to his home
country for the taxable year. The right to deduct
foreign income taxes paid given only where
alternative right to tax credit exists. Section 30 of the
NIRC, Gross Income Par. C (3): Credits against tax
per taxes of foreign countries. If the taxpayer
signifies in his return his desire to have the benefits
of this paragraph, the tax imposed by this shall be
credited with: Paragraph (B), Alien resident of the
Philippines; and, Paragraph C (4), Limitation on
credit. An alien resident not entitled to tax credit for
foreign income taxes paid when his income is derived
wholly from sources within the Philippines. Double
taxation becomes obnoxious only where the taxpayer
is taxed twice for the benefit of the same
governmental entity. In the present case, although
the taxpayer would have to pay two taxes on the
same income but the Philippine government only
receives the proceeds of one tax, there is no
obnoxious double taxation.
4. LOSSES
Refer to such losses which do not come under the
category of bad debts, inventory losses,
depreciation, etc and which arise in taxpayers
profession trade or business
Kinds of Losses:
a. Ordinary- incurred in trade or business or
practice of profession
b. Capital Losses- deductible to the extent of
capital gains
1. Losses from sale or exchange of capital
assets
2. Losses resulting from securities becoming
worthless and which are capital assets
3. Losses from Short Sale of property
4. Losses due to failure to exercise privilege or
option to buy or sell property
c. Special Losses- ie. Wagering Losses(to the extent
of gain in such transactions), losses on wash sales
(sec 38)
i. Sec 34(D) of the NIRC
Losses- Losses actually sustained during the taxable
year and not compensated for by insurance or other
forms of indemnity shall be allowed as deductions:
(a) If incurred in trade, profession or business;
(b) Of property connected with the trade, business or
profession, if the loss arises from fires, storms,
shipwreck, or other casualties, or from robbery, theft
or embezzlement.
Prescription/ when must submit report to Sec
of Finance: not be less than thirty (30) days nor more
than ninety (90) days from the date of discovery of
the casualty or robbery, theft or embezzlement
giving rise to the loss.
ii. Casualty Losses
a. RMO 31-09 dated October 16, 2009
-prescribes the policies and guidelines for declaration
and reporting or casualty losses incurred as result of
Typhoons Ondoy and Pepeng
Requirements:
1. Sworn Declaration of Loss ( filed within 45 days
after date of event)
2. Proof of the elements of the losses claimed such
as photos, documents, insurance policy, police report
(a mere allged theft or robbery to police authorities is
not considered conclusive proof)
Taxpayer engaged in trade and business- may claim
business deductions casualty losses for properties
used in business that were damaged or reported as
losses
Extent of loss to be deducted-> do not include the
amount covered by insurance
Destruction of property-> net book value
immediately preceding disaster
Restoration-> recorded as repairs expense or
capitalized assets
iii. Net Operating Loss Carry-Over
The net operating loss of the business or enterprise
for any taxable year immediately preceding the
current taxable year, which had not been previously
offset as deduction from gross income shall be
carried over as a deduction from gross income for the
next 3 consecutive taxable years immediately
following the year of such loss, provided that any net
loss incurred in a taxable year during which the
taxpayer is exempt from income tax shall not be
allowed as a deduction.
The deduction is allowed only if there has been no
substantial change in the ownership of the business
or enterprise in that
a. Not less than 75% in nominal value of outstanding
issued shares, if the business is in the name of a
corporation, is held by or on behalf of the same
persons; or
b. Not less than 75% of the paid up capital of the
corporation, if the business is in the name of a
corporation, is held by or on behalf of the same
persons.
For mines other than oil and gas wells, a net
operating loss without the benefit of incentives
provided under EO No. 226,as amended, incurred in
any of the first 10 years of operation may be carried
over as a deduction, from taxable income for the
next 5 years immediately following the year of such
loss. The entire amount of the loss shall be carried
over to the first of the 5 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 4 years.
Net operating loss = excess of allowable deductions
over gross income.
a. RR No. 14-01 dated August 27, 2001-
NOLCO as deduction from Gross Income
a) Only net operating losses accumulated by
a qualified taxpayer beginning January
1, 1998 may be carried over as a deduction
from gross income to the next three (3)
immediately succeeding taxable years
following the year of such loss.
b) For mines other than oil and gas wells, a
net operating loss (realized without the
benefit of incentives provided for under the
Omnibus Investments Code of 1997) incurred
in any of its first ten(10) years of operation
may be carried over as a deduction from
taxable income for the next five (5) years
immediately following the year of such loss.
c) No substantial Change in Ownership (75%
Rule)
Who may avail of NOLCO:
1. Any individual, including estates and trusts,
engaged in trade or business or in the exercise of
profession, and
2. domestic and resident foreign corporations
Who may not avail NOLCO:
1) Offshore Banking Unit of a foreign banking
corporation, and Foreign Currency Deposit Unit of a
domestic or foreign banking corporation, duly
authorized as such by the Bangko Sentral ng Pilpinas;
2) enterprises registered with the Board of
Investments (BOI), with respect to its BOI-registered
activity enjoying the Income Tax Holiday incentive;
3) enterprises registered with the Philippine
Economic Zone Authority (PEZA), with respect to its
PEZA-registered business activity;
4) enterprises registered under the Bases Conversion
and Development Act of 1992;
5) foreign corporations engaged in international
shipping or air carriage business in the Philippines;
and
6) any person, natural or juridical, enjoying
exemption from income tax, pursuant to the
provisions of the Code or any special law, with
respect to its operation during the period for which
the aforesaid exemption is applicable.
NOTE: The 3 year period shall continue to run
notwithstanding that the corporation paid its taxes
under MCIT, or that the individual availed of the 10%
OSD
An individual who claims the 10% optional standard
deduction shall not simultaneously claim deduction
of the NOLCO, provided that the three-year
reglementary period shall continue to run
notwithstanding the fact that the said individual
availed of the
10% optional standard deduction during the said
period. In the case of corporations, the three-year
reglementary period on the carry-over of NOLCO
shall also continue to run notwithstanding the fact
that it has paid its income tax under the Minimum
Corporate
Income Tax computation. NOLCO shall be availed of
on a first-in, first-out basis.
CASES:
PAPER INDUSTRIES v CA ( Dec. 1, 1995)
FACTS:
The Paper Industries Corporation of the
Philippines ("Picop"), 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.
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.
Picop also issued promissory notes of about
P230M, on w/c it paid P45M in interest.
In its 1977 Income Tax Return, Picop claimed
the interest payments on the loans as
DEDUCTIONS 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.
ISSUE:
W/n the interest payments can be deducted
from gross income YES transaction tax
RULING:
The 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.
In this 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.
THIS PART DI KO SUPER MAGETS:
The CIR invokes Section 79 of Revenue
Regulations No. 2 w/c provides that 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.
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.
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.
5. BAD DEBTS
-refer to those debts resulting from the worthlessness
or uncollectibility in whole or in parts of amounts due
the taxpayer by others, arising money let or from
uncollectible amounts of income from goods sold or
services rendered.
*Before a debt can be ascertained to be worthless,
the creditor must have taken all reasonable steps to
collect within the period of prescription, and in the
light of the following circumstances, acting in good
faith, he may justify an ascertainment of
worthlessness of a debt:
i. insufficiency of collateral
ii. bankruptcy or insolvency
iii. loss of evidence of indebtedness
iv. disappearance of debtor, who fled leaving no
properties
v. death of debtor leaving no properties
vi. injury to debtor incapacitating him from work
vii. fruitless efforts to collect small amounts from
debtors scattered all over the country.
i. Sec 34(E) of the NIRC
Definition. Debts due to the taxpayer actually
ascertained to be worthless and charged off within
the taxable year except those not connected with
profession, trade or business and those sustained in
a transaction entered into between parties
mentioned under Section 36 (B) of this Code:
Provided, That recovery of bad debts previously
allowed as deduction in the preceding years shall be
included as part of the gross income in the year of
recovery to the extent of the income tax benefit of
said deduction.
Securities Becoming Worthless. Loss in the case
of a taxpayer other than a bank or trust company
incorporated under the laws of the Philippines a
substantial part of whose business is the receipt of
deposits, be considered as a loss from the sale or
exchange, on the last day of such taxable year, of
capital assets.
ii. RR No. 5-99
Requirements for Deductibility:
I. there must be an existing indebtedness due to the
taxpayer which must be valid and legally
demandable
II. it must be connected with the taxpayers trade,
business, or practice of profession
III. it must not be sustained in a transaction entered
into between related parties enumerated under Sec.
36 (b)
IV. it must be actually charged off the books of
accounts of the taxpayer as of the end of the taxable
year.
V. It must be actually ascertained to be worthless and
uncollectible as of the end of the taxable year.
The recovery of bad debts previously allowed as
deduction in the preceding year or years will be
included as part of the taxpayer's gross income in
the year of such recovery to the extent of the income
tax benefit of said deduction.
TAX BENEFIT RULE
The recovery of bad debts previously claimed as
deduction shall be included as part of gross income
in the year of recovery to the extent of the income
tax benefit of said deduction.
Under the tax benefit rule, the recovery of amounts
deducted in previous years from gross income
become taxable income unless to the extent thereof,
the deduction did not result in any tax benefit to the
taxpayer.
Example: If in the year the taxpayer claimed
deduction of bad debts written-off, he realized a
reduction of the income tax due from him on account
of the said deduction, his subsequent recovery
thereof from his debtor shall be treated as a receipt
of realized taxable income. Conversely, if the said
taxpayer did not benefit from the deduction of the
said bad debt written-off because it did not result to
any reduction of his income tax in the year of such
deduction (i.e. where the result of his business
operation was a net loss even without deduction of
the bad debts written-off), then his subsequent
recovery thereof shall be treated as a mere recovery
or return of capital, hence, not treated as receipt of
realized taxable income.
- not deductible.
- Refer to E10 above on who are related taxpayers.
(members of a family (brothers/sisters of the whole
or half blood, spouse, ancestors and lineal
descendants an individual and corporation, if the
individual owns, directly or indirectly, more than 50%
in value of the outstanding stock two corporations, if
more than 50% in value of the outstanding stock in
both is owned, directly or indirectly, by the same
individual, if either one of such corporations was a
personal holding company or a foreign personal
holding company
the grantor and a fiduciary of any trust
fiduciary of a trust and the fiduciary of another trust
if the same person is a grantor with respect to each
trust fiduciary of a trust and a beneficiary of such
trust.)
CASES:
PHILIPPINE REFINING CO v CA
FACTS:
Philippine Refining Corp (PRC) was assessed
deficiency tax payments for the year 1985 in the
amount of around 1.8M. This figure was computed
based on the disallowance of the claim of bad debts
by PRC. PRC duly protested the assessment claiming
that under the law, bad debts and interest expense
are allowable deductions.
When the BIR subsequently garnished some of PRCs
properties, the latter considered the protest as being
denied and filed an appeal to the CTA which set aside
the disallowance of the interest expense and
modified the disallowance of the bad debts by
allowing 3 accounts to be claimed as deductions.
However, 13 supposed bad debts were disallowed
as the CTA claimed that these were not substantiated
and did not satisfy the jurisprudential requirement of
worthlessness of a debt The CA denied the petition
for review.
ISSUE: Whether or not the CA was correct in
disallowing the 13 accounts as bad debts.
RULING: YES.
Both the CTA and CA relied on the case of Collector
vs. Goodrich International, which laid down the
requisites for worthlessness of a debt to wit:
In said case, we held that for debts to be considered
as "worthless," and thereby qualify as "bad debts"
making them deductible, the taxpayer should show
that (1) there is a valid and subsisting debt. (2) the
debt must be actually ascertained to be worthless
and uncollectible during the taxable year; (3) the
debt must be charged off during the taxable year;
and (4) the debt must arise from the business or
trade of the taxpayer. Additionally, before a debt can
be considered worthless, the taxpayer must also
show that it is indeed uncollectible even in the
future.
Furthermore, there are steps outlined to be
undertaken by the taxpayer to prove that he exerted
diligent efforts to collect the debts, viz.: (1) sending
of statement of accounts; (2) sending of collection
letters; (3) giving the account to a lawyer for
collection; and (4) filing a collection case in court.
PRC only used the testimony of its accountant Ms.
Masagana in order to prove that these accounts were
bad debts. This was considered by all 3 courts to be
self-serving. The SC said that PRC failed to exercise
due diligence in order to ascertain that these debts
were uncollectible. In fact, PRC did not even show the
demand letters they allegedly gave to some of their
debtors.
PHILIPPINE REFINING CO v CA
FACTS:
Plaintiff Philippine Refining Co. and defendant Jarque
executed three mortgages on the motor vessels
Pandan and Zargazo. The documents were recorded
as transfer and encumbrances of the vessels for the
port of Cebu and each was denominated a chattel
mortgage.
The first two mortgages did not have an affidavit of
good faith. A fourth mortgage was executed by
Jarque and Ramon Aboitiz over motorship Zaragoza
and was entered in the Chattel Mortgage Registry on
May 12, 1932, within the period of 30 days prior to
the foreclosure/institution of the insolvency
proceedings.
Jose Curaminas filed with the CFI of Cebu a petition
praying that Francisco Jarque be declared an
insolvent debtor. This was granted and Jarques
properties were then assigned to Curaminas.
A problem arose when Judge Jose Hontiveros declined
to order the foreclosure of the mortgages, and
instead, ruled that they were defective because they
did not have affidavits of good faith.
ISSUE:
1. Whether or not the mortgages of the vessels
are governed by the Chattel Mortgage Law
2. Whether or not an affidavit of good faith is
needed to enforce achattel mortgage on a vessel
RULING:
Yes. Personal property includes vessels. They are
subject to the provisions of the Chattel Mortgage
Law. The Chattel Mortgage Law says that a good
chattel mortgage includes an affidavit of good faith.
The absence of such affidavit makes mortgage
unenforceable against creditors and subsequent
encumbrances. The judge was correct.
Note: A mortgage on a vessel is generally like other
chattel mortgages. The only difference between a
chattel mortgage of a vessel and a chattel mortgage
of other personalty is that the first must be noted in
the registry of the register of deeds.
FERNANDEZ HERMANOS v CIR
FACTS:
Fernandez Hermanos is an investment company. The
CIR assessed it for alleged deficiency income taxes. It
claimed as deduction, among others, losses in or bad
debts of Palawan Manganese Mines Inc. which the
CIR disallowed and was sustained by the CTA.
ISSUE: W/N disallowance is correct
HELD: YES
It was shown that Palawan Manganese Mines sought
financial help from Fernandez to resume its mining
operations hence a Memorandum of Agreement
(MOA) was executed where Fernandez would give
yearly advances to Palawan. But it still continued to
suffer loses and Fernandez realized it could no longer
recover the advances hence claimed it as worthless.
Looking at the MOA, Fernandez did not expect to be
repaid. The consideration for the advances was 15%
of the net profits. If there were no earnings or profits
there was no obligation to repay. Voluntary advances
without expectation of repayment do not result in
deductible losses. Fernandez cannot even sue for
recovery as the obligation to repay will only arise if
there was net profits. No bad debt could arise where
there is no valid and subsisting debt.
Even assuming that there was valid or subsisting
debt, the debt was not deductible in 1951 as a
worthless debt as Palawan was still in operation in
1951 and 1952 as Fernandez continued to give
advances in those years. It has been held that if the
debtor corporation although losing money or
insolvent was still operating at the end of the taxable
year, the debt is not considered worthless and
therefore not deductible.
FERNANDEZ HERMANOS v CIR
FACTS: Fernandez Hermanos Inc. is a domestic
corporation organized for the principal purpose of
engaging in business as an investment company.
The CIR disallowed the following deductions:
1. losses in Mati Lumber Co in 1950
2. losses or bad debts in Palawan Manganese Mines
Inc in 1951
3. losses in Balamban Coal Mines in 1950 and 1951
4. losses in Hacienda Dalupiri and Hacienda Samal
from 1950-1954
HELD: The Supreme Court discussed the allowance
or disallowance of each in the following manner:
1. Allowed. These losses represent the shares of
stock (worth P8,050) petitioner acquired from Mati in
Jan. 1, 1948. The petitioner was correct in writing off
and claiming as a deduction in 1950 the amount on
the ground that the lumber company had ceased
operations and became insolvent in that year. The
CIR was incorrect in arguing that since the company
still owned a sawmill and some equipment, the
shares of stock still had value. The proper
assessment would be to treat as income for the year
in which petitioner gets the proceeds from the
liquidation of those assets.
2. Disallowed. These losses represent part of the
loans extended by the petitioner to its 100% owned
subsidiary. Petitioner advanced financial assistance
to Palawan from 1945 to 1952. By way of payment,
Palawan was to give petitioner 15% of net profits.
Whether Palawan was able to pay the loans or not
because it continued to operate at a loss is
immaterial. Petitioner cannot properly claim as a loss
the advances given to Palawan in 1951 for that year.
There can be no partial writing off as a loss or bad
debt under the Tax Code. Those losses or bad debts
ascertained within the taxable year are deductible in
full or not at all. Petitioner continued to give Palawan
advances even beyond 1951. It was only in 1956
when Palawan decided to cease operations.
3. Disallowed. These losses represent sums spent by
the petitioner for the operation of its Balamban coal
mines in 1950 and 1951. The petitioner should have
treated them as losses in 1952 when the mines were
abandoned and not in 1950 and 1951 on the ground
that the mines made no sales of coal during those
years.
4. Allowed. These losses represent sums spent by
petitioner for the operation of the 2 haciendas. The
amounts were properly reported as deductions for
the correct years. The only reason why the CIR
disallowed them was on the ground that the farms
were operated solely for pleasure or as a hobby and
not for profit. But the Supreme Court is not
convinced, and being for business, the petitioner
may properly deduct the same.
FERNANDEZ HERMANOS v CIR
"The filing of an answer to taxpayer's petition for
review is considered as institution of judicial action."
FACTS:
The Commissioner of Internal Revenue assessed the
petitioner investment corporation of deficiency
income taxes for the years 1950 to 1954 and for
1957. There were two conflicting dates of
assessment, which are vital to the compliance with
the statute of limitations, based on each claim of the
petitioner and the respondent; the Commisioner's
record of date of assesment is February 27, 1956
while the petitioner believes the demand was made
on December 27, 1955 so that, as the petitioner
corporation claims, the Commissioner's action to
recover its tax liability should be deemed to have
prescribed for failure on the part of the
Commissioner to file a complaint for collection
against it in an appropriate civil action.
ISSUE: Has the action for collection prescribed?
HELD: No. It has been held that "a judicial action for
the collection of a tax is begun by the filing of a
complaint with the proper court of first instance, or
where the assessment is appealed to the Court of Tax
Appeals, by filing an answer to the taxpayer's
petition for review wherein payment of the tax is
prayed for." This is but logical for where the taxpayer
avails of the right to appeal the tax assessment to
the Court of Tax Appeals, the said Court is vested
with the authority to pronounce judgment as to the
taxpayer's liability to the exclusion of any other
court. In the present case, regardless of whether the
assessments were made on February 24 and 27,
1956, as claimed by the Commissioner, or on
December 27, 1955 as claimed by the taxpayer, the
government's right to collect the taxes due has
clearly not prescribed, as the taxpayer's appeal or
petition for review was filed with the Tax Court on
May 4, 1960, with the Commissioner filing on May 20,
1960 his Answer with a prayer for payment of the
taxes due, long before the expiration of the five-year
period to effect collection by judicial action counted
from the date of assessment.

FERNANDEZ HERMANOS v CIR
FACTS:
Four cases involve two decisions of the Court of Tax
Appeal s determining the taxpayer ' s income tax
liability for the years 1950 to 1954 and for the year
1957. Both the taxpayer and the Commissioner of
Internal Revenue, as petitioner and respondent in the
cases a quo respectively , appealed from the Tax
Court's decisions , insofar as their respective
contentions on particular tax items were therein
resolved against them. Since the issues raised are
inter related, the Court resolves the four appeals in
this joint decision.
The taxpayer , Fernandez Hermanos, Inc. , is a
domestic corporation organized for the principal
purpose of engaging in business as an " investment
company " wi th main office at Manila. Upon
verification of the taxpayer's income tax returns for
the period in quest ion, the Commissioner of Internal
Revenue assessed against the taxpayer the sums of
P13,414.00, P119,613.00, P11,698.00, P6,887.00 and
P14,451.00 as alleged deficiency income taxes for
the year s 1950, 1951, 1952, 1953 and 1954,
respectively. Said assessments were the result of
alleged discrepancies found upon the examination
and verification of the taxpayer's income tax returns
for the said years, summarized by the Tax Court in its
decision of June 10, 1963 in CTA Case No. 787, as
follows:
ISSUE: The correctness of the Tax Court's rulings
with respect to the disputed items of disallowances
enumerated in the Tax Court's summary reproduced
HELD:
That the circumstances are such that the method
does not reflect the taxpayers income with
reasonable accuracy and certainty and proper and
just additions of personal expenses and other non-
deductible expenditures were made and correct , fair
and equitable credit adjustments were given by way
of eliminating non-taxable items.
Proper adjustments to conform to the income tax
laws. Proper adjustments for non-deductible items
must be made. The following non-deductibles , as the
case may be, must be
added to the increase of decrease in the net worth:
1. Personal living or family expenses
2. Premiums paid on any life insurance policy
3. Losses from sales or exchanges of property
between members of the family
4. Income taxes paid
5. Other non-deductible taxes
6. Election expenses and other expense against
public policy
7. Non-deductible contributions
8. Gifts to others
9. Estate inheritance and gift taxes
10. Net Capital Loss
On the other hand, non- taxable items should be
deducted therefrom. These items are necessary
adjustments to avoid the inclusion of what otherwise
are non-taxable receipts. They are:
1. inheritance gifts and bequests received
2. non- taxable gains
3. compensation for injuries or sickness
4. proceeds of life insurance policies
5. sweepstakes
6. winnings
7. interest on government securities and increase in
net worth are not taxable if they are shown not to be
the result of unreported income but to be the result
of the correction of errors in the taxpayers entries in
the books relating to indebtedness