G.R. No.

L-21551 September 30, 1969

FERNANDEZ HERMANOS, INC., petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.
-----------------------------
G.R. No. L-21557 September 30, 1969
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
FERNANDEZ HERMANOS, INC., and COURT OF TAX APPEALS, respondents.
-----------------------------
G.R. No. L-24972 September 30, 1969
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
FERNANDEZ HERMANOS INC., and the COURT OF TAX APPEALS, respondents.
-----------------------------
G.R. No. L-24978 September 30, 1969
FERNANDEZ HERMANOS, INC., petitioner,
vs.
THE COMMISSIONER OF INTERNAL REVENUE, and HON. ROMAN A. UMALI, COURT OF TAX
APPEALS, respondents.
L-21551:
Rafael Dinglasan for petitioner.
Office of the Solicitor General Arturo A. Alafriz, Solicitor Alejandro B. Afurong and Special Attorney Virgilio G.
Saldajeno for respondent.
L-21557:
Office of the Solicitor General for petitioner.
Rafael Dinglasan for respondent Fernandez Hermanos, Inc.
L-24972:
Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and Special
Attorney Virgilio G. Saldajeno for petitioner.
Rafael Dinglasan for respondent Fernandez Hermanos, Inc.
L-24978:
Rafael Dinglasan for petitioner.
Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Antonio G. Ibarra and Special
Attorney Virgilio G. Saldajeno for respondent.

TEEHANKEE, J.:
These four appears involve two decisions of the Court of Tax Appeals 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 interrelated, the Court resolves the four appeals in this joint decision.
Cases L-21551 and L-21557
The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal purpose of
engaging in business as an "investment company" with main office at Manila. Upon verification of the
taxpayer's income tax returns for the period in question, 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 years 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:
1. Losses —
 a. Losses in Mati Lumber Co. (1950) P 8,050.00
b. Losses in or bad debts of Palawan Manganese Mines, Inc. (1951) 353,134.25
c. Losses in Balamban Coal Mines —
1950 8,989.76
1951 27,732.66
d. Losses in Hacienda Dalupiri —
1950 17,418.95
1951 29,125.82
1952 26,744.81
1953 21,932.62
1954 42,938.56
e. Losses in Hacienda Samal —
1951 8,380.25
1952 7,621.73
2. Excessive depreciation of Houses —
1950 P 8,180.40
1951 8,768.11
1952 18,002.16
1953 13,655.25
1954 29,314.98
3. Taxable increase in net worth —
1950 P 30,050.00
1951 1,382.85
4. Gain realized from sale of real property in 1950 P 11,147.2611
The Tax Court sustained the Commissioner's disallowances of Item 1, sub-items (b) and (e) and Item 2
of the above summary, but overruled the Commissioner's disallowances of all the remaining items. It
therefore modified the deficiency assessments accordingly, found the total deficiency income taxes due
from the taxpayer for the years under review to amount to P123,436.00 instead of P166,063.00 as
originally assessed by the Commissioner, and rendered the following judgment:
RESUME
1950 P2,748.00
1951 108,724.00
1952 3,600.00
1953 2,501.00
1954 5,863.00

Total P123,436.00
WHEREFORE, the decision appealed from is hereby modified, and petitioner is ordered to pay the sum
of P123,436.00 within 30 days from the date this decision becomes final. If the said amount, or any part
thereof, is not paid within said period, there shall be added to the unpaid amount as surcharge of 5%,
plus interest as provided in Section 51 of the National Internal Revenue Code, as amended. With costs
against petitioner. (Pp. 75, 76, Taxpayer's Brief as appellant)
Both parties have appealed from the respective adverse rulings against them in the Tax Court's decision. Two
main issues are raised by the parties: first, the correctness of the Tax Court's rulings with respect to the disputed
items of disallowances enumerated in the Tax Court's summary reproduced above, and second, whether or not
the government's right to collect the deficiency income taxes in question has already prescribed.
On the first issue, we will discuss the disputed items of disallowances seriatim.
1. Re allowances/disallowances of losses.
(a) Allowance of losses in Mati Lumber Co. (1950). — The Commissioner of Internal Revenue questions the
Tax Court's allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum of
P8,050.00 representing the cost of shares of stock of Mati Lumber Co. acquired by the taxpayer on January 1,
1948, on the ground that the worthlessness of said stock in the year 1950 had not been clearly established. The
Commissioner contends that although the said Company was no longer in operation in 1950, it still had its
sawmill and equipment which must be of considerable value. The Court, however, found that "the company
ceased operations in 1949 when its Manager and owner, a certain Mr. Rocamora, left for Spain ,where he
subsequently died. When the company eased to operate, it had no assets, in other words, completely insolvent.
This information as to the insolvency of the Company — reached (the taxpayer) in 1950," when it properly
claimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30 (e) (3) of
the National Internal Revenue Code. 2
We find no reason to disturb this finding of the Tax Court. There was adequate basis for the writing off of the
stock as worthless securities. Assuming that the Company would later somehow realize some proceeds from its
sawmill and equipment, which were still existing as claimed by the Commissioner, and that such proceeds
would later be distributed to its stockholders such as the taxpayer, the amount so received by the taxpayer would
then properly be reportable as income of the taxpayer in the year it is received.
(b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). — The taxpayer appeals
from the Tax Court's disallowance of its writing off in 1951 as a loss or bad debt the sum of P353,134.25, which
it had advanced or loaned to Palawan Manganese Mines, Inc. The Tax Court's findings on this item follow:
Sometime in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are also the
controlling stockholders of petitioner corporation, requested financial help from petitioner to enable it to
resume it mining operations in Coron, Palawan. The request for financial assistance was readily and
unanimously approved by the Board of Directors of petitioner, and thereafter a memorandum agreement
was executed on August 12, 1945, embodying the terms and conditions under which the financial
assistance was to be extended, the pertinent provisions of which are as follows:
"WHEREAS, the FIRST PARTY, by virtue of its resolution adopted on August 10, 1945, has
agreed to extend to the SECOND PARTY the requested financial help by way of accommodation
advances and for this purpose has authorized its President, Mr. Ramon J. Fernandez to cause the
release of funds to the SECOND PARTY.
"WHEREAS, to compensate the FIRST PARTY for the advances that it has agreed to extend to
the SECOND PARTY, the latter has agreed to pay to the former fifteen per centum (15%) of its
net profits.
"NOW THEREFORE, for and in consideration of the above premises, the parties hereto have
agreed and covenanted that in consideration of the financial help to be extended by the FIRST
PARTY to the SECOND PARTY to enable the latter to resume its mining operations in Coron,
Palawan, the SECOND PARTY has agreed and undertaken as it hereby agrees and undertakes to
pay to the FIRST PARTY fifteen per centum (15%) of its net profits." (Exh. H-2)
Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearly advances
starting from 1945, which advances amounted to P587,308.07 by the end of 1951. Despite these advances and
the resumption of operations by Palawan Manganese Mines, Inc., it continued to suffer losses. By 1951,
petitioner became convinced that those advances could no longer be recovered. While it continued to give
advances, it decided to write off as worthless the sum of P353,134.25. This amount "was arrived at on the basis
of the total of advances made from 1945 to 1949 in the sum of P438,981.39, from which amount the sum of
P85,647.14 had to be deducted, the latter sum representing its pre-war assets. (t.s.n., pp. 136-139, Id)." (Page 4,
Memorandum for Petitioner.) Petitioner decided to maintain the advances given in 1950 and 1951 in the hope
that it might be able to recover the same, as in fact it continued to give advances up to 1952. From these facts,
and as admitted by petitioner itself, Palawan Manganese Mines, Inc., was still in operation when the advances
corresponding to the years 1945 to 1949 were written off the books of petitioner. Under the circumstances, was
the sum of P353,134.25 properly claimed by petitioner as deduction in its income tax return for 1951, either as
losses or bad debts?
It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be repaid.
It is true that some testimonial evidence was presented to show that there was some agreement that the advances
would be repaid, but no documentary evidence was presented to this effect. The memorandum agreement signed
by the parties appears to be very clear that the consideration for the advances made by petitioner was 15% of the
net profits of Palawan Manganese Mines, Inc. In other words, if there were no earnings or profits, there was no
obligation to repay those advances. It has been held that the voluntary advances made without expectation of
repayment do not result in deductible losses. 1955 PH Fed. Taxes, Par. 13, 329, citing W. F. Young, Inc. v.
Comm., 120 F 2d. 159, 27 AFTR 395; George B. Markle, 17 TC. 1593.
Is the said amount deductible as a bad debt? As already stated, petitioner gave advances to Palawan Manganese
Mines, Inc., without expectation of repayment. Petitioner could not sue for recovery under the memorandum
agreement because the obligation of Palawan Manganese Mines, Inc. was to pay petitioner 15% of its net
profits, not the advances. No bad debt could arise where there is no valid and subsisting debt.
Again, assuming that in this case there was a valid and subsisting debt and that the debtor was incapable of
paying the debt in 1951, when petitioner wrote off the advances and deducted the amount in its return for said
year, yet the debt is not deductible in 1951 as a worthless debt. It appears that the debtor was still in operation in
1951 and 1952, as petitioner continued to give advances in those years. It has been held that if the debtor
corporation, although losing money or insolvent, was still operating at the end of the taxable year, the debt is
not considered worthless and therefore not deductible. 3
The Tax Court's disallowance of the write-off was proper. The Solicitor General has rightly pointed out that the
taxpayer has taken an "ambiguous position " and "has not definitely taken a stand on whether the amount
involved is claimed as losses or as bad debts but insists that it is either a loss or a bad debt." 4 We sustain the
government's position that the advances made by the taxpayer to its 100% subsidiary, Palawan Manganese
Mines, Inc. amounting to P587,308,07 as of 1951 were investments and not loans. 5 The evidence on record
shows that the board of directors of the two companies since August, 1945, were identical and that the only
capital of Palawan Manganese Mines, Inc. is the amount of P100,000.00 entered in the taxpayer's balance sheet
as its investment in its subsidiary company. 6 This fact explains the liberality with which the taxpayer made such
large advances to the subsidiary, despite the latter's admittedly poor financial condition.
The taxpayer's contention that its advances were loans to its subsidiary as against the Tax Court's finding that
under their memorandum agreement, the taxpayer did not expect to be repaid, since if the subsidiary had no
earnings, there was no obligation to repay those advances, becomes immaterial, in the light of our resolution of
the question. The Tax Court correctly held that the subsidiary company was still in operation in 1951 and 1952
and the taxpayer continued to give it advances in those years, and, therefore, the alleged debt or investment
could not properly be considered worthless and deductible in 1951, as claimed by the taxpayer. Furthermore,
neither under Section 30 (d) (2) of our Tax Code providing for deduction by corporations of losses actually
sustained and charged off during the taxable year nor under Section 30 (e) (1) thereof providing for deduction of
bad debts actually ascertained to be worthless and charged off within the taxable year, can there be a partial
writing off of a loss or bad debt, as was sought to be done here by the taxpayer. For such losses or bad debts
must be ascertained to be so and written off during the taxable year, are therefore deductible in full or not at all,
in the absence of any express provision in the Tax Code authorizing partial deductions.
The Tax Court held that the taxpayer's loss of its investment in its subsidiary could not be deducted for the year
1951, as the subsidiary was still in operation in 1951 and 1952. The taxpayer, on the other hand, claims that its
advances were irretrievably lost because of the staggering losses suffered by its subsidiary in 1951 and that its
advances after 1949 were "only limited to the purpose of salvaging whatever ore was already available, and for
the purpose of paying the wages of the laborers who needed help." 7 The correctness of the Tax Court's ruling in
sustaining the disallowance of the write-off in 1951 of the taxpayer's claimed losses is borne out by subsequent
events shown in Cases L-24972 and L-24978 involving the taxpayer's 1957 income tax liability. (Infra,
paragraph 6.) It will there be seen that by 1956, the obligation of the taxpayer's subsidiary to it had been reduced
from P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on January 1, 1956 that the subsidiary
decided to cease operations. 8
(c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). — The Court sustains the Tax Court's
disallowance of the sums of P8,989.76 and P27,732.66 spent by the taxpayer for the operation of its Balamban
coal mines in Cebu in 1950 and 1951, respectively, and claimed as losses in the taxpayer's returns for said years.
The Tax Court correctly held that the losses "are deductible in 1952, when the mines were abandoned, and not
in 1950 and 1951, when they were still in operation." 9 The taxpayer's claim that these expeditions should be
allowed as losses for the corresponding years that they were incurred, because it made no sales of coal during
said years, since the promised road or outlet through which the coal could be transported from the mines to the
provincial road was not constructed, cannot be sustained. Some definite event must fix the time when the loss is
sustained, and here it was the event of actual abandonment of the mines in 1952. The Tax Court held that the
losses, totalling P36,722.42 were properly deductible in 1952, but the appealed judgment does not show that the
taxpayer was credited therefor in the determination of its tax liability for said year. This additional deduction of
P36,722.42 from the taxpayer's taxable income in 1952 would result in the elimination of the deficiency tax
liability for said year in the sum of P3,600.00 as determined by the Tax Court in the appealed judgment.
(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). — The
Tax Court overruled the Commissioner's disallowance of these items of losses thus:
Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950,
P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954. These deductions
were disallowed by respondent on the ground that the farm was operated solely for pleasure or as a
hobby and not for profit. This conclusion is based on the fact that the farm was operated continuously at
a loss.1awphîl.nèt
 From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for business
and not pleasure. It was mainly a cattle farm, although a few race horses were also raised. It does not
appear that the farm was used by petitioner for entertainment, social activities, or other non-business
purposes. Therefore, it is entitled to deduct expenses and losses in connection with the operation of said
farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939-1, p.164)
Section 100 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, authorizes
farmers to determine their gross income on the basis of inventories. Said regulations provide:
"If gross income is ascertained by inventories, no deduction can be made for livestock or
products lost during the year, whether purchased for resale, produced on the farm, as such losses
will be reflected in the inventory by reducing the amount of livestock or products on hand at the
close of the year."
Evidently, petitioner determined its income or losses in the operation of said farm on the basis of
inventories. We quote from the memorandum of counsel for petitioner:
"The Taxpayer deducted from its income tax returns for the years from 1950 to 1954 inclusive,
the corresponding yearly losses sustained in the operation of Hacienda Dalupiri, which losses
represent the excess of its yearly expenditures over the receipts; that is, the losses represent the
difference between the sales of livestock and the actual cash disbursements or expenses." (Pages
21-22, Memorandum for Petitioner.)
As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in its
operation, which losses were determined by means of inventories authorized under Section 100 of
Revenue Regulations No. 2, it was error for respondent to have disallowed the deduction of said losses.
The same is true with respect to loss sustained in the operation of the Hacienda Samal for the years 1951
and 1952. 10
The Commissioner questions that the losses sustained by the taxpayer were properly based on the inventory
method of accounting. He concedes, however, "that the regulations referred to does not specify how the
inventories are to be made. The Tax Court, however, felt satisfied with the evidence presented by the taxpayer ...
which merely consisted of an alleged physical count of the number of the livestock in Hacienda Dalupiri for the
years involved." 11 The Tax Court was satisfied with the method adopted by the taxpayer as a farmer breeding
livestock, reporting on the basis of receipts and disbursements. We find no Compelling reason to disturb its
findings.
2. Disallowance of excessive depreciation of buildings (1950-1954). — During the years 1950 to 1954, the
taxpayer claimed a depreciation allowance for its buildings at the annual rate of 10%. The Commissioner
claimed that the reasonable depreciation rate is only 3% per annum, and, hence, disallowed as excessive the
amount claimed as depreciation allowance in excess of 3% annually. We sustain the Tax Court's finding that the
taxpayer did not submit adequate proof of the correctness of the taxpayer's claim that the depreciable assets or
buildings in question had a useful life only of 10 years so as to justify its 10% depreciation per annum claim,
such finding being supported by the record. The taxpayer's contention that it has many zero or one-peso assets,
12 representing very old and fully depreciated assets serves but to support the Commissioner's position that a
10% annual depreciation rate was excessive.
3. Taxable increase in net worth (1950-1951). — The Tax Court set aside the Commissioner's treatment as
taxable income of certain increases in the taxpayer's net worth. It found that:
For the year 1950, respondent determined that petitioner had an increase in net worth in the sum of
P30,050.00, and for the year 1951, the sum of P1,382.85. These amounts were treated by respondent as
taxable income of petitioner for said years.
It appears that petitioner had an account with the Manila Insurance Company, the records bearing on
which were lost. When its records were reconstituted the amount of P349,800.00 was set up as its
liability to the Manila Insurance Company. It was discovered later that the correct liability was only
319,750.00, or a difference of P30,050.00, so that the records were adjusted so as to show the correct
liability. The correction or adjustment was made in 1950. Respondent contends that the reduction of
petitioner's liability to Manila Insurance Company resulted in the increase of petitioner's net worth to the
extent of P30,050.00 which is taxable. This is erroneous. The principle underlying the taxability of an
increase in the net worth of a taxpayer rests on the theory that such an increase in net worth, if
unreported and not explained by the taxpayer, comes from income derived from a taxable source. (See
Perez v. Araneta, G.R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 & L-11558, Nov.
25, 1958.) In this case, the increase in the net worth of petitioner for 1950 to the extent of P30,050.00
was not the result of the receipt by it of taxable income. It was merely the outcome of the correction of
an error in the entry in its books relating to its indebtedness to the Manila Insurance Company. The
 Income Tax Law imposes a tax on income; it does not tax any or every increase in net worth whether or
not derived from income. Surely, the said sum of P30,050.00 was not income to petitioner, and it was
error for respondent to assess a deficiency income tax on said amount.
The same holds true in the case of the alleged increase in net worth of petitioner for the year 1951 in the sum of
P1,382.85. It appears that certain items (all amounting to P1,382.85) remained in petitioner's books as
outstanding liabilities of trade creditors. These accounts were discovered in 1951 as having been paid in prior
years, so that the necessary adjustments were made to correct the errors. If there was an increase in net worth of
the petitioner, the increase in net worth was not the result of receipt by petitioner of taxable income." 13 The
Commissioner advances no valid grounds in his brief for contesting the Tax Court's findings. Certainly, these
increases in the taxpayer's net worth were not taxable increases in net worth, as they were not the result of the
receipt by it of unreported or unexplained taxable income, but were shown to be merely the result of the
correction of errors in its entries in its books relating to its indebtednesses to certain creditors, which had been
erroneously overstated or listed as outstanding when they had in fact been duly paid. The Tax Court's action
must be affirmed.
4. Gain realized from sale of real property (1950). — We likewise sustain as being in accordance with the
evidence the Tax Court's reversal of the Commissioner's assessment on all alleged unreported gain in the sum of
P11,147.26 in the sale of a certain real property of the taxpayer in 1950. As found by the Tax Court, the
evidence shows that this property was acquired in 1926 for P11,852.74, and was sold in 1950 for P60,000.00,
apparently, resulting in a gain of P48,147.26. 14 The taxpayer reported in its return a gain of P37,000.00, or a
discrepancy of P11,147.26. 15 It was sufficiently proved from the taxpayer's books that after acquiring the
property, the taxpayer had made improvements totalling P11,147.26, 16 accounting for the apparent discrepancy
in the reported gain. In other words, this figure added to the original acquisition cost of P11,852.74 results in a
total cost of P23,000.00, and the gain derived from the sale of the property for P60,000.00 was correctly
reported by the taxpayer at P37,000.00.
On the second issue of prescription, the taxpayer's contention that 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, as contradistinguished from the answer filed by the
Commissioner to its petition for review of the questioned assessments in the case a quo has long been rejected
by this Court. This Court has consistently 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."
17 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.
Cases L-24972 and L-24978
These cases refer to the taxpayer's income tax liability for the year 1957. Upon examination of its corresponding
income tax return, the Commissioner assessed it for deficiency income tax in the amount of P38,918.76,
computed as follows:
Net income per return P29,178.70 18

Add: Unallowable deductions:

(1) Net loss claimed on Ha. Dalupiri 89,547.33
(2) Amortization of Contractual right claimed
as an expense under Mines Operations 48,481.62

Net income per investigation P167,297.65

Tax due thereon 38,818.00

Less: Amount already assessed 5,836.00

Balance P32,982.00
Add: 1/2% monthly interest from 6-20- 5,936.76
 59 to 6-20-62

TOTAL AMOUNT DUE AND

COLLECTIBLE P38,918.76
The Tax Court overruled the Commissioner's disallowance of the taxpayer's losses in the operation of its
Hacienda Dalupiri in the sum of P89,547.33 but sustained the disallowance of the sum of P48,481.62, which
allegedly represented 1/5 of the cost of the "contractual right" over the mines of its subsidiary, Palawan
Manganese Mines, Inc. which the taxpayer had acquired. It found the taxpayer liable for deficiency income tax
for the year 1957 in the amount of P9,696.00, instead of P32,982.00 as originally assessed, and rendered the
following judgment:
WHEREFORE, the assessment appealed from is hereby modified. Petitioner is hereby ordered to pay to
respondent the amount of P9,696.00 as deficiency income tax for the year 1957, plus the corresponding
interest provided in Section 51 of the Revenue Code. If the deficiency tax is not paid in full within thirty
(30) days from the date this decision becomes final and executory, petitioner shall pay a surcharge of
five per cent (5%) of the unpaid amount, plus interest at the rate of one per cent (1%) a month, computed
from the date this decision becomes final until paid, provided that the maximum amount that may be
collected as interest shall not exceed the amount corresponding to a period of three (3) years. Without
pronouncement as to costs. 19
Both parties again appealed from the respective adverse rulings against them in the Tax Court's decision.
5. Allowance of losses in Hacienda Dalupiri (1957). — The Tax Court cited its previous decision overruling the
Commissioner's disallowance of losses suffered by the taxpayer in the operation of its Hacienda Dalupiri, since
it was convinced that the hacienda was operated for business and not for pleasure. And in this appeal, the
Commissioner cites his arguments in his appellant's brief in Case No. L-21557. The Tax Court, in setting aside
the Commissioner's principal objections, which were directed to the accounting method used by the taxpayer
found that:
It is true that petitioner followed the cash basis method of reporting income and expenses in the
operation of the Hacienda Dalupiri and used the accrual method with respect to its mine operations. This
method of accounting, otherwise known as the hybrid method, followed by petitioner is not without
justification.
... A taxpayer may not, ordinarily, combine the cash and accrual bases. The 1954 Code provisions
permit, however, the use of a hybrid method of accounting, combining a cash and accrual
method, under circumstances and requirements to be set out in Regulations to be issued. Also, if
a taxpayer is engaged in more than one trade or business he may use a different method of
accounting for each trade or business. And a taxpayer may report income from a business on
accrual basis and his personal income on the cash basis.' (See Mertens, Law of Federal Income
Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 12.08, p. 26.) 20
The Tax Court, having satisfied itself with the adequacy of the taxpayer's accounting method and
procedure as properly reflecting the taxpayer's income or losses, and the Commissioner having failed to
show the contrary, we reiterate our ruling [supra, paragraph 1 (d) and (e)] that we find no compelling
reason to disturb its findings.
6. Disallowance of amortization of alleged "contractual rights." — The reasons for sustaining this disallowance
are thus given by the Tax Court:
It appears that the Palawan Manganese Mines, Inc., during a special meeting of its Board of Directors on
January 19, 1956, approved a resolution, the pertinent portions of which read as follows:
"RESOLVED, as it is hereby resolved, that the corporation's current assets composed of ores,
fuel, and oil, materials and supplies, spare parts and canteen supplies appearing in the inventory
and balance sheet of the Corporation as of December 31, 1955, with an aggregate value of
P97,636.98, contractual rights for the operation of various mining claims in Palawan with a value
of P100,000.00, its title on various mining claims in Palawan with a value of P142,408.10 or a
total value of P340,045.02 be, as they are hereby ceded and transferred to Fernandez Hermanos,
Inc., as partial settlement of the indebtedness of the corporation to said Fernandez Hermanos Inc.
in the amount of P442,895.23." (Exh. E, p. 17, CTA rec.)
On March 29, 1956, petitioner's corporation accepted the above offer of transfer, thus:
"WHEREAS, the Palawan Manganese Mines, Inc., due to its yearly substantial losses has
decided to cease operation on January 1, 1956 and in order to satisfy at least a part of its
indebtedness to the Corporation, it has proposed to transfer its current assets in the amount of
NINETY SEVEN THOUSAND SIX HUNDRED THIRTY SIX PESOS & 98/100 (P97,636.98)
 as per its balance sheet as of December 31, 1955, its contractual rights valued at ONE
HUNDRED THOUSAND PESOS (P100,000.00) and its title over various mining claims valued
at ONE HUNDRED FORTY TWO THOUSAND FOUR HUNDRED EIGHT PESOS & 10/100
(P142,408.10) or a total evaluation of THREE HUNDRED FORTY THOUSAND FORTY FIVE
PESOS & 08/100 (P340,045.08) which shall be applied in partial settlement of its obligation to
the Corporation in the amount of FOUR HUNDRED FORTY TWO THOUSAND EIGHT
HUNDRED EIGHTY FIVE PESOS & 23/100 (P442,885.23)," (Exh. E-1, p. 18, CTA rec.)
Petitioner determined the cost of the mines at P242,408.10 by adding the value of the contractual rights
(P100,000.00) and the value of its mining claims (P142,408.10). Respondent disallowed the deduction
on the following grounds: (1) that the Palawan Manganese Mines, Inc. could not transfer P242,408.10
worth of assets to petitioner because the balance sheet of the said corporation for 1955 shows that it had
only current as worth P97,636.96; and (2) that the alleged amortization of "contractual rights" is not
allowed by the Revenue Code.
The law in point is Section 30(g) (1) (B) of the Revenue Code, before its amendment by Republic Act
No. 2698, which provided in part:
"(g) Depletion of oil and gas wells and mines.:
"(1) In general. — ... (B) in the case of mines, a reasonable allowance for depletion thereof not to
exceed the market value in the mine of the product thereof, which has been mined and sold
during the year for which the return and computation are made. The allowances shall be made
under rules and regulations to be prescribed by the Secretary of Finance: Provided, That when the
allowances shall equal the capital invested, ... no further allowance shall be made."
Assuming, arguendo, that the Palawan Manganese Mines, Inc. had assets worth P242,408.10 which it
actually transferred to the petitioner in 1956, the latter cannot just deduct one-fifth (1/5) of said amount
from its gross income for the year 1957 because such deduction in the form of depletion charge was not
sanctioned by Section 30(g) (1) (B) of the Revenue Code, as above-quoted.
xxx xxx xxx
The sole basis of petitioner in claiming the amount of P48,481.62 as a deduction was the memorandum
of its mining engineer (Exh. 1, pp. 31-32, CTA rec.), who stated that the ore reserves of the Busuange
Mines (Mines transferred by the Palawan Manganese Mines, Inc. to the petitioner) would be exhausted
in five (5) years, hence, the claim for P48,481.62 or one-fifth (1/5) of the alleged cost of the mines
corresponding to the year 1957 and every year thereafter for a period of 5 years. The said memorandum
merely showed the estimated ore reserves of the mines and it probable selling price. No evidence
whatsoever was presented to show the produced mine and for how much they were sold during the year
for which the return and computation were made. This is necessary in order to determine the amount of
depletion that can be legally deducted from petitioner's gross income. The method employed by
petitioner in making an outright deduction of 1/5 of the cost of the mines is not authorized under Section
30(g) (1) (B) of the Revenue Code. Respondent's disallowance of the alleged "contractual rights"
amounting to P48,481.62 must therefore be sustained. 21
The taxpayer insists in this appeal that it could use as a method for depletion under the pertinent provision of the
Tax Code its "capital investment," representing the alleged value of its contractual rights and titles to mining
claims in the sum of P242,408.10 and thus deduct outright one-fifth (1/5) of this "capital investment" every
year. regardless of whether it had actually mined the product and sold the products. The very authorities cited in
its brief give the correct concept of depletion charges that they "allow for the exhaustion of the capital value of
the deposits by production"; thus, "as the cost of the raw materials must be deducted from the gross income
before the net income can be determined, so the estimated cost of the reserve used up is allowed." 22 The
alleged "capital investment" method invoked by the taxpayer is not a method of depletion, but the Tax Code
provision, prior to its amendment by Section 1, of Republic Act No. 2698, which took effect on June 18, 1960,
expressly provided that "when the allowances shall equal the capital invested ... no further allowances shall be
made;" in other words, the "capital investment" was but the limitation of the amount of depletion that could be
claimed. The outright deduction by the taxpayer of 1/5 of the cost of the mines, as if it were a "straight line" rate
of depreciation, was correctly held by the Tax Court not to be authorized by the Tax Code.
ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the appeals in Cases Nos. L-21551 and
L-21557, as modified by the crediting of the losses of P36,722.42 disallowed in 1951 and 1952 to the taxpayer
for the year 1953 as directed in paragraph 1 (c) of this decision, is hereby affirmed. The judgment of the Court
of Tax Appeals appealed from in Cases Nos. L-24972 and L-24978 is affirmed in toto. No costs. So ordered.
[G.R. No. 118794. May 8, 1996]
PHILIPPINE REFINING COMPANY (now known as UNILEVER PHILIPPINES [PRC], INC.), petitioner, vs.
COURT OF APPEALS, COURT OF TAX APPEALS, and THE COMMISSIONER OF INTERNAL
REVENUE, respondents.
SYLLABUS
1. REMEDIAL LAW; EVIDENCE; FINDINGS OF FACT OF THE COURT OF TAX APPEALS,
GENERALLY UPHELD ON APPEAL; CASE AT BENCH. The Court of Tax Appeals is a highly
specialized body specifically created for the purpose of reviewing tax cases. Through its expertise, it is
undeniably competent to determine the issue of whether or not the debt is deductible through the evidence
presented before it. Because of this recognized expertise, the findings of the CTA will not ordinarily be
reviewed absent a showing of gross error or abuse on its part. The findings of fact of the CTA are binding on
this Court and in the absence of strong reasons for this Court to delve into facts, only questions of law are open
for determination. Were it not, therefore, due to the desire of this Court to satisfy petitioners calls for
clarification and to use this case as a vehicle for exemplification, this appeal could very well have been
summarily dismissed.
2. TAXATION; NATIONAL INTERNAL REVENUE CODE; INCOME TAX; BAD DEBTS;
REQUISITES FOR DEDUCTION. 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.
3. ID.; ID.; ID.; DEFICIENCY TAX ASSESSMENT; FAILURE TO PAY WITHIN 30 DAYS RENDERS
TAXPAYER LIABLE FOR PAYMENT OF 25% SURCHARGE AND 20% INTEREST. As correctly
pointed out by the Solicitor General, the deficiency tax assessment in this case, which was the subject of the
demand letter of respondent Commissioner dated April 11, 1989, should have been paid within thirty (30) days
from receipt thereof. By reason of petitioners default thereon, the delinquency penalties of 25% surcharge and
interest of 20% accrued from April 11, 1989. The fact that petitioner appealed the assessment to the CTA and
that the same was modified does not relieve petitioner of the penalties incident to delinquency. The reduced
amount of P237,381.25 is but a part of the original assessment of P1,892,584.00.
4. ID.; TAX LAWS IMPOSING PENALTIES FOR DELINQUENCIES, INTENDED TO HASTEN
PAYMENT OF TAXES. Tax laws imposing penalties for delinquencies, so we have long held, are intended to
hasten tax payments by punishing evasions or neglect of duty in respect thereof. If penalties could be condoned
for flimsy reasons, the law imposing penalties for delinquencies would be rendered nugatory, and the
maintenance of the Government and its multifarious activities will be adversely affected.
5. ID.; NATIONAL INTERNAL REVENUE CODE; COLLECTION OF PENALTY AND INTEREST IN
CASE OF DELINQUENCY, MANDATORY. We have likewise explained that it is mandatory to collect
penalty and interest at the stated rate in case of delinquency. The intention of the law is to discourage delay in
the payment of taxes due the Government and, in this sense, the penalty and interest are not penal but
compensatory for the concomitant use of the funds by the taxpayer beyond the date when he is supposed to have
paid them to the Government.
APPEARANCES OF COUNSEL
Antonio H. Garces for petitioner.
The Solicitor General for respondents.
DECISION
REGALADO, J.:
This is an appeal by certiorari from the decision of respondent Court of Appeals1 affirming the decision of the
Court of Tax Appeals which disallowed petitioners claim for deduction as bad debts of several accounts in the
total sum of P395,324.27, and imposing a 25% surcharge and 20% annual delinquency interest on the alleged
deficiency income tax liability of petitioner.
Petitioner Philippine Refining Company (PRC) was assessed by respondent Commissioner of Internal Revenue
(Commissioner) to pay a deficiency tax for the year 1985 in the amount of P1,892,584.00, computed as follows:
Deficiency Income Tax
Net Income per investigation P197,502,568.00
Add: Disallowances
Bad Debts P 713,070.93
Interest Expense P2.666.545.49 P3.379.616.00
Net Taxable Income P200.882.184.00
Tax Due Thereon P 70,298,764.00
Less: Tax Paid P 69,115,899.00
Deficiency Income Tax P 1,182,865.00
Add: 20% Interest (60% max.) P 709.719.00
Total Amount Due and Collectible P 1.892.584.002
The assessment was timely protested by petitioner on April 26, 1989, on the ground that it was based on the
erroneous disallowances of bad debts and interest expense although the same are both allowable and legal
deductions. Respondent Commissioner, however, issued a warrant of garnishment against the deposits of
petitioner at a branch of City Trust Bank, in Makati, Metro Manila, which action the latter considered as a
denial of its protest.
Petitioner accordingly filed a petition for review with the Court of Tax Appeals (CTA) on the same assignment
of error, that is, that the bad debts and interest expense are legal and allowable deductions. In its decision3 of
February 3, 1993 in C.T.A. Case No. 4408, the CTA modified the findings of
the Commissioner by reducing the deficiency income tax assessment to P237,381.26, with surcharge and
interest incident to delinquency. In said decision, the Tax Court reversed and set aside the Commissioners
disallowance of the supposed interest expense of P2,666,545.19 but maintained the disallowance of the bad
debts of thirteen (13) debtors in the total sum of P395,324.27.
Petitioner then elevated the case to respondent Court of Appeals which, as earlier stated, denied due course to
the petition for review and dismissed the same on August 24, 1994 in CA-G.R. S.P. No. 31190,4 on the
following ratiocination:
We agree with respondent Court of Tax Appeals:
Out of the sixteen (16) accounts alleged as bad debts, We find that only three (3) accounts have met the
requirements of the worthlessness of the accounts, hence were properly written off as bad debts, namely:
1. Petronila Catap P29,098.30
(Pet Mini Grocery)

2. Esther Guinto 254,375.54

(Esther Sari-sari Store)

3. Manuel Orea 34,272.82

(Elman Gen. Mdsg.)
TOTAL P317,746.66
xxx xxx xxx
With regard to the other accounts, namely:
1. Remoblas Store P 11,961.00
2. Tomas Store 16,842.79
3. AFPCES 13,833.62
4. CM Variety Store 10,895.82
5. URen Mart Enterprise 10,487.08
6. Aboitiz Shipping Corp. 89,483.40
7. J. Ruiz Trucking 69,640.34
8. Renato Alejandro 13,550.00
9. Craig, Mostyn Pty. Ltd. 23,738.00
10. C. Itoh 19,272.22
11. Crocklaan B. V. 77,690.00
12. Enriched Food Corp. 24,158.00
13. Lucito Sta. Maria 13,772.00
TOTAL P395,324.27
We find that said accounts have not satisfied the requirements of the worthlessness of a debt. Mere testimony of
the Financial Accountant of the Petitioner explaining the worthlessness of said debts is seen by this Court as
nothing more than a self-serving exercise which lacks probative value. There was no iota of documentary
evidence (e. g., collection letters sent, report from investigating fieldmen, letter of referral to their legal
department, police report/affidavit that the owners were bankrupt due to fire that engulfed their stores or that the
owner has been murdered, etc.), to give support to the testimony of an employee of the Petitioner. Mere
allegations cannot prove the worthlessness of such debts in 1985. Hence, the claim for deduction of these
thirteen (13) debts should be rejected.5
1. This pronouncement of respondent Court of Appeals relied on the ruling of this Court in Collector vs.
Goodrich International Rubber Co.,6 which established the rule in determining the worthlessness of a debt. In
said case, we held that for debts to be considered as worthless, and thereby qualify as bad debts making them
deductible, the taxpayer should show that (1) there is a valid and subsisting debt; (2) the debt must be actually
ascertained to be worthless and uncollectible during the taxable year; (3) the debt must be charged off during
the taxable year; and (4) the debt must arise from the business or trade of the taxpayer. Additionally, before a
debt can be considered worthless, the taxpayer must also show that it is indeed uncollectible even in the future.
Furthermore, there are steps outlined to be undertaken by the taxpayer to prove that he exerted diligent efforts to
collect the debts, viz: (1) sending of statement of accounts; (2) sending of collection letters; (3) giving the
account to a lawyer for collection; and (4) filing a collection case in court.
On the foregoing considerations, respondent Court of Appeals held that petitioner did not satisfy the
requirements of worthlessness of a debt as to the thirteen (13) accounts disallowed as deductions.
It appears that the only evidentiary support given by PRC for its aforesaid claimed deductions was the
explanation or justification posited by its financial adviser or accountant. Guia D. Masagana. Her allegations
were not supported by any documentary evidence, hence, both the Court of Appeals and the CTA ruled that said
contentions per se cannot prove that the debts were indeed uncollectible and can be considered as bad debts as
to make them deductible. That both lower courts are correct is shown by petitioners own submission and the
discussion thereof which we have taken time and patience to cull from the antecedent proceedings in this case,
albeit bordering on factual settings.
The accounts of Remoblas Store in the amount of P11,961.00 and CM Variety Store in the amount of
P10,895.82 are uncollectible, according to petitioner, since the stores were burned in November, 1984 and in
early 1985, respectively, and there are no assets belonging to the debtors that can be garnished by PRC.7
However, PRC failed to show any documentary evidence for said allegations. Not a single document was
offered to show that the stores were burned, even just a police report or an affidavit attesting to such loss by fire.
In fact, petitioner did not send even a single demand letter to the owners of said stores.
The account of Tomas Store in the amount of P16,842.79 is uncollectible, claims petitioner PRC, since the
owner thereof was murdered and left no visible assets which could satisfy the debt. Withal, just like the
accounts of the two other stores just mentioned, petitioner again failed to present proof of the efforts exerted to
collect the debt, other than the aforestated asseverations of its financial adviser.
The accounts of Aboitiz Shipping Corporation and J. Ruiz Trucking in the amounts of P89,483.40 and
P69,640.34, respectively, both of which allegedly arose from the hijacking of their cargo and for which they
were given 30% rebates by PRC, are claimed to be uncollectible. Again, petitioner failed to present an iota of
proof, not even a copy of the supposed policy regulation of PRC that it gives rebates to clients in case of loss
arising from fortuitous events or force majeure, which rebates it now passes off as uncollectible debts.
As to the account of P13,550.00 representing the balance collectible from Renato Alejandro, a former employee
who failed to pay the judgment against him, it is petitioners theory that the same can no longer be collected
since his whereabouts are unknown and he has no known property which can be garnished or levied upon. Once
again, petitioner failed to prove the existence of the said case against that debtor or to submit any
documentation to show that Alejandro was indeed bound to pay any judgment obligation.
The amount of P13,772.00 corresponding to the debt of Lucito Sta. Maria is allegedly due to the loss of his
stocks through robbery and the account is uncollectible due to his insolvency. Petitioner likewise failed to
submit documentary evidence, not even the written reports of the alleged investigation conducted by its agents
as testified to by its aforenamed financial adviser. Regarding the accounts of C. Itoh in the amount of
P19,272.22, Crocklaan B.V. in the sum of P77,690.00, and Craig, Mostyn Pty. Ltd. with a balance of
P23,738.00, petitioner contends that these debtors being foreign corporations, it can sue them only in their
country of incorporation; and since this will entail expenses more than the amounts of the debts to be collected,
petitioner did not file any collection suit but opted to write them off as bad debts. Petitioner was unable to show
proof of its efforts to collect the debts, even by a single demand letter therefor. While it is not required to file
suit, it is at least expected by the law to produce reasonable proof that the debts are uncollectible although
diligent efforts were exerted to collect the same.
The account of Enriched Food Corporation in the amount of P24,158.00 remains unpaid, although petitioner
claims that it sent several letters. This is not sufficient to sustain its position, even if true, but even smacks of
insouciance on its part. On top of that, it was unable to show a single copy of the alleged demand letters sent to
the said corporation or any of its corporate officers.
With regard to the account of AFPCES for unpaid supplies in the amount of P13,833.62, petitioner asserts that
since the debtor is an agency of the government, PRC did not file a collection suit therefor. Yet, the mere fact
that AFPCES is a government agency does not preclude PRC from filing suit since said agency, while
discharging proprietary functions, does not enjoy immunity from suit. Such pretension of petitioner cannot pass
judicial muster.
No explanation is offered by petitioner as to why the unpaid account of URen Mart Enterprise in the amount of
P10,487.08 was written off as a bad debt. However, the decision of the CTA includes this debtor in its findings
on the lack of documentary evidence to justify the deductions claimed, since the worthlessness of the debts
involved are sought to be established by the mere self-serving testimony of its financial consultant.
The contentions of PRC that nobody is in a better position to determine when an obligation becomes a bad debt
than the creditor itself, and that its judgment should not be substituted by that of respondent court as it is PRC
which has the facilities in ascertaining the collectibility or uncollectibility of these debts, are presumptuous and
uncalled for. The Court of Tax Appeals is a highly specialized body specifically created for the purpose of
reviewing tax cases. Through its expertise, it is undeniably competent to determine the issue of whether or not
the debt is deductible through the evidence presented before it.8
Because of this recognized expertise, the findings of the CTA will not ordinarily be reviewed absent a showing
of gross error or abuse on its part.9 The findings of fact of the CTA are binding on this Court and in the absence
of strong reasons for this Court to delve into facts, only questions of law are open for determination.10 Were it
not, therefore, due to the desire of this Court to satisfy petitioners calls for clarification and to use this case as a
vehicle for exemplification, this appeal could very well have been summarily dismissed.
The Court vehemently rejects the absurd thesis of petitioner that despite the supervening delay in the tax
payment, nothing is lost on the part of the Government because in the event that these debts are collected, the
same will be returned as taxes to it in the year of the recovery. This is an irresponsible statement which
deliberately ignores the fact that while the Government may eventually recover revenues under that hypothesis,
the delay caused by the non-payment of taxes under such a contingency will obviously have a disastrous effect
on the revenue collections necessary for governmental operations during the period concerned.
2. We need not tarry at length on the second issue raised by petitioner. It argues that the imposition of the 25%
surcharge and the 20% delinquency interest due to delay in its payment of the tax assessed is improper and
unwarranted, considering that the assessment of the Commissioner was modified by the CTA and the decision
of said court has not yet become final and executory.
Regarding the 25% surcharge penalty, Section 248 of the Tax Code provides:
SEC 248. Civil Penalties. (a) There shall be imposed, in addition to the tax required to be paid, a penalty
equivalent to twenty-five percent (25%) of the amount due, in the following cases:
xxx xxx xxx
(3) Failure to pay the tax within the time prescribed for its payment.
With respect to the penalty of 20% interest, the relevant provision is found in Section 249 of the same Code, as
follows:
SEC. 249. Interest. (a) In general. There shall be assessed and collected on any unpaid amount of tax, interest at
the rate of twenty percent (20%) per annum, or such higher rate as may be prescribed by regulations, from the
date prescribed for payment until the amount is fully paid.
xxx xxx xxx
(c) Delinquency interest. In case of failure to pay:
(1) The amount of the tax due on any return required to be filed, or
(2) The amount of the tax due for which no return is required, or
3) A deficiency tax, or any surcharge or interest thereon, on the due date appearing in the notice and demand of
the Commissioner,
there shall be assessed and collected, on the unpaid amount, interest at the rate prescribed in paragraph (a)
hereof until the amount is fully paid, which interest shall form part of the tax. (Italics supplied)
xxx xxx xxx
As correctly pointed out by the Solicitor General, the deficiency tax assessment in this case, which was the
subject of the demand letter of respondent Commissioner dated April 11, 1989, should have been paid within
thirty (30) days from receipt thereof. By reason of petitioners default thereon, the delinquency penalties of 25%
surcharge and interest of 20% accrued from April 11, 1989. The fact that petitioner appealed the assessment to
the CTA and that the same was modified does not relieve petitioner of the penalties incident to delinquency. The
reduced amount of P237,381.25 is but a part of the original assessment of P1,892,584.00.
Our attention has also been called to two of our previous rulings and these we set out here for the benefit of
petitioner and whosoever may be minded to take the same stance it has adopted in this case. Tax laws imposing
penalties for delinquencies, so we have long held, are intended to hasten tax payments by punishing evasions or
neglect of duty in respect thereof. If penalties could be condoned for flimsy reasons, the law imposing penalties
for delinquencies would be rendered nugatory, and the maintenance of the Government and its multifarious
activities will be adversely affected.11
We have likewise explained that it is mandatory to collect penalty and interest at the stated rate in case of
delinquency. The intention of the law is to discourage delay in the payment of taxes due the Government and, in
this sense, the penalty and interest are not penal but compensatory for the concomitant use of the funds by the
taxpayer beyond the date when he is supposed to have paid them to the Government.12 Unquestionably,
petitioner chose to turn a deaf ear to these injunctions.
ACCORDINGLY, the petition at bar is DENIED and the judgment of respondent Court of Appeals is hereby
AFFIRMED, with treble costs against petitioner.
SO ORDERED.
Romero, Puno, Mendoza, and Torres, Jr., JJ., concur.
COMMISSIONER OFG. R. No. 163653
INTERNAL REVENUE,

Petitioner,

-versus-

FILINVEST DEVELOPMENT
CORPORATION,

Respondent.

x-------------------------------------x
G. R. No. 167689

COMMISSIONER OF
INTERNAL REVENUE, Present:

Petitioner,
CORONA, C.J.,

CARPIO,

VELASCO, JR.,

LEONARDO-DE CASTRO,
-versus- BRION,

PERALTA,

BERSAMIN,

DEL CASTILLO,
FILINVEST DEVELOPMENT
CORPORATION, ABAD,

Respondent. VILLARAMA, JR.,

PEREZ,

MENDOZA, and

SERENO,* JJ.

Promulgated:

July 19, 2011

x----------------------------------------------------------------------------------------------- x

DECISION

PEREZ, J.:

Assailed in these twin petitions for review on certiorari filed pursuant to Rule 45 of the 1997
Rules of Civil Procedure are the decisions rendered by the Court of Appeals (CA) in the
following cases: (a) Decision dated 16 December 2003 of the then Special Fifth Division in
CA-G.R. SP No. 72992;[1] and, (b) Decision dated 26 January 2005 of the then Fourteenth
Division in CA-G.R. SP No. 74510.[2]

The Facts

The owner of 80% of the outstanding shares of respondent Filinvest Alabang, Inc. (FAI),
respondent Filinvest Development Corporation (FDC) is a holding company which also owned
67.42% of the outstanding shares of Filinvest Land, Inc. (FLI). On 29 November 1996, FDC
and FAI entered into a Deed of Exchange with FLI whereby the former both transferred in favor
of the latter parcels of land appraised at P4,306,777,000.00. In exchange for said parcels which
were intended to facilitate development of medium-rise residential and commercial buildings,
463,094,301 shares of stock of FLI were issued to FDC and FAI.[3] As a result of the exchange,
FLIs ownership structure was changed to the extent reflected in the following tabular prcis, viz.:

Stockholder Number and Percentage of Number of Number and Percentage of

Shares Held Prior to the Additional Shares Held After the
Exchange Shares Issued Exchange

FDC 2,537,358,000 67.42% 42,217,000 2,579,575,000 61.03%

FAI 00 420,877,000 420,877,000 9.96%

OTHERS 1,226,177,000 32.58% 0 1,226,177,000 29.01%

----------------- ----------- -------------- ---------------

3,763,535,000 100% 463,094,301 4,226,629,000 (100%)

On 13 January 1997, FLI requested a ruling from the Bureau of Internal Revenue (BIR) to the
effect that no gain or loss should be recognized in the aforesaid transfer of real properties.
Acting on the request, the BIR issued Ruling No. S-34-046-97 dated 3 February 1997, finding
that the exchange is among those contemplated under Section 34 (c) (2) of the old National
Internal Revenue Code (NIRC)[4] which provides that (n)o gain or loss shall be recognized if
property is transferred to a corporation by a person in exchange for a stock in such corporation
of which as a result of such exchange said person, alone or together with others, not exceeding
four (4) persons, gains control of said corporation."[5] With the BIRs reiteration of the
foregoing ruling upon the 10 February 1997 request for clarification filed by FLI,[6] the latter,
together with FDC and FAI, complied with all the requirements imposed in the ruling.[7]

On various dates during the years 1996 and 1997, in the meantime, FDC also extended
advances in favor of its affiliates, namely, FAI, FLI, Davao Sugar Central Corporation (DSCC)
and Filinvest Capital, Inc. (FCI).[8] Duly evidenced by instructional letters as well as cash and
journal vouchers, said cash advances amounted to P2,557,213,942.60 in 1996[9] and
P3,360,889,677.48 in 1997.[10] On 15 November 1996, FDC also entered into a Shareholders
Agreement with Reco Herrera PTE Ltd. (RHPL) for the formation of a Singapore-based joint
venture company called Filinvest Asia Corporation (FAC), tasked to develop and manage FDCs
50% ownership of its PBCom Office Tower Project (the Project). With their equity participation
in FAC respectively pegged at 60% and 40% in the Shareholders Agreement, FDC subscribed to
P500.7 million worth of shares in said joint venture company to RHPLs subscription worth
P433.8 million. Having paid its subscription by executing a Deed of Assignment transferring to
FAC a portion of its rights and interest in the Project worth P500.7 million, FDC eventually
reported a net loss of P190,695,061.00 in its Annual Income Tax Return for the taxable year
1996.[11]

On 3 January 2000, FDC received from the BIR a Formal Notice of Demand to pay deficiency
income and documentary stamp taxes, plus interests and compromise penalties,[12] covered by
the following Assessment Notices, viz.: (a) Assessment Notice No. SP-INC-96-00018-2000 for
deficiency income taxes in the sum of P150,074,066.27 for 1996; (b) Assessment Notice No.
SP-DST-96-00020-2000 for deficiency documentary stamp taxes in the sum of P10,425,487.06
for 1996; (c) Assessment Notice No. SP-INC-97-00019-2000 for deficiency income taxes in the
sum of P5,716,927.03 for 1997; and (d) Assessment Notice No. SP-DST-97-00021-2000 for
deficiency documentary stamp taxes in the sum of P5,796,699.40 for 1997.[13] The foregoing
deficiency taxes were assessed on the taxable gain supposedly realized by FDC from the Deed
of Exchange it executed with FAI and FLI, on the dilution resulting from the Shareholders
Agreement FDC executed with RHPL as well as the arms-length interest rate and documentary
stamp taxes imposable on the advances FDC extended to its affiliates.[14]

On 3 January 2000, FAI similarly received from the BIR a Formal Letter of Demand for
deficiency income taxes in the sum of P1,477,494,638.23 for the year 1997.[15] Covered by
Assessment Notice No. SP-INC-97-0027-2000,[16] said deficiency tax was also assessed on the
taxable gain purportedly realized by FAI from the Deed of Exchange it executed with FDC and
FLI.[17] On 26 January 2000 or within the reglementary period of thirty (30) days from notice
of the assessment, both FDC and FAI filed their respective requests for reconsideration/protest,
on the ground that the deficiency income and documentary stamp taxes assessed by the BIR
were bereft of factual and legal basis.[18] Having submitted the relevant supporting documents
pursuant to the 31 January 2000 directive from the BIR Appellate Division, FDC and FAI filed
on 11 September 2000 a letter requesting an early resolution of their request for
reconsideration/protest on the ground that the 180 days prescribed for the resolution thereof
under Section 228 of the NIRC was going to expire on 20 September 2000.[19]

In view of the failure of petitioner Commissioner of Internal Revenue (CIR) to resolve their
request for reconsideration/protest within the aforesaid period, FDC and FAI filed on 17
October 2000 a petition for review with the Court of Tax Appeals (CTA) pursuant to Section
228 of the 1997 NIRC. Docketed before said court as CTA Case No. 6182, the petition alleged,
among other matters, that as previously opined in BIR Ruling No. S-34-046-97, no taxable gain
should have been assessed from the subject Deed of Exchange since FDC and FAI collectively
gained further control of FLI as a consequence of the exchange; that correlative to the CIR's
lack of authority to impute theoretical interests on the cash advances FDC extended in favor of
its affiliates, the rule is settled that interests cannot be demanded in the absence of a stipulation
to the effect; that not being promissory notes or certificates of obligations, the instructional
letters as well as the cash and journal vouchers evidencing said cash advances were not subject
to documentary stamp taxes; and, that no income tax may be imposed on the prospective gain
from the supposed appreciation of FDC's shareholdings in FAC. As a consequence, FDC and
FAC both prayed that the subject assessments for deficiency income and documentary stamp
taxes for the years 1996 and 1997 be cancelled and annulled.[20]

On 4 December 2000, the CIR filed its answer, claiming that the transfer of property in question
should not be considered tax free since, with the resultant diminution of its shares in FLI, FDC
did not gain further control of said corporation. Likewise calling attention to the fact that the
cash advances FDC extended to its affiliates were interest free despite the interest bearing loans
it obtained from banking institutions, the CIR invoked Section 43 of the old NIRC which, as
implemented by Revenue Regulations No. 2, Section 179 (b) and (c), gave him "the power to
allocate, distribute or apportion income or deductions between or among such organizations,
trades or business in order to prevent evasion of taxes." The CIR justified the imposition of
documentary stamp taxes on the instructional letters as well as cash and journal vouchers for
said cash advances on the strength of Section 180 of the NIRC and Revenue Regulations No. 9-
94 which provide that loan transactions are subject to said tax irrespective of whether or not
they are evidenced by a formal agreement or by mere office memo. The CIR also argued that
FDC realized taxable gain arising from the dilution of its shares in FAC as a result of its
Shareholders' Agreement with RHPL.[21]

At the pre-trial conference, the parties filed a Stipulation of Facts, Documents and Issues[22]
which was admitted in the 16 February 2001 resolution issued by the CTA. With the further
admission of the Formal Offer of Documentary Evidence subsequently filed by FDC and
FAI[23] and the conclusion of the testimony of Susana Macabelda anent the cash advances FDC
extended in favor of its affiliates,[24] the CTA went on to render the Decision dated 10
September 2002 which, with the exception of the deficiency income tax on the interest income
FDC supposedly realized from the advances it extended in favor of its affiliates, cancelled the
rest of deficiency income and documentary stamp taxes assessed against FDC and FAI for the
years 1996 and 1997,[25] thus:

WHEREFORE, in view of all the foregoing, the court finds the instant petition partly meritorious.
Accordingly, Assessment Notice No. SP-INC-96-00018-2000 imposing deficiency income tax on FDC for
taxable year 1996, Assessment Notice No. SP-DST-96-00020-2000 and SP-DST-97-00021-2000 imposing
deficiency documentary stamp tax on FDC for taxable years 1996 and 1997, respectively and Assessment
Notice No. SP-INC-97-0027-2000 imposing deficiency income tax on FAI for the taxable year 1997 are hereby
CANCELLED and SET ASIDE. However, [FDC] is hereby ORDERED to PAY the amount of P5,691,972.03
as deficiency income tax for taxable year 1997. In addition, petitioner is also ORDERED to PAY 20%
delinquency interest computed from February 16, 2000 until full payment thereof pursuant to Section 249 (c)
(3) of the Tax Code.[26]

Finding that the collective increase of the equity participation of FDC and FAI in FLI rendered
the gain derived from the exchange tax-free, the CTA also ruled that the increase in the value of
FDC's shares in FAC did not result in economic advantage in the absence of actual sale or
conversion thereof. While likewise finding that the documents evidencing the cash advances
FDC extended to its affiliates cannot be considered as loan agreements that are subject to
documentary stamp tax, the CTA enunciated, however, that the CIR was justified in assessing
undeclared interests on the same cash advances pursuant to his authority under Section 43 of the
NIRC in order to forestall tax evasion. For persuasive effect, the CTA referred to the equivalent
provision in the Internal Revenue Code of the United States (IRC-US), i.e., Sec. 482, as
implemented by Section 1.482-2 of 1965-1969 Regulations of the Law of Federal Income
Taxation.[27]

Dissatisfied with the foregoing decision, FDC filed on 5 November 2002 the petition for review
docketed before the CA as CA-G.R. No. 72992, pursuant to Rule 43 of the 1997 Rules of Civil
Procedure. Calling attention to the fact that the cash advances it extended to its affiliates were
interest-free in the absence of the express stipulation on interest required under Article 1956 of
the Civil Code, FDC questioned the imposition of an arm's-length interest rate thereon on the
ground, among others, that the CIR's authority under Section 43 of the NIRC: (a) does not
include the power to impute imaginary interest on said transactions; (b) is directed only against
controlled taxpayers and not against mother or holding corporations; and, (c) can only be
invoked in cases of understatement of taxable net income or evident tax evasion.[28] Upholding
FDC's position, the CA's then Special Fifth Division rendered the herein assailed decision dated
16 December 2003,[29] the decretal portion of which states:

WHEREFORE, premises considered, the instant petition is hereby GRANTED. The assailed Decision dated
September 10, 2002 rendered by the Court of Tax Appeals in CTA Case No. 6182 directing petitioner Filinvest
Development Corporation to pay the amount of P5,691,972.03 representing deficiency income tax on allegedly
undeclared interest income for the taxable year 1997, plus 20% delinquency interest computed from February
16, 2000 until full payment thereof is REVERSED and SET ASIDE and, a new one entered annulling
Assessment Notice No. SP-INC-97-00019-2000 imposing deficiency income tax on petitioner for taxable year
1997. No pronouncement as to costs.[30]

With the denial of its partial motion for reconsideration of the same 11 December 2002
resolution issued by the CTA,[31] the CIR also filed the petition for review docketed before the
CA as CA-G.R. No. 74510. In essence, the CIR argued that the CTA reversibly erred in
cancelling the assessment notices: (a) for deficiency income taxes on the exchange of property
between FDC, FAI and FLI; (b) for deficiency documentary stamp taxes on the documents
evidencing FDC's cash advances to its affiliates; and (c) for deficiency income tax on the gain
FDC purportedly realized from the increase of the value of its shareholdings in FAC.[32] The
foregoing petition was, however, denied due course and dismissed for lack of merit in the herein
assailed decision dated 26 January 2005[33] rendered by the CA's then Fourteenth Division,
upon the following findings and conclusions, to wit:

1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-046-97, the 29 November 1996 Deed of Exchange
resulted in the combined control by FDC and FAI of more than 51% of the outstanding shares of FLI, hence, no
taxable gain can be recognized from the transaction under Section 34 (c) (2) of the old NIRC;
2. The instructional letters as well as the cash and journal vouchers evidencing the advances FDC extended to
its affiliates are not subject to documentary stamp taxes pursuant to BIR Ruling No. 116-98, dated 30 July 1998,
since they do not partake the nature of loan agreements;

3. Although BIR Ruling No. 116-98 had been subsequently modified by BIR Ruling No. 108-99, dated 15 July
1999, to the effect that documentary stamp taxes are imposable on inter-office memos evidencing cash advances
similar to those extended by FDC, said latter ruling cannot be given retroactive application if to do so would be
prejudicial to the taxpayer;

4. FDC's alleged gain from the increase of its shareholdings in FAC as a consequence of the Shareholders'
Agreement it executed with RHPL cannot be considered taxable income since, until actually converted thru sale
or disposition of said shares, they merely represent unrealized increase in capital.[34]

Respectively docketed before this Court as G.R. Nos. 163653 and 167689, the CIR's petitions
for review on certiorari assailing the 16 December 2003 decision in CA-G.R. No. 72992 and
the 26 January 2005 decision in CA-G.R. SP No. 74510 were consolidated pursuant to the 1
March 2006 resolution issued by this Courts Third Division.
 The Issues

In G.R. No. 163653, the CIR urges the grant of its petition on the following ground:

THE COURT OF APPEALS ERRED IN REVERSING THE DECISION OF THE COURT OF TAX
APPEALS AND IN HOLDING THAT THE ADVANCES EXTENDED BY RESPONDENT TO ITS
AFFILIATES ARE NOT SUBJECT TO INCOME TAX.[35]

In G.R. No. 167689, on the other hand, petitioner proffers the following issues for resolution:

THE HONORABLE COURT OF APPEALS COMMITTED GRAVE ABUSE OF DISCRETION IN

HOLDING THAT THE EXCHANGE OF SHARES OF STOCK FOR PROPERTY AMONG
FILINVEST DEVELOPMENT CORPORATION (FDC), FILINVEST ALABANG, INCORPORATED
(FAI) AND FILINVEST LAND INCORPORATED (FLI) MET ALL THE REQUIREMENTS FOR THE
NON-RECOGNITION OF TAXABLE GAIN UNDER SECTION 34 (c) (2) OF THE OLD NATIONAL
INTERNAL REVENUE CODE (NIRC) (NOW SECTION 40 (C) (2) (c) OF THE NIRC.

II

THE HONORABLE COURT OF APPEALS COMMITTED REVERSIBLE ERROR IN HOLDING

THAT THE LETTERS OF INSTRUCTION OR CASH VOUCHERS EXTENDED BY FDC TO ITS
AFFILIATES ARE NOT DEEMED LOAN AGREEMENTS SUBJECT TO DOCUMENTARY STAMP
TAXES UNDER SECTION 180 OF THE NIRC.

III

THE HONORABLE COURT OF APPEALS GRAVELY ERRED IN HOLDING THAT GAIN ON

DILUTION AS A RESULT OF THE INCREASE IN THE VALUE OF FDCS SHAREHOLDINGS IN
FAC IS NOT TAXABLE.[36]

The Courts Ruling

While the petition in G.R. No. 163653 is bereft of merit, we find the CIRs petition in G.R. No.
167689 impressed with partial merit.

In G.R. No. 163653, the CIR argues that the CA erred in reversing the CTAs finding that
theoretical interests can be imputed on the advances FDC extended to its affiliates in 1996 and
1997 considering that, for said purpose, FDC resorted to interest-bearing fund borrowings from
commercial banks. Since considerable interest expenses were deducted by FDC when said
funds were borrowed, the CIR theorizes that interest income should likewise be declared when
the same funds were sourced for the advances FDC extended to its affiliates. Invoking Section
43 of the 1993 NIRC in relation to Section 179(b) of Revenue Regulation No. 2, the CIR
maintains that it is vested with the power to allocate, distribute or apportion income or
deductions between or among controlled organizations, trades or businesses even in the absence
of fraud, since said power is intended to prevent evasion of taxes or clearly to reflect the income
of any such organizations, trades or businesses. In addition, the CIR asseverates that the CA
should have accorded weight and respect to the findings of the CTA which, as the specialized
court dedicated to the study and consideration of tax matters, can take judicial notice of US
income tax laws and regulations.[37]

Admittedly, Section 43 of the 1993 NIRC[38] provides that, (i)n any case of two or more
organizations, trades or businesses (whether or not incorporated and whether or not organized in
the Philippines) owned or controlled directly or indirectly by the same interests, the
Commissioner of Internal Revenue is authorized to distribute, apportion or allocate gross
income or deductions between or among such organization, trade or business, if he determines
that such distribution, apportionment or allocation is necessary in order to prevent evasion of
taxes or clearly to reflect the income of any such organization, trade or business. In
amplification of the equivalent provision[39] under Commonwealth Act No. 466,[40] Sec.
179(b) of Revenue Regulation No. 2 states as follows:

Determination of the taxable net income of controlled taxpayer. (A) DEFINITIONS. When used in this section
(1) The term organization includes any kind, whether it be a sole proprietorship, a partnership, a trust,
an estate, or a corporation or association, irrespective of the place where organized, where operated, or where its
trade or business is conducted, and regardless of whether domestic or foreign, whether exempt or taxable, or
whether affiliated or not.
(2) The terms trade or business include any trade or business activity of any kind, regardless of whether
or where organized, whether owned individually or otherwise, and regardless of the place where carried on.
(3) The term controlled includes any kind of control, direct or indirect, whether legally enforceable,
and however exercisable or exercised. It is the reality of the control which is decisive, not its form or mode of
exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.
(4) The term controlled taxpayer means any one of two or more organizations, trades, or businesses
owned or controlled directly or indirectly by the same interests.
(5) The term group and group of controlled taxpayers means the organizations, trades or businesses
owned or controlled by the same interests.
(6) The term true net income means, in the case of a controlled taxpayer, the net income (or as the case
may be, any item or element affecting net income) which would have resulted to the controlled taxpayer, had it
in the conduct of its affairs (or, as the case may be, any item or element affecting net income) which would have
resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the particular
contract, transaction, arrangement or other act) dealt with the other members or members of the group at arms
length. It does not mean the income, the deductions, or the item or element of either, resulting to the controlled
taxpayer by reason of the particular contract, transaction, or arrangement, the controlled taxpayer, or the interest
controlling it, chose to make (even though such contract, transaction, or arrangement be legally binding upon
the parties thereto).

(B) SCOPE AND PURPOSE. - The purpose of Section 44 of the Tax Code is to place a controlled taxpayer on a
tax parity with an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled taxpayer,
the true net income from the property and business of a controlled taxpayer. The interests controlling a group of
controlled taxpayer are assumed to have complete power to cause each controlled taxpayer so to conduct its
affairs that its transactions and accounting records truly reflect the net income from the property and business of
each of the controlled taxpayers. If, however, this has not been done and the taxable net income are thereby
understated, the statute contemplates that the Commissioner of Internal Revenue shall intervene, and, by
making such distributions, apportionments, or allocations as he may deem necessary of gross income or
deductions, or of any item or element affecting net income, between or among the controlled taxpayers
constituting the group, shall determine the true net income of each controlled taxpayer. The standard to be
applied in every case is that of an uncontrolled taxpayer. Section 44 grants no right to a controlled taxpayer to
apply its provisions at will, nor does it grant any right to compel the Commissioner of Internal Revenue to apply
its provisions.

(C) APPLICATION Transactions between controlled taxpayer and another will be subjected to special scrutiny
to ascertain whether the common control is being used to reduce, avoid or escape taxes. In determining the true
net income of a controlled taxpayer, the Commissioner of Internal Revenue is not restricted to the case of
improper accounting, to the case of a fraudulent, colorable, or sham transaction, or to the case of a device
designed to reduce or avoid tax by shifting or distorting income or deductions. The authority to determine true
net income extends to any case in which either by inadvertence or design the taxable net income in whole or in
part, of a controlled taxpayer, is other than it would have been had the taxpayer in the conduct of his affairs
been an uncontrolled taxpayer dealing at arms length with another uncontrolled taxpayer.[41]

As may be gleaned from the definitions of the terms controlled and "controlled taxpayer" under
paragraphs (a) (3) and (4) of the foregoing provision, it would appear that FDC and its affiliates
come within the purview of Section 43 of the 1993 NIRC. Aside from owning significant
portions of the shares of stock of FLI, FAI, DSCC and FCI, the fact that FDC extended
substantial sums of money as cash advances to its said affiliates for the purpose of providing
them financial assistance for their operational and capital expenditures seemingly indicate that
the situation sought to be addressed by the subject provision exists. From the tenor of paragraph
(c) of Section 179 of Revenue Regulation No. 2, it may also be seen that the CIR's power to
distribute, apportion or allocate gross income or deductions between or among controlled
taxpayers may be likewise exercised whether or not fraud inheres in the transaction/s under
scrutiny. For as long as the controlled taxpayer's taxable income is not reflective of that which it
would have realized had it been dealing at arm's length with an uncontrolled taxpayer, the CIR
can make the necessary rectifications in order to prevent evasion of taxes.

Despite the broad parameters provided, however, we find that the CIR's powers of distribution,
apportionment or allocation of gross income and deductions under Section 43 of the 1993 NIRC
and Section 179 of Revenue Regulation No. 2 does not include the power to impute "theoretical
interests" to the controlled taxpayer's transactions. Pursuant to Section 28 of the 1993 NIRC,
[42] after all, the term gross income is understood to mean all income from whatever source
derived, including, but not limited to the following items: compensation for services, including
fees, commissions, and similar items; gross income derived from business; gains derived from
dealings in property; interest; rents; royalties; dividends; annuities; prizes and winnings;
pensions; and partners distributive share of the gross income of general professional
partnership.[43] While it has been held that the phrase "from whatever source derived" indicates
a legislative policy to include all income not expressly exempted within the class of taxable
income under our laws, the term "income" has been variously interpreted to mean "cash
received or its equivalent", "the amount of money coming to a person within a specific time" or
"something distinct from principal or capital."[44] Otherwise stated, there must be proof of the
actual or, at the very least, probable receipt or realization by the controlled taxpayer of the item
of gross income sought to be distributed, apportioned or allocated by the CIR.

Our circumspect perusal of the record yielded no evidence of actual or possible showing that
the advances FDC extended to its affiliates had resulted to the interests subsequently assessed
by the CIR. For all its harping upon the supposed fact that FDC had resorted to borrowings
from commercial banks, the CIR had adduced no concrete proof that said funds were, indeed,
the source of the advances the former provided its affiliates. While admitting that FDC obtained
interest-bearing loans from commercial banks,[45] Susan Macabelda - FDC's Funds
Management Department Manager who was the sole witness presented before the CTA -
clarified that the subject advances were sourced from the corporation's rights offering in 1995 as
well as the sale of its investment in Bonifacio Land in 1997.[46] More significantly, said
witness testified that said advances: (a) were extended to give FLI, FAI, DSCC and FCI
financial assistance for their operational and capital expenditures; and, (b) were all temporarily
in nature since they were repaid within the duration of one week to three months and were
evidenced by mere journal entries, cash vouchers and instructional letters.[47]

Even if we were, therefore, to accord precipitate credulity to the CIR's bare assertion that FDC
had deducted substantial interest expense from its gross income, there would still be no factual
basis for the imputation of theoretical interests on the subject advances and assess deficiency
income taxes thereon. More so, when it is borne in mind that, pursuant to Article 1956 of the
Civil Code of the Philippines, no interest shall be due unless it has been expressly stipulated in
writing. Considering that taxes, being burdens, are not to be presumed beyond what the
applicable statute expressly and clearly declares,[48] the rule is likewise settled that tax statutes
must be construed strictly against the government and liberally in favor of the taxpayer.[49]
Accordingly, the general rule of requiring adherence to the letter in construing statutes applies
with peculiar strictness to tax laws and the provisions of a taxing act are not to be extended by
implication.[50] While it is true that taxes are the lifeblood of the government, it has been held
that their assessment and collection should be in accordance with law as any arbitrariness will
negate the very reason for government itself.[51]

In G.R. No. 167689, we also find a dearth of merit in the CIR's insistence on the imposition of
deficiency income taxes on the transfer FDC and FAI effected in exchange for the shares of
stock of FLI. With respect to the Deed of Exchange executed between FDC, FAI and FLI,
Section 34 (c) (2) of the 1993 NIRC pertinently provides as follows:

Sec. 34. Determination of amount of and recognition of gain or loss.-

xxxx

(c) Exception x x x x

No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for
shares of stock in such corporation of which as a result of such exchange said person, alone or together with
others, not exceeding four persons, gains control of said corporation; Provided, That stocks issued for services
shall not be considered as issued in return of property.

As even admitted in the 14 February 2001 Stipulation of Facts submitted by the parties,[52] the
requisites for the non-recognition of gain or loss under the foregoing provision are as follows:
(a) the transferee is a corporation; (b) the transferee exchanges its shares of stock for
property/ies of the transferor; (c) the transfer is made by a person, acting alone or together with
others, not exceeding four persons; and, (d) as a result of the exchange the transferor, alone or
together with others, not exceeding four, gains control of the transferee.[53] Acting on the 13
January 1997 request filed by FLI, the BIR had, in fact, acknowledged the concurrence of the
foregoing requisites in the Deed of Exchange the former executed with FDC and FAI by issuing
BIR Ruling No. S-34-046-97.[54] With the BIR's reiteration of said ruling upon the request for
clarification filed by FLI,[55] there is also no dispute that said transferee and transferors
subsequently complied with the requirements provided for the non-recognition of gain or loss
from the exchange of property for tax, as provided under Section 34 (c) (2) of the 1993 NIRC.
[56]

Then as now, the CIR argues that taxable gain should be recognized for the exchange
considering that FDC's controlling interest in FLI was actually decreased as a result thereof. For
said purpose, the CIR calls attention to the fact that, prior to the exchange, FDC owned
2,537,358,000 or 67.42% of FLI's 3,763,535,000 outstanding capital stock. Upon the issuance
of 443,094,000 additional FLI shares as a consequence of the exchange and with only
42,217,000 thereof accruing in favor of FDC for a total of 2,579,575,000 shares, said
corporations controlling interest was supposedly reduced to 61%.03 when reckoned from the
transferee's aggregate 4,226,629,000 outstanding shares. Without owning a share from FLI's
initial 3,763,535,000 outstanding shares, on the other hand, FAI's acquisition of 420,877,000
FLI shares as a result of the exchange purportedly resulted in its control of only 9.96% of said
transferee corporation's 4,226,629,000 outstanding shares. On the principle that the transaction
did not qualify as a tax-free exchange under Section 34 (c) (2) of the 1993 NIRC, the CIR
asseverates that taxable gain in the sum of P263,386,921.00 should be recognized on the part of
FDC and in the sum of P3,088,711,367.00 on the part of FAI.[57]

The paucity of merit in the CIR's position is, however, evident from the categorical language of
Section 34 (c) (2) of the 1993 NIRC which provides that gain or loss will not be recognized in
case the exchange of property for stocks results in the control of the transferee by the transferor,
alone or with other transferors not exceeding four persons. Rather than isolating the same as
proposed by the CIR, FDC's 2,579,575,000 shares or 61.03% control of FLI's 4,226,629,000
outstanding shares should, therefore, be appreciated in combination with the 420,877,000 new
shares issued to FAI which represents 9.96% control of said transferee corporation. Together
FDC's 2,579,575,000 shares (61.03%) and FAI's 420,877,000 shares (9.96%) clearly add up to
3,000,452,000 shares or 70.99% of FLI's 4,226,629,000 shares. Since the term "control" is
clearly defined as "ownership of stocks in a corporation possessing at least fifty-one percent of
the total voting power of classes of stocks entitled to one vote" under Section 34 (c) (6) [c] of
the 1993 NIRC, the exchange of property for stocks between FDC FAI and FLI clearly qualify
as a tax-free transaction under paragraph 34 (c) (2) of the same provision.

Against the clear tenor of Section 34(c) (2) of the 1993 NIRC, the CIR cites then Supreme
Court Justice Jose Vitug and CTA Justice Ernesto D. Acosta who, in their book Tax Law and
Jurisprudence, opined that said provision could be inapplicable if control is already vested in
the exchangor prior to exchange.[58] Aside from the fact that that the 10 September 2002
Decision in CTA Case No. 6182 upholding the tax-exempt status of the exchange between FDC,
FAI and FLI was penned by no less than Justice Acosta himself,[59] FDC and FAI significantly
point out that said authors have acknowledged that the position taken by the BIR is to the effect
that "the law would apply even when the exchangor already has control of the corporation at the
time of the exchange."[60] This was confirmed when, apprised in FLI's request for clarification
about the change of percentage of ownership of its outstanding capital stock, the BIR opined as
follows:

Please be informed that regardless of the foregoing, the transferors, Filinvest Development Corp. and Filinvest
Alabang, Inc. still gained control of Filinvest Land, Inc. The term 'control' shall mean ownership of stocks in a
corporation by possessing at least 51% of the total voting power of all classes of stocks entitled to vote. Control
is determined by the amount of stocks received, i.e., total subscribed, whether for property or for services by the
transferor or transferors. In determining the 51% stock ownership, only those persons who transferred property
for stocks in the same transaction may be counted up to the maximum of five (BIR Ruling No. 547-93 dated
December 29, 1993.[61]

At any rate, it also appears that the supposed reduction of FDC's shares in FLI posited by the
CIR is more apparent than real. As the uncontested owner of 80% of the outstanding shares of
FAI, it cannot be gainsaid that FDC ideally controls the same percentage of the 420,877,000
shares issued to its said co-transferor which, by itself, represents 7.968% of the outstanding
shares of FLI. Considered alongside FDC's 61.03% control of FLI as a consequence of the 29
November 1996 Deed of Transfer, said 7.968% add up to an aggregate of 68.998% of said
transferee corporation's outstanding shares of stock which is evidently still greater than the
67.42% FDC initially held prior to the exchange. This much was admitted by the parties in the
14 February 2001 Stipulation of Facts, Documents and Issues they submitted to the CTA.[62]
Inasmuch as the combined ownership of FDC and FAI of FLI's outstanding capital stock adds
up to a total of 70.99%, it stands to reason that neither of said transferors can be held liable for
deficiency income taxes the CIR assessed on the supposed gain which resulted from the subject
transfer.

On the other hand, insofar as documentary stamp taxes on loan agreements and promissory
notes are concerned, Section 180 of the NIRC provides follows:

Sec. 180. Stamp tax on all loan agreements, promissory notes, bills of exchange, drafts, instruments and
securities issued by the government or any of its instrumentalities, certificates of deposit bearing interest
and others not payable on sight or demand. On all loan agreements signed abroad wherein the object of the
contract is located or used in the Philippines; bill of exchange (between points within the Philippines), drafts,
instruments and securities issued by the Government or any of its instrumentalities or certificates of deposits
drawing interest, or orders for the payment of any sum of money otherwise than at sight or on demand, or on all
promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation, and on each
renewal of any such note, there shall be collected a documentary stamp tax of Thirty centavos (P0.30) on each
two hundred pesos, or fractional part thereof, of the face value of any such agreement, bill of exchange, draft,
certificate of deposit or note: Provided, That only one documentary stamp tax shall be imposed on either loan
agreement, or promissory notes issued to secure such loan, whichever will yield a higher tax: Provided
however, That loan agreements or promissory notes the aggregate of which does not exceed Two hundred fifty
thousand pesos (P250,000.00) executed by an individual for his purchase on installment for his personal use or
that of his family and not for business, resale, barter or hire of a house, lot, motor vehicle, appliance or
furniture shall be exempt from the payment of documentary stamp tax provided under this Section.

When read in conjunction with Section 173 of the 1993 NIRC,[63] the foregoing provision
concededly applies to "(a)ll loan agreements, whether made or signed in the Philippines, or
abroad when the obligation or right arises from Philippine sources or the property or object of
the contract is located or used in the Philippines." Correlatively, Section 3 (b) and Section 6 of
Revenue Regulations No. 9-94 provide as follows:

Section 3. Definition of Terms. For purposes of these Regulations, the following term shall mean:

(b) 'Loan agreement' refers to a contract in writing where one of the parties delivers to another money or other
consumable thing, upon the condition that the same amount of the same kind and quality shall be paid. The term
shall include credit facilities, which may be evidenced by credit memo, advice or drawings.

The terms 'Loan Agreement" under Section 180 and "Mortgage' under Section 195, both of the Tax Code, as
amended, generally refer to distinct and separate instruments. A loan agreement shall be taxed under Section
180, while a deed of mortgage shall be taxed under Section 195."

"Section 6. Stamp on all Loan Agreements. All loan agreements whether made or signed in the Philippines, or
abroad when the obligation or right arises from Philippine sources or the property or object of the contract is
located in the Philippines shall be subject to the documentary stamp tax of thirty centavos (P0.30) on each two
hundred pesos, or fractional part thereof, of the face value of any such agreements, pursuant to Section 180 in
relation to Section 173 of the Tax Code.

In cases where no formal agreements or promissory notes have been executed to cover credit facilities, the
documentary stamp tax shall be based on the amount of drawings or availment of the facilities, which may be
evidenced by credit/debit memo, advice or drawings by any form of check or withdrawal slip, under Section
180 of the Tax Code.

Applying the aforesaid provisions to the case at bench, we find that the instructional letters as
well as the journal and cash vouchers evidencing the advances FDC extended to its affiliates in
1996 and 1997 qualified as loan agreements upon which documentary stamp taxes may be
imposed. In keeping with the caveat attendant to every BIR Ruling to the effect that it is valid
only if the facts claimed by the taxpayer are correct, we find that the CA reversibly erred in
utilizing BIR Ruling No. 116-98, dated 30 July 1998 which, strictly speaking, could be invoked
only by ASB Development Corporation, the taxpayer who sought the same. In said ruling, the
CIR opined that documents like those evidencing the advances FDC extended to its affiliates
are not subject to documentary stamp tax, to wit:

On the matter of whether or not the inter-office memo covering the advances granted by an affiliate company is
subject to documentary stamp tax, it is informed that nothing in Regulations No. 26 (Documentary Stamp Tax
Regulations) and Revenue Regulations No. 9-94 states that the same is subject to documentary stamp tax. Such
being the case, said inter-office memo evidencing the lendings or borrowings which is neither a form of
promissory note nor a certificate of indebtedness issued by the corporation-affiliate or a certificate of obligation,
which are, more or less, categorized as 'securities', is not subject to documentary stamp tax imposed under
Section 180, 174 and 175 of the Tax Code of 1997, respectively. Rather, the inter-office memo is being prepared
for accounting purposes only in order to avoid the co-mingling of funds of the corporate affiliates.

In its appeal before the CA, the CIR argued that the foregoing ruling was later modified in BIR
Ruling No. 108-99 dated 15 July 1999, which opined that inter-office memos evidencing
lendings or borrowings extended by a corporation to its affiliates are akin to promissory notes,
hence, subject to documentary stamp taxes.[64] In brushing aside the foregoing argument,
however, the CA applied Section 246 of the 1993 NIRC[65] from which proceeds the settled
principle that rulings, circulars, rules and regulations promulgated by the BIR have no
retroactive application if to so apply them would be prejudicial to the taxpayers.[66]
Admittedly, this rule does not apply: (a) where the taxpayer deliberately misstates or omits
material facts from his return or in any document required of him by the Bureau of Internal
Revenue; (b) where the facts subsequently gathered by the Bureau of Internal Revenue are
materially different from the facts on which the ruling is based; or (c) where the taxpayer acted
in bad faith.[67] Not being the taxpayer who, in the first instance, sought a ruling from the CIR,
however, FDC cannot invoke the foregoing principle on non-retroactivity of BIR rulings.

Viewed in the light of the foregoing considerations, we find that both the CTA and the CA erred
in invalidating the assessments issued by the CIR for the deficiency documentary stamp taxes
due on the instructional letters as well as the journal and cash vouchers evidencing the advances
FDC extended to its affiliates in 1996 and 1997. In Assessment Notice No. SP-DST-96-00020-
2000, the CIR correctly assessed the sum of P6,400,693.62 for documentary stamp tax,
P3,999,793.44 in interests and P25,000.00 as compromise penalty, for a total of
P10,425,487.06. Alongside the sum of P4,050,599.62 for documentary stamp tax, the CIR
similarly assessed P1,721,099.78 in interests and P25,000.00 as compromise penalty in
Assessment Notice No. SP-DST-97-00021-2000 or a total of P5,796,699.40. The imposition of
deficiency interest is justified under Sec. 249 (a) and (b) of the NIRC which authorizes the
assessment of the same at the rate of twenty percent (20%), or such higher rate as may be
prescribed by regulations, from the date prescribed for the payment of the unpaid amount of tax
until full payment.[68] The imposition of the compromise penalty is, in turn, warranted under
Sec. 250[69] of the NIRC which prescribes the imposition thereof in case of each failure to file
an information or return, statement or list, or keep any record or supply any information
required on the date prescribed therefor.
To our mind, no reversible error can, finally, be imputed against both the CTA and the CA for
invalidating the Assessment Notice issued by the CIR for the deficiency income taxes FDC is
supposed to have incurred as a consequence of the dilution of its shares in FAC. Anent FDCs
Shareholders Agreement with RHPL, the record shows that the parties were in agreement about
the following factual antecedents narrated in the 14 February 2001 Stipulation of Facts,
Documents and Issues they submitted before the CTA,[70] viz.:

1.11. On November 15, 1996, FDC entered into a Shareholders Agreement (SA) with Reco Herrera Pte. Ltd.
(RHPL) for the formation of a joint venture company named Filinvest Asia Corporation (FAC) which is based
in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and 7, Answer).

1.12. FAC, the joint venture company formed by FDC and RHPL, is tasked to develop and manage the 50%
ownership interest of FDC in its PBCom Office Tower Project (Project) with the Philippine Bank of
Communications (par. 6.12, Petition; par. 7, Answer).

1.13. Pursuant to the SA between FDC and RHPL, the equity participation of FDC and RHPL in FAC was 60%
and 40% respectively.

1.14. In accordance with the terms of the SA, FDC subscribed to P500.7 million worth of shares of stock
representing a 60% equity participation in FAC. In turn, RHPL subscribed to P433.8 million worth of shares of
stock of FAC representing a 40% equity participation in FAC.

1.15. In payment of its subscription in FAC, FDC executed a Deed of Assignment transferring to FAC a portion
of FDCs right and interests in the Project to the extent of P500.7 million.

1.16. FDC reported a net loss of P190,695,061.00 in its Annual Income Tax Return for the taxable year 1996.
[71]

Alongside the principle that tax revenues are not intended to be liberally construed,[72] the rule
is settled that the findings and conclusions of the CTA are accorded great respect and are
generally upheld by this Court, unless there is a clear showing of a reversible error or an
improvident exercise of authority.[73] Absent showing of such error here, we find no strong and
cogent reasons to depart from said rule with respect to the CTA's finding that no deficiency
income tax can be assessed on the gain on the supposed dilution and/or increase in the value of
FDC's shareholdings in FAC which the CIR, at any rate, failed to establish. Bearing in mind the
meaning of "gross income" as above discussed, it cannot be gainsaid, even then, that a mere
increase or appreciation in the value of said shares cannot be considered income for taxation
purposes. Since a mere advance in the value of the property of a person or corporation in no
sense constitute the income specified in the revenue law, it has been held in the early case of
Fisher vs. Trinidad,[74] that it constitutes and can be treated merely as an increase of capital.
Hence, the CIR has no factual and legal basis in assessing income tax on the increase in the
value of FDC's shareholdings in FAC until the same is actually sold at a profit.

WHEREFORE, premises considered, the CIR's petition for review on certiorari in G.R. No.
163653 is DENIED for lack of merit and the CAs 16 December 2003 Decision in G.R. No.
72992 is AFFIRMED in toto. The CIRs petition in G.R. No. 167689 is PARTIALLY
GRANTED and the CAs 26 January 2005 Decision in CA-G.R. SP No. 74510 is MODIFIED.

Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-97-00021-2000

issued for deficiency documentary stamp taxes due on the instructional letters as well as journal
and cash vouchers evidencing the advances FDC extended to its affiliates are declared valid.

The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC-97-00019-2000

and SP-INC-97-0027-2000 issued for deficiency income assessed on (a) the arms-length
interest from said advances; (b) the gain from FDCs Deed of Exchange with FAI and FLI; and
(c) income from the dilution resulting from FDCs Shareholders Agreement with RHPL is,
however, upheld.

SO ORDERED.
[G.R. No. 125508. July 19, 2000]
CHINA BANKING CORPORATION, petitioner, vs. COURT OF APPEALS, COMMISSIONER OF
INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.
DECISION
VITUG, J.:
The Commissioner of Internal Revenue denied the deduction from gross income of "securities
becoming worthless" claimed by China Banking Corporation (CBC). The Commissioners
disallowance was sustained by the Court of Tax Appeals ("CTA"). When the ruling was appealed to
the Court of Appeals ("CA"), the appellate court upheld the CTA. The case is now before us on a
Petition for Review on Certiorari.
Sometime in 1980, petitioner China Banking Corporation made a 53% equity investment in the First
CBC Capital (Asia) Ltd., a Hongkong subsidiary engaged in financing and investment with "deposit-
taking" function. The investment amounted to P16,227,851.80, consisting of 106,000 shares with a
par Value of P100 per share.
In the course of the regular examination of the financial books and investment portfolios of petitioner
conducted by Bangko Sentral in 1986, it was shown that First CBC Capital (Asia), Ltd., has become
insolvent. With the approval of Bangko Sentral, petitioner wrote-off as being worthless its investment
in First CBC Capital (Asia), Ltd., in its 1987 Income Tax Return and treated it as a bad debt or as an
ordinary loss deductible from its gross income.
Respondent Commissioner of internal Revenue disallowed the deduction and assessed petitioner for
income tax deficiency in the amount of P8,533,328.04, inclusive of surcharge, interest and
compromise penalty. The disallowance of the deduction was made on the ground that the investment
should not be classified as being "worthless" and that, although the Hongkong Banking
Commissioner had revoked the license of First CBC Capital as a "deposit-taping" company, the latter
could still exercise, however, its financing and investment activities. Assuming that the securities had
indeed become worthless, respondent Commissioner of Internal Revenue held the view that they
should then be classified as "capital loss," and not as a bad debt expense there being no
indebtedness to speak of between petitioner and its subsidiary.
Petitioner contested the ruling of respondent Commissioner before the CTA. The tax court sustained
the Commissioner, holding that the securities had not indeed become worthless and ordered
petitioner to pay its deficiency income tax for 1987 of P8,533,328.04 plus 20% interest per annum
until fully paid. When the decision was appealed to the Court of Appeals, the latter upheld the CTA. In
its instant petition for review on certiorari, petitioner bank assails the CA decision.
The petition must fail.
The claim of petitioner that the shares of stock in question have become worthless is based on a
Profit and Loss Account for the Year-End 31 December 1987, and the recommendation of Bangko
Sentral that the equity investment be written-off due to the insolvency of the subsidiary. While the
matter may not be indubitable (considering that certain classes of intangibles, like franchises and
goodwill, are not always given corresponding values in financial statements [1], there may really be no
need, however, to go of length into this issue since, even to assume the worthlessness of the shares,
the deductibility thereof would still be nil in this particular case. At all events, the Court is not prepared
to hold that both the tax court and the appellate court are utterly devoid of substantial basis for their
own factual findings.
Subject to certain exceptions, such as the compensation income of individuals and passive income
subject to final tax, as well as income of non-resident aliens and foreign corporations not engaged in
trade or business in the Philippines, the tax on income is imposed on the net income allowing certain
specified deductions from gross income to be claimed by the taxpayer. Among the deductible items
allowed by the National Internal Revenue Code ("NIRC") are bad debts and losses.[2]
An equity investment is a capital, not ordinary, asset of the investor the sale or exchange of which
results in either a capital gain or a capital loss. The gain or the loss is ordinary when the property
sold or exchanged is not a capital asset.[3] A capital asset is defined negatively in Section 33(1) of the
NIRC; viz:
(1) Capital assets. - The term 'capital assets' means property held by the taxpayer (whether or not
connected with his trade or business), but does not include stock in trade of the taxpayer or other
property of a kind which would properly be included in the inventory of the taxpayer if on hand at the
close of the taxable year, or property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business, or property used in the trade or business, of a character
which is subject to the allowance for depreciation provided in subsection (f) of section twenty-nine; or
real property used in the trade or business of the taxpayer.
Thus, shares of stock; like the other securities defined in Section 20(t) [4] of the NIRC, would be
ordinary assets only to a dealer in securities or a person engaged in the purchase and sale of,
or an active trader (for his own account) in, securities. Section 20(u) of the NIRC defines a dealer
in securities thus:
"(u) The term 'dealer in securities' means a merchant of stocks or securities, whether an individual,
partnership or corporation, with an established place of business, regularly engaged in the purchase
of securities and their resale to customers; that is, one who as a merchant buys securities and sells
them to customers with a view to the gains and profits that may be derived therefrom."
In the hands, however, of another who holds the shares of stock by way of an investment, the shares
to him would be capital assets. When the shares held by such investor become worthless, the
loss is deemed to be a loss from the sale or exchange of capital assets. Section 29(d)(4)(B) of
the NIRC states:
"(B) Securities becoming worthless. - If securities as defined in Section 20 become worthless during
the tax" year and are capital assets, the loss resulting therefrom shall, for the purposes of his Title, be
considered as a loss from the sale or exchange, on the last day of such taxable year, of capital
assets."
The above provision conveys that the loss sustained by the holder of the securities, which are capital
assets (to him), is to be treated as a capital loss as if incurred from a sale or exchange
transaction. A capital gain or a capital loss normally requires the concurrence of two conditions for it
to result: (1) There is a sale or exchange; and (2) the thing sold or exchanged is a capital asset.
When securities become worthless, there is strictly no sale or exchange but the law deems the loss
anyway to be "a loss from the sale or exchange of capital assets. [5]A similar kind of treatment is given,
by the NIRC on the retirement of certificates of indebtedness with interest coupons or in registered
form, short sales and options to buy or sell property where no sale or exchange strictly exists. [6] In
these cases, the NIRC dispenses, in effect, with the standard requirement of a sale or exchange for
the application of the capital gain and loss provisions of the code.
Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains derived
from the sale or exchange of capital assets, and not from any other income of the taxpayer.
In the case at bar, First CBC Capital (Asia), Ltd., the investee corporation, is a subsidiary corporation
of petitioner bank whose shares in said investee corporation are not intended for purchase or sale but
as an investment. Unquestionably then, any loss therefrom would be a capital loss, not an ordinary
loss, to the investor.
Section 29(d)(4)(A), of the NIRC expresses:
"(A) Limitations. - Losses from sales or exchanges of capital assets shall be allowed only to the extent
provided in Section 33."
The pertinent provisions of Section 33 of the NIRC referred to in the aforesaid Section 29(d)(4)(A),
read:
"Section 33. Capital gains and losses. -
x x x x x x x x x.
"(c) Limitation on capital losses. - Losses from sales or exchange of capital assets shall be
allowed only to the extent of the gains from such sales or exchanges. If a bank or trust company
incorporated under the laws of the Philippines, a substantial part of whose business is the receipt of
deposits, sells any bond, debenture, note, or certificate or other evidence of indebtedness issued
by any corporation (including one issued by a government or political subdivision thereof), with
interest coupons or in registered form, any loss resulting from such sale shall not be subject to the
foregoing limitation an shall not be included in determining the applicability of such limitation to other
losses.
The exclusionary clause found in the foregoing text of the law does not include all forms of securities
but specifically covers only bonds, debentures, notes, certificates or other evidence of
indebtedness, with interest coupons or in registered form, which are the instruments of credit
normally dealt with in the usual lending operations of a financial institution. Equity holdings cannot
come close to being, within the purview of "evidence of indebtedness" under the second sentence
of the aforequoted paragraph. Verily, it is for a like thesis that the loss of petitioner bank in its equity
in vestment in the Hongkong subsidiary cannot also be deductible as a bad debt. The shares of
stock in question do not constitute a loan extended by it to its subsidiary (First CBC Capital) or a debt
subject to obligatory repayment by the latter, essential elements to constitute a bad debt, but a long
term investment made by CBC.
One other item. Section 34(c)(1) of the NIRC , states that the entire amount of the gain or loss upon
the sale or exchange of property, as the case may be, shall be recognized. The complete text reads:
SECTION 34. Determination of amount of and recognition of gain or loss.-
"(a) Computation of gain or loss. - The gain from the sale or other disposition of property shall be the
excess of the amount realized therefrom over the basis or adjusted basis for determining gain and the
loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized.
The amount realized from the sale or other disposition of property shall be to sum of money received
plus the fair market value of the property (other than money) received. (As amended by E.O. No. 37)
"(b) Basis for determining gain or loss from sale or disposition of property. - The basis of property
shall be - (1) The cost thereof in cases of property acquired on or before March 1, 1913, if such
property was acquired by purchase; or
"(2) The fair market price or value as of the date of acquisition if the same was acquired by
inheritance; or
"(3) If the property was acquired by gift the basis shall be the same as if it would be in the hands of
the donor or the last preceding owner by whom it was not acquired by gift, except that if such basis is
greater than the fair market value of the property at the time of the gift, then for the purpose of
determining loss the basis shall be such fair market value; or
"(4) If the property, other than capital asset referred to in Section 21 (e), was acquired for less than an
adequate consideration in money or moneys worth, the basis of such property is (i) the amount paid
by the transferee for the property or (ii) the transferor's adjusted basis at the time of the transfer
whichever is greater.
"(5) The basis as defined in paragraph (c) (5) of this section if the property was acquired in a
transaction where gain or loss is not recognized under paragraph (c) (2) of this section. (As amended
by E.O. No. 37)
(c) Exchange of property.
"(1) General rule.- Except as herein provided, upon the sale or exchange of property, the entire
amount of the gain or loss, as the case may be, shall be recognized.
"(2) Exception. - No gain or loss shall be recognized if in pursuance of a plan of merger or
consolidation (a) a corporation which is a party to a merger or consolidation exchanges property
solely for stock in a corporation which is, a party to the merger or consolidation, (b) a shareholder
exchanges stock in a corporation which is a party to the merger or consolidation solely for the stock in
another corporation also a party to the merger or consolidation, or (c) a security holder of a
corporation which is a party to the merger or consolidation exchanges his securities in such
corporation solely for stock or securities in another corporation, a party to the merger or consolidation.
"No gain or loss shall also be recognized if property is transferred to a corporation by a person in
exchange for stock in such corporation of which as a result of such exchange said person, alone or
together with others, not exceeding four persons, gains control of said corporation: Provided, That
stocks issued for services shall not be considered as issued in return of property."
The above law should be taken within context on the general subject of the determination, and
recognition of gain or loss; it is not preclusive of, let alone renders completely inconsequential, the
more specific provisions of the code. Thus, pursuant, to the same section of the law, no such
recognition shall be made if the sale or exchange is made in pursuance of a plan of corporate merger
or consolidation or, if as a result of an exchange of property for stocks, the exchanger, alone or
together with others not exceeding four, gains control of the corporation. [7] Then, too, how the
resulting gain might be taxed, or whether or not the loss would be deductible and how, are matters
properly dealt with elsewhere in various other sections of the NIRC. [8] At all events, it may not be
amiss to once again stress that the basic rule is still that any capital loss can be deducted only
from capital gains under Section 33(c) of the NIRC.
In sum -
(a) The equity investment in shares of stock held by CBC of approximately 53% in its Hongkong
subsidiary, the First CBC Capital (Asia), Ltd., is not an indebtedness, and it is a capital, not an
ordinary, asset.[9]
(b) Assuming that the equity investment of CBC has indeed become "worthless," the loss sustained
is a capital, not an ordinary, loss.[10]
(c) The capital loss sustained by CBC can only be deducted from capital gains if any derived by it
during the same taxable year that the securities have become "worthless." [11]
WHEREFORE, the Petition is DENIED. The decision of the Court of Appeals disallowing the claimed
deduction of P16,227,851.80 is AFFIRMED.
SO ORDERED.
G.R. No. 148187 April 16, 2008
PHILEX MINING CORPORATION, petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
DECISION
YNARES-SANTIAGO, J.:
This is a petition for review on certiorari of the June 30, 2000 Decision 1 of the Court of Appeals in CA-G.R. SP
No. 49385, which affirmed the Decision2 of the Court of Tax Appeals in C.T.A. Case No. 5200. Also assailed is
the April 3, 2001 Resolution3 denying the motion for reconsideration.
The facts of the case are as follows:
On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into an agreement 4 with
Baguio Gold Mining Company ("Baguio Gold") for the former to manage and operate the latter’s mining claim,
known as the Sto. Nino mine, located in Atok and Tublay, Benguet Province. The parties’ agreement was
denominated as "Power of Attorney" and provided for the following terms:
4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall make available to the
MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS (P11,000,000.00), in such amounts as
from time to time may be required by the MANAGERS within the said 3-year period, for use in the
MANAGEMENT of the STO. NINO MINE. The said ELEVEN MILLION PESOS (P11,000,000.00)
shall be deemed, for internal audit purposes, as the owner’s account in the Sto. Nino PROJECT. Any part
of any income of the PRINCIPAL from the STO. NINO MINE, which is left with the Sto. Nino
PROJECT, shall be added to such owner’s account.
5. Whenever the MANAGERS shall deem it necessary and convenient in connection with the
MANAGEMENT of the STO. NINO MINE, they may transfer their own funds or property to the Sto.
Nino PROJECT, in accordance with the following arrangements:
(a) The properties shall be appraised and, together with the cash, shall be carried by the Sto. Nino
PROJECT as a special fund to be known as the MANAGERS’ account.
(b) The total of the MANAGERS’ account shall not exceed P11,000,000.00, except with prior
approval of the PRINCIPAL; provided, however, that if the compensation of the MANAGERS as
herein provided cannot be paid in cash from the Sto. Nino PROJECT, the amount not so paid in
cash shall be added to the MANAGERS’ account.
(c) The cash and property shall not thereafter be withdrawn from the Sto. Nino PROJECT until
termination of this Agency.
(d) The MANAGERS’ account shall not accrue interest. Since it is the desire of the PRINCIPAL
to extend to the MANAGERS the benefit of subsequent appreciation of property, upon a
projected termination of this Agency, the ratio which the MANAGERS’ account has to the
owner’s account will be determined, and the corresponding proportion of the entire assets of the
STO. NINO MINE, excluding the claims, shall be transferred to the MANAGERS, except that
such transferred assets shall not include mine development, roads, buildings, and similar property
which will be valueless, or of slight value, to the MANAGERS. The MANAGERS can, on the
other hand, require at their option that property originally transferred by them to the Sto. Nino
PROJECT be re-transferred to them. Until such assets are transferred to the MANAGERS, this
Agency shall remain subsisting.
xxxx
12. The compensation of the MANAGER shall be fifty per cent (50%) of the net profit of the Sto. Nino
PROJECT before income tax. It is understood that the MANAGERS shall pay income tax on their
compensation, while the PRINCIPAL shall pay income tax on the net profit of the Sto. Nino PROJECT
after deduction therefrom of the MANAGERS’ compensation.
xxxx
16. The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS and, in the future,
may incur other obligations in favor of the MANAGERS. This Power of Attorney has been executed as
security for the payment and satisfaction of all such obligations of the PRINCIPAL in favor of the
MANAGERS and as a means to fulfill the same. Therefore, this Agency shall be irrevocable while any
obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the
MANAGERS’ account. After all obligations of the PRINCIPAL in favor of the MANAGERS have been
 paid and satisfied in full, this Agency shall be revocable by the PRINCIPAL upon 36-month notice to the
MANAGERS.
17. Notwithstanding any agreement or understanding between the PRINCIPAL and the MANAGERS to
the contrary, the MANAGERS may withdraw from this Agency by giving 6-month notice to the
PRINCIPAL. The MANAGERS shall not in any manner be held liable to the PRINCIPAL by reason
alone of such withdrawal. Paragraph 5(d) hereof shall be operative in case of the MANAGERS’
withdrawal.
x x x x5
In the course of managing and operating the project, Philex Mining made advances of cash and property in
accordance with paragraph 5 of the agreement. However, the mine suffered continuing losses over the years
which resulted to petitioner’s withdrawal as manager of the mine on January 28, 1982 and in the eventual
cessation of mine operations on February 20, 1982.6
Thereafter, on September 27, 1982, the parties executed a "Compromise with Dation in Payment" 7 wherein
Baguio Gold admitted an indebtedness to petitioner in the amount of P179,394,000.00 and agreed to pay the
same in three segments by first assigning Baguio Gold’s tangible assets to petitioner, transferring to the latter
Baguio Gold’s equitable title in its Philodrill assets and finally settling the remaining liability through properties
that Baguio Gold may acquire in the future.
On December 31, 1982, the parties executed an "Amendment to Compromise with Dation in Payment" 8 where
the parties determined that Baguio Gold’s indebtedness to petitioner actually amounted to P259,137,245.00,
which sum included liabilities of Baguio Gold to other creditors that petitioner had assumed as guarantor. These
liabilities pertained to long-term loans amounting to US$11,000,000.00 contracted by Baguio Gold from the
Bank of America NT & SA and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two
segments by first assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its
Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a remaining outstanding
indebtedness to petitioner in the amount of P114,996,768.00.
Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding indebtedness of
Baguio Gold by charging P112,136,000.00 to allowances and reserves that were set up in 1981 and
P2,860,768.00 to the 1982 operations.
In its 1982 annual income tax return, petitioner deducted from its gross income the amount of P112,136,000.00
as "loss on settlement of receivables from Baguio Gold against reserves and allowances." 9 However, the Bureau
of Internal Revenue (BIR) disallowed the amount as deduction for bad debt and assessed petitioner a deficiency
income tax of P62,811,161.39.
Petitioner protested before the BIR arguing that the deduction must be allowed since all requisites for a bad debt
deduction were satisfied, to wit: (a) there was a valid and existing debt; (b) the debt was ascertained to be
worthless; and (c) it was charged off within the taxable year when it was determined to be worthless.
Petitioner emphasized that the debt arose out of a valid management contract it entered into with Baguio Gold.
The bad debt deduction represented advances made by petitioner which, pursuant to the management contract,
formed part of Baguio Gold’s "pecuniary obligations" to petitioner. It also included payments made by
petitioner as guarantor of Baguio Gold’s long-term loans which legally entitled petitioner to be subrogated to
the rights of the original creditor.
Petitioner also asserted that due to Baguio Gold’s irreversible losses, it became evident that it would not be able
to recover the advances and payments it had made in behalf of Baguio Gold. For a debt to be considered
worthless, petitioner claimed that it was neither required to institute a judicial action for collection against the
debtor nor to sell or dispose of collateral assets in satisfaction of the debt. It is enough that a taxpayer exerted
diligent efforts to enforce collection and exhausted all reasonable means to collect.
On October 28, 1994, the BIR denied petitioner’s protest for lack of legal and factual basis. It held that the
alleged debt was not ascertained to be worthless since Baguio Gold remained existing and had not filed a
petition for bankruptcy; and that the deduction did not consist of a valid and subsisting debt considering that,
under the management contract, petitioner was to be paid fifty percent (50%) of the project’s net profit.10
Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment, as follows:
WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby DENIED for lack of
merit. The assessment in question, viz: FAS-1-82-88-003067 for deficiency income tax in the amount of
P62,811,161.39 is hereby AFFIRMED.
ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to PAY respondent
Commissioner of Internal Revenue the amount of P62,811,161.39, plus, 20% delinquency interest due
 computed from February 10, 1995, which is the date after the 20-day grace period given by the
respondent within which petitioner has to pay the deficiency amount x x x up to actual date of payment.
SO ORDERED.11
The CTA rejected petitioner’s assertion that the advances it made for the Sto. Nino mine were in the nature of a
loan. It instead characterized the advances as petitioner’s investment in a partnership with Baguio Gold for the
development and exploitation of the Sto. Nino mine. The CTA held that the "Power of Attorney" executed by
petitioner and Baguio Gold was actually a partnership agreement. Since the advanced amount partook of the
nature of an investment, it could not be deducted as a bad debt from petitioner’s gross income.
The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of Baguio Gold
could not be allowed as a bad debt deduction. At the time the payments were made, Baguio Gold was not in
default since its loans were not yet due and demandable. What petitioner did was to pre-pay the loans as
evidenced by the notice sent by Bank of America showing that it was merely demanding payment of the
installment and interests due. Moreover, Citibank imposed and collected a "pre-termination penalty" for the pre-
payment.
The Court of Appeals affirmed the decision of the CTA. 12 Hence, upon denial of its motion for
reconsideration,13 petitioner took this recourse under Rule 45 of the Rules of Court, alleging that:
I.
The Court of Appeals erred in construing that the advances made by Philex in the management of the
Sto. Nino Mine pursuant to the Power of Attorney partook of the nature of an investment rather than a
loan.
II.
The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of the Sto. Nino Mine
indicates that Philex is a partner of Baguio Gold in the development of the Sto. Nino Mine
notwithstanding the clear absence of any intent on the part of Philex and Baguio Gold to form a
partnership.
III.
The Court of Appeals erred in relying only on the Power of Attorney and in completely disregarding the
Compromise Agreement and the Amended Compromise Agreement when it construed the nature of the
advances made by Philex.
IV.
The Court of Appeals erred in refusing to delve upon the issue of the propriety of the bad debts write-
off.14
Petitioner insists that in determining the nature of its business relationship with Baguio Gold, we should not
only rely on the "Power of Attorney", but also on the subsequent "Compromise with Dation in Payment" and
"Amended Compromise with Dation in Payment" that the parties executed in 1982. These documents, allegedly
evinced the parties’ intent to treat the advances and payments as a loan and establish a creditor-debtor
relationship between them.
The petition lacks merit.
The lower courts correctly held that the "Power of Attorney" is the instrument that is material in determining the
true nature of the business relationship between petitioner and Baguio Gold. Before resort may be had to the
two compromise agreements, the parties’ contractual intent must first be discovered from the expressed
language of the primary contract under which the parties’ business relations were founded. It should be noted
that the compromise agreements were mere collateral documents executed by the parties pursuant to the
termination of their business relationship created under the "Power of Attorney". On the other hand, it is the
latter which established the juridical relation of the parties and defined the parameters of their dealings with one
another.
The execution of the two compromise agreements can hardly be considered as a subsequent or
contemporaneous act that is reflective of the parties’ true intent. The compromise agreements were executed
eleven years after the "Power of Attorney" and merely laid out a plan or procedure by which petitioner could
recover the advances and payments it made under the "Power of Attorney". The parties entered into the
compromise agreements as a consequence of the dissolution of their business relationship. It did not define that
relationship or indicate its real character.
An examination of the "Power of Attorney" reveals that a partnership or joint venture was indeed intended by
the parties. Under a contract of partnership, two or more persons bind themselves to contribute money, property,
or industry to a common fund, with the intention of dividing the profits among themselves. 15 While a
corporation, like petitioner, cannot generally enter into a contract of partnership unless authorized by law or its
charter, it has been held that it may enter into a joint venture which is akin to a particular partnership:
The legal concept of a joint venture is of common law origin. It has no precise legal definition, but it has
been generally understood to mean an organization formed for some temporary purpose. x x x It is in
fact hardly distinguishable from the partnership, since their elements are similar – community of interest
in the business, sharing of profits and losses, and a mutual right of control. x x x The main distinction
cited by most opinions in common law jurisdictions is that the partnership contemplates a general
business with some degree of continuity, while the joint venture is formed for the execution of a single
transaction, and is thus of a temporary nature. x x x This observation is not entirely accurate in this
jurisdiction, since under the Civil Code, a partnership may be particular or universal, and a particular
partnership may have for its object a specific undertaking. x x x It would seem therefore that under
Philippine law, a joint venture is a form of partnership and should be governed by the law of
partnerships. The Supreme Court has however recognized a distinction between these two business
forms, and has held that although a corporation cannot enter into a partnership contract, it may however
engage in a joint venture with others. x x x (Citations omitted) 16
Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties had intended to
create a partnership and establish a common fund for the purpose. They also had a joint interest in the profits of
the business as shown by a 50-50 sharing in the income of the mine.
Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money, property and
industry to the common fund known as the Sto. Niño mine. 17 In this regard, we note that there is a substantive
equivalence in the respective contributions of the parties to the development and operation of the mine.
Pursuant to paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were to contribute equally to the
joint venture assets under their respective accounts. Baguio Gold would contribute P11M under its owner’s
account plus any of its income that is left in the project, in addition to its actual mining claim. Meanwhile,
petitioner’s contribution would consist of its expertise in the management and operation of mines, as well as the
manager’s account which is comprised of P11M in funds and property and petitioner’s "compensation" as
manager that cannot be paid in cash.
However, petitioner asserts that it could not have entered into a partnership agreement with Baguio Gold
because it did not "bind" itself to contribute money or property to the project; that under paragraph 5 of the
agreement, it was only optional for petitioner to transfer funds or property to the Sto. Niño project "(w)henever
the MANAGERS shall deem it necessary and convenient in connection with the MANAGEMENT of the STO.
NIÑO MINE."18
The wording of the parties’ agreement as to petitioner’s contribution to the common fund does not detract from
the fact that petitioner transferred its funds and property to the project as specified in paragraph 5, thus
rendering effective the other stipulations of the contract, particularly paragraph 5(c) which prohibits petitioner
from withdrawing the advances until termination of the parties’ business relations. As can be seen, petitioner
became bound by its contributions once the transfers were made. The contributions acquired an obligatory
nature as soon as petitioner had chosen to exercise its option under paragraph 5.
There is no merit to petitioner’s claim that the prohibition in paragraph 5(c) against withdrawal of advances
should not be taken as an indication that it had entered into a partnership with Baguio Gold; that the stipulation
only showed that what the parties entered into was actually a contract of agency coupled with an interest which
is not revocable at will and not a partnership.
In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the principal due
to an interest of a third party that depends upon it, or the mutual interest of both principal and agent. 19 In this
case, the non-revocation or non-withdrawal under paragraph 5(c) applies to the advances made by petitioner
who is supposedly the agent and not the principal under the contract. Thus, it cannot be inferred from the
stipulation that the parties’ relation under the agreement is one of agency coupled with an interest and not a
partnership.
Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the parties was one
of agency and not a partnership. Although the said provision states that "this Agency shall be irrevocable while
any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS’
account," it does not necessarily follow that the parties entered into an agency contract coupled with an interest
that cannot be withdrawn by Baguio Gold.
It should be stressed that the main object of the "Power of Attorney" was not to confer a power in favor of
petitioner to contract with third persons on behalf of Baguio Gold but to create a business relationship between
petitioner and Baguio Gold, in which the former was to manage and operate the latter’s mine through the
parties’ mutual contribution of material resources and industry. The essence of an agency, even one that is
coupled with interest, is the agent’s ability to represent his principal and bring about business relations between
the latter and third persons.20 Where representation for and in behalf of the principal is merely incidental or
necessary for the proper discharge of one’s paramount undertaking under a contract, the latter may not
necessarily be a contract of agency, but some other agreement depending on the ultimate undertaking of the
parties.21
In this case, the totality of the circumstances and the stipulations in the parties’ agreement indubitably lead to
the conclusion that a partnership was formed between petitioner and Baguio Gold.
First, it does not appear that Baguio Gold was unconditionally obligated to return the advances made by
petitioner under the agreement. Paragraph 5 (d) thereof provides that upon termination of the parties’ business
relations, "the ratio which the MANAGER’S account has to the owner’s account will be determined, and the
corresponding proportion of the entire assets of the STO. NINO MINE, excluding the claims" shall be
transferred to petitioner.22 As pointed out by the Court of Tax Appeals, petitioner was merely entitled to a
proportionate return of the mine’s assets upon dissolution of the parties’ business relations. There was nothing in
the agreement that would require Baguio Gold to make payments of the advances to petitioner as would be
recognized as an item of obligation or "accounts payable" for Baguio Gold.
Thus, the tax court correctly concluded that the agreement provided for a distribution of assets of the Sto. Niño
mine upon termination, a provision that is more consistent with a partnership than a creditor-debtor relationship.
It should be pointed out that in a contract of loan, a person who receives a loan or money or any fungible thing
acquires ownership thereof and is bound to pay the creditor an equal amount of the same kind and quality. 23 In
this case, however, there was no stipulation for Baguio Gold to actually repay petitioner the cash and property
that it had advanced, but only the return of an amount pegged at a ratio which the manager’s account had to the
owner’s account.
In this connection, we find no contractual basis for the execution of the two compromise agreements in which
Baguio Gold recognized a debt in favor of petitioner, which supposedly arose from the termination of their
business relations over the Sto. Nino mine. The "Power of Attorney" clearly provides that petitioner would only
be entitled to the return of a proportionate share of the mine assets to be computed at a ratio that the manager’s
account had to the owner’s account. Except to provide a basis for claiming the advances as a bad debt
deduction, there is no reason for Baguio Gold to hold itself liable to petitioner under the compromise
agreements, for any amount over and above the proportion agreed upon in the "Power of Attorney".
Next, the tax court correctly observed that it was unlikely for a business corporation to lend hundreds of
millions of pesos to another corporation with neither security, or collateral, nor a specific deed evidencing the
terms and conditions of such loans. The parties also did not provide a specific maturity date for the advances to
become due and demandable, and the manner of payment was unclear. All these point to the inevitable
conclusion that the advances were not loans but capital contributions to a partnership.
The strongest indication that petitioner was a partner in the Sto Niño mine is the fact that it would receive 50%
of the net profits as "compensation" under paragraph 12 of the agreement. The entirety of the parties’
contractual stipulations simply leads to no other conclusion than that petitioner’s "compensation" is actually its
share in the income of the joint venture.
Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in the profits of a
business is prima facie evidence that he is a partner in the business." Petitioner asserts, however, that no such
inference can be drawn against it since its share in the profits of the Sto Niño project was in the nature of
compensation or "wages of an employee", under the exception provided in Article 1769 (4) (b).24
On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold who will be paid
"wages" pursuant to an employer-employee relationship. To begin with, petitioner was the manager of the
project and had put substantial sums into the venture in order to ensure its viability and profitability. By pegging
its compensation to profits, petitioner also stood not to be remunerated in case the mine had no income. It is
hard to believe that petitioner would take the risk of not being paid at all for its services, if it were truly just an
ordinary employee.
Consequently, we find that petitioner’s "compensation" under paragraph 12 of the agreement actually
constitutes its share in the net profits of the partnership. Indeed, petitioner would not be entitled to an equal
share in the income of the mine if it were just an employee of Baguio Gold. 25 It is not surprising that petitioner
was to receive a 50% share in the net profits, considering that the "Power of Attorney" also provided for an
almost equal contribution of the parties to the St. Nino mine. The "compensation" agreed upon only serves to
reinforce the notion that the parties’ relations were indeed of partners and not employer-employee.
All told, the lower courts did not err in treating petitioner’s advances as investments in a partnership known as
the Sto. Nino mine. The advances were not "debts" of Baguio Gold to petitioner inasmuch as the latter was
under no unconditional obligation to return the same to the former under the "Power of Attorney". As for the
amounts that petitioner paid as guarantor to Baguio Gold’s creditors, we find no reason to depart from the tax
court’s factual finding that Baguio Gold’s debts were not yet due and demandable at the time that petitioner paid
the same. Verily, petitioner pre-paid Baguio Gold’s outstanding loans to its bank creditors and this conclusion is
supported by the evidence on record.26
In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income. Deductions for
income tax purposes partake of the nature of tax exemptions and are strictly construed against the taxpayer, who
must prove by convincing evidence that he is entitled to the deduction claimed. 27 In this case, petitioner failed
to substantiate its assertion that the advances were subsisting debts of Baguio Gold that could be deducted from
its gross income. Consequently, it could not claim the advances as a valid bad debt deduction.
WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in CA-G.R. SP No. 49385
dated June 30, 2000, which affirmed the decision of the Court of Tax Appeals in C.T.A. Case No. 5200 is
AFFIRMED. Petitioner Philex Mining Corporation is ORDERED to PAY the deficiency tax on its 1982
income in the amount of P62,811,161.31, with 20% delinquency interest computed from February 10, 1995,
which is the due date given for the payment of the deficiency income tax, up to the actual date of payment.
SO ORDERED.