TAX Week 10 Digests

7/28/2019 TAX Week 10 Digests

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1. Requirements for deductibility

Collector of Internal Revenue v. Goodrich Sandra

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4. RR 5-99, March 10, 1999, requirements for deductibility of bad debts including

banks

PHILEX MINING vs. COMMISSIONER OF INTERNAL REVENUE(April 16, 2008)

PONENTE: Ynares-Santiago

RATIO: Deductions for income tax purposes partake of the nature of tax exemptions andare strictly construed against the taxpayer, who must prove by convincing evidence thathe is entitled to the deduction claimed. To enjoy deductions for bad debts, the taxpayermust show that there was a valid debt to begin with.

FACTS:

1. Philex Mining entered into an agreement with Baguio Gold Mining Company forthe former to manage and operate the latter's mining claim, known as the Sto.

Nino mine. The parties' agreement was denominated as "Power of Attorney"and provided for the following terms:

4. Within three (3) years from date thereof, thePRINCIPAL (Baguio Gold) shall make available tothe MANAGERS (Philex Mining) up to ELEVENMILLION PESOS (P11,000,000.00), in such amountsas from time to time may be required by theMANAGERS within the said 3-year period, for usein the MANAGEMENT of the STO. NINO MINE. Thesaid ELEVEN MILLION PESOS (P11,000,000.00)shall be deemed, for internal audit purposes, as theowner'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. NinoPROJECT, shall be added to such owner's account.

x x x x

12. The compensation of the MANAGER shall befifty per cent (50%) of the net profit of the Sto.Nino PROJECT before income tax. It is understoodthat the MANAGERS shall pay income tax on theircompensation, while the PRINCIPAL shall payincome tax on the net profit of the Sto. NinoPROJECT after deduction therefrom of the

MANAGERS' compensation.

x x x x

16. The PRINCIPAL has current pecuniaryobligation in favor of the MANAGERS and, in thefuture, may incur other obligations in favor of theMANAGERS. This Power of Attorney has beenexecuted as security for the payment andsatisfaction of all such obligations of thePRINCIPAL in favor of the MANAGERS and as a

means to fulfill the same. Therefore, this Agencyshall be irrevocable while any obligation of thePRINCIPAL in favor of the MANAGERS isoutstanding, inclusive of the MANAGERS' account.After all obligations of the PRINCIPAL in favor ofthe MANAGERS have been paid and satisfied in full,this Agency shall be revocable by the PRINCIPALupon 36-month notice to the MANAGERS.

x x x x

2. Philex Mining made advances of cash and property in accordance withparagraph 5 of the agreement. However, the mine suffered continuing losses

over the years which resulted to petitioner's withdrawal as manager of themine on January 28, 1982 and in the eventual cessation of mine operationson February 20, 1982.

a. The parties executed a "Compromise with Dation in Payment" wherein Baguio Gold admitted an indebtedness to petitioner in theamount of P179,394,000.00 and agreed to pay the same in threesegments by first assigning Baguio Gold's tangible assets topetitioner, transferring to the latter Baguio Gold's equitable title inits Philodrill assets and finally settling the remaining liabilitythrough properties that Baguio Gold may acquire in the future.

b. Later, the parties executed an "Amendment to Compromise withDation in Payment where the parties determined that BaguioGold's indebtedness to petitioner actually amounted toP259,137,245.00, which sum included liabilities of Baguio Gold toother creditors that petitioner had assumed as guarantor.

c. This time, Baguio Gold undertook to pay petitioner in two segmentsby first assigning its tangible assets for P127,838,051.00 and thentransferring its equitable title in its Philodrill assets forP16,302,426.00. The parties then ascertained that Baguio Gold hada remaining outstanding indebtedness to petitioner in the amountof P114,996,768.00.

3. Petitioner then wrote off in its 1982 books of account the remainingoutstanding indebtedness of Baguio Gold by charging P112,136,000.00 toallowances and reserves that were set up in 1981 and P2,860,768.00 to the1982 operations.


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a. In its 1982 annual income tax return, petitioner deducted from itsgross income the amount of P112,136,000.00 as "loss on settlement ofreceivables from Baguio Gold against reserves and allowances.

b. However, the Bureau of Internal Revenue (BIR) disallowed theamount as deduction for bad debt and assessed petitioner a deficiencyincome tax of P62,811,161.39.

c. Petitioner protested before the BIR arguing that the deduction mustbe 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 thetaxable year when it was determined to be worthless.

4. Petitioner emphasized that the debt arose out of a valid management contract itentered into with Baguio Gold.

a. The bad debt deduction represented advances made by petitionerwhich, pursuant to the management contract, formed part of BaguioGold's "pecuniary obligations" to petitioner.

b. It also included payments made by petitioner as guarantor of BaguioGold's long-term loans which legally entitled petitioner to besubrogated to the rights of the original creditor.

c. Petitioner also asserted that due to Baguio Gold's irreversible losses,it became evident that it would not be able to recover the advancesand payments it had made in behalf of Baguio Gold.

d. For a debt to be considered worthless, petitioner claimed that it wasneither required to institute a judicial action for collection against thedebtor nor to sell or dispose of collateral assets in satisfaction of thedebt. It is enough that a taxpayer exerted diligent efforts to enforcecollection and exhausted all reasonable means to collect.

5. BIR denied petitioner's protest for lack of legal and factual basis.a. It held that the alleged debt was not ascertained to be worthless since

Baguio Gold remained existing and had not filed a petition forbankruptcy; and that the deduction did not consist of a valid andsubsisting debt considering that, under the management contract,petitioner was to be paid fifty percent (50%) of the project's netprofit.

b. Petitioner appealed before the Court of Tax Appeals.c. CTA rendered judgment against Philex, affirming the deficiency

income tax assessment and ordering Philex to pay the amount plusdelinquency interest.

6. CTA rejected petitioner's assertion that the advances it made for the Sto. Ninomine were in the nature of a loan. It instead characterized the advances aspetitioner's investment in a partnership with Baguio Gold for the developmentand exploitation of the Sto. Nino mine.

a. The CTA held that the "Power of Attorney" executed by petitioner andBaguio Gold was actually a partnership agreement. Since the

advanced amount partook of the nature of an investment, it couldnot be deducted as a bad debt from petitioner's gross in come.

b. It likewise held that the amount paid by petitioner for the long-term loan obligations of Baguio Gold could not be allowed as a baddebt deduction. At the time the payments were made, Baguio Goldwas not in default since its loans were not yet due anddemandable.

c. What petitioner did was to pre-pay the loans as evidenced by thenotice sent by Bank of America showing that it was merely

demanding payment of the installment and interestsdue. Moreover, Citibank imposed and collected a "pre-terminationpenalty" for the pre-payment.

d. The Court of Appeals affirmed the decision of the CTA.7. Hence, upon denial of its motion for reconsideration, petitioner took this

recourse under Rule 45 of the Rules of Court, alleging that:

a. The Court of Appeals erred in construing that the advances madeby Philex in the management of the Sto. Nino Mine pursuant to thePower of Attorney partook of the nature of an investment ratherthan a loan.

b. The Court of Appeals erred in ruling that the 50%-50% sharing inthe net profits of the Sto. Nino Mine indicates that Philex is apartner of Baguio Gold in the development of the Sto. Nino Minenotwithstanding the clear absence of any intent on the part ofPhilex and Baguio Gold to form a partnership.

c. The Court of Appeals erred in relying only on the Power of Attorneyand in completely disregarding the Compromise Agreement and theAmended Compromise Agreement when it construed the nature ofthe advances made by Philex.

d. The Court of Appeals erred in refusing to delve upon the issue ofthe propriety of the bad debts write-off.

8. Petitioner insists that in determining the nature of its business relationshipwith Baguio Gold, SC should not only rely on the "Power of Attorney", butalso on the subsequent "Compromise with Dation in Payment" and"Amended Compromise with Dation in Payment" that the parties executed in1982.

a. These documents, allegedly evinced the parties' intent to treat theadvances and payments as a loan and establish a creditor-debtorrelationship between them.

HELD: The petition lacks merit. [Bear with this please. The Courts reasoning is long

because it had to characterize the relationship between Philex and Baguio Gold tocome up with the ratio at the end.]

1. SC agrees with the lower courts in holding that the "Power of Attorney" is theinstrument that is material in determining the true nature of the business

relationship between petitioner and Baguio Gold.


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a. Before resort may be had to the two compromise agreements, theparties' contractual intent must first be discovered from theexpressed language of the primary contract under which the parties'business relations were founded.

b. It should be noted that the compromise agreements were merecollateral documents executed by the parties pursuant to thetermination of their business relationship created under the "Powerof Attorney".

c. On the other hand, it is the Power of Attorney which established thejuridical relation of the parties and defined the parameters of theirdealings with one another.

d. The compromise agreements were executed eleven years after the"Power of Attorney" and merely laid out a plan or procedure by whichpetitioner could recover the advances and payments it made underthe "Power of Attorney".

e. The parties entered into the compromise agreements as aconsequence of the dissolution of their business relationship. It didnot define that relationship or indicate its real character.

2. An examination of the "Power of Attorney" reveals that a partnership or jointventure 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 amongthemselves.

a. While a corporation, like petitioner, cannot generally enter into acontract of partnership unless authorized by law or its charter, it hasbeen held that it may enter into a joint venture which is akin to aparticular partnership.

b. Perusal of the agreement denominated as the "Power of Attorney"indicates that the parties had intended to create a partnership andestablish a common fund for the purpose. They also had a jointinterest in the profits of the business as shown by a 50-50 sharing inthe income of the mine.

3. Under the "Power of Attorney", petitioner and Baguio Gold undertook tocontribute money, property and industry to the common fund known as theSto. Nio mine.

a. Pursuant to paragraphs 4 and 5 of the agreement, petitioner andBaguio Gold were to contribute equally to the joint venture assetsunder their respective accounts.

b. Baguio Gold would contribute P11M under its owner's account plusany of its income that is left in the project, in addition to its actualmining claim.

c. Petitioner's contribution would consist of its expertise in themanagement and operation of mines, as well as the manager's accountwhich is comprised ofP11M in funds and property andpetitioner's "compensation" as manager that cannot be paid in cash.

4. The wording of the parties' agreement as to petitioner's contribution to thecommon fund does not detract from the fact that petitioner transferred itsfunds and property to the project as specified in paragraph 5, thus renderingeffective the other stipulations of the contract, particularly paragraph 5(c)which prohibits petitioner from withdrawing the advances until terminationof the parties' business relations.

a. Petitioner became bound by its contributions once the transferswere made. The contributions acquired an obligatory nature as

soon as petitioner had chosen to exercise its option underparagraph 5.b. The non-revocation or non-withdrawal under paragraph 5(c)

applies to the advances made by petitioner who is supposedlythe agentand not the principal under the contract.

c. Thus, it cannot be inferred from the stipulation that the parties'relation under the agreement is one of agency coupled with aninterest and not a partnership.

d. Neither can paragraph 16 of the agreement be taken as anindication that the relationship of the parties was one of agency andnot a partnership.

e. Although the said provision states that "this Agency shall beirrevocable while any obligation of the PRINCIPAL in favor of the

MANAGERS is outstanding, inclusive of the MANAGERS' account," itdoes not necessarily follow that the parties entered into an agencycontract coupled with an interest that cannot be withdrawn byBaguio Gold.

5. In this case, the totality of the circumstances and the stipulations in theparties' agreement indubitably lead to the conclusion that a partnership wasformed between petitioner and Baguio Gold.

a. First, it does not appear that Baguio Gold was unconditionallyobligated to return the advances made by petitioner under theagreement.

b. Paragraph 5 (d) thereof provides that upon termination of theparties' business relations, "the ratio which the MANAGER'Saccount has to the owner's account will be determined, and thecorresponding proportion of the entire assets of the STO. NINOMINE, excluding the claims" shall be transferred to petitioner.

c. As pointed out by the Court of Tax Appeals, petitioner was merelyentitled to a proportionate return of the mine's assets upondissolution of the parties' business relations.

d. There was nothing in the agreement that would require BaguioGold to make payments of the advances to petitioner as would berecognized as an item of obligation or "accounts payable" forBaguio Gold.

6. Thus, the tax court correctly concluded that the agreement provided for adistribution of assets of the Sto. Nio mine upon termination, a provision

that is more consistent with a partnership than a creditor-debtorrelationship.


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a. It should be pointed out that in a contract of loan, a person whoreceives a loan or money or any fungible thing acquires ownershipthereof and is bound to pay the creditor an equal amount of the samekind and quality.

b. In this case, however, there was no stipulation for Baguio Gold toactually repay petitioner the cash and property that it had advanced,but only the return of an amount pegged at a ratio which themanager's account had to the owner's account.

7. SC finds no contractual basis for the execution of the two compromiseagreements in which Baguio Gold recognized a debt in favor of petitioner,which supposedly arose from the termination of their business relations overthe Sto. Nino mine.

a. The "Power of Attorney" clearly provides that petitioner would onlybe entitled to the return of a proportionate share of the mine assets tobe computed at a ratio that the manager's account had to the owner'saccount.

b. Except to provide a basis for claiming the advances as a bad debtdeduction, there is no reason for Baguio Gold to hold itself liable topetitioner under the compromise agreements, for any amount over

and above the proportion agreed upon in the "Power of Attorney".

8. CTA correctly observed that it was unlikely for a business corporation to lendhundreds of millions of pesos to another corporation with neither security, orcollateral, nor a specific deed evidencing the terms and conditions of suchloans.

a. The parties also did not provide a specific maturity date for theadvances to become due and demandable, and the manner of paymentwas unclear. All these point to the inevitable conclusion that theadvances were not loans but capital contributions to a partnership.

b. The strongest indication that petitioner was a partner in the Sto Niomine is the fact that it would receive 50% of the net profits as"compensation" under paragraph 12 of the agreement.

c. The entirety of the parties' contractual stipulations simply leads to noother conclusion than that petitioner's "compensation" is actually itsshare in the income of the joint venture.

d. 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 primafacie evidence that he is a partner in the business."

9. Petitioner asserts, however, that no such inference can be drawn against itsince its share in the profits of the Sto Nio project was in the nature ofcompensation or "wages of an employee", under the exception provided inArticle 1769 (4) (b).

a. CTA correctly noted that petitioner was not an employee of BaguioGold who will be paid "wages" pursuant to an employer-employeerelationship.

b. To begin with, petitioner was the manager of the project and hadput substantial sums into the venture in order to ensure its viabilityand profitability.

c. By pegging its compensation to profits, petitioner also stood not tobe remunerated in case the mine had no income.

d. It is hard to believe that petitioner would take the risk of not beingpaid at all for its services, if it were truly just an ordinary employee.

10. SC finds that petitioner's "compensation" under paragraph 12 of theagreement actually constitutes its share in the net profits of the partnership.

a. Petitioner would not be entitled to an equal share in the income ofthe mine if it were just an employee of Baguio Gold.

b. It is not surprising that petitioner was to receive a 50% share in thenet profits, considering that the "Power of Attorney" also providedfor an almost equal contribution of the parties to the St. Nino mine.

c. The "compensation" agreed upon only serves to reinforce thenotion that the parties' relations were indeed of partners and notemployer-employee.

11. The lower courts did not err in treating petitioner's advances as investmentsin a partnership known as the Sto. Nino mine.

a.

The advances were not "debts" of Baguio Gold to petitionerinasmuch as the latter was under no unconditional obligation toreturn the same to the former under the "Power of Attorney".

b. As for the amounts that petitioner paid as guarantor to BaguioGold's creditors, we find no reason to depart from the tax court'sfactual finding that Baguio Gold's debts were not yet due anddemandable at the time that petitioner paid the same.

c. Petitioner pre-paid Baguio Gold's outstanding loans to its bankcreditors and this conclusion is supported by the evidence onrecord.

12. Petitioner thus cannot claim the advances as a bad debt deduction from itsgross income.

a. Deductions for income tax purposes partake of the nature oftax exemptions and are strictly construed against the taxpayer,

who must prove by convincing evidence that he is entitled to

the deduction claimed. [WHAT IS IMPORTANT!]b. In this case, petitioner failed to substantiate its assertion that the

advances were subsisting debts of Baguio Gold that could bededucted from its gross income. Consequently, it could not claimthe advances as a valid bad debt deduction.

WHEREFORE, the petition is DENIED. The decision of the Court of AppealsisAFFIRMED. Petitioner Philex Mining Corporation is ORDERED to PAYthedeficiency 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.-Jan


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R. DEPRECIATION

1. Depreciation base

ZAMORA v. COLLECTOR OF INTERNAL REVENUE

(May 31, 1963)MARIANO ZAMORA, petitioner, vs. COLLECTOR OF INTERNAL REVENUE and COURT OF

TAX APPEALS, respondents.

NOTE: Im not sure why this is assigned under depreciation expense because the discussionfor depreciation is really not substantial at all. It discusses other issues like promotional

expenses and capital gains, which I think is more relevant in this case and Im pretty sure if

maam discusses this in class shell focus more on those issues rather than the depreciation

expense.

DOCTRINE: ... [T]he useful life of the building for business purposes depends to a largeextent on the suitability of the structure to its use and location, its architectural quality,the rate of change in population, the shifting of land values, as well as the extent andmaintenance and rehabilitation.

NATURE: Appeal from CTAPONENTE: PAREDES, J.:

FACTS:

1stcase1. Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed

his income tax returns the years 1951 and 1952.2. The Collector of Internal Revenue found that he failed to file his return of the capital

gains derived from the sale of certain real properties and claimed deductionswhich were not allowable.

3. The collector required him to pay the sums of P43,758.50 and P7,625.00, asdeficiency income tax for the years 1951 and 1952, respectively. On appeal, thedecision was modified and ordered him to pay the reduced total sum of P30,258.00(P22,980.00 and P7,278.00, as deficiency income tax for the years 1951 and 1952,respectively

2nd case4. Mariano Zamora and his deceased sister Felicidad Zamora, bought a piece of land

located in Manila on May 16, 1944, for P132,000.00 and sold it for P75,000.00 onMarch 5, 1951. They also purchased a lot located in Quezon City for P68,959.00 onJanuary 19, 1944, which they sold for P94,000 on February 9, 1951.

5. The CTA ordered the estate of the late Felicidad Zamora (represented by EsperanzaA. Zamora, as special administratrix of her estate), to pay the sum of P235.50,representing alleged deficiency income tax and surcharge due from said estate.

ISSUES:1. WON the deductions for promotional expenses should have been allowed. NO2. WON the CIR erred in disallowing 3% per annum as the rate of depreciation. NO3. WON the CIR erred in disregarding the price stated in the deed of sale as the cost in

determining the alleged capital gains. NO.

HELD/RATIO/RULING:

1. PROMOTION EXPENSES AS DEDUCTION:PETITIONERS ARGUMENT:- He contends that the whole amount of P20,957.00 as promotion expenses in his

1951 income tax returns, should be allowed and not merely one-half of it orP10,478.50

- While not all the itemized expenses are supported by receipts, the absence of somesupporting receipts has been sufficiently and satisfactorily established.

- For, as alleged, the said amount of P20,957.00 was spent by Mrs. Esperanza A.Zamora (wife of Mariano), during her travel to Japan and the United States topurchase machinery for a new Tiki-Tiki plant, and to observe hotel management inmodern hotels.

CIR/CTA ARGUMENT:- The CTA found that for said trip Mrs. Zamora obtained only the sum of P5,000.00

from the Central Bank and that in her application for dollar allocation, she statedthat she was going abroad on a combined medical and business trip

- No evidence had been submitted as to where Mariano had obtained the amount inexcess of P5,000.00 given to his wife which she spent abroad.

COURTS RULING:- Claim for the deduction of promotion expenses or entertainment expenses must

also be substantiated or supported by record showing in detail the amount andnature of the expenses incurred.

- Considering, as heretofore stated, that the application of Mrs. Zamora for dollarallocation shows that she went abroad on a combined medical and business trip,not all of her expenses came under the category of ordinary and necessaryexpenses; part thereof constituted her personal expenses.

- There having been no means by which to ascertain which expense was incurredby her in connection with the business of Mariano Zamora and which wasincurred for her personal benefit, the Collector and the CTA in their decisions,considered 50% of the said amount of P20,957.00 as business expenses and theother 50%, as her personal expenses.

- In the case of Visayan Cebu Terminal Co., Inc. v. Collector of Int. Rev., it wasdeclared that representation expenses fall under the category of businessexpenses which are allowable deductions from gross income, if they meet theconditions prescribed by law, particularly section 30 (a) [1], of the Tax Code that to be deductible, said business expenses must be ordinary and necessary

expenses paid or incurred in carrying on any trade or business; that those expenses must also meet the further test of reasonableness in

amount; that when some of the representation expenses claimed by the taxpayer were

evidenced by vouchers or chits, but others were without vouchers or chits,documents or supporting papers and it is not possible to determine the actualamount covered by supporting papers and the amount without supportingpapers, the court should determine from all available data, the amountproperly deductible as representation expenses.


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2. DEPRECIATION EXPENSEPETITIONERS ARGUMENT:1. CTA erred in disallowing 3-% per annum as the rate of depreciation of the Bay

View Hotel Building but only 2-%.2. Justification for the 3% rate:

(1) the Ermita District, where the Bay View Hotel is located, is now becoming acommercial district;

(2) the hotel has no room for improvement; and(3) the changing modes in architecture, styles of furniture and decorative designs,

"must meet the taste of a fickle public".

COURTS RULING:- The CTA in arriving with the said rate had already considered the justifications

submitted by the petitioner: Normally, an average hotel building is estimated to have a useful life of 50

years, but inasmuch as the useful life of the building for business purposesdepends to a large extent on the suitability of the structure to its use and

location, its architectural quality, the rate of change in population, the

shifting of land values, as well as the extent and maintenance and

rehabilitation. It is allowed a depreciation rate of 2-% corresponding to anormal useful life of only 40 years

- It is true that Bulletin F has no binding force, but it has a strong persuasive effectconsidering that the same has been the result of scientific studies and observationfor a long period in the United States after whose Income Tax Law ours ispatterned." Verily, courts are permitted to look into and investigate the antecedentsor the legislative history of the statutes involved

3. CAPITAL GAINS ON SALE OF PROPERTIES (two properties in dispute [a] theManila property and [b] the Quezon City property)NOTE: Undeclared capital gains derived from the sales in 1951 of certain realproperties in Malate, Manila and in Quezon City, acquired during the Japaneseoccupation.

[a] MANILA PROPERTYPETITIONER ARGUMENT (inferred from the computation/decision):- Purchased the property in Philippine Peso and not Japanese war notes (Note:

Japanese war notes have smaller value than Peso.)- The acquisition cost (purchase price) was P132, 000 and it was later sold for P75,

000.- So in effect, they are arguing that there was no gain because: P132, 000 P75, 000 =

LOSS (so, lugi pa, gets?)

CTA/CIR ARGUMENT:- The purchase price of P132,000.00 was not entirely paid in Japanese war notes.

They came up with that conclusion be cause:(1) Mariano Zamora, co-owner of the property in question, testified that

P66,000.00 was paid in Philippine currency and the other P66,000.00 was paidin Japanese war notes.

(2) The Zamoras owned the Farmacia Zamora which continued to engage inbusiness during the war years and that a considerable portion of its sales waspaid for in genuine Philippine currency

(3) P132,000.00 in Japanese war notes in May, 1944 is equivalent to onlyP11,000.00. The property in question had at the time an assessed value ofP27,031.00 (in Philippine currency). Considering the well known fact thatthe assessed value of real property is very much below the fair market value,it is incredible that said property should have been sold by the owner thereoffor less than one-half of its assessed value.

COURTS RULING: These facts have convinced us of the veracity of the allegation thatof the purchase price of P132,000.00 the sum of P66,000.00 was paid in Philippinecurrency, so that only the sum of P66,000.00 was paid in Japanese War notes.

-

This being the case, the Ballantyne Scale of values, which was the result of animpartial scientific study, adopted and given judicial recognition, should be applied.- As the value of the Japanese war notes in May, 1944 when the Manila property was

bought, was 1 of the genuine Philippine Peso (Ballantyne Scale), the value of theJapanese war notes used in the purchase of the property, must be reduced in termsof the genuine Philippine Peso to determine the cost of acquisition.

- It, therefore, results that since the sum of P66,000.00 in Japanese war notes in May,1944 is equivalent to P5,500.00 in Philippine currency (P66,000.00 divided by 12),

- the acquisition cost of the property in question is P66,000.00 plus P5,500.00 orP71,500.00

- As the property was sold for P75,000.00 in 1951, the owners thereof Mariano andFelicidad Zamora derived a capital gain of P3,500.00 or P1,750.00 each.

[b] QUEZON CITY PROPERTYPETITIONER: The entire purchase price of P68,959.00 was paid in Philippinecurrency. CTA/CIR: The purchase price of P68,959.00 was paid in Japanese war notes.

COURTS RULING: Agreed with the CTA- As contended by respondent, the purchase price of P68,959.00 was paid in

Japanese war notes, the purchase price in Philippine currency would be onlyP17,239.75 (P68,959.00 divided by 4, 34.00 in war notes being equivalent toP1.00 in Philippine currency).

- The assessed value of said property in Philippine currency at the time ofacquisition was P46,910.00.

- It is quite incredible that real property with an assessed value of P46,910.00should have been sold by the owner thereof in Japanese war notes with anequivalent value in Philippine currency of only P17,239.75.

- We are more inclined to believe the allegation that it was purchased forP68,959.00 in genuine Philippine currency.

- Since the property was sold for P94,000.00 on February 9, 1951, the gain derivedfrom the sale is P15,361.75, after deducting from the selling price the cost ofacquisition in the sum of P68,959.00 and the expense of sale in the sum ofP9,679.25.

HELD: Consequently, the total undeclared income of petitioners derived from thesales of the Manila and Quezon City properties in 1951 is P17,111.75 (P1,750.00 plusP15,361.75), 50% of which in the sum of P8,555.88 is taxable, the said propertiesbeing capital assets held for more than one year.


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DISPOSITION: IN VIEW HEREOF, the petition in each of the above-entitled cases isdismissed, and the decision appealed from is affirmed, without special pronouncementas to costs.

VOTE: EN BANC; Bengzon, C.J., Padilla, Bautista Angelo, Concepcion, Reyes, J.B.L., Dizon,Regala and Makalintal, JJ., concur.Labrador and Barrera, JJ., took no part.

-David

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Y. ITEMS NOT DEDUCTIBLE

Atlas Consolidated Mining vs CIR

(Jan 27, 1981)

Doctrine: The statutory test of deductibility (1) the expense must be ordinary andnecessary, (2) it must be paid or incurred within the taxable year, and (3) it must be paidor incurred in carrying in a trade or business. In addition, not only must the taxpayermeet the business test, he must substantially prove by evidence or records thedeductions claimed under the law, otherwise, the same will be disallowed. The mereallegation of the taxpayer that an item of expense is ordinary and necessary does notjustify its deduction

Ponente: De Castro

Facts:

This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income taxassessments made by the CIR where Atlas, a mining company, was a ssessed P546,295.16for 1957 and P215,493.96 for 1958 deficiency income taxes.

Atlas is a corporation engaged in the mining industry registered under the laws of thePhilippines. On August 20, 1962, the Commissioner assessed against Atlas the sum ofP546,295.16 and P215,493.96 or a total of P761,789.12 as deficiency income taxes forthe years 1957 and 1958. For the year 1957, it was the opinion of the Commissioner thatAtlas is not entitled to exemption from the income tax under Section 4 of Republic Act909 1 because same covers only gold mines, the provision of which reads:

New mines, and old mines which resume operation, when certified toas such by the Secretary of Agriculture and Natural Resources uponthe recommendation of the Director of Mines, shall be exempt fromthe payment of income tax during the first three (3) years of actualcommercial production. Provided that, any such mine and/or mines

making a complete return of its capital investment at any time withinthe said period, shall pay income tax from that year.

After some bargaining with the CIR and the Secretary of Finance, the Secretary ofFinance issued a memo saying that RA 909 covers all mines whether for gold or not.Thus, the tax liability assessment was recomputed and lowered to P159K. Howeverthe recomputed tax liability included Transfer agent's fee, Stockholders relationservice fee, U.S. stock listing expenses, Suit expenses, Provision for contingencies. Casewas then filed in the CTA.

CTA once again lowered the liability assessment and considered as deductible thetransfer agents fee, U.S. stock listing expenses, and provision for contingencies. It did

not however allow the deduction of the Stockholders relation service fee which is atissue.

Atlass Argument: It is the contention of Atlas that th e amount of P25,523.14 paid in1958 as annual public relations expenses is a deductible expense from gross incomeunder Section 30 (a) (1) of the National Internal Revenue Code. Atlas claimed that itwas paid for services of a public relations firm, P.K Macker & Co., a reputable publicrelations consultant in New York City, U.S.A., hence, an ordinary and necessarybusiness expense in order to compete with other corporations also interested in theinvestment market in the United States.

Issue: Is the stockholder relation service fee a deductible business expense?

Ruling:

Ratio:The law allowing expenses as deduction from gross income for purposes of the

income tax is Section 30 (a) (1) of the National Internal Revenue which allows adeduction of "all the ordinary and necessary expenses paid or incurred during thetaxable year in carrying on any trade or business."

The statutory test of deductibility (1) the expense must be ordinary and necessary, (2)it must be paid or incurred within the taxable year, and (3) it must be paid or incurredin carrying in a trade or business. In addition, not only must the taxpayer meet thebusiness test, he must substantially prove by evidence or records the deductionsclaimed under the law, otherwise, the same will be disallowed. The mere allegation of

the taxpayer that an item of expense is ordinary and necessary does not justify itsdeduction.

this Court has never attempted to define with precision the terms "ordinary andnecessary." There are however, certain guiding principles worthy of seriousconsideration in the proper adjudication of conflicting claims. Ordinarily, an expensewill be considered "necessary" where the expenditure is appropriate and helpful inthe development of the taxpayer's business. 8 It is "ordinary" when it connotes apayment which is normal in relation to the business of the taxpayer and thesurrounding circumstances. 9 The term "ordinary" does not require that the paymentsbe habitual or normal in the sense that the same taxpayer will have to make themoften; the payment may be unique or non-recurring to the particular taxpayer affected

There is thus no hard and fast rule on the matter. The right to a deduction depends ineach case on the particular facts and the relation of the payment to the type of


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business in which the taxpayer is engaged. The intention of the taxpayer often may bethe controlling fact in making the determination

It appears that on December 27, 1957, Atlas increased its capital stock from P15,000,000to P18,325,000. 13 It was claimed by Atlas that its shares of stock worth P3,325,000 weresold in the United States because of the services rendered by the public relations firm, P.K. Macker & Company. The Court of Tax Appeals ruled that the information about Atlasgiven out and played up in the mass communication media resulted in full subscriptionof the additional shares issued by Atlas; consequently, the questioned item, stockholders

relation service fee, was in effect spent for the acquisition of additional capital, ergo, acapital expenditure.

We sustain the ruling of the tax court that the expenditure of P25,523.14 paid to P.K.Macker & Co. as compensation for services carrying on the selling campaign in an effortto sell Atlas' additional capital stock of P3,325,000 is not an ordinary expense in line withthe decision of U.S. Board of Tax Appeals in the case ofHarrisburg Hospital Inc. vs.Commissioner of Internal Revenue.

The said expense is not deductible from Atlas gross income in 1958 because expensesrelating to recapitalization and reorganization of the corporation the cost of obtainingstock subscription, promotion expenses, and commission or fees paid for the sale ofstock reorganization are capital expenditures.

That the expense in question was incurred to create a favorable image of the corporationin order to gain or maintain the public's and its stockholders' patronage, does not makeit deductible as business expense. As held in the case of Welch vs. Helvering, 15efforts toestablish reputation are akin to acquisition of capital assets and, therefore, expensesrelated thereto are not business expense but capital expenditures.

-Kester

xxx

Definition of ordinary income

CALASANZ v. CIR

(October 8, 1986)

IMPORTANT :The statutory definition of capital assets is negative in nature. If the asset is not amongthe exceptions, it is a capital asset; conversely, assets falling within the exceptions areordinary assets. And necessarily, any gain resulting from the sale or exchange of an assetis a capital gain or an ordinary gain depending on the kind of asset involved in thetransaction.

However, there is no rigid rule or fixed formula by which it can be determined with

finality whether property sold by a taxpayer was held primarily for sale to customers inthe ordinary course of his trade or business or whether it was sold as a capital asset.

Although several factors or indices have been recognized as helpful guides in making adetermination, none of these is decisive; neither is the presence nor the absence ofthese factors conclusive. Each case must in the last analysis rest upon its own peculiarfacts and circumstances.

Also a property initially classified as a capital asset may thereafter be treated as anordinary asset if a combination of the factors indubitably tend to show that the activitywas in furtherance of or in the course of the taxpayer's trade or business. Thus, a saleof inherited real property usually gives capital gain or loss even though the property

has to be subdivided or improved or both to make it salable. However, if the inheritedproperty is substantially improved or very actively sold or both it may be treated asheld primarily for sale to customers in the ordinary course of the heir's business.

FACTS

- Ursula Calasanz inherited from her father an agricultural land in Cainta- To liquidate their inheritance, they subdivided the lots and introduced

improvements such as roads, concrete gutters, drainage and lighting systemto make them saleable.

- Petitioners joint income tax return :o Profit P31,060.06 from the sale of the lotso 50% = P15,530.03 as taxable capital gains

- Revenue Examiner adjudged the petitioners as engaged in business of realestate dealers thus, assessed Real Estate Dealers Tax and a deficiency

income tax on profits.

ISSUE

(1) WON petitioners are real estate dealers liable for real es tate dealers fixedtax

(2) WON the gains realized from the sale of the lots are taxable in full as ordinaryincome or capital gains taxable at capital gain rates.

HELDPetitioners engaged in the real estate business and the gains from the sale of the

lots are ordinary income taxable in full

Arguments of Petitioners :1- Inherited land is considered a capital asset ; mere liquidation of an

inheritance cannot be said to have engaged in the real estate business and bedenied the preferential tax treatment merely because the manner of disposalis in the most advantageous way.

2- Subdivision into smaller lots and the introduction of improvements weredone merely to facilitate the sale

Argument of CIR :

1-

Petitioners are deemed to be in the real estate business for being involved ina series of real estate transactions for profit.


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2- Real property acquired through inheritance may be converted to a businessproperty when if certain factors are present (e.g. number, continuity andfrequency of the sale)

3- The fact that the ultimate purpose is to liquidate the inheritance is of nomoment ; the important questions is what the taxpayer did to the property.

COURT :1- Activities of the petitioners are similar to those employed by one engaged in the

business of real estate.

2- The business element of development is evidence against the contention of thepetitioners.

- Petitioners did not sell the land in the same condition which they acquired it- Extensive improvements were made in order to enhance the value of the lot

and make it more attractive to prospective buyers ; the improved land is evennamed Don Mariano Subdivision

3- Property ceases to be a capital asset if the amount expended to improve itdoubles that of its original cost ; the extensive improvement indicates that theseller held the property for the sale to customers in the ordinary course ofbusiness

4-

The sizeable amount receivables in comparison to sales volume during thesame period signifies that the lots were sold on installment basis and suggeststhe number, continuity and frequency of the sales.

5- Lots were also advertised for sale to the public ; sales and collectioncommissions were paid out

6- The fact that the property is sold for purposes of liquidation does not foreclosethe determination that a trade or business is being conducted by the seller.

-Maexxx

1. Computation of gain or loss

Commissioner of Internal Revenue, petitioner, vs.Aquafresh SeafoodInc., respondents.

(October 20, 2010)

NOTES:

Kind of tax: DST (documentary stamp tax) a nd CGT (capital gains tax)DOCTRINE:

Under Section 27(D)(5) of the NIRC of 1997, a CGT of six (6%) percent is imposed on thegains presumed to have been realized in the sale, exchange or disposition of landsand/or buildings which are not actively used in the business of a corporation and whichare treated as capital assets based on the gross selling price or fair market value as

determined in accordance with Section 6(E) of the NIRC, whichever is higher.

x x x "zonal valuation was established with the objective of having an efficient taxadministration by minimizing the use of discretion in the determination of the taxbased on the part of the administrator on one hand and the taxpayer on the otherhand." Zonal value is determined for the purpose of establishing a more realistic basisfor real property valuation. Since internal revenue taxes, such as CGT and DST, areassessed on the basis of valuation, the zonal valuation existing at the time of the saleshould be taken into account.

NATURE: Petition for review a decision of CTA

PONENTE: Peralta; 2nd

Division

FACTS:

1. Aquafresh Seafoods solf to Philis Seafood two parcels of land located at BarrioBanica, Roxas City for P3.1 M. Aquafresh paid the corresponding CGT (CapitalGains Tax) of P186,000 and DST (Documentary Stamp Tax) of P46,500.

2. However, BIR received a report that the purchase price of the sale wasundervalued for tax purposes. They conducted an investigation and concludedthat the subject properties were commercial and had a high zonal value (P2000).They sent deficiency assessment notices to Aquafresh for the tax deficiencies. Thedeficiencies were based on the supposed selling price following the P2000 zonalvalue.

3. Aquafresh protested but its protest was denied. Aquafresh filed a petition forreview with the CTA seeking reversal of the decision. Aquafresh argued that sincethe properties were located in Barrio Banica, classified as residential area andgiven a zonal value of P650per sq/m in the 1995 Revised Zonal Values of RealProperty, the prescribed zonal value should prevail. Aquafresh contends that theBIR had no business re-classifying the subject properties to commercial. CTAdecided in favor of Aquafresh, stating that while the CIR is given authority todetermine the zonal values, the same is not without limitation- it should be donein consultation with competent appraisers from both the public and privatesector (Sec. 6e, NIRC).

4. CIR now assails the CTA decision, saying the requirement of consultation ismandatory only when it is prescribing real property values- that is when aformulation or change is made in the schedule of zonal values. CIR argues thatwhat they did was not to prescribe zonal value, but merely to classify the same ascommercial and apply the corresponding zonal value for such classification based

on the existing schedule of zonal values. Second, CIR also argues that their act waspursuant to their Zonal Valuation Guidelines. According to CIR, the guidelinesprovide that All real properties, regardless of actual use, located in a

street/barangay zone, the use of which are predominantly commercial shall beclassified as Commercial for purposes of zonal valuation.

ISSUES:(1) W/N the CIR is correct in re-classifying the subject properties from residentialto commercial, consequently raising the zonal va lue of the properties.

Held/Ratio:

1. NO.On the other hand, under Section 196 of the NIRC, DST is based on the consideration

contracted to be paid or on its fair market value determined in accordance withSection 6(E) of the NIRC, whichever is higher.


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Thus, in determining the value of CGT and DST arising from the sale of a property, thepower of the CIR to assess is subject to Section 6(E) of the NIRC, which provides:Section 6. Power of the Commissioner to Make Assessments and Prescribe AdditionalRequirements for Tax Administration and Enforcement. -x x x x(E) Authority of the Commissioner to Prescribe Real Property Values TheCommissioner is hereby authorized to divide the Philippines into different zones or areaand shall, upon consultation with competent appraisers both from the private andpublic sectors, determine the fair market value of real properties located in each zone

or area. For purposes of computing internal revenue tax, the value of the property shallbe, whichever is higher of:(1) the fair market value as determined by the Commissioner; or(2) the fair market value as shown in the schedule of values of the Provincial and CityAssessors.

While the CIR has the authority to prescribe real property values and divide thePhilippines into zones, the law is clear that the same has to be done upon consultationwith competent appraisers both from the public and private sectors. It is undisputed thatat the time of the sale of the subject properties found in Barrio Banica, Roxas City, thesame were classified as residential. The petitioner cannot unilaterally classify the sameto commercial without first conducting a re-evaluation of the zonal values as mandatedunder Section 6(E) of the NIRC. As to the contention that consultation is needed onlywhen there is a change in the prescribed zonal values, and what they did was merely toclassify the properties to commercial and apply the zonal values, it should be noted thatALL the properties in Barrio Banica were classified as residential, under the 1995Revised Zonal Values. The act of classifying the subject properties into commercialinvolves a re-classification and revision of the prescribed zonal values. While the CIR isgiven the authority to determine the fair market value of the subject properties for thepurpose of computing internal revenue taxes, such authority is not without restriction orlimitation. The first sentence of Section 6(E) sets the limitation or condition in theexercise of such power by requiring respondent to consult with competent appraisersboth from private and public sectors.

As to the second contention, the Guidelines provision being invoked may only be used asbasis when the real property is located in an area or zone where the properties are notyet classified and their respective zonal valuation are not yet determined. The BIR itself

expressed this view in a BIR Ruling. Such is not the situation in the case.

This Court agrees with the observation of the CTA that "zonal valuation was establishedwith the objective of having an efficient tax administration by minimizing the use ofdiscretion in the determination of the tax based on the part of the administrator on onehand and the taxpayer on the other hand." Zonal value is determined for the purpose ofestablishing a more realistic basis for real property valuation. Since internal revenuetaxes, such as CGT and DST, are assessed on the basis of valuation, the zonal valuationexisting at the time of the sale should be taken into account.

If petitioner feels that the properties in Barrio Banica should also be classified ascommercial, then petitioner should work for its revision in accordance with RevenueMemorandum Order No. 58-69. The burden was on petitioner to prove that the

classification and zonal valuation in Barrio Banica have been revised in accordance with

the prevailing memorandum. In the absence of proof to the contrary, the 1995 RevisedZonal Values of Real Properties must be followed.

COURTS RULING: Petition denied.

DISPOSITION: CTA Decision affirmed.VOTE: Carpio, De Castro, Sereno and Mendonza concur.

-Ann

xxx

i. Merger or consolidation

COMMISSIONER OF INTERNAL REVENUE v VICENTE RUFINO

(February 27, 1987)

DOCTRINE: The basic consideration of course, is the purpose of the merger, as thiswould determine whether the exchange of properties involved therein shall be subjector not to the capital gains tax. The criterion laid down by the law is that the mergermust be undertaken for a bona fide business purpose and not solely for the purpose ofescaping the burden of taxation.

It has been suggested that one certain indication of a scheme to evade the capital gainstax is the subsequent dissolution of the new corporation after the transfer to it of theproperties of the old corporation and the liquidation of the former soon after.

We see no such furtive intention in the instant case. It is clear, in fact, that the purposeof the merger was to continue the business of the Old Corporation, whose corporatelife was about to expire, through the New Corporation to which all the assets andobligations of the former had been transferred. what argues strongly, indeed, for theNew Corporation is that it was not dissolved after the merger. On the contrary, itcontinued to operate the places of amusement originally owned by the OldCorporation.

NATURE: Petition for certiorariPONENTE: Cruz,J.

SHORT FACTS:Private respondents were majority stockholder of an old theatre corporation, whichwill end its corporate life in 1959. Private respondents were also majoritystockholders in a new corporation (organized in 1958) which operated on the samebusiness. They decided to merge the two in order to continue the business of the oldcorporation. They signed a Deed of assignment wherein the Old Corporations

business, assets, etc. were transferred to the New Corporation. Then the capitalizationof the New Corporation was increased. And then shares from New Corporation weredistributed/issued to the shareholders of the Old Corporation. New Corp continuedwith the business of the Old Corp. CIR examined and said that this was a ploy to avoidliability, imposing upon them deficiency taxes.


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FACTS:

1. OLD CORPORATION: The private respondents were the majority stockholdersof the defunctEastern Theatrical Co., Inc., a corporation organized in 1934,for a term of 25 years terminating on January 25, 1959. It operated theatres,opera houses and other places of amusement, including Lyric and CapitolTheaters.

a. In 1949, it had an authorized capital stock of P2,000,000.00, dividedinto 200,000 shares at P10.00 per share

b. The President of this corporation during the year in question wasErnesto D. Rufino.2. NEW CORPORATION: The private respondents are also the majority and

controlling stockholders of another corporation, the Eastern Theatrical CoInc., which was organized on December 8, 1958, for a term of 50 years. Thiscorporation is engaged in the same kind of business as the Old Corporation.

a. It had an authorized capital stock of P200,000.00 each share having apar value of P10.00.

b. The General-Manager at the time was Vicente A. Rufino.3. In a special meeting of stockholders of the Old Corporation on December 17,

1958, to provide for the continuation of its business after the end of itscorporate life, and upon the recommendation of its board of directors, aresolution was passed authorizing the Old Corporation to merge with theNew Corporation by transferring its business, assets, goodwill, and

liabilities to the latter, which in exchange would issue and distribute to

the shareholders of the Old Corporation one share for each share held by

them in the said Corporation.

4. It was expressly declared that the merger of the Old Corporation with the NewCorporation was necessary to continue the exhibition of moving pictures atthe Lyric and Capitol Theaters even after the expiration of the corporate

existence of the former, in view of its pending booking contracts, not tomention its collective bargaining agreements with its employees.

5. Pursuant to the said resolution, the Old Corporation and the New Corporation,signed on January 9, 1959, a Deed of Assignment

a. providing for the conveyance and transfer of all the business,property, assets and goodwill of the Old Corporation to the NewCorporation in exchange for the latter's shares of stock to be

distributed among the shareholders on the basis of one stock foreach stock held in the Old Corporation except that no new andunissued shares would be issued to the shareholders of the OldCorporation;

b. the delivery by the New Corporation to the Old Corporation of125,005-3/4 shares to be distributed to the shareholders of the

Old Corporation as their corresponding shares of stock in the

New Corporation;c. the assumption by the New Corporation of all obligations and

liabilities of the Old Corporation under its bargaining agreement withthe Cinema Stage & Radio Entertainment Free Workers (FFW) whichincluded the retention of all personnel in the latter's employ;

d. The increase of the capitalization of the New Corporation incompliance with their agreement. This agreement was maderetroactive to January 1, 1959.

6. The aforesaid transfer was eventually made which continued theoperation of the theaters and assumed all the obligations and liabilities

of the Old Corporation.7. The resolution and deed of assignment was approved by the board of the

New Corporation. The increased capitalization of the New Corporation toP2,000,000.00 was also divided into 200,000 shares at P10.00 par value eachshare, and the increase was registered with the Securities and ExchangeCommission, on March 5, 1959.

8.

As agreed, and in exchange for the properties, and other assets of the OldCorporation, the New Corporation issued to the stockholders of theformer stocks in the New Corporation equal to the stocks each one held

in the Old Corporation, as follows:Mr. & Mrs. Vicente A. Rufino............... 17,083 sharesMr. & Mrs. Rafael R. Rufino ................. 16,881 sharesMr. & Mrs. Ernesto D. Rufino .............. 18,347 sharesMr. & Mrs. Manuel S. Galvez ............... 16,882 shares

9. It was this above-narrated series of transactions that the Bureau of InternalRevenue examined later. The petitioner declared that the merger of theaforesaid corporations was not undertaken for a bona fide businesspurpose but merely to avoid liability for the capital gains tax on the

exchange of the old for the new shares of stock. Accordingly, he imposedthe deficiency assessments against the private respondents for the amountsalready mentioned.

10. Private respondents MR to the CIR was denied. They elevated it to the CA,which reversed the decision in favor of the private respondents.

CIR: the New Corporation did not actually issue stocks in exchange for the propertiesof the Old Corporation at the time of the supposed merger on January 9, 1959. Theexchange, he says, was only on paper. The increase in capitalization of the NewCorporation was registered with the Securities and Exchange Commission only 37days after the Old Corporation expired on January 25, 1959. Prior to such registration,it was not possible for the New Corporation to effect the exchange provided for in thesaid agreement because it was capitalized only at P200,000.00 as against thecapitalization of the Old Corporation at P2,000,000.00. Consequently, as there was no

merger, the automatic dissolution of the Old Corporation on its expiry date resulted inits liquidation, for which the respondents are now liable in taxes on their capital gains.RUFINO: there was a genuine merger between the Old Corporation and the NewCorporation pursuant to a plan aimed at enabling the latter to continue the business ofthe former in the operation of places of amusement, specifically the Capitol and LyricTheaters. The plan was evolved through the series of transactions above narrated, allof which could be treated as a single unit in accordance with the requirements ofSection 35. Obviously, all these steps did not have to be completed at the time of themerger, as there were some of them, such as the increase and distribution of the stockof the New Corporation, which necessarily had to come afterwards. Moreover, the OldCorporation was dissolved on January 1, 1959, pursuant to the Deed of Assignment,and not on January 25, 1959, its original expiry date. As the properties of the OldCorporation were transferred to the New Corporation before that expiry date, there

could not have been any distribution of liquidating dividends by the Old Corporationfor which the private respondents should be held liable in taxes.


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ISSUE:1. WON that there was a valid merger between the Old Corporation and the New

Corporation. YES2. WON taxable gain was derived by petitioners from the exchange of their old

stocks and distributed to stockholders, pursuant to a plan of reorganization. NO

RATIO: (See Sec 35 of the NIRC)

There was a valid merger although the actual transfer of the properties subject of

the Deed of Assignment was not made on the date of the merger.

RETROACTIVITY OF TRANSACTIONSObviously, it was necessary for the Old Corporation to surrender its net assets first to theNew Corporation before the latter could issue its own stock to the shareholders of theOld Corporation because the New Corporation had to increase its capitalization for thispurpose. All these took place after the date of the merger but they were deemed part andparcel of and indispensable to the validity and enforceability of, the Deed of Assignment.The Court finds no impediment to the exchange of property for stock between the twocorporations being considered to have been effected on the date of the merger. That, infact, was the intention, and the reason why the Deed of Assignment was made retroactiveto January 1, 1959. Such retroaction provided in effect that all transactions set forthin the merger agreement shall be deemed to be taking place simultaneously on

January 1, 1959, when the Deed of Assignment became operative.

Certificates of stock issued were only evidence of ownership, but could only be issuedafter approval of the increase in capitalization. However, the title to them wastransferred on the date the merger took effect, in accordance with the Deed ofAssignment.

PURPOSE OF THE MERGER

The criterion laid down by the law is that the merger" must be undertaken for

a bona fide business purpose and not solely for the purpose of escaping the burden

of taxation."

One certain indication of a scheme to evade the capital gains tax is the subsequent

dissolution of the new corporation after the transfer to it of the properties of theold corporation and the liquidation of the former soon thereafter. This highly

suspect development is likely to be a mere subterfuge aimed at circumventing therequirements of Section 35 of the Tax Code while seeming to be a valid corporate

combination

NO FURTIVE INTENTION IN INSTANT CASEWe see no such furtive intention in the instant case. The purpose of the merger was tocontinue the business of the Old Corporation, whose corporate life was about to expire,through the New Corporation to which all the assets and obligations of the former hadbeen transferred. The New Corp was not dissolved the merger agreement in 1959. Onthe contrary, it continued to operate the places of amusement originally owned by

the Old Corporation. In fact, it continues to do so today after taking over the business ofthe Old Corporation twenty-seven years ago.

OLD CORPORATION CODE NECESSITATED SUCH SERIES OF TRANSACTIONS

Under the Corporation Code existing at the time of merger, a corporation cannotextend the terms of its existence. This prohibition, which incidentally has since beendeleted, made it necessary for the Old and New Corporations to enter into thequestioned merger, to enable the former to continue its unfinished business throughthe latter.

The transaction contemplated in the old law covered the second type of mergerdefined by Section 35 of the Tax Code as "the acquisition by one corporation of all orsubstantially all of the properties of another corporation solely for stock," which is

precisely what happened in the present case.

What is also worth noting is that, as in the case of the Old Corporation when it wasdissolved on December 31, 1958, there has been no distribution of the assets ofthe New Corporation since then and up to now, as far as the record discloses. To

date, the private respondents have not derived any benefit from the merger of

the Old Corporation and the New Corporation almost three decades earlier that

will make them subject to the capital gains tax under Section 35. They are nomore liable now than they were when the merger took effect in 1959, as the merger,being genuine, exempted them under the law from such tax.

GOVERNMENT NOT LEFT WITHOUT RECOURSEBy this decision, the government is, of course, not left entirely without recourse, atleast in the future. The fact is that the merger had merely deferred the claim for taxes,which may be asserted by the government later, when gains are realized and benefitsare distributed among the stockholders as a result of the merger.

The reason for this conclusion is traceable to the purpose of the legislature in adoptingthe provision of law in question. The basic idea was to correct the Tax Code which, byimposing taxes on corporate combinations and expansions, discouraged the same tothe detriment of economic progress, particularly the promotion of local industry.Speaking of this problem, HB No. 7233, which was subsequently enacted into R.A. No.1921 embodying Section 35 as now worded, declared in the Explanatory Note:

The exemption from the tax of the gain derived from exchanges of stocksolely for stock of another corporation resulting from corporate mergers orconsolidations under the above provisions, as amended, was intended toencourage corporations in pooling, combining or expanding their resources

conducive to the economic development of the country.

The merger in question involved a pooling of resources aimed at the

continuation and expansion of business and so came under the letter and

intendment of the National Internal Revenue Code, as amended by the abovecitedlaw, exempting from the capital gains tax exchanges of property effected under lawfulcorporate combinations.

DISPOSITION: WHEREFORE, the decision of the Court of Tax Appeals is affirmed infull, without any pronouncement as to costs.VOTING: 1st Division. Yap (Chairman), Narvasa, Melencio-Herrera, Feliciano, Gancaycoand sarmiento, JJ., concur.

-Jenin


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RTEZAWEEK10:

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It was brought into existence for no other purpose and it performed. When thatlimited function had been exercised, it immediately was put to death

The whole undertaking, though conducted according to the terms of subdivision(B), was in fact an elaborate and devious form of conveyance masquerading as a

corporate reorganization, and nothing else.

The rule which excludes from consideration the motive of tax avoidance is notpertinent to the situation, because the transaction, upon its face, lies outside theplain intent of the statute. To hold otherwise would be to exalt artifice above

reality and to deprive the statutory provision in question of all serious p urpose.

Thus in sum, the scheme adopted by Gregory was nothing more than a devise toavoid the payment of just taxes. Hence the deficiency assessed by the

Commissioner is proper

DISPOSITION: Judgement AFFIRMED

-Raffy

xxx

2. Taxable income from sources within the Philippines

CIR vs. CTA and SMITH KLINE & FRENCH OVERSEAS CO.

(January 17, 1984)

DOCTRINE: (This is essentially an example of computing deductions, but if maam asks

say this) Where an expense is clearly related to the production of Philippine-derivedincome or to Philippine operations (e.g. salaries of Philippine personnel, rental of officebuilding in the Philippines), that expense can be deducted from the gross incomeacquired in the Philippines without resorting to apportionment.

NATURE: Smith Kline asking for a tax refund due to underdeduction.PONENTE: Aquino, J.

FACTS:

Respondent company is a multinational firm domiciled in Philadelphia,Pennsylvania, is licensed to do business in the Philippines. It is engaged in theimportation, manufacture and sale of pharmaceuticals drugs and chemicals.

o In its 1971 original income tax return, respondent claimed deductionsfrom gross income of P501,040 ($77,060) as its share of the head officeoverhead expenses;

o However, respondent now claims that there was an underdeduction ofhome office overheard, hence it made a request for refund of theoverpayment with the CIR;

o Respondent had received from its international auditors , an authenticatedcertification to the effect that the Philippine share in the unallocated

overhead expenses of the main office for the year.

It further stated in the certification that the allocation wasmade on the basis of the percentage of gross income in thePhilippines to gross income of the corporation as a whole.

[what really matters] By reason of the new adjustment,Smith Kline's tax liability was greatly reduced from

P511,247 to P186,992 resulting in an overpayment of

P324,255. Respondent then filed a petition with the CTA even though

it had a pending case with the CIR.

CTA ordered the CIR to refund the overpayment and grant a tax credit to therespondent.

o CIR now appealed, hence the present case.LAWS:

The governing law is found in section 37 of the old National Internal RevenueCode, Commonwealth Act No. 466, which is reproduced in Presidential Decree No.1158, the National Internal Revenue Code of 1977 and which reads:

SEC. 37. Income form sources within the Philippines.xxx xxx xxx(b) Net income from sources in the Philippines. From the items ofgross income specified in subsection (a) of this section there shallbe deducted the expenses, losses, and other deductions properlyapportioned or allocated thereto anda ratable part of any expenses,losses, or other deductions which cannot definitely be allocated tosome item or class of gross income. The remainder, if any, shall beincluded in full as net income from sources within the Philippines.xxx xxx xxx

Revenue Regulations No. 2 of the Department of Finance contains the followingprovisions on the deductions to be made to determine the net income from Philippinesources:

SEC. 160.Apportionment of deductions. From the items specifiedin section 37(a), as being derived specifically from sources withinthe Philippines there shall be deducted the expenses, losses, and

other deductions properly apportioned or allocated thereto and aratable part of any other expenses, losses or deductions which cannot definitely be allocated to some item or class of gross income.The remainder shall be included in full as net income from sourceswithin the Philippines. The ratable part is based upon the ratio ofgross income from sources within the Philippines to the total grossincome.

EXAMPLE PROVIDED BY THE CASE:A non-resident alien individual whose taxable year is the calendar year, derived grossincome from all sources for 1939 of P180,000, including therein:Interest on bonds of a domestic corporation P9,000Dividends on stock of a domestic corporation 4,000

Royalty for the use of patents within the Philippines 12,000Gain from sale of real property located within the Philippines 11,000


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Total P36,000that is, one-fifth of the total gross income was from sources within the Philippines. Theremainder of the gross income was from sources without the Philippines, determinedunder section 37(c).The expenses of the taxpayer for the year amounted to P78,000. Of these expenses theamount of P8,000 is properly allocated to income from sources within the Philippinesand the amount of P40,000 is properly allocated to income from sources without thePhilippines.The remainder of the expense, P30,000, cannot be definitely allocated to any class of

income. A ratable part thereof, based upon the relation of gross income from sourceswithin the Philippines to the total gross income, shall be deducted in computing netincome from sources within the Philippines. Thus, these are deducted from the P36,000of gross income from sources within the Philippines expenses amounting to P14,000[representing P8,000 properly apportioned to the income from sources within thePhilippines and P6,000, a ratable part (one-fifth) of the expenses which could not beallocated to any item or class of gross income.] The remainder, P22,000, is the netincome from sources within the Philippines.

EXPLANTION OF PROVISIONS

From the foregoing provisions, it is manifest that where an expense is clearlyrelated to the production of Philippine-derived income or to Philippine

operations (e.g. salaries of Philippine personnel, rental of office building in

the Philippines), that expense can be deducted from the gross incomeacquired in the Philippines without resorting to apportionment.

The overhead expenses incurred by the parent company in connection with finance,administration, and research and development, all of which direct benefit itsbranches all over the world, including the Philippines, fall under a different categoryhowever.

o These are items which cannot be definitely allocated or Identified with theoperations of the Philippine branch.

o For 1971, the parent company of Smith Kline spent $1,077,739. Undersection 37(b) of the Revenue Code and section 160 of the regulations,Smith Kline can claim as its deductible share a ratable part of suchexpenses based upon the ratio of the local branch's gross income to thetotal gross income, worldwide, of the multinational corporation.

CIR CONTENDS:

The Commissioner contends that since the share of the Philippine branch has beenfixed at $77,060, Smith Kline itself cannot claim more than the said amount

The Commissioner also argues that the Tax Court erred in relying on thecertification of Peat, Marwick, Mitchell and Company that Smith Kline is entitled todeduct P1,427,484 ($219,547) as its allotted share and that Smith Kline has notpresented any evidence to show that the home office expenses chargeable toPhilippine operations exceeded $77,060.

RESPONDENT CONTENDS

Smith Kline submits that the contract between itself and its home office cannotamend tax laws and regulations.

Smith Kline had to amend its return because it is of common knowledge that auditedfinancial statements are generally completed three or four months after the close of

the accounting period. There being no financial statements yet when thecertification of January 11, 1972 was made the treasurer could not have correctlycomputed Smith Kline's share in the home office overhead expenses inaccordance with the gross income formula prescribed in section 160 of theRevenue Regulations. What the treasurer certified was a mere estimate.

Smith Kline likewise submits that it has presented ample evidence to support itsclaim for refund.

o To this end, it has presented before the Tax Court the authenticatedstatement of Peat, Marwick, Mitchell and Company to show that since

the gross income of the Philippine branch was P7,143,155 ($1,098,617)for 1971 as per audit report prepared by Sycip, Gorres, Velayo andCompany, and the gross income of the corporation as a whole was$6,891,052, Smith Kline's share at 15.94% of the home office overheadexpenses was P1,427,484 ($219,547) (Exh. G to G-2, BIR Records, 4-5).

COURT: The weight of evidence bolsters its position that the amount of

P1,427,484 represents the correct ratable share, the same having been

computed pursuant to section 37(b) and section 160.

In a manifestation dated July 19, 1983, Smith Kline declared that with respect to itsshare of the head office overhead expenses in its income tax returns for the years1973 to 1981, it deducted its ratable share of the total overhead expenses of its headoffice for those years as computed by the independent auditors hired by the parentcompany in Philadelphia, Pennsylvania U.S.A., as soon as said computations weremade available to it.

DISPOSITIVE:We hold that Smith Kline's amended 1971 return is in conformity with the law andregulations. The Tax Court correctly held that the refund or credit of the resultingoverpayment is in order.WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs.

-Ice

xxx

6. Definition of royalties

Philamlife v. CTA Ivan

CIR vs. Marubeni Corp

(Dec. 18, 2001)

DISCLAIMER: Please read the orig of this one. I dont know if this digest will be of anyreal help. D:

Definition of Terms:

Branch Profit Remittance Tax- Any profit remitted by a branch to its head office shallbe subject to a tax of fifteen (15%)


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Contractors tax A contractors tax is a tax imposed upon the privilege of engaging inbusiness. It is generally in the nature of an excise tax

Income tax- Tax on income

PONENTE: PUNO,J.

FACTS:

Marubeni Corporation is a foreign corporation organized and existing underthe laws of Japan, engaged in general import + export trading + financing +construction business. It is duly registered to engage in such business in thePhilippines and maintains a branch office in Manila.

Sometime in November 1985, CIR issued a letter of authority to examine thebooks of accounts of the Manila branch office for the fiscal year ending March1985. They found respondent to have undeclared income from 2 contractsin the Philippines, both of which were completed in 1984.

Contracts: (1) with the National Development Company (NDC) for theconstruction and installation of a wharf/port complex at the Leyte IndustrialDevelopment Estate (LIDE) in Isabel, Leyte. (2) with the Philippine Phosphate

Fertilizer Corporation (Philphos) for the construction of an ammonia storagecomplex also at the LIDE.

March 1, 1986 - CIR revenue examiners recommended an assessment fordeficiency income, branch profit remittance, contractors and commercial

brokers taxes.

The assessed deficiency internal revenue taxes, inclusive of surcharge andinterest, were as follows: (For March 31, 1985) Deficiency Income Tax:P 290,583,972.40, Deficiency Branch Profit Remittance Tax:P 83,036,965.16, Deficiency Commercial Brokers Tax: P 3,600,535.68 (seecase for computation)

CIR found thatthe NDC and Philphos contracts were made on a turn-keybasis and that the gross income from the two projects amountedto P967,269,811.14. Each contract was for a piece of work and since theprojects called for the construction and installation of facilities in the

Philippines, the entire income therefrom constituted income from

Philippine sources, hence, subject to internal revenue taxes. Theassessment letter further stated that the same was petitioners final decision

and that if respondent disagreed with it, respondent may file an appeal with theCourt of Tax Appeals within thirty (30) days from receipt of the assessment.

On September 26, 1986, respondent filed two (2) petitions for review with theCourt of Tax Appeals. CTA Case No. 4109, questioned the deficiency income,branch profit remittance and contractors tax assessments in petitioners

assessment letter. CTA Case No. 4110, questioned the deficiency commercialbrokers assessment in the same letter.

(NEXT PART IS ABOUT TAX AMNESTY, w hich weve already [andunnecessarily THOROUGHLY] discussed. Okay to skip, but I kept this here incase she asks again. :D)

August 2, 1986 Executive Order (E.O.) No. 41 declaring a one-time amnestycovering unpaid income taxes for the years 1981 to 1985 was issued. E.O., ataxpayer who wished to avail of the income tax amnesty should, on or beforeOctober 31, 1986 upon submission of certain requirements (see original forrequirements)

In accordance with the terms of E.O. No. 41, respondent filed its tax amnestyreturn dated October 30, 1986 and attached thereto its sworn statement ofassets and liabilities and net worth as of Fiscal Year (FY) 1981 and FY 1986.The return was received by the BIR on November 3, 1986 and respondentpaid the amount of P2,891,273.00 equivalent to ten percent (10%) of its networth increase between 1981 and 1986.

The period of the amnesty in E.O. No. 41 was later extended from October 31,1986 to December 5, 1986 by E.O. No. 54 dated November 4, 1986.

On November 17, 1986, the scope and coverage of E.O. No. 41 was expandedby Executive Order (E.O.) No. 64. In addition to the income tax amnestygranted by E.O. No. 41 for the years 1981 to 1985, E.O. No. 64 included estateand donors taxes under Title III and the tax on business un der Chapter II,Title V of the National Internal Revenue Code, also covering the years 1981to 1985. E.O. No. 64 further provided that the immunities and privilegesunder E.O. No. 41 were extended to the foregoing tax liabilities, and theperiod within which the taxpayer could avail of the amnesty was extended toDecember 15, 1986. Those taxpayers who already filed their amnesty returnunder E.O. No. 41, as amended, could avail themselves of the benefits,immunities and privileges under the new E.O. by filing an amended return

and paying an additional 5% on the increase in net worth to cover business,estate and donors tax liabilities.

The period of amnesty under E.O. No. 64 was extended to January 31, 1987by E.O No. 95 dated December 17, 1986.

On December 15, 1986, respondent filed a supplemental tax amnesty returnunder the benefit of E.O. No. 64 and paid a further amount of P1,445,637.00to the BIR equivalent to five percent (5%) of the increase of its net worthbetween 1981 and 1986.


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On July 29, 1996, The CTA rendered a decision finding tha respondent hadproperly availed of the tax amnesty under E.O. Nos. 41 and 64 and declared thedeficiency taxes subject of said case as deemed cancelled and withdrawn.

Petitioner challenged the decision of the tax court with the CA CA dismissed + affirmed CTA

ISSUES:

W/N: Marubeni corp could avail of the tax amnesty granted by E.O.41 and E.O. 64,considering that one of the exceptions under E.O. 41 of corps who can apply for amnestyare those with income tax cases already filed in the CTA as of its effectivity?

W/N: Contractors tax is included in the tax amnesty considering that E.O. 64 amended

E.O. 41 by including business tax in the coverage of tax amnesty

W/N: Assuming that the contractors tax was not covered in the tax amnesty such

tax was still exempted because it arose out of offshore activities

HELD:

1. Yes. This applies to both the income and branch remittance tax2. No. It does not have retroactive effect. There was already a pending case in the

CTA. The exception in E.O. 41 applies regardless if the words expressly usedwasincome

3. Yes. The Onshore activities were already declared and unquestioned. TheOffshore activities were not subject to tax as they were completed in

Japan.

RATIO:

1.

The main controversy in this case lies in the interpretation of the exception tothe amnesty coverage of E.O. Nos. 41 and 64. There are three (3) types of taxesinvolved hereinincome tax, branch profit remittance tax and contractors tax.These taxes are covered by the amnesties granted by E.O. Nos. 41 and 64.

Petitioner claims, however, that respondent is disqualified from availing of thesaid amnesties because the latter falls under the exception in Section 4 (b) ofE.O. No. 41:

b) Those with income tax cases already filed in Court as of the effectivityhereof;

Petitioner argues that at the time respondent filed for income tax amnesty

on October 30, 1986, The CTA Case had already been filed and waspending.

Petitioners claim cannot be sustained. Section 4 (b) of E.O. No. 41 is veryclear and unambiguous. It excepts from income tax amnesty thosetaxpayers with income tax cases already filed in court as of the effectivity

hereof. The point of reference is the date ofeffectivity of E.O. No. 41. Thefiling of income tax cases in court must have been made before and as ofthe date of effectivity of E.O. No. 41. Thus, for a taxpayer not to bedisqualified under Section 4 (b) there must have been no income tax casesfiled in court against him when E.O. No. 41 took effect. This is regardlessof when the taxpayer filed for income tax amnesty, provided of course hefiles it on or before the deadline for filing.

E.O. No. 41 took effect on August 22, 1986. CTA Case No. 4109 questioningthe 1985 deficiency income, branch profit remittance and contractors taxassessments was filed by respondent with the Court of Tax Appeals onSeptember 26, 1986. When E.O. No. 41 became effective on August 22,1986, CTA Case No. 4109 had not yet been filed in court. Respondentcorporation did not fall under the said exception in Section 4 (b), hence,respondent was not disqualified from availing of the amnesty for incometax under E.O. No. 41.

The same ruling also applies to the deficiency branch profit remittancetax assessment. A branch profit remittance tax is defined and imposed inSection 24 (b) (2) (ii), Title II, Chapter III of the National Internal Revenue

Code. In the tax code, this tax falls under Title II on Income Tax. It is a taxon income. Respondent therefore did not fall under the exception inSection 4 (b) when it filed for amnesty of its deficiency branch profitremittance tax assessment.

2. The difficulty herein is with respect to the contractors tax assessment andrespondents availment of the amnesty under E.O. No. 64. E.O. No. 64expanded the coverage of E.O. No. 41 by including estate and donors taxes

and tax on business.. The contractors tax is provided in Section 205, Chapter

II, Title V of the Tax Code; it is defined and imposed under the title onbusiness taxes, and is therefore a tax on business.

When E.O. No. 64 took effect on November 17, 1986, it did not provide forexceptions to the coverage of the amnesty for business, estate and donors

taxes. Instead, Section 8 of E.O. No. 64 provided that

Section 8. The provisions of Executive Orders Nos. 41 and 54 which are notcontrary to or inconsistent with this amendatory Executive Order shallremain in full force and effect.

By virtue of Section 8 as afore-quoted, the provisions of E.O. No. 41 notcontrary to or inconsistent with the amendatory act were reenacted in E.O.No. 64. Thus, Section 4 of E.O. No. 41 on the exceptions to amnesty coveragealso applied to E.O. No. 64. With respect to Section 4 (b) in particular, thisprovision excepts from tax amnesty coverage a taxpayer who hasincome tax cases already filed in court as of the effectivity hereof. As towhat Executive Order the exception refers to, respondent argues thatbecause of the words income and hereof, they refer to Executive Order

No. 41.


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In view of the amendment introduced by E.O. No. 64, Section 4 (b) cannot beconstrued to refer to E.O. No. 41 and its date of effectivity. The general rule isthat an amendatory act operates prospectively. While an amendment isgenerally construed as becoming a part of the original act as if it had alwaysbeen contained therein, it may not be given a retroactive effect unless it is soprovided expressly or by necessary implication and no vested right orobl

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