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SUBSTANTIATION RULE AND THE COHAN RULE

Santiago Gancayco v. The Collector of Internal RevenueL-13325 April 20, 1961

In 1950, Gancayco filed his income tax return for the year 1949. RespondentCollector of Internal Revenue issued a notice advising him that his income tax liabilityfor that year amounted P9,793.62, which he paid on May 15, 1950. A year later,respondent notified Gancayco that, upon investigation, there was still due from him, adeficiency income tax for the year 1949, the sum of P29,554.05. Gancayco sought areconsideration, which was part granted by respondent, who in a letter dated April 8,1953 informed petitioner that his income tax deficiency amounted to P16,860.31.Gancayco urged another reconsideration but no action taken on this request.

Respondent issued a warrant of distraint and levy against the properties ofGancayco for the satisfaction of his deficiency income tax liability. Upon petition of

Gancayco, the Court of Tax Appeal issued a resolution ordering the cancellation of thesale and directing that the same be readvertised at a future date, in accordance with theprocedure established by the National Internal Revenue Code. Subsequently, he filedan amended petition praying for the Court to allow the deduction of entertainment,representation and farming expenses.

ISSUE: Whether the sum his claim for deduction of two (2) items, namely: (a) forfarming expenses, P27,459.00; and (b) for representation expenses, P8,933.45 beallowed

No. Cohan Rule Principle states that if there is showing that expenses havebeen incurred but the exact amount thereof cannot be ascertained due to the absenceof documentary evidence, it is the duty of the BIR to make an estimate of deduction thatmay be allowed in computing the taxpayers taxable income bearing heavily against thetaxpayer whose inexactitude is of his own making. Substantiation Rule on the otherhand requires that before business or professional expenses are allowed as deductionsfrom gross income, the taxpayer must satisfy the BIR that the deductions being claimedare indeed ordinary and necessary expenses incurred during the taxable year carryingon any trade or business.

Gancayco's claim for representation expenses aggregated P31,753.97, of whichP22,820.52 was allowed, and P8,933.45 disallowed. Such disallowance is justified bythe record, for, apart from the absence of receipts, invoices or vouchers of theexpenditures in question, petitioner could not specify the items constituting the same, orwhen or on whom or on what they were incurred. The case of Cohan v. Commissioner,cited by petitioner is not in point, because in that case there was evidence on theamounts spent and the persons entertained and the necessity of entertaining them,although there were no receipts and vouchers of the expenditures involved therein.Such is not the case of petitioner herein.

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BAD DEBTS

Philex Mining Corporation v. Commissioner of Internal RevenueGR No. 148187 April 16, 2008

On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), enteredinto an agreement with Baguio Gold Mining Company (Baguio Gold) for the former tomanage and operate the latters mining claim, known as the Sto. Nino mine, located in

Atok and Tublay, Benguet Province. The parties agreement was denominated asPower of Attorney and provided that within three (3) years from date thereof, thePRINCIPAL (Baguio Gold) shall make available to the MANAGERS (Philex Mining) upto ELEVENMILLIONPESOS (P11,000,000.00), in such amounts as from time to timemay be required by the MANAGERS within the said 3-year period, for use in theMANAGEMENT of the STO. NINO MINE and that whenever the MANAGERS shalldeem 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 their arrangements.

However, the mine suffered continuing losses over the years which resulted topetitioners withdrawal as manager of the mine on January 28, 1982 and in the eventualcessation of mine operations on February 20, 1982 and thereafter the parties executeda Compromise with Dation in Payment wherein Baguio Gold admitted anindebtedness to petitioner in the amount of P179,394,000.00 and agreed to pay thesame in three segments by first assigning Baguio Golds tangible assets to petitioner,transferring to the latter Baguio Golds equitable title in its Philodrill assets and finallysettling the remaining liability through properties that Baguio Gold may acquire in thefuture.

In 1982, the parties executed an Amendment to Compromise with Dation inPaymentwhere the parties determined that Baguio Golds indebtedness to petitioneractually amounted to P259,137,245.00, which sum included liabilities of Baguio Gold toother creditors that petitioner had assumed as guarantor.

Likewise in its 1982 annual income tax return, petitioner deducted from its grossincome the amount of P112,136,000.00 as loss on settlement of receivables fromBaguio Gold against reserves and allowances. However, the Bureau of InternalRevenue (BIR) disallowed the amount as deduction for bad debt and assessedpetitioner a deficiency income tax of P62,811,161.39.

ISSUE:Whether or not the alleged bad debts are deductible

No. The requisites for a bad debt deduction were: (a) there was a valid andexisting debt; (b) the debt was ascertained to be worthless; and (c) it was charged offwithin the taxable year when it was determined to be worthless.

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The lower courts did not err in treating petitioners advances as investments in apartnership known as the Sto. Nino mine. The advances were not debts of BaguioGold to petitioner inasmuch as the latter was under no unconditional obligation to returnthe same to the former under the Power of Attorney. As for the amounts thatpetitioner paid as guarantor to Baguio Golds creditors, Baguio Golds debts were not

yet due and demandable at the time that petitioner paid the same. Verily, petitioner pre-paid Baguio Golds outstanding loans to its bank creditors and this conclusion issupported by the evidence on record.

Petitioner cannot claim the advances as a bad debt deduction from its grossincome. Deductions for income tax purposes partake of the nature of tax exemptionsand are strictly construed against the taxpayer, who must prove by convincing evidencethat he is entitled to the deduction claimed. In this case, petitioner failed to substantiateits assertion that the advances were subsisting debts of Baguio Gold that could bededucted from its gross income. Consequently, it could not claim the advances as avalid bad debt deduction.