Taxation (Income Tax) - Pp41-60

8/12/2019 Taxation (Income Tax) - Pp41-60

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TAXATION I (DEAN GRUBA)

CASE DOCTRINE FACTS

CIR v. Philippine Airlines, Inc., GR No. 160528,

9 October 2006

Q: What is taxable income? How is it

computed?Under PALs franchise, the basic corporate

income tax or franchise tax, whichever is

lower, that is payable by PAL in a given taxable

year shall be in lieu of all other taxes. Is the

20% final withholding tax on bank deposits

included in all other taxes? In CIR v.

Philippine Airlines, Inc., the Supreme Court

held affirmatively.[As a consequence, PAL was

held to be entitled to a refund of the 20% FWT

it paid on bank deposits for the period starting

March 1995 through November 1997.] A

corporate income tax liability has twocomponents: the general rate of now 30%, and

the specific final rates for certain passive

incomes. In arriving at the taxable income of

PAL, are these passive incomes taken into

consideration? No. The definition of gross

income is broad enough to include all passive

incomes subject to specific rates or final taxes.

However, since these passive incomes are

already subject to different rates and taxed

finally at source, they are no longer included in

thecomputation of gross income, which

determines taxable income.

The case involves the application of the tax

provision in PALs franchise defining its liability

for taxes. P.D. 1590, the legislative franchise of

PAL granted it an option to pay the lower of

two alternatives: (1) the basic corporate

income tax based on PALs annual net taxable

income computed in accordance with the

provisions of the NIRC, or (2) a franchise tax of

two percent of gross revenues. Availment of

either of these two alternatives shall exempt

the airline from the payment of all other

taxes. On this basis, a claim for refund of the

20% final withholding tax on its interest

income with various banks was instituted.

CIR v. Philippine Airlines, Inc., GR No. 180066,

7 July 2009

Q: What is taxable income? How is it

computed?Under PALs franchise, the basic corporate

income tax or franchise tax, whichever is

lower, that is payable by PAL in a given taxable

year shall be in lieu of all other taxes. Is

For its fiscal year ending 31 March 2001 (FY

2000-2001), PAL incurred zero taxable income,

which left it with unapplied creditable

withholding tax in the amount of P2.3M. PAL

did not pay any MCIT for the period. In a letter

dated 12 July 2002, addressed to CIR, PAL

requested for the refund of its unapplied


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MCIT included in all other taxes? In CIR v.

Philippine Airlines, Inc.,the Supreme Court

held affirmatively. [As a consequence, PAL was

held not liable to pay MCIT for the fiscal year

2000-2001.] Although regular corporate

income tax and minimum corporate income

tax are both income taxes, they are computed

differently, i.e., varying rates and bases. The

basis for regular corporate income tax is

taxable income, while the basis for minimum

corporate income tax is gross income. It must

be further noted that the gross income base

for MCIT is slightly different from gross

income under Section 32 of the 1997 Tax

Code.Taxable income is defined under Section 31 of

the NIRC of 1997 as the pertinent items ofgross income specified in the said Code, less

the deductions and/or personal and

additional exemptions, if any, authorized for

such types of income by the same Code or

other special laws. The gross income, referred

to in Section 31, isdescribed in Section 32 of

the NIRC of 1997 as income from whatever

source, including compensation for services;

the conduct of trade or business or the

exercise of profession; dealings in property;

interests; rents; royalties; dividends; annuities;

prizes and winnings; pensions; and a partners

distributive share in the net income of a

general professional partnership.On the other hand, gross income in relation

to MCIT is understood to mean gross receipts,

less sales returns, allowances, discounts and

cost of services. Noticeably, inclusions in

andexclusions/deductions from gross income

creditable withholding tax for FY 2000-2001.

PAL attached to its letter the following: (1)

Schedule of Creditable Tax Withheld at Source

for FY 2000-2001; (2) Certificates of Creditable

Taxes Withheld; and (3) Audited Financial

Statements. Acting on the aforementioned

letter of PAL, the Large Taxpayers Audit and

Investigation Division 1 (LTAID 1) of the BIR

Large Taxpayers Service (LTS), issued Tax

Verification authorizing Revenue Officer Cueto

to verify the supporting documents and

pertinent records relative to the claim of PAL

for refund of its unapplied creditable

withholding tax for FY 2000-20001. LTAID 1

Chief Linsangan invited PAL to an informal

conference.

BIR officers and PAL representatives attended

the scheduled informal conference, during

which the former relayed to the latter that the

BIR was denying the claim for refund of PAL

and, instead, was assessing PAL for deficiency

MCIT for FY 2000-2001. The PAL

representatives argued that PAL was not liable

for MCIT under its franchise. The BIR officers

then informed the PAL representatives that

the matter would be referred to the BIR Legal

Service for opinion.


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for MCIT purposes are limited to those directly

arising from the conduct of the taxpayers

business. It is, thus, more limited than the

gross income used in the computation of basic

corporate income tax.Nitafan v. CIR, GR No. 78780, 23 July 1987 Q: Are the salaries of the members of the

judiciary subject to income tax?

Are salaries of judges subject to income tax?

Yes. Nitafan v. CIRconfirmed that during their

continuance in office, judges and justices enjoy

the constitutional protection against decrease

of their salaries. However, the salaries of

members of the judiciary are subject to the

general income tax applied to all taxpayers.

The Chief Justice has previously issued a

directive to the Fiscal Management and

Budget Office to continue to deduct

withholding taxes from the salaries of the

Justices of the Supreme Court and other

members of the judiciary. This was affirmed by

the Supreme Court En Banc on 4 December

1987. RTC judges seek to prohibit or enjoin the

Commissioner of the Internal Revenue and the

Financial Officer of the Supreme Court from

making any deduction of withholding taxesfrom their salaries.

CIR v. British Overseas Airways Corporation,

GR Nos. L-65773-74, 30 April 1987.

Q: What is gross income?In CIR v. British Overseas Airways Corporation,

BOAC was a British Government-owned

corporation engaged in the international

airline business. As such, it operated air

transportation service and sold transportation

tickets over the routes of the other airlinemembers. For the years 1959 to 1971, BOAC

had no landing rights for traffic purposes in the

Philippines. It did not carry passengers and/or

cargo to and from the Philippines, although

from 1959 to 1971, BOAC maintained a

general sales agent in the country which was

responsible for selling BOAC tickets covering

passengers and cargoes. The CIR issued an

assessment against BOAC for deficiency

income taxes for the years 1959 to 1971 for

British Overseas Airways Corporation

(BOAC) is a 100% British Government

Owned airline corporation organized under

the laws of the UK. BOAC maintains a

general sales agent (of its tickets) in the

Philippines namely Warner and Barnes

and Qantas Airways. It also did not have

landing rights in the Philippines. It wasassessed deficiency income taxes by CIR

in the years 1959-1963 and 1968-1979.

However, on appeal, the CTA held that the

proceeds of sales of BOAC tickets in the

Philippines do not constitute BOAC income

from Philippine sources since no service of

carriage of passengers or freight was

performed by BOAC within the Philippines

therefore said income is not subject to


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the sale of tickets in the Philippines for air

transportation. Did BOACs income from the

sale of tickets in the Philippines come from

sources within the Philippines and thus taxable

under Philippine income tax laws? The

Supreme Court held in the affirmative.

Although the enumeration in now Section

32(A) of the 1997 Tax Code does not include

income from the sale of tickets for

international transportation, the definition of

gross income is broad and comprehensive to

include proceeds from the sale of transport

documents. *Section 32 of the 1997 Tax

Code], by its language, does not intend the

enumeration to be exclusive. It merely directs

that the types of income listed therein be

treated as income from sources within thePhilippines. A cursory reading of the section

will show that it does not state that it is an all-

inclusive enumeration, and that no other kind

of income may be so considered."

income tax. The CTA held that the place

where services are rendered determines

the source of the income. The petitioner

contends that the revenue derived by

BOAC from sales of tickets in the

Philippines are taxable and that BOAC

should be considered a resident foreigncorporation and accordingly taxed as such.

Sison v. Ancheta, GR No. L-59431, 25 July 1984 Q: Compensation for services in whatever

form paid; illustrative case.See the case of Sison v. Anchetawhich was

governed by the 1977 Tax Code. Under the oldcode, a higher tax rate was imposed on

professional and business income than on

compensation income. Sison attacked the

distinction made by law on such grounds as

equal protection and uniformity in taxation.

The Supreme Court justified the difference in

treatment, thus: Taxpayers who are

recipients of compensation income are set

apart as a class. As there is practically no

overhead expense, these taxpayers are not

Sison, as a taxpayer, questions the validity of

Section 1 of BP 135 which amended Section 21

of the NIRC of 1977. BP 135 provides for rates

of tax on citizens or residents on: (a) taxable

compensation income, (b) taxable net income,(c) Royalties, prizes and other winnings, (d)

Interest from bank deposits and yield or any

other monetary benefit from deposit

substitutes and from trust fund and similar

arrangements, (e) Dividends and share of

individual partner in the net profits of taxable

partnership, and (e) Adjusted gross income.

Sison characterizes the law as arbitrary,

amounting to class legislation, oppressive and

capricious. Petitioner invokes the Equal


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entitled to make deductions for income tax

purposes because they are in the same

situation more or less. On the other hand, in

the case of professionals in the practice of

their calling and businessmen, there is no

uniformity in the costs or expenses necessary

to produce their income. It would not be just

then to disregard the disparities by giving all of

them zero deduction and indiscriminately

impose on all alike the same tax rates on the

basis of gross income. There is ample

justification then for the Batas Pambansa to

adopt the gross system of income taxation to

compensation income, while continuing the

system of net income taxation as regards

professional and business income.

Protection and Due Process clauses, as well as

the rule requiring Uniformity in Taxation.

Tan v. del Rosario, GR Nos. 109289 and109446, 3 October 1994

Q: Gross income derived from the conduct oftrade or business or the exercise of a

profession; illustrative case.The case of Tan v. del Rosariodealt with the

constitutionality of RA No. 7496, also

commonly known as the Simplified Net

Income Taxation Scheme (SNIT), amending

certain provisions of the old Tax Code. One

argument raised by petitioners was that the

law now taxed single proprietorships and

professionals differently from the manner it

imposed tax on corporations and partnerships.

Another argument was that general

professional partnerships should not be

treated differently from ordinary business

partnerships. The Supreme Court held that the

classification made between single

proprietorships and professionals on the one

hand, and corporations and partnerships on

Petitioners assail the constitutionality ofRA7496, known as the Simplified Net Income

Taxation Scheme (SNIT), which amended

certain provisions of the NIRC. They also seek

a declaration that public respondents have

exceeded their rule-making authority in

applying SNIT to general professional

partnerships through the issuance of Revenue

Regulations No 2-93, specifically Section 6

thereof


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the other, was valid. Furthermore, as regards

the first group, i.e., single proprietorships and

professionals: There is, then and now, no

distinction in income tax liability between a

person who practices his profession alone or

individually and one who does it through

partnership (whether registered or not) with

others in the exercise of a common profession.

Indeed, outside of the gross compensation

income tax and the final tax on passive

investment income, under the present income

tax system all individuals deriving from any

source whatsoever are treated in almost

invariably the same manner and under a

common set of rules.

CIR v. Court of Appeals, GR No. 108576, 20

January 1999

Q: Dividends; illustrative case

At issue in CIR v. Court of Appealswas the

taxability of the shares of stock in ANSCOR

owned by the estate of Don Andres Soriano as

well as Don Andres Sorianos widow, Doa

Carmen Soriano. On various dates, (1) the

estate and Doa Carmen exchanged a portion

of their common shares for preferred shares,

and (2) ANSCOR redeemed a portion of the

common shares owned by the estate and

Doa Carmen. ANSCORs business purpose for

the redemption of stocks was to partially retire

said stocks as treasury shares in order to

reduce the companys foreign exchange

remittances in case cash dividends were

declared. Subsequently, ANSCOR was issued

an assessment for deficiency withholding tax

at source based on the transactions of

exchange and redemption of stocks. Regarding

the exchange of stocks, the Supreme Court

Don Andres Soriano, a citizen and resident of

the United States, formed the corporation "A.Soriano Y Cia", predecessor of ANSCOR.

ANSCOR is wholly owned and controlled by

the family of Don Andres, who are all non-

resident aliens. Don Andres died, but his

estate continued to receive stock dividends as

well as his wife Doa Carmen Soriano.

Pursuant to a board resolution, ANSCOR

redeemed a stated in the Board Resolutions,

ANSCOR's business purpose for both

redemptions of stocks is to partially retire said

stocks as treasury shares in order to reduce

the company's foreign exchange remittances

in case cash dividends are declared. ANSCOR

also reclassified some of Doa Carmens

common shares to preferred shares. After

examining ANSCOR's books of account and

records, Revenue examiners issued a report

proposing that ANSCOR be assessed for

deficiency withholding tax-at-source based on


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found that there was no change in the

proportional interest of the estate and Doa

Carmen before and after the exchange. The

exchange transaction did not result into a flow

of wealth and hence, there was no income tax

liability.As regards the redemption of stocks, the issue

was, particularly, whether ANSCORs

redemption of stocks from its stockholder as

well as the exchange of common with

preferred shares could be considered as

essentially equivalent to the distribution of

taxable dividends, making the proceeds

thereof taxable income. The Supreme Court

started by saying that the stock dividends,

strictly speaking, represent capital and do not

constitute income to its recipient. The mereissuance of stock dividends is not yet subject

to income tax. As capital, the stock dividends

postpone the realization of profits. However, a

redemption of the stocks converts into money

the stock dividends which become a realized

profit or gain and consequently, the

stockholders separate property. As realized

income, the proceeds of the redeemed stock

dividends can be reached by income taxation

regardless of the existence of any business

purpose for the redemption. Here, the

proceeds of the redemption of the stock

dividends were deemed taxable dividends, i.e.,

income subject to income tax which was

required to be withheld at source.The determining factor for the imposition of

income tax is whether any gain or profit was

derived from a transaction. Furthermore,

there are 3 elements in the imposition of

the transactions of exchange and redemption

of stocks. ANSCOR filed a petition for review

with the CTA assailing the tax assessments on

the redemptions and exchange of stocks. The

CTA ruled that ANSCORs redemption and

exchange of the stocks of its foreign

stockholders cannot be considered as

"essentially equivalent to a distribution of

taxable dividends" under Section 83(b) of the

then 1939 Internal Revenue Act. ANSCOR

avers that it has no duty to withhold any tax

either from the Don Andres estate or from

Doa Carmen based on the two transactions,

because the same were done for legitimate

business purposes which are (a) to reduce its

foreign exchange remittances in the event the

company would declare cash dividends, and to(b) subsequently "filipinized" ownership of

ANSCOR, as allegedly, envisioned by Don

Andres. It likewise invoked the amnesty

provisions of P.D. 67.


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income tax, namely: (1) there must be gain or

profit; (2) the gain or profit is realized or

received, actually or constructively; and (3) the

gain or profit is not exempted by law or treaty

from income tax. Any business purpose as to

why or how the income was earned by the

taxpayer is not a requirement. Income tax is

assessed on income received from any

property, activity or service that produces the

income because the Tax Code stands as an

indifferent neutral party on the matter where

income comes from.El Oriente Fabrica de Tabacos, Inc. v. Posadas,

GR No. 34774, 21 September 1931

Q: Are proceeds of life insurance policies

excluded from gross income?Section 32(B) of the 1997 Tax Code partlyprovides: The following items shall not be

included in gross income and shall be exempt

from taxation under this title: xxx The

proceeds of life insurance policies paid to the

heirs or beneficiaries upon the death of the

insured, whether in a single sum or otherwise,

but if such amounts are held by the insurer

under an agreement to pay interest thereon,

the interest payments shall be included in

gross income. The law is clear that the

proceeds of life insurance policies paid to

individual beneficiaries are excluded from

gross income. Suppose the proceeds of a life

insurance policy are paid to a corporate

beneficiary upon the death of the insured, are

such proceeds likewise excluded from gross

income? In El Oriente Fabrica deTabacos, Inc.

v. Posadas, El Oriente took out insurance on

the life ofits manager, who had more than 35

El Oriente in order to protect itself against the

loss that it might suffer by reason of the death

of its manager, A. Velhagen, who had had

more than thirty-five (35) years of experiencein the manufacture of cigars in the Philippines,

procured from the Manufacturers Life

Insurance Co., of Toronto, Canada, thru its

local agent E. E. Elser, an insurance policy on

the life of the said A. Velhagen for the sum of

$50,000, United States currency designating

itself as the beneficiary.

El Oriente paid for the premiums due thereon

and charged as expenses of its business all the

said premiums and deducted the same from

its gross incomes as reported in its annual

income tax returns, which deductions were

allowed upon a showing that such premiums

were legitimate expenses of its business.

Upon the death of A. Velhagen in 1929, the El

Oriente received all the proceeds of the said

life insurance policy, together with the


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years of experience in the manufacture of

cigars in the Philippines, to protect itself

against the loss it might suffer by reason of the

death of its manager. The Supreme Court held

that: Considering, therefore, the purport of

the stipulated facts, considering the

uncertainty of Philippine law, and considering

the lack of express legislative intention to tax

the proceeds of life insurance policies paid to

corporate beneficiaries, particularly when in

the exemption in favor of individual

beneficiaries in the chapter on this subject, the

clause is inserted exempt from the provisions

of this law, we deem it reasonable to hold the

proceeds of the life insurance policy in

question as representing an indemnity and not

taxable income. *Note that this case wasdecided in 1931, and that in our present Tax

Code, the clause exempt from provisions of

this law does not appear anywhere in Section

32 of the code.]

interests and the dividends accruing thereon,

aggregating P104,957.88

CIR assessed El Oriente for deficiency taxes

because El Oriente did not include as income

the proceeds received from the insurance.

Santos v. Servier Philippines, Inc., GR No.

166377, 28 November 2008

Q: When are retirement benefits excluded

from gross income?

In Santos v. Servier Philippines, Inc., Santos was

the human resource manager of Servier

Philippines, Inc. since 1991. In 1998, while on

vacation in Paris, Santos suffered from a

sudden attack of alimentary allergy. Despite

months of medical treatment, Santos did not

fully recover mentally and physically. Servier

Philippines, Inc. was constrained to terminate

Santos services effective 31 August 1999. As a

consequence thereof, Servier Philippines, Inc.

offered Santos a retirement package. Were

Santos retirement benefits taxable? The

Santos was the Human Resource Manager of

Servier Philippines, Inc. Santos attended a

meeting of all human resource managers of

Servier, held in Paris, France. Since the last day

of the meeting coincided with the graduation

of Santos only child, she arranged for a

European vacation with her family right after

the meeting. She, thus, filed a vacation leave.

Santos, together with her husband Antonio P.

Santos, her son, and some friends, had dinner

at Leon des Bruxelles, a Paris restaurant

known for mussels as their specialty. While

having dinner, Santos complained of stomach

pain, then vomited. Eventually, she was

brought to a hospital where she fell into coma


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Supreme Court held in the affirmative. For

retirement benefits to be exempt from income

tax, and hence withholding tax, the taxpayer is

burdened to prove the concurrence of the

following elements:(1)a reasonable private benefit plan is

maintained by the employer;

(2) the retiring employee has been in the

service of the same employer for at

least 10 years;

(3) the retiring employee is not less than

50 years of age at the time of his/her

retirement; and

(4) the benefit had been availed of only

once.

Here, at the time of her retirement, Santos

was only 41 years of age, and had been in theservice for more or less 8 years. As such,

Section 32(B)(6)(a) of the 1997 Tax Code was

inapplicable for failure to comply with the age

and length of service requirements. The

retirement benefits received by Santos were

taxable.

for 21 days; and later stayed at the ICU for 52

days. The hospital found that the probable

cause of her sudden attack was "alimentary

allergy. During the time that Santos was

confined at the hospital, her husband and son

stayed with her in Paris. Santos

hospitalization expenses, as well as those of

her husband and son, were paid by Servier.

Santos was then allowed to go back to the

Philippines to continue her medical treatment.

She was confined at St. Lukes. During the

period of Santos rehabilitation, Servier

continued to pay Santos salaries and to assist

her in paying her hospital bills. Thereafter,

Servier informed Santos that it requested her

physician to conduct an evaluation of her

condition to determine her fitness to resumeher work at the company. It was concluded

that she was not fully recovered mentally and

physically. Hence, Servier was constrained to

terminate Santos services. As a consequence

of her termination from employment, Servier

offered a retirement package. Of the promised

retirement benefit, a portion was withheld

allegedly for taxation purposes. Servier also

failed to give other benefits in the package.

Santos filed a case against Servier. Santos

raised the legality of said deduction and stated

that it formed an "unpaid balance of the

retirement package."

Intercontinental Broadcasting Corporation

(IBC) v. Amarilla, GR No. 162775, 27 October

2006


from gross income?

In Intercontinental Broadcasting Corporation

(IBC) v. Amarilla,

Quiones, Amarilla, Lagahit, and Otadoy

Intercontinental Broadcasting Corporation

(IBC) employed at its Cebu Station the

petitioners Amarilla, Quinones, Lagahit and

Otadoy. The four employees retired from the

company and received, on staggered basis,

their retirement benefits under the collective


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retired from IBC. It was agreed that IBC would

shoulder the income tax due on the retirement

benefits to be received by the four individuals.

The Supreme Court first held that the

retirement benefits granted to the retirees

were taxable. However, the Court

acknowledged that IBC bound itself to pay the

taxes on the retirement benefits. An

agreement to pay the taxes on the retirement

benefits as an incentive to prospective retirees

and for them to avail of the optional

retirement scheme is not contrary to law or to

public morals. Petitioner had agreed to

shoulder such taxes to entice them to

voluntarily retire early, on its belief that this

would prove disadvantageous to it.

Respondents agreed and relied on thecommitment of petitioner. For petitioner to

renege on its contract with respondents simply

because its new management had found the

same disadvantageous would amount to a

breach of contract.

bargaining agreement (CBA) between IBC and

the bargaining unit of its employees. In the

meantime, a salary increase was given to all

employees, current and retired. However,

when the four retirees demand theirs, the IBC

refused and instead informed them that their

differentials would be used to offset the tax

due on their retirement benefits in accordance

with the NIRC. The retirees thus lodged a

complaint with the NLRC questioning said

withholding. They averred that their

retirement benefits were exempt from income

tax; and IBC had no authority to withhold their

salary differentials. For its part, the IBC

averred that the retirement benefits received

by employees from their employers constitute

taxable income. While retirement benefits areexempt from taxes under the Code, the law

requires that such benefits received should be

in accord with a reasonable retirement plan

duly registered with the BIR after compliance

with the requirements therein enumerated.

Since its retirement plan in the CBA was not

approved by the BIR, the retirees were liable

for income tax on their retirement benefits.

The Labor Arbiter rendered judgment in

favour of the retirees. The NLRC affirmed. IBC

appealed to the CA. The CA dismissed the

petition and held that the salary differentials

of the respondents are part of their taxable

gross income, considering that the CBA was

not approved, much less submitted to the BIR.

However, petitioner could not withhold the

corresponding tax liabilities of respondents

due to the then existing CBA, providing that

such retirement benefits would not be


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subjected to any tax deduction, and that any

such taxes would be for its account.

CIR v. Court of Appeals, GR No. 96016, 17

October 1991


from gross income?

In CIR v. Court of Appeals,Castaeda retired

from the government service as revenue

attach in the Philippine Embassy in London.

Upon retirement, he received terminal leave

pay from which the CIR withheld a certain

amount allegedly representing income tax

thereon. The issue in this case was whether

terminal leave pay received by a government

official or employee on the occasion of his

compulsory retirement from the government

service was subject to income tax, and hence

withholding tax. The Supreme Court ruled thatterminal leave pay was not a part of the gross

income of a government official or employee,

but a retirement benefit that was not subject

to income tax. Commutation of leave credits is

more commonly known as terminal leave. In

the exercise of sound personnel policy, the

Government encourages unused leaves to be

accumulated. The Government recognizes that

for most public servants, retirement pay is

always less than generous if not meager and

scrimpy. A modest nest egg which the senior

citizen may look forward to is thus avoided.

Terminal leave payments are given not only at

the same time but also for the same policy

considerations governing retirement benefits.

Castaneda retired from the government

service as Revenue Attache in the Philippine

Embassy in London. Upon retirement, he

received, among other benefits, terminal leave

pay from which the CIR withheld a portion

allegedly representing income tax thereon.

Castaneda filed a claim with the CIR for refund

contending that the cash equivalent of his

terminal leave is exempt from income tax. He

likewise filed a petition for review with the

CTA. The CTA ruled in favor of Castaneda and

ordered the CIR to refund Castaneda. CA

affirmed the decision of the CTA. Hence, this

petition by the CIR. The Solgen, acting on

behalf of the CIR, contends that the terminalleave pay is income derived from employer-

employee relationship; that as part of the

compensation for services rendered, terminal

leave pay is actually part of gross income of

the recipient.

CIR v. Central Luzon Drug Corporation, GR No.

159610, 12 June 2008.

Q: Differentiate between a tax deduction and

a tax credit. Respondent is a domestic corporationprimarily engaged in retailing of medicines andpharmaceutical products. Respondent granted


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How may a drugstore treat the 20% discount

given to senior citizens? May it be claimed as a

tax deduction from gross income or a tax

credit? The case of CIR v. Central Luzon Drug

Corporationcovered the taxable year 1997

and thus applied the old rule under RA No.

7432, i.e., the 20% senior citizens discount

could be claimed as a tax credit. However,

with the effectivity of RA No. 9257 (21 March

2004), there is now a new tax treatment for

senior citizens discount granted by all covered

establishments. This discount should be

considered as a deductible expense from gross

income and no longer as tax credit.

20% percent sales discount to qualified senior

citizens on their purchase of medicines.

Respondent filed for a tax refund/credit

alledgly arising from the 20% sales discount

granted by respondent to qualified senior

citizens in compliance with RA 7432. Unable to

obtain an affirmative response from

petitioner, Respondent elevated its claim to

the CTA. The CTA dismissed the petition but

eventually granted the motion for

reconsideration ordering petitioner to issue a

Tax Credit certificate. CA affirmed. Hence, this

petition.

Carlos Superdrug Corp. v. Department of

Social Welfare and Development (DSWD), GR

No. 166494, 29 June 2007

Q: Differentiate between a tax deduction and

a tax credit.In Carlos Superdrug Corp. v. Department of

Social Welfare andDevelopment (DSWD),

petitioners were drugstores assailing the

constitutionality of RA No. 9257, particularly,

the validity of the tax deduction scheme as a

reimbursement mechanism for the 20% senior

citizens discount. A tax deduction was

differentiated from a tax credit in this wise:

the tax deduction scheme does not fully

reimburse petitioners for the discount

privilege accorded to senior citizens. This is

because the discount is treated as a deduction,

a tax-deductible expense that is subtracted

from the gross income and results in a lower

taxable income. Stated otherwise, it is an

amount that is allowed by law to reduce the

income prior to the application of the tax rate

to compute the amount of tax which is due.

Being a tax deduction, the discount does not

Petitioners are domestic corporations and

proprietors operating drugstores in the

Philippines. Petitioners assail theconstitutionality of Section 4(a) of RA 9257,

otherwise known as the Expanded Senior

Citizens Act of 2003. Section 4(a) of RA 9257

grants twenty percent (20%) discount as

privileges for the Senior Citizens. Petitioner

contends that said law is unconstitutional

because it constitutes deprivation of private

property.


14/37

reduce taxes owed on a peso for peso basis

but merely offers a fractional reductions in

taxes owed. On the other hand, a tax credit is

a peso-for-peso deduction from a taxpayers

tax liability due to the government of the

amounts of seniors citizens discount given by

the covered establishment. Such

establishment recovers the full amount and

hence, the government shoulders 100% of the

discounts granted. Ultimately, the Supreme

Court upheld the constitutionality of RA No.

9257 primarily on the ground that the law was

a legitimate exercise of police power.Basilan Estates, Inc. v. CIR, GR No. L-22492, 5

September 1967

Q: In general, what is the treatment accorded

to deductions from gross income?In Basilan Estates, Inc. v. CIR, petitioner was a

domestic corporation engaged in the coconut

industry. In 1953, petitioner received a

deficiency income tax assessment partly due

to disallowed deductions from its gross income

in the form of depreciation, travelling and

miscellaneous expenses. One issue tackled was

whether depreciation should be determined

on the acquisition cost or on the reappraised

value of the assets. The Supreme Court ruled

that the income tax law did not authorize the

depreciation of an asset beyond its acquisition

cost. A deduction over and above such cost

must be disallowed. The reason is that

deductions from gross income are privileges,

not matters of right. They are not created by

implication but upon clear expression in the

law.Moreover, the recovery, free of income tax, of

Basilan Estates, Inc. claimed deductions for the

depreciation of its assets on the basis of their

acquisition cost. As of January 1, 1950 itchanged the depreciable value of said assets

by increasing it to conform with the increase

in cost for their replacement. Accordingly,

from 1950 to 1953 it deducted from gross

income the value of depreciation computed on

the reappraised value.

CIR disallowed the deductions claimed by

petitioner, consequently assessing the latter of

deficiency income taxes.


15/37

an amount more than the invested capital in

an asset will transgress the underlying purpose

of a depreciation allowance. For then what the

taxpayer would recover will be not only the

acquisition cost, but also some profit.

Recovery in due time thru depreciation of

investment made is the philosophy behind

depreciation allowance; the idea of profit on

the investment made has never been the

underlying reason for the allowance of a

deduction for depreciation.Aguinaldo Industries Corporation v. CIR, GR

No. L-29790, 25 February 1982


to deductions from gross income?InAguinaldo Industries Corporation v. CIR,

when petitioner sold its property inMuntinglupa, the corporate officers of

petitioner were given bonuses. The amount

representing these bonuses was claimed by

petitioner as a deductible business expense.

The Supreme Court held that the bonuses

could not be deemed a deductible expense for

tax purposes, even if the aforesaid sale could

be considered as a transaction for carrying on

the trade or business of the petitioner and the

grant of the bonus to the corporate officers

pursuant to petitioners by-laws could, as an

intra-corporate matter, be sustained. Citing

Alhambra Cigar andCigarette Manufacturing

Co. v. CIR (GR No. L- 12026, 29 May 1959),the

Supreme Court stated that: whenever a

controversy arises on the deductibility, for

purposes of income tax, of certain items for

alleged compensation of officers of the

taxpayer, two (2) questions become material,

Aguinaldo Industries Corporation (AIC) is a

domestic corporation engaged in the

manufacture of fishing nets, a tax-exempt

industry and the manufacture of furniture. For

accounting purposes, each division is providedwith separate books of accounts. Previously,

AIC acquired a parcel of land in Muntinlupa,

Rizal, as site of the fishing net factory. Later, it

sold the Muntinlupa property. AIC derived

profit from this sale which was entered in the

books of the Fish Nets Division as

miscellaneous income to distinguish it from its

tax-exempt income.

For the year 1957, AIC filed two separate

income tax returns for each division. After

investigation, the examiners of the BIR found

that the Fish Nets Division deducted from its

gross income for that year the amount of

P61,187.48 as additional remuneration paid to

the officers of AIC. This amount was taken

from the net profit of an isolated transaction

(sale of Muntinlupa land) not in the course of

or carrying on of AIC's trade or business, and

was reported as part of the selling expenses of


16/37

namely: (a) Have personal services been

actually rendered by said officers? (b) In the

affirmative case, what is the reasonable

allowance therefor? Here, no evidence was

presented to show that the corporate officers

who received bonuses had a hand in the sale

transaction of the Muntinglupa property

[which could be the basis of a grant to them of

the bonuses out of the profit derived from the

sale]. Thus, the amount representing the

bonuses could not be allowed as a deductible

business expense.This posture is in line with the doctrine in the

law of taxation that the taxpayer must show

that its claimed deductions clearly come within

the language of the law since allowances, like

exemptions, are matters of legislative grace.

the Muntinlupa land. Upon recommendation

of the examiner that the said sum of

P61,187.48 be disallowed as deduction from

gross income, petitioner asserted in its letter

of February 19, 1958, that said amount should

be allowed as deduction because it was paid

to its officers as allowance or bonus pursuant

to its by-laws.

CIR v. General Foods (Phils.), Inc., GR No.

143672, 24 April 2003


to deductions from gross income?To be deductible from gross income, an

advertising expense must comply with the

following requirements:(1) the expense must be ordinary and

necessary;

(2) it must have been paid or incurred

during the taxable year;

(3) it must have been paid or incurred in

carrying on the trade or business of the

taxpayer; and

(4) it must be supported by receipts,

records or other pertinent papers.

In CIR v. General Foods (Phils.), Inc.,

respondent filed its income tax return for

1985, claiming a certain amount as deductible

Respondent corporation General Foods (Phils),

which is engaged in the manufacture of

Tang, Calumet and Kool-Aid, filed its

income tax return for the fiscal year ending

February 1985 and claimed as deduction,

among other business expenses, P9,461,246

for media advertising for Tang.

The Commissioner disallowed 50% of the

deduction claimed and assessed deficiency

income taxes of P2,635,141.42 against General

Foods, prompting the latter to file an MR

which was denied.

General Foods later on filed a petition for

review at CA, which reversed and set aside an

earlier decision by CTA dismissing the

companys appeal.


17/37

media advertising expense for the product

Tang. Respondent and the CIR were in

agreement that the subject advertising

expense was paid or incurred within the

relevant taxable year and was incurred in

carrying on a trade or business. Hence, it was

necessary. However, as to whether it was

ordinary, their views were in conflict. The CIR

maintained that the subject advertising

expense was not ordinary for failure to comply

with two requirements set by US

jurisprudence: (1) the amount incurred must

be reasonable, and (2) the amount incurred

must not be a capital outlay to create

goodwill for the product and/or the

corporations business. *Otherwise, the

expense must be considered a capitalexpenditure to be spread out over a

reasonable time.]There is yet to be a clear-cut criteria or fixed

test for determining the reasonableness of an

advertising expense. There being no hard and

fast rule on the matter, the right to a

deduction depends on a number of factors

such as but not limited to: the type and size of

business in which the taxpayer is engaged; the

volume and amount of its net earnings; the

nature of the expenditure itself; the intention

of the taxpayer and the general economic

conditions. It is the interplay of these, among

other factors and properly weighted, that will

yield a proper evaluation. Here, the Supreme

Court held that the advertising expense for a

single product (Tang) was inordinately large.

Even if it was necessary, it could not be

considered an ordinary expense. In order to be


18/37

deductible, a business expense must be both

ordinary and necessary.Deductions for income tax purposes partake

the nature of tax exemptions; hence, if tax

exemptions are strictly construed, then

deductions must also be strictly construed

[against the taxpayer and liberally in favor of

the taxing authority].Philex Mining Corporation v. CIR, GR No.

148187, 16 April 2008


to deductions from gross income?In Philex Mining Corporation v. CIR, petitioner

entered into an agreement with Baguio Gold

Mining Company for the former to manage

and operate the latters mining claim in the

Benguet Province. The agreement was

denominated as Power of Attorney. In thecourse of managing and operating the project,

petitioner made advances of cash and

property to Baguio Gold. However, the mine

suffered continuing losses over the years

which resulted to petitioners withdrawal as

manager of the mine and in the eventual

cessation of mine operations. In its 1982

income tax return, petitioner deducted from

its gross income a sum representing loss on

settlement of receivables from Baguio Gold

against reserves and allowances. The CIR

disallowed the amount as deductible bad debt

and assessed petitioner a deficiency income

tax. The Supreme Court found that petitioners

advances were investments in a partnership

known as the Sto. Nio Mine. The advances

were not debts of Baguio Gold to petitioner

inasmuch as the latter was under no

unconditional obligation to return the same to

Philex Mining entered into a management

agreement with Baguio Gold. The parties'

agreement was denominated as "Power of

Attorney" which provided among others:

a. Funds available for Philex Mining

during the management agreement;

and

b. Compensation to Philex Mining which

shall be fifty per cent (50%) of the netprofit;

In the course of managing and operating the

project, Philex Mining made advances of cash

and property in accordance with the

agreement. However, the mine suffered

continuing losses over the years which

resulted to petitioner's withdrawal as manager

and cessation of mine operations.

The parties executed a "Compromise with

Dation in Payment" wherein Baguio Gold

admitted an indebtedness to Philex Mining,

which was subsequently amended to include

additional obligations.

Subsequently, Philex Mining wrote off in its

1982 books of account the remaining

outstanding indebtedness of Baguio Gold by

charging P112,136,000.00 to allowances and

reserves that were set up in 1981 and

P2,860,768.00 to the 1982 operations.


19/37

the former under the Power of Attorney.

Petitioner failed to substantiate its assertion

that the advances were subsisting debts of

Baguio Gold that could be deducted from its

gross income.Deductions for income tax purposes partake

of the nature of tax exemptions and are

strictly construed against the taxpayer, who

must prove by convincing evidence that he is

entitled to the deduction claimed.

In its 1982 annual income tax return, Philex

Mining deducted from its gross income the

amount of P112,136,000.00 as "loss on

settlement of receivables from Baguio Gold

against reserves and allowances." However,

BIR disallowed the amount as deduction for

bad debt and assessed petitioner a deficiency

income tax of P62,811,161.39.

Atlas Consolidated Mining & Development

Corporation v. CIR, GR Nos. L-26911 and L-

26924, 27 January 1981

Q: What are the general requisites for

deductibility of business expense?InAtlas Consolidated Mining & Development

Corporation v. CIR, one question was: were the

expenses paid by Atlas for the services

rendered by a public relations firm, P.K.MacKer & Co., labeled as stockholders relation

service fee considered deductible business

expense? The expense in question was

incurred to create a favorable image of the

corporation in order to gain or maintain the

patronage of its stockholders and the public.

The Supreme Court held that such expense

was notan ordinary and necessary expense

allowed to be deducted from the corporations

gross income.In order to be deductible as a business

expense, three conditions must concur

[business test]: (1) the expense must be

ordinary and necessary; (2) it must be paid or

incurred within the taxable year; and (3) it

must be paid or incurred in carrying on a trade

or business. Additionally, the taxpayer must

substantially prove by evidence or records the

deductions claimed under the law.

Atlas is a corporation engaged in the mining

industry registered. On August 1962, CIR

assessed against Atlas for deficiency income

taxes for the years 1957 and 1958. For the

year 1957, it was the opinion of the CIR that

Atlas is not entitled to exemption from the

income tax under RA 909 because same coversonly gold mines. For the year 1958, the

deficiency income tax covers the disallowance

of items claimed by Atlas as deductible from

gross income. Atlas protested for

reconsideration and cancellation, thus the CIR

conducted a reinvestigation of the case.

On October 1962, the Secretary of Finance

ruled that the exemption provided in RA 909

embraces all new mines and old mines

whether gold or other minerals. Accordingly,

the CIR recomputed Atlas deficiency income

tax liabilities in the light of said ruling. On June

1964, the CIR issued a revised assessment

entirely eliminating the assessment for the

year 1957. The assessment for 1958 was

reduced from which Atlas appealed to the

CTA, assailing the disallowance of the

following items claimed as deductible from its

gross income for 1958: Transfer agent's fee,


20/37

There is no hard and fast rule on the matter.

The right to a deduction depends in each case

on the particular facts and the relation of the

payment to the type of business in which the

taxpayer is engaged. The intention of the

taxpayer often may be the controlling fact in

making the determination. Assuming that the

expenditure is ordinary and necessary in theoperation of the taxpayers business, the

answer to the question as to whether the

expenditure is an allowable deduction as a

business expense must be determined from

the nature of the expenditure itself, which in

turn depends on the extent and permanency

of the work accomplished by the expenditure.

In all events, however, the taxpayer must

establish a logical link between the expenseand the taxpayers business.The Supreme Court eventually held that the

expense incurred by Atlas was not a deductible

business expense, but a capital expenditure.

Stockholders relation service fee, U.S. stock

listing expenses, Suit expenses, and Provision

for contingencies. The CTA allowed said items

as deduction except those denominated by

Atlas as stockholders relation service fee and

suit expenses.

Both parties appealed the CTA decision to the

SC by way of two (2) separate petitions for

review. Atlas appealed only the disallowance

of the deduction from gross income of the so-

called stockholders relation service fee.

Esso Standard Eastern, Inc. v. CIR, GR Nos.

28508-9, 7 July 1989


deductibility of business expense?At issue in Esso Standard Eastern, Inc. v. CIR

was the classification of the margin fees paid

by ESSO to the Central Bank on its profit

remittances to its New York head office in the

taxable years 1959 and 1960. ESSO sought the

refund of the amount it paid as margin fees

contending that these fees were deductible

from gross income either as a tax or as an

ordinary and necessary business expense. The

Supreme Court held that the margin fees were

not taxes, as they were imposed by the State

in the exercise of its police power and not the

ESSO deducted from its gross income, as part

of its ordinary and necessary business

expenses, the amount it had spent for drilling

and exploration of its petroleum concessions.

This claim was disallowed by the CIR on the

ground that the expenses should be

capitalized and might be written off as a loss

only when a "dry hole" should result.

ESSO then filed an amended return and

claimed as ordinary and necessary expenses

margin fees it had paid to the Central Bank on

its profit remittances to its New York head

office. The CIR disallowed the claimed

deduction for the margin fees paid. CIR


21/37

power of taxation. The margin fees were an

exaction designed to curb the excessive

demands upon the countrys international

reserve. The High Court also stated that the

margin fees were not an ordinary and

necessary business expense, because ESSO

had not shown that the remittance to the

head office of part of its profits was made in

furtherance of its own trade or business. If at

all, the margin fees were incurred for purposes

proper to the conduct of the corporate affairs

of Standard Vacuum Oil Company in New York,

but certainly not in the Philippines.

assessed ESSO a deficiency income tax which

arose from the disallowance of the margin

fees.

ESSO paid under protest and claimed for a

refund. CIR denied the claims for refund,

holding that the margin fees paid to the

Central Bank could not be considered taxes or

allowed as deductible business expenses.

Hospital de San Juan de Dios, Inc. v. CIR, GR

No. 31305, 10 May 1990


deductibility of business expense?In Hospital de San Juan de Dios, Inc. v. CIR,petitioner was a charitable, non-stock non-

profit corporation which was engaged in both

taxable and non-taxable operations. Its income

included rentals, interests and dividends

received from its properties and investments.

In the computation of its taxable income for

the years 1952 to 1955, petitioner allowed all

its taxable income to share in the allocation of

administrative expenses. The CIR, however,

disallowed the interests and dividends from

sharing in the allocation of administrative

expenses on the ground that the expenses

incurred in the administration or management

of petitioners investments were not allowable

business expenses inasmuch as they were not

incurred in carrying on any trade or

business. The Supreme Court held that as

the principle of allocating expenses is

grounded on the premise that the taxable

In a letter dated January 15, 1959, the

Commissioner of Internal Revenue assessed

and demanded from the petitioner, Hospital

De San Juan De Dios, Inc., payment of P51,462as deficiency income taxes for 1952 to 1955.

The petitioner protested against the

assessment and requested the Commissioner

to cancel and withdraw it. After reviewing the

assessment, the Commissioner advised

petitioner on November 8, 1960 that the

deficiency income tax assessment against it

was reduced to only P16,852.41. Still the

petitioner, through its auditors, insisted on the

cancellation of the revised assessment. The

request was, however, denied.

On September 18, 1965, petitioner sought a

review of the assessment by the CTA. In a

decision dated August 29, 1969, the CTA

upheld the Commissioner. It held that the

expenses incurred by the petitioner for

handling its funds or income consisting solely

of dividends and interests, were not expenses

incurred in "carrying on any trade or


22/37

income was derived from carrying on a trade

or business, as distinguished from mere

receipt of interests and dividends from ones

investments, the Court of Tax Appeals

correctly ruled that said income should not

share in the allocation of administrative

expenses. Otherwise stated, the expenses

incurred in the administration or management

of petitioners investments, i.e., interests and

dividends, were not deductible business

expenses.

business," hence, not deductible as business

or administrative expenses.

Petitioner filed a motion for reconsideration of

the CTA decision. When its motion was

denied, it filed this petition for review.

C.M. Hoskins & Co., Inc. v. CIR, GR No. L-

24059, 28 November 1969

Q: Compensation for personal services actually

rendered; illustrative cases.In C.M. Hoskins & Co., Inc. v. CIR, petitioner

filed its income tax return for the year 1957.The CIR disallowed as deductible business

expense a certain sum representing

supervision fee paid to its controlling

stockholder, Hoskins. Considering the

circumstances (e.g., Hoskins almost wholly

owning and controlling petitioner), the

Supreme Court found that the supervision fee

paid to Hoskins was inordinately large, and

could not be accorded the treatment of

ordinary and necessary expenses allowed as

deductible items. [It was treated as a

distribution of earnings and profits of

petitioner.] The Court explained the test of

reasonableness, citing in the process the case

of Kuenzle & Streiff, Inc. v. CIR(28 SCRA 366,

29 May 1969), to wit: The conditions

precedent to the deduction of bonuses to

employees are: (1) the payment of the

bonuses is in fact compensation; (2) it must be

Petitioner, a domestic corporation engaged in

the real estate business as brokers, managing

agents and administrators, filed its income tax

return for its fiscal year ending September 30,

1957 showing a net income of P92,540.25 anda tax liability due thereon of P18,508.00,

which it paid in due course. Upon verification

of its return, CIR, disallowed four items of

deduction in petitioner's tax returns and

assessed against it an income tax deficiency in

the amount of P28,054.00 plus interests. The

Court of Tax Appeals upon reviewing the

assessment at the taxpayer's petition, upheld

respondent's disallowance of the principal

item of petitioner's having paid to Mr. C. M.

Hoskins, its founder and controlling

stockholder the amount of P99,977.91

representing 50% of supervision fees earned

by it and set aside respondent's disallowance

of three other minor items.

Petitioner questions in this appeal the Tax

Court's findings that the disallowed payment

to Hoskins was an inordinately large one,


23/37

for personal services actually rendered; and (3)

the bonuses, when added to the salaries, are

reasonable x x x when measured by the

amount and quality of the services performed

with relation to the business of the particular

taxpayer.Of course, *t+here is no fixed test for

determining the reasonableness of a given

bonus as compensation. This depends upon

many factors, one of them being the amount

and quality of the services performed with

relation to the business. Other tests

suggested are: payment must be made in

good faith; the character of the taxpayers

business, the volume and amount of its net

earnings, its locality, the type and extent of

the services rendered, the salary policy of thecorporation; the size of the particular

business; the employees qualifications and

contributions to the business venture; and

general economic conditions.Finally, the right of an employer to fix the

compensation of its officers and employees is

recognized, but for income tax purposes the

employer cannot legally claim such bonuses as

deductible expenses unless they are shown to

be reasonable. To hold otherwise would open

the gate of rampant tax evasion.

which bore a close relationship to the

recipient's dominant stockholdings and

therefore amounted in law to a distribution of

its earnings and profits.

Aguinaldo Industries Corporation v. CIR, GR

No. L-29790, 25 February 1982


rendered; illustrative cases.InAguinaldo Industries Corporation v. CIR,

when petitioner sold its property in

Muntinglupa, the corporate officers of

petitioner were given bonuses. The amount

representing these bonuses was claimed by

Aguinaldo Industries Corporation (AIC) is a

domestic corporation engaged in the

manufacture of fishing nets, a tax-exempt

industry and the manufacture of furniture. For

accounting purposes, each division is provided

with separate books of accounts. Previously,

AIC acquired a parcel of land in Muntinlupa,

Rizal, as site of the fishing net factory. Later, it


24/37

petitioner as a deductible business expense.

The Supreme Court held that the bonuses

could not be deemed a deductible expense for

tax purposes, even if the aforesaid sale could

be considered as a transaction for carrying on

the trade or business of the petitioner and the

grant of the bonus to the corporate officers

pursuant to petitioners by-laws could, as anintra-corporate matter, be sustained. Citing

Alhambra Cigar andCigarette Manufacturing

Co. v. CIR (GR No. L- 12026, 29 May 1959),the

Supreme Court stated that: whenever a

controversy arises on the deductibility, for

purposes of income tax, of certain items for

alleged compensation of officers of the

taxpayer, two (2) questions become material,

namely: (a) Have personal services beenactually rendered by said officers? (b) In the

affirmative case, what is the reasonable

allowance therefor? Here, no evidence was

presented to show that the corporate officers

who received bonuses had a hand in the sale

transaction of the Muntinglupa property

[which could be the basis of a grant to them of

the bonuses out of the profit derived from the

sale]. Thus, the amount representing the

bonuses could not be allowed as a deductiblebusiness expense

sold the Muntinlupa property. AIC derived

profit from this sale which was entered in the

books of the Fish Nets Division as

miscellaneous income to distinguish it from its

tax-exempt income.

For the year 1957, AIC filed two separate

income tax returns for each division. After

investigation, the examiners of the BIR foundthat the Fish Nets Division deducted from its

gross income for that year the amount of

P61,187.48 as additional remuneration paid to

the officers of AIC. This amount was taken

from the net profit of an isolated transaction

(sale of Muntinlupa land) not in the course of

or carrying on of AIC's trade or business, and

was reported as part of the selling expenses of

the Muntinlupa land. Upon recommendationof the examiner that the said sum of

P61,187.48 be disallowed as deduction from

gross income, petitioner asserted in its letter

of February 19, 1958, that said amount should

be allowed as deduction because it was paid

to its officers as allowance or bonus pursuant

to its by-laws.

CIR v. Algue, Inc., GR No. L-28896, 17 February

1988


rendered; illustrative cases.In CIR v. Algue, Inc., for the years 1958 and

1959 respondent sought to claim as deductible

business expense the sum of Php 75,000 as

promotional fees. Respondent was a family

corporation appointed by the Philippine Sugar

Algue Inc. is a domestic corporation engaged

in engineering and construction. The

corporation was appointed by the Philippine

Sugar Estate Development Company (PSEDC)

as its agent, authorizing Algue to sell the

latters land, factories and oil manufacturing

process. Pursuant to this, a certain Guevara

and others worked for the formation of the


25/37

Estate Development Company as its agent and

pursuant to such authority, several employees

of respondent worked for the formation of the

Vegetable Oil Investment Corporation,

inducing others to invest in it. The

compensation that these employees received

formed part of the promotional fees. The CIR

argued that these payments were fictitiousbecause most of the payees were members of

the same family in control of respondent. The

CIR suggested a tax dodge, i.e., an attempt to

evade a legitimate assessment by involving an

imaginary deduction. The Supreme Court

found for respondent. The burden is on the

taxpayer to prove the validity of the claimed

deduction. The Court held that in the present

case, that onus was discharged satisfactorily.Because respondent was a family corporation,

strict business procedures did not apply to it.

Moreover, payment of the promotional fees

was necessary and reasonable in the light of

the efforts exerted by the payees in inducing

investors and prominent businessmen to

venture in an experimental enterprise and

involve themselves in a new business requiring

millions of pesos.

Vegetable Oil Investment Corporating,

incuding others to invest. This corporation

purchased the PSEDC properties. For this sale,

Algue received a commission of 125K and 75K

was paid as promotional fees to the five

individuals led by Guevara. CIR sent Algue a

letter assessing it for delinquent income taxes.

Algue claims the 75k was deductible as anecessary business expense,. On the other

hand, the CIR contends otherwise and claimed

that these payments are fictitious because

most of the payees (the five individuals) are

members of the same family in control of

Algue.

3M Philippines, Inc. v. CIR, GR No. L-82833, 26

September 1988

Q: Rentals and other payments; illustrative

case

In 3M Philippines, Inc. v. CIR, 3M Phils. was a

subsidiary of 3M US. The parties entered into

agreements under which 3M Phils. agreed to

pay to 3M US a 3% technical service fee and a

royalty of 2% of its net sales. In its income tax

return for 1974, 3M Phils. claimed Php 3

million as deductible business expense,

3M Philippines, Inc. is a subsidiary of the

Minnesota Mining and Manufacturing

Company (or "3M-St. Paul") a non-resident

foreign corporation with principal office in St.

Paul, Minnesota, U.S.A. It is the exclusive

importer, manufacturer, wholesaler, and

distributor in the Philippines of all products of

3M-St. Paul. To enable it to manufacture,

package, promote, market, sell and install the

highly specialized products of its parent


26/37

particularly, as royalties and technical service

fees. The CIR allowed a deduction only of an

amount representing royalties and technical

service fees for locally manufactured products.

The CIR disallowed the deduction of the

amount representing royalties and technical

service fees for finished products imported by

3M Phils. from 3M US. The CIR based itsdecision on CB Circular No. 393 (Regulations

Governing Royalties/Rentals) dated 7

December 1973 partly providing that royalties

should be paid only on commodities

manufactured by the licensee under the

royalty agreement. [No royalty was payable on

the wholesale price of finished products

imported by the licensee from the licensor.]

The Supreme Court upheld the CIRs argumentand ruled thus: although the Tax Code allows

payments of royalty to be deducted from gross

income as business expenses, it is CB Circular

No. 393 that defines what royalty payments

are proper. Hence, improper payments of

royalty are not deductible as legitimate

business expenses.

company, and render the necessary post-sales

service and maintenance to its customers, 3M

Phils. entered into a "Service Information and

Technical Assistance Agreement" and a

"Patent and Trademark License Agreement"

with the latter under which the 3m Phils.

agreed to pay to 3M-St. Paul a technical

service fee of 3% and a royalty of 2% of its netsales. Both agreements were submitted to,

and approved by, the Central Bank of the

Philippines. the petitioner claimed the

following deductions as business expenses:

(a) royalties and technical service fees of P

3,050,646.00; and

(b) pre-operational cost of tape coater of

P97,485.08.

As to (a), the Commissioner of InternalRevenue allowed a deduction of P797,046.09

only as technical service fee and royalty for

locally manufactured products, but disallowed

the sum of P2,323,599.02 alleged to have

been paid by the petitioner to 3M-St. Paul as

technical service fee and royalty on

P46,471,998.00 worth of finished products

imported by the petitioner from the parent

company, on the ground that the fee and

royalty should be based only on locallymanufactured goods. While as to (b), the CIR

only allowed P19,544.77 or one-fifth (1/5) of

3M Phils.capital expenditure of P97,046.09 for

its tape coater which was installed in 1973

because such expenditure should be

amortized for a period of five (5) years, hence,

payment of the disallowed balance of

P77,740.38 should be spread over the next

four (4) years. The CIR ordered 3M Phil. to pay


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P840,540 as deficiency income tax on its 1974

return, plus P353,026.80 as 14% interest per

annum from February 15, 1975 to February

15, 1976, or a total of P1,193,566.80.

3M Phils. protested the CIRs assessment but it

did not answer the protest, instead issuing a

warrant of levy. The CTA affirmed the

assessment on appeal.Roxas v. Court of Tax Appeals, GR No. L-25043,

26 April 1968

Q: Entertainment, amusement and recreation

expense; illustrative cases.In Roxas v. Court of Tax Appeals, the late Roxas

Spouses bequeathed several properties to

their grandchildren. To manage said

properties, a partnership called Roxas y Cia

was formed. For the years 1953 and 1955, the

CIR disallowed deductions from gross incomeof various business expenses of Roxas y Cia.

The business expenses comprised of Php 40

for tickets to a banquet given in honor of

Sergio Osmea and Ph 28 for San Miguel beer

given as gifts to various persons. These

deductions were claimed as representation

expenses. The Supreme Court found that no

evidence was shown to link the expenses to

the business of Roxas y Cia. Hence, according

to the Court, such deductions were correctly

disallowed by the CIR.Representation expenses are deductible from

gross income as expenditures incurred in

carrying on a trade or business under [now

Section 34(A) of the 1997 Tax Code] provided

the taxpayer proves that they are reasonable

in amount, ordinary and necessary, and

incurred in connection with his business.

Don Pedro Roxas and Dona Carmen Ayala,

Spanish subjects, transmitted to their

grandchildren by hereditary succession

agricultural lands in Batangas, a residential

house and lot in Manila, and shares of stocks

in different corporations. To manage the

properties, said children, namely, Antonio,

Eduardo and Jose Roxas formed a partnership

called Roxas y Compania.On June 1958, the CIR assessed deficiency

income taxes against the Roxas Brothers for

the years 1953 and 1955. Part of the

deficiency income taxes resulted from the

disallowance of deductions from gross income

of various business expenses and

contributions claimed by Roxas. (see expense

items below)

The Roxas brothers protested the assessment

but inasmuch as said protest was denied, theyinstituted an appeal in the CTA, which

sustained the assessment except the demand

for the payment of the fixed tax on dealer of

securities and the disallowance of the

deductions for contributions to the Philippine

Air Force Chapel and Hijas de Jesus' Retiro de

Manresa. Not satisfied, Roxas brothers

appealed to the SC. The CIR did not appeal.

Revenue Regulations No. 10-2001, 10 July Q: Entertainment, amusement and recreation


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2002 expense; illustrative cases.Revenue Regulations No. 10-2002 enumerates

the requisites for the deductibility of

entertainment, amusement and recreation

expense as follows:(1) it must be paid or incurred during the

taxable year;(2) it must be directly connected to the

development, management and

operation of the trade, business or

profession of the taxpayer, OR directly

related to or in furtherance of the

conduct of his/its trade, business or

exercise of a profession;

(3) it must not be contrary to law, morals,

good customs, public policy or publicorder;

(4) it must not have been paid, directly or

indirectly, to any person as a bribe,

kickback or other similar payment;

(5) it must be duly substantiated by

adequate proof; and

the appropriate amount of withholding tax, if

applicable, should have been withheld

therefrom and paid to the BIR

CIR v. A. Soriano y Cia, GR No. L-24893, 26March 1971

Q: Make a distinction between businessexpense and capital expenditure

How does one classify expenses incurred on

property? In CIR v.A. Soriano y Cia,

respondent owned a parcel of land in

Intramuros,which it later sold to J.M. Tuason

& Co. In computing the income tax due, was

respondent allowed to include as cost of the

property the expenditures it incurred in

A. Soriano y Cia owned a piece of land locatedin Intramuros, City of Manila, on which it

proposed to construct an office building. To

carry out the project it had the necessary

plans drawn in 1960 by Architect J. M.

Zaragoza, and entered into a pile-driving

contract that same year with the construction

firm of A. M. Oreta & Co. The pile-driving was

actually done in 1960.

After these preparations and before the


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improving said property (e.g., pile-driving

service fee and architects fee)? The Supreme

Court said that: expenditures for

replacements, alterations, improvements or

additions which either prolong the life of the

property or increase its value are capital in

nature. The expenses incurred by respondent

increased the value of the Intramuros propertyand hence, must be considered as capital

expenditures that formed part of the cost of

the property [which amount was relevant in

computing the income tax due].

construction of the building, the Taxpayer sold

the property to J. M. Tuason & Co.

The balance of P49,329.55 due on the

Contractor's fees, including the cost of testing

timber piles in the amount of P4,000.00, was

paid only on June 16, 1961 after the

Contractor had concluded negotiations with

the City Engineer of Manila for the settlementof the problem brought by J. M. Tuason & Co.

and after said Contractor had secured a

certification by the Office of the City Engineer

of Manila in connection therewith.

It also appears that in the year 1961, the

Taxpayer completed payment to the architect,

Mr. Zaragoza, of the latter's fees for services

rendered, the same consisting of the unpaid

balance of P10,000.00, plus P1,000.00reimbursement for disbursements made by

the latter in connection with the Intramuros

property.

On April 17, 1961, the Taxpayer filed its 1960

Income Tax Return and in due time paid the

income tax due. On October 4, 1961, it filed an

amended Income Tax Return for the year 1960

showing a refundable amount of P15,099.00

due to the inclusion of expenses paid on June

1 and June 16, 1961 amounting to P50,329.55,expenses allegedly incurred for pile-driving

and architect's fees which the Taxpayer

claimed were part of the cost of its Intramuros

property sold. On the same day, a request for

the refund of the said amount was filed. Again,

on March 12, 1963, the Taxpayer filed a

second amended return showing this time a

refundable amount of P18,099.00 based on

expenses already included in the previous


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amended Income Tax Return, plus another

item of expense in the amount of P10,000.00

paid as architect's fees on March 15, 1961,

upon the claim that all said expenses formed

part of the cost of the Intramuros property

aforesaid. A request for the refund of the total

amount of P18,099.00 was also made.

Atlas Consolidated Mining & DevelopmentCorporation v. CIR, GR Nos. L-26911 and L-

26924, 27 January 1981

Q: Make a distinction between businessexpense and capital expenditure

InAtlas Consolidated Mining & Development

Corporation v. CIR, one question was: were the

expenses paid by Atlas for the services

rendered by a public relations firm, P.K.

MacKer & Co., labeled as stockholders relation

service fee considered deductible business

expense? The expense in question wasincurred to create a favorable image of the

corporation in order to gain or maintain the

patronage of its stockholders and the public.

The Supreme Court held that such expense

was not an ordinary and necessary expense

allowed to be deducted from the corporations

gross income.

In order to be deductible as a business

expense, three conditions must concur

[business test]: (1) the expense must be

ordinary and necessary; (2) it must be paid or

incurred within the taxable year; and (3) it

must be paid or incurred in carrying on a trade

or business. Additionally, the taxpayer must

substantially prove by evidence or records the

deductions claimed under the law.The Supreme Court eventually held that the

expense incurred by Atlas was not a deductible

business expense, but a capital expenditure.

Atlas is a corporation engaged in the miningindustry registered. On August 1962, CIR

assessed against Atlas for deficiency income

taxes for the years 1957 and 1958. For the

year 1957, it was the opinion of the CIR that

Atlas is not entitled to exemption from the

income tax under RA 909 because same covers

only gold mines. For the year 1958, the

deficiency income tax covers the disallowance

of items claimed by Atlas as deductible fromgross income. Atlas protested for

reconsideration and cancellation, thus the CIR

conducted a reinvestigation of the case.

On October 1962, the Secretary of Finance

ruled that the exemption provided in RA 909

embraces all new mines and old mines

whether gold or other minerals. Accordingly,

the CIR recomputed Atlas deficiency income

tax liabilities in the light of said ruling. On June

1964, the CIR issued a revised assessment

entirely eliminating the assessment for the

year 1957. The assessment for 1958 was

reduced from which Atlas appealed to the

CTA, assailing the disallowance of the

following items claimed as deductible from its

gross income for 1958: Transfer agent's fee,

Stockholders relation service fee, U.S. stock

listing expenses, Suit expenses, and Provision

for contingencies. The CTA allowed said items


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The expense incurred to create a favorable

image of the corporation in order to gain or

maintain the patronage of it stockholders and

the public, similar to expenses relating to

recapitalization and reorganization of the

corporation, the cost of obtaining stock

subscription, promotion and commission or

fees paid for the sale of stock reorganizationare capital expenditures which should be

spread out over a reasonable period of t ime.

as deduction except those denominated by

Atlas as stockholders relation service fee and

suit expenses.

Both parties appealed the CTA decision to the

SC by way of two (2) separate petitions for

review. Atlas appealed only the disallowance

of the deduction from gross income of the so-

called stockholders relation service fee.

CIR v. General Foods (Phils.), Inc., GR No.

143672, 24 April 2003

Q: Make a distinction between business

expense and capital expenditure

To be deductible from gross income, an

advertising expense must comply with the

following requirements:(1) the expense must be ordinary andnecessary;

(2) it must have been paid or incurred

during the taxable year;

(3) it must have been paid or incurred in

carrying on the trade or business of the

taxpayer; and

(4) it must be supported by receipts,

records or other pertinent

papers.In CIR v. General Foods (Phils.), Inc.,respondent filed its income tax return for

1985, claiming a certain amount as deductible

media advertising expense for the product

Tang. Respondent and the CIR were in

agreement that the subject advertising

expense was paid or incurred within the

relevant taxable year and was incurred in

carrying on a trade or business. Hence, it was

necessary. However, as to whether it was

Commissioner disallowed 50% of the

deduction claimed and assessed deficiency

income taxes of P2,635,141.42 against General

Foods, prompting the latter to file an MR

which was denied.

General Foods later on filed a petition for

review at CA, which reversed and set aside anearlier decision by CTA dismissing the

companys appeal.


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ordinary, their views were in conflict. The CIR

maintained that the subject advertising

expense was not ordinary for failure to comply

with two requirements set by US

jurisprudence: (1) the amount incurred must

be reasonable, and (2) the amount incurred

must not be a capital outlay to create

goodwill for the product and/or thecorporations business. *Otherwise, the

expense must be considered a capital

expenditure to be spread out over a

reasonable time.]There is yet to be a clear-cut criteria or fixed

test for determining the reasonableness of an

advertising expense. There being no hard and

fast rule on the matter, the right to a

deduction depends on a number of factorssuch as but not limited to: the type and size of

business in which the taxpayer is engaged; the

volume and amount of its net earnings; the

nature of the expenditure itself; the intention

of the taxpayer and the general economic

conditions. It is the interplay of these, among

other factors and properly weighted, that will

yield a proper evaluation. Here, the Supreme

Court held that the advertising expense for a

single product (Tang) was inordinately large.Even if it was necessary, it could not be

considered an ordinary expense. In order to be

deductible, a business expense must be both

ordinary and necessary. The Supreme Court

also found that the subject advertising

expense was a capital expenditure which

should be spread out over a reasonable period

of time.Advertising is generally of two kinds: (1)


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advertising to stimulate the currentsale of

merchandise or use of services and (2)

advertising designed to stimulate thefuture

sale of merchandise or use of services. The

second type involves expenditures incurred, in

whole or in part, to create or maintain some

form of goodwill for the taxpayers trade or

business or for the industry or profe

Documents

Taxation (Income Tax) - Pp41-60