El Oriente v.

Posadas 56 Phil 147

Doctrine:

Exclusions From Gross Income- Life Insurance

Facts:

El Oriente Fabrica de Tabacos Inc., the plaintiff, procured from Manufacturers Life
Insurance Co., of Toronto, Canada, through its local agent E.E. Elser, an insurance policy on
the life of A. Velhagen, the plaintiff’s manager, the sum of $50,000, and designated itself as
the sole beneficiary of said policy on the life of its said manager. The plaintiff secured a life
insurance to protect itself against the loss that it might suffer by reason of the death of its
manager, who had had more than 35 years of experience in the manufacture of cigarettes in
the Philippine Islands.

During the time the life insurance policy was in force and effect, the plaintiff paid from
its funds all the insurance premiums due thereon. It 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 by the defendant, Juan Posadas,
Collector of Internal Revenue, upon a showing made by the plaintiff that such premiums were
legitimate expenses of its business.

The insured manager had no interest or participation in the proceeds of said life
insurance policy. Upon his death, the plaintiff received all the proceeds of the said life
insurance policy, together with the interests and the dividends accruing thereon, aggregating
P104,957.88.

Then, the defendant assessed and levied the sum of P3,148.74 as income tax on the
proceeds of the insurance policy, which tax the plaintiff paid under protest.

Issue:

Whether the proceeds of insurance taken by a corporation on the life of an important

official to indemnify it against loss in case of his death, are taxable as income.

Ruling:

In Tax Code, Chapter I On Individuals, Section 4 provides that, "The following

incomes shall be exempt from the provisions of this law: (a) The proceeds of life insurance
policies paid to beneficiaries upon the death of the insured . . ." while Chapter II On
Corporations, Section 10 as amended provides that, "There shall be levied, assessed,
collected, and paid annually upon the total net income received in the preceding calendar
year from all sources by every corporation . . .a tax of three per centum upon such
income . . ." Section 11 of the same chapter provides the exemptions under the law, but
neither on Section 11 nor in any other section is reference made to the provisions of Section 4
in Chapter I.

Supreme Court (SC), on the anomalous and vague condition of the law, is certain that
the proceeds of life insurance policies paid to individual beneficiaries upon the death of the
insured are exempt. However, it is not so certain that the proceeds of life insurance policies
paid to corporate beneficiaries upon the death of the insured are likewise exempt. But
according to them, the law is indefinite in phraseology and does not permit them
unequivocally to hold that the proceeds of life insurance policies received by corporations
constitute income which is taxable.

The situation was better elucidated by a brief reference to laws on the same subject
in the United States where in it was stated that not only in the part of the law concerning
individuals were exemptions provided for beneficiaries, but also in the part concerning
corporations, specific reference was made to the exemptions in favor of individuals, thereby
making the same applicable to corporations.

SC do not believe that when the plaintiff received P104,957.88 from the insurance on
the life of its manager, it thereby realized a net profit in the said amount. It is true that the
Income Tax Law, in exempting individual beneficiaries, speaks of the proceeds of life
insurance policies as income, but this is a very slight indication of legislative intention. In
reality, what the plaintiff received was in the nature of an indemnity for the loss which it
actually suffered because of the death of its manager.

SC quoted the words in the cited case of Chief Justice Taft stating that “that proceeds
of a life insurance policy paid on the death of the insured are not usually classed as income”
and that “Life insurance in such a case is like that of fire and marine insurance, — a contract
of indemnity. The benefit to be gained by death has no periodicity. It is a substitution of
money value for something permanently lost, either in a house, a ship, or a life.

Therefore, SC held that it is reasonable to hold the proceeds of the life insurance
policy in question as representing an indemnity and not taxable income.
FISHER V. TRINIDAD, G.R. NO. L-17518, OCTOBER 30, 1922

FACTS:

That during the year 1919, the Philippine American Drug Company was a corporation
duly organized and existing under the laws of the Philippine Islands, doing business in the
City of Mania; that the appellant was a stockholder in said corporation; that said corporation,
as result of the business for that year, declared a “stock dividend”; that the proportionate
share of said stock divided of the appellant was P24,800; that the stock dividend for that
amount was issued to the appellant; that thereafter, in the month of March 1920, the
appellant, upon demand of the appellee, paid under protest, and involuntarily, unto the
appellee the sum of P889.91 as income tax on said stock dividend. For the recovery of that
sum (889.91), the present action was instituted. The defendant demurred to the petition upon
the ground that it did not state facts sufficient to constitute cause of action. The demurrer was
sustained, and the plaintiff appealed.

The appellee admits the doctrine established in the case of Eisner vs. Macomber
(252 U. S., 189), that a "stock dividend" is not "income" but argues that said Act No. 2833, in
imposing the tax on the stock dividend, does not violate the provisions of the Jones Law.

Further argues that the statute of the United States providing for tax upon stock
dividends is different from the statute of the Philippine Islands, and therefore the decision of
the Supreme Court of the United States should not be followed in interpreting the statute... in
force here.

It will be rioted from a reading of the provisions of the two laws above quoted that the
writer of the law of the Philippine Islands must have had before him the statute of the United
States. No important argument can be based upon the slight difference in the wording of the
two... sections.

There is no question that the Philippine Legislature may provide for the payment of an
income tax, but it cannot, under the guise of an income tax, collect a tax on property which is
not an "income." The Philippine Legislature cannot impose a tax upon "property" under a law
which provides for a tax upon "income" only.

The Philippine Legislature has no power to provide a tax upon "automobiles" only, and under
that law collect a tax upon a carreton or bull cart.

A statute providing for an income tax cannot be construed to cover property which is
not, in fact, income. The Legislature cannot, by a... statutory declaration, change the real
nature of a tax which it imposes. A law which imposes an importation tax on rice only cannot
be construed to impose an importation tax on corn.

ISSUE: Whether the income received as dividends is taxable as an income

RULING:

No. Generally speaking, stock dividends represent undistributed increase in the capital of
corporations or firms, joint stock companies, etc., for a particular period. They are used to
show the increased interest or proportional shares in the capital of each stockholder. In other
words, the inventory of the property of the corporation for a particular period shows an
increase in its capital, so that the stock theretofore issued does not show the real value of
stockholder’s interest, and additional stock is issued showing the increase in the actual
capital, or property, or assets of the corporation, etc.
 The New Standard Dictionary, edition of 1915, defines an income as "the amount of...
money coming to a person or corporation within a specified time whether as payment for
services, interest, or profit from investment."

Webster's International Dictionary defines an income as "the receipts, salary;

especially, the annual receipts of a private person or a... corporation from property."

Bouvier, in his law dictionary, says that an "income" in the federal constitution and income tax
act, is used in its common or ordinary meaning and not in its technical or economic sense.

Mr. Black, in his law... dictionary, says: "An income is the return in money from one's
business, labor, or capital invested ; gains, profit, or private revenue." "An income tax is a tax
on the yearly profits arising from property, professions, trades, and offices."

Gray vs. Darlington (82 U. S., 63), said in speaking of income that mere advance in value in
no sense constitutes the "income"

Such advance constitutes and can be treated merely as an increase of capital.

Mr. Justice Hughes: "income" in an income... tax law, unless it is otherwise specified, to mean
cash or its equivalent. It does not mean choses in action or unrealized increments in the value
of the property

Towne vs. Eisner, supra, Mr, Justice Holmes: 'A... stock dividend really takes nothing
from the property of the corporation, and adds nothing to the interests of the shareholders. Its
property is not diminished and their interests are not increased. * * * The proportional interest
of each shareholder remains the same. * * *' In... short, the corporation is no poorer and the
stockholder is no richer than they were before.

Mr. Justice Pitney

Eisner vs. Macomber: "An income may be defined as the gain derived from capital,
from labor, or from both combined, provided it be understood to include profit gained through
a sale... or conversion of capital assets. when stock dividends are declared, the corporation or
company acknowledges a liability, in form, to the stockholders If profits have been made by
the... corporation... they create additional bookkeeping liabilities under the head of "profit and
loss,"

None of these, however, gives to the stockholders as a body, much less to any... one
of them, either a claim against the going concern or corporation, for any particular sum of
money, or a right to any particular portion of the asset, or any share unless or until the
directors conclude that dividends shall be made and a part of the company's assets...
segregated from the common fund for that purpose.

The dividend normally is payable in money and when so paid, then only does the
stockholder realize a profit or gain, which becomes his separate property, and thus derive an
income from the capital that he has invested. Until that... is done the increased assets belong
to the corporation and not to the individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's
accumulated profits have been capitalized, instead of distributed to the stockholders or
retained as surplus available for distribution, in money or in kind, should opportunity offer.

it tends rather to postpone said realization, in that the fund represented by the new stock has
been transferred from surplus to assets, and no longer is available for actual distribution.

The essential and controlling fact is... that the stockholder has received nothing out of
the company's assets for his separate use and benefit
 The stockholder who receives a stock dividend has received nothing but a
representation of his increased interest in the capital of the corporation.

There has been no separation or segregation of his interest.

All the property or capital of the corporation still belongs to... the corporation.

no separation of the interest of the stockholder from the general capital of the corporation

The stockholder, by virtue of the stock dividend, has no separate or individual control over the
interest represented thereby, further than he had before... the stock dividend was issued

He cannot use it for the reason that it is still the property of the corporation

A certificate of stock represented by the stock dividend is simply a statement of his

proportional... interest or participation in the capital of the corporation.

We believe that the Legislature, when it provided for an "income tax," intended to tax only the
"income" of corporations, firms, or individuals, as that term is generally used in its common
acceptation;... that the income means money received, coming to a person or corporation for
services, interest, or profit from investments.

We do not believe that the Legislature intended that a mere increase in the value of
the capital or assets of a corporation, firm, or individual,... should be taxed as "income."

Mr. Justice Pitney, in the case of Eisner vs. Macomber

"That the fudamental relation of 'capital' to 'income' has been much discussed by
economists, the former being likened to the tree or the... land, the latter to the fruit or the
crop... the former depicted as a reservoir supplied from springs; the latter as the outlet
stream, to be measured by its flow during a period of time."

There is a clear distinction between an extraordinary cash dividend, no matter when

earned, and stock dividends declared, as in the present case.

The one is a disbursement to the stockholder of accumulated earnings, and the

corporation at once parts irrevocably with all... interest thereon. The other involves no
disbursement by the corporation. It parts with nothing to the stockholder.

The latter receives, not an actual dividend, but certificate of stock which simply
evidences his interest in the entire capital, including such as by investment of... accumulated
profits has been added to the original capital.

They are not income to him, but represent additions1 to the source of his income,
namely, his invested capital.

Gibbons vs. Mahon

The ownership of that property is in... the corporation, and not in the holders of
shares of its stock.

DeKoven vs. Alsop

Mr. Justice Wilkin said: "A dividend is defined as 'a corporate profit set aside,
declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed
time. Until the dividend is... declared, these corporate

  profits belong to the corporation, not to the stockholders, and are liable for corporate
indebtedness.'"
 When a cash dividend is declared and paid to the... stockholders, such cash
becomes the absolute property of the stockholders and cannot be reached by the creditors of
the corporation in the absence of fraud. A stock dividend, however, still being the property of
the corporation, and not of the stockholder, it may be reached by... an execution against the
corporation, and sold as a part of the property of the corporation

The rule is well established that cash dividends, whether large or small, are regarded
as "income"... and all stock dividends, as capital or assets.

if the holder of the stock... dividend is required to pay an income tax on the same, the result
would be that he has paid a tax upon an income which he never received. Such a conclusion
is absolutely contradictory to the idea of an income. An income subject to taxation under the
law must be an actual income... and not a promised or prospective income.

The appellee emphasizes the "income from dividends." Of course, income received
as dividends is taxable as an income, but an income from "dividends" is a very different thing
from a receipt of a "stock dividend." One is... an actual receipt of profits; the other is a receipt
of a representation of the increased value of the assets of a corporation.

In- asmuch, however, as appeals may be taken... from this court to the Supreme Court of the
United States, we feel bound to follow the same doctrine announced by that court.

"stock dividends" are not "income," the same cannot be taxed under that provision of Act No,
2833 which provides for a tax upon income.

Under the guise of an income tax, property which is not an... income cannot be taxed.

Principles:

We believe that the Legislature, when it provided for an "income tax," intended to tax
only the "income" of corporations, firms, or individuals, as that term is generally used in its
common acceptation; that... is, that the income means money received, coming to a person or
corporation for services, interest, or profit from investments. We do not believe that the
Legislature intended that a mere increase in the value of the capital or assets of a
corporation, firm, or individual,... should be taxed as "income."

"That the fudamental relation of 'capital' to 'income' has been much discussed by
economists, the former being likened to the tree or the... land, the latter to the fruit or the crop;
the former depicted as a reservoir supplied from springs; the latter as the outlet stream, to be
measured by its flow during a period of time."

When a cash dividend is declared and paid to the... stockholders, such cash becomes the
absolute property of the stockholders and cannot be reached by the creditors of the
corporation in the absence of fraud. A stock dividend, however, still being the property of the
corporation, and not of the stockholder, it may be reached by... an execution against the
corporation, and sold as a part of the property of the corporation.

The rule is well established that cash dividends, whether large or small, are regarded
as "income"... and all stock dividends, as capital or assets.

if the holder of the stock... dividend is required to pay an income tax on the same, the result
would be that he has paid a tax upon an income which he never received. Such a conclusion
is absolutely contradictory to the idea of an income. An income subject to taxation under the
law must be an actual income... and not a promised or prospective income.

The appellee emphasizes the "income from dividends." Of course, income received
as dividends is taxable as an income, but an income from "dividends" is a very different thing
from a receipt of a "stock dividend." One is... an actual receipt of profits; the other is a receipt
of a representation of the increased value of the assets of a corporation.
"stock dividends" are not "income," the same cannot be taxed under that provision of Act No,
2833 which provides for a tax upon income. Under the guise of an income tax, property which
is not an... income cannot be taxed.

Lombo VS Standard Cigarette Manufacturing Corporation GR No. L-35531

Facts:

Petitioner Pascuala Lombo claimed for compensation with Regional office of the
Department of Labor The claim alleged, among the other things, that herein petitioner
Pascuala Lombo worked as a laborer with respondent company from 1951 to June 5, 1967,
when she last reported for work by reason of her physical disability (PTB minimal, heart
disease and high blood pressure) allegedly contracted in the course of her employment with
the respondent company; that she first felt pains in the chest in 1965; that this was
aggravated by the nature of her work and the working conditions in the company; that she has
incurred expenses more or less in the amount of P500.00 for medical treatment and
medicines, and that her illness was brought to the attention of the company. The respondent
company in time filed its answer controverting the claim.

Issue:

Is Pascuala Lombo entitled to workmen’s compensation?

Held:

The Supreme Court ruled in the negative. Workmen’s compensation refers to liability for
compensation for loss resulting from injury, disability or death of the workingman through
industrial accident or disease. It is based on incapacity or disability for work, and hence on the
loss or impairment of the employee’s earning capacity in the employment at which he was
engaged when injured, the compensation payments being in lieu of wages or based on the
loss thereof and on the idea of providing means of subsistence to the employees during the
time when his earning capacity has been partially or entirely destroyed. In other words as long
as the employee is able to work and receives his pay even if he is suffering from illness, he is
not entitled to compensation.

In the instant case, claimant never incurred loss of earning power as she stopped
working only after June 5, 1967, after which she worked with La Ilustre Cigar and Cigarette
Factory as evidenced by the Certificate of Employment issued by none other than the latter’s
Accountant. Her claim that her illness arose out of her work and that her supposed pulmonary
tuberculosis and high blood pressure had started in 1965 also was not substantiated.
MIGUEL J. OSSORIO PENSION FOUNDATION, INCORPORATED (MJOPFI), vs.
COURT OF APPEALS and COMMISSIONER OF INTERNAL REVENUE.
G.R. No. 162175, June 28, 2010

Facts:

Petitioner, MJOPFI, is a corporation that was formed to administer the Employees' Trust Fund
established for the benefit of the employees of Victorias Milling Company, Inc. (VMC).

Petitioner invested ₱5,504,748.25 of the funds of the Employees' Trust Fund to purchase the
Madrigal Business Park (MBP) lot. After the purchase, the MBP lot is now co-owned by the
MJOPFI (49.59%), VMC (32.23%), VFC (18.18%). The lot was sold to pay the retirement and
pension benefits of VMC employees.

When the MBP lot was sold, the gross income of the Employees’ Trust Fund (share of
MJOPFI) from the sale of the MBP lot was ₱40,500,000. The 7.5% withholding tax of
₱3,037,500 and 3% broker’s commission were deducted from the proceeds and withheld by
Metrobank, as the buyer of the Property.

Petitioner claims that it is a co-owner of the MBP lot as trustee of the Employees’ Trust Fund,
based on the notarized Memorandum of Agreement presented before the appellate courts.
Petitioner asserts that VMC has confirmed that petitioner, as trustee of the Employees’ Trust
Fund, is VMC’s co-owner of the MBP lot.

Petitioner further contends that there is no dispute that the Employees’ Trust Fund is exempt
from income tax. Since petitioner, as trustee, purchased 49.59% of the MBP lot using funds of
the Employees’ Trust Fund, petitioner asserts that the Employees’ Trust Fund's 49.59% share
in the income tax paid amounting to ₱3,037,500 should be refunded.

Hence, petitioner, as trustee of the Employees’ Trust Fund, filed for refund.

Issue:

Is petitioner entitled to tax refund?

Ruling:

Petitioner is entitled for the tax refund.

It is evident that tax-exemption is likewise to be enjoyed by the income of the pension trust.
Otherwise, taxation of those earnings would result in a diminution of accumulated income and
reduce whatever the trust beneficiaries would receive out of the trust fund. This would run
afoul of the very intendment of the law.

There can be no denying either that the final withholding tax is collected from income in
respect of which employees’ trusts are declared exempt (under the Tax Code). xxx If an
employees’ trust xxx enjoys a tax-exempt status from income, we see no logic in withholding
a certain percentage of that income which it is not supposed to pay in the first place.

Similarly, the BIR ruled that the private employees benefit trust funds, which included
petitioner, have met the requirements of the law and the regulations and therefore qualify as
reasonable retirement benefit plans within the contemplation of Republic Act No. 4917 (now
Sec. 28(b)(7)(A), Tax Code) (Note: it is now Sec. 32(B)(6a) of NIRC). The income from the
trust fund investments is therefore exempt from the payment of income tax and consequently
from the payment of the creditable withholding tax on the sale of their real property.

(Not in the case)

Requisites of exclusion of benefits from Retirement Benefit Plans and Pension Plans
from Gross Income (Sec. 32(B)(6a) of NIRC)

(1) reasonable private benefit plan maintained by the employer (and approved by the
BIR)

(2) retiring official or employee has been in the service of the same employer for at
least ten (10) years

(3) is not less than fifty (50) years of age at the time of his retirement, and

(4) benefits granted under this subparagraph shall be availed of by an official or

employee only once.
IV. (7) RETIREMENT BENEFITS

MA. ISABEL T. SANTOS vs. SERVIER PHILIPPINES, INC.

G.R. No. 166377             November 28, 2008

FACTS:

Petitioner Ma. Isabel T. Santos was the Human Resource Manager of respondent Servier
Philippines, Inc. since 1991 until her termination from service in 1999. On March 26 and 27,
1998, petitioner attended a meeting of all human resource managers of respondent, held in
Paris, France.

On March 29, 1998, while having dinner (in Paris), petitioner complained of stomach pain,
then vomited. Eventually, she was brought to the hospital known as Centre Chirurgical de
L’Quest where she fell into coma for 21 days; and later stayed at the Intensive Care Unit
(ICU) for 52 days. The hospital found that the probable cause of her sudden attack was
"alimentary allergy.’

In June 1998, petitioner was allowed to go back to the Philippines for the continuation of her
medical treatment. She was then confined at the St. Luke’s Medical Center for rehabilitation. 

In a letter dated May 14, 1999, respondent informed the petitioner that the former had
requested the latter’s physician to conduct a thorough physical and psychological evaluation
of her condition, to determine her fitness to resume her work at the company. Petitioner’s
physician concluded that the former had not fully recovered mentally and physically. Hence,
respondent was constrained to terminate petitioner’s services effective August 31, 1999.

As a consequence of petitioner’s termination from employment, respondent offered a

retirement package which consists of:

Retirement Plan Benefits: P 1,063,841.76

Insurance Pension at 20,000.00/month for

60 months from company-sponsored
group life policy: P 1,200,000.00

Educational assistance: P 465,000.00

Medical and Health Care: P 200,000.001

Of the promised retirement benefits amounting to P1,063,841.76, only P701,454.89 was

released to petitioner’s husband, the balance thereof was withheld allegedly for taxation
purposes. Respondent also failed to give the other benefits listed above.

ISSUE:

Whether the retirement benefits are taxable.

HELD:
YES.

Section 32 (B) (6) (a) of the New National Internal Revenue Code (NIRC) provides for the
exclusion of retirement benefits from gross income, thus:

(6) Retirement Benefits, Pensions, Gratuities, etc. –

a) Retirement benefits received under Republic Act 7641 and those received by officials and
employees of private firms, whether individual or corporate, in accordance with a reasonable
private benefit plan maintained by the employer: Provided, That the retiring official or
employee has been in the service of the same employer for at least ten (10) years and is not
less than fifty (50) years of age at the time of his retirement: Provided further, That the
benefits granted under this subparagraph shall be availed of by an official or employee only
once. x x x.

Thus, for the retirement benefits to be exempt from the 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 official or employee has been in the
service of the same employer for at least ten (10) years; (3) the retiring official or employee is
not less than fifty (50) years of age at the time of his retirement; and (4) the benefit had been
availed of only once.

As discussed above, petitioner was qualified for disability retirement. At the time of such
retirement, petitioner was only 41 years of age; and had been in the service for more or less
eight (8) years. As such, the above provision is not applicable for failure to comply with the
age and length of service requirements. Therefore, respondent cannot be faulted for
deducting from petitioner’s total retirement benefits the amount of P362,386.87, for taxation
purposes.
G.R. No. 173373               July 29, 2013

H. TAMBUNTING PAWNSHOP, INC., VS. CIR

Doctrine: To be entitled to claim a tax deduction, the taxpayer must competently establish
the factual and documentary bases of its claim.

FACTS: H. Tambunting Pawnshop, Inc. a domestic corporation duly licensed and authorized
to engage in the pawnshop business. On June 26, 2000, the Bureau of Internal Revenue
(BIR) issued assessment notices and demand letters, all numbered 32-1-97, assessing
Tambunting for deficiency percentage tax, income tax and compromise penalties for taxable
year 1997 plus 20% delinquency interest computed from August 29, 2000 until full payment,
but cancelling the compromise penalties for lack of basis.

On July 26, 2000, Tambunting instituted an administrative protest against the assessment
notices and demand letters with the Commissioner of Internal Revenue. On February 21,
2001, Tambunting brought a petition for review in the CTA, pursuant to Section 228 of the
National Internal Revenue Code of 1997, citing the inaction of the Commissioner of Internal
Revenue on its protest within the 180-day period prescribed by law.

Apparently, petitioner is still liable for deficiency income tax in the reduced amount of
₱4,536,687.15. Petitioner’s contention that the NIRC of 1977 did not impose substantial
requirements on deductions from gross income is bereft of merit. Tambunting filed a petition
for review in the CTA En Banc, arguing that the First Division erred in disallowing its
deductions on the ground that it had not substantiated them by sufficient evidence.

Tambunting argues that the CTA should have allowed its deductions because it had been
able to point out the provisions of law authorizing the deductions; that it proved its entitlement
to the deductions through all the documentary and testimonial evidence presented in
court; that the provisions of Section 34 (A)(1)(b) of the 1997 National Internal Revenue Code,
governing the types of evidence to prove a claim for deduction of expenses, were applicable
because the law took effect during the pendency of the case in the CTA; that the CTA had
allowed deductions for ordinary and necessary expenses on the basis of cash vouchers
issued by the taxpayer or certifications issued by the payees evidencing receipt of interest on
loans as well as agreements relating to the imposition of interest; that it had thus shown
beyond doubt that it had incurred the losses in its auction sales; and that it substantially
complied with the requirements of Revenue Regulations No. 12-77 on the deductibility of its
losses.

ISSUE: Whether the petitioner is entitled to tax deduction.

HELD: NO. To be entitled to claim a tax deduction, the taxpayer must competently establish
the factual and documentary bases of its claim. Tambunting did not discharge its burden of
substantiating its claim for deductions due to the inadequacy of its documentary support of its
claim. Its reliance on withholding tax returns, cash vouchers, lessor’s certifications, and the
contracts of lease was futile because such documents had scant probative value.

This case involved assessments relating to transactions incurred by Tambunting prior to the
effectivity of Republic Act No. 8424 (National Internal Revenue Code of 1997, or NIRC of
1997), the provisions governing the propriety of the deductions was Presidential Decree 1158
(NIRC of 1977).
To reiterate, 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. The rule that tax deductions, being in the nature of tax
exemptions, are to be construed in strictissimi juris against the taxpayer is well
settled. Corollary to this rule is the principle that when a taxpayer claims a deduction, he must
point to some specific provision of the statute in which that deduction is authorized and must
be able to prove that he is entitled to the deduction which the law allows. An item of
expenditure, therefore, must fall squarely within the language of the law in order to be
deductible. A mere averment that the taxpayer has incurred a loss does not automatically
warrant a deduction from its gross income.

Tambunting did not properly prove that it had incurred losses. The subasta books it presented
were not the proper evidence of such losses from the auctions because they did not reflect
the true amounts of the proceeds of the auctions due to certain items having been left unsold
after the auctions. The rematado books did not also prove the amounts of capital because the
figures reflected therein were only the amounts given to the pawnees. It is interesting to note,
too, that the amounts received by the pawnees were not the actual values of the pawned
articles but were only fractions of the real values.
[G.R. No. L-8505.  May 30, 1956.]
THE COLLECTOR OF INTERNAL REVENUE, Petitioner, vs. THE PHILIPPINE
EDUCATION CO., INC., Respondent.

FACTS:
The Philippine Education Co., Inc., lost all its pre-war books of accounts and records, with the
exception of a copy of the trial balance sheet of November 30, 1941. The accounting firm of
Dalupan, Sanchez & Co. was employed to prepare and prove Respondent’s war damage
claim, as in fact it did so. On October 29, 1948, the War Damage Commission made the first
payment of P402,273.96 to the Respondent which paid to Dalupan, Sanchez & Co. the sum
of P13,045.48 as the latter’s stipulated fee. In the income tax return filed by
the Respondent for the fiscal year ending on March 31, 1949, the Respondent claimed the
sum of P13,045.48 as a deduction under section 30 of the National Internal Revenue Code.
Disallowing said deduction, the Collector of Internal Revenue, Petitioner herein, assessed
against the Respondent the sum of P2,405.14 as deficiency income tax on the amount of
P13,045.48, including surcharge, penalty and interest, payment of which was demanded from
the Respondent. Refusing to acquiesce in said ruling, the Respondent appealed to the Court
of Tax Appeals which rendered a decision reversing the view of the Petitioner and declaring
the Respondent exempt from the deficiency income tax in question.

RULING:
The legal provision involved is section 30 of the National Internal Revenue Code which allows
as deductions “all the ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business.”
As pointed out by the Court of Tax Appeals, three conditions are imposed:  (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.
It is admitted that the sum of P13,045.13 was paid by the Respondent to Dalupan, Sanchez &
Co. within the fiscal year 1949. The questions to be decided are whether or not the expense
in question was ordinary and necessary and whether or not it was paid or incurred in carrying
on Respondent’s business.
It is Petitioner’s theory that the Respondent is a corporation engaged in the purchase and
sale of textbooks, magazines, office and school supplies, and a variety of other merchandise
and commodities; that it was never normally and customarily engaged in filing petitions for
war damage compensation; and that, therefore, the fee paid by it to the accounting firm of
Dalupan, Sanchez & Co. was not incurred in the kind of business transactions in which it is
normally and customarily engaged.
In our opinion, this view is too narrow and technical. To carry on its business, even as
specified by the Petitioner, the Respondent not only must have sufficient assets but must
preserve the same and recover any that should be lost. The fee in question was paid by
the Respondent to recover its lost assets occasioned by the war and thereby to be so
rehabilitated as to be able to carry on its business. The law does not say that the expense
must be for or on account of transactions in one’s trade or business.
As stated in Merten’s Law of Federal Income Taxation, Vol. IV, “ordinarily, an expense will be
considered necessary where the expenditure is appropriate and helpful in the development of
the taxpayer’s business” (page 35); “it is sufficient that the expense were incurred for
purposes proper to the conduct of the corporate affairs or for the purpose of realizing a profit
or of minimizing a loss” (pp. 382-383);“the term ‘ordinary’ as used in these statutes does not
require that the payments be habitual or normal in the sense that the same taxpayer will have
to make them often; the payment may be unique or non-recurring to the particular taxpayer
affected” (p. 316); and “attorney’s fees for services rendered in the prosecution of claim
before the Mixed Claims Commission are deductible” (p. 346).
There is no essential difference between attorney’s fees and that paid to an accountant, as
regards the benefit derived by the claimant. With particular reference to attorney’s fees, the
following cases were cited: Commissioner of Internal Revenue vs. Ullmann 77 F (2d) 827,
296, U.S. 631, 80 L fd. 449, 56 SCRA 155 (1935), and Commissioner of Internal Revenue vs.
Speyer 77 F (2d) 824, 296 U. S. 631, 80 L fd. 449, 56 SCRA 1955. The Petitioner observes,
however, that these cases are not applicable because there is no law of the United States
Federal Government exempting the proceeds of war damage claims from taxes. This
observation is successfully answered by the Respondent which has pointed out that the
exemption provided in Republic Act No. 227 is a surplusage, because even without said
statutory exemption, a war damage compensation would still not be subject to tax, not being
an income. “The word ‘income’, as used in the sixteenth amendment, cannot be construed to
include property other than income, even if such property is described as income by an act of
Congress.” (Brewester vs. Walch, D. C. Conn. 268 F207, 216.) “Compensation for injury to
capital is never ‘income,’ no matter when collected.” (H. Liebes & Co. vs. Commissioner of
Internal Revenue, C. C. A. 9, 90 F 2nd 932.)
The Petitioner also resorts to the argument that Republic Act No. 227 gives taxpayers double
benefits, namely, that of deducting from the gross income the loss sustained, and that of
exempting the recovered amounts from income tax; and if the fees incurred in the recovery of
war damage compensation can be allowed as a deduction, it would work to the great
prejudice and disadvantage of the Government. As ruled by the Court of Tax Appeals, “the
questioned item represent legitimate business expense incurred in the recovery of losses and
it has never been deducted by Petitioner (Respondent herein) as part of his war losses.” And
the Respondent, moreover, add: “Besides, there is nothing in the stipulation of facts which
suggest even vaguely that there was in this case an infringement of the double-benefit theory.
On the contrary, the Respondent failed to deduct in any of its income tax returns its war
losses, and even the amount of its approved claim which the United States Philippine War
Damage Commission did not pay for lack of appropriation.”
ESSO Standard Eastern v. Commissioner 175 SCRA 149 G.R. Nos. L-28508-9 July 7,
1989

Rule on Expenses

Doctrine:

Margin fees shall be ordinary and necessary business expenses incurred for purposes of
carrying on its own trade or business in the Philippines exclusively in order to be deductible
from gross income.

Facts:

Petitioner ESSO claimed for deductions from its gross income in 1959, as part of its ordinary
and necessary business expenses, P323,279.00 representing abandonment as dry holes of
its several oil wells and P340,822.04 representing margin fees it had paid to the Central Bank
on its profit remittances to its New York head office.

Respondent CIR granted then a tax credit of P221,033.00 only, disallowing the claimed
deduction for the margin fees paid. Later, the CIR assessed ESSO a deficiency income tax
for the year 1960 plus interests for a total of P434,232.92, which arose from the disallowance
of the margin fees paid by ESSO to the Central Bank on its profit remittances to its New York
head office.

ESSO settled this deficiency assessment in 1964, by applying the tax credit of P221,033.00
representing its overpayment on its income tax for 1959 and paying under protest the
additional amount of P213,201.92.

CIR then denied the claims of ESSO for refund of the overpayment of its income taxes,
holding that the margin fees paid to the Central Bank could not be considered taxes or
allowed as deductible business expenses.

ESSO appealed to the CTA and sought the refund, contending that the margin fees were
deductible from gross income either as a tax or as an ordinary and necessary business
expense.

Issue:

Whether the margin fees paid by the petitioner to the Central Bank on its profit remittances to
its New York head office should be deductible from ESSO's gross income either as tax or as
ordinary and necessary business expenses, and hence entitle ESSO to refund of the margin
fees paid.

Ruling:

No, the margin fees are not deductible from petitioner’s gross income, either as tax or
ordinary and necessary business expense, and hence ESSO is not entitled to refund.

The SC held that a tax is levied to provide revenue for government operations, while the
proceeds of the margin fee are applied to strengthen our country's international reserves.
Thus, a margin fee is not a tax but an exaction designed to curb the excessive demands upon
and strengthen our international reserve, and hence shall not be deductible from gross
income.

As to whether a margin fee is a business expense, the statutory test of deductibility states
that to be deductible, three conditions are imposed, namely: (1) the expense must be ordinary
and necessary, (2) it must be paid or incurred within the taxable year, and (3) it must be paid
or incurred in carrying on a trade or business. In addition, not only must the taxpayer meet
the business test, he must substantially prove by evidence or records the deductions claimed
under the law, otherwise, the same will be disallowed. The mere allegation of the taxpayer
that an item of expense is ordinary and necessary does not justify its deduction.

Ordinarily, an expense will be considered 'necessary' where the expenditure is appropriate

and helpful in the development of the taxpayer's business. It is 'ordinary' when it connotes a
payment which is normal in relation to the business of the taxpayer and the surrounding
circumstances. The term 'ordinary' does not require that the payments be habitual or normal
in the sense that the same taxpayer will have to make them often; the payment may be
unique or non-recurring to the particular taxpayer affected.

Considering the foregoing test of what constitutes an ordinary and necessary deductible
expense, the margin fees are not expenses in connection with the production or earning of
petitioner's incomes in the Philippines. They were expenses incurred in the disposition of said
incomes; expenses for the remittance of funds after they have already been earned by
petitioner's branch in the Philippines for the disposal of its Head Office in New York which is
already another distinct and separate income taxpayer.

It can never be said therefore that the margin fees were appropriate and helpful in the
development of petitioner's business in the Philippines exclusively or were incurred for
purposes proper to the conduct of the affairs of petitioner's branch in the Philippines
exclusively or for the purpose of realizing a profit or of minimizing a loss in the Philippines
exclusively.

Therefore, ESSO, having assumed an expense properly attributable to its head office, cannot
now claim this as an ordinary and necessary expense, deductible from its gross income, and
thus cannot also claim for refund.
Atlas Consolidated Mining v. CIR
G.R. No. L-26911, L-26924, January 27, 1981
DE CASTRO, J.

Doctrine: For the expense to be deductible, it must be: (1) ordinary and necessary, (2)
incurred within the taxable year, and (3) incurred in carrying in a trade or business.
Facts: Atlas is a corporation engaged in the mining industry registered in Philippines. The
CIR assessed Atlas deficiency income taxes for the years 1957 and 1958.
For the year 1957, the CIR opined that Atlas is not entitled to exemption from the income tax
under Sec 4 of RA 909 because same covers only gold mines. For the year 1958, the
assessment of deficiency income tax covers the disallowance of items claimed by Atlas as
deductible from gross income.
Atlas protested the assessment. The Secretary of Finance ruled that the exemption in RA 909
embraces all new and old mines whether gold or other minerals. The CIR issued a revised
assessment entirely eliminating the assessment for the year 1957. The assessment for 1958
was reduced disallowing the following items 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
Atlas appealed to the CTA. The CTA allowed the disallowed items, except the stockholders
relation service fee and suit expenses.
It is well settled that suit or litigation expenses incurred in defense or protection of title are
capital in nature and not deductible.

Issue: Whether the stockholders relation service fee paid by Atlas to P.K. Macker & Co. is an
allowable deduction as business expense.

Ruling: No, stockholders relation service fee is capital in nature, hence not deductible.

Section 30 (a)(1) of the NIRC states that for an expense to be deductible it must be: (1) be
ordinary and necessary, (2) incurred within the taxable year, and (3) incurred in carrying in a
trade or business.

The expense is paid as compensation to P.K. Macker & Co. for its services of carrying on the
selling campaign to sell Atlas' additional capital stock. It was incurred to create a favorable
image of the corporation. Efforts to establish reputation are akin to acquisition of capital
assets and, therefore, expenses related thereto are not business expense but capital
expenditures.
Commissioner of Internal Revenue v. Algue Inc. Rule on Expenses
G.R. No. L-28896, February 17, 1988

Doctrine: The test of deductibility of compensation payments is whether they are reasonable
and are, in fact, payments purely for services. Any amount paid in the form of compensation,
but not in fact as the purchase price of services, is not deductible.

Facts: Algue Inc. is a corporation engaged in engineering and construction. It was assessed
for delinquency income taxes totaling P83,183.85 for the years 1958, and 1959. Algue filed a
protest which was duly received. Algue was served a warrant of distraint and levy but refused
to receive it on the ground of its protest. The warrant was received only when Algue was
informed that the BIR was not acting on its protest. Algue filed a petition for review with the
CTA.

The CTA held that Algue’s claimed deduction of P75,000 represented a necessary business
expense and should not be disallowed by the BIR. The payment was for promotional fees
paid for the creation of the Vegetable Oil Investment Company (VOICO) and purchase of the
Philippine Sugar Estate Development Company (PSEDCO).

The CIR claimed that the payments were fictitious because most of the payees are members
of the same family in control of Algue. CIR suggested that the expenses were made as an
attempt to evade a legitimate assessment, considering that the payments were not sufficiently
substantiated. During the trial it was shown that strict business procedures were not applied
because of the close relationship among the persons in the family corporation.

Issue: Whether the claim of expenses is proper

Ruling: Yes. The SC agreed with the CTA in holding that the promotional fees were not
excessive. PSEDCO paid Algue P125,000. The claimed deduction of P75,000 which was
60% of the commission was reasonable under the circumstances, considering that the
payees did practically everything from forming VOICO and purchasing PSEDCO.

Ostensible salaries paid by a corporation may be a distribution of a dividend on stock. This is

likely to occur in corporations having few stockholders. In such cases, the payment of salaries
are not paid wholly for services rendered but for distribution of earnings upon the stock. Under
the test of deductibility of compensation payments, such expenses are disallowed.

The test does not apply in this case because the payees were not in the regular employ of
Algue, nor were they its controlling stockholders. The expenses claimed are thus proper.
Deductions from Gross Income; Examples of Business Expenses; Advertising and
Promotional Expenses

COMMISSIONER v. GENERAL FOODS (2003)

FACTS:

General Foods, which is engaged in the manufacture of beverages such as Tang, Calumet
and Kool-Aid, filed its income tax return for the fiscal year ending February 28, 1985. In said
tax return, respondent corporation claimed as deduction, among other business expenses,
the amount of P9,461,246 for media advertising for Tang, 50% of which was later disallowed
by the Commissioner. Consequently, respondent corporation was assessed deficiency
income taxes in the amount of P2,635, 141.42. The Commissioner maintains that the subject
advertising expense was not ordinary on the ground that it failed the two conditions set by
U.S. jurisprudence: first, “reasonableness” of the amount incurred and second, the amount
incurred must not be a capital outlay to create “goodwill” for the product and/or private
respondent’s business. Otherwise, the expense must be considered a capital expenditure to
be spread out over a reasonable time.

ISSUE:

Should the advertising expense be allowed as deduction from General Foods’ gross income?

RULING:

NO. To be deductible from gross income, the subject advertising expense must comply with
the following requisites: (a) the expense must be ordinary and necessary; (b) it must have
been paid or incurred during the taxable year; (c) it must have been paid or incurred in
carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts,
records or other pertinent papers.

While the subject advertising expense was paid or incurred within the corresponding taxable
year and was incurred in carrying on a trade or business, hence necessary, the parties’ views
conflict as to whether or not it was ordinary. To be deductible, an advertising expense should
not only be necessary but also ordinary.

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an
advertising expense. There being no hard and fast rule on the matter, the right to a deduction
depends on a number of factors such as but not limited to: the type and size of business in
which the taxpayer is engaged; the volume and amount of its net earnings; the nature of the
expenditure itself; the intention of the taxpayer and the general economic conditions. It is the
interplay of these, among other factors and properly weighed, that will yield a proper
evaluation. The Court finds the subject expense for the advertisement of a single product to
be inordinately large. Therefore, even if it is necessary, it cannot be considered an ordinary
expense deductible under then Section 29 (a) (1) (A) of the NIRC.

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of
merchandise or use of services and (2) advertising designed to stimulate the future sale of
merchandise or use of services. The second type involves expenditures incurred, in whole or
in part, to create or maintain some form of goodwill for the taxpayer’s trade or business or for
the industry or profession of which the taxpayer is a member. If the expenditures are for the
advertising of the first kind, then, except as to the question of the reasonableness of amount,
there is no doubt such expenditures are deductible as business expenses. If, however, the
expenditures are for advertising of the second kind, then normally they should be spread out
over a reasonable period of time.

The company’s media advertising expense for the promotion of a single product is doubtlessly
unreasonable considering it comprises almost one-half of the company’s entire claim for
marketing expenses for that year under review. Petition granted, judgment reversed and set
aside.

Commissioner v Palanca (18 SCRA 496) G.R. No. L-16626 October 29, 1966

DOCTRINE: Interests on taxes should be considered as interests on indebtedness and hence

deductible from the gross income as contemplated by the Tax Code.

FACTS: Sometime in July, 1950, the late Don Carlos Palanca, Sr. donated in favor of his son,
the petitioner, herein shares of stock in La Tondeña, Inc. amounting to 12,500 shares. For
failure to file a return on the donation within the statutory period, the petitioner was assessed
of gift tax and 25% surcharge and interest which he paid.

In March of 1956, the petitioner filed with the Bureau of Internal Revenue his income tax
return for the calendar year 1955, claiming, among others, a deduction for interest amounting
to P9,076.45. The BIR denied the claim for refund.

Meanwhile, Palanca Sr. died and the BIR considered the transfer of 12,500 shares of stock of
La Tondeña Inc. to be a transfer in contemplation of death. Consequently, the respondent
assessed against the petitioner the sum of P191,591.62 as estate and inheritance taxes on
the transfer of said 12,500 shares of stock. In 1958, the petitioner, once more filed an
amended income tax return for the calendar year 1955, claiming, in addition to the interest
deduction of P9,076.45 appearing in his original return, a deduction in the amount of
P60,581.80, representing interest on the estate and inheritance taxes on the 12,500 shares of
stock. The claims for deduction was based on the provisions of Section 30(b) (1) of the Tax
Code, which authorizes the deduction from gross income of interest paid within the taxable
year on indebtedness. Without waiting for the BIR’s decision (na deny rin lang), the petitioner
filed his petition for review before the CTA and obtained a favorable ruling, Hence, this
appeal.

ISSUE: Whether the amount paid (60, 581.80) by Palanca as interest on his delinquent estate
and inheritance tax is deductible from the gross income and should be refunded by the BIR?

HELD: Yes. While "taxes" and "debts" are distinguishable legal concepts, in certain cases as
in the suit at bar, on account of their nature, the distinction becomes inconsequential such as
when statutes impose personal liability (interest) for a tax, the tax becomes at least in a broad
sense, a debt.

In the case of CIR v Prieto, it was explicitly announced that while the distinction between
"taxes" and "debts" was recognized in this jurisdiction, the variance in their legal conception
does not extend to the interests paid on them, at least insofar as Section 30 (b) (1) of the
National Internal Revenue Code is concerned.

In both this and the said case, the taxpayer sought the allowance as deductible items from the
gross income of the amounts paid by them as interests on delinquent tax liabilities. Of course,
what was involved in the cited case was the donor's tax while the present suit pertains to
interest paid on the estate and inheritance tax. This difference, however, submits no
appreciable consequence to the rationale of this Court's previous determination that interests
on taxes should be considered as interests on indebtedness within the meaning of Section
30(b) (1) of the Tax Code. The interpretation we have placed upon the said section was
predicated on the congressional intent, not on the nature of the tax for which the interest was
paid.

-x

Q: differentiate a tax from debt?

A: debts are due to the government in its corporate capacity, while taxes are due to the
government in its sovereign capacity. A debt is a sum of money due upon contract express or
implied or one which is evidenced by a judgment. Taxes are imposts levied by government for
its support or some special purpose which the government has recognized.

THE COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.

CONSUELO L. VDA. DE PRIETO, respondent

G.R. No. L-13912 September 30, 1960

GUTIERREZ DAVID, J.

FACTS: On December 4, 1945, the respondent conveyed by way of gifts to her four children,
namely, Antonio, Benito, Carmen and Mauro, all surnamed Prieto, real property with a total
assessed value of P892,497.50. After the filing of the gift tax returns on or about February 1,
1954, the petitioner Commissioner of Internal Revenue appraised the real property donated
for gift tax purposes at P1,231,268.00, and assessed the total sum of P117,706.50 as donor's
gift tax, interest and compromises due thereon. Of the total sum of P117,706.50 paid by
respondent on April 29, 1954, the sum of P55,978.65 represents the total interest on account
of deliquency. This sum of P55,978.65 was claimed as deduction, among others, by
respondent in her 1954 income tax return. Petitioner, however, disallowed the claim and as a
consequence of such disallowance assessed respondent for 1954 the total sum of
P21,410.38 as deficiency income tax due on the aforesaid P55,978.65, including interest up
to March 31, 1957, surcharge and compromise for the late payment.

ISSUE: Whether or not such interest was paid upon an indebtedness within the contemplation
of section 30 (b) (1) of the Tax Code

RULING: SEC. 30 Deductions from gross income. — In computing net income there shall be
allowed as deductions —

(b) Interest:

(1) In general. — The amount of interest paid within the taxable year on indebtedness, except
on indebtedness incurred or continued to purchase or carry obligations the interest upon
which is exempt from taxation as income under this Title.

The term "indebtedness" as used in the Tax Code of the United States containing similar
provisions as in the above-quoted section has been defined as an unconditional and legally
enforceable obligation for the payment of money. Within the meaning of that definition, it is
apparent that a tax may be considered an indebtedness. It follows that the interest paid by
herein respondent for the late payment of her donor's tax is deductible from her gross income
under section 30(b) of the Tax Code. Thus, under sec. 23(b) of the Internal Revenue Code of
1939, as amended, which contains similarly worded provisions as sec. 30(b) of our Tax Code,
the uniform ruling is that interest on taxes is interest on indebtedness and is deductible. The
rule applies even though the tax is nondeductible.

In conclusion, we are of the opinion and so hold that although interest payment for delinquent
taxes is not deductible as tax under Section 30(c) of the Tax Code and section 80 of the
Income Tax Regulations, the taxpayer is not precluded thereby from claiming said interest
payment as deduction under section 30(b) of the same Code.
Marcelo Steel Corp. v. CIR

G.R. No. L-12401

FACTS: Petitioner is a corporation engaged in industrial activities, namely manufacture of

wire fence, nails, steel bars, rods and other allied steel products. Petitioner enjoyed the
benefit of tax exemption under R.A. No. 35. On 1953 petitioner filed its ITR for the years 1952
and 1953 which did not reflect the financial results of its tax exempt business activities but
those realized solely from its business of manufacturing wire fence. On 1954 petitioner filed
its amended ITR for taxable years 1952 and 1953 declaring that it suffered a net loss ofP871,
407.37 in 1952 and P104, 956.29 in 1953. The losses were arrived at by consolidating the
gross income and expenses and/or deductions of the petitioner in all its business activities.
Also petitioner filed a claim for refund erroneously paid to respondent. Petitioner relies on the
theory that it is a corporation organized with a single capital that answer for all its financial
obligation including those incurred in the tax exempt industries, the gross income derived
from both its taxable or non-exempt and tax-exempt industries, and the allowable deductions
from said incomes, should be consolidated and its income tax liability should be based on the
difference between the consolidated gross incomes and the consolidated allowable
deductions ISSUE: Whether petitioner may be allowed to deduct from the profits realized from
its business activities, the losses sustained by its tax exempt industries.

RULING: No, petitioner is not allowed to deduct from the profits realize from its business
activities, the losses sustained by its tax exempt industries.

The fact that a corporation is organized with a single capital that answers for all its financial
obligations including those incurred in the tax exempt industries is of no moment. The intent
of the law is to treat taxable or non-exempt industries as separate and distinct from new and
necessary industries which are tax-exempt for purposes of taxation.

In addition, the purpose or aim of Republic Act No. 35 is to encourage the establishment or
exploitation of new and necessary industries to promote the economic growth of the country.
It is a form of subsidy granted by the Government to courageous entrepreneurs staking their
capital in an unknown venture. An entrepreneur engaging in a new and necessary industry
faces uncertainty and assumes a risk bigger than one engaging in a venture already known
and developed. Like a settler in an unexplored land who is just blazing a trail in a virgin forest,
he needs all the encouragement and assistance from the Government. He needs capital to
buy his implements, to pay his laborers and to sustain him and his family. Comparable to the
farmer who has just planted the seeds of fruit bearing trees in his orchard, he does not expect
an immediate return on his investment. Usually loss is incurred rather than profit made. It is
for these reasons that the law grants him tax exemption to lighten onerous financial burdens
and reduce losses. However these may be, Republic Act No. 35 has confined the privilege of
tax exemption only to new and necessary industries. It did not intend to grant the tax
exemption benefit to an entrepreneur engaged at the same time in a taxable or non-exempt
industry and a new and necessary industry, by allowing him to deduct his gain or profits
derived from the operation of the first from the losses incurred in the operation of the second.
Unlike a new and necessary industry, a taxable or non-exempt industry is already a going
concern, deriving profits from its operation, and deserving no subsidy from the Government. It
is but fair that it be required to give the Government a share in its profits in the form of taxes.
Collector v. Asturias Sugar Central, Inc., 2 SCRA 1140

Requisites for deductibility of losses

Doctrine: Losses, to be deductible, must be evidenced by closed and completed transactions.

Facts: Asturias Sugar Central, Inc., is a domestic corporation engaged in the manufacture of
sugar from sugar cane. On April 18, 1942, the Asturias Sugar Central, Inc. was burned by the
retreating United States Army Forces in the Far East (USAFFE) under its scorch earth policy
and to resist enemy attack. The Central was totally destroyed and was reconstructed only on
or about 1947. The petitioner on February 26, 1948, filed with the Philippine War Damage
Commission a claim for damages sustained on its properties during the war in the amount of
P2,135,685.51. The War Damage Commission approved payment in favor of petitioner in the
amount of P1,064,812.92 and extended the first payment amounting to P426,526.16. When
the petitioner received the second payment of P319,413.90, it was informed that the amount
would be the last payment because there was no more funds available.

In its income tax return for 1950, the petitioner claimed a deduction of P354,606.30 as war
losses. The Collector of Internal Revenue (now Commissioner of Internal Revenue)
disallowed all deductions for war losses and consequently, notices of deficiency income tax
assessments were issued against the petitioner corresponding to the years 1950 and 1951.
Petitioner paid the taxes assessed but requested the its refund on October 25, 1956. The
request for refund was denied by the CIR.

Issue: Whether the war losses in question were properly deductible in 1942, when the losses
were actually sustained, or in 1950 end 1951, when petitioner was advised by the Philippine
War Damage Commission that no further payment would be made

Ruling: The losses must be claimed as deduction in the year they were actually sustained, not
in the years the claim for indemnity was finally determined. 1aw library

The Asturias Sugar Central, Inc. had the duty, before it claimed the corresponding deduction
for the loss of its central, to wait until it could determine, with reasonable certainty, how much
compensation, if any, it would get pursuant to the War Damage Corporation Act. Only then
could it be fairly said that it had complied with the requirement of section 96 of our Tax Code,
to the effect that:j

"Losses must usually be evidenced by closed and completed transactions. Proper adjustment
must be made in each case . . . Moreover, the amount of loss must be reduced by the amount
of any insurance or other compensation received, and by the salvage value, if any, of the
property . . .."
PHILIPPINE SUGAR ESTATE DEV VS. POSADAS

INCOME TAX; DEDUCTION OF LOSSES SUSTAINED FROM INCOME TAX RETURNS. —

A taxpayer who does not deduct his losses from his income tax returns for the year in which
he may have sustained them on account of the opposition of an internal revenue agent-
examiner to that deduction, but makes this ten years thereafter without objection on the part
of the Collector of Internal Revenue, should not, in equity, answer for the additional payment
for that omission after the lapse of fifteen years for the reason that he has acted in good faith.

Facts: Philippine sugar estate transferred from its “Losses and Profits” account to its “Items in
Suspense” account the amount of P63,831.71 as a loss actually sustained by the corporation.
On December 21 of the same year, when it considered said amount as definitely lost, the
corporation made it thus appear in its book by transferring it from its “Items in Suspense”
account to that of “Losses and Profits” but at the instance of the internal revenue agent-
examiner, said entry was returned from the “Losses and Profits” account to that of that of
“Items in Suspense” and entered in its book on December 31, 1918.

The return of the defrauded sum to the “Items in Suspense” account at the instance of the
internal revenue agent-examiner, prevented the plaintiff from excluding from its income tax
returns for 1918 the amount swindled in 1917, and was able to do so only in the month of
December, 1928, when it was definitely known that it was no longer possible to recover the
said loss, charging it to the losses account and excluding it from its income tax returns for
1918. The Bureau of Internal Revenue not only ignored that deduction, but also in view of the
returns filed by the said plaintiff the CIR assessed the tax for that year which was paid under
protest. Five years after the CIR claimed the amount that had been erroneously deducted as
a loss sustained by the plaintiff corporation and should have excluded from its ITRs.

Defendant tried to detract from the validity and force of the opposition of his agent- examiner
to the deduction of said loss from the income tax returns filed by the plaintiff corporation in the
year 1918, alleging that said agent had no authority or power to interpose that opposition, and
that the annotation which appears in the books of the plaintiff corporation, made on December
31, 1918, and which says: "Returned to the Debit of the first account (Items in Suspense) —
amounts swindled by Federico R Almela which we paid on June 28 last and charged to the
respective accounts of this column (Losses and Profits) at the instance of the agent-examiner
of the Bureau of Internal Revenue for the determination of the income tax for previous years
— P63,831.77", is self-serving, that is, a statement made in favor of the plaintiff corporation
itself, and hence not admissible.

ISSUE: Whether a Tax payer who does not deduct his losses from his income tax is liable to
answer for the additional payment.

RULING: No. the supreme court held that a taxpayer who does not deduct his losses from his
income tax returns for the year in which he may have sustained them on account of the
opposition of an internal revenue agent-examiner to that deduction, but makes this ten years
thereafter without objection on the part of the Collector of Internal Revenue, should not, in
equity, answer for the additional payment for that omission after the lapse of fifteen years for
the reason that he has acted in good faith; second, that the difference in the total value of the
shares of stock of a bank resulting from the reduction of the number of said shares which
keep their par value, while the assets of the bank remain intact, cannot be considered as a
loss until the assets are liquidated; and third, that although the Collector of Internal Revenue
has no authority to make an administrative summary collection of the tax upon discovery of
erroneous, false and fraudulent tax returns, after the three years fixed by law counting from
the filing of said income tax returns have elapsed, when the taxpayer paid the additional tax
under protest and brought the corresponding action to recover the protested additional
payment, the collection became judicial and the right of the collector of Internal Revenue to
effect the collection through that means has not prescribed.

Cu Unjieng Sons, Inc. v. Board of Tax Appeals and Collector, 100 Phil. 1

Facts: Cu Unjieng Sons, Inc. is a corporation duly organized and existing under the laws of
the Phili[pines. On February 29, 1948, it filed with the Philippine War Damage Commission a
claim for compensation in accordance with the provisions of Philippine Rehabilitation Act of
1945, for losses sustained during the battle of liberation of Manila and other parts of the
Philippines, in the total sum of P1,079,388.05, representing the appraised value of the
properties lost. The Philippine War Damage Commission notified CU Unjieng that only P671,
770.19 of the total was approved by the Commission and that of the P671, 770.19, the sum of
P470, 239.13 will be paid. On June 15, 1950, the Commission transmitted to the corporation a
US Treasury warrant for the sum of P202, 531.06 as partial payment and on November 8,
1950, another US treasury warrant in the sum of P151, 148.31 was transmitted to the
corporation together with a notice that it was the last payment to be made by the Commission.

Cu Unjieng then filed its income tax return for the years 1945- 1950. For the years 1945 and
1946, it did not pay any income tax, but it paid certain amounts for the years 1947, 1948,
1949, 1950. According to the returns made by the corporation, it deducted the following war
losses for the years set forth below:

1945 – 22, 492.50 1946 – 7,875.00 1947 – 94, 315.25

For the years 1948 and 1950, it did not make any further claims for war losses in the returns it
made for the said years. The Board of Tax Appeals disallowed the deductions for war losses
that the corporation was claiming for the years 1946 and 1947 on the ground that al war
losses sustained should have been claimed as deduction for the year 1945 when the said
losses were actually sustained, pursuant to Section 30(d) (2) of the National Internal Revenue
Code.

Issue: Are the losses, aggregating P1,079,388.05, admittedly suffered by Cu Unjieng Sons,
Inc., were deductible, for income tax purposes, in 1945, when the losses were physically
sustained, or in 1950, when petitioner was advised by the Philippine War Damage
Commission that no payments, other than those effected by said Commission in June and
November, 1950, would be made for said losses?

Supreme Court:

The determination of this question hinges on the interpretation and construction of section 30
of Commonwealth Act No. 466, otherwise known as the National Internal Revenue Code,
from which we quote:

"Deduction from gross income. — In computing net income there shall be allowed as
deductions —

"(d) Losses: "

(2) B y corporations. In the case of a corporation, all losses actually sustained and charged off
within the taxable year and not compensated for by insurance or otherwise." (National Internal
Revenue Code or C. A. No. 466.) (Emphasis supplied.)

This legal provision is implemented by Revenue Regulations No. 2, otherwise known as

Income Tax Regulations, issued by the Secretary of Finance, pursuant to Sections 4(1) and
338 of said Commonwealth Act No. 466. Sections 94 and 96 of the aforementioned
regulations read:
"SEC. 94. Losses by corporations. — Domestic corporations may deduct losses actually
sustained and charged off within the year and not compensated for by insurance or otherwise.

"SEC. 96. Losses generally. — Losses must usually be evidenced by closed and completed
transactions. Moreover, the amount of loss must be reduced by the amount of any insurance
or other compensation received, and by the salvage value, in any, of the property . . ."

It is not disputed that the losses in question could only be charged off in the income tax return
for the year 1945, unless compensated for "by insurance or otherwise." Petitioner maintains
that said losses were so compensated for "by insurance or otherwise"; that the said losses
were not evidenced by "closed or completed transaction," until notice by the Philippine War
Damage Commission that further compensation therefor would not be forthcoming; and that,
inasmuch as such notice was given in 1950, it follows that the losses in question were not
chargeable as deductions in the year 1945. The Collector of Internal Revenue and the Board
of Tax Appeals held, however, that the said losses were not compensated for by insurance or
otherwise, and that, accordingly, the corresponding deduction was permissible, in 1945, only,
not in any other year.

As above stated, this law was approved, and became effective, on April 30, 1946. In order to
be entitled to defer deductions for losses materially sustained within a given year, the right to
compensation therefor, "by way of insurance or otherwise", if any, must exist, however, prior
to the conclusion of said year. Consequently, the approval of the Philippine Rehabilitation Act
of 1946 did not constitute in 1945 a compensation "otherwise" than by insurance, and did not
authorize petitioner herein to postpone, to another year, its claim for deduction arising from
the war losses in question.

In other words, it is claimed that the acts and declarations of responsible officials and organs
of the Government of the United States before the end of 1945 were such as to constitute
"conclusive assurances that property owners had reasonable expectation, that their war
losses would be compensated for." This "reasonable expectation", it is said, sufficed to place
the losses of herein petitioner, during 1945, within the purview of the phrase "compensated
for . . . otherwise" than by insurance in section 30 of our National Internal Revenue Code.

Upon careful consideration of the reasons adduced, and the authorities cited, by counsel for
the petitioner and the amici curiae to bolster up this contention, we find that same is
untenable. In general, the word "otherwise" means but for, or under other circumstances
(Shepherd vs. Davis, 110 A, 17, 19, 91, N. J. Eq. 468, 30 W & P 496); in a different manner;
in another way, or in other ways (Safe Deposit & Trust Co. of Baltimore vs.New York Life
Insurance Co., D.C. Md., 14 F Supp. 721, 726). However, when said term is immediately
preceded by an enumeration, it should receive an ejusdem generis interpretation, or be
limited in its application by the rule noscitur a sociis. In this connection, words and phrases
uses the following language:

"Under the 'ejusdem generis' rule, a 'clean-up' phrase, such as the term 'otherwise' with
respect to a classification which immediately precedes it, includes only things of a like or
similar kind, and nothing of a higher class than that which it immediately follows. Hodgson vs.
Mountain & Gulf Oil Co., D. C. Wyo. 297 F. 269, 272. "

'Otherwise,' as used in Rev. St. sec. 811, denouncing punishment against whoever shall be
found guilty of attempting to rob from the person by cutting or tearing the clothes, or thrusting
the hand into the pockets, or 'otherwise,' is intended to include all similar acts to those
specified, resorted to in an attempt to rob. State vs. West, 30 So. 848, 106 La. 274.

In other words, the vocable "otherwise" in the clause "compensated for by insurance or
otherwise" (in section 30 of our National Internal Revenue Code) should be construed to refer
to compensation due under a title analogous or similar to insurance. Inasmuch as the latter is
a contract establishing a legal obligation (Sec. 2, Art. No. 2427), it follows that in order to be
deemed "compensated for . . . otherwise", the losses sustained by a taxpayer must be
covered by a judicially enforceable right, springing from any of the juridical sources of
obligations, namely: law, contract, quasi- contract, torts or crime (Art. 1157, Civil Code of the
Philippines; Art. 1089, Civil Code of Spain). Hence, Mertens, in his work on the "Law of
Federal Income Taxation" (Vol. 5, p. 104), states: ". . .

The term 'or otherwise' is broad enough to cover any form of off- setting benefit as well as
acutal recoupment. However, there must be a measurable right to compensation for the loss
with ultimate collection reasonably clear." (Emphasis supplied.)

The accuracy of this self-evident propositions is impliedly admitted in petitioner's brief. Thus,
in an effort to distinguish the case at bar from that of U. S. vs. White Dental Manufacturing
Co., (supra,) cited in the decision of the Board of Tax Appeals, petitioner stresses the fact that
"the obligation to pay . . . compensation for war losses sustained by the petitioner during the
war was expressly provided by law" (referring evidently to the Philippine Rehabilitation Act of
1946), and that no such legislation existed in the case of the White Dental Manufacturing Co.
This is an implicit, but, clear, acknowledgment of the fact that petitioner's right to indemnity for
its war losses accrued upon the approval of said Act of Congress of the United States. In
short, such right did not exist, in legal contemplation, during the year 1945. In fact, petitioner
says that its right to compensation "was created by law" and entered into the statute book" (p.
39, Petitioner's Brief). Hence, it could have no legal recognition, much less any juridical effect,
prior to April 30, 1946, when said legislation was approved and became effective.