G.R. Nos.

L-28508-9 July 7, 1989

ESSO STANDARD EASTERN, INC., (formerly, Standard-Vacuum Oil

Company), petitioner,
vs.
THE COMMISSIONER OF INTERNAL REVENUE, respondent.

Padilla Law Office for petitioner.

On appeal before us is the decision of the Court of Tax Appeals 1 denying petitioner's claims for
refund of overpaid income taxes of P102,246.00 for 1959 and P434,234.93 for 1960 in CTA
Cases No. 1251 and 1558 respectively.

In CTA Case No. 1251, petitioner ESSO deducted from its gross income for 1959, 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 respondent Commissioner of
Internal Revenue 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 where it asked
for the refund of P323,279.00 by reason of its abandonment as dry holes of several of its oil
wells. Also claimed as ordinary and necessary expenses in the same return was the amount of
P340,822.04, representing margin fees it had paid to the Central Bank on its profit remittances to
its New York head office.

On August 5, 1964, the CIR granted a tax credit of P221,033.00 only, disallowing the claimed
deduction for the margin fees paid.

In CTA Case No. 1558, the CR assessed ESSO a deficiency income tax for the year 1960, in the
amount of P367,994.00, plus 18% interest thereon of P66,238.92 for the period from April
18,1961 to April 18, 1964, for a total of P434,232.92. The deficiency arose from the
disallowance of the margin fees of Pl,226,647.72 paid by ESSO to the Central Bank on its profit
remittances to its New York head office.

ESSO settled this deficiency assessment on August 10, 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. On August 13, 1964, it claimed the refund of P39,787.94
as overpayment on the interest on its deficiency income tax. It argued that the 18% interest
should have been imposed not on the total deficiency of P367,944.00 but only on the amount of
P146,961.00, the difference between the total deficiency and its tax credit of P221,033.00.

This claim was denied by the CIR, who insisted on charging the 18% interest on the entire
amount of the deficiency tax. On May 4,1965, the CIR also denied the claims of ESSO for
refund of the overpayment of its 1959 and 1960 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 of P102,246.00 for 1959, contending that the
margin fees were deductible from gross income either as a tax or as an ordinary and necessary
business expense. It also claimed an overpayment of its tax by P434,232.92 in 1960, for the same
reason. Additionally, ESSO argued that even if the amount paid as margin fees were not legally
deductible, there was still an overpayment by P39,787.94 for 1960, representing excess interest.

After trial, the CTA denied petitioner's claim for refund of P102,246.00 for 1959 and
P434,234.92 for 1960 but sustained its claim for P39,787.94 as excess interest. This portion of
the decision was appealed by the CIR but was affirmed by this Court in Commissioner of
Internal Revenue v. ESSO, G.R. No. L-28502- 03, promulgated on April 18, 1989. ESSO for its
part appealed the CTA decision denying its claims for the refund of the margin fees P102,246.00
for 1959 and P434,234.92 for 1960. That is the issue now before us.

II

The first question we must settle is whether R.A. 2009, entitled An Act to Authorize the Central
Bank of the Philippines to Establish a Margin Over Banks' Selling Rates of Foreign Exchange, is
a police measure or a revenue measure. If it is a revenue measure, 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 under Sec. 30(c) of the National Internal Revenue Code.
This provides that all taxes paid or accrued during or within the taxable year and which are
related to the taxpayer's trade, business or profession are deductible from gross income.

The petitioner maintains that margin fees are taxes and cites the background and legislative
history of the Margin Fee Law showing that R.A. 2609 was nothing less than a revival of the
17% excise tax on foreign exchange imposed by R.A. 601. This was a revenue measure formally
proposed by President Carlos P. Garcia to Congress as part of, and in order to balance, the
budget for 1959-1960. It was enacted by Congress as such and, significantly, properly originated
in the House of Representatives. During its two and a half years of existence, the measure was
one of the major sources of revenue used to finance the ordinary operating expenditures of the
government. It was, moreover, payable out of the General Fund.

On the claimed legislative intent, the Court of Tax Appeals, quoting established principles,
pointed out that —

We are not unmindful of the rule that opinions expressed in debates, actual proceedings of the
legislature, steps taken in the enactment of a law, or the history of the passage of the law through
the legislature, may be resorted to as an aid in the interpretation of a statute which is ambiguous
or of doubtful meaning. The courts may take into consideration the facts leading up to,
coincident with, and in any way connected with, the passage of the act, in order that they may
properly interpret the legislative intent. But it is also well-settled jurisprudence that only in
extremely doubtful matters of interpretation does the legislative history of an act of Congress
become important. As a matter of fact, there may be no resort to the legislative history of the
enactment of a statute, the language of which is plain and unambiguous, since such legislative
history may only be resorted to for the purpose of solving doubt, not for the purpose of creating
it. [50 Am. Jur. 328.]

Apart from the above consideration, there are at least two cases where we have held that a
margin fee is not a tax but an exaction designed to curb the excessive demands upon our
international reserve.

In Caltex (Phil.) Inc. v. Acting Commissioner of Customs, 2 the Court stated through Justice Jose
P. Bengzon:

A margin levy on foreign exchange is a form of exchange control or restriction

designed to discourage imports and encourage exports, and ultimately, 'curtail any
excessive demand upon the international reserve' in order to stabilize the
currency. Originally adopted to cope with balance of payment pressures,
exchange restrictions have come to serve various purposes, such as limiting non-
essential imports, protecting domestic industry and when combined with the use
of multiple currency rates providing a source of revenue to the government, and
are in many developing countries regarded as a more or less inevitable
concomitant of their economic development programs. The different measures of
exchange control or restriction cover different phases of foreign exchange
transactions, i.e., in quantitative restriction, the control is on the amount of foreign
exchange allowable. In the case of the margin levy, the immediate impact is on
the rate of foreign exchange; in fact, its main function is to control the exchange
 rate without changing the par value of the peso as fixed in the Bretton Woods
Agreement Act. For a member nation is not supposed to alter its exchange rate (at
par value) to correct a merely temporary disequilibrium in its balance of
payments. By its nature, the margin levy is part of the rate of exchange as fixed by
the government.

As to the contention that the margin levy is a tax on the purchase of foreign exchange and hence
should not form part of the exchange rate, suffice it to state that We have already held the
contrary for the reason 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.

Earlier, in Chamber of Agriculture and Natural Resources of the Philippines v. Central

Bank, 3 the same idea was expressed, though in connection with a different levy, through Justice
J.B.L. Reyes:

Neither do we find merit in the argument that the 20% retention of exporter's
foreign exchange constitutes an export tax. A tax is a levy for the purpose of
providing revenue for government operations, while the proceeds of the 20%
retention, as we have seen, are applied to strengthen the Central Bank's
international reserve.

We conclude then that the margin fee was imposed by the State in the exercise of its police
power and not the power of taxation.

Alternatively, ESSO prays that if margin fees are not taxes, they should nevertheless be
considered necessary and ordinary business expenses and therefore still deductible from its gross
income. The fees were paid for the remittance by ESSO as part of the profits to the head office in
the Unites States. Such remittance was an expenditure necessary and proper for the conduct of its
corporate affairs.

The applicable provision is Section 30(a) of the National Internal Revenue Code reading as
follows:

SEC. 30. Deductions from gross income in computing net income there shall be
allowed as deductions

(a) Expenses:

(1) In general. — All the ordinary and necessary expenses paid or incurred during
the taxable year in carrying on any trade or business, including a reasonable
allowance for salaries or other compensation for personal services actually
rendered; traveling expenses while away from home in the pursuit of a trade or
business; and rentals or other payments required to be made as a condition to the
continued use or possession, for the purpose of the trade or business, of property
to which the taxpayer has not taken or is not taking title or in which he has no
equity.

(2) Expenses allowable to non-resident alien individuals and foreign

corporations. — In the case of a non-resident alien individual or a foreign
corporation, the expenses deductible are the necessary expenses paid or incurred
in carrying on any business or trade conducted within the Philippines exclusively.

In the case of Atlas Consolidated Mining and Development Corporation v. Commissioner of

Internal Revenue, 4 the Court laid down the rules on the deductibility of business expenses, thus:

The principle is recognized 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. As previously adverted to, the law allowing expenses as deduction
from gross income for purposes of the income tax is Section 30(a) (1) of the
National Internal Revenue which allows a deduction of 'all the ordinary and
necessary expenses paid or incurred during the taxable year in carrying on any
trade or business.' An item of expenditure, in order to be deductible under this
section of the statute, must fall squarely within its language.

We come, then, to the statutory test of deductibility where it is axiomatic that to

be deductible as a business expense, 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.

While it is true that there is a number of decisions in the United States delving on
the interpretation of the terms 'ordinary and necessary' as used in the federal tax
laws, no adequate or satisfactory definition of those terms is possible. Similarly,
this Court has never attempted to define with precision the terms 'ordinary and
necessary.' There are however, certain guiding principles worthy of serious
consideration in the proper adjudication of conflicting claims. 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.

There is thus 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 the operation of the taxpayer's 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 the light of the above explanation, we hold that the Court of Tax Appeals did not err when it
held on this issue as follows:

Considering the foregoing test of what constitutes an ordinary and necessary

deductible expense, it may be asked: Were the margin fees paid by petitioner on
its profit remittance to its Head Office in New York appropriate and helpful in the
taxpayer's business in the Philippines? Were the margin fees incurred for purposes
proper to the conduct of the affairs of petitioner's branch in the Philippines? Or
were the margin fees incurred for the purpose of realizing a profit or of
minimizing a loss in the Philippines? Obviously not. As stated in the Lopez case,
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.
 Since the margin fees in question were incurred for the remittance of funds to
petitioner's Head Office in New York, which is a separate and distinct income
taxpayer from the branch in the Philippines, for its disposal abroad, 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. 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.

ESSO has not shown that the remittance to the head office of part of its profits was made in
furtherance of its own trade or business. The petitioner merely presumed that all corporate
expenses are necessary and appropriate in the absence of a showing that they are illegal or ultra
vires. This is error. The public respondent is correct when it asserts that "the paramount rule is
that claims for deductions are a matter of legislative grace and do not turn on mere equitable
considerations ... . The taxpayer in every instance has the burden of justifying the allowance of
any deduction claimed." 5

It is clear that ESSO, having assumed an expense properly attributable to its head office, cannot
now claim this as an ordinary and necessary expense paid or incurred in carrying on its own
trade or business.

WHEREFORE, the decision of the Court of Tax Appeals denying the petitioner's claims for
refund of P102,246.00 for 1959 and P434,234.92 for 1960, is AFFIRMED, with costs against the
petitioner.

SO ORDERED.

Esso Standard Eastern, Inc. v CIR GR Nos L-28508-9, July 7, 1989

FACTS:
Esso deducted from its gross income, as part of its ordinary and necessary business expenses,
margin fees it had paid to the Central Bank on its profit remittances to its New York Office. The
CIR disallowed the claimed deduction. ESSO appealed to the CTA but was denied. Hence, this
petition.
ISSUE:
Whether the margin fees were deductible from gross income either as a
(1) tax or
(2) ordinary and necessary business expense
RULING:
(1) No, it is not a tax. 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
the margin fee was imposed by the State in the exercise of its police power ant not the power of
taxation.
(2) No. ESSO has not shown that the remittance to the head office of part of its profits was made
in furtherance of its own trade or business. The petitioner merely presumed that all corporate
expenses are necessary and appropriate in the absence of a showing that they are illegal or ultra
vires. This is error. The public respondent is correct when it asserts that the paramount rule is
that claims for deductions are a matter of legislative grace and do not turn on mere equitable
considerations... The taxpayer in every instance has the burden of justifying the allowance of any
deduction claimed.

G.R. No. 172231             February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.
ISABELA CULTURAL CORPORATION, Respondent.

DECISION

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision 1 of
the Court of Appeals in CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision 2 of the
Court of Tax Appeals (CTA) in CTA Case No. 5211, which cancelled and set aside the
Assessment Notices for deficiency income tax and expanded withholding tax issued by the
Bureau of Internal Revenue (BIR) against respondent Isabela Cultural Corporation (ICC).

The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR
Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of
P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded
withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the
taxable year 1986.

The deficiency income tax of P333,196.86, arose from:

(1) The BIR’s disallowance of ICC’s claimed expense deductions for professional and
security services billed to and paid by ICC in 1986, to wit:

(a) Expenses for the auditing services of SGV & Co., 3 for the year ending
December 31, 1985;4

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm
Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for the years 1984
and 1985.5

(c) Expense for security services of El Tigre Security & Investigation Agency for
the months of April and May 1986.6

(2) The alleged understatement of ICC’s interest income on the three promissory notes
due from Realty Investment, Inc.

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was
allegedly due to the failure of ICC to withhold 1% expanded withholding tax on its claimed
P244,890.00 deduction for security services.7

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9,
1995, however, it received a final notice before seizure demanding payment of the amounts
stated in the said notices. Hence, it brought the case to the CTA which held that the petition is
premature because the final notice of assessment cannot be considered as a final decision
appealable to the tax court. This was reversed by the Court of Appeals holding that a demand
letter of the BIR reiterating the payment of deficiency tax, amounts to a final decision on the
protested assessment and may therefore be questioned before the CTA. This conclusion was
sustained by this Court on July 1, 2001, in G.R. No. 135210. 8 The case was thus remanded to the
CTA for further proceedings.

On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment
notices issued against ICC. It held that the claimed deductions for professional and security
services were properly claimed by ICC in 1986 because it was only in the said year when the
bills demanding payment were sent to ICC. Hence, even if some of these professional services
were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said
years as the amount thereof could not be determined at that time.

The CTA also held that ICC did not understate its interest income on the subject promissory
notes. It found that it was the BIR which made an overstatement of said income when it
compounded the interest income receivable by ICC from the promissory notes of Realty
Investment, Inc., despite the absence of a stipulation in the contract providing for a compounded
interest; nor of a circumstance, like delay in payment or breach of contract, that would justify the
application of compounded interest.

Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed
deduction for security services as shown by the various payment orders and confirmation
receipts it presented as evidence. The dispositive portion of the CTA’s Decision, reads:

WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90-000680 for
deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-
000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of
surcharges and interest, both for the taxable year 1986, are hereby CANCELLED and SET
ASIDE.

SO ORDERED.9

Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA
decision,10 holding that although the professional services (legal and auditing services) were
rendered to ICC in 1984 and 1985, the cost of the services was not yet determinable at that time,
hence, it could be considered as deductible expenses only in 1986 when ICC received the billing
statements for said services. It further ruled that ICC did not understate its interest income from
the promissory notes of Realty Investment, Inc., and that ICC properly withheld and remitted
taxes on the payments for security services for the taxable year 1986.

Hence, petitioner, through the Office of the Solicitor General, filed the instant petition
contending that since ICC is using the accrual method of accounting, the expenses for the
professional services that accrued in 1984 and 1985, should have been declared as deductions
from income during the said years and the failure of ICC to do so bars it from claiming said
expenses as deduction for the taxable year 1986. As to the alleged deficiency interest income and
failure to withhold expanded withholding tax assessment, petitioner invoked the presumption
that the assessment notices issued by the BIR are valid.

The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of
the expenses for professional and security services from ICC’s gross income; and (2) held that
ICC did not understate its interest income from the promissory notes of Realty Investment, Inc;
and that ICC withheld the required 1% withholding tax from the deductions for security services.

The requisites for the deductibility of ordinary and necessary trade, business, or professional
expenses, like expenses paid for legal and auditing services, are: (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.11
The requisite that it must have been paid or incurred during the taxable year is further qualified
by Section 45 of the National Internal Revenue Code (NIRC) which states that: "[t]he deduction
provided for in this Title shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or
incurred’, dependent upon the method of accounting upon the basis of which the net income is
computed x x x".

Accounting methods for tax purposes comprise a set of rules for determining when and how to
report income and deductions.12 In the instant case, the accounting method used by ICC is the
accrual method.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of
accounting, expenses not being claimed as deductions by a taxpayer in the current year when
they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a
taxpayer who is authorized to deduct certain expenses and other allowable deductions for the
current year but failed to do so cannot deduct the same for the next year.13

The accrual method relies upon the taxpayer’s right to receive amounts or its obligation to pay
them, in opposition to actual receipt or payment, which characterizes the cash method of
accounting. Amounts of income accrue where the right to receive them become fixed, where
there is created an enforceable liability. Similarly, liabilities are accrued when fixed and
determinable in amount, without regard to indeterminacy merely of time of payment.14

For a taxpayer using the accrual method, the determinative question is, when do the facts present
themselves in such a manner that the taxpayer must recognize income or expense? The accrual of
income and expense is permitted when the all-events test has been met. This test requires: (1)
fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate
determination of such income or liability.

The all-events test requires the right to income or liability be fixed, and the amount of such
income or liability be determined with reasonable accuracy. However, the test does not demand
that the amount of income or liability be known absolutely, only that a taxpayer has at his
disposal the information necessary to compute the amount with reasonable accuracy. The all-
events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test
is satisfied where a computation may be unknown, but is not as much as unknowable, within the
taxable year. The amount of liability does not have to be determined exactly; it must be
determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy"
implies something less than an exact or completely accurate amount.[15]

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could
reasonably be expected to have known, at the closing of its books for the taxable year.
[16] Accrual method of accounting presents largely a question of fact; such that the taxpayer
bears the burden of proof of establishing the accrual of an item of income or deduction.17

Corollarily, it is a governing principle in taxation that tax exemptions must be construed

in strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and one
who claims an exemption must be able to justify the same by the clearest grant of organic or
statute law. An exemption from the common burden cannot be permitted to exist upon vague
implications. And since a deduction for income tax purposes partakes of the nature of a tax
exemption, then it must also be strictly construed.18

In the instant case, the expenses for professional fees consist of expenses for legal and auditing
services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of
the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for
reimbursement of the expenses of said firm in connection with ICC’s tax problems for the year
1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960’s. 19 From
the nature of the claimed deductions and the span of time during which the firm was retained,
ICC can be expected to have reasonably known the retainer fees charged by the firm as well as
the compensation for its legal services. The failure to determine the exact amount of the expense
during the taxable year when they could have been claimed as deductions cannot thus be
attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the
exercise of due diligence could have inquired into the amount of their obligation to the firm,
especially so that it is using the accrual method of accounting. For another, it could have
reasonably determined the amount of legal and retainer fees owing to its familiarity with the
rates charged by their long time legal consultant.

As previously stated, the accrual method presents largely a question of fact and that the taxpayer
bears the burden of establishing the accrual of an expense or income. However, ICC failed to
discharge this burden. As to when the firm’s performance of its services in connection with the
1984 tax problems were completed, or whether ICC exercised reasonable diligence to inquire
about the amount of its liability, or whether it does or does not possess the information necessary
to compute the amount of said liability with reasonable accuracy, are questions of fact which
ICC never established. It simply relied on the defense of delayed billing by the firm and the
company, which under the circumstances, is not sufficient to exempt it from being charged with
knowledge of the reasonable amount of the expenses for legal and auditing services.

In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC
for the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because
ICC failed to present evidence showing that even with only "reasonable accuracy," as the
standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the
professional fees which said company would charge for its services.

ICC thus failed to discharge the burden of proving that the claimed expense deductions for the
professional services were allowable deductions for the taxable year 1986. Hence, per Revenue
Audit Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income
for the said year and were therefore properly disallowed by the BIR.

As to the expenses for security services, the records show that these expenses were incurred by
ICC in 198620 and could therefore be properly claimed as deductions for the said year.

Anent the purported understatement of interest income from the promissory notes of Realty
Investment, Inc., we sustain the findings of the CTA and the Court of Appeals that no such
understatement exists and that only simple interest computation and not a compounded one
should have been applied by the BIR. There is indeed no stipulation between the latter and ICC
on the application of compounded interest.21 Under Article 1959 of the Civil Code, unless there
is a stipulation to the contrary, interest due should not further earn interest.

Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required
withholding tax from its claimed deductions for security services and remitted the same to the
BIR is supported by payment order and confirmation receipts. 22 Hence, the Assessment Notice
for deficiency expanded withholding tax was properly cancelled and set aside.

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for

deficiency income tax should be cancelled and set aside but only insofar as the claimed
deductions of ICC for security services. Said Assessment is valid as to the BIR’s disallowance of
ICC’s expenses for professional services. The Court of Appeal’s cancellation of Assessment
Notice No. FAS-1-86-90-000681 in the amount of P4,897.79 for deficiency expanded
withholding tax, is sustained.

WHEREFORE, the petition is PARTIALLY GRANTED. The September 30, 2005 Decision of
the Court of Appeals in CA-G.R. SP No. 78426, is AFFIRMED with the MODIFICATION that
Assessment Notice No. FAS-1-86-90-000680, which disallowed the expense deduction of
Isabela Cultural Corporation for professional and security services, is declared valid only insofar
as the expenses for the professional fees of SGV & Co. and of the law firm, Bengzon Zarraga
Narciso Cudala Pecson Azcuna & Bengson, are concerned. The decision is affirmed in all other
respects.

The case is remanded to the BIR for the computation of Isabela Cultural Corporation’s liability
under Assessment Notice No. FAS-1-86-90-000680.

SO ORDERED.

CONSUELO YNARES-SANTIAGO
Associate Justice

CIR v. ISABELA CULTURAL CORPORATION, GR NO. 172231, 2007-02-12

Facts:
Isabela Cultural Corporation (ICC).a domestic corporation, received from the BIR Assessment...
for deficiency income tax in the amount of P333,196.86... for deficiency expanded withholding
tax in... the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year
1986 arose from P333,196.86
Issues:
whether the Court of Appeals correctly: (1) sustained the deduction of the expenses for
professional and security services from ICC's gross income; and (2) held that ICC did not
understate its interest income from the promissory notes of Realty Investment, Inc; and that ICC
withheld the required 1% withholding tax from the deductions for security services.
Ruling:
Accounting methods for tax purposes comprise a set of rules for determining when and how to
report income and deductions.[12] In the instant case, the accounting method used by ICC is the
accrual method.
It is a governing principle in taxation that tax exemptions must be construed in
strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and one who
claims an exemption must be able to justify the same by the clearest... grant of organic or statute
law.
From the nature of the claimed deductions and... the span of time during which the firm
was retained, ICC can be expected to have reasonably known the retainer fees charged by the
firm as well as the compensation for its legal services. The failure to determine the exact amount
of the expense during the taxable year when... they could have been claimed as deductions
cannot thus be attributed solely to the delayed billing of these liabilities by the firm. For one,
ICC, in the exercise of due diligence could have inquired into the amount o... the taxpayer bears
the burden of proof of establishing the accrual of an item of income or deduction.
If their obligation to the firm, especially so that it is... using the accrual method of
accounting. The propriety of an accrual must be judged by the facts that a taxpayer knew, or
could reasonably be expected to have known, at the closing of its books for the taxable year. As
previously stated, the accrual method presents largely a question of fact and that the taxpayer
bears the burden of establishing the accrual of an expense or income. However, ICC failed to
discharge this burden.
 The professional fees of SGV & Co. for auditing the financial statements of ICC for the
year 1985 cannot be validly claimed as expense deductions in 1986. ICC failed to present
evidence showing that even with only "reasonable accuracy,"... as the standard to ascertain its
liability to SGV & Co. in the year 1985, it cannot determine the professional fees which said
company would charge for its services. ICC thus failed to discharge the burden of proving that
the claimed expense deductions for the professional services were allowable deductions for the
taxable year 1986.
Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for
deficiency income tax should be cancelled and set aside but only insofar as the claimed
deductions of ICC for security services. Valid as to the BIR's disallowance of ICC's expenses for
professional services.

Principles:
For a taxpayer using the accrual method, the determinative question is, when do the facts
present themselves in such a manner that the taxpayer must recognize income or expense? The
accrual of income and expense is permitted when the all-events test has been met.
This test requires: (1) fixing of a right to income or liability to pay; and (2) the
availability of the reasonable accurate determination of such income or liability.
The all-events test requires the right to income or liability be fixed, and the amount of
such income or liability be determined with reasonable accuracy. However, the test does not
demand that the amount of income or liability be known absolutely, only that a taxpayer has... at
his disposal the information necessary to compute the amount with reasonable accuracy. The all-
events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test
is satisfied where a computation may be unknown, but is not as much as... unknowable, within
the taxable year. The amount of liability does not have to be determined exactly; it must be
determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies
something less than an exact or completely accurate... amount.
G.R. No. 143672 April 24, 2003

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
GENERAL FOODS (PHILS.), INC., respondent.

CORONA, J.:

Petitioner Commissioner of Internal Revenue (Commissioner) assails the resolution1 of the

Court of Appeals reversing the decision2 of the Court of Tax Appeals which in turn denied the
protest filed by respondent General Foods (Phils.), Inc., regarding the assessment made against
the latter for deficiency taxes.
The records reveal that, on June 14, 1985, respondent corporation, 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."
On May 31, 1988, the Commissioner disallowed 50% or P4,730,623 of the deduction claimed by
respondent corporation. Consequently, respondent corporation was assessed deficiency income
taxes in the amount of P2,635, 141.42. The latter filed a motion for reconsideration but the same
was denied.
On September 29, 1989, respondent corporation appealed to the Court of Tax Appeals but the
appeal was dismissed:
With such a gargantuan expense for the advertisement of a singular product, which even
excludes "other advertising and promotions" expenses, we are not prepared to accept that such
amount is reasonable "to stimulate the current sale of merchandise" regardless of Petitioner’s
explanation that such expense "does not connote unreasonableness considering the grave
economic situation taking place after the Aquino assassination characterized by capital fight,
strong deterioration of the purchasing power of the Philippine peso and the slacking demand for
consumer products" (Petitioner’s Memorandum, CTA Records, p. 273). We are not convinced
with such an explanation. The staggering expense led us to believe that such expenditure was
incurred "to create or maintain some form of good will for the taxpayer’s trade or business or for
the industry or profession of which the taxpayer is a member." The term "good will" can hardly
be said to have any precise signification; it is generally used to denote the benefit arising from
connection and reputation (Words and Phrases, Vol. 18, p. 556 citing Douhart vs. Loagan, 86 III.
App. 294). As held in the case of Welch vs. Helvering, efforts to establish reputation are akin to
acquisition of capital assets and, therefore, expenses related thereto are not business expenses but
capital expenditures. (Atlas Mining and Development Corp. vs. Commissioner of Internal
Revenue, supra). For sure such expenditure was meant not only to generate present sales but
more for future and prospective benefits. Hence, "abnormally large expenditures for advertising
are usually to be spread over the period of years during which the benefits of the expenditures
are received" (Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).

WHEREFORE, in all the foregoing, and finding no error in the case appealed from, we hereby
RESOLVE to DISMISS the instant petition for lack of merit and ORDER the Petitioner to pay
the respondent Commissioner the assessed amount of P2,635,141.42 representing its deficiency
income tax liability for the fiscal year ended February 28, 1985."3
Aggrieved, respondent corporation filed a petition for review at the Court of Appeals which
rendered a decision reversing and setting aside the decision of the Court of Tax Appeals:
Since it has not been sufficiently established that the item it claimed as a deduction is excessive,
the same should be allowed.
WHEREFORE, the petition of petitioner General Foods (Philippines), Inc. is hereby
GRANTED. Accordingly, the Decision, dated 8 February 1994 of respondent Court of Tax
Appeals is REVERSED and SET ASIDE and the letter, dated 31 May 1988 of respondent
Commissioner of Internal Revenue is CANCELLED.

SO ORDERED.4

Thus, the instant petition, wherein the Commissioner presents for the Court’s consideration a
lone issue: whether or not the subject media advertising expense for "Tang" incurred by
respondent corporation was an ordinary and necessary expense fully deductible under the
National Internal Revenue Code (NIRC).
It is a governing principle in taxation that tax exemptions must be construed in strictissimi juris
against the taxpayer and liberally in favor of the taxing authority;5 and he who claims an
exemption must be able to justify his claim by the clearest grant of organic or statute law. An
exemption from the common burden cannot be permitted to exist upon vague implications.6
Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax
exemptions are strictly construed, then deductions must also be strictly construed.
We then proceed to resolve the singular issue in the case at bar. Was the media advertising
expense for "Tang" paid or incurred by respondent corporation for the fiscal year ending
February 28, 1985 "necessary and ordinary," hence, fully deductible under the NIRC? Or was it a
capital expenditure, paid in order to create "goodwill and reputation" for respondent corporation
and/or its products, which should have been amortized over a reasonable period?
Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:
(A) Expenses.-
(1) Ordinary and necessary trade, business or professional expenses.-
(a) In general.- There shall be allowed as deduction from gross income all ordinary and
necessary expenses paid or incurred during the taxable year in carrying on, or which are directly
attributable to, the development, management, operation and/or conduct of the trade, business or
exercise of a profession.
Simply put, 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.7
The parties are in agreement that the subject advertising expense was paid or incurred within the
corresponding taxable year and was incurred in carrying on a trade or business. Hence, it was
necessary. However, their views conflict as to whether or not it was ordinary. To be deductible,
an advertising expense should not only be necessary but also ordinary. These two requirements
must be met.
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.
We agree.
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.
In the case at bar, the P9,461,246 claimed as media advertising expense for "Tang" alone was
almost one-half of its total claim for "marketing expenses." Aside from that, respondent-
corporation also claimed P2,678,328 as "other advertising and promotions expense" and another
P1,548,614, for consumer promotion.
Furthermore, the subject P9,461,246 media advertising expense for "Tang" was almost double
the amount of respondent corporation’s P4,640,636 general and administrative expenses.
We find 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.
We agree with the Court of Tax Appeals that the subject advertising expense was of the second
kind. Not only was the amount staggering; the respondent corporation itself also admitted, in its
letter protest8 to the Commissioner of Internal Revenue’s assessment, that the subject media
expense was incurred in order to protect respondent corporation’s brand franchise, a critical point
during the period under review.
The protection of brand franchise is analogous to the maintenance of goodwill or title to one’s
property. This is a capital expenditure which should be spread out over a reasonable period of
time.9
Respondent corporation’s venture to protect its brand franchise was tantamount to efforts to
establish a reputation. This was akin to the acquisition of capital assets and therefore expenses
related thereto were not to be considered as business expenses but as capital expenditures.10
True, it is the taxpayer’s prerogative to determine the amount of advertising expenses it will
incur and where to apply them.11 Said prerogative, however, is subject to certain considerations.
The first relates to the extent to which the expenditures are actually capital outlays; this
necessitates an inquiry into the nature or purpose of such expenditures.12 The second, which
must be applied in harmony with the first, relates to whether the expenditures are ordinary and
necessary. Concomitantly, for an expense to be considered ordinary, it must be reasonable in
amount. The Court of Tax Appeals ruled that respondent corporation failed to meet the two
foregoing limitations.
We find said ruling to be well founded. Respondent corporation incurred the subject advertising
expense in order to protect its brand franchise. We consider this as a capital outlay since it
created goodwill for its business and/or product. The P9,461,246 media advertising expense for
the promotion of a single product, almost one-half of petitioner corporation’s entire claim for
marketing expenses for that year under review, inclusive of other advertising and promotion
expenses of P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly unreasonable.
It has been a long standing policy and practice of the Court to respect the conclusions of quasi-
judicial agencies such as the Court of Tax Appeals, a highly specialized body specifically created
for the purpose of reviewing tax cases. The CTA, by the nature of its functions, is dedicated
exclusively to the study and consideration of tax problems. It has necessarily developed an
expertise on the subject. We extend due consideration to its opinion unless there is an abuse or
improvident exercise of authority.13 Since there is none in the case at bar, the Court adheres to
the findings of the CTA.
Accordingly, we find that the Court of Appeals committed reversible error when it declared the
subject media advertising expense to be deductible as an ordinary and necessary expense on the
ground that "it has not been established that the item being claimed as deduction is excessive." It
is not incumbent upon the taxing authority to prove that the amount of items being claimed is
unreasonable. The burden of proof to establish the validity of claimed deductions is on the
taxpayer.14 In the present case, that burden was not discharged satisfactorily.
WHEREFORE, premises considered, the instant petition is GRANTED. The assailed decision of
the Court of Appeals is hereby REVERSED and SET ASIDE. Pursuant to Sections 248 and 249
of the Tax Code, respondent General Foods (Phils.), Inc. is hereby ordered to pay its deficiency
income tax in the amount of P2,635,141.42, plus 25% surcharge for late payment and 20%
annual interest computed from August 25, 1989, the date of the denial of its protest, until the
same is fully paid.
SO ORDERED.
CIR v. GENERAL FOODS, GR No. 143672, 2003-04-24
Facts:
on June 14, 1985, respondent corporation, 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.
respondent corporation... claimed as deduction, among other business expenses, the amount of
P9,461,246 for media advertising for "Tang."
Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent
corporation.
was assessed deficiency income taxes... corporation appealed to the Court of Tax Appeals but the
appeal was dismissed... and finding no error in the case appealed from
DISMISS the instant petition... and ORDER the Petitioner to pay the respondent Commissioner
the assessed amount... corporation filed a petition for review at the Court of Appeals... which
rendered a decision reversing and setting aside the decision of the Court of Tax Appeals
Since it has not been sufficiently established that the item it claimed as a deduction is excessive,
the same should be allowed.
Issues:
hether or not the subject media advertising expense for "Tang" incurred by respondent
corporation was an ordinary and necessary expense fully deductible under the National
Internal Revenue Code (NIRC).
Ruling:
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.
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.
However,... To be... deductible, an advertising expense should not only be necessary but also
ordinary
These two requirements must be met.
Commissioner maintains that... advertising expense was not ordinary on the ground that it failed
the two conditions... 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.
There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an
advertising expense.
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.
In the case at bar, the P9,461,246 claimed as media advertising expense for "Tang" alone was
almost one-half of its total claim for "marketing expenses."... also claimed P2,678,328 as "other
advertising and promotions expense" and another
P1,548,614, for consumer promotion.
the subject P9,461,246 media advertising expense for "Tang" was almost double the amount of...
general and administrative expenses.
We find 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.
the subject advertising expense was of the second kind. Not only was the amount staggering; the
respondent corporation itself also admitted,... that the subject media expense was incurred in
order to protect respondent corporation's brand franchise... is analogous to the maintenance of
goodwill or title to one's property.
This is a capital expenditure which should be spread out over a reasonable period of time.
Respondent corporation's venture to protect its brand franchise was tantamount to efforts to
establish a reputation. This was akin to the acquisition of capital assets and therefore expenses
related thereto were not to be considered as business expenses but as capital... expenditures.
True, it is the taxpayer's prerogative to determine the amount of advertising expenses it will incur
and where to apply them.[11] Said prerogative, however, is subject to certain considerations. The
first relates to the extent to which the expenditures are... actually capital outlays; this necessitates
an inquiry into the nature or purpose of such expenditures.
The second, which must be applied in harmony with the first, relates to whether the expenditures
are ordinary and necessary. Concomitantly, for an... expense to be considered ordinary, it must
be reasonable in amount. The Court of Tax Appeals ruled that respondent corporation failed to
meet the two foregoing limitations.
Respondent corporation incurred the subject advertising expense in order to protect its brand
franchise. We consider this as a capital outlay since it created goodwill for its business and/or
product. The P9,461,246 media advertising... expense for the promotion of a single product,
almost one-half of petitioner corporation's entire claim for marketing expenses for that year
under review, inclusive of other advertising and promotion expenses of P2,678,328 and
P1,548,614 for consumer promotion, is doubtlessly... unreasonable.
Principles:
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.

Republic of the Philippines

SUPREME COURT
Manila
THIRD DIVISION
G.R. No. 148187             April 16, 2008
PHILEX MINING CORPORATION, petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
DECISION
YNARES-SANTIAGO, J.:
This is a petition for review on certiorari of the June 30, 2000 Decision 1 of the Court of Appeals
in CA-G.R. SP No. 49385, which affirmed the Decision 2 of the Court of Tax Appeals in C.T.A.
Case No. 5200. Also assailed is the April 3, 2001 Resolution 3 denying the motion for
reconsideration.
The facts of the case are as follows:
On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into an
agreement4 with Baguio Gold Mining Company ("Baguio Gold") for the former to manage and
operate the latter’s mining claim, known as the Sto. Nino mine, located in Atok and Tublay,
Benguet Province. The parties’ agreement was denominated as "Power of Attorney" and
provided for the following terms:
4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall make available
to the MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS (P11,000,000.00), in
such amounts as from time to time may be required by the MANAGERS within the said 3-year
period, for use in the MANAGEMENT of the STO. NINO MINE. The said ELEVEN MILLION
PESOS (P11,000,000.00) shall be deemed, for internal audit purposes, as the owner’s account in
the Sto. Nino PROJECT. Any part of any income of the PRINCIPAL from the STO. NINO
MINE, which is left with the Sto. Nino PROJECT, shall be added to such owner’s account.
5. Whenever the MANAGERS shall deem it necessary and convenient in connection with the
MANAGEMENT of the STO. NINO MINE, they may transfer their own funds or property to the
Sto. Nino PROJECT, in accordance with the following arrangements:
(a) The properties shall be appraised and, together with the cash, shall be carried by the Sto. Nino
PROJECT as a special fund to be known as the MANAGERS’ account.
(b) The total of the MANAGERS’ account shall not exceed P11,000,000.00, except with prior
approval of the PRINCIPAL; provided, however, that if the compensation of the MANAGERS
as herein provided cannot be paid in cash from the Sto. Nino PROJECT, the amount not so paid
in cash shall be added to the MANAGERS’ account.
(c) The cash and property shall not thereafter be withdrawn from the Sto. Nino PROJECT until
termination of this Agency.
(d) The MANAGERS’ account shall not accrue interest. Since it is the desire of the PRINCIPAL
to extend to the MANAGERS the benefit of subsequent appreciation of property, upon a
projected termination of this Agency, the ratio which the MANAGERS’ account has to the
owner’s account will be determined, and the corresponding proportion of the entire assets of the
STO. NINO MINE, excluding the claims, shall be transferred to the MANAGERS, except that
such transferred assets shall not include mine development, roads, buildings, and similar
property which will be valueless, or of slight value, to the MANAGERS. The MANAGERS can,
on the other hand, require at their option that property originally transferred by them to the Sto.
Nino PROJECT be re-transferred to them. Until such assets are transferred to the MANAGERS,
this Agency shall remain subsisting.
xxxx
12. The compensation of the MANAGER shall be fifty per cent (50%) of the net profit of the
Sto. Nino PROJECT before income tax. It is understood that the MANAGERS shall pay income
tax on their compensation, while the PRINCIPAL shall pay income tax on the net profit of the
Sto. Nino PROJECT after deduction therefrom of the MANAGERS’ compensation.
xxxx
16. The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS and, in the
future, may incur other obligations in favor of the MANAGERS. This Power of Attorney has
been executed as security for the payment and satisfaction of all such obligations of the
PRINCIPAL in favor of the MANAGERS and as a means to fulfill the same. Therefore, this
Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the
MANAGERS is outstanding, inclusive of the MANAGERS’ account. After all obligations of the
PRINCIPAL in favor of the MANAGERS have been paid and satisfied in full, this Agency shall
be revocable by the PRINCIPAL upon 36-month notice to the MANAGERS.
17. Notwithstanding any agreement or understanding between the PRINCIPAL and the
MANAGERS to the contrary, the MANAGERS may withdraw from this Agency by giving 6-
month notice to the PRINCIPAL. The MANAGERS shall not in any manner be held liable to the
PRINCIPAL by reason alone of such withdrawal. Paragraph 5(d) hereof shall be operative in
case of the MANAGERS’ withdrawal.
x x x x5
In the course of managing and operating the project, Philex Mining made advances of cash and
property in accordance with paragraph 5 of the agreement. However, the mine suffered
continuing losses over the years which resulted to petitioner’s withdrawal as manager of the
mine on January 28, 1982 and in the eventual cessation of mine operations on February 20,
1982.6
Thereafter, on September 27, 1982, the parties executed a "Compromise with Dation in
Payment"7 wherein Baguio Gold admitted an indebtedness to petitioner in the amount of
P179,394,000.00 and agreed to pay the same in three segments by first assigning Baguio Gold’s
tangible assets to petitioner, transferring to the latter Baguio Gold’s equitable title in its Philodrill
assets and finally settling the remaining liability through properties that Baguio Gold may
acquire in the future.
On December 31, 1982, the parties executed an "Amendment to Compromise with Dation in
Payment"8 where the parties determined that Baguio Gold’s indebtedness to petitioner actually
amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other creditors
that petitioner had assumed as guarantor. These liabilities pertained to long-term loans
amounting to US$11,000,000.00 contracted by Baguio Gold from the Bank of America NT &
SA and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two segments by
first assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in
its Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a
remaining outstanding indebtedness to petitioner in the amount of P114,996,768.00.
Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding
indebtedness of Baguio Gold by charging P112,136,000.00 to allowances and reserves that were
set up in 1981 and P2,860,768.00 to the 1982 operations.
In its 1982 annual income tax return, petitioner deducted from its gross income the amount of
P112,136,000.00 as "loss on settlement of receivables from Baguio Gold against reserves and
allowances."9 However, the Bureau of Internal Revenue (BIR) disallowed the amount as
deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39.
Petitioner protested before the BIR arguing that the deduction must be allowed since all
requisites for a bad debt deduction were satisfied, to wit: (a) there was a valid and existing debt;
(b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable year
when it was determined to be worthless.
Petitioner emphasized that the debt arose out of a valid management contract it entered into with
Baguio Gold. The bad debt deduction represented advances made by petitioner which, pursuant
to the management contract, formed part of Baguio Gold’s "pecuniary obligations" to petitioner.
It also included payments made by petitioner as guarantor of Baguio Gold’s long-term loans
which legally entitled petitioner to be subrogated to the rights of the original creditor.
Petitioner also asserted that due to Baguio Gold’s irreversible losses, it became evident that it
would not be able to recover the advances and payments it had made in behalf of Baguio Gold.
For a debt to be considered worthless, petitioner claimed that it was neither required to institute a
judicial action for collection against the debtor nor to sell or dispose of collateral assets in
satisfaction of the debt. It is enough that a taxpayer exerted diligent efforts to enforce collection
and exhausted all reasonable means to collect.
On October 28, 1994, the BIR denied petitioner’s protest for lack of legal and factual basis. It
held that the alleged debt was not ascertained to be worthless since Baguio Gold remained
existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a
valid and subsisting debt considering that, under the management contract, petitioner was to be
paid fifty percent (50%) of the project’s net profit.10
Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment, as
follows:
WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby DENIED for
lack of merit. The assessment in question, viz: FAS-1-82-88-003067 for deficiency income tax in
the amount of P62,811,161.39 is hereby AFFIRMED.
ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to PAY
respondent Commissioner of Internal Revenue the amount of P62,811,161.39, plus, 20%
delinquency interest due computed from February 10, 1995, which is the date after the 20-day
grace period given by the respondent within which petitioner has to pay the deficiency amount x
x x up to actual date of payment.
SO ORDERED.11
The CTA rejected petitioner’s assertion that the advances it made for the Sto. Nino mine were in
the nature of a loan. It instead characterized the advances as petitioner’s investment in a
partnership with Baguio Gold for the development and exploitation of the Sto. Nino mine. The
CTA held that the "Power of Attorney" executed by petitioner and Baguio Gold was actually a
partnership agreement. Since the advanced amount partook of the nature of an investment, it
could not be deducted as a bad debt from petitioner’s gross income.
The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of
Baguio Gold could not be allowed as a bad debt deduction. At the time the payments were made,
Baguio Gold was not in default since its loans were not yet due and demandable. What petitioner
did was to pre-pay the loans as evidenced by the notice sent by Bank of America showing that it
was merely demanding payment of the installment and interests due. Moreover, Citibank
imposed and collected a "pre-termination penalty" for the pre-payment.
The Court of Appeals affirmed the decision of the CTA. 12 Hence, upon denial of its motion for
reconsideration,13 petitioner took this recourse under Rule 45 of the Rules of Court, alleging that:
I.
The Court of Appeals erred in construing that the advances made by Philex in the management
of the Sto. Nino Mine pursuant to the Power of Attorney partook of the nature of an investment
rather than a loan.
II.
The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of the Sto. Nino
Mine indicates that Philex is a partner of Baguio Gold in the development of the Sto. Nino Mine
notwithstanding the clear absence of any intent on the part of Philex and Baguio Gold to form a
partnership.
III.
The Court of Appeals erred in relying only on the Power of Attorney and in completely
disregarding the Compromise Agreement and the Amended Compromise Agreement when it
construed the nature of the advances made by Philex.
IV.
The Court of Appeals erred in refusing to delve upon the issue of the propriety of the bad debts
write-off.14
Petitioner insists that in determining the nature of its business relationship with Baguio Gold, we
should not only rely on the "Power of Attorney", but also on the subsequent "Compromise with
Dation in Payment" and "Amended Compromise with Dation in Payment" that the parties
executed in 1982. These documents, allegedly evinced the parties’ intent to treat the advances
and payments as a loan and establish a creditor-debtor relationship between them.
The petition lacks merit.
The lower courts correctly held that the "Power of Attorney" is the instrument that is material in
determining the true nature of the business relationship between petitioner and Baguio Gold.
Before resort may be had to the two compromise agreements, the parties’ contractual intent must
first be discovered from the expressed language of the primary contract under which the parties’
business relations were founded. It should be noted that the compromise agreements were mere
collateral documents executed by the parties pursuant to the termination of their business
relationship created under the "Power of Attorney". On the other hand, it is the latter which
established the juridical relation of the parties and defined the parameters of their dealings with
one another.
The execution of the two compromise agreements can hardly be considered as a subsequent or
contemporaneous act that is reflective of the parties’ true intent. The compromise agreements
were executed eleven years after the "Power of Attorney" and merely laid out a plan or
procedure by which petitioner could recover the advances and payments it made under the
"Power of Attorney". The parties entered into the compromise agreements as a consequence of
the dissolution of their business relationship. It did not define that relationship or indicate its real
character.
An examination of the "Power of Attorney" reveals that a partnership or joint venture was indeed
intended by the parties. Under a contract of partnership, two or more persons bind themselves to
contribute money, property, or industry to a common fund, with the intention of dividing the
profits among themselves.15 While a corporation, like petitioner, cannot generally enter into a
contract of partnership unless authorized by law or its charter, it has been held that it may enter
into a joint venture which is akin to a particular partnership:
The legal concept of a joint venture is of common law origin. It has no precise legal definition,
but it has been generally understood to mean an organization formed for some temporary
purpose. x x x It is in fact hardly distinguishable from the partnership, since their elements are
similar – community of interest in the business, sharing of profits and losses, and a mutual right
of control. x x x The main distinction cited by most opinions in common law jurisdictions is that
the partnership contemplates a general business with some degree of continuity, while the joint
venture is formed for the execution of a single transaction, and is thus of a temporary nature. x x
x This observation is not entirely accurate in this jurisdiction, since under the Civil Code, a
partnership may be particular or universal, and a particular partnership may have for its object a
specific undertaking. x x x It would seem therefore that under Philippine law, a joint venture is a
form of partnership and should be governed by the law of partnerships. The Supreme Court has
however recognized a distinction between these two business forms, and has held that although a
corporation cannot enter into a partnership contract, it may however engage in a joint venture
with others. x x x (Citations omitted) 16
Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties had
intended to create a partnership and establish a common fund for the purpose. They also had a
joint interest in the profits of the business as shown by a 50-50 sharing in the income of the mine.
Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money,
property and industry to the common fund known as the Sto. Niño mine. 17 In this regard, we note
that there is a substantive equivalence in the respective contributions of the parties to the
development and operation of the mine. Pursuant to paragraphs 4 and 5 of the agreement,
petitioner and Baguio Gold were to contribute equally to the joint venture assets under their
respective accounts. Baguio Gold would contribute P11M under its owner’s account plus any of
its income that is left in the project, in addition to its actual mining claim. Meanwhile,
petitioner’s contribution would consist of its expertise in the management and operation of
mines, as well as the manager’s account which is comprised of P11M in funds and property and
petitioner’s "compensation" as manager that cannot be paid in cash.
However, petitioner asserts that it could not have entered into a partnership agreement with
Baguio Gold because it did not "bind" itself to contribute money or property to the project; that
under paragraph 5 of the agreement, it was only optional for petitioner to transfer funds or
property to the Sto. Niño project "(w)henever the MANAGERS shall deem it necessary and
convenient in connection with the MANAGEMENT of the STO. NIÑO MINE."18
The wording of the parties’ agreement as to petitioner’s contribution to the common fund does
not detract from the fact that petitioner transferred its funds and property to the project as
specified in paragraph 5, thus rendering effective the other stipulations of the contract,
particularly paragraph 5(c) which prohibits petitioner from withdrawing the advances until
termination of the parties’ business relations. As can be seen, petitioner became bound by its
contributions once the transfers were made. The contributions acquired an obligatory nature as
soon as petitioner had chosen to exercise its option under paragraph 5.
There is no merit to petitioner’s claim that the prohibition in paragraph 5(c) against withdrawal
of advances should not be taken as an indication that it had entered into a partnership with
Baguio Gold; that the stipulation only showed that what the parties entered into was actually a
contract of agency coupled with an interest which is not revocable at will and not a partnership.
In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the
principal due to an interest of a third party that depends upon it, or the mutual interest of both
principal and agent.19 In this case, the non-revocation or non-withdrawal under paragraph 5(c)
applies to the advances made by petitioner who is supposedly the agent and not the principal
under the contract. Thus, it cannot be inferred from the stipulation that the parties’ relation under
the agreement is one of agency coupled with an interest and not a partnership.
Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the
parties was one of agency and not a partnership. Although the said provision states that "this
Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the
MANAGERS is outstanding, inclusive of the MANAGERS’ account," it does not necessarily
follow that the parties entered into an agency contract coupled with an interest that cannot be
withdrawn by Baguio Gold.
It should be stressed that the main object of the "Power of Attorney" was not to confer a power
in favor of petitioner to contract with third persons on behalf of Baguio Gold but to create a
business relationship between petitioner and Baguio Gold, in which the former was to manage
and operate the latter’s mine through the parties’ mutual contribution of material resources and
industry. The essence of an agency, even one that is coupled with interest, is the agent’s ability to
represent his principal and bring about business relations between the latter and third
persons.20 Where representation for and in behalf of the principal is merely incidental or
necessary for the proper discharge of one’s paramount undertaking under a contract, the latter
may not necessarily be a contract of agency, but some other agreement depending on the ultimate
undertaking of the parties.21
In this case, the totality of the circumstances and the stipulations in the parties’ agreement
indubitably lead to the conclusion that a partnership was formed between petitioner and Baguio
Gold.
First, it does not appear that Baguio Gold was unconditionally obligated to return the advances
made by petitioner under the agreement. Paragraph 5 (d) thereof provides that upon termination
of the parties’ business relations, "the ratio which the MANAGER’S account has to the owner’s
account will be determined, and the corresponding proportion of the entire assets of the STO.
NINO MINE, excluding the claims" shall be transferred to petitioner. 22 As pointed out by the
Court of Tax Appeals, petitioner was merely entitled to a proportionate return of the mine’s
assets upon dissolution of the parties’ business relations. There was nothing in the agreement that
would require Baguio Gold to make payments of the advances to petitioner as would be
recognized as an item of obligation or "accounts payable" for Baguio Gold.
Thus, the tax court correctly concluded that the agreement provided for a distribution of assets of
the Sto. Niño mine upon termination, a provision that is more consistent with a partnership than a
creditor-debtor relationship. It should be pointed out that in a contract of loan, a person who
receives a loan or money or any fungible thing acquires ownership thereof and is bound to pay
the creditor an equal amount of the same kind and quality. 23 In this case, however, there was no
stipulation for Baguio Gold to actually repay petitioner the cash and property that it had
advanced, but only the return of an amount pegged at a ratio which the manager’s account had to
the owner’s account.
In this connection, we find no contractual basis for the execution of the two compromise
agreements in which Baguio Gold recognized a debt in favor of petitioner, which supposedly
arose from the termination of their business relations over the Sto. Nino mine. The "Power of
Attorney" clearly provides that petitioner would only be entitled to the return of a proportionate
share of the mine assets to be computed at a ratio that the manager’s account had to the owner’s
account. Except to provide a basis for claiming the advances as a bad debt deduction, there is no
reason for Baguio Gold to hold itself liable to petitioner under the compromise agreements, for
any amount over and above the proportion agreed upon in the "Power of Attorney".
Next, the tax court correctly observed that it was unlikely for a business corporation to lend
hundreds of millions of pesos to another corporation with neither security, or collateral, nor a
specific deed evidencing the terms and conditions of such loans. The parties also did not provide
a specific maturity date for the advances to become due and demandable, and the manner of
payment was unclear. All these point to the inevitable conclusion that the advances were not
loans but capital contributions to a partnership.
The strongest indication that petitioner was a partner in the Sto Niño mine is the fact that it
would receive 50% of the net profits as "compensation" under paragraph 12 of the agreement.
The entirety of the parties’ contractual stipulations simply leads to no other conclusion than that
petitioner’s "compensation" is actually its share in the income of the joint venture.
Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in
the profits of a business is prima facie evidence that he is a partner in the business." Petitioner
asserts, however, that no such inference can be drawn against it since its share in the profits of
the Sto Niño project was in the nature of compensation or "wages of an employee", under the
exception provided in Article 1769 (4) (b).24
On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold
who will be paid "wages" pursuant to an employer-employee relationship. To begin with,
petitioner was the manager of the project and had put substantial sums into the venture in order
to ensure its viability and profitability. By pegging its compensation to profits, petitioner also
stood not to be remunerated in case the mine had no income. It is hard to believe that petitioner
would take the risk of not being paid at all for its services, if it were truly just an ordinary
employee.
Consequently, we find that petitioner’s "compensation" under paragraph 12 of the agreement
actually constitutes its share in the net profits of the partnership. Indeed, petitioner would not be
entitled to an equal share in the income of the mine if it were just an employee of Baguio
Gold.25 It is not surprising that petitioner was to receive a 50% share in the net profits,
considering that the "Power of Attorney" also provided for an almost equal contribution of the
parties to the St. Nino mine. The "compensation" agreed upon only serves to reinforce the notion
that the parties’ relations were indeed of partners and not employer-employee.
All told, the lower courts did not err in treating petitioner’s advances as investments in a
partnership known as the Sto. Nino mine. The advances were not "debts" of Baguio Gold to
petitioner inasmuch as the latter was under no unconditional obligation to return the same to the
former under the "Power of Attorney". As for the amounts that petitioner paid as guarantor to
Baguio Gold’s creditors, we find no reason to depart from the tax court’s factual finding that
Baguio Gold’s debts were not yet due and demandable at the time that petitioner paid the same.
Verily, petitioner pre-paid Baguio Gold’s outstanding loans to its bank creditors and this
conclusion is supported by the evidence on record.26
In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income.
Deductions for income tax purposes partake of the nature of tax exemptions and are strictly
construed against the taxpayer, who must prove by convincing evidence that he is entitled to the
deduction claimed.27 In this case, petitioner failed to substantiate its assertion that the advances
were subsisting debts of Baguio Gold that could be deducted from its gross income.
Consequently, it could not claim the advances as a valid bad debt deduction.
WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in CA-G.R. SP
No. 49385 dated June 30, 2000, which affirmed the decision of the Court of Tax Appeals in
C.T.A. Case No. 5200 is AFFIRMED. Petitioner Philex Mining Corporation is ORDERED to
PAY the deficiency tax on its 1982 income in the amount of P62,811,161.31, with 20%
delinquency interest computed from February 10, 1995, which is the due date given for the
payment of the deficiency income tax, up to the actual date of payment.
SO ORDERED.

PHILEX MINING vs. CIR (DIGEST) G.R. No. 148187 (2008)

PARTIES:

Petitioner Philex Mining Corporation

Respondent Commissioner of Internal Revenue

SUMMARY:
Petitioner Philex Mining agreed to manage and operate the Baguio Gold’s mining claim,
known as the Sto. Nino mine. The mine suffered continuing losses over the years which resulted
to petitioner’s withdrawal as manager of the mine and in the eventual cessation of mine
operations. In the course of managing and operating the project, Philex made advances of cash
and property which remains unpaid. Philex, as the guarantor, also paid the creditors of Baguio
Gold. Since Baguio Gold was unable to pay, Philex wrote-off in its books its receivables from
Baguio Gold comprising the advances and payment made to the creditors. Philex also claimed as
deduction in its ITR these bad debts written-off. The BIR disallowed the deduction. The CTA,
CA, and SC agreed with the BIR. The SC ruled that (1) the advances are not actually debts but
are investments because the agreement to manage and operate the Sto. Nino mine is a joint
venture between Philex and Baguio Gold, and (2) the payment to creditors is not also deductible
because Philex paid them even though they are not yet due and demandable.

DOCTRINES:
Petitioner cannot claim the advances as a bad debt deduction from its gross income. Deductions
for income tax purposes partake of the nature of tax exemptions and are strictly construed against
the taxpayer, who must prove by convincing evidence that he is entitled to the deduction
claimed. In this case, petitioner failed to substantiate its assertion that the advances were
subsisting debts of Baguio Gold that could be deducted from its gross income. Consequently, it
could not claim the advances as a valid bad debt deduction.

FACTS:
On April 16, 1971, petitioner Philex Mining Corporation, entered into an agreement with Baguio
Gold Mining Company for the former to manage and operate the latter’s mining claim, known as
the Sto. Nino mine, located in Atok and Tublay, Benguet Province. The parties’ agreement was
denominated as Power of Attorney.

In the course of managing and operating the project, Philex Mining made advances of cash and
property in accordance with paragraph 5 of the agreement. However, the mine suffered
continuing losses over the years which resulted to petitioner’s withdrawal as manager of the
mine on January 28, 1982 and in the eventual cessation of mine operations on February 20, 1982.

THE COMPROMISE AGREEMENTS

Thereafter, on September 27, 1982, the parties executed a Compromise with Dation in
Payment wherein Baguio Gold admitted an indebtedness to petitioner in the amount of
P179,394,000.00 and agreed to pay the same in three Segments.

The parties executed an Amendment to Compromise with Dation in Payment where the parties
determined that Baguio Gold’s indebtedness to petitioner actually amounted to P259,137,245.00,
which sum included liabilities of Baguio Gold to other creditors that petitioner had assumed as
guarantor. These liabilities pertained to long-term loans amounting to US$11,000,000.00
contracted by Baguio Gold from the Bank of America NT & SA and Citibank N.A. This time,
Baguio Gold undertook to pay petitioner in two segments.

PHILEX CLAIMED BAD DEBTS AS DEDUCTIONS IN ITS ITR

Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding
indebtedness of Baguio Gold by charging P112,136,000.00 to allowances and reserves that were
set up in 1981 and P2,860,768.00 to the 1982 operations.

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

BIR DISALLOWED THE BAD DEBTS AS DEDUCTION

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

Petitioner protested before the BIR arguing that the deduction must be allowed since all
requisites for a bad debt deduction were satisfied, to wit: (a) there was a valid and existing debt;
(b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable year
when it was determined to be worthless.

The BIR denied petitioner’s protest for lack of legal and factual basis. It held that the alleged
debt was not ascertained to be worthless since Baguio Gold remained existing and had not filed a
petition for bankruptcy; and that the deduction did not consist of a valid and subsisting debt
considering that, under the management contract, petitioner was to be paid fifty percent (50%) of
the project’s net profit.

COURT OF TAX APPEALS

Petitioner appealed before the CTA which denied the petition. The CTA rejected petitioner’s
assertion that the advances it made for the Sto. Nino mine were in the nature of a loan. It instead
characterized the advances as petitioner’s investment in a partnership with Baguio Gold for the
development and exploitation of the Sto. Nino mine.

The CTA held that the “Power of Attorney” executed by petitioner and Baguio Gold was
actually a partnership agreement. Since the advanced amount partook of the nature of an
investment, it could not be deducted as a bad debt from petitioner’s gross income.

The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of
Baguio Gold could not be allowed as a bad debt deduction. At the time the payments were made,
Baguio Gold was not in default since its loans were not yet due and demandable.

COURT OF APPEALS
The Court of Appeals affirmed the decision of the CTA.

SUPREME COURT
Hence, upon denial of its motion for reconsideration, petitioner took this recourse under Rule 45.

ISSUES:
(1) WON the Power of Attorney shows a partnership agreement between the parties? (YES)

(2) WON the payments made by Philex to Baguio Gold’s creditors and subsequently written off
is deductible as bad debts. (NO)

RATIO:
(1) PHILEX MINING AND BAGUIO GOLD ENTERED INTO A PARTNERSHIP
AGREEMENT

An examination of the Power of Attorney reveals that a partnership or joint venture was indeed
intended by the parties. While a corporation, like petitioner, cannot generally enter into a
contract of partnership unless authorized by law or its charter, it has been held that it may enter
into a joint venture which is akin to a particular partnership.

Perusal of the agreement denominated as the Power of Attorney indicates that the parties had
intended to create a partnership and establish a common fund for the purpose. They also had a
joint interest in the profits of the business as shown by a 50-50 sharing in the income of the mine.

THERE IS NO AGENCY COUPLED WITH AN INTEREST

There is no merit to petitioner’s claim that the prohibition in paragraph 5(c) against withdrawal
of advances should not be taken as an indication that it had entered into a partnership with
Baguio Gold; that the stipulation only showed that what the parties entered into was actually a
contract of agency coupled with an interest which is not revocable at will and not a partnership.

In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the
principal due to an interest of a third party that depends upon it, or the mutual interest of both
principal and agent. In this case, the non-revocation or non-withdrawal under paragraph 5(c)
applies to the advances made by petitioner who is supposedly the agent and not the principal
under the contract. Thus, it cannot be inferred from the stipulation that the parties’ relation under
the agreement is one of agency coupled with an interest and not a partnership.

It should be stressed that the main object of the Power of Attorney was not to confer a power in
favor of petitioner to contract with third persons on behalf of Baguio Gold but to create a
business relationship between petitioner and Baguio Gold, in which the former was to manage
and operate the latter’s mine through the parties’ mutual contribution of material resources and
industry. The essence of an agency, even one that is coupled with interest, is the agent’s ability to
represent his principal and bring about business relations between the latter and third persons.

THERE IS NO CONTRACT OF LOAN EITHER

It should be pointed out that in a contract of loan, a person who receives a loan or money or any
fungible thing acquires ownership thereof and is bound to pay the creditor an equal amount of
the same kind and quality. In this case, however, there was no stipulation for Baguio Gold to
actually repay petitioner the cash and property that it had advanced, but only the return of an
amount pegged at a ratio which the manager’s account had to the owner’s account.

In this connection, we find no contractual basis for the execution of the two compromise
agreements in which Baguio Gold recognized a debt in favor of petitioner, which supposedly
arose from the termination of their business relations over the Sto. Nino Mine. The Power of
Attorney clearly provides that petitioner would only be entitled to the return of a proportionate
share of the mine assets to be computed at a ratio that the manager’s account had to the owner’s
account. Except to provide a basis for claiming the advances as a bad debt deduction, there is no
reason for Baguio Gold to hold itself liable to petitioner under the compromise agreements, for
any amount over and above the proportion agreed upon.

(2) THE AMOUNTS PAID BY PHILEX AS GUARANTOR TO BAGUIO GOLD’S

CREDITORS ARE NOT DEDUCTIBLE AS BAD DEBTS

As for the amounts that petitioner paid as guarantor to Baguio Gold’s creditors, we find no
reason to depart from the tax court’s factual finding that Baguio Gold’s debts were not yet due
and demandable at the time that petitioner paid the same. Verily, petitioner pre-paid Baguio
Gold’s outstanding loans to its bank creditors and this conclusion is supported by the evidence
on record.

In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income.
Deductions for income tax purposes partake of the nature of tax exemptions and are strictly
construed against the taxpayer, who must prove by convincing evidence that he is entitled to the
deduction claimed.

In this case, petitioner failed to substantiate its assertion that the advances were subsisting debts
of Baguio Gold that could be deducted from its gross income. Consequently, it could not claim
the advances as a valid bad debt deduction.

DISPOSITIVE:
WHEREFORE, the petition is DENIED. The decision of the Court of Appeals which affirmed
the decision of the Court of Tax Appeals is AFFIRMED.