~Epublic of the Phlllpplr-..1': Court of ~Ax Appeal.' Manlu. Visaya Cebu Terminal T~~T Co, et al. vs. R C, et al.

DECISION -

C.T.As CASE NO. 126 -2« 3e Miscellaneous expenses a) Christmas bonus given to various Persons --<-~--2- #1, 500.00

(o) Tips to ships'* The said sums of ?#2,375,00, $75,855.88 and #6,300.00, representing salaries, representation exe penses and miscellaneous expenses, respectively, or a total of P34,5%.88, were disailowe .y the Cole lector of Internal Kevenue, thus gii g rise toa deficiency assessment of #18,991,00, The disallow- ances were explainec by the Collectcr in his letter of February 4, 1954, as follows:

Se ~ an tee fhis item re- presents bonus allegedly paid to Messrs. Felix G. Chan, I. Kk. Tiam and Juan Eugenio Co in the amounts of ®250.00, 2250.00 and #1,875.00, respectively. fhe first two amounts were disallowed because they were ee to persons who were not (appellant's) onafide employees and, therefore, not en- titled to any compensation. The amount of #1,875.00 given to Mr. Juan Eugenio Co who is (appellant's) employee and a stockholder at the same time was likewise disallowed because the payment is considered distri- bution of dividend.

This amount censists o Ie 0 e ne fit given to re (appellant's) general manager, 6% of the net profit given to (appellant's) vicespresident, both of whom are members of the Joard of Directors, and 5% of the net profit to each of the rest of the five members of the Boamd of Virec- tors.and to a legal counsel. The amount of 175,855.88 represents distributions to (appellant's) aforesaid officers based on the percent of the net profit. It has been observed that the recipients of the afore- presenvarcion exp oS. y, pro= ae 265 44 ae - ,

ECISION •

• T. A.

E • 128 . - said 6 • · s an ou x en e • This scr.pancy const1tute y t e amount of 1,500.00 hich (appcll nt) gave as hrist s bo u o various per- sons who are not (appell~nt ' s) bonafide e ployees and the u o ~ .

given as tips to unknown persons. Th hole a ount cannot be llo ed s d uction because they were not ordinary nd n • cessqry exp ses.

Upon 1·equost for reconsi ratio , h o 1 c- nt by allowing ~h d uc ion fro. pp n t gro s inoome of the salary of Juan ugenio Lo in the su of 1, 875.00 and mi cell n ous expen e a oun to 532.00, at the s e ain aining the di ~1· lowance of th full ount o ,a ~.as s repre• sentati on exp n • h r vi~e o i1 i cv a ess- ment ls itemize in th letter of the o 1 ctor dat arch 26, 1955, -nd is r pro b .lOW:.

et !nco e as per return •••·•·····-·--·--------·- 41,59 .4 D sallo anc s:.

per investigation:

salaries of of- ficers --·--· ~ ---·­ allo ed per rc~udit - --~--.-­ p•r investig tion and reaudit , r pr - 1ntation xpenses--------···- 7 ,85 ... 08 per 1nve ti atlon, iscellaneou expenves --·------- , • allo ed per 1d t • 532.00 5 768.00 ~et inco su~j c~ o tax per reaudit ···-·-·-·· ---· _.......; ___ _ Tax due on 1 ,ooo.

23, 720.

123,720.3 :

t aJ -- t 28 -- ..

266 ,ooo.co 6, 642, 26, 642. 00 • 128 - 4 - Less tax previously as esse nd pa d ----~~-~-------·----­ eficiency tax --·-----·-------- Add: 5 surcharg ·---------·--- 1 ~ onthl y int r s fro.., 5/31/5 to 4/ /55 ------ ~ompromise for 1 te p y ent ---- ot 1 amount due on Apr 1 30, 1955 ----~--~----------~---~-- 6 Appellant has agr e o the disa!lo 'ance of the su of , repr e~entin t he salaries of Felix o Chan and Teotimo i u Tian at 2r. .co each, and the su~ oi .5, 768. O, representing .i~c lancous expenses.

lates to th e only issu xaise in this npp al re• uctibi ity o th su of ~ 75,85 . 88 as repr s ntation xpens s. In co pu-ci deduction fro n t 1 com , h la a lo co !nco of - t " 11 he or in ry nd nece .ary x• penses pa"d or incurr d dur "ng tho t xable yoar in carrying o •Y r o sin ss , i~cludin a re1~ona le allowance for sal - r ies or other c o.up n tion or porsone~l services ct 1 ~' 1 · rendered • • • ., ( c.

~ (a)(l, iona nt rna v .u oa . )

Hepres ~ ntation or nt r-cai n 11 un • r the ca \.egory of usJ.ne s exp n es an allo a le ded\lctions ft'o ross :1.1 cc .• e i y condi- tions pr scri y a .•• J In or de~ hat expen y e ucti e , hey must be • (1} Ordinary an 1 c ~., a ... y, a1 d

(2) Paid or inc rrc uri

t. e

a. a 1 year under one of the ollo in conditions -

(a) In carryin on any trade or ..,. .

267 D • T. A.

• 128 - 5 - ueiness;

(o ) For th pro c ion or coll c- tion of !nco • ,

(c) F r tho m na e nt, co .., rva- io , or aint na ...

of pro· "' perty ld for th pro uction of inco e• '

(d) In conn tion ~ith th d t rmi- nation, r fund or coll c ion Par.ll ,OOO P-H /,v n i of &ny ax.

. d. 1955. )

expens s r p id or incurr d ·n earry1n on a r de or busin s ithin the taxabl yearJ or for th pro uction or coll ction of ncor. ; or for the ana em nt, conserv tio , or int n nee of property held for the production of inc J or in eonnect!on with the det rminatiora, refund or coll c- tlon of any tax, s ch expenses ould not be deductibl ~••• they were ot ordinary nd necess ry. n ex- penae is gener lly considered ~c ssary h r the ex- penditure is appropri ~e or h lpful in t dev lop- ment of the taxpayer' s bu ·ne or that th c:~me · s proper f or the purpose of real zin a profit or min·- mizing a lo&s.

J\n xpens is rdinary wh n 1t con- notes a payment ~hlch is norm 1 in rel tion o the business of the taxpayer nd th urrounding circu G- tance~ A& to h eaning o the Otd ordinary , 26 D

I I

• C. T. A, CA • 128 - 6 - the upreme Court of the Un ted St~tes stated: " O\ , .h t is ordinzry, though th re ust al ays be a a n o~ c n~ cy 1 h• in it , S none th 1 wS ~ V riabl Df• f ct by t· e nd place and eire Gta~c • Ordinary in this cont xt doos not that the pay ents ust e ha itu 1 o nor mal in the sense that the sa tax- payer till av to ma· h o4t, .

A lawsuit afiect~n tho G fety of usi- ness ay h JP 1 once in 11 ti@ • h cocnsel f cs may so h~avy that peti• tion i unlikely.

en t le , th ex- pense is an ordinary on becaus w kno from experience tha·t payment for uch a purpose, \Wh ther the mount ·s 1 r e or mall, ar th c~ ~on n c ept ans of defense ag inst cttack. Cf. Korn- hauser v.

nit t t , 276 u. • 145, 48 • Ct. 219 72 L.

d.

5 (6 AFT

7358) .

The i u t on i i e in the li e of the individual ff ct d, but not n the life of t~e roup, th co unity, of hich he is o t. At ~uch t es t ere re nor s o conduct th t p o eta i iz our judgm nt, nd t cert in nd ob· jec~ive .

he , s ot err tic , but is brou ht wit kno ··n type."

( elch v. H lvcrin u •• 111, cit d in Par. 11 ,008 P-H 1955.)

Business expens s , n o der t o be ductibl , ust not only be ord·nary and n c ssary ut must lso eet the f rther test of~ son bleness in mount. The el ment of reasonablene a n amount is inherent in the phras 1 ordinary and n c sGary ... It was not the intention of Congress to utom t c lly 0 a deductions op r ting xp n s :tncurr d orp d by the taxpayer in an unl:tmit d mount.

(Comm ss on or ••· Lincoln 1 c. Co., 176 f d. 2d 815, 38 F 411.)

Have the re irements for d d ct b~l ty of t sum of 75,855. 8 be n sat sfied? Counsel for t he nt admit that the ex- pens• of 75,855.88 w s p d nd inc tt·red within the 269 - • 128 - 7 • axao e ye r 1 51. " It is, i o ev r , ~on nded hat "ic i not ordinary and n cessary xpens nor as it inc rr a n c~rryin on h trad or busi- n s o t pp 11 nt in 1951. "

1 .a , ccordi 19 to th Collector , in th nature of di ide dis- tr ution.

( a 5, e orand fo t ppelle . )

h nd, app llan ou h to prov that n th the oun ac u lly spent y l officers an c d of · ectors ~ th pro o- tion an enhance ant of h bu in ss of th corp- oration.

L t us x min th acts.

I pp r th Y a solution of he o r of Director o ppell nt corpo ion da d July 22, 1949, aiv·d nd of 50 of the net profit .as authorize to b d clar d to the stoc holders an- nually and t burse the :c anager, e legal con ul .anager , 1 otrs of th sultant, oth r 50 nt tion r of th n at the i tant o rd of ir e ch o th aOll to be used to r im- xp ns s of the Gen ral oard of !rectors and tho fol owing rates: Gen~r al ener 1 a·nager, 8 ' .e. - ctors and the 1 gal con- ne profit.

uring he p r od of our y ar fro 19 9 to 19 2, ppellant had gro s i com , net sentation exp n ' 5 :!.!.!!:

i 49 722,1S5.42 1 4~1 .

. 21 1951 420, 479. 39 195~ 425, 26. 86 ..

profits 1m ollowa 61 , 2~7 .5 33, 23.78 41 , 596.45 4 , 7.31 270 cla d repre- 83, 103. 54 lC , 424.39 75, 855. 88 63, 618. 64 s DECISIO D. T • • • 128 - 8 - It also appears fro the testimony of Dioa• coro • asco, Accountant- ookkeeper of appellant, th t rel.tnburse ents of repre entation xp nsea in• curred by the officers and me ber of the Board of Directors were ade upon present tion of the cor- responding vouchers and chits, but ther were in• stances when reimburs ants w re made ithout pre- sentation of supporting paper • ~a co justified reimbursement of a cla for representation expenses without presentation of supporting papers by stating that he did not h ve the courage to ask the officers and embers of the oard to co ply with the re ire• ent because of the "unouest oned !nt gr!ty of th se people and the h gh este of the co unity toward them.• esldes, •tt was the policy of the office to give them free way to spend such ount without, of course, co plete supporting papers.• Ae to how the amounts claimed by the officers and members of the o rd were apent, asco testified that , with respect to the m nagar, they ere spent for •hotel and ace~ odation charges nd entertain• ment expensea hila in •. anilaJ entert !nment of the ag•nts of th ship and other officera and also porters when he comea to anila on official busin s for the Company."

As regards the embers of the Board, he testified that •they used to present chits covering their expenses for the entertainments o friends who came ir other pla~es to ••• Ce u to 271 I l1 • C. T. A.

A E

• 128 - 9 - get ind ntions of the"r import • The me bErs of th oard o Dir ctors or the liason officers en- tertained h • n which case t hese li on officers submi t hotel and ace~. odatlon expens s and lso transpor tion ex~enses . " { p. 61- b2, . s. n. ; p.

20 , r,e o:ranau for 1\ppellant. ) ( rom th evidence adduced y appellant, ther ~ ere wo s t of r presentation xp nses. On cov~ xpens G supported by appropriat vouch_rs and chits; t he other covers expen eg i out upporting p per • Unfortunat ly, it i not po sibl to cov.r d by ter i.n th and the amoun ithout supporting pap YS. It i 11 9ed that th r cor s wer e~troyed when t hou 0 uenavet ~,ur • Ve o o, tre urer o ppellant, where .r c eras 1c;r k pt as burn ay, there ore, accept corr ct the c t 1 as a por i on o a ount of a sp nt .. or r pre& n tion xp s of ppellant corpor tion, whi e he por ion her o no cover y up ort" papers a sp n for purpos no clea tablished.

he first ali ies or he d due io , 0 a er 0 not . It is up to us 0 termin fro 11 avail a 1• oa a ~unt properlv deductible as rcpre ntatlon ex. ns s.

It ioul sec unjust to disallo the d • uc ion of th entire amount for lac of docu: entarv evi once to st~ lish th precise amount b yond a - !:

rea ona le doubt . ~ The pr ctice un er th F 1 In- come Tax L ~ of the n"t t tes 1 ·27 2 D-CT ·:r ~ - C.I.A. CASE ~ . 128 - 10 - " · • • that while a taxpay r is not relieved from th urd.n of suos antiatinc his claimed deductions, the examJning agent hould exerci a c reful jud tent lich will p rmit reasonable determinations for enter• tai~.en~ expens , provided he is atisfied hat th re s a proper basis for ome al• lowar~ce .

Disallowin amounts clai 1ed fo eductio.

erely ecause there is vailaol no docu-entary evidence which il e-ta- b~ish t precise amount beyond a reasonable doubt tgnores commonly reco nized usiness practices as wel as the fact proof may be established by credible or 1 testimony. On he other hand , it i$ not tha policy to allo an arbitrary ~ cc nta of the clalued d duction erely for purpose of settleocnt.

Ir-. an. No. 5t:l•92, Par. 76, 700 P• Jf Fed. 1954." (Par. 11 , 3JO P•H Fed. 1?55. )

..

/ In this case, it is impossiole to determ n the precise amount ~pent for ropr sentation. But it 1& our duty to mak a 6v~t-minaticn , ven if th re- sult be merely an appr.o,l(. u tion. )

' 1 In the p=oduction of his plays Cohan as obliged to be free•handed in nter- taining actors, employees, an , as he naively dds, dramatic critic • He had also to travel much, at times u.th hi~ attorney.

These expenses amounted to su stantial sums, ut e kep' no account and probably cculd ot have done so. At th~ trial befo~e th Board he estimated that he had spent eleven thousand dollars in this ftshion during the £ st six months of 1921, tv.lcnty-two tt.ous nd doll rs, oet- veen July fit·sc , 1921, and June thirtieth, 1922, and a$ much for his following fiscal year , fifty-five thousand dollars ·n all. The oard r fused to allow him any part of this, on the ground that tt was impo .. s ·ble to tell how uch he had in fact spen , !n the absence of eny items or details. The question is how far thi~ refusal is justified, in view of tl.e findin., that he had spent much and that the sums were al• lowable expenses.

Absolute c rtainty in such matters is usually impossible and iG not ecessary; the Boa1:d sl,ould make as close an approxima~ion as it can, bear•ng heavily if it chooses upon the taxpay r whose inexactitude is of his own~making . .. ..

273 ' l f a a a i ll en ee ES x i

DECISION «

GeleAe CASE NO. 128 «elie t to allow nothing at all appears to us inconsistent with saying that somee - thing was spent. True, we do not know how many trips Cohan made, nor how large his entertainments were; yet there was obviously some basis for computations, if necessary by drawing upon the Board's personal estimates of the mininun of such expenses, fhe amount -“ be trie vial and unsatisfactory, but there was basis for some allowance, and it was wrong to refuse any, even though it were the traveling expenses of a ——- trip. It is not fatal that the result will inevitably be speculative; many important decisions must be such, We think that the Board was in error as to this and must reconsider the avidence,.” (Pp. 343-544, Vol. 39 Fed. Rep.)

We shall, therefore, endeavor to ascertain the amount actually spent by appellant for repre- sentation or entertainment which we deem reasonably necessary in carrying on its business. As already adverted to above, appellant claimed representation expenses from 1949 to 1952 in the following amounts:

1949 «+2 e = se = & #80, 703. 54 1951 one eo ae 2s @ 8 © 75,855.88 19582 --+<+==+=« = = 63,613.64 We presume that, as in 1951, the expenses incurred by the officers and members of the Board of Directors were not all covered by supporting papers showing that said expenses were all for entertainaent purposes as testified by appellant's accountant-booxkeeper, From the above figures, we may infer that the sum of #10,000,00 may be considered reasonably necessary for entertainment expenses of appellant in 1951, it having Claimed a little over that amount in 1950, when its gross income was more than its gross incomes in 195] E • 128 • 12 - and 1 52.

.oreover, it allegedl y spant for enter- tai nm nt purposes in 194 th sum of 500.

only.

I ~s ar u d, ho ever , th t th hole a ount claimed by t h appellant should e d sallo~ed bc- caus t r a 1 no n cessity for app 11 nt to incur expenses f or cntertainm nt , the usin ss in hich it is enga ed eing monopoly.

To cc t this proposition i ~ to 1 nore the commonl y r cognized busin ss practices.

h ther a onopoly or one hich operates in highly co p ti• tiv ar ~t , h s n ed to provide for entortainm nt or r pr ~ ent io pcnscs to pres rv and aintai n t ill and patronage of its cu t~~er nd to win ore custo ers !f possi 1 • .or over, in th ase of appellant, 11 it is tru th t •t has the • clu&ive contrac to undertake arrastre operations i n t he po of Ce u, the co tract is for lim ted peri o a ter ic t h s o co pet gain ith others efore it ay in newal o·f the contr ct. h r i ' th.

or ' n y for it to rov d for a reasonable oun or presentation or nterta n• ment expens s.

It is also cont nded that the s m of 7 ,855. 88 bein claim as repr scntation expenses was an ·n· direct di tri tti n of divid nd, th off c rs and rs of th Boar of D rectors of appellant being th holders of the aj or ity stock of t he corporation, to ether wit h th ir rel at i ves. The reco ds show that 1:.-::l,j c.t.A.

E.

...

• 128 - 13 - t e officers and embers of tho oard of Dir ~tors of appellant ~ orporation had never b en t he holders of t h j ority stock of t!1e corporation. It is true t hat some of their relatives were and ar toe holders of said corporat on, but it has not ~en shown that the stocks in the n mas of ch r • latlves ere owned or controlled, dir ctly or u - d~ ectly, by th officers and er of th oard of Directors.

Accordingly, th re is no sis for holding that the officers and emb r of the Board of irec·ors of appellant own or control the a- jority stock to just fy the infer~nce that r presen• tation exponses b !ng cla· ned are an ·ndiroct di • tribution of dividend. Finally, it is ar ued that while the officers nd m mb rs of the oard ot ire tors of app llant corporation reported in their inco e tax r et urn5 the le ed repre&en ~ion exp nse , they did not cla~ eduction of th amounts actually spent by th • .

rom this tho conclusion is a n that th runounts receiv d y h ~ er not in reality reimburse • ts for r presentation expenses but a distr"bution of part of t e e profit of ~he corpor t i on. e T n not accept the soundness of th s propos tion. vft, in conne~ tion ith ·nco~e deriv d from a corporat on cannot af- feet 1 9 lity of t educt·on cla· ed y th corpor t ·on ih resp ~t of a oun p ·d by t to 276 CI£i IO • . r. .

~E ~ . 120 - l • such pvrson.

0 the same na ure is the argument of appellant hat because th Col lecto of Inter nal evenue has not qu stioned tho 1 gality of the d - du~ t ion for repre cntat·on xpens s cl ai~ed in other year in ount sa • s th cla · · n 1951, h r is no jus !fication for questlonin he u-~~uv ti n for rcpre entation xp n es in that year. The le ality of a d ficiency a v ssment cannot be affected by the failure o a s s~ in cases of s · 11 r nature.

The rule is ~ell establish d that the Govern- ant i not est opped by error or mlstak on th part of il.S gents.

Pi. eda v. Court of First Inst nc of T y s, FO ·r 52 Pl il. 803. )

·0 GO TIO.>S , the d ci appeal d fro is hereby modifi d, and appellant is here y ordered to ~ay to the Collecto of Internal evenue, within a r asonable period t o b fixed by the latte , the sum of 15,517.00, co put d belo • on 'et income per return ------·-·-- is llow n c f ;~ Salari s ····-----· -··;:·--- 41 , 596.45 500. 00 ( 3) , ...,r. .e 10 ooo.oo 65,855. 88 .l.l • 720.

l \. ~ .J -- a • 8;o •• 2 ' 42.00 277 ee ee eS a ee ee ate

DECISION «

GelsAs CASE NO. 128 - 15 « With costs against appellant. 30 ORDERED, Manila, June 29, 1957.

"Chetan Associate Judge

WE CONGUR:

eK Fresiding Judge nana A at 8 —