China Banking Corporation vs. The Commissioner of Internal Revenue

DECISION

-2- bad debt expense and consequently, considered it as an ordinary loss deduction ~rom gross income in its 1987 income tax return. Respondent, on January 25, 1990, issued a letter 0~ demand under Assessment No. FAS 1-5-87-90-000 against petitioner for, among other th ings, 1987 deficiency tax plus surcharge, interest and compromise penalty, in the total amount 0~ P8,533,328.04 resu lting ~rom the disallowance of the b ad debt ex pens e the write- of~ of alleged worthless securi ties in Firs t CBC Capital <Asia ), Limited. Petitioner, in a let ter, dated May 7, 1990, formally protesting said asse ssment stated e~~ect th a t:

a .

Th e total wort h lessness o~ petitioner's s hares o~ stock in Fir~t CBC Capital <Asia), Li•ited, wa s establ i shed beyond all doubt due to severe ~inancia l reverses and that said co•pany ceased its busines s operat ion s and even surrendered its license to operate. b.

The write- off o~ worthless securities was correctly treated by petitioner as a bad debt expense for which an "ordinary l oss" deduc tion fro• gross inco•e was correctly taken under pertinent provisions o~ the Tax Code, •ore particularly Sec.

3 (e), now Sec. 29 (e) (2) thereof.

in Respondent, in a le t ter, date d August 22, 1990, rendered its final decision on petitioner's protest, denying t h e same and reiterating its J

- 3 - demand for payment of the latter's 1987 deficiency income tax, plus surcharge, interest and compromise penalty, in the total amount of P8, 533,328.04. Hence, this Petition for Review. Petitioner anchors its corporate decision to the write-off of its entire investment with First CBC Capital <Asia>, Limited, a.s worthless securities on the ground that said off-shore company was bankrupt a.nd that its investment in the form of securities no longer ha.d a.ny value a.t all (July 4, 1991, t. s. n., pp 7 - 8>. Petitioner further avers that this corporate decision wa.s shared by the Hongkong authorities, more particularly, the office of the Commissioner of Banking.

The external · auditors of the First CBC Capital <Asia), Limited which is Berne and Co. , the internal < auditors of pet it ioner, Sycip, Gorres a.nd Vela.yo a.nd Co.

a.nd the Central Bank of the Philippines, were also of the same "opinion." A witness for the petitioner, Mr.

Zacarias Antonio, Head of the Central Accounting Department, testified that examiners of the Central Bank made the conclusion that the First CBC Capital <Asia.), Limited, _ "is already a.n insolvent company a.nd that in their report of examination, petitioner wa.s required to 'book a.n allowance', a.

one hundred percent <100~> 8b )

- 4- allowance, considering that the investment is already 1 Q St-. II Petitioner further drew the conclusion that the equity investment account is qualified to be written-off, which decision was approved by the Board of Directors with the final approval of the Central Bank of the Philippines.

As stated earlier, petitioner considered these so- called worthless securities as a bad debt expense and consequent ly as an ordinary loss deduction from gr os s income in its ·ncome ta~ return for the year ended in 1987.

Respond ent in his Answer a verred that in the present case, there is no loan or debt to speak of as understood under Section 30 <e> <2>, now Section 29 ( e > <2>, of the Tax Code.

Accordingly, no bad debt expense could arise where there is no valid or subsisting debt.

He further stated that the revocation of the reg istration of First CBC <Asia>, L:imited in 1987 was only for its deposit - taking activities while its <co mpan y's> financing and investment holding concerns remained;

therefore, the alleged debt or investment could not be considered worthless and deductible in 1987. In the First CBC Capital <Asia> Limited Report and Financial Statements for the year ended 31 December 1987 prepared by Berne and Co. <Exh. E>,

- 5 - it confirmed that the "principal activities of the company during the year were in financing and investment holding."

It disclosed however that the company was "de-registered" as a deposit - taking company during the year.

Based on the audited financial statements as reported by its external auditors to the shareholders of First CBC Capital <Asia>, Limited, the company had collectible amounts due from the subsidiary of HK $4,159,595.00 included under interest in subsidiary, as well as loans extended to customers and other debtors totalling HK $46,264,929.00 although the auditors were unable to obtain independent confirmations of these balances.

There was even an investment of HK $38,892.00 in the subsidiary. It would appear therefore that based on the audited financial statements for the year ended 31 December 1987, the First CBC Capital <Asia> Limited was a going concern, operating probably difficult circumstances, but certainly, with no indication that it was going bankrupt. No evidence was introduced indicating that this company had applied for bankruptcy nor a declaration of bankruptcy under the banking laws and regulations of Hongkong where it is based.

There was likewise no evidence presented that the company continued to o r::'' ou,.;;, .J

- 6 - e><ist, that is as of 1ga7, for purposes of liquidation.

What i s c le a r on the recor d is that the company was d .. ~ .. ::: .~~ .YA ~ .t. .. ~. re9 . as a deposit - taking company, one of its busin e ss a ctivities, during the year i n question.

However, its principal activities as a financing and investment holding company continued as shown by its e><posure and business operations in the f o r m of loans to customers and other debtors and in vestm ents . Petitioner is an investor o f the entire First CBC Capital <Asia), Limited, not just a segment or of its operation or business.

The declaration by the petit ion er of the "worthle s sness" of its shares of stock was a com pany d ee ision.

Th 9 rli?ason for i ts decision coul d be gleaned f ~ om the te s timony of Mr. Ricardo R.

Chu a , He ad of th e Operat ions an d Contr ol Division of petitioner , when he s tated that: " • • • • th e only wa y th e y will allow us to continue operation, i s to infuse additional capital but the n therP wer e several things in our ~ind .

We felt that continuing its operation, somehow is not going to guara ntee that we can recover.

In fact, we felt 99~ that is going to result into a loss.

Considering the overhead cos t i nvolv ed in Hongkong, plus the fact that, the country just went through foreign exchang e crisis two years before that, and we felt that the country needed the foreign exchang e more h ere , than to throw it to Hongl<ong. So we then decided.

J t was very painful d ecision for u s . We said 'let go Hongkong.' We h a ve to clo s e operation, because we are told, ' if you do not infuse any capital

- 7 - then we T. S. N., will close pp. 9-10] you down.'" [July 4, 1991, Petitioner also lay stress on the findings of the Central Bank that the First CBC Capital <Asia>, Limited is insolvent and the Central Bank of the Philippines has approved the write-off.

To our mind, such determination is ill-conceived.

It is not for the Central Bank of the Philippines to determine the solvency or insolvency of the First CBC Capital <Asia>, Limited. Its recommendation to write-off the investment and provide reserve is not in any way synonymous to insolvency of the company much less worthlessness of the securities in question.

We cannot therefore agree with the proposition of petitioner that its investment was entirely worthless.

There were other options open to it which it decided not to pursue.

Instead, petitioner chose to "let go" its investment in Hongkong by declaring them "worthless" and to salvage a bad situation, avail of the provision of the Ta>< Code by considering said investment as a bad debt e><pense so that its investment will not be entirely lost.

But as borne by the evidence, its Hong kong connection continued to be a going )

- 8- concern, with so me proble ms admitt edl y, but s t i 11 viable.

Under the circumstances, petiti oner cannot rely on Section 29 ( e > ( 2) of the NIRC to escape assessm ent.

The law provides thus:

X X X X X X

<e> !.l.!!~-.--..P..~_t?.,t.~·

(1) In general. - Debts due to the taxpayer actually accertained to be worthle s and ~harged off wi th in the taxable year exc pt those not connected with profession , t rade or busi ness and th ose sustained n a transact ion entered into between parties •entioned under Section 30 (b) of this Code.

< 2) §g_£.!!:r.it.t~1L..tJ e.£..Q.!I..!.D.Q.._ .. !'!'.Q.t:~.b .L~L .. ~. , - I f s ec u r it i e s as defined in Section 20 are a scertained to be worthless a nd charged off within the t axable year and are capital assets, the loss resulting therefro• sha 1, in the case of a t a>< payer .QJ~.h~r.::.._. __ th.~~···- ~-···-·- -9. ... ~J! ... Q..r.-___ ,_:t! .. t"-~~.!- .£. .Q.~P~.~.Y incorporated under the laws of the Philippines a substantial part of whose business is the receipt of deposits, fo r the purpose of this Title, be con sidered as a loss fro• the sale or exchange, on the last day of such taxable year of capital assets.

(underscoring s upplied) Requisites for deductibility of bad debts are: <1> the debt must be ascertained to be worthless as when the debtor is insolvent;

( 2) it must be actually charged-off within the taxable year; and ( 3) the debt must be connected with one's profession, trade or business.

In determining whether a debt is worthless, the Commissioner of Internal Revenue will consider all pertinent 855 )

-9- evidence, including the value of the collateral, if any, securing the debt and the financial conditions of the debtor (Sec. 102, Rev. Regs. No. 2). Having determined that the investment , of petitioner was not entirely worthless, it cannot translate the same as a bad debt e~pense under the above provision of 1 aw.

There i s actually no debt _to speak of much l ess a bad d ebt e~pense und er the law and e~isting ad minist r ative r egulations.

Likewi se, petitio ne r ' s citatio fl of the case of F e rnande z Hermanos, Inc.

vs Commissioner of Internal Revenue,

29 SCRA

552, to the effect that worthle ss s e c urities o wned by corporation in another corporation could be written-off as an o rdinary loss d e ductibl e under the Ta~ Code, is not applicable to the case at bar, because petitioner is differently circumstanced.

It should be recalled that the company in said case, ceased to operate when the owner died, it had no assets and was completely insolvent.

In Fine, petitioner has not successfully impugned the validity of the assessment of respondent Commissioner of Internal Revenue and therefore all presumptibns are in favor of the correctness of the latter's assessment against the petitioner.

- 10-

WHEREFORE, the decision of the respondent Commissioner of Internal Revenue is therefore affirmed and petitioner is hereby ordered to pay respondent the amount of P8,533,328.04 deficiency income ta>< for the year 1987, twenty percent (20 ") intere s t per annum fully paid, w i th costs ag a inst the petitioner.

WE CONCUR:

(dissenting) ERNESTO D.

ACOSTA Presiding Judge

~/} C J~

RAMON 0. DE VE As s ociate Judg as plus until )

-11- CERTIFICATION I hereby certify that this decision was reached after due consultation among the members of the Court of Tax Appeals, in accordance with Section 13, Article VIII, of the Constitution. C' -- I.Q .. ~ ~TO D.

ACOSTA Presiding Judge Court of Tax Appeals