CTA Case No. 787

DECISION

The respondent assessed against the petitioner the sums of 213,414.00, #119,613.09, °11,698.00, 6,887.00 and $14,451.00, as alleged deficiency income tax for the years 1950, 1951, 1952, 1953 and 1954, respectively, These income tax deficiencies were) the result of alleged discrepancies found in the income tax returns of petitioners for said years, which are summarized be lows ls Losses « ae Losses in Mati Lumber

b. Losses in or bed debts ef Palawan anese ce Losses in 8s lamban pon Mines - 1980 «--- 8,989.76

d. eaias in Haelende

Dalupiri ~

1983 Qeeeeene eee 20040 21,932.62 1934 OT 42, e @. Losses in Macienda Samal- 198] ....<...------ -- 8,380.23 1952 eonenn ne ne nn 7,621.73 2e Excessive depreciation of houses -

OO

DECISION -

C.T.A. CASE NO. 787 -m 2 -— 198D ncacucecccsunee 8 8,180.40 1981 wewencccncennan-= 8,768.11 1952 RVRMeHeeweeenseseraeee 18,002. 16 1983 e-en---cewenen-- 13,655. 25 1954 eonnene-cnnnnes 29,314.98

3. Taxable increase in net worth - 1930 Seven Se Beaeeer2ee 30,050.00 4 Gain realized from sale of real property in 1990 e-- 11,147.% In this appeal, two main issues have been raised by the parties, viz.s (1) the correctness ef respond- ent's determination with resnect to the disputed items described above, and (2) whether or not the right of the Government to collect the deficiency income tax in question has already prescribed.

We will first consider the second issue.

/ Section 332 of the National Internal Revenue Code provides that where the assessment of an internd rev- enue tax has been made within the time »orescribed by lew, such tex may be collected by judicial action with- in 5 years from the date cf assessment. in the case of a disputed assessment appealed by the texpayer to this Court, the “judicial action® is deemed to have been commenced on the date of the filing of the appeal, and not on the date of the filing of respondent's ans- were *It is but logical to conelude that the Wesnal acremas tax is doened commenced with the filing of the taxpayer's appeal with this Court, for the purpose of reckon- ing the prescriptive period for collection er Sections 316 and 332 of the Revenue 4 Code, for the following reasons. In the ( first place, when the taxpayer appeals from mm) the decision of the Commissioner of Inter- 200 aE

UECISION «

CTA CAS NO. 787 «~ 3 « nal Revenue, the latter is precluded from instituting an action for collec- tion in the nok courts. (See Ledes- 29, 1958.) If the wT is filed on the last day it, the fifth year after assessment, and the answer of the Com- missioner As filed after fifteen days, is it just that the Government be de- clared barred from collecting the tax because the answer was filed fifteen days after the five-year period for cole lection, when it was prehibited frem in- stituting judicial action upon the fil- ing of the taxnayer's appeal? In the second place, if the Commissioner, through eversi ght, Ra a met or otherwise of his counse d fail to file anawer and he is decienet in default, as haa actual- ly happened in some cases, is it reason- le to conclude that no judicial action has been commenced despite the y ef the eppesl end 5 , of this Court to pronounce judgment as to the taxpayer's liabi lit ra er such be the case, the running the prescriptive peried would wheney at 4 to run notwithstand- ‘ing the cape saad of the appeal, which is admittedly unreasonable and unjust on the part of the Government, snd contrary to the doctrine laid down by the Supreme ae in the cases of the Alhambra Cigar om gro ye | Mig. Ces, Bohol Land Transp. and Gancayco, zo tn (Manuel P.

+ dl ve Commissione te. Reve, CTA.

No. 676, Oct. 25, 1961. )

In this case, petitioner contends that the ase sessment was made on December 27, 1955. On the other hend, resnondent contends that the assessment was made on Pebruery 24 and 27, 1956. Whichever date is cor- rect is immaterial as the herein appeal was filed on May 4, 1960, which is less than five years from Decen- ber 27, 1955, Therefore, the right to collect the tax in question has not yet prescribed.

1G. R. Nose 1o120% & L-12131, May 29, 1959. 2G. R. Nos. 1013099 & 1013462, April 29, 1960. 3G. R. Me. 1013325, April 20, 1961.

- 204 a a ner DECISION e C.T.A. CASE MO. 787 o 4 « We now come to the disputed items. The first of these items is the sum of 86,050.00, the value of the shares of stock of Mati Lumber Co. acquired by peti- tioner on January 1, 1948 These shares of stock were determined by petitioner to be worthless in 1950. Con- sequently, the sum of #8,050.00, representing the cost of said shares, was written off in its books in said year and was claived as a loss deduction in its income tex return for said year. Respondent disallowed the deduction solely on the ground that the warthlessness of said shares of stock was not clearly established in 1950.

The evidence shows that sometime in 1950 peti- tioner became aware that Mati Lumber Co. ceased to Operate in 1949. For this reason, investigation was made as to the financial status of said company. The report submitted to petitioner was to the effect that the commany ceased operations in 1949 when its manager and owner, @ certain My. Reocamora, left for Spain where he subsequently died.‘ When the company ceased to Operate, it had no assets, in other words, completely insolvent. This information as to the insolvency of the company having reached vetitioner in 1950, it tock immediate steps to write off the investment as worth- less and consequently claived the loss as a deduction in its income tax return for 1950. These facts are supported by the evidence. We, therefore, find and hold that said investment has been proven to be worth- less; that it was ascertained to be worthless in 1950; and that it was properly claimed as a less deduction ‘- 2,0 2 wre DECISION e« C.T.A. CASE NO, 787 = § = in said year, pursuant to Section 230(d)(4)(B) or Sec- tion 30(e)(3). | Petitioner deducted in 1951 the sum of #353,134.25, representing alleged losses in or bad debts of Pala- wan Manganese Mines, Inc. Respondent claims that the deduction is net allowable either as losses or as bad debts. | Sometine in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are also the con- trolling stockholders of petitioner corperation, re- quested financial help from petitioner te enable it to resume its mining operations in Coron, Palawan. The request for financial] assistance was readily and unanie mously approved by the Board of Directors of petition- er, and thereafter @ memorandum agreement was executed on August 12, 1945, embedying the terms and conditions under which the financial assistance was to be extend. ed, the pertinent provisions of which are as follows: “WHEREAS, the FIRST PARTY, by virtue of its reselution adepted on August 10, 1945, has agreed to extend to the SECOND -PARTY the requested financial help way ef accommodation advances and for S pur- pose has authorized its President, Mr. RAMON J. FERNANDEZ te cause the release of funds to the SEOOND PARTY:

"WHEREAS, to compensate the FIRST PARTY for the advances that it hes to exe tend te the SEOOND PARTY, the latter has agreed to to the former fifteen per centum tisk)” of its net profits.

"NOW THEREFORE, for and in consider- ation of the above premises, the oarties hereto have agreed and covenanted that in consideration of the financial help te be extended by the FIRST PARTY to the SECOND PARTY to enable the latter to resume its mining operations in Coron, Palawan, the * 203 ed

DECISION «

C.T.A. CASE NO. 787 @ 6 « SECOND PARTY has agreed and undertaken as it hereby agrees and undertakes to pay ¢o the FIRST PARTY fifteen per cen- ag (15%) cf ite net profits.* (Exh. He Pursuant te the agreement mentioned above, peti- tioner gave to Palawan Manganese Mines, Ince yearly advances starting from 1945, which advances amounted to #587,308.07 by the end cf 1951. Despite these ad-~- vances and the resumption of eperations by Palawan Mange anese Mines, Ince, it continued to suffer losses. By 1951, petitioner became convinced that those advances could no lenger be recovered. While it continued to give advances, it decided to write off as worthless the * gum of #353,134.25. This amount “was arrived at on the basis of the total of advances made from 1945 to 1949 in the sum of 436,961.39, from which amount the sum of 785,847.14 had to be deducted, the latter sum representing its pre-war assets (t.s.ns. pps 1360139, Id}.* (Page 4, Memorandum for Petitioner.) Petitions er decided to maintain the advances given in 1950 and 1951 in the hepe that it might be able te recover the same, as in fact it continued te give advances up to 1952. From these facts, and as admitced by petitioner itself, Palawan Manganese Mines, Inc. was still in operation when the advances corresponding to the years 1945 to 1949 were written off the books of petitioner. Under the circumstances, @as the sum of #353,134.2% properly claimed by netitioner as deduction in its in- come tex return for 1951, either as losses or bad debts?

fit will be noted that in giving advances to Pale- ' 904 o

DECISION -

C.TeA. CASE NO, 787 7.

wan Manganese Mines, Inc. petitioner did not expect to be repaid. It is true thet some testimonial evidence was presented to show that there was some agreement that the advances would be repaid, but no documentary evicience was oresented to this effect. The memorandum egreement signed by the parties appears to be very clear that the consideration for the advances made by peti- tioner was 15% of the net prefits of Palawan Manganese Mines, Inc. In other words, if there were no earnings or profits, there was ne obligation to repay those ed- vances. It hae been held that voluntary advances made without expectation of repayment do not result in de- ductible losses. | 1955 PH Fed. Taxes, Par. 13,229, cite ing 4. F. Young, Inc. v. Com., 120 F. 2d 159, 27 AFTR 3953 ‘Bo Markle, 17 T.C. 1593.

Is the said amount deductible ss a bad debt? As already stated, petitioner gave advances to Palawan Manganese Mines, Inc. without exnectation of repayment. Petitioner could not sue for recovery under the memo- Tendum agreement because the ebligation of Palawan Manganese Mines, Inc. was to nay petitioner 15% ofits net profits, net the advances. No bad debt could arise where there is no valid end subsisting debt. | / Again, assuming that in this case there was a valid and subsisting debt and that the debtor was in- canable of paying the debt in 1951, when petitioner wrote off the advances and deducted the amount in its return for said year, yet the debt is not deductible in 1931 as a worthless debt. It appears that the debt- or was Still ir operation in 1951 and 1952, as petic + 205 giao

BECISION -

GeTeAe CASE MO. 787 - 8 « tioner continued to give advances in these years. It has been held that if the debtor corporation, although losing money or insolvent, was pti operating st the end of the taxable year, the debt is not considered worthless and therefore not deductible. | 1955 PH Fed. Taxes, Par. 13, 967, citing Equinox Co., 2 B.T.A. 4663 Baumann Rubber G., 4 B.T.A. 6713 John Lutz, 9 B.TA. 23; Peabody Coal Co., 186 8.T.A. 1081, affd. in 55 F. 24d 7, 10 AFTR 1025; Clifford Yewdall, Par. 54,087 P-H Memo TC.

“Petitioner spent for the eperation of its Belam- ban Coal Mines in Cebu 98,989.76 in 1930 and ¥27,732.66 in 1951. These amounts were deducted by petitioner as losses in its returns for said years. The deduction was disallowed by resnondent on the greund that the expenditures should have been capitelized, or if they are deductible losses, the losses are deductible in 1952, not in 1950 and 1951.

A The disbursements consisted ef engineer's and men*s payrolls, supfilies, tools, taxes and other extrac- tion costs. As there was no road or outlet through which coal produets could be transported from the mines to the provincial road, it became necessary to aban- don the mines, and they were actually abandoned in 1952. Considered as losses, we agree with respondent that they are deductible in 1952, when the mines were aban - doned, and not in 1950 and 1951 when they were still in operations “Running through this chapter as be constantly basic proposition is the thought that losses must always be established by 206

DECISION «

C.T.A. CASE NO. 787 =o Fe some identifiable event. The event ef be a sale: it may be the destruction or injury to property;

But in a een Me some definite event must fix the when the less is sustained." (Mere ten's Lew of Federal Income Taxation.

Vel. S, Sec. 28.04. pp. 89, cited with approval in the Memorandum for Peti- _ tioner, p. 203 underscoring supp lied. } In this case, the event which definitely fixed the time when the loss was sustained was the abandonment of the mines in 1952. The expenditures in 1950 and 1951 could not have been considered losses prier te the abandon. ment of the mines. The dissllowance of the deduction has to be sustained. \ Petitioner deducted losses in the cperation of its Macienda Daluvird the sums of 717,418.95 in 1990, #29,125.82 in 1951, 226,744.81 in 1952, 221,932.62 in 1953, and #42,938.56 in 1954. These deductions were disallowed by respondent on the ground thet the farm was operated solely for ‘pleasure or as a hobby and not for profit. This ccnclusion is based on the fact that the fara was operated continuously at 4 loss.

_ From the evidence, we are convinesd that the Hacienda Dalupiri was operated by petitioner for busi- hess and not for pleasure. It wes mainly a cattle farm, although a few race horses were also raised. It does not appear that the farm was used by petitioner forven- Aertainment, secial activities, or other non-business purvoses. Therefore, it is entitled to deduct expene ses and losses in connection with the operaticn of said farm.\ (See 1955 PH Fed. Taxes, Par. 13,663, citing 907

AOS

~~

DECISION «

C.TeAe CASE NO. 787 - 10 «- G. C. M. 21103, CB 1939-1, p. 164. )

Section 100 of Revenue Regulations No. 2, other- wise known as the Income Tax Regulations, suthorizes farmers to determine their gross income on the basis of inventories)\ Said requiations provides *Tf gross income is ascertained by inventories, no deduction can be made for livestock or preducts lest during the year, whether purchased for resale, produced on the farm, as such losses will be reflected in the inventory reducing the amount of livest or products on hand at the close of the year.* Rvidently, petitioner determined its income or losses in the operation of said farm on the basis of invente ories. “Ye quote from the memorandum of counsel for .

petitiocnert "The Taxpayer deducted from its in« come tax returns for the years from 19) to 1954 inelusive, the corres~ ponding yearly lesses sustained in the operation of Hacienda Dalupiri, which losses represent the excess of its yearly expenditures over the receipts: that is, the losses re- present the difference between the sales of livestock and the actual cash disbursements or expenses.”

(Pages 21-22, Memorandum for Peti- tioner. } / As the Hacienda Daluviri was operated by peti- tioner for business ond since it sustained losses in its operation, which losses were determined by means of inventories authorized under Section 100 of Revenue Reguletions No. 2, it was error for resnondent to have disallowed the deduction of said losses. The same is true with respect to losses sustained in the operation of the Mecienda Samal for-the years 195] and 1952. \ / During the years 1950 to 1954, petitioner claimed vor 20 ws TeAc CASE NO. 787 - ll.

a depreciation allowance for ite buildings at the rate of 10%. Resnondent claims that the reasonable sllow- ance for deoreciation is only M%. Accordingly, the amount claimed as depreciation allowance in excess of 3% was disallowed, as excessive. Petitioner has not submitted adequate proof of the correctness of its de. termination that the depreciable assets in question — hed a useful life of only 10 years. We’ are, therefore, constrained to sustain the disallowance made by res- For the year 1950, resnondent determined that peti- tioner had an increase in net worth in the sum of $30,050.00, and for the year 1951, the sum of ?)],282. 85. These amounts were treated by respondent as taxeble income of netitioner for said years.

f, It appears that petitioner had an account with the Menila Insurance Company, the records bearing on which were lest. When its records were reconstituted, the amount ef 349,800.00 was set up as its liability to the Manile Insurance Company. It was discovered later that the correct liability was only #319,750.00, or a difference of 930,050.00, so that the records were adjusted so as to show the correct liability. The cor- rection or adjustment was made in 1950. Respondent contends that the reduction of petitioner's liebi lity to Manila Insurance Company resulted in the increase of petitioner's net worth to the extent of 830,050.00 which is taxable. This is erroneous, The principle underlying the taxability of an increase in the net worth of « texpayer rests on the theory that such an 209 was

DECISION «

C.T.A. CASE NO. 787 - 12.

increase in net worth, if unreported and net expleined by the taxpayer, from income . derived from a taxable source. (See een ©: Auenata, Ge Ro Ho. L-9193, May 2, 19573 Coll. v. Reyes, G. RA. Nos. Lel1534 & L-115568, Nov. 25, 1988. ) In this case, the increase in the net worth of petitioner fer 1930 to the extent of 830,050.00 was not the result of the receipt by it of taxable ine come. It was merely the outcome of the correction of an error in the entry in its books relating te its indebted. ness to the Manila Insurance Company. The Income Tax Lew imposes a tax on incomes it does not tax any or every increase in net worth whether or not derived from in- come. Surely, the said sum of 230,050.00 was not’ ine come to petitioner, end it was error for respondent to assess a deficiency income tax on said amount..\ ‘The same holds true in the cese of the alleged increase in net worth of petitioner for the year 1951 in the sum of #1,382.85. It appears that certain. itens (all amounting to 71,382.85) remained in vetitioner's books as outstanding liabilities of trade creditors. These accounts were discovered in 1951 as having been paid in prior years, so that the necessary adjustments were made to correct the errors. If there was an in- crease in net worth of the petitioner, the increase in net worth was not the result of receipt by petition- er of taxable income. | The last disputed item relates to the discrepan- cy in the basis of a certain real property which was sold in 1950. The evidence shews that this property Wee deqarrad im [GOL for PU P52, FY and ams gota tm 210 Ont,

DECISION =

C.T.Ae CASE NO. 787 e 13.

198 for 960,000.00, apoarently resulting in e@ gain of 948,127.26. Petitioner renorted in its «return a gain of 937,000.00, or a ciscreoancy of 811,852.74. It wes sufficiently proved during the hearing that, after ac- quiring the property, petitioner made improvements the value of which have been duly recorded. The total val- ue of these improvements was 911,852.74, se that the gain derived by petitioner from the sale of said prop- erty was correctly reverted. | The decision of resnend- ent on this point must have te be reversed.

In line with the foregoing opinion, the deficien- cy income tax due from petitioner for the years under review amounts tc #123,436.00, itemized and computed .

as follows!

A259

Net income per respondent «----. ® 230,739.45

Deducts

1. Losses in Mati Lumber Co, -«-- ® 8,030.00

2. Increase in net worth arising from ¢orrec- tion of errore- BW ,050,00

3. Losses in Ma- elfends Dalupiri- 17,418.95 4 Gain from sale real property fset by value of improvements- _1),147.26 Net taxable income Senne tee eee Tax 8 16% NO FDS HROSSHES SEES BHEED e *e Less amount previously paid «..< Deficiency income tax «---------

AZ)

Net income per resvondent .----. 523,855. 14

Deduct

l. Increase in net worth re- sulting from eorrection of erroneous b DOK » 944 Or DECISION eo CoTeAe CASE NO. 787

Cd 14 -

entries - ® 1,382.85

2. Less in

Hacienda

Dalupiri- 29,125.82

3. Lesses in

Hacienda

Samael a...

Net taxable income ««-<..- Less amount previously paid Deficiency income tax «-~-< 1952 Net income per respondent ~- %115,316.8

Deduct}

l. Lesses in

Hacienda

Delupiri - 926,744.81

2. Losses in.

Macienda

Samal -e-- _Zs62)073 Net taxable income e---~-- Tax & 20% ee) Less amount previously paid Deficiency inccme tax «-<- 4233 Net income per respondent «

Deducts

l. Losses in

Tax 2 ROS Ce 8 Ee OTe OS

Less amount previcusly paid Deficiency income tax o--<--

A234

| Net income per respondent ~- 72,629.17

Deducts

1. Losses in Hacienda Dalupirdi enwenaasne :

Net taxable income -~-.--~.

Tax a QE CEM aseaesvonanwceue e et Less amount previously paid Deficiency income tax «----

RESUME

1950 OD Rate tenia Teed deabe edhe d YP 2,748.00 neers 3,600.00 8988 weeweeenencera—ce 2,901.00 Total ---.. #8 .

» a8 2

DECISION -

CTA. CASE NO. 787 e 15 «

WHEREFORE, the decision appealed from is howeby modified, and vetitioner is ordered to pay the sum of $123,436.00 within 30 days from the date this decision becomes final. If the said amount, or any part theree ef, is not paid within seid ceriod, there shall be added to the unpaid amount e surcharge of %, plus ine terest as previded in Section $1 of the National Ine _ ternal Revenue Code, as amended. With costs against petitioner.

$0 ORDERED.

Manila, June 10, 1963.

“nN é ’ ROWAN M. UMALI

Asseciate Judge

I CONCURS

sociate Judge