Mitsubishi Heavy Industries Philippines, Inc.

July 27, 2007 BIR RULING [DA-423-07] Section 34 (E) & RR 5-99 Mitsubishi Heavy Industries Philippines, Inc. 24/F, Yuchengco Tower, RCBC Plaza Ayala cor. Sen. Gil Puyat Avenues Makati City Attention: Mr. Tatsuo Aiba President Gentlemen : This refers to your letter dated June 9, 2007 requesting for a ruling on the procedures and requirements on how to write off the existing allowance for doubtful accounts (allowance for the uncollectible debt) and the tax implications of the write off. In reply, please be informed that the following are the requirements in order that bad debts may be deductible: 1) there must be an existing indebtedness due to the taxpayer which must be valid and legally demandable; 2) the same must be connected with the taxpayer's trade, business or practice of profession; 3) the same must not be sustained in a transaction entered into between related parties enumerated under Section 36 (B) of the Tax Code of 1997; 4) the same must be actually charged off the books of the taxpayer as of the end of the taxable year; and 5) the same must be actually ascertained to be worthless and uncollectible as of the end of the taxable year (Section 3, Revenue Regulations No. 5-99). Section 102 of Revenue Regulations No. 2, as amended, otherwise known as "The Income Tax Regulations," also requires that a statement showing the propriety of the bad debt deduction must be filed with the return. HSaIDc Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to demonstrate with reasonable degree of certainty the uncollectibility of the debt. The Commissioner of Internal Revenue will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor in determining whether a debt is worthless, or the assigning of the case for collection to an independent collection lawyer who is not under the employ of the taxpayer and who shall report on the legal obstacle and the virtual impossibility of collecting the same from the debtor and who shall issue a statement under oath showing the propriety of the deductions thereon made for alleged bad debts. Thus, where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction. The recovery of bad debts previously allowed as deduction in the preceding year or years shall be included as part of the taxpayer's gross income in the year of such recovery to the extent of the income tax benefit of said deduction. Conversely, if the said taxpayer did not benefit from the deduction of the said bad debt written-off because it did not result to any reduction of his income tax in the year of such deduction (i.e., where the result of his business operation was a net loss even without deduction of the bad debts written-off), then his subsequent recovery thereof shall be treated as a mere recovery or a return of capital, hence, not treated as receipt of realized taxable income. Herewith attached is a copy of Revenue Regulations No. 5-99 implementing Section 34 (E) of the Tax Code of 1997 on the requirements for deductibility of bad debts from gross income for your information and guidance. EHIcaT Please be guided accordingly. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service