Carag De Mesa & Zaballero Law Offices

May 27, 2009 BIR RULING [DA-(C-075) 257-09] DA537-06 Carag De Mesa & Zaballero Law Offices Suite 2602, 26th Floor, The Atlanta Centre No. 31 Annapolis Street, Greenhills 1500 San Juan, Metro Manila Attention: Attys. Othelo C. Carag Gladys G. Bravo Gentlemen : This refers to your letter dated May 8, 2009 requesting for confirmation of your opinion that the loan receivables of your client, ALEJANDRO S. NG WEE (hereinafter called "Mr. Ng Wee"), which have been written-off prior to December 31, 2005 for being worthless or uncollectible, no longer form part of his assets that are required to be declared in his Statements of Assets, Liabilities and Networth ("SALN") as of December 31, 2005 for purpose of availing of the tax amnesty authorized and granted under Republic Act No. 9480 ("Tax Amnesty Law"). DSETac It is represented that Mr. Ng Wee made money placements with Westmont Investment Corporation ("Wincorp"); that each money placement given by Mr. Ng Wee to Wincorp is evidenced by a serially numbered confirmation advice issued by Wincorp stating that his money was lent to the borrower stated in the confirmation advice subject to the payment of interest at a rate stated therein and payable on maturity date; that the confirmation advice typically provides as follows: "This is to confirm that pursuant to your authority, we have acted in your behalf and/or for your benefit, risk or account without recourse or liability, real or contingent, to Westmont Investment Corporation in respect of the loan granted to the Borrower named and under the terms specified hereunder: Borrower: ____________ Amount: Rate: % Term: Value Date: Due Date: Yield: Tax: Maturity Value: Instrument: LOAN AGREEMENT Payment on Value Date: TO No. For convenience but without any obligation on our part, we may act as your collecting and paying agent for this transaction. Kindly note that your receipt hereof is an indication of your conformity to the foregoing terms and conditions of the transaction." that it is further represented that based on the confirmation advice given to Mr. Ng Wee, his money was lent to the borrower Power Merge Corporation ("Power Merge"); that however, sometime in February 2000 and prior to the maturity date of his money placements, Mr. Ng Wee received disturbing news about the shaky financial condition of Wincorp and its borrowers, including Power Merge; that Mr. Ng Wee conducted inquiries and investigated the veracity of the news reports and discovered the following based on the documents which came to his possession and the result of his investigation: 1. Power Merge, to which his money placements were loaned by Wincorp and its officers, is insolvent with no known assets with which to satisfy all its loans; 2. Power Merge, which was incorporated only in August 1997 was thinly capitalized and does not have a record of any business license issued to it by the Business Permit and Licensing Office of the City of Makati where its principal office is located. Neither did Power Merge file any audited financial statements with the Securities and Exchange Commission ("SEC") that can show that it commenced business operations and has earned revenues that can determine its ability to pay back any of its loan obligations; 3. All loans obtained by Power Merge, through Wincorp, have no collaterals to secure their payment; and HAEIac 4. Worst of all, there is even an Agreement between Wincorp and Power Merge effectively absolving Power Merge of the obligation to pay back its loan obligations to Wincorp since Power Merge allegedly acted as a mere accommodation party to another borrower, Hottick Holdings Corporation. that upon maturity of the money placements of Mr. Ng Wee in 2000, Wincorp defaulted on account of the failure of Power Merge to pay back its loan obligations; that Mr. Ng Wee was compelled to file in 2000 a collection case against Power Merge, Wincorp and their respective officers with the Regional Trial Court which case is still pending for nearly ten (10) years already; that Mr. Ng Wee has not yet been able to collect any interest or principal payment from its loan receivables from Power Merge that are the subject of the collection case he filed against it and its officers; that in 2004, the Certificate of Incorporation of Power Merge was revoked by the SEC pursuant to the Order dated February 10, 2004, which was published on February 14, 2004 in a newspaper of general circulation, for failure of Power Merge to submit its annual reports such as its General Information Sheet and Audited Financial Statements under Section 141 of the Corporation Code; that when Mr. Ng Wee learned of the revocation of the Certificate of Incorporation of Power Merge sometime in 2005, Mr. Ng Wee decided to write-off his loan receivables from Power Merge on account of their worthlessness or uncollectibility notwithstanding the pendency of the collection case he filed against it; that on May 24, 2007, the Tax Amnesty Law lapsed into law without the signature of the President in accordance with Article VI of the Constitution; that under the Tax Amnesty Law, a taxpayer can avail of an amnesty to cover all national internal revenue taxes for the taxable year 2005 and prior years provided the following prescribed Tax Amnesty Forms have been filed with the Bureau of Internal Revenue ("BIR") and the corresponding amnesty tax due have been paid within the period prescribed under the Tax Amnesty Law or until May 5, 2008: (1) Notice of Availment of the Tax Amnesty; (2) SALN as of December 31, 2005; (3) Tax Amnesty Return; and (4) Acceptance of Payment Form. The Tax Amnesty Law grants the following immunities and privileges to taxpayers who availed themselves of the tax amnesty and have fully complied with all its conditions for availment: (1) The taxpayer shall be immune from the payment of taxes, as well as additions thereto, and the appurtenant civil, criminal or administrative penalties under the National Internal Revenue Code of 1997, as amended, arising from the failure to pay any and all internal revenue taxes for taxable year 2005 and prior years; aSIAHC (2) The taxpayer's Tax Amnesty Return and the SALN as of December 31, 2005 shall not be admissible as evidence in all proceedings that pertain to taxable year 2005 and prior years, insofar as such proceedings relate to internal revenue taxes, before judicial, quasi-judicial or administrative bodies in which he is a defendant or respondent, and except for the purpose of ascertaining the networth beginning January 1, 2006, the same shall not be examined, inquired or looked into by any person or government office. However, the taxpayer may use this as a defense, whenever appropriate, in cases brought against him; and (3) The books of accounts and other records of the taxpayer for the years covered by the tax amnesty availed of shall not be examined: Provided, That the Commissioner of Internal Revenue may authorize in writing the examination of the said books of accounts and other records to verify the validity or correctness of a claim for any tax refund, tax credit (other than refund or credit of taxes withheld on wages), tax incentives, and/or exemptions under existing laws. Corollarily, under Section 3 of the Tax Amnesty Law, the SALN to be filed by the taxpayer shall contain a declaration of the assets, liabilities and networth of the taxpayer as of December 31, 2005, to wit: "SEC. 3. What to Declare in the SALN. The SALN shall contain a declaration of the assets, liabilities and networth as of December 31, 2005, as follows: (a) Assets within or without the Philippines, whether real or personal, tangible or intangible, whether or not used in trade or business: Provided, That property other than money shall be valued at the cost at which the property was acquired: Provided, further, That foreign currency assets and/or securities shall be valued at the rate of exchange prevailing as of the date of the SALN; (b) All existing liabilities which are legitimate and enforceable, secured or unsecured, whether or not incurred in trade or business; and (c) The networth of the taxpayer, which shall be the difference between the total assets and total liabilities." that before the deadline for availment of the benefits of the amnesty under the Tax Amnesty Law on May 5, 2008, Mr. Ng Wee decided to avail of the tax amnesty for the purpose of enjoying the immunities and privileges granted under the Tax Amnesty Law; that Mr. Ng Wee complied with the requirements for availment of the amnesty under the Tax Amnesty Law and filed the prescribed forms with the Revenue District Office that has jurisdiction over his legal residence or principal place of business and accordingly paid the applicable amnesty tax due; that however, Mr. Ng Wee did not include in his SALN as of December 31, 2005 the amount of his unsecured loan receivables from Power Merge because they have already been written off for being worthless or uncollectible in 2005. aIAEcD In reply thereto, please be informed that under Section 34 (E) (1) of the National Internal Revenue Code of 1997, as amended, ("Tax Code"), a taxpayer is authorized to write-off his/her receivables provided the same have been ascertained to be worthless, to wit: "Sec. 34. Deductions from Gross Income . (E) Bad Debts. (1) In General. Debts due to the taxpayer actually ascertained to be worthless and charged off within the taxable year except those not connected with profession, trade or business and those sustained in a transaction entered into between parties mentioned under Section 36(B) of this Code: Provided, That recovery of bad debts previously allowed as deduction, in the preceding years shall be included as part of the gross income in the year of recovery to the extent of the income tax benefit of said deduction." (Emphasis supplied.) Corollarily, Section 2 of Revenue Regulations No. 05-99 dated March 10, 1999 ("Rev. Reg. No. 5-99") as amended by Revenue Regulations No. 25-02 dated November 19, 2002 ("Rev. Reg. No. 25-02") implementing Section 34 (E) (1) of the Tax Code provided the guidelines in the determination of the worthlessness or uncollectibility of a debt to be written-off, to wit: "The determination of worthlessness in a given case must depend upon the particular facts and the circumstances of the case. A taxpayer may not postpone a bad debt deduction on the basis of a mere hope of ultimate collection or because of a continuance of attempts to collect notes which have long become overdue. While a mere hope probably will not justify postponement of the deduction, a reasonable possibility of recovery will permit the account to be carried along notwithstanding that the probabilities are that the debt may not be collected at all. The creditor may offer evidence to show some expectation that the debt would have been paid in the intervening years, and that subsequently, the hope was shattered or appeared to have been unfounded. Good faith does not require that the taxpayer be an 'incorrigible optimist' but on the other hand, he may not be unduly pessimistic. Creditors do not have to wait until some turn of the wheel of fortune may bring their debtors into affluence. The taxpayer may strike a middle course between pessimism and optimism and determine debts to be worthless in the exercise of sound business judgment based upon as complete information as is reasonably ascertainable. The taxpayer need not have perfect discernment. EaScHT xxx xxx xxx 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." (Emphasis supplied) The Court of Tax Appeals, in interpreting the above-quoted provision on the write-off of bad debts, held that a taxpayer is not required to be an "incorrigible optimist" to enforce collection of a debt ( Western Pacific Corporation v. Commissioner of Internal Revenue , CTA Case No. 720, 22 May 1961 citing White Dental Mfg. vs. US , 274 US 398). In view thereof, a taxpayer may not postpone the write-off of a bad debt on the basis of a mere hope of ultimate collection but rather, should exercise sound business judgment based upon information reasonably obtainable in determining worthless debts and in the examination of all the circumstances. In BIR Ruling No. UN 097-95 dated March 8, 1995, this Office ruled: ". . . [B]ad debts are allowed as deductions in the year when ascertained to be worthless and not at the time when the taxpayer may finally 'give up' on the possibility of recovering any part of the debts and decide to charge them off. (CCH, 60 Vol. 2, p. 21.009; (page 252, updated National Internal Revenue Code with Notations and Appendices, 1988 Edition, Jose Aranas). SAHaTc The taxpayer must take reasonable steps to collect the debt. He does not have to go to court if it can be shown that a judgment once obtained would be worthless because the debtor is insolvent or 'judgment proof'. If, in the exercise of sound business judgment a taxpayer believes there is no likelihood of recovery at any time in the future, the debt has been worthless. ( Western Pacific Corporation v. Collector of Internal Revenue , CTA Case No. 720)." In addition, this Office in the same ruling mentioned above considered the cessation of the business operations of the debtor as a ground for the write-off of a debt, to wit: "Accordingly, and since the debtor, Philippine Blooming Mills, Inc. has ceased operations since 1981, its debt in the amount of P20,546,236.02 should have been charged off in 1981 and not in 1989 when you have allegedly fully exhausted your collection efforts and finally 'give up' on the possibility of recovering the aforesaid debt." Finally, in BIR Ruling [DA-537-06] dated 05 September 2006, this Office authorized the write-off of a debt when the borrower company has ceased business operations or when its corporate life has ceased to exist regardless of when the SEC actually approves the shortening of its corporate life, to wit: "Without any assets and any prospect of future revenues both on the long and the short term, owing to the cessation of Goya's business operations, the sale thereof effective upon the close of business on March 1, 2006 and the cessation of its corporate existence as of June 30, 2006, there is no prospect left for Nestl to recover the Advances from Goya. Accordingly, it would be appropriate for Nestl to determine the worthlessness of such debt and deduct the same as bad debts in its gross income for the taxable year 2006. The ascertainment of worthlessness should be pegged as of December 31, 2006, the end of the taxable year when Goya has actually ceased its business operations (effective, March 1, 2006), or when its corporate life has ceased to exist (that is, June 30, 2006). This is so regardless of when the Securities and Exchange Commission actually approves the shortening of its corporate life. As of December 31, 2006, the amount of Advances that are deductible as bad debts should be the outstanding amount of Advances as of January 11, 2006, the date when the Stockholders approved and ratified the sale of Goya's business less any amounts paid thereafter by Goya to Nestl as a result of the sale of Goya's assets. If, after December 31, 2006, Nestl should receive additional amounts from Goya as payment for the Advances, Nestl should recognize the same as income in the year the payment was received." (Emphasis supplied.) CcADHI In applying the above principles under the circumstances of the instant case, it appears that the money of Mr. Ng Wee was loaned to the borrower, Power Merge, which was incorporated only in 1997, was thinly capitalized with no known assets with which to satisfy its loans and hence, insolvent. Moreover, it appears that Power Merge was able to obtain unsecured loans from Wincorp and its investor clients notwithstanding that Power Merge has no prospect of future revenues to pay back its loans as may be shown by its failure file any audited financial statements with the SEC and its failure to secure any business license from the City of Makati where its principal place of business is located as stated in its Articles of Incorporation. More importantly, you represented that there's an Agreement between Wincorp and Power Merge wherein Power Merge was effectively absolved of any obligation to pay back its loan to Wincorp or any of its investor clients, including Mr. Ng Wee, because Power Merge allegedly acted merely as an accommodation party for another borrower, Hottick Holdings Corporation. Thus, despite the maturity of the loan obligations of Power Merge in 2000 and the filing of the collection case against it and its officers in the same year, which is still pending before the lower court, Mr. Ng Wee has not yet been able to collect any of the principal and interest payments due on his loan receivables from Power Merge. Power Merge also failed to file with the SEC any annual reports such as the General Information Sheet and the audited financial statements, which may be used to determine its ability to raise revenues to pay back any of its loan obligations. Consequently, the SEC revoked the Certificate of Incorporation of Power Merge in 2004 pursuant to its Order dated February 10, 2004 which was published on February 14, 2004 in a newspaper of general circulation. In view thereof, it seems apparent that there is no longer any prospect left that Mr. Ng Wee can recover his loan receivables from Power Merge. Accordingly, it would be appropriate for Mr. Ng Wee to determine the worthlessness of his loan receivables from Power Merge in the year when the corporate life of Power Merge ceased to exist on account of the revocation of its Certificate of Incorporation by the SEC in 2004 and to cancel or write them off in the year they became worthless or uncollectible. Under Section 2 of Rev. Reg. No. 5-99, if a receivable has actually become worthless, the same can be cancelled or written off from the books of accounts of the taxpayer. Consequently, the same no longer forms part of the taxpayer's asset from the date of the write-off, to wit: STIEHc "SEC. 2. Definition of Terms . For purposes of these regulations, the following words and phrases shall have the following meaning, viz. : xxx xxx xxx d. 'Actually charged off from the taxpayers' books of accounts' This phrase means that the money lent by the taxpayer (in the course of his business, trade or profession) to his debtor had been recorded in his books of account as a receivable has actually become worthless as of the end of the taxable year, that the said receivable has been cancelled and written-off from the said taxpayer's books of account. . . . In no case may any bad debt deduction be allowed unless the facts pertaining to the money or property lent and its cancellation or write-off from the taxpayer's accounting records, after having been determined that the same has actually become worthless, have been complied with." Considering that the loan receivables of Mr. Ng Wee from Power Merge have already become worthless in 2004 and should have already been written-off in the same year but was only cancelled or written-off in the books of accounts of Mr. Ng Wee in 2005 when he learned of the revocation of the Certificate of Incorporation of Power Merge by the SEC, said loan receivables from Power Merge should no longer form part of the assets of Mr. Ng Wee as of December 31, 2005. Thus, we confirm your opinion that the loan receivables of Mr. Ng Wee from Power Merge that were already written-off in 2005 for being worthless or uncollectible shall no longer form part of his assets that were required to be declared in his SALN as of December 31, 2005 for purpose of availing of the tax amnesty authorized and granted under the Tax Amnesty Law. It is, however, understood that if Mr. Ng Wee should receive any payment from Power Merge for his loan receivables after December 31, 2005, Mr. Ng Wee should recognize the same as his income in the year the payment was received to the extent of the income tax benefit received from such deduction of bad debts. Conversely, if Mr. Ng Wee did not benefit from the deduction of the bad debt written-off because it did not result to any reduction of his income tax in the year of such deduction, then his subsequent recovery thereof shall be treated as a mere recovery or a return of capital and hence, not treated as receipt of realized taxable income. (BIR Ruling DA-423-07 dated July 27, 2007) This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. CIcEHS Very truly yours, (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Legal & Inspection Group