Aranas Consunji Barleta Law Offices

October 28, 2008 BIR RULING [DA-(C-111) 362-08] Section 34 (E) (1); Revenue Regulations 25-02; BIR Ruling DA 537-06 & 008-07 Aranas Consunji Barleta Law Offices Unit 106 G/F Le Metropole Building 326 Tordesillas cor. De la Costa Sts. Salcedo Village, Makati City Attention: Ma. Louella M. Aranas Partner Gentlemen : This refers to your letter dated October 10, 2008, requesting for a ruling relative to the intention of LG Electronics Philippines, Inc. ("LGE") to write-off its accounts receivables due from the Uniwide Group of Companies and Estrellita Home Value Center and claim it as a bad debt deduction from its gross income pursuant to Section 34 (E) (1) of the Tax Code of 1997. It is represented that LGE, a domestic corporation with TIN No. 000-286-404-000 and with principal place of business at #15 F. Legazpi Street, Maybunga, Pasig City; that it is engaged in the business of marketing, supplying and trading electronic home appliances and has gained recognition as a leader in the said field; that as such supplier, it has entered into various transactions with big corporations in the Philippines for the sale of goods on credit; that such buyers include the Uniwide Group of Companies ("Uniwide") and Estrellita Home Value Center; that the continuing sales on credit arrangement resulted in receivables from Uniwide for goods supplied until the year 1998, in the amount of Twenty Million Thirty One Thousand One Hundred Ninety One Pesos and Seven Centavos (P20,031,191.07) and Seven Million One Hundred Ninety One Pesos and Seven Centavos (P7,147,154.77) * from Estrellita Home Value Center for supply of goods until 2003; that both debtors have failed to fulfill their obligation to pay notwithstanding the many demand letters sent by LGE and its legal counsel; that Uniwide has been undergoing rehabilitation proceedings for the past 6 years now while a criminal case has been filed against the owner of Estrellita Home Value Center for a debt since 2003 and a report from a credit investigation company hired by LGE stated that the same can no longer be located; that to date, the outstanding obligation of both parties have reached Twenty Seven Million One Hundred Seventy Eight Thousand Three Hundred Forty Five Pesos and Eighty Four Centavos (27,178,345.84). HIACac Based on the above representations, you are requesting for a ruling that "LGE" can write-off its accounts receivables due from the Uniwide and Estrellita Home Value Center in the total amount of P27,178,345.84 and claim it as a bad debt deduction from its gross income pursuant to Section 34 (E) (1) of the Tax Code of 1997. In reply thereto, please be informed that Section 34 (E) (1) of the Tax Code of 1997 provides: "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." Similarly, Revenue Regulations No. 25-02, amending Revenue Regulations No. 05-99, and implementing Section 34 (E) (1) of the Tax Code of 1997, provides the requisites for valid deduction of bad debts from gross income, to wit: "Sec. 3. Requisites for valid deduction of bad debts from gross income. The requisites for deductibility of bad debts are: (1) There must be an existing indebtedness due to the taxpayer which must be valid and legally demandable; ETaSDc (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 accounts 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." The Court of Tax Appeals (CTA) in interpreting the above requisites held that the taxpayer is not required to be an "incorrigible optimist" in enforcing 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). He may not postpone a bad debt deduction 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. Thus, this Office, in BIR Ruling No. UN097-95 dated March 8, 1995, as reiterated in BIR Ruling Nos. DA-696-06 dated December 11, 2006 and DA-008-07 dated January 9, 2007 held that ". . . [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) 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) TIaDHE In applying the above principle in this case, LGE took reasonable steps to collect the debt. Since the appointment of its rehabilitation receiver, all claims against Uniwide were suspended. In the same manner, the pending criminal case and warrant of arrest for Mr. Magsadia who can no longer be located has been certified by Dun and Brad Street Philippines, Inc., a credit investigation company. Considering that there is no likelihood of recovery at any time in the future, the debt can now be considered worthless. In view of the foregoing, LGE may write-off its accounts receivables due from Uniwide and Estrellita Home Value Center in the total amount of P27,178,345.84 and claim it as a bad debt deduction from its gross income pursuant to Section 34 (E) (1) of the Tax Code of 1997. Furthermore, there is no donor's tax due on the said write off considering that LGE did not have donative intent (BIR Ruling 537-06 dated September 5, 2006). 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. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service