BIR Ruling [UN-097-95]

March 8, 1995 BIR RULING [UN-097-95] Philippine Bank of Communications 214-216 Juan Luna Street Binondo, Manila Attention: Mr . William B . Go President Gentlemen : This refers to your letter dated August 16, 1993 protesting your internal revenue tax case involving the amounts of P11,060,056.92, P425,616.18, P16,259,617.67 and P485,883.93 representing deficiency income tax and deficiency onshore tax for the years 1988 and 1989 respectively on the ground that the same has no legal and factual bases. cdtech Records of this case disclosed that you are a domestic corporation duly registered with the Securities and Exchange Commission and licensed by the Central Bank of the Philippines to engage in commercial banking activities as a regular banking unit and as an expanded foreign currency deposit unit. Re: Deficiency income tax (1988) P11,060,056.92 Deficiency income tax (1989) P16,259,617.67 Deficiency income tax (1988) P11,060,056.92 Investigation of this case disclosed that the deficiency income tax for the year 1988 arose from the disallowance of the deductions claimed by you for bad debts written off in the amount of P11,000,000 for 1988 as well as the disallowance of taxes and licenses likewise for the year 1988. The deduction for bad debts written off was disallowed because it is a prior year's expense since the debtor, Consolidated Mines, Inc. (CMI) was determined to be bankrupt as early as 1982. Thus, your accounts receivable of P11,000,000 from the said company should have been written off as worthless and charged against income in 1982 and not in 1988. Besides the P11,000,000 was only a portion of your exposure to Consolidated Mines, Inc. since the total amount of your accounts receivables was P55,000,000 which is written off over a period of five (5) years at P11,000,000 per year; and that the write off in 1988 is the fifth and last partial write off. The disallowed taxes and licenses represent a compromise payment of tax to the Bureau of Internal Revenue made by you on your tax liability arising from non-payment/affixture of documentary stamps due on non-negotiable promissory notes issued from 1981 to 1984 which was paid under Payment Order No. 3252231 and Central Bank Confirmation Receipt No. 14457392 both dated May 21, 1988. In letter dated August 16, 1993, you stated that "this last staggered write-off was based on the approval of the Monetary Board of the Central Bank as required by the General Banking Act. There is a compelling economic reason why Central Bank authorized the staggered write-off of bank's loans to CMI. The first write-off was authorized by the Central Bank in 1985. The onset of the country's extreme financial condition, which started about two years earlier when a moratorium was declared on payments of international obligations, saw interest rates reaching 40 plus per cent and perceived at that time to stay at this level indefinitely. The banking systems unpaid loans were at an all-time high. The bank's principal exposure to CMI is US$51.1 million. Writing off this entire amount in a single year would have adversely affected the stability of the banking system which the government itself, through Central Bank was determined to prevent." Section 29(e) of the Tax Code provides for the following concurring requisites before a bad debt deduction can properly be made 1) There must be an existing indebtedness; 2) Such debt must be ascertained to be worthless; and 3) Such debt must be actually charged off within the taxable year when it was determined to be worthless. Under Section 29(a)(1) of the Tax Code, providing for deduction of bad debts actually ascertained to be worthless and charged off within the taxable year, there cannot be partial writing off of a loss or bad debts. For such losses or bad debts must be ascertained to be so and written off during the taxable year. Therefore, they are deductible in full or not at all, in the absence of any express provision in the Tax Code authorizing partial deductions (Fernandez Hermanos, Inc. vs. CIR< 29 SCRA 533) Such being the case, and since the aforesaid debt of CMI was ascertained as worthless in 1988 when CMI was determined bankrupt, said debt should have been written off as worthless and charged off in 1982 and not in 1988. Thus, the disallowance of the amount of P11,000,000 as bad debts written off for the year 1988 is legal and proper . Moreover, the disallowance of the amount of P2,585,452.04 as taxes and licenses which actually represent a compromise payment on your tax liability arising from non-payment/affixture of documentary stamp tax due on non-negotiable promissory notes issued from 1981 to 1984 is legal and proper since said compromise payment is not deductible from gross income under Section 29(c)(1) of the Tax Code, as amended. Re: Deficiency income tax (1989) P16,259,617 . 67 The deficiency income tax for the year 1989 in the amount of P16,259,617.67 arose from the disallowance of bad debts written off in the amount of P20,546,236.02 for 1989 as well as the disallowance of miscellaneous expense of P1,844,550.00 likewise for 1989. The write-off of accounts receivables in the amount of P20,546,236.02 due from the Philippine Blooming Mills, Inc. was disallowed because it is also a prior year's expense considering that the debtor has ceased operations since 1981. The accounts receivable should have been written off and charged against income in 1981 and not in 1989. In a letter dated August 16, 1993 you protested the assessment stating that the account had original loans in the total amount of P30,983, 173.79; that the bank holds security for the loan and shared in the proceeds resulting from the bank's and other creditors exercise of their respective rights under their individual security and collateral agreements with the debtor that the write-off of the loan could not be made earlier, there being security and collaterals which were the subject of court litigations that would determine the bank's share in the sale of chattels, steel inventories, scrap etc: that payments were being received and applied to the debtor's loans on the following dates: May 29, 1986 P3,334,909.37 March 12, 1987 P2,607,022.40 January 9, 1990 P4,500,000.00 P10,441,937.77 ============ that the Central Bank was aware of the status of the loan and was monitoring the bank's efforts to collect based on the exercise of rights under security and collateral agreements; and that it was only upon the bank's full exhaustion of efforts and Central Bank's determination of the debts worthlessness that it approved the write-off. However, bad 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 Araas) 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 vs. Collector of Internal Revenue, CTA Case No. 720) 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 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. Such being the case, the disallowance of the amount of P20,546,236.02 as bad debts written off for the year 1988 is legal and proper. Miscellaneous Expense (1980) P1,844,550 . 00 Investigation of this case disclosed that the aforesaid deduction represents final income tax paid by you in 1985 which was erroneously booked in the same year as a debit to Accounts Receivable BIR instead of Provision for income tax. The error was corrected in 1989 thru a year end adjusting journal entry. Under Section 29 (c)(1) of the Tax Code, as amended income tax is not allowable as deduction from gross income for income tax purposes either as taxes and licenses or as miscellaneous expenses. Thus, the disallowance of the miscellaneous expense of P1,244,550.00 for 1989 is legal and proper . Re: Deficiency Onshore tax (1982) P425,616 . 18 Deficiency Onshore tax (1989) P485,883 . 93 The deficiency onshore taxes for 1988 and 1989 in the respective amounts of P425,616.18 and P485,883.93 arose due to your failure to pay the 10% onshore tax imposed under Section 25(a) (6) (9) of the Tax Code on your interest income derived from foreign currency denominated loans to the Light Rail Transit Authority (LRT) amounting to P1,768,967.20 in 1988 and P2,260,058.40 in 1989. Investigation disclosed that you passed on the payment of the 10% onshore tax due on the said interest income to the borrower, LRT. However, LRT did not pay the said tax because it is a tax exempt entity under Executive Order No. 603 (LR Charter) which provides among others, that foreign loans contracted by LRT shall be exempt from all direct and indirect taxes. Pursuant to Section 25(a) (6) (B) of the Tax Code, as amended, interest income from foreign currency loans granted by depository banks under the Expanded Foreign Currency Deposit System to residents (other then offshore banking units in the Philippines or other depository banks under the expanded system) shall be subject to a 10% tax. Such being the case, and since you did not pay the aforesaid 10% tax on your interest income pursuant to Section 25(a) (6) (B) of the Tax Code, as amended, you are liable to the payment of the respective amounts of P425,616.18 and P485,883.93 as deficiency onshore taxes for the years 1988 and 1989. In view thereof, you are requested to pay the amounts of P11,060,056.92, P425,616.18, P16,259,617.67 and P485,883.93 representing deficiency income tax and deficiency onshore tax for the years 1988 and 1989 respectively within thirty (30) days from receipt hereof otherwise this Office will enforce collection thereof thru the summary remedies prescribed by law. aisadc This constitutes the final decision of the Office in this case. Very truly yours, LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue