CTA Case No. 128 (Decision)

, ~EPUBLIC OF ~THAEX PHlLlPP l r-..1':) � COURT OF APPEAL.' MANlU. VISAYA CEBU TERMINAL t~~t q CO,, IN;., Appellant , ry 1 r � versus � ~ COLLECTOR OF INTI!RHAL C, T, A, CASE NO, 128 REVENUE , Appellee. X� � � � � � � � � � � � � X DEC I ION Tht appellant, Viaayan Cebu Terminal Co,, Ine., !a a corporation organized for the purpoae of hand- ling arraatre operations in the port of Cebu . It was awuded the contract for the said arraatre ope� rations by the Bureau of Cuat~a , pursuant to Act No. 3CX)2, a� �ended. On March 1, 1952, appellant filed its income tax return for 1951 reporting a gross income of 420,633. ~ and claiaed deduetions amounting to 379 , 036. 95 , leaving a net incoae of � 41 , ~6. 45 on which it paid incoae tax in the sum of 8, 319. 29. The sua of t 379,036, 95 claimed aa deduction� con� slated of various items, among which were the fol� lowl~ga 1. Salaries � 1,875.00 2,375,00 ( a) Salary and bonus 250 , 0 0 of Juan Eugenio Lo ������������� 2~.QQ (b) alary of Felix Go Chan �������- (c) alary of Teottmo Tiu iian ������� 2, epreaentatlon expenses ��������� 75,855,88

- -- ..... � � - 2- 3. i c 11 nee s expen es � ( a ) Chr � a .. as onu !v n to v riou pi e rs s o n s s - -ip- - - - - - - 1, 0 t officers -------- _4..........,.;..oo;.;..--- _-......-......--...-. Tot 1 ----- . 88 T o said sw.s of 2, 375.00, 75, 855. 88 nd 6 , .co, representin � sDl rics , represent t~cn x- penae and ..iscellnneous cxpcns s , respsc tiv 1y , or a tot 1 o .. 84, 5 �88 , wcr dis<Jllm:( JY the cl- leeto of In ernal ev nue , thus g� ris to a defic iency ~~sessrnent of 18 , 991 . r ,e di ollo.- ances ere explained by the ollectcr in 1~ lettwr of e uary 4 , 19~4 , ns ollo~s: This of ot t n t pro- fit given to �our ( p llant �s} eneral J .1a er , of tl '"'t rofit iv n to ( appellant ' s) vice- prosi ent , both of ho ~e embers of he o r o � ctor , n 5 of th net prof! o ach of the rest of the fiv 1 er o ~h o � o Uirec- tor& nd to a legal counsel. The ount of ~ 75 , 8o5 . 8 r r s t distr� utions to (appellant' ) �for said officer bed on th percent of h n rofi � It ha en o served th t th recipients of th afore- � � 2 65

- , ECISION � .- � T. A. E � 128 said 6� � s an ou x en e � This scr.pancy const1tute y t e amount of 1,500.00 hich ( appcll nt) gave as hrist s bo u o various per- sons who are not (appell~nt ' s) bonafide e ployees and the u o ~ . given as tips to unknown persons. Th hole a ount cannot be llo ed s d uction because they were not ordinary nd n � cessqry exp ses. Upon 1�equost for reconsi ratio , h o 1 c- nt by allowing ~h d uc ion fro. pp n t gro s inoome of the salary of Juan ugenio Lo in the su of 1 , 875. 00 and mi cell n ous expen e a oun to 532.00, at the s e ain aining the di ~1� lowanc e of th full ount o , a ~.as s repre� sentat i on exp n � h r vi~e o i1 i cv a ess- ment ls itemize in th letter of the o 1 ctor dat arch 26, 1955, -nd is r pro b .lOW:. et !nco e as per Drestaulrlno �an�c���s:�. ����-�--�--------�- 41,59 .4 per investigation: 7 , 85... 08 salaries of of- allfoiceedrsp-e-r�-rc-�~u~d-i--t�- --~--.- p�r investig tion and reaudit , r pr - 1ntation xpenses--------���- per 1nve ti atlon , iscellaneou ____ alleoxpeednvpeser--�--1-d--t --� , 532�.00 5 768.00 ~et inco su~j c~ o tax per reaudit ���-�-�-�� ---�_.......; Tax due on 123,720.3 : ,ooo.co t aJ -- 1 ,ooo. 23, 720. t 28 -- 6, 642, 26, 642. 00 . 266

� 128 - 4- Less tax previously as esse nd pa d ----~~-~-------�---- efi ciency tax --�-----�-------- Add: 51 ~ suorncthhalyrg in�t--r --s---fr-o-..�,--- 5/31/5 to 4/ /55 ------ ~ompromise for 1 te p y ent ---- ot 1 amount due on Apr 1 30 , 1955 ----~--~----------~---~-- 6 Appellant has agr e o the di sa!lo 'ance of the su of , repr e~entin t he salaries of Felix o Chan and Teotimo i u Tian at 2r. .co each, and the su~ oi .5 , 768. O, representing .i~c lancous expenses. e only issu xaise in this npp al re� lates to th uctibi ity o th su of ~ 75 , 85 . 88 as repr s ntation xpens s. In co pu-ci n t 1 com , h la a lo t deduction fro co !nco of - " 11 he or in ry nd nece .ary x� penses pa"d or incurr d dur "ng tho t xable yoar in carrying o �Y r o sin ss , i~cludin a re1~ona le allowance for sal - r ies or other c o.up n tion or porsone~l services ct 1 ~' 1 � rendered � � � ., ( c . ~ ~ (a)(l, iona nt rna v .u oa . ) 11 un � r Hepres ntation or nt r-cai n the ca \.egory of usJ.ne s exp n es an allo a le ded\lctions ft'o ross :1.1 cc.�e i y condi- tions pr scri J y a .�� In orde~ hat expen y e ucti e , hey must be � (1} Ordinary an 1 c ~., a... y , a1 d (2) Paid or inc rrc uri t. e a. a 1 year under one of the ollo in conditions - (a) I n carryin on any trade or ..,. . 267

D � 128 � T. A. - 5- ueiness; (o ) For th pro c ion or coll c- , tion of !nco � ( c) F r tho m na e nt, co .., rva- io , or aint na ... of pro� "' perty ld for th pro uction ' of inco e� ( d) In conn tion ~ith th d t rmi- nation, r fund or coll c ion of &ny ax. Par.ll ,OOO P-H /,vn . d. 1955. ) i expens s r p id or incurr d �n earry1n on a r de or busin s ithin the taxabl yearJ or for th pro uction or coll ction of ncor. ; or for the ana em nt, conserv tio , or int n nee of property held for the production of inc J or in eonnect!on with the det rminatiora, refund or coll c- tlon of any tax, s ch expenses ould not be deductibl ~��� they were ot ordinary nd necess ry. n ex- penae is gener lly considered ~c ssary h r the ex- penditure is appropri ~e or h lpful in t dev lop- ment of the taxpayer ' s bu � ne or that th c:~me � s proper f or the purpose of real zin a profit or min�- mizing a lo& s . J\n xpens is rdinary wh n 1t con- notes a payment ~hlch is norm 1 in rel tion o the business of the taxpayer nd th urrounding circu G- tance ~ A& to h eaning o the Otd ordinary , 26

D II � � 128 C. T. A, CA - 6- the upreme Court of the Un ted St~tes stated: " O\ , .h t is ordinzry , though th re ust al ays be a a n o~ c n~ cy 1 h� in it , S none th 1 wS ~ V riabl Df� f ct by t� e nd place and eire Gta~c � Ordinary in this cont xt doos not that the pay ents ust e ha itu 1 o nor mal in the sense that the sa tax- payer till av to ma� h o4 t , . A lawsuit afiect~n tho G fety of usi- ness ay h JP 1 once in 11 ti@ � h cocnsel f cs may so h~avy that peti� tion i unlikely. en t le , th ex- pense is an ordinary on becaus w kno from exper ience tha�t payment for uch a purpose , \Wh ther the mount �s 1 r e or mall , ar th c~ ~on n c ept ans of defense ag inst ctt ac k2. 76Cuf.. K� o1r4n5- , hauser v. nit t t , 48 � Ct. 219 72 L. d. 5 (6 AFT 7358) . The i u t on i i e in the li e of the individual ff ct d, but not n the life of t~e roup , th co unity , of hich he is o t. At ~uch t es t ere re nor s o conduct th t p o eta i iz our judgm nt, nd t cert in nd ob� jec~ive . he , s ot err tic , but is brou ht wit kno ��n type." ( elch v. H lvcrin u�� 111 , cit d in Par. 11 ,008 P-H 1955.) Business expens s , n o der t o be ductibl , ust not only be ord�nary and n c ssary ut must lso eet the f rther test of~ son bleness in mount . The el ment of reasonablene a n amount is inherent in the phras 1ordinary and n c sGary... I t was not the intention of Congress to utom t c lly 0 a deductions op r ting xp n s :tncurr d orp d by the taxpayer in an unl:tmit d mount. (Comm ss onor ��� Lincoln 1 c. Co., 176 f d. 2d 815 , 38 F 411.) Have the re irements for d d ct b~l ty of t sum of 75, 855. 8 be n sat sfied? Counsel for t he nt admit that the ex- pens� of 75,855.88 w s p d nd inc tt�red within the 269

- � 128 - 7� axao e ye r 1 51 . " It is , i o ev r , ~on nded hat "ic i not ordinary and n cessary xpens nor as it inc rr a n c~rryin on h trad or busi- n s o t pp 11 nt in 1951. " 1 .a , ccordi 19 to th Collector , in th nature of di ide dis- tr ution. ( a 5, e orand fo t ppelle . ) n th h nd , app llan ou h to prov that the oun ac u lly spent y l officers an c d of � ectors ~ th pro o- tion an enhance ant of h bu in ss of th corp- oration. L t us x min th acts . I pp r th Y a solution of he o r of Director o ppell nt corpo ion da d July 22 , 1949, aiv�d nd of 50 of the net profit .as authorize to b d clar d to the stoc holders an- nually and t oth r 50 aOll to be used to r im- burse the :c nt tion xp ns s of the Gen ral anager, e r of th oard of !rectors and tho legal con ul n at the fol owing rates: Gen~r al .anager , 1 i tant ener 1 a�nager , .e. - 8' otrs of th o rd of ir ctors and the 1 gal con- sultant , e ch o th ne profit . uring he p r od of our y ar fro 19 9 to 19 2, ppel lant had gro s i com , net profits 1m cla d repre- sentation exp n ' 5 ollowa s :!.!.!!: 83, 103. 54 lC , 424.39 i 49 722, 1S5.42 61 , 2~7 .5 75, 855. 88 63, 618. 64 1 4~1 . . 21 33 , 23.78 1951 41 , 596.45 420, 479. 39 195~ 425, 26. 86 4, 7.31 .. 270

DECISIO � 128 D. T� � - 8- It also appears fro the testimony of Dioa� coro � asco, Accountant- ookkeeper of appellant, th t rel.tnburse ents of repre entation xp nsea in� curred by the officers and me ber of the Board of Directors were ade upon present tion of the cor- responding vouchers and chits, but ther were in� stances when reimburs ants w re made ithout pre- sentation of supporting paper � ~a co justified reimbursement of a cla for representation expenses without presentation of supporting papers by stating that he did not h ve the courage to ask the officers and embers of the oard to co ply with the re ire� ent because of the "unouest oned !nt gr!ty of th se people and the h gh este of the co unity toward them.� esldes , �tt was the policy of the office to give them free way to spend such ount without, of course, co plete supporting papers.� Ae to how the amounts claimed by the officers and members of the o rd were apent, asco testified that , with respect to the m nagar, they ere spent for �hotel and ace~ odation charges nd entertain� ment expensea hila in �. anilaJ entert !nment of the ag�nts of th ship and other officera and also porters when he comea to anila on official busin s for the Company." As regards the embers of the Board, he testified that �they used to present chits covering their expenses for the entertainments o friends who came ir other pla~es to ��� Ce u to 271

I l1 � C. T. A. A E � 128 - 9- get ind ntions of the"r import � The me bErs of th oard o Dir ctors or the liason officers en- tertained h � n which case t hese l i on officers submi t hotel and ace~. odatlon expens s and lso transpor tion ex~enses . " { p. 61- b2, . s . n. ; p. 20 , r,e o:ranau for 1\ppellant . ) ( rom th evidence adduced y appellant , ther ~ ere wo s t of r presentation xp nses . On cov~ xpens G supported by appropriat vouch_rs and chits; t he other covers expen eg i out upporting p per � Unfortunat ly , it i not po sibl to ter i.n th cov.r d by and the amoun ithout supporting pap YS. It i 11 9ed that th r cor s wer e~troyed when t hou 0 uenavet ~,ur � Ve o o , tre urer o ppellant , where .r c eras 1c;r k pt as burn ay, there ore , accept c orr c t the c t 1 as a por i on o a ount of a sp nt .. or r pre& n tion xp s of ppellant corpor tion , whi e he por ion her o no cover y up ort" papers a sp n for purpos no clea tablished. he first ali ies or he d due io , 0 a er 0 not . It is up to us 0 termin fro 11 avail a 1� oa a ~unt properlv deductible as rcpre ntatlon ex. ns s . It ioul sec unjust to disallo the d � uc ion of th entire amount for lac of docu: entarv evi once to st~ lish th precise amoun t b yond a rea ona le doubt-. ~ !T:he pr ctice un er th F 1 In- c ome Tax L ~ of the n"t t tes 1 �27 2

D-CT �:r ~ - C.I. A. CASE ~ . 128 - 10 - " � � � that while a taxpay r is not relieved from th urd.n of suos antiatinc his claimed deductions , the examJning agent hould exerci a c reful jud tent lich will p rmit reasonable determinations for enter� tai~.en~ expens , provided he is atisfied hat th re s a proper basis for ome al� l' lowar~ce . Disallowin amounts clai 1ed fo f eductio. erely ecause there is vailaol no docu-entary evidence which il e-ta- b~ish t precise amount beyond a reasonable doubt tgnores commonly reco nized usiness practices as wel as the fact proof may be established by credible or 1 testimony. On he other hand , it i$ not tha policy to allo an arbitrary ~ cc nta of the clalued d duction erely for purpose of settleocnt . Ir-. an. No. 5t:l�92, Par. 76, 700 P� Jf Fed. 1954." (Par. 11 , 3JO P� H Fed. 1?55. ) .. / In this case , it is impossiole to determ n the precise amount ~pent for ropr sentation. But it 1& our duty to mak a 6v~t-minaticn , ven if th re- sult be merely an appr.o,l(. u tion. ) ' 1In the p=oduction of his plays Cohan as obliged to be free� handed in nter- taining actors , employees , an , as he naively dds, dramatic critic � He had also to travel much , at times u.th hi~ attorney. These expenses amounted to su stantial sums , ut e kep' no account and probably cculd ot have done so. At th~ trial befo~e th Board he estimated that he had spent eleven thousand dollars in this ftshion during the � st six months of 1921, tv.lcnty-two tt.ous nd doll rs , oet- veen July fit�sc , 1921, and June thirtieth , 1922, and a$ much for his following fiscal year , fifty-five thousand dollars �n all. The oard r fused to allow him any part of this, on the ground that tt was impo .. s �ble to tell how uch he had in fact spen , !n the absence of eny items or details. The question is how far thi~ refusal is justified, in view of tl.e findin., that he had spent much and that the sums were al� lowable expenses. Absolute c rtainty in such matters is usually impossible and iG not ecessary; the Boa1:d sl,ould make as close an approxima~ion as it can, bear�ng heavily if it chooses upon the taxpay r whose inexactitude is of his own~making . . . 273

� 12 ... l l .. to allot not ing at all app ars to ~ s inc onsi tent with s aying ~hat some- ' 1 n as pent . True , ~ do not kno~ ho� many trips ohan ado � nor howi1 large 11S n rt in nt& r&J yet ther w s obviously s o . ba~i& for co putations , i nee ss y y drawin pon the oard' s personal es at s of t min � u of suc h xpen a � e a ount ay b r i � vial a. d unsatisfactory, u1. t 113re w s as is for s . al l o ance , and i t as lrong o r f so cmy, even t ou . it ere t he traveling expen es o a single trip. It s not tal that r sult ill inevitaoly L spocul tive; any import a 1t cisions ust such. .o h~n. t hat the oard was in orror as o t is and st rec onsider ho vldenc � ' (Pp. 543- 544, Vol . 39 F d. shall . ther fo1.�o , end avor to ascertain t.e auount ctu 11y �p 1t y appoll .t for X pr � s at.:on or ent�rt n hich te onably n c sarv i carrying on its usin s . s lre y adver ed t o a ov , p llnnt cl d !' ntat ion exp . scs f o~ 1949 to 1952 �nth follo in a ount6' 1 49 - - - � ~- -~ - - 8... ' 7Q � 4 19 - � - - - - 10 , 642o4..3sa9 1995512 -- -- -� -- -- -- -- -- 75 , 63 , 618. 6 e pr sume t at , s in 1 51 , th xpn �ncurr d by th off i c rs an s of the o~rd o Director wer not al l cov r d y upport ng p pers o � ng that sa d xpens s er all for purposes a te st "f . d oy p ell nt ' s accountant� rom the above f gure~ , we ay �11f r th t the s 1w of �10 ,000. 00 ma y cons red >ly necessary for entert �n ont e �pons so appollont in i 95 , it a i n cla ed a 1 ttlc over that n 1950 , wh n i s gros tnco~ was ore than it& gross income~ in 1951 .. 27 4

E � 128 � 12 - and 1 52. .oreover , it allegedl y spant for enter- ta i nm nt purposes in 194 th sum of 500. only. I ~s ar u d, ho ever , th t th hole a ount claimed by t h appellant should e d sallo~ed bc- caus t r a 1 no n cessity for app 11 nt to incur expens es f or cntertainm nt , the usin ss in hich it is enga ed eing monopoly. To cc t this proposition i ~ to 1 nore the commonl y r cognized busin ss pract ic e s . h ther a onopoly or one hich operates in highly co p ti� tiv ar ~t , h s n ed to provide for entortainm nt or r pr ~ ent io pcnscs to pres rv and aint ai n t ill and patronage of its cu t~~er nd to win ore custo ers !f possi 1 � .or over, in th ase of appellant , 11 it is tru th t �t has the � clu&ive c ontrac to undertake arrastre operations i n t he po of Ce u , the co tract is for lim ted peri o a ter ic t h s o co pet gain ith others efore it ay in newal o�f the contr ct. h r i ' th. or ' n y for it to rov d for a reasonable oun or presentation or nterta n� ment expens s. It is also cont nded that the s m of 7 , 855. 88 bein cl aim as repr scntation expenses was an � n� direc t di tri tti n of divid nd , th off c rs and rs of th Boar of D rectors of appellant being th holders of the aj or ity s tock of t he corporation , to ether wit h th ir rel at i ve s . The reco ds show that

- ... 1:.-::l,j c. t . A. E. � 128 - 13 - t e officers and embers of tho oard of Dir ~tors of appellant ~ orporation had never b en t he holders of t h j ority stock of t!1e c orporation. It is true t hat some of their relatives were and ar toe holders of sa id corporat on , but it has not ~en shown that the stocks in the n mas of ch r � latlves ere owned or c ontrolled , dir ctly or u - d~ ectly, by th officers and er of th oard of Directors . Accordingly, th re is no sis for holding that the officers and emb r of the Board of irec�ors of appellant own or control the a- jority stock to just fy the infer~nce that r presen� tation exponses b !ng cla� ned are an �ndiroct di � tribution of dividend. Finally, it is ar ued that while the officers nd m mb rs of the oard ot ire tors of app llant c orporation reported in their inco e tax r et urn5 the le ed repre&en ~ion exp nse , they did not cla~ eduction .of th amounts actually spent by th � rom this tho conclusion is a n that th runounts receiv d y h ~ er not in reality reimburse � ts for r presentation expenses but a distr"bution of T part of t e e profit of ~he corpor t i on. e n not accept the soundness of th s propos tion. vft, in conne~ tion ith �nco~e deriv d from a corporat on cannot af- feet 1 9 lity of t educt�on cla� ed y th corpor t �on ih resp ~t of a oun p �d by t to 276

. r . . CI�i IO � ~E ~ . 120 -l � such pvrson. 0 the same na ure is the argument of appellant hat because th Col lecto of Inter nal evenue has not qu stioned tho 1 gality of the d - du~ t ion for repre cntat�on xpens s cl ai~ed in other year in ount sa � s th cla � �n 1951, h r is no jus !fication for ques tlonin he u-~~uv ti n for rcpre entation xp n es in that year . The le ality of a d ficiency a v ssment cannot be affected by the failure o a s s~ in c as es of s � 11 r nature. The rule is ~ell establish d that the Govern- ant i not est opped by error or mlstak on th part of il.S gents. Pi. eda v. Court of First Inst nc of T y s , 52 Pl il . 803. ) TIO.>S , the d ci on FO �r �0 GO appeal d fro is hereby modifi d, and appellant is here y ordered to ~ay to the Collect o of Interna l evenue, within a r as onable period t o b fixed by the latte , the sum of 15,517. 00, co put d belo � 'eist linlocwomne pecr return ------�-�-- 41 , 596.45 f ;~ Salari s ����-----� -��;:�--- 500. 00 , ..,r. .e 10 ooo.oo 65,855. 88 ( 3) .l.l � 720. l ~ \. .J -- a � 8;o �� 2 ' 42.00 277

.. - ~. I � � � l28 - 15 � ith costs again>.J app 1 n � t ani1a, June 2 , 1957. � ~ � �. 27