CTA Case No. 2951 (Decision)

Rt'.PUIH.Ir OF 'Jill'. PlllLTPPINES COUP.T OF TAX APPE.�.:\1.9 onr.70N CJTV I A 0 SORIANO CORPORA~I~N' Pet1t1oner - versus - C.T.A. CASE NO. 2951 COMMISSIONER OF INTERNAL REVENUE, Respondent. X - .- .- - ----X D E C I s� I 0 N This suit brought by petitioner A. Soriano Corporation for tax credit of the amount of P415,075.19 as overpaid income tax for the year 1974 poses the question of whether or not res- pendent Commissioner of Internal Revenue was justified in his refusal to permit deduction from the gross income of petitioner of an alleged. indebtedness ascertQined to be worthless and charged off in the said taxable year. As shown by the pleadings submitted by the parties and records of the case, it appears that petitioner is a domestic corporation engaged in business primarily as general managers of certain corporations. It is authorized to invest in other businesses and to own property. On April 15, 1975, .Petitioner filed its income tax return for taxable year 1974 declaring 13G

DECISION - CTA CASE NO. 2951 - 2- therein a net taxable income of P20,580,121.46. (Exh. 11 1", pp. 60--69, BIR records.) Upon invcs- tigation of said return by respondent's examiners, the disallowance, among other ite~s, of bad debts deduction in the amount of Pl,039,239.85 was recommendcc1. (E:--: 1~ 3 � II 2 " I -A 11 2 11 p p � 7 9-�B1 , DI R , records.) As a consequence the~cof, ~e~pondent assessed and demanded from petitioner, in a letter dated Ap~il 19, 1976, the payment of the amount of P540,007 35 as deficiency income tax for 1974, the details of which are a s follows: -1 -9 -7 -4 Net income per return - - - .- - - - - - P20,580,l21.46 Add: Unallowable deductions: (1) AC~inistrative Expenses - not supported - - 197,347.46 (2) Bonus - 1972 expense 65,000.00 (3) General Expenses - personal and/or not supported -. 50,448.58 (4) Bad debts - still collectible 1,039 , 239 . 05 1,352,035.89 �Jet i11can1e per in~ves tig at ion-::-::--:---�::-:.:-f22.~i..;-9 3 ?.~ 15 7. 35.. T<::x due thereon - - -- - - - - - - ~-7;'66-G-;255-:-oci Less: Amount already assessed -- - ---"Z.t.l.9lr_Qt1]...!'..90 Ba 1a n c e ----- - - P 473,213.00 Add: 14% int. fr. 4-16-75 to 4-19-76 66,794.35 TOTAL AfviOUNT DUE & C'JTJLECTIBLE t1 St.fO;G-67-:35 (Exh. "3", pp. 93--94, BIR records.) On April 27, 1978, petitioner filed with res- pendent a claim for tax credit, Qsserting that the disallowance of bad debts deduction finds no legal 13 7 J (

DECISION - CTA CASE NO. 2951 - 3- basis in the Tax Code; and considering that it had paid the income ta~ plus interest on the dis- allowed amount of ~1,039,239.85, it is entitled t.o a tax credit in the sum of P4.15,075.19, computed thus: Dad debts written off but disallowed Pl,039,239.85 35% tax thereon P363,733.93 14% interest, 4/16/75 to 4/19/76 _ _?1!....~41 .::.26 Total tax credit -P-4-1-5�.-0-7-5-.-1�9- (Exl~."5", pp. 99-100, BlR records.) It appears that petitioner had paid the amount of ~540,007.35 as deficiency income tax on May 19, 1976. (See Memorandum for the Chief, Appellate Division, p. 109, DIR rccorus.) Since no action was seasonably taken by res- pendent on the aforesaid claim for tax credit, petitioner appealed to this Court on May 4, 1978 . Is petitioner legally entitled to a tax credit in the amount of P4l5,075.1~? A determination of how petitioner's claim for bad debts deduction arose would be helpful in the rcsolution of the issue presented in the case at bar. The records disclose that petitioner owned in 1974 and earlier a nickel mining concession in Palawan, covered by some 12,000 to 13,000 13 8

DECISION - CTA CASE NO. 2951 - 4- hectares surface area of timber stan~. The timber st2nd, however, belonged to a logging concessionaire, the Victoria Range Forest Resources, Inc., hereinafter called VRFR for short. VRFR has a small sawmill in the area of its forest concession, and sold its logs and timber products locally. (See pp. 3-5, t.s.n., hearing of June 19, 1979.) To e~able it to conduct its operations, VRFR bought some of its machinery and equipment and leased a greater part thereof from the Makati Leasing Corporation u~der terms and con- ditions set forth in a lease agreement entered into with the latter. (pp. 6-8, t.s,,n.; Exh. "D".) On its part, pe!:itioner executed an Undertaking And Guaranty in favor oE the Makati Leasing Corpo- ration whereby it agreed to guarantee performance by VRFR of all the obligations called for in the lease agreement. Petitioner's undertaking as set forth in the document is as follows: "1. ~�mEREl\S, the t�1AK.i\TI LEASING COR- PORATION, a corporation organized and exist- ing under the laws of the Philippines, with postal address at the 6th Floor, Insular Life Building, Ayala Avenue, Makati, Rizal, has executed a contract of lease dated May 21, 1971, with VICTORIA RANGE FOREST RSSOURCES, INC., a copy of which is hereto attached and ma~e a part hereof as Annex 'A'; 13 9

-- DECISION - CTA CASE NO. 2951 - 5- "2. WHERE!>.S, the aforesaid VICTORIA RANGE FOREST RESOURCES, INC. as lessee, and the MAKATI LEASING CORPORZ\TION would not have executed the contract of lease o equipment specified in the Schedule attached to Annex A' without the solidary guarantee of A. SORIANO Y CIA., and the latter has agreed to guarantee performance by the lessee of all its obligations to the lessor under the said contract. "NOW, THEREFORE, for and in consider- ation of the premises, A . . SORIANO Y CIA., hereby: (a) Guarantee unto the MAKATI LEASING CORPORATION the prompt and full perform- ance by the lessee VICTORIA RANGE FOREST RESOURCES, INC. of all its obligations, including the payment of the rents and other amounts due or which shall here- . after become due, to the said corporation under the aforesaid contract of lease;and . (b) Undertakes to remit to the said MAKATI LEASING CORPORATION at its afore- said postal address all the rents and other obligations including insurance premiums, license and registration fees and other charges under the contract of � lease. "It is understood that the above guaranty is effective and enforceable independently of the existence or non- existence of funds pertaining to VICTORIA RANGE FOREST RESOURCES, INC. and in the possession of A. SORIANO Y CIA." (Exh. "A") As VRFR lagged behind in its scheduled pay- ments of rentals, the Makati Leasing Corporation collected directly from petitioner who paid the accounts. (Exhs. "C" to� "C-14", "M" to "AA-1") 14 0

DECISION - CTA CASZ NO. 2951 -6 - It appears that all these payments and advances for the account of VRFR exceeded Pl,051,739.83. (Exhs. "CC" & "DD".) . Petitioner, on several occasions, sent demand letters for payment of the advances made by it to the Makati L2asing Corporation, but VRFR consistently asked for gr?ce period to pay. (Exhs. "D" to "J-3") . In t~2 latter part of 1973 and early part of 1974, VRFR sold its machinery and equipment for P605,000.00, which it turned over to peti- tioner in partial payment of its obligations. (Exhs. "K" & "L 11 ; "CC" & "DD 11 .) Considering petitioner's collection efforts, against the fact that VRFR sold its machinery and equipment and ceased logging operations in 1974, and the bleak picture reflected by the latter 1 s fi~ancial statements (Exhs. "I", "I-1" to "I-4") '� peti- tioner ascertained in 1974 that the VRFR debt was worthless and uncollectible and charged off as bad debts in that year the amount of ~1,051,739.83. (Exh. 11 BB") Petitioner claimed therefore the sum of Pl,051,739.83 as bad debts deduction in its 1974 income tax return. Of this amount, respondent refused however to allow deduction of 14 1

-- JlECISION - CTA CASS NO. 2951 -- 7 -� the sum of Pl,039,239.85, which, ~s stated earlier, petitioner paid the income tax plus interest due thereon, and from which the present proceedings for allowance of tax credit in the sum of P415,075.19 arose. 'rhe applicable provision of Section 30 (c) (1) of the National Internal Revenue Code permits the deduction of "debts due to the t~xpaycr actually ascertained to be worthless and ch~rged off Hithin the taxable year." In order that a bad debt deduction may be validly claimed, it is essential (1) .that there be a valid and subsisting debt, and (2) that the debt be actually ascertained to be worthless and charged off within the taxable year. (Philippine Trust Co. vs. Collector of Inter~al Revenue, CTA Case No. 367, January 30, 1961,) Petitioner's position in the instant case is that, by virtue of the undertaking and guaranty it executed and its payment of the obligations of VRFR pursuant thereto to the Makati Leasing Corporation, it became a creditor of VRFR. Petitioner should therefore be permitted to deduct the amm!nts so paid as debts "actually ascertained to be worthless and charged off"

DECISION - CTA CASE NO. 2951 - 8- in 1974, VRFR having been shown to be incapable of paying its obligations or of reimbursing petitioner of the payments it made. A claim of subrogation is thus made by petitioner. Contrariwise, respondent maintains that the existence and basis of the indebtedness of VRFR to petitioner has not bee~ proven. Res- pendent contends that petitioner's payment of the obligations of VRFR did not give rise to a debtor-creditor relationship between them because nowhere in the undertaking and guaranty, nor from the evidence presented, could there be found an uncond~tional obligation of VRFR to repay, should it be remiss in paying the rents and other obligations arising under the lease agreement with the Makati Leasing Corporation. Hence, the amount so paid by petitioner cannot be considered as worthless debt which could be charged off . Respondent further asserts that the propriety of bad debts deduction was not shown by petitioner. Although petitioner herein, pursuant to the undertaking and guaranty, was depicted as a guarantor of the obligations of VRPR, its liability was primary; an insurer of the debt 143

-- DECISION - CTA CASE NO. 2951 - 9- not the solvency of the debtori and required to pay if VRPR did not comply with its obligations without benefit of excussion. Thus: II 2. ~�'1HERSAS r the aforesaid VICTORIA RANGE FOREST RESOURCES, INC. as lessee, and the HZ\.KATI LEASING CORPORATION V�,7<:;uld not have executed the contract of lease of equipment specified in the Schedule attached to Annex 'A' wi ~~.h2.~~!:_t.:.b~oli_da~ quarantee of A. SORIANO Y. CIA., and tte taTter-has 'asi:ee(f'"to guarantee performance by the lessee of all its obligations to the lessm: under the said contract." (Undertaking And Guaranty, supra.~ under- scoring supplied) In other words, the Ha!~ati Leasing Corporation did rot ~ely solely and exclusively on the ability and capability of VRFR to comply with its commit- ments but rather on petitioner's representation and undertaking of being ~olidarily liable thereto in the perform3nce of the obligations called for 1n the lease contract. Having guaranteed VRFR's obligations in such manner and under such circum- stances as to constitute petitioner, in practical effect, the primary obligor thereof, a debt did not spring into existence by payment of the obliga- tions, and the amount paid thereof is not deduct- ible as a debt found t~ be worthless and charged off within the taxable year in the computation of its net taxable income. (Florence O.R. Lang,

-- DECISION - CTA CASE NO . 2951 - 10 - et al. vs. Commissioner of Internal Revc~ue, 32 United States Board of Tax Appesls Report 522 . ) Truly, we can not fin~ any stipulation of uncondi- tion2l obllgation on the part of. VRFR to repay petitioner, because, as stated by petitioner i tsel:[, "The business reason for the accomEiodaticn was obvious - _the logging oper0tions by V~FR would actually clear and clean the surface area covering the nickel concession of petitioner, virtually preparing the ground for its contemplated nickel mining operations at practically no expense to it." (p. 35, CTA records.) By guar c. :.' l.:y a per son, called a guar iln tor, binds himself to the creditor to fulfill the obligation of the principill debtor in case the latter should fail to do so. However, if a person binds himself sr)li?ariJJ[. with the principal debtor, the provisions of Section 4, Chapter 3, \ Title I of Book IV of the Civil Code should be observed. In such case the contract ic called s �;retyship. {Art. 2047, Civil Code.). In surety- ship the s~rety becomes liable to the credito without the benefit of the principal debtor's cxc~ssion of his properties, for he (the surety) may be sued independently. So, he is an insurer 1 'l t" L. ;) j

. .._ ... ... - DECIS~ON - CTA CASE NO. 29~1 - ll - of the debt and as such he has assumed or under- taken a responsibility or obligation greater or more onerous than that of a guarantor, who is merely the insurer of the solvency of the debtor. A surety is alrnost the same as a :solidar:_y_.~!.S:L~~ (Manila Su~ety and Fidelity Company, Inc. v~. Bat Construction and Company, ct al . , L-9353 May 21, 1957, 101 Phil. 494.) In a solidary or joint and several obligation, the relationship between the active and the passive subjects is so close that each of the former or of the latter may demand the fulfillment of or must comply with the whole obl�gation. (8 Hanresa 194.) As Justice Edgardo L . Paras of the Court of Appeals succintly stated in his Civil Code of the Philip;?ines Al1i10tated, 9th edition 1978, Volume II{, page 207, "SoJ. idary Obligations - ' Cne for 2ll, all for o e. '" Being solidaJ~ily liable, petitioner can v not now claim that it was a mere guarantor. Consequentl y, when it complied with its obligations under the Undert2king and Guaranty dated May 26, 1971, no debtor-creditor. relationship sprang into existence between VRFR and petitioner. 14 G

.., ...... DECISION - CTA CASE NO. 2951 - 12 - Upon failure therefore to obtain reimbursement thereof, petitioner was not entitled to take a deduction as bad debt under Section 30 (e) (1) of the Nat:onal Internal Revenu .Cede. (See Shiman vs. Commissioner of Internal Revenue, 60 Federal Reporter, 2d Series, 65.) And as to the claim of subrogation, there is good authority to the effect that one who indemnifies creditor for the non- performance of obligation does not by payment thereof acquire remedy over against debtor, in absence of stipulation there- oz for. (See Howell vs. Commissioner Internal Revenue, No. 9674, 69 F. (2d) _447) Finally, we agree with respondent thRt petitioner had no attached to its income tax return for 1974 a statement showing the proprie~y of the deduction therein made for alleged bad debts 1n violation of Section 102 of Revenue Regulations No. 2. (Collector of Internal Revenue vs. Goodrich I nternational Rubber Co., L-22265, December 22, 1967, 21 SCRA 1337 . ) Petitioner A. Soriano Corporation having fa1led to show that tha disallowance of its bad debts deduction by respondent Commissioner of Internal Revenue was erroneous and unjustified, 14 7

DECL)l0i'J' - CT A C ~SE NO. 29 51 - 13 �~ i t i s !10 ~: ent i t l cd t o tr:c~ tc)X c.rc'--:1 L o E �the shou l d h8re[o r c ~e dcn i eJ . t he 0~ovc-ent i tle6 C~3o i s ~ercby 0is~i~s e du ?l~cw;/;A/ yr s ~.i'�ii\ ~.rr r.Jl� t~R P r esiding ,JuJ.ge 'dE CO"lCUI~ : �~ 14 8