BASILAN ESTATES, INC., PETITIONER, VS. THE COMMISSIONER OF INTER­NAL REVENUE AND THE COURT OF TAX APPEALS, RESPONDENTS.

A Philippine corporation engaged in coconut industry, Basilan Estates, Inc. with principal offices in Basilan City,
filed on March 24, 1954 its
income tax returns for 1953 and paid an income tax of P8,028.  On February
26, 1959, the Commissioner of Internal Revenue, per examiner’s
report of February 19, 1959,
assessed Basilan Estates, Inc., a deficiency income
tax of P3,912 for 1953 and P86,876.85 as 25% surtax on unreasonably accumulated
pro­fits as of 1953 pursuant to Section 25 of the Tax Code.  On non-payment of the assessed amount, a
warrant of distraint and levy was issued but the same
was not executed because Basilan Estates, Inc.
succeeded in getting tile Deputy Commissioner of Internal Revenue to order the
Di­rector of the district in Zamboanga
City to hold execu­tion and
maintain constructive embargo instead. 
Because of its refusal to waive the period of prescription, the
corporation’s request for reinvestigation was not given due course, and on December 2, 1960, notice was served
the corporation that the warrant of distraint and
levy would be executed.

On December 20, 1960, Basilan Estates,
Inc. filed be­fore the Court of Tax Appeals a petition for review of the
Commissioner’s assessment, alleging prescription of the period for assessment
and collection; error in disallowing claimed depreciations, travelling
and miscellaneous expenses; and error in finding the existence of unreasonably
accumulated profits and the imposition of 25% surtax there­on.  On October
31, 1963, the Court of Tax Appeals found that there was no
prescription and affirmed the deficien­cy assessment in toto.

On February 21, 1964,
the case was appealed to Us by the taxpayer, upon the following issues:

1.     
Has the Commissioner’s right to collect deficien­cy
income tax prescribed?

2.     
Was the disallowance of items claimed as deducti­ble
proper?

3.     
Have there been unreasonably accumulated
profits?  If so, should the 25% surtax be
imposed on the balance of the entire surplus from 1947-1953, or only for 1953?

4.     
Is the petitioner exempt from the penalty tax un­der
Republic Act 1823 amending Section 25 of the Tax Code?

PRESCRIPTION

There is no dispute that the assessment of the defi­ciency tax
was made on February 26, 1959;
but the petitio­ner claims that it never received notice of such assess­ment or
if it did, it received the notice beyond the five-year prescriptive
period.  To show prescription, the an­notation
on the notice (Exhibit 10 No. 52 ACR, p. 54-A of the BIR records) “No
accompanying letter 11[25]” is ad­vanced as indicative of the fact that
receipt of the no­tice was after March 24, 1959, the, last date of the
five-year period within which to assess deficiency tax, since the original
returns were filed on March 24, 1954.

Although the evidence is not clear on this point, We cannot
accept this interpretation of the petitioner, con­sidering the presence of
circumstances that lead Us to presume regularity in the performance of official
func­tions.  The notice of assessment
shows the assessment to have been made on February 26, 1959, well within the five-year period.  On the right side of the notice is also
stamped “Feb. 26, 1959”
– denoting the date of release, according to Bureau of Internal Revenue
practice.  The Commissioner himself in
his letter (Exh. H, p. 84 of BIR records) answering
petitioner’s request to lift the war­rant of distraint
and levy, asserts that notice had been sent to petitioner.  In the letter of the Regional Director
forwarding the case to the Chief of the Investigation Division which the latter
received on, March 10, 1959
(p. 71 of the BIR records), notice of assessment seas said to have been sent to
petitioner.  Subsequently, the Chief of
the Investigation Division indorsed on March
18, 1959 (p. 24 of the BIR records) the case to the Chief of the
Law Division.  There it was alleged that
notice was alrea­dy sent to petitioner on February 26,1959. 
These circumstances pointing to official performance of duty must
necessarily avail over petitioner’s contrary interpre­tation.  Besides, even granting that notice had been
received by the petitioner late, as alleged, under Section 331 of the Tax Code
requiring five years within which to assess deficiency taxes, the
assessment is deemed made when notice to his effect is released, mailed or sent
by the Collector to the taxpayer and it is not required that the notice be
received by the taxpayer within the aforementioned five-year period.^[1]

ASSESSMENT

The questioned assessment is as follows:

The Commissioner disallowed:

DEDUCTIONS

A. Depreciation. – Basilan
Estates, Inc. claimed deductions for the depreciation of its assets up to 1949
on the basis of their acquisition cost. 
As of January 1, 1950
it changed the depreciable value of said assets by increasing it to conform
with the increase in cost for their replacement.  Accordingly, from 1950 to 1953 it deducted
from gross income the value of depreciation compu­ted on the reappraised value.

In 1953, the year involved in this case, taxpayer claimed the
following depreciation deduction:

Upon investigation and examination of
taxpayer’s books and papers, the Commissioner of Internal Revenue found that the
reappraised assets depreciated in 1953 were the same ones upon which
depreciation was claimed in 1952.  And
for the year 1952, the Commissioner had already de­termined, with taxpayer’s
concurrence, the depreciation allowable on said assets to be P36,842.04,
computed on their acquisition cost at rates fixed by the taxpayer.  Hence, the Commissioner pegged the deductible
deprecia­tion for 1953 on the same old assets at P36,842.04 and disallowed the
excess thereof in the amount of P10,500.49.

The question for resolution therefore is whether depreciation
shall be determined on the acquisition cost or on the reappraised value of the
assets.

Depreciation is the gradual diminution in the use­ful value of
tangible property resulting from wear and tear aid normal obsolescence.  The term is also applied to amortization of
the value of intangible assets, the use of which in the trade or business is
definitely limi­ted in duration.^[2]
Depreciation commences with the acquisition of the property and its owner is
not bound to see his property gradually waste, without making provision out of
earnings for its replacement.  It is
entitled to see that from earnings the value of the property invested is kept
unimpaired, so that at the end of any given terms of the years, the original
investment remains as it was in tie beginning. 
It is not only the right of a company to make such a provision, but it
is its duty to its bond and stockholder and, in the case of a public serviced
corpo­ration, at least, its plain duty to the public.^[3]
Accord­ingly, the law permits the taxpayer to recover gradually his capital
investment in wasting assets free from income tax.^[4]
Precisely, Section 30(f) (1) which states:

(1) In general. – A reasonable allowance for
deterioration of property arising out of its use or employment in the business
or trade, or out of its not being used:  Provided,
That when the allowance authorized un­der this subsection shall equal the
capital invested by the taxpayer x x x, no further allowance shall be made. x x x“

allows a deduction from gross income for
depreciation but limits the recovery to the capital invested in the asset being
depreciated.

The income tax law does not authorize the deprecia­tion of an
asset beyond its acquisition cost. 
Hence, a deduction over and above such cost cannot be claimed and
allowed.  The reason is that deductions
from gross income are privileges^[5]
not matters of right.^[6]
They are not created by implication but upon clear expression in the law.^[7]

Moreover, the recovery, free of income tax, of an amount more
than the invested capital in an asset will transgress the underlying purpose of
a depreciation al­lowance.  For then what
the taxpayer would recover will be, not only the acquisition cost, but also
some profit.  Recovery in due time thru
depreciation of investment made is the philosophy behind depreciation
allowance; the idea of profit on the investment made has never been the under­lying
reason for the allowance of a deduction for depreciation.

Accordingly, the claim for depreciation beyond P36,842.04 or in
the amount of P10,500.49 has no justi­fication in the law.  The determination, therefore, of the
Commissioner of Internal Revenue disallowing said amount, affirmed by the Court
of Tax Appeals, is sustained.

B. Expenses. – The next item involves disallowed expenses
incurred in 1953, broken as follows:

These were disallowed on the ground that
the nature of these expenses could not be satisfactorily explained nor could
the same be supported by appropriate papers.

Felix Gulfin, petitioner’s accountant,
explained the P6,759.17 as actual expenses credited to the account of the
president of the corporation incurred in the interest of the corporation during
the president’s trip to Manila (pp. 33-34 of TSN of Dec. 5, 1962); he stated
that the P2,300.40 was the president’s travelling expenses
to and from Manila; as to the vouchers and receipts of these, he said the same
were made but got burned during the Basi­lan fire on
March 30, 1962 (p. 40 of same TSN). 
Petitioner further argues that when it sent its records to Mani­la in
February, 1959 the papers in support of these mis­cellaneous and travelling expenses were not included for the reason that
by February 9, 1959, when the Bureau of Internal Revenue decided to
investigated, petitioner had no more obligation to keep the same since five
years had lapsed from the time these expenses were incurred (p. 41 of same
TSN).  On this ground the petitioner may
be sus­tained for under Section 337 of the Tax Code, receipts and papers
supporting such expenses need be kept by the taxpayer for a period of five
years from the last entry.  At the time
of the investigation, said five years had lapsed.  Taxpayer’s stand on this issue is therefore
sus­tained.

UNREASONABLY
ACCUMULATED PROFITS

Section 25 of the Tax Code which imposes a surtax on profits
unreasonably accumulated, provides:

“SEC. 25. Additional tax on corporation improperly
accumulating profits or surplus – (a) Imposition of tax. – If any
corporation, except banks, insurance companies, or personal holding companies,
whether domestic or foreign, is formed or availed of for the purpose of
preventing, the imposition of the tax upon its shareholders or members or the
shareholders or members of another corporation, through the medium of
permitting its gains and profits to accumulate instead of being divided or
distributed, there is levied and assessed against such corporation, for each
taxable year, a tax equal to twenty-five per centum of the
undistributed portion of its accumulated profits or surplus which shall be in
addition to the tax imposed by section twenty-four, and shall be computed,
collected and paid in the same manner and sub­ject to the same  provisions of law, including penalties, as
that tax.”

The Commissioner found that in violation of the above-quoted
section, petitioner had unreasonably accu­mulated profits as of 1953 in the
amount of P347,507.01, based on the following circumstances (Examiner’s Report
pp. 62-68 of BIR records):

1.     
Strong financial position of the petitioner as
of December 31, 1953.  Assets were P388,617.00 while the liabilities
amounted to only P61,117.31 or a ratio of 6:1.

2.     
As of 1953, the corporation had considerable
capital adequate to meet the reasonable needs of the busi­ness amounting to
P327,499.69 (assets less liabilities).

3.     
The P200,000 reserved for electrification of
drier and mechanization and the P50,000 reserved for malaria control were
reverted to its surplus in 1953.

4.     
Withdrawal of shareholders of large sums of
money as personal loans.

5.     
Investment of undistributed earnings in assets
having no proximate connection with the business – as hospital building and
equipment worth P59,794.72.

6.     
In 1953, with an increase of surplus amounting
to P677,232.01, the capital stock was increased to 500,000 although there was
no need for such increase.

Petitioner tried to show that in considering the surplus, the
examiner did not take into account the possible expenses for cultivation,
labor, fertilization, drainage, irrigation, repair, etc. (pp. 235-237 of TSN of
Dec. 7, 1962).  As aptly answered by the examiner himself,
how­ever, they were already included as part of the working capital (pp.
237-238 of TSN of Dec. 7, 1962).

In the unreasonable accumulation of P347,507.01 are included
P200,000 for electrification of driers and me­chanization and P50,000 for
malaria control which were reserved way back in 1948 (p. 67 of the BIR records)
but reverted to the general fund only in 1953. 
If there were any plans for these amounts to be used in further expan­sion
through projects, it did not appear in the records as was properly indicated in
1948 when such amounts were reserved. 
Thus, while in 1948 it was already clear that the money was intended to
go to future projects, in 1953 upon reversion to the general fund, no such
intention was shown.  Such reversion
therefore gave occasion for the Government to consider the same for tax
purposes.  The P250,000 reverted to the
general fund was sought to be explained as later used elsewhere:  “part of it in the Hilano
Industries, Inc. in building the factory site and buildings to house technical
men x x x part of it was
spent in the facilities for the waterworks system and for industrialization of
the coconut industry” (p. 117 of TSN of Dec. 6, 1962).  This is not sufficient explanation.  Persuasive jurisprudence on the matter such
as those in the United States from where our tax law was derived,^[8]
has it that:  “In order to determine
whether profits were accumulated for the reasonable needs, of the business or,
to avoid the surtax upon shareholder the controlling intention of the taxpayer
is that which is manifested at ‘the time of the accumulation, not subsequently
declared intentions which are merely the products of afterthought.^[9]
The reversion here was made because the reserved amount was not enough for the
projects intended, without any in­tent to channel the same to some particular
future pro­jects in mind.

Petitioner argues that since it has P560,717.44 as its expenses
for the year 1953, a surplus of P347,507.01 is not unreasonably
accumulated.  As rightly contended by the
Government, there is no need to have such a large amount at the beginning of
the following year because during the year, current assets are converted into
cash and with the income realized from the business as the year goes, these
expenses may well be taken care of (pp. 238 of TSN of Dec. 7, 1962).  Thus, it is erroneous to say that the
taxpayer is entitled to retain enough liquid net assets in amounts
approximately equal to current operating needs for the year to cover “cost
of goods sold and operating expenses” for “it excludes proper conside­ration
of funds generated by the collection of notes receivable as trade accounts
during the course of the year.”^[10]
In fact, just because the total accumulations are less than 70% of the annual
operating expenses of the year, it does not mean that the accumulations are
reasonable as a matter of law.”^[11]

Petitioner tried to show that investments were made with Basilan Coconut Producers Cooperative Association and Basilan Hospital
(pp. 103-105 of TSN of Dec. 6, 1962)
totaling P59,794.72 as of December
31, 1953.  This shows all the
more the unreasonable accumulation.  As
of December 31, 1953 already P59,794.72 was spent – yet as of that date there
was still a surplus of P347,507.01.

Petitioner question why the examiner covered the period from
1948-1953 when the taxable year on review was 1953.  The surplus of P347,507.01 was taken by the
exami­ner from the balance sheet of petitioner for 1953.  To check the figure arrived at, the examiner
traced the ac­cumulation process from 1947 until 1953, and petitioner’s figure
stood out to be correct.  There was no
error in the process applied, for previous accumulations should be considered
in determining unreasonable accumulation for the year concerned.  “In determining whether accumula­tions
of earnings or profits in a particular year are within the reasonable needs of
a corporation, it is ne­cessary to take into account prior accumulations, since
accumulations prior to the year involved may have been sufficient to cover the
business needs and additional accumulations during the year involved would not
reasonably be necessary.^[12]

Another factor that stands but to show unreasonable accumulation
is the fact that large amounts were with­drawn by or advanced to the
stockholders.  For the year 1953 alone
these totaled P197,229.26.  Yet the
surplus of P347,507.01 was left as of December
31, 1953.  We find
unacceptable petitioner’s explanation that these were ad­vances made in
furtherance of the business purposes of the petitioner.  As correctly held by the Court of Tax Appeals,
while certain expenses of the corporation were credited against these amounts,
the unspent balance was retained by the stockholders without refunding them to
petitioner at the end of each year. 
These advances were in fact indirect loans to the stockholders
indicating the unreasonable accumulation of surplus beyond the needs of the
business.

ALLEGED EXEMPTION

Petitioner wishes to avail of the exempting proviso in Sec. 25 of
the Internal Revenue Code as amended by R.A. 1823, approved June 22, 1957, whereby
accumulated profits or surplus if invested in any dollar-producing or
dollar-earning industry or in the purchase of bonds issued by the Central Bank,
may not be subject to the 25% tax.  We
have but to point out that the unreasonable accumulations was in 1953.  The exemption was by virtue of Republic Act
1823 which amended Sec. 25 only June 22, 1957 – more than three years after the
pe­riod covered by the assessment.`

In resume, Basilan Estates, Inc. is
liable for the patent of deficiency income tax and surtax for the year 1953 if
in the amount of P88,977.42, computed as follows:

WHEREFORE, the judgment appealed from is modified to the
extent that petitioner is allowed its deductions for travelling
and miscellaneous expenses, but affirmed insofar as the petitioner is liable
for P2,100.67 as de­ficiency income tax for 1953 and P86,876.75 as 25% sur­tax
on the unreasonably accumulated profit of P347,507.01.  No costs.

SO ORDERED.

Concepcion, C.J., Reyes, Dizon, Makalintal, Zaldivar, Sanchez, Castro, Angeles, and Fernando, JJ., concur.`

^[1]
Collector of Internal Revenue v. Bautista, G.R. Nos. L-12250 & L-­12259,
May 27, 1959.

^[2]
Jose Arañas, Annotations and Jurisprudence on the
Natio­nal Internal Revenue Code, as Amended Second Ed., Vol. I, p. 263.

^[3] Knoxville
v. Knoxville Water Co., 212 U.S.
l, 53 L. ed. 371.

^[4]
Detroit Edison Co. v. Commissioner, 131 F (2d) 619 (CCA 6th, 1942), Aff’d 319 U.S. 98, 87 L. ed. 12860 63 S.Ct.
902.

^[5]
Palmer v. State Commission of Revenue & Taxation, 156 Kan.
690, 135 P 2d 899.

^[6]
Southern Weaving Co. v. Query, 206 SC 307, 34 SE
2d 51.

^[7]
See Gutierrez v. Collector of Internal Revenue, G.R. No. L-19537, May 20, 1965.

^[8]
Collector of Internal Revenue v. Binalbagan
Estate, Inc., G.R. No. L-12752, Jan.
30, 1965.

^[9]
Jacob Mertens, Jr., The Law of Federal Income
Taxation, Vol. 7, Cumulative Supplement, p. 213.

^[10] Ibid.,
p. 229.

^[11] Ibid.,
p. 222.

^[12] Ibid.,
202.