FERNANDEZ HERMANOS, INC., PETITIONER, VS. COMMISSIONER OF INTERNAL REVENUE AND COURT OF TAX APPEALS, RESPONDENTS.

These four appeals involve two decisions of the Court of Tax
Appeals determining the taxpayer’s income tax liability for the years 1950 to
1954 and for the year 1957.  Both the
taxpayer and the Commissioner of Internal Revenue, as petitioner and respondent
in the cases a quo respectively, appealed from the Tax Court’s
decisions, insofar as their respective contentions on particular tax items were
therein resolved against them.  Since the
issues raised are inter-related, the Court resolves the four appeals in this
joint decision.

Cases L-21551 and L-21557

The taxpayer, Fernandez Hermanos, Inc.
is a domestic corporation organized for the principal purpose of engaging in
business as an “investment company” with main office at Manila.  Upon verification of the taxpayer’s income
tax returns for the period in question, the Commissioner of Internal Revenue
assessed against the taxpayer the sums of P13,414.00, P119,613.00, P11,698.00,
P6,887.00 and P14,451.00 as alleged deficiency income taxes for the years 1950,
1951, 1952, 1953 and 1954, respectively. 
Said assessments were the result of alleged discrepancies found upon the
examination and verification of the taxpayer’s income tax returns for the said
years, summarized by the Tax Court in its decision of June 10, 1963 in CTA Case No. 787, as follows:

The Tax Court sustained the Commissioner’s disallowances of Item
1, sub-items (b) and (c) and Item 2 of the above summary, but overruled the
Commissioner’s disallowances of all the remain­ing items.  It therefore modified the deficiency assessments
accord­ingly, found the total deficiency income taxes due from the taxpayer for
the years under review to amount to P123,436.00 instead of P166,063.00 as
originally assessed by the Commissioner, and rendered the following judgment:

“RESUME

“WHEREFORE, the decision appealed from is
hereby modified, and petitioner is ordered to pay the sum of P123,436.00 within
30 days from the date this decision becomes final.  If the said amount, or any part thereof, is
not paid within said period, there shall be added to the unpaid amount a
surcharge of 5%, plus interest as provided in Section 51 of the National
Internal Rev­enue Code, as amended.  With
costs against petitioner.” (Pp. 75, 76, Taxpayer’s Brief as appellant)

Both parties have appealed from the respective adverse rulings
against them in the Tax Court’s decision. 
Two main issues are raised by the parties:  first, the correctness of the Tax Court’s
rulings with respect to the disputed items of dis­allowances enumerated in the
Tax Court’s summary reproduced above, and second, whether or not the
government’s right to col­lect the deficiency income taxes in question has
already prescribed.

On the first issue, we will discuss the disputed items of
disallowances seriatim.

1.  Re
allowances/disallowances of losses.

(a) Allowance of
losses in Mati Lumber Co. (1950) — The
Commissioner of Internal Revenue questions the Tax Court’s allowance of the
taxpayers uniting off as worthless securities in its 1950 return the sum of
P8,050.00 representing the cost of shares of stock of Mati
Lumber Co. acquired by the taxpayer on January 1, 1948, on the ground that the
worthlessness of said stock in the year 1950 had not been clearly
established.  The Commissioner contends
that although the said Company was no longer in operation in 1950, it still had
its sawmill and equipment which must be of considerable value.  The Tax Court, however, found that “the
company ceased operations in 1949 when its Manager and owner, a certain Mr. Rocamora, left for Spain
where he subsequently died.  When the
company ceased to operate, it had no assets, in other words, completely
insolvent.  This information as to the
insolvency of the Company — reached (the taxpayer) in 1950″, when it
properly claimed the loss as a deduction in its 1950 tax return, pursuant to
Section 30(d) (4) (b) or Section 30(e) (3) of the National Internal Revenue
Code.^[2]

We find no reason to disturb this finding of the Tax Court.  There was adequate basis for the writing-off
of the stock as worthless securities. 
Assuming that the Company would later somehow realize some proceeds from
its sawmill and equipment, which were still existing as claimed by the
Commissioner, and that such proceeds would later be distributed to its
stockholders such as the taxpayer, the amount so received by the taxpayer would
then properly be reportable as income of the taxpayer on the year it is
received.

(b) Disallowance
of losses in or bad debts of Palawan Manganese Mines,
Inc. (1951).  — The taxpayer appeals
from the Tax Court’s disallowance of its writing off in 1951 as a loss or bad
debt the sum of P353,134.25, which it had advanced or loaned to Palawan Manganese Mines, Inc.  The Tax Court’s findings on this item follow.

“Sometime in 1945, Palawan Manganese
Mines, Inc., the controlling stockholders of which are also the control­ling
stockholders of petitioner corporation, requested financial help from
petitioner to enable it to resume its mining operations in Coron,
Palawan.  The request for financial assistance was
readily and unanimously ap­proved by the Board of Directors of petitioner, and
thereafter a memorandum agreement was executed on August 12, 1945, embodying
the terms and conditions under which the financial assistance was to be
extended, the pertinent provisions of which are as follows:

‘WHEREAS, the FIRST PARTY, by virtue of its resolution adopted on
August 10, 1945, has agreed to extend to the SECOND PARTY the requested
financial help by way of accommoda­tion advances and for this purpose has
author­ized its President, Mr. Ramon J. Fernandez to cause the release of funds
to the SECOND PARTY.

‘WHEREAS, to compensate the FIRST PARTY for the advances that it
has agreed to extend to the SECOND PARTY, the latter has agreed to pay to the
former fifteen per centum (15%) of its net profits.

‘NOW THEREFORE, for and in considera­tion of the above premises,
the parties hereto have agreed and convenanted that
in consider­ation of the financial help to be extended by the FIRST PARTY to
the SECOND PARTY to enable the latter to resume its mining operations in Coron, Palawan, the SECOND PARTY
has agreed and un­dertaken as it hereby agrees and undertakes to pay to the
FIRST PARTY fifteen per centum (15%) of its net profits.’ (Exh.
H-2)

Pursuant to the agreement mentioned above, peti­tioner gave to Palawan Manganese Mines, Inc. yearly advances starting from
1945, which advances amounted to P587,308.07 by the end of 1951.  Despite these ad­vances and the resumption of
operations by Palawan Manganese Mines, Inc., it
continued to suffer losses.  By 1951,
petitioner became convinced that those advances could no longer be
recovered.  While it con­tinued to give
advances, it decided to write off as worthless the sum of P353,134.25.  This amount ‘was arrived at on the basis of
the total of advances made from 1945 to 1949 in the sum of P438,981.39, from
which amount the sum of P85,647.14 had to be de­ducted, the latter sum
representing its pre-war assets.  (t.s.n., pp. 136-139, Id.).’
(Page 4, Memorandum for Petitioner.) Petitioner decided to maintain the advances
given in 1950 and 1951 in the hope that it might be able to recover the same,
as in fact it con­tinued to give advances up to 1952.  From these facts, and as admitted by
petitioner itself, Palawan Man­ganese Mines, Inc. was
still in operation when the advances corresponding to the years 1945 to 1949
were written off the books of petitioner. 
Under the circumstances, was the sum of P353,134.25 properly claimed by
petitioner as deduction in its income tax return for 1951, either as losses or
bad debts?

“It will be noted that in giving advances to Palawan
Manganese Mines, Inc. petitioner did not expect to be repaid.  It is true that some testimo­nial evidence
was presented to show that there was some agreement that the advances would be
repaid, but no documentary evidence was presented to this effect.  The memorandum agreement signed by the
parties appears to be very clear that the consideration for the advances made
by petitioner was 15% of the net profits of Palawan
Manganese Mines, Inc.  In other words, if
there were no earnings or profits, there was no obligation to repay those
advances.  It has been held that the
voluntary advances made with­out expectation of repayment do not result in
deducti­ble losses.  1955 PH Fed. Taxes,
Par. 13,329, cit­ing W. F. Young, Inc. v. Comm., 120 F 2d. 159, 27 AFTR 395;
George B. Markle, 17 T.C. 1593.

“Is the said amount deductible as a bad debt?  As already stated, petitioner gave advances
to Pal­awan Manganese Mines, Inc. without expectation
of repayment.  Petitioner could not sue
for recovery under the memorandum agreement because the obli­gation of Palawan Manganese Mines, Inc. was to pay petitioner 15% of
its net profits, not the advances.  No
bad debt could arise where there is no valid and subsisting debt.

“Again, assuming that in this case there was a valid and
subsisting debt and that the debtor was in­capable of paying the debt in 1951,
when petitioner wrote off the advances and deducted the amount in its return
for said year, yet the debt is not deductible in 1951 as a worthless debt.  It appears that the debtor was still in
operation in 1951 and 1952, as petitioner continued to give advances in those
years.  It has been held that if the debtor
corporation, although losing money or insolvent, was still operating at the end
of the taxable year, the debt is not considered worthless and therefore not
deductible.”^[3]

The Tax Courts disallowance of the write-off was proper.  The Solicitor General has rightly pointed out
that the taxpayer has taken an “ambiguous position” and “has not
definitely taken a stand on whether the amount involved is claimed as losses or
as bad debts but insists that it is either a loss or a bad debt.”^[4]
We sustain the government’s position that the advances made by the taxpayer to
its 100% subsidiary, Palawan
Manganese Mines, Inc. amounting to P587,308.07 as of 1951 were investments and
not loans.^[5]
The evidence on record shows that the board of directors of the two companies
since August, 1945 were identical and that the only capital of Palawan Manganese Mines, Inc. is the amount of P100,000.00
entered in the taxpayer’s balance sheet as its investment in its subsidiary
company.^[6]
This fact explains the liberality with which the taxpayer made such large ad­vances
to the subsidiary, despite the latter’s admittedly poor fin­ancial condition.

The taxpayer’s contention that its advances were loans to its
subsidiary as against the Tax Court’s finding that under their memorandum
agreement, the taxpayer did not expect to be repaid, since if the subsidiary
had no earnings, there was no obligation to repay those advances, becomes
immaterial, in the light of our resolution of the question.  The Tax Court correctly held that the
subsidiary company was still in operation in 1951 and 1952 and the taxpayer
continued to give it advances in those years, and there­fore, the alleged debt
or investment could not properly be consi­dered worthless and deductible in
1951, as claimed by the tax­payer. 
Furthermore, neither under Section 30(d) (2) of our Tax Code providing
for deduction by corporations of losses actually sustained and charged off
during the taxable year nor under Sec­tion 30 (e) (1) thereof providing for
deduction of bad debts actual­ly ascertained to be worthless and charged off
within the taxable year, can there be a partial writing off of a loss or bad
debt, as was sought to be done here by the taxpayer.  For such losses or bad debts must be
ascertained to be so and written off during the taxable year, are therefore
deductible in full or not at all, in the absence of any express provision in
the Tax Code author­izing partial deductions.

The Tax Court held that the taxpayer’s loss of its invest­ment in
its subsidiary could not be deducted for the year 1951, as the subsidiary was
still in operation in 1951 and 1952.  The
tax­payer, on the other hand, claims that its advances were irretriev­ably lost
because of the staggering losses suffered by its subsidia­ry in 1951 and that
its advances after 1949 were “only limited to the purpose of salvaging
whatever ore was already available, and for the purpose of paying the wages of
the laborers who needed help.”^[7]
The correctness of the Tax Court’s ruling in sustain­ing the disallowance of
the write-off in 1951 of the taxpayer’s claimed losses is borne out by
subsequent events shown in Cases L-24972 and L-24978 involving the taxpayer’s
1957 income tax liability.  (Infra,
paragraph 6).  It will there be seen that
by 1956, the obligation of the taxpayer’s subsidiary to it had been reduced
from P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on
January 1, 1956 that the subsidiary decided to cease operations.^[8]

(c.) Disallowance
of losses in Balamban Coal Mines  (1950 and 1951) — The Court sustains the
Tax Court’s disallowance of the sums of P8,989.76 and P27,732.66 spent by the
taxpayer for the operation of its Balamban coal mines
in Cebu in 1950 and 1951, respectively, and claimed
as losses in the taxpayer’s re­turns for said years.  The Tax Court correctly held that the losses
“are deductible in 1952, when the mines were abandoned, and not in 1950
and 1951, when they were still in operation.”^[9]
The taxpayer’s claim that these expenditures should be allowed as losses for
the corresponding years that they were incurred, because it made no sales of
coal during said years, since the promised road or outlet through which the
coal could be transported from the mines to the provincial road was not
constructed, cannot be sus­tained.  Some
definite event must fix the time when the loss is sustained, and here it was
the event of actual abandonment of the mines in 1952.  The Tax Court held that the losses, totalling P36,722.42 were properly deductible in 1952, but
the appealed judgment does not show that the taxpayer was credited therefor in the determination of its tax liability for said
year.  This addi­tional deduction of
P36,722.42 from the taxpayer’s taxable in­come in 1952 would result in the
elimination of the deficiency tax liability for said year in the sum of
P3,600.00 as determined by the Tax Court in the appealed judgment.

(d) and (e)
Allowance of losses in Hacienda Dalu­piri (1950 to
1954) and Hacienda Samal (1951-1952).  — The Tax Court overruled the Commissioner’s
disallowance of these items of losses thus:

“Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950, P29,125.82 in
1951, P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954.  These deductions were disallowed by
respondent on the ground that the farm was operated solely for pleasure or as a
hobby and not for profit.  This
conclusion is based on the fact that the farm was operated continuously at a
loss.

“From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for busi­ness and not
pleasure.  It was mainly a cattle farm, although
a few race horses were also raised.  It
does not appear that the farm was used by petitioner for entertainment, social
activities, or other non-business purposes. 
Therefore, it is entitled to deduct expenses and losses in connection
with the operation of said farm.  (See
1955 PH Fed. Taxes, Par. 13,663, cit­ing G. C. M. 21103, CB 1939-1, p. 164)

Section 100 of Revenue Regulations No. 2, other­wise known as the
Income Tax Regulations, authorizes farmers to determine their gross income on
the basis of inventories.  Said
regulations provides:

‘If gross income is ascertained by inven­tories, no deduction can
be made for livestock or products lost during the year, whether pur­chased for
resale, produced on the farm, as such losses will be reflected in the inventory
by reducing the amount of livestock or products on hand at the close of the
year.’

“Evidently, petitioner determined its income or losses in the
operation of said farm on the basis of inven­tories.  We quoted from the memorandum of counsel for petitioner;

‘The Taxpayer deducted from its income tax returns for the years
from 1950 to 1954 inclusive, the corresponding yearly losses sustained in the
operation of Hacienda Dalupiri, which losses
represent the excess of its yearly expenditures over the receipts; that is, the
losses represent the difference between the sales of livestock and the actual
cash disbursements or expenses.’ (Pages 21-22, Memorandum for Petitioner.)

“As the Hacienda Dalupiri was
operated by petitioner for business and since it sustained losses in its
operation, which losses were determined by means of inventories authorized
under Section 100 of Revenue Regulations No. 2, it was error for res­pondent to
have disallowed the deduction of said losses. 
The same is true with respect to losses sustained in the operation of
the Hacienda Samal for the years 1951 and 1952.”^[10]

The Commissioner questions that the losses sustained by the
taxpayer were properly based on the inventory method of accounting.  He concedes, however, “that the regulations
re­ferred to does not specify how the inventories are to be made.  The Tax Court however, felt satisfied with
the evidence present­ed by the taxpayer . . . which merely consisted of an
alleged phy­sical count of the number of the livestocks
in Hacienda Dalupiri for the years involved.”^[11]
The Tax Court was satisfied with the method adopted by the taxpayer as a farmer
breeding live­stock, reporting on the basis of receipts and disbursements.  We find no compelling reason to disturb its
findings.

2. Disallowance of excessive depreciation of buildings.  (1950-1954). 
–During the years 1950 to 1954, the taxpayer claimed a depreciation
allowance for its buildings at the annual rate of 10%.  The Commissioner claimed that the reasonable
depreciation rate is only 3% per annum and hence disallowed as excessive the
amount claimed as depreciation allowance in excess of 3% annually.  We sustain the Tax Court’s finding that the
taxpayer did not sub­mit adequate proof of the correctness of the taxpayer’s
claim that the depreciable assets or buildings in question had a useful life
only of 10 years so as to justify its 10% depreciation per annum claim, such
finding being supported by the record. 
The taxpayer’s contention that it has many zero or one-peso assets,^[12]
representing very old and fully depreciated assets serves but to support the
Commissioner’s position that a 10% annual deprecia­tion rate was excessive.

3.  Taxable increase in
net worth (1950-1951).  — The Tax
Court set aside the Commissioner’s treatment as taxable income of certain
increases in the taxpayer’s net worth. 
It found that:

“For the year 1950, respondent determined that petitioner had
an increase in net worth in the sum of P30,050.00, and for the year 1951,  the sum of P 1,382.85.  These amounts were treated by respondent as
taxable income of petitioner for said years.

“It appears that petitioner had an account with the Manila
Insurance Company, the records bearing on which were lost.  When its records were reconstituted the
amount of P349,800.00 was set up as its liability to the Manila Insurance
Company.  It was discovered later that
the correct liability was only P319,750.00, or a difference of P30,050.00, so
that the records were adjusted so as to show the correct liability.  The correction or adjustment was made in
1950.  Respondent contends that the
reduction of petitioner’s liability to Manila Insurance Company restated in the
increase, of petitioner’s, net worth to the extent of P30,050.00 which is
taxable.  This is erroneous.  The principle underlying the taxability of an
increase in the net worth of a tax-payer rests on the theory that such an
increase net worth, if unreported and not explained by the taxpayer, comes from
income derived from a taxable 
source.  (See Perez v. Araneta, G. R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G. R. Nos. L-11534 &
L-11558, Nov. 25, 1958.)
In this case, the increase in the net worth of petitioner for 1950 to the
extent of P30,050.00 was not the result of the receipt by it of taxable income.  It was merely the outcome of the correction
of an error in the entry in its books relating to its indebtedness to the
Manila Insurance Company.  The Income Tax
Law imposes a tax on income; it does not tax any or every increase net worth
whe­ther or not derived from income. 
Surely, the said sum of P30,050,00 was not income to petitioner, and it
was error for respondent to assess a deficiency income tax on said amount.

“The same holds true in the case of the alleged increase in
net worth of petitioner for the year, 1951 in the sum of P1,382.85.  It appears that certain items (all amounting
to P1,382.85) remained in petitioner’s books as outstanding liabilities of
trade creditors.  These accounts were
discovered in 1951 as in the sum of P1,382.85) remained in petitioners books as
outstanding liabilities of trade creditors. 
These accounts were discovered in 1951 as having been paid in prior
years, so that the necessary adjustments were made to correct the errors.  If there was an increase in net worth of the petitioner,
the increase in net worth was not the result of receipt by petitioner of
taxable income.”^[13]

The Commissioner advances no valid
grounds in his brief for contesting the Tax Court’s findings.  Certainly, these increases in the taxpayer’s
net worth were not taxable increases in net worth, as they were not the result
of the receipt by it of unreport­ed or unexplained taxable income, but were
shown to be merely the result of the correction of errors in its entries in its
books relating to its indebtednesses to certain creditors, which had been
erroneously overstated or listed as outstanding when they had in fact been duly
paid.  The Tax Court’s action must be
affirmed.

4.  Gain realized from
sale of real property (1950).  — We
likewise sustain as being in accordance with the evidence the Tax Court’s
reversal of the Commissioner’s assessment on an alleged unreported gain in the
sum of P11,147.26 in the sale of a certain real property of the taxpayer in
1950.  As found by the Tax Court, the
evidence shows that this property was acquired in 1926 for P11,852.74, and was
sold in 1950 for P60,000.00, apparently, resulting in a gain of P48,147.26.^[14]
The taxpayer reported in its return a gain of P37,000.00, or a discrepancy of
P11,147.26.^[15]
It was sufficiently proved from the taxpayer’s books that after acquir­ing the
property, the taxpayer had made improvements totalling
P11,147.26,^[16]
accounting for the apparent discrepancy in the reported gain.  In other words, this figure added to the
original acquisition cost of P11,852.74 results in a total cost of P23,000.00,
and the gain derived from the sale of the property for P60,000.00 was correctly
reported by the taxpayer at P37,000.00.

On the second issue of prescription, the taxpayer’s conten­tion
that the Commissioner’s action to recover its tax liability should be deemed to
have prescribed for failure on the part of the Commissioner to file a complaint
for collection against it in an appropriate civil action, as
contradistinguished from the answer filed by the Commissioner to its petition
for review of the ques­tioned assessments in the case a quo has
long been rejected by this Court.  This
Court has consistently held that “a judicial action for the collection of
a tax is begun by the filing of a complaint with the proper court of first
instance, or where the assess­ment is appealed to the Court of Tax Appeals,
by filing an answer to the taxpayer’s petition for review wherein payment of
the tax is prayed for.“^[17]
This is but logical for where the taxpayer avails of the right to appeal the
tax assessment to the Court of Tax Appeals, the said Court is vested with the
authority to pronounce judgment as to the taxpayer’s liability to the exclusion
of any other court.  In the present case,
regardless of whether the assessments were made on February 24 and 27, 1956, as
claimed by the Com­missioner, or on December 27, 1955 as claimed by the
taxpayer, the government’s right to collect the taxes due has clearly not
prescribed, as the taxpayer’s appeal or petition for review was filed with the
Tax Court on May 4, 1960, with the Commissioner filing on May 20, 1960 his
Answer with a prayer for payment of the taxes due, long before the expiration
of the five-year period to ef­fect collection by judicial action counted from
the date of assess­ment.

Cases L-24972 and L-24978

These cases refer to the taxpayer’s income tax liability for the
year 1957.  Upon examination of its
corresponding income tax return, the Commissioner assessed it for deficiency
income tax in the amount of P38,918.76, computed as follows:

The Tax Court overruled the Commissioner’s disallowance of the
taxpayer’s losses in the operation of its Hacienda Dalupiri
in the sum of P89,547.33 but sustained the disallowance of the sum of
P48,481.62, which allegedly represented 1/5 of the cost of the
“contractual right” over the mines of its subsidiary, Palawan Man­ganese Mines, Inc. which the taxpayer had
acquired.  It found the taxpayer liable
for deficiency income tax for the year 1957 in the amount of P9,696.00, instead
of P32,982.00 as originally assessed, and rendered the following judgment:

“WHEREFORE, the assessment appealed from is hereby
modified.  Petitioner is hereby ordered
to pay to respondent the amount of P9,696.00 as defi­ciency income tax for the
year 1957, plus the corres­ponding interest provided in Section 51 of the
Revenue Code.  If the deficiency tax is
not paid in full within thirty (30) days from the date this decision becomes
final and executory, petitioner shall pay a surcharge
of five per cent (5%) of the unpaid amount, plus inter­est at the rate of one
per cent (1%) a month, computed from the date this decision becomes final until
paid, provided that the maximum amount that may be col­lected as interest shall
not exceed the amount corres­ponding to a period of three (3) years.  Without pro­nouncement as to costs.”^[19]

Both parties again appealed from the respective adverse rulings
against them in the Tax Court’s decision.

5. Allowance of losses in
Hacienda Dalupiri (1957).   — The Tax Court cited its previous decision
overruling the Commissioner’s disallowance of losses suffered by the taxpayer
in the operation of its Hacienda Dalupiri, since it
was convinced that the hacienda was operated for business and not for
pleasure.  And in this appeal, the
Commissioner cites his arguments in his appellant’s brief in Case No.
L-21557.  The Tax Court, in setting aside
the Commis­sioner’s principal objections, which were directed to the account­ing
method used by the taxpayer found that:

“It is true that petitioner followed the cash basis method of
reporting income and expenses in the operation of the Hacienda Dalupiri and used the accrual method with respect to its
mine operations.  This method of account­ing,
otherwise known as the hybrid method, followed by petitioner is not without
justification.

‘x x x A taxpayer may not, ordinarily,
combine the cash and accrual bases.  The
1954 Code provisions permit, however, the use of a hybrid method of accounting,
com­bining a cash and accrual method, under cir­cumstances and requirements to
be set out in Regulations to be issued. 
Also, if a taxpayer is engaged in more than one trade or business he may
use a different method of accounting for each trade or business.  And a taxpayer may report income from a
business on accrual basis and his personal income on the cash basis.’ (See Mertens, Law of Federal Income Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 12.08, p.
26.)”^[20]

The Tax Court, having satisfied itself with the adequacy of the taxpayer’s
accounting method and procedure as properly reflecting the taxpayer’s income or
losses, and the Commissioner having failed to show the contrary, we reiterate
our ruling [supra, paragraph 1 (d) and (e)] that we find no compelling
reason to dis­turb its findings.

6. Disallowance of
amortization of alleged “contractual rights.” — The reasons for
sustaining this disallowance are thus given by the Tax Court:

“It appears that the Palawan
Manganese Mines, Inc., during a special meeting of its Board of Directors on
Jan­uary 19, 1956, approved a resolution, the pertinent por­tions of which read
as follows:

‘RESOLVED, as it is hereby resolved, that the corporation’s current
assets composed of ores, fuel, and oil, materials and supplies, spare parts and
canteen supplies appearing in the inventory and balance sheet of the Corpor­ation
as of December 31, 1955, with an aggre­gate value of P97,636.98, contractual
rights for the operation of various mining claims in Palawan
with a value of P100,000.00, its title on various mining claims in Palawan with a value of P142,408.10 or a total value of
P340,045.08 be, as they hereby ceded and transferred to Fernandez Hermanos, Inc., as partial settlement of the indebtedness
of the corporation to said Fernandez Hermanos, Inc.,
in the amount of P442,885.23.’ (Exh. E, p. 17, CTA
rec.)

“On March 29, 1956,
petitioner’s corporation accepted the above-offer of transfer, thus:

“WHEREAS, the Palawan Manganese
Mines, Inc., due to its yearly substantial losses has decided to cease operation
on January 1, 1956 and in order to satisfy at least a part of its indebt­edness
to the Corporation, it has proposed to transfer its current assets in the
amount of NINETY SEVEN THOUSAND SIX HUNDRED THIRTY SIX PESOS & 98/100
(P97,636.98) as per its balance sheet as of December 31, 1955, its contractual
rights valued at ONE HUNDRED THOUSAND PESOS (P100,000.00) and its title over
various mining claims valued at ONE HUNDRED FORTY TWO THOUSAND FOUR HUNDRED
EIGHT PESOS & 10/100 (P142,408.10) or a total valuation of THREE HUNDRED
FORTY THOUSAND FORTY FIVE PESOS & 08/100 (P340,045.08) which shall be
applied in partial settlement of its obli­gation to the Corporation in the
amount of FOUR HUNDRED FORTY TWO THOUSAND EIGHT HUN­DRED EIGHTY FIVE PESOS
& 23/100 (P442,885.23);’ (Exh. E-1, p. 18, CTA
rec.)

“Petitioner determined the cost of the mines at P242,408.10 by
adding the value of the contractual rights (P100,000.00) and the value of its
mining claims (P142,408.10).  Respondent
disallowed the deduction on the following grounds:  (1) that the Palawan
Manganese Mines, Inc. could not trans­fer P242,408.10 worth of assets to
petitioner because the balance sheet of the said corporation for 1955 shows
that it had only current assets worth P97,636.96; and (2) that the alleged
amortization of ‘contractual rights’ is not allowed by the Revenue Code.

“The law in point is Section 30(g) (1) (B) of the Revenue
Code, before its amendment by Republic Act No. 2698, which provided in part:

‘(g) Depletion of oil and gas wells and mines.:

‘(1) In general.  — x
x x

(B) in the case of mines, a reasonable
allowance for depletion thereof not to exceed the market val­ue in the mine of
the product thereof, which has been mined and sold during the year for which
the return and computation, are made. 
The allowances shall be made under rules and regulations to be
prescribed by the Secretary of Finance:  Provided,
That when the allowances shall equal the capital invested, x x x no further allowance shall be
made.’

“Assuming, arguendo, that the Palawan Manganese Mines, Inc. had assets worth P242,408.10
which it actual­ly transferred to the petitioner in 1956, the latter cannot
just deduct one-fifth (1/5) of said amount from its gross income for the year
1957 because such deduction in the form of depletion charge was not sanctioned
by Section 30(g) (1) (B) of the Revenue Code, as above-quoted.

x        x          x          x

“The sole basis of petitioner in claiming the amount of
P48,481.62 as a deduction was the memorandum of its mining engineer (Exh. I, pp. 31-32, CTA rec.), who stated that the ore
reserves of the Busuange Mines (Mines transferred by
the Palawan Manganese Mines Inc to the petitioner)
would be exhausted in five (5) years, hence, the claim for P48,481.62 or
one-fifth (1/5) of the alleged cost of the mines corresponding to the year 1957
and every year thereafter for a period of 5 years.  The said memorandum merely showed the
estimated ore reserves of the mines and its probable selling price.  No evidence whatsoever was presented to show
the produce mined and for how much they were sold during the year for which the
return and compu­tation were made.  This
is necessary in order to de­termine the amount of depletion that can be legally
deducted from petitioner’s gross income. 
The method employed by petitioner in making an outright deduction of 1/5
of the cost of the mines is not authorized under Section 30(g) (1) (B) of the
Revenue Code.  Respon­dent’s disallowance
of the alleged ‘contractual rights’ amounting to P48,481.62 must therefore be
sus­tained.”^[21]

The taxpayer insists in this appeal that it could use as a method
for depletion under the pertinent provision of the Tax Code its “capital
investment,” representing the alleged value of its contractual rights and
titles to mining claims in the sum of P242,408.10 and thus deduct outright
one-fifth (1/5) of this “capital investment” every year, regardless
of whether it had actually mined the product and sold the products.  The very authorities cited in its brief give
the correct concept of deple­tion charges that they “allow for the
exhaustion of the capital value of the deposits by production“;
thus, “as the cost of the raw materials must be deducted from the gross
income before the net income can be determined, so the estimated cost of the
reserve used up is allowed.”22 The alleged “capital
investment” method invoked by the taxpayer is not a method of deple­tion,
but the Tax Code provision, prior to its amendment by Section 1, of Republic
Act No. 2698, which took effect on June 18, 1960, expressly provided that
“when the allowances shall equal the capital invested … no further
allowances shall be made;” in other words, the “capital
investment” was but the limitation of the amount of depletion that could be
claimed.  The outright deduction by the
taxpayer of 1/5 of the cost of the mines, as if it were a “straight
line” rate of depreciation, was correctly held by the Tax Court not to be
authorized by the Tax Code.

ACCORDINGLY, the judgment of the Court of Tax Appeals,
subject of the appeals in Cases Nos. L-21551 and 21557, as modified by the cre­diting
of the losses of P36,722.42 disallowed in 1951 and 1952 to the taxpayer for the
year 1953 as directed in paragraph 1 (c) of this decision, is hereby
affirmed.  The judgment of the Court of
Tax Appeals appealed from in Cases Nos. L-24972 and 24978 is affirmed in
toto. 
No costs.

SO ORDERED.

Concepcion, C.J., Dizon,
Makalintal, Zaldivar,
Sanchez, Ruiz Castro, Fernando, Capistrano, and
Barredo, JJ.,  concur.

^[1]
Taxpayer’s Brief as appellant, p. 57-59.

^[2]
CTA decision in Case 787, Taxpayer”s Brief as
appellant, p. 62.

^[3]
CTA decision in Case 787, Taxpayer’s Brief as appellant, pp. 63-66.

^[4]
Commissioner’s Brief as appellee, p. 9.

^[5]
Idem, p. 18.

^[6]
Idem, p. 18.

^[7]
Taxpayer’s Brief as appellant, p. 22.

^[8]
CTA Decision in Case 787, Taxpayer’s Brief, p. 74.

^[9]
Idem, pp. 66-67.

^[10]
CTA decision in Case 787, Taxpayer’s Brief as appellant, p. 68-70.

^[11]
Commissioner’s Brief as appellant, p. 15-16.

^[12]
Taxpayer’s Brief as appellant, p. 44.

^[13]
CTA decision in Case 787, Taxpayer’s Brief as appellant, pp. 70-72.

^[14]
Not P48,127.26, as erroneously stated in the CTA decision.

^[15]
Not P11,852.74 as erroneously stated in the CTA decision.

^[16]
Idem.  Apparently, the CTA inadvertently
switched the figures.

^[17]
Alhambra Cigar & Cigarette Mfg. Co. vs. Collector, 105 Phil. 1337,
cited in Palanca vs. Commissioner 4 SCRA 263,
266; Collector vs. Bohol Land Trans. Co. 107
Phil, 965, 972.

^[18]
CTA decision in CTA Case 1389, Annex C, Commis­sioner’s Petition, p. 1.

^[19]
CTA decision in CTA Case 1389, Annex C, Commissioner’s Petition, p. 6.

^[20]
CTA decision in CTA Case 1389, Annex C. Commis­sioner’s Petition, p. 3.

^[21]
CTA decision in CTA Case 1389, Annex C, Commissioner’s Petition, pp. 4-5.