PLARIDEL SURETY & INSURANCE COMPANY, PETITIONER, VS. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Plaridel Surety and Insurance versus Commissioner of Internal Revenue

The Case

This is a tax case between Plaridel Surety and Insurance Company, a domestic corporation in the bonding business, and the Commissioner of Internal Revenue. Plaridel paid out a large sum on a performance bond after a final judgment, then claimed that payment as a deductible loss on its income tax return. The Commissioner disallowed the deduction and assessed a deficiency. The case matters because it fixes the rule on when a loss is deductible under the Tax Code: a loss that is compensable by insurance or otherwise cannot be deducted in the year it is paid, and the taxpayer must first exhaust his remedies to recover or reduce it before any deduction may be claimed.

Procedural History

The Commissioner disallowed the deduction and assessed deficiency income tax against Plaridel, and denied its protest. Plaridel appealed to the Court of Tax Appeals, which dismissed the appeal. The Tax Court held that Plaridel was compensated otherwise than by insurance, through the mortgages executed in its favor, and that it had not exhausted all its available remedies, especially against Cuervo, to minimize its loss. Plaridel moved for reconsideration, which was denied. It then elevated the matter to the Supreme Court by appeal.

Facts

On November 9, 1950, Plaridel, as surety, and Constancio San Jose, as principal, solidarily executed a performance bond in the penal sum of 30,600 pesos in favor of P.L. Galang Machinery Company, Incorporated, to secure San Jose's obligation to produce and supply logs to that company. To protect itself, Plaridel required San Jose and one Ramon Cuervo to execute an indemnity agreement obligating them, solidarily, to indemnify Plaridel for whatever liability it might incur under the bond. San Jose constituted a chattel mortgage on logging machineries and other movables in Plaridel's favor, while Cuervo executed a real estate mortgage.

San Jose failed to deliver the logs, and Galang Machinery sued on the bond. The Court of First Instance adjudged San Jose and Plaridel liable, and directed San Jose and Cuervo to reimburse Plaridel for whatever amount it would pay. The Court of Appeals affirmed, and the Supreme Court likewise affirmed, with a slight modification on attorney's fees. On February 19 and March 20, 1957, Plaridel paid Galang Machinery a total of 44,490 pesos pursuant to the final decision.

In its income tax return for 1957, Plaridel claimed the 44,490 pesos as a deductible loss and paid 136 pesos as income tax. The Commissioner disallowed the deduction and assessed 8,898 pesos, plus interest, as deficiency income tax. Of the 44,490 pesos, the amount of 30,600 pesos, the principal sum in the bond, was claimed as a loss deduction, and 10,000 pesos, the interest that had accrued, was claimed as an interest deduction.

Issues

• Whether or not the 30,600 pesos paid on the performance bond was a deductible loss for the year 1957, given that Plaridel held a right to reimbursement from San Jose and Cuervo.
• Whether or not the 10,000 pesos claimed as an interest deduction may be raised and allowed on appeal, it not having been litigated before the Tax Court.

Applicable Provisions

Section 30, paragraph (d), subparagraph (2) of the Tax Code, on losses, provides:

In the case of a corporation, all losses actually sustained and charged-off within the taxable year and not compensated for by insurance or otherwise.

This is the provision under which Plaridel claimed the principal sum as a loss, and it supplies both the compensation requirement and the charge-off requirement that defeat the claim.

Ruling

On the first issue, the Court held that the loss was not deductible in 1957. A loss is deductible only in the taxable year it actually happens or is sustained. But if it is compensable by insurance or otherwise, the deduction is postponed to the year in which it appears that no compensation at all can be had, or that there is a remaining or net loss. Here, the very judgment that fixed Plaridel's liability also obligated San Jose and Cuervo to reimburse it. Plaridel's loss was therefore compensable otherwise than by insurance, and the deduction could not be claimed in 1957.

Plaridel argued that its case was an exception, citing Cu Unjieng Sons and American cases, because the possibility of recovery was remote. The Court rejected this. In Cu Unjieng the taxpayer had no legal right to compensation at all, so the pronouncement was not authoritative for Plaridel's situation. The American cases were not in point, because none involved a taxpayer who had obtained a final judgment against third persons for reimbursement. The rule, the Court said, is that loss deduction will be denied if there is a measurable right to compensation, with ultimate collection reasonably clear. Where there is reasonable ground for reimbursement, the taxpayer must seek his redress and may not secure a loss deduction until he establishes that no recovery may be had. In short, the taxpayer must exhaust his remedies first.

The Court found that Plaridel had not exhausted its remedies, especially against Cuervo, who was solidarily liable. Its president said they would go after Cuervo, but no evidence showed anything was done. Its evidence on remote possibility of recovery was fatally wanting: its right was secured not only by the mortgages but by a final and executory judgment, yet no writ of execution was ever submitted, and Cuervo's insolvency was not established. The claim was therefore premature.

Even assuming no reasonable expectation of recovery, the Court held that no loss deduction could still be had, because the provision requires a charge-off:

In the case of a corporation, all losses actually sustained and charged-off within the taxable year and not compensated for by insurance or otherwise.

Plaridel, which bore the burden of proof, failed to adduce evidence of any charge-off in connection with the amount paid.

On the second issue, the Court held that the interest deduction could not be raised. The question was never raised before the Tax Court. Plaridel's counsel had admitted before that court, and in its memorandum, that the only issue was whether the entire 44,490 pesos was a deductible loss, and in its return the whole amount was claimed as losses on its bonds. The interest deduction not having been properly litigated below, it was too late to assert it before the Supreme Court.

Doctrine

A loss is deductible only in the taxable year it actually happens or is sustained. If the loss is compensable by insurance or otherwise, the deduction is postponed to the year it appears that no compensation at all can be had, or that there is a remaining or net loss. A loss deduction will be denied where there is a measurable right to compensation with ultimate collection reasonably clear; the taxpayer must exhaust his remedies to recover or reduce the loss before claiming the deduction. For a corporation, the loss must also be charged-off within the taxable year, and the taxpayer bears the burden of proving the charge-off. Finally, an issue not raised and litigated before the Tax Court cannot be raised for the first time on appeal.

Disposition

The Supreme Court affirmed the decision of the Tax Court, with costs against Plaridel Surety and Insurance Company.

Remember This

Memorize the line: a loss compensable by insurance or otherwise is not deductible until the taxpayer exhausts his remedies and shows that no recovery can be had, and for a corporation it must be charged-off within the taxable year. Examiners use this case on loss deductions, the charge-off requirement, and the rule that issues not raised before the Tax Court cannot be raised on appeal.