KUENZLE & STREIFF, INC., PETITIONER, VS. THE COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Petition filed by Kuenzle & Streiff, Inc. for the review of the decision of the Court
of Tax Appeals in C.T.A. Case No. 551 sustaining the assessments of the res­pondent
issued against it, for deficiency income taxes for the years 1953, 1954 and
1955 in the amounts of P40,455.00, P11,248.00 and P16,228.00, respectively,
arising from the disallowance, as deductible expenses, of the bonuses paid by
petitioner to its officers, upon the ground that they were not ordinary, nor
necessary, nor reasonable expenses within the purview of Section 30(a) (1) of
the National In­ternal Revenue Code.

Petitioner, a domestic corporation, filed its income tax returns
for the taxable years 1953, 1954 and 1955, de­claring net losses of P2,085.84,
P4,953.91 and P9,246.07, respectively. 
Upon a verification thereof, the respondent, on
September 9, 1957, assessed against it the deficiency income taxes in question,
arrived at as follows:

For the year 1953, by disallowing as deductions all amounts paid
that year by the petitioner as bonus to its officers and staff-members in the
aggregate sum of P175,140.00, this resulting in a net taxable income of
petitioner amounting to P173,054.16; for the taxable years 1954 and 1955, the
similar disallowance as deductions of a portion of the bonuses paid by
petitioner in said years to its officers and staff-members in the aggregate
sums of P88,193.33 for 1954 and P90,385.00 for 1955, re­sulted likewise in a
net taxable income for petitioner in the sum of P83,239.42 for 1954 and
P81,138.93 for 1955.

On July 9, 1958 petitioner filed with the Court of Tax Appeals a
petition for review contesting the afore­mentioned assessments (C.T.A. Case No.
551), and on April 28, 1961, said Court rendered judgment as follows:

“FOR THE FOREGOING CONSIDERATIONS, the decision appealed from
is hereby affirmed with respect to the deficiency assessment for the years 1953
and 1955.  As regards the deficiency
assessment for the year 1954, the same is hereby modified in the sense that the
amount due from petitioner is P11,248.00, instead of
P16,648.00.  Accordingly, peti­tioner is
ordered to pay within thirty days from the date this decision becomes final the
sums of P40,455.00 and P16,228.00, plus 5% surcharge
and 1% monthly interest from October
1, 1957 until paid.  It is
likewise ordered to pay the sum of P11,248.00 within
the same period, and, if not so paid, there shall be added thereto 5% surcharge
and 1% monthly interest from the date of delinquency to the date of
payment.  With costs
against petitioner.”

Petitioner moved for a reconsideration of the above-quoted
decision, and on August 21, 1961,
the court amended the same to include the following at the end thereof:

“x x x In
both cases, the maximum amount of interest shall not exceed the amount
corresponding to a period of three years, pursuant to Section 51(e) (2) of the
National Internal Revenue Code, as amended by Section 8 of Republic Act No.
2343.  With costs
against petitioner.”

Having found that the bonuses in question were paid for services
actually rendered by the recipients thereof, the tax court proceeded to
consider the question of “whether or not they are reasonable”.  In this connection it construed Section 30(a)
(1) of the Revenue Code as allowing the de­duction from gross income of all the
ordinary and necessary expenses incurred during the taxable year in carrying on
the trade or business of the taxpayer, including a reasonable allowance
for salaries or other compensation for personal services actually
rendered.  We agree with the view thus
expressed, as well as with said court’s conclusion that the bonuses in question
were not reasonable considering all material and relevant factors.

Petitioner contends that the tax court, in arriving at its
conclusion, acted “in a purely arbitrary manner”, and erred in not
considering individually the total com­pensation paid to each of petitioner’s
officers and staff members in determining the reasonableness of the bonuses in
question, and that it erred likewise in holding that there was nothing in the
record indicating that the actuation of the respondent was unreasonable or
unjust.

It is not true, as petitioner claims to support its view, that
the respondent and the tax court based their ruling exclusively upon the fact
that petitioner had suf­fered net losses in its business operations during the
years when the bonuses in question were paid. 
The truth appears to be that, in arriving at such conclusion, the
respondent and the tax court gave due consideration to all the material factors
that led this Court to decide an earlier case of petitioner itself involving
the same issue and where the test for determining the reasonable­ness of
bonuses and additional compensation for services actually rendered were laid
down by Us as follows:

“It is a general rule that ‘Bonuses to employees made in good
faith and as addi­tional compensation for the services actual­ly rendered by
the employees are deductible, provided such payments, when added to the
stipulated salaries, do not exceed a reasonable compensation for the services
rendered’ (4 Mertens, Law of Federal In­come
Taxation, Sec. 25-50, p. 410).  The
condition precedents to the deduction of bonuses to employees are:  (1) the payment of the bonuses is in fact
compensation; (2) it must be for personal services actual­ly rendered; and (3)
bonuses, when added to the salaries, are reasonable x x
x when measured by the amount and quality of the
services performed with relation to the business of the particular taxpayer’
(Idem., Sec. 25.44, p. 395).  Here it is
admitted that the bonuses are in fact compensation and were paid for services
actually rendered.  The only question is
whether the payment of said bonuses is reasonable.”

“There is no fixed test for determining the reasonableness of
a given bonus as com­pensation.  This
depends upon many factors, one of them being ‘the amount and quality of the services
performed with relation to the business’. 
Other tests suggested are:  pay­ment
must be ‘made in good faith’; ‘the char­acter of the taxpayer’s business, the
volume and amount of its net earnings, its locality, the type and extent of the
services rendered, the salary policy of the corporation’; ‘the size of the
particular business’; ‘the employees’ qualifications and contributions to the
busi­ness venture’; and ‘general economic condi­tions (4 Mertens
Law of Federal Income Taxa­tion, Secs. 25.44, 25.49,
25.50, 25.51, pp. 407-412).  However, ‘in
determining whether the particular salary or compensation payment is
reasonable, the situation must be considered as a whole.  Ordinarily, no single factor is de­cisive.  x x x it is important to keep in mind that it seldom happens
that the application of one test can give a satisfactory answer, and that
ordinarily it is the interplay of several factors, properly weighted for the
particular case, which must furnish the final answer (Idem.).” (Kuenzle & Streiff
v. Coll. of Int. Rev., G. R. Nos. L-12010 & L-12113, Oct. 20, 1959.)

Making a distinction between petitioner’s previous case and the
present, the tax court said that while it is true that in the former (C.T.A.
No. 169, December 29, 1956,
G. R. Nos. L-12010 and L-12113, October 20, 1959, involving taxable years 1950
to 1952) We allowed – and considered de­ductible – bonuses in amounts bigger
than the ones allowed by respondent in the case at bar, that was due to the
fact that petitioner had earned huge profits during the years 1950-52.  So much so that, the payment of such bonuses
not­withstanding, petitioner still had substantial net profits distributable as
dividends among its stockholders.  In the
present case, on the other hand, it is clear that the ul­timate and inevitable
result of the payment of the questioned bonuses would be net losses
for petitioner during the taxable years in which they were paid.

It seems clear from the record that, in arriving at its main,
conclusion, the tax court considered, inter alia, the following factors:

In the first place, for the years 1953, 1954 and 1955 the
petitioner paid to its following top officers: 
A. P. Kuenzle, H. A. Streiff,
A. Jung, G. Cattaneo, A. Schatzmann,
F. E. Rein, M. Klingler, A. Huber, S. Meili, M. Triaca, J. Ortiz, H.
Vogt, W. Ramp, W. Strehler, H. R. Jung, K. Schedler, P. C. Curtis, R. Oefeli,
substantial amounts as salaries and bonuses ranging from P9,000.00 yearly as a
minimum (except in one case) and P50,000.00 as maximum.  All these officials headed various
departments of petitioner’s business. 
While it must be assumed, on the one hand, in the absence of evidence to
the contrary, that they were competent, on the other the record discloses no
evidence nor has petitioner ever made the claim that all or some of them were
gifted with some special talent, or had undergone some extraordinary training,
or had accomplished any particular task, that contributed materially to the
success of petitioner’s business during the taxable years in question.

In the second place, working under the abovenamed
officials and constituting what we might call the staff of petitioner’s working
personnel, were a good number of other employees – mostly Filipinos (T.s.n. pp. 222-223) – all of whom, according to the record
(Idem 223), received no pay increase at all during the same years.

In the third place, the above salaries and bonuses were paid to
petitioner’s top officials mentioned hereto­fore, inspite
of the fact that according to its income tax returns for the relevant years, it
had suffered net losses as follows:  P2,085.84, P4,953.91, P9,246.07 for the years 1953, 1954 and
1955, respectively.  In fact,
petitioner’s financial statements further show that its gross assets suffered a
gradual decrease for the same years (Exh. B-1, p. 58, B.I.R. records, Exh. D-1, p. 36 id., Exh. F-1, p. 14 id.), and that a similar downward trend took place in
its surplus and capital position during the same period of time.

That the charge of arbitrariness against respondent is without
merit is further shown by the following con­siderations:

Petitioner admits that the amounts it paid to its top officers in
1953 as bonus or “additional remuneration” were taken either from
operating funds, that is, funds from the year’s business operations, or from
its general reserve.  Normally, the
amounts taken from the first source should have constituted profits of the
corporation distributable as dividends amongst its shareholders.  Instead it would appear that they were
diverted from this purpose and used to pay the bonuses for the year 1953.  In the case of the amounts taken from the
general reserve it seems clear that the company had to resort to the use of
such reserve funds because the item of expense to be met could not be consider­ed
as ordinary or necessary – and was therefore beyond the purview of the
provisions of Section 30(a) (1) of the Na­tional Internal Revenue Code.  This being so, We can not see our way clear
to holding that the respondent acted arbitrarily in disallowing as deductible
expenses the amounts thus paid as bonus or “additional remuneration”.

Neither does the total disallowance of the bonuses paid to some
officers and the partial disallowance of those paid to others show that
respondent acted unjustly and un­reasonably. 
The record sufficiently shows that the total disallowance was more or
less due to the fact that the affected officers had previously received
substantial in­creases in their basic salaries.

Petitioner justifies payment of these bonuses to its top
officials by saying that its general salary policy was to give a low salary but
to grant substantial bonuses at the end of each year, so that its officers may
receive considerable lump sums with which to purchase whatever
expensive objects or items they might need. 
While We are not prepared to hold that such policy is unreasonable,
still We believe that its application should not result in producing a net
loss for the employer at the end of the year, for if that were to be the
case, the scheme may be utilized to freely achieve some other purpose – evade
payment of taxes.

The authority relied upon by petitioner (Mertens
Law of Federal Income Taxation, Vol. IV p. 418) does not apply to the present
case, because it refers to the salary paid to an employee, which may be
claimed as a deductible amount.  In the
case before Us the respondent does not question the
basic salaries paid by petitioner to its officers and em­ployees, but
disallowed only the bonuses paid to petitioner’s top officers at the end of the
taxable years in question.

In further support of its appeal petitioner claims that the
amounts disallowed by the respondent should be considered as legitimate
business expenses as their payment was made in good faith.  In bringing up this point, peti­tioner treads
on dangerous ground.  In the first place,
good faith can not decide whether a business expense is reasonable or
unreasonable for purposes of income tax de­duction.  In the second place, petitioner’s good faith
in the matter at issue is not overly manifest, considering that the questioned
bonuses were fixed and paid at the end of the years in question – at a time,
therefore, when petitioner fully knew that it was going to suffer a net loss in
its business operations.

As far as petitioner’s contention that as employer it has the
right to fix the compensation of its officers and employees and that it was in
the exercise of such right that it deemed proper to pay the bonuses in
question, all that We need say is this: 
that right may be conceded, but for income tax purposes the employer can
not legally claim such bonuses as deductible expenses unless they are shown to
be reasonable.  To hold otherwise would
open the gate to rampant tax evasion.

Lastly, We must not lose sight of the
fact that the question of allowing or disallowing as deductible expenses the
amounts paid to corporate officers by way of bonus is determined by respondent
exclusively for income tax pur­poses. 
Concededly, he has no authority to fix the amounts to be paid to
corporate officers by way of basic salary, bonus or additional remuneration – a
matter that lies more or less exclusively within the sound discretion of the
corporation itself.  But this right of
the corporation is, of course, not absolute. 
It can not exercise it for the purpose of evading payment of taxes
legitimately due to the State.

WHEREFORE, the appealed decision being in accordance with
law, the same is hereby affirmed, with costs.

Reyes, J.B.L., (Acting C.J.), Makalintal,
Zaldivar, Sanchez, Fernando, Capistrano, Teehankee, and Barredo, JJ., concur.

Concepcion, C.J., and Castro, J., are
on official leave of absence.