EN BANC
[G.R. No. 125508.
July 19, 2000]
CHINA BANKING CORPORATION, petitioner,
vs. COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX
APPEALS, respondents.
D E C I S I O N
VITUG, J.:
The Commissioner of Internal
Revenue denied the deduction from gross income of "securities becoming
worthless" claimed by China Banking Corporation (“CBC”). The Commissioner’s disallowance was
sustained by the Court of Tax Appeals ("CTA"). When the ruling was appealed to the Court of
Appeals ("CA"), the appellate court upheld the CTA. The case is now before us on a Petition for
Review on Certiorari.
Sometime in 1980, petitioner
China Banking Corporation made a 53% equity investment in the First CBC Capital
(Asia) Ltd., a Hongkong subsidiary engaged in financing and investment with
"deposit-taking" function.
The investment amounted to P16,227,851.80, consisting of 106,000 shares
with a par Value of P100 per share.
In the course of the regular
examination of the financial books and investment portfolios of petitioner
conducted by Bangko Sentral in 1986, it was shown that First CBC Capital
(Asia), Ltd., has become insolvent.
With the approval of Bangko Sentral, petitioner wrote-off as
being worthless its investment in First CBC Capital (Asia), Ltd., in its 1987
Income Tax Return and treated it as a bad debt or as an ordinary loss
deductible from its gross income.
Respondent Commissioner of
internal Revenue disallowed the deduction and assessed petitioner for income
tax deficiency in the amount of P8,533,328.04, inclusive of surcharge, interest
and compromise penalty. The
disallowance of the deduction was made on the ground that the investment should
not be classified as being "worthless" and that, although the
Hongkong Banking Commissioner had revoked the license of First CBC Capital as a
"deposit-taping" company, the latter could still exercise, however,
its financing and investment activities.
Assuming that the securities had indeed become worthless, respondent
Commissioner of Internal Revenue held the view that they should then be
classified as "capital loss," and not as a bad debt expense there
being no indebtedness to speak of between petitioner and its subsidiary.
Petitioner contested the ruling
of respondent Commissioner before the CTA.
The tax court sustained the Commissioner, holding that the securities
had not indeed become worthless and ordered petitioner to pay its deficiency
income tax for 1987 of P8,533,328.04 plus 20% interest per annum until fully
paid. When the decision was appealed to
the Court of Appeals, the latter upheld the CTA. In its instant petition for review on certiorari,
petitioner bank assails the CA decision.
The petition must fail.
The claim of petitioner that the
shares of stock in question have become worthless is based on a Profit and Loss
Account for the Year-End 31 December 1987, and the recommendation of Bangko
Sentral that the equity investment be written-off due to the insolvency of
the subsidiary. While the matter may
not be indubitable (considering that certain classes of intangibles, like
franchises and goodwill, are not always given corresponding values in financial
statements[1], there may really be no need, however, to go of
length into this issue since, even to assume the worthlessness of the shares,
the deductibility thereof would still be nil in this particular case. At all events, the Court is not prepared to
hold that both the tax court and the appellate court are utterly devoid of
substantial basis for their own factual findings.
Subject to certain exceptions,
such as the compensation income of individuals and passive income subject to
final tax, as well as income of non-resident aliens and foreign corporations
not engaged in trade or business in the Philippines, the tax on income is
imposed on the net income allowing certain specified deductions from gross
income to be claimed by the taxpayer.
Among the deductible items allowed by the National Internal Revenue Code
("NIRC") are bad debts and losses.[2]
An equity investment is a capital,
not ordinary, asset of the investor the sale or exchange of which
results in either a capital gain or a capital loss. The gain or the loss is ordinary when the property sold or
exchanged is not a capital asset.[3] A capital asset is defined negatively in Section
33(1) of the NIRC; viz:
(1) Capital assets. - The term
'capital assets' means property held by the taxpayer (whether or not connected
with his trade or business), but does not include stock in trade of the
taxpayer or other property of a kind which would properly be included in the
inventory of the taxpayer if on hand at the close of the taxable year, or
property held by the taxpayer primarily for sale to customers in the ordinary
course of his trade or business, or property used in the trade or business, of
a character which is subject to the allowance for depreciation provided in
subsection (f) of section twenty-nine; or real property used in the trade or
business of the taxpayer.”
Thus, shares of stock; like the
other securities defined in Section 20(t)[4] of the NIRC, would be ordinary assets only to
a dealer in securities or a person engaged in the purchase and sale of, or
an active trader (for his own account) in, securities. Section 20(u) of the NIRC defines a
dealer in securities thus:
"(u) The term 'dealer in
securities' means a merchant of stocks or securities, whether an individual,
partnership or corporation, with an established place of business, regularly
engaged in the purchase of securities and their resale to customers; that is,
one who as a merchant buys securities and sells them to customers with a view
to the gains and profits that may be derived therefrom."
In the
hands, however, of another who holds the shares of stock by way of an
investment, the shares to him would be capital assets. When the shares held by such investor
become worthless, the loss is deemed to be a loss from the sale or exchange of
capital assets. Section 29(d)(4)(B)
of the NIRC states:
"(B) Securities becoming
worthless. - If securities as defined in Section 20 become worthless during the
tax" year and are capital assets, the loss resulting therefrom shall, for
the purposes of his Title, be considered as a loss from the sale or exchange,
on the last day of such taxable year,
of capital assets."
The above
provision conveys that the loss sustained by the holder of the securities,
which are capital assets (to him), is to be treated as a capital loss as if
incurred from a sale or exchange transaction. A capital gain or a capital loss normally requires the
concurrence of two conditions for it to result: (1) There is a sale or exchange; and (2) the thing sold or
exchanged is a capital asset. When
securities become worthless, there is strictly no sale or exchange but the law
deems the loss anyway to be "a loss from the sale or exchange of capital
assets.”[5]A similar kind of treatment is given, by the NIRC on
the retirement of certificates of indebtedness with interest coupons or in
registered form, short sales and options to buy or sell property where no sale
or exchange strictly exists.[6] In these cases, the NIRC dispenses, in effect, with
the standard requirement of a sale or exchange for the application of the
capital gain and loss provisions of the code.
Capital losses are allowed to
be deducted only to the extent of capital gains, i.e., gains derived from the
sale or exchange of capital assets, and not from any other income of the
taxpayer.
In the case at bar, First CBC
Capital (Asia), Ltd., the investee corporation, is a subsidiary corporation of
petitioner bank whose shares in said investee corporation are not intended for
purchase or sale but as an investment.
Unquestionably then, any loss therefrom would be a capital loss, not an
ordinary loss, to the investor.
Section 29(d)(4)(A), of the NIRC
expresses:
"(A) Limitations. - Losses
from sales or exchanges of capital assets shall be allowed only to the extent
provided in Section 33."
The
pertinent provisions of Section 33 of the NIRC referred to in the aforesaid
Section 29(d)(4)(A), read:
"Section 33. Capital gains and
losses. -
“x x x x x x x
x x.
"(c) Limitation on capital
losses. - Losses from sales or exchange of capital assets shall be allowed
only to the extent of the gains from such sales or exchanges. If a bank or trust company incorporated
under the laws of the Philippines, a substantial part of whose business is the
receipt of deposits, sells any bond, debenture, note, or certificate or
other evidence of indebtedness issued by any corporation (including one issued
by a government or political subdivision thereof), with interest coupons or
in registered form, any loss resulting from such sale shall not be subject
to the foregoing limitation an shall not be included in determining the
applicability of such limitation to other losses.”
The exclusionary clause found in
the foregoing text of the law does not include all forms of securities but
specifically covers only bonds, debentures, notes, certificates or other
evidence of indebtedness, with interest coupons or in registered form,
which are the instruments of credit normally dealt with in the usual lending
operations of a financial institution.
Equity holdings cannot come close to being, within the purview of "evidence
of indebtedness" under the second sentence of the aforequoted
paragraph. Verily, it is for a like
thesis that the loss of petitioner bank
in its equity in vestment in the Hongkong subsidiary cannot also be
deductible as a bad debt. The shares of
stock in question do not constitute a loan extended by it to its subsidiary
(First CBC Capital) or a debt subject to obligatory repayment by the latter,
essential elements to constitute a bad debt, but a long term investment made by
CBC.
One other item. Section 34(c)(1)
of the NIRC , states that the entire amount of the gain or loss upon the sale
or exchange of property, as the case may be, shall be recognized. The complete text reads:
“SECTION 34. Determination of amount of and recognition
of gain or loss.-
"(a) Computation of gain or
loss. - The gain from the sale or other disposition of property shall be the
excess of the amount realized therefrom over the basis or adjusted basis for
determining gain and the loss shall be the excess of the basis or adjusted
basis for determining loss over the amount realized. The amount realized from the sale or other disposition of
property shall be to sum of money received plus the fair market value of the
property (other than money) received.
(As amended by E.O. No. 37)
"(b) Basis for determining
gain or loss from sale or disposition of property. - The basis of property
shall be - (1) The cost thereof in cases of property acquired on or before
March 1, 1913, if such property was acquired by purchase; or
"(2) The fair market price or
value as of the date of acquisition if the same was acquired by inheritance; or
"(3) If the property was
acquired by gift the basis shall be the same as if it would be in the hands of
the donor or the last preceding owner by whom it was not acquired by gift,
except that if such basis is greater than the fair market value of the property
at the time of the gift, then for the purpose of determining loss the basis
shall be such fair market value; or
"(4) If the property, other
than capital asset referred to in Section 21 (e), was acquired for less than an
adequate consideration in money or moneys worth, the basis of such property is
(i) the amount paid by the transferee for the property or (ii) the transferor's
adjusted basis at the time of the transfer whichever is greater.
"(5) The basis as defined in
paragraph (c) (5) of this section if the property was acquired in a transaction
where gain or loss is not recognized under paragraph (c) (2) of this
section. (As amended by E.O. No. 37)
“(c) Exchange of property.
"(1) General rule.- Except as
herein provided, upon the sale or exchange of property, the entire amount of
the gain or loss, as the case may be, shall be recognized.
"(2) Exception. - No gain or
loss shall be recognized if in pursuance of a plan of merger or consolidation
(a) a corporation which is a party to a merger or consolidation exchanges
property solely for stock in a corporation which is, a party to the merger or
consolidation, (b) a shareholder exchanges stock in a corporation which is a
party to the merger or consolidation solely for the stock in another
corporation also a party to the merger or consolidation, or (c) a security
holder of a corporation which is a party to the merger or consolidation
exchanges his securities in such corporation solely for stock or securities in
another corporation, a party to the merger or consolidation.
"No gain or loss shall also be
recognized if property is transferred to a corporation by a person in exchange
for stock in such corporation of which as a result of such exchange said
person, alone or together with others, not exceeding four persons, gains
control of said corporation: Provided,
That stocks issued for services shall not be considered as issued in return of
property."
The above law should be taken
within context on the general subject of the determination, and recognition of
gain or loss; it is not preclusive of, let alone renders completely
inconsequential, the more specific provisions of the code. Thus, pursuant, to the same section of the
law, no such recognition shall be made if the sale or exchange is made in
pursuance of a plan of corporate merger or consolidation or, if as a result of
an exchange of property for stocks, the exchanger, alone or together with
others not exceeding four, gains control of the corporation.[7] Then, too, how the resulting gain might be taxed, or
whether or not the loss would be deductible and how, are matters properly dealt
with elsewhere in various other sections of the NIRC.[8] At all events, it may not be amiss to once again
stress that the basic rule is still that any capital loss can be deducted
only from capital gains under Section 33(c) of the NIRC.
In sum -
(a) The equity investment in
shares of stock held by CBC of approximately 53% in its Hongkong subsidiary,
the First CBC Capital (Asia), Ltd., is not an indebtedness, and it is a capital,
not an ordinary, asset.[9]
(b) Assuming that the equity
investment of CBC has indeed become "worthless," the loss sustained
is a capital, not an ordinary, loss.[10]
(c) The capital loss sustained by
CBC can only be deducted from capital gains if any derived by it during the
same taxable year that the securities have become "worthless."[11]
WHEREFORE, the Petition is DENIED. The decision of the Court of Appeals disallowing the claimed
deduction of P16,227,851.80 is AFFIRMED.
SO ORDERED.
Davide, Jr., C.J., Bellosillo,
Melo, Puno, Kapunan, Mendoza, Panganiban, Quisumbing, Purisima, Pardo, Buena,
Gonzaga-Reyes, Ynares-Santiago, and De Leon, Jr.,
JJ., concur.
[1] Let it be stressed that referred to here are the
intangibles of first CBC Capital (Asia), Ltd., specifically its franchise and
goodwill, and not of CBC or its investments nor to any outstanding shares of
stock for that matter of either corporation which are correctly treated as
equity capital of First CBC Capital or investment of CBC, as the case may be,
and thus invariably reflected as such in financial statements.
[2] See Sections 29 and 30, NIRC.
[3] Section
20 (z) of the NIRC provides:
“(z) The term ‘ordinary
income’ includes any gain from the sale or exchange of property which is not a
capital asset or property described in section 34 (now 33) (a). Any gain from the sale or exchange of
property which is treated or considered, under other provisions of this Title,
as ‘ordinary income’ shall be treated as from the sale or exchange of property
which is not a capital asset as defined in Section 34 (now 33) (a). The term ‘ordinary loss’ includes any loss
from the sale or exchange of property which is not a capital asset. Any loss from the sale or exchange of
property which is treated or considered, under other provisions of this Title,
as ‘ordinary loss’ shall be treated as loss from the sale or exchange of
property which is not a capital asset.”
[4] “(t) The term ‘securities’ means shares of stock in a
corporation and rights to subscribe for or to receive such shares. The term includes bonds, debentures, notes,
or certificates, or other evidence of indebtedness, issued by any corporation,
including those issued by a government or political subdivision thereof, with
interest coupons or in registered form.”
[5] Sec. 29(4)(B) of the NIRC.
[6] Sec.
33(e) and (f), NIRC, provides:
x x x x x x x x x
(e) Retirement of bonds, etc.
– For the purposes of this Title, amounts received by the holder upon the
retirement of bonds, debentures, notes or certificates or other evidences of
indebtedness issued by any corporation (including those issued by a government
or political subdivision thereof) with the interest coupons or in registered
form, shall be considered as amounts received in exchange therefor.
(f) Gains and losses from
short sales, etc. – For the purpose of this Title –
(1) Gains or losses from short sales of property shall be considered
as gains or losses from sales or exchanges of capital assets; and
(2) Gains or losses attributable to the
failure to exercise privileges or options to buy or sell property shall be
considered as capital gains or losses.
[7] Sec. 34(c), NIRC.
[8] See Sections 29, 30, 32 and 33, NIRC.
[9] Sec. 33(1), NIRC.
[10] Sec. 29(D)(4)(B), NIRC.
[11] Sec. 33 (c), in relation to Sec. 29 (d)(4)(B), NIRC;
evidently, no such capital gains have been derived by CBC during the taxable
year in question.