552 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc, vs. Commissioner of Internal

Revenue

No. L21551. September 30, 1969.

FERNANDEZ HERMANOS, INC., petitioner, vs.

COMMISSIONER OF INTERNAL REVENUE and COURT
OF TAX APPEALS, espondents.

No. L21557, September 30, 1969.

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs. FERNANDEZ HERMANOS, INC., and COURT OF
TAX APPEALS, respondents,

No. L24972. September 30, 1969.

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.. FERNANDEZ HERMANOS, INC., and the COURT OF
TAX APPEALS, respondents.

No. L24978. September 30, 1969.

FERNANDEZ HERMANOS, INC., petitioner, vs. THE

COMMISSIONER OF INTERNAL REVENUE, and HON.
ROMAN A. UMALI, COURT OF TAX APPEALS,
respondents.

553

VOL. 29, SEPTEMBER 30, 1969 553

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

Taxation Income tax Disallowances of losses Where

worthless securities were allowed as losses.There is adequate
basis for writing off as worthless securities the stock of a lumber
company which had ceased operations, even if it still had its
sawmill and equipment of some value. Assuming that the
company would later somehow realize some proceeds from its
sawmill and equipment and such proceeds would later be
distributed to its stockholders, the amount so received by the
taxpayer would then properly be reportable as income of the
taxpayer on the year it is received. In the meantime, it may
properly be claimed as loss in its tax return pursuant to Section
30(d) 4(b) or Section 30(e) (3) of the National Internal Revenue
Code.
Same Same Disallowances of losses and bad debts No
partial disallowance or deductions allowed.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. 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.
Same Same Disallowance of depreciation of buildings or
assets Proof of useful life of asset required.The taxpayer must
submit adequate proof of the useful life of the depreciable assets
or buildings in question so as to justify its 10% depreciation per
annum claim.
Same Same When increases in net worth are not taxable.
Increases in the taxpayer's net worth are not taxable increases
in net worth if they are not the result of the receipt by it 01
unreported or unexplained taxable income, but are 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.
Same Prescription Fiveyear 'period to effect collection by
judicial action When period of prescription is counted.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

554

554 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal Revenue

wherein payment of the tax is prayed for. 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.
Same Tax Code, Section 30(g) (1.) (B) construed Depletion of
oil and gas wells and mines Capital investment as a method of
depletion.The "capital investment" method is not a method of
depletion, but the Tax Code provision, prior to its amendment by
Section 1 of Republic Act No. 3698, which took effect on June 18,
1960, expressly provided that "when the allowances shall equal
the capital invested x x x 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 is not authorized by the Tax
Code.

APPEALS from two decisions of the Court of Tax Appeals,

The facts are stated in the opinion of the Court.

L21551:

Rafael Dinglasan for petitioner.

Solicitor General Arturo A. Alafriz, Solicitor
Alejandro B. Afurong and Special Attorney Virgilio G.
Saldajeno for respondent.

L21557:

Solicitor General for petitioner,

Rafael Dinglasan for respondent Fernandez
Hermanos, Inc.

L24972:

Solicitor General Antonio P. Barredo, Assistant Solicitor

General Felicisimo R. Rosete and Special Attorney Virgilio
G. Saldajeno for petitioner.
Rafael Dinglasan for respondent Fernandez
Hermanos, Inc.
555

VOL. 29, SEPTEMBER 30, 1969 555

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

L24978:

Rafael Dinglasan for petitioner.

 Solicitor General Antonio P. Barredo, Assistant
Solicitor General Antonio G. Ibarra and Special Attorney
Virgilio G. Saldajeno for respondent.

TEEHANKEE, J.:

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 interrelated, the Court resolves the four appeals
in this joint decision.

Cases L21551 and L21557

The taxpayer, Fernandez Hermanos, Inc., is a

domesticcorporation 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:

"1. Losses
a. Losses in Mati Lumber Co. (1950) P 8,050.00
...................................................................
b. Losses in or bad debts of Palawan Manga 353,134.25
nese Mines, Inc. (1951)
.....................................................................................

556

556 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs, Commissioner of Internal
Revenue

c. Losses in Balamban Coal Mines1950 8,989.76

...................................................
 1951 27,732.66
.........................................................................................................
d. Losses in Hacienda Dalupiri
1950 17,418.95
.........................................................................................................
1951 29,125.82
.........................................................................................................
1952 26,744.81
.........................................................................................................
1953 21,932.62
.........................................................................................................
1954 42,938.56
.........................................................................................................
e. Losses in Hacienda Samal
1951 8,380.25
.........................................................................................................
1952 7,621.73
.........................................................................................................
2. Excessive depreciation of Houses
1950 P 8,180.40
................................................................................................................
1951 8,768.11
................................................................................................................
1952 18,002.16
................................................................................................................
1953 13,655.25
................................................................................................................
1954 29,314.98
................................................................................................................
3. Taxable Increase in net worth
1950 30,050.00
................................................................................................................
1951 1,382.85
................................................................................................................
4. Gain realized from sale of real property in
1950 P1
................................................................................................................ 11,147.26"

The Tax Court sustained the Commissioner's disallowances

of Item 1, subitems (b) and (c) and Item 2 of the above
summary, but overruled the Commissioners 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
1950 P 2,748.00
............................................................................................................................
1951 108,724.00
............................................................................................................................
1952 3,600.00
............................................................................................................................
1953 2,601,00
............................................................................................................................
1954 5,863.00
............................................................................................................................
Total .......................................................... P123,436.00

________________

1 Taxpayer's Brief as appellant, pp. 5759.

557

VOL. 29, SEPTEMBER 30, 1969 557

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

"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 as 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 def ficiency 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 taxpayer's writing 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 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 Companyreached (the taxpayer) in 1950," when it
properly claimed the loss as a deduction in its 1950 tax
558

558 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc, vs. Commissioner of Internal
Revenue

return, pursuant to Section 30 (d) (4) (b) or

2
Section 30 (e)
(3). of the National Internal Revenue Code.
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 In
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.

________________

2 CTA decision in Case 787, Taxpayer's Brief as appellant, p. 62,

559

VOL. 29, SEPTEMBER 30, 1969 559

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

'NOW THEREFORE, for and in consideration of the above premises, the

parties hereto have agreed and covenanted 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. H2)

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 prewar assets. (t.s.n., pp. 136139, 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 TC. 1593.

560

560 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue,

"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,3 the debt is not considered
worthless and therefore not deductible."

The Tax Court's disallowance of the writeoff 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
4
bad debts but insists that it is either
a loss or a bad debt." We sustain the government's position
that the advances made by the taxpayer to its 100%
subsidiary, Palawan Manganese Mines, Inc. amounting' to
5
P587,308.07 as of 1951 were investments and not loans.
 5
P587,308.07 as of 1951 were investments and not loans.
The evidence on record shows that the board 01 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's6
balance sheet as its investment in its subsidiary company.
This fact explains the liberality with which the taxpayer
made such large advances to the subsidiary, despite the
latter's admittedly poor financial condition.

________________

3 CTA decision in Case 787, Taxpayer's Brief as appellant, pp. 6366.

4 Commissioner's Brief as appellee, p. 9.
5 Idem., p. 18.
6 Idem., p. 18.

561

VOL. 29, SEPTEMBER 30, 1969 561

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

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 allged 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 f or the
purpose
7
of paying the wages of the laborers who needed
help." The correctness of the Tax Court's ruling in
sustaining the disallowance of the writeoff in 1951 of the
taxpayer's claimed losses is borne out by subsequent events
shown in Cases L24972 and L24978 involving the tax

________________

7 Taxpayer's Brief as appellant, p. 22.

562

562 SUPREME COURT REPORTS ANOOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

payer'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
8
1, 1956 that the subsidiary decided to
cease operations.
(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 in9 1950
and 1951, when they were still in operation." The
taxpayer's claim that these expeditions 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 f rom 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 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 (19511952).The Tax
Court overruled the Commissioner's disallowance of

________________

8 CTA Decision in Case 787, Taxpayer's Brief, p. 74.

9 Idem, pp. 6667.

563

VOL. 29, SEPTEMBER 80, 1969 563

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

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 nonbusiness purposes,
Therefore, it is entitled to deduct expenses and Iosses in.
connection with the operation of said farm, (See 1955 PH Fed.
Taxes, Par. 13, 663, citing G.C.M. 21103, CB 19391, 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
provide:

'lf 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 quote 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 2122, 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.

564

564 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

The same is true with respect to losses sustained in 10the operation

of the Hacienda Samal for the years 1951 and 1952."

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 x x x which merely
consisted of an alleged physical count of the number of the11
livestock in Hacienda Dalupiri for the years involved."
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
(19501954).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
12
contention that it
has many zero or onepeso assets, 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 (19501951).The Tax
Court set aside the Commissioner's treatment as tax

________________

10 CTA decision in Case 787, Taxpayer's Brief as appellant, pp. 6870.

11 Commissioner's Brief as appellant, pp. 1516.
12 Taxpayer's Brief as appellant, p. 44.

565

VOL. 29, SEPTEMBER 30, 1909 565

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

able 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 P1,382.85. 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 resulted 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 taxpayer rests on
the theory that such an increase in 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. L9193, May 29,
1957 Coll. vs. Reyes, G.R. Nos. L11534 & L11558, 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 in 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 P 1,382.85) remained
in petitioner's books as outstanding liabilities of trade creditors.
Those 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
13
was not the result of receipt
by petitioner of taxable income."

________________

13 CTA decision in Case 787, Taxpayer's Brief as appellant, pp. 7072.

566

566 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

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 f or P11,852.74, and was
sold in 1950 for
14
P60,000.00, apparently, resulting in a gain
of P48,147.26. The taxpayer reported in its return 15
a gain
of P37,000.00, or a discrepancy of P11,147.26. It was
sufficiently proved from the taxpayer's books that after
acquiring the property, the taxpayer 16
had made
improvements totalling P11,147.26, accounting for the
apparent discrepancy in the reported gain. In other words.
this figure added to the original acquisition cost of P1
1,852.74 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

_________________

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.

567

VOL. 29, SEPTEMBER 30, 1969 567

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

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 17
for review
wherein payment of the tax is prayed for." 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 taxpayers 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 fiveyear period to
effect collection by judicial action counted from the date of
assessment.

Cases L24972 and L24978

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:

"Net income per return P

.................................................................................................... 29,178.70
Add: Unallowable deductions:
(1) Net loss claimed on Ha. Dalupiri 89,547.33
.......................................................................

________________

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.

568

568 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

(2) Amortization of Contractual right claimed 48,481.62

as an expense under Mines Operations
Net income per investigation P167,297.65
................................................................................
Tax due thereon 38,818.00
....................................................................................................
Less: Amount already assessed 5,836.00
...............................................................................
Balance P 32,982.00
.................................................................................................................
Add: 1/2% monthly interest from 62059 to 5,936.76
62062
............................................................................................................
TOTAL AMOUNT DUE AND COLLECTIBLE P
18
38,918.76"

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 far 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 19to a period of
three (3) years. Without pronouncement as to costs."

Both parties again appealed from the respective adverse

rulings against them in the Tax Court's decision.

________________

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.

569

VOL. 29, SEPTEMBER 30, 1969 569

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

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
20

Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 1208, p 26.)"

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, dur

________________

20 CTA decision in CTA Case 1389, Annex C, Commissioner's Petition,

p. 3.

570

570 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

ing 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
P340,045.02 be, as they are 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. E1, 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.

571

VOL. 29, SEPTEMBER 30, 1969 571

Fernandez Hermanos, Inc. vs, Commissioner of Internal
Revenue

"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 onefifth (1/5)
01 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 abovequoted.

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. 1, pp. 3132, 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 produced mine 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
disaIIowance of the alleged 'contractual 21
rights'' amounting to
P48,481.62 must therefore be sustained."

The taxpayer insists in this appeal that it could use as a

method for depletion under the pertinent provision of

________________

21 CTA Decision in CTA Case 1389, Annex C, Commissioner's Petition,

pp. 45.

572

572 SUPREME COURT REPORTS ANNOTATED

Fernandez Hermanos, Inc. vs. Commissioner of Internal
Revenue

the Tax Code its "capital investment/' representing the

alleged value of its contractual rights and titles to mining
claims in the sum of ?242,408.10 and thus deduct outright
onefifth (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 22
the estimated cost of the reserve
used up is allowed." 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 x x x 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. L21551 and
L21557, 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. L24972 and L
24978 is affirmed in toto. No costs. So ordered.

Concepcion, C.J., Dizon, Makalintal, Zaldivar,

Sanchez, Castro, Fernando, Capistrano and Barredo, JJ.,
concur.

________________

22 CTA Decision in CTA Case 1389, Annex C. Commissioner's Petition,

pp. 45.

573

VOL. 29, SEPTEMBER 30, 1969 573

Philippine National Railways vs. Del Valle

Note.Prescription of action to recover tax.See the

annotation in 16 SCRA 596599.

_____________

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