G.R. No.

L-22492

September 5, 1967

BASILAN ESTATES, INC., petitioner,

vs.
THE COMMISSIONER OF INTERNAL REVENUE and THE COURT OF TAX
APPEALS, respondents.
A Philippine corporation engaged in the coconut industry, Basilan Estates, Inc., with principal offices
in Basilan City, filed on March 24, 1954 its income tax returns for 1953 and paid an income tax of
P8,028. On February 26, 1959, the Commissioner of Internal Revenue, per examiners' report of
February 19, 1959, assessed Basilan Estates, Inc., a deficiency income tax of P3,912 for 1953 and
P86,876.85 as 25% surtax on unreasonably accumulated profits as of 1953 pursuant to Section 25
of the Tax Code. On non-payment of the assessed amount, a warrant of distraint and levy was
issued but the same was not executed because Basilan Estates, Inc. succeeded in getting the
Deputy Commissioner of Internal Revenue to order the Director of the district in Zamboanga City to
hold execution and maintain constructive embargo instead. Because of its refusal to waive the
period of prescription, the corporation's request for reinvestigation was not given due course, and on
December 2, 1960, notice was served the corporation that the warrant of distraint and levy would be
executed.
On December 20, 1960, Basilan Estates, Inc. filed before the Court of Tax Appeals a petition for
review of the Commissioner's assessment, alleging prescription of the period for assessment and
collection; error in disallowing claimed depreciations, travelling and miscellaneous expenses; and
error in finding the existence of unreasonably accumulated profits and the imposition of 25% surtax
thereon. On October 31, 1963, the Court of Tax Appeals found that there was no prescription and
affirmed the deficiency assessment in toto.
On February 21, 1964, the case was appealed to Us by the taxpayer, upon the following issues:
1. Has the Commissioner's right to collect deficiency income tax prescribed?
2. Was the disallowance of items claimed as deductible proper?
3. Have there been unreasonably accumulated profits? If so, should the 25% surtax be imposed on
the balance of the entire surplus from 1947-1953, or only for 1953?
4. Is the petitioner exempt from the penalty tax under Republic Act 1823 amending Section 25 of the
Tax Code?
PRESCRIPTION
There is no dispute that the assessment of the deficiency tax was made on February 26, 1959; but
the petitioner claims that it never received notice of such assessment or if it did, it received the
notice beyond the five-year prescriptive period. To show prescription, the annotation on the notice
(Exhibit 10, No. 52, ACR, p. 54-A of the BIR records) "No accompanying letter 11/25/" is advanced
as indicative of the fact that receipt of the notice was after March 24, 1959, the last date of the fiveyear period within which to assess deficiency tax, since the original returns were filed on March 24,
1954.

Although the evidence is not clear on this point, We cannot accept this interpretation of the
petitioner, considering the presence of circumstances that lead Us to presume regularity in the
performance of official functions. The notice of assessment shows the assessment to have been
made on February 26, 1959, well within the five-year period. On the right side of the notice is also
stamped "Feb. 26, 1959" denoting the date of release, according to Bureau of Internal Revenue
practice. The Commissioner himself in his letter (Exh. H, p. 84 of BIR records) answering petitioner's
request to lift, the warrant of distraint and levy, asserts that notice had been sent to petitioner. In the
letter of the Regional Director forwarding the case to the Chief of the Investigation Division which the
latter received on March 10, 1959 (p. 71 of the BIR records), notice of assessment was said to have
been sent to petitioner. Subsequently, the Chief of the Investigation Division indorsed on March 18,
1959 (p. 24 of the BIR records) the case to the Chief of the Law Division. There it was alleged that
notice was already sent to petitioner on February 26, 1959. These circumstances pointing to official
performance of duty must necessarily prevail over petitioner's contrary interpretation. Besides, even
granting that notice had been received by the petitioner late, as alleged, under Section 331 of the
Tax Code requiring five years within which to assess deficiency taxes, the assessment is deemed
made when notice to this effect is released, mailed or sent by the Collector to the taxpayer and it is
not required that the notice be received by the taxpayer within the aforementioned five-year period. 1
ASSESSMENT
The questioned assessment is as follows:
Net Income per return
Add: Over-claimed depreciation
Mis. expenses disallowed
Officer's
travelling
disallowed

P40,142.90
P10,500.49
6,759.17

expenses

2,300.40

19,560.06

Net Income per Investigation

20% tax on P59,702.96
Less: Tax already assessed

P59,702.96
11,940.00
8,028.00

Deficiency income tax

Add: Additional tax of 25% on P347,507.01

P3,912.00
86,876.75

Tax Due & Collectible

P90,788.75
=========

The Commissioner disallowed:

Over-claimed depreciation
Miscellaneous expenses
Officer's travelling expenses

P10,500.49
6,759.17
2,300.40

DEDUCTIONS
A. Depreciation. Basilan Estates, Inc. claimed deductions for the depreciation of its assets up to
1949 on the basis of their acquisition cost. As of January 1, 1950 it changed the depreciable value of
said assets by increasing it to conform with the increase in cost for their replacement. Accordingly,

from 1950 to 1953 it deducted from gross income the value of depreciation computed on the
reappraised value.
In 1953, the year involved in this case, taxpayer claimed the following depreciation deduction:
Reappraised assets
P47,342.53
New assets consisting of hospital building and
equipment
3,910.45
Total depreciation
P51,252.98
Upon investigation and examination of taxpayer's books and papers, the Commissioner of Internal
Revenue found that the reappraised assets depreciated in 1953 were the same ones upon which
depreciation was claimed in 1952. And for the year 1952, the Commissioner had already
determined, with taxpayer's concurrence, the depreciation allowable on said assets to be
P36,842.04, computed on their acquisition cost at rates fixed by the taxpayer. Hence, the
Commissioner pegged the deductible depreciation for 1953 on the same old assets at P36,842.04
and disallowed the excess thereof in the amount of P10,500.49.
The question for resolution therefore is whether depreciation shall be determined on the acquisition
cost or on the reappraised value of the assets.
Depreciation is the gradual diminution in the useful value of tangible property resulting from wear
and tear and normal obsolescense. The term is also applied to amortization of the value of intangible
assets, the use of which in the trade or business is definitely limited in duration. 2 Depreciation
commences with the acquisition of the property and its owner is not bound to see his property
gradually waste, without making provision out of earnings for its replacement. It is entitled to see that
from earnings the value of the property invested is kept unimpaired, so that at the end of any given
term of years, the original investment remains as it was in the beginning. It is not only the right of a
company to make such a provision, but it is its duty to its bond and stockholders, and, in the case of
a public service corporation, at least, its plain duty to the public. 3 Accordingly, the law permits the
taxpayer to recover gradually his capital investment in wasting assets free from income
tax.4 Precisely, Section 30 (f) (1) which states:
(1)In general. A reasonable allowance for deterioration of property arising out of its use or
employment in the business or trade, or out of its not being used: Provided, That when the
allowance authorized under this subsection shall equal the capital invested by the
taxpayer . . . no further allowance shall be made. . . .
allows a deduction from gross income for depreciation but limits the recovery to the capital invested
in the asset being depreciated.
The income tax law does not authorize the depreciation of an asset beyond its acquisition cost.
Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is that
deductions from gross income are privileges, 5 not matters of right.6 They are not created by
implication but upon clear expression in the law.7
Moreover, the recovery, free of income tax, of an amount more than the invested capital in an asset
will transgress the underlying purpose of a depreciation allowance. For then what the taxpayer would
recover will be, not only the acquisition cost, but also some profit. Recovery in due time thru
depreciation of investment made is the philosophy behind depreciation allowance; the idea of profit

on the investment made has never been the underlying reason for the allowance of a deduction for
depreciation.
Accordingly, the claim for depreciation beyond P36,842.04 or in the amount of P10,500.49 has no
justification in the law. The determination, therefore, of the Commissioner of Internal Revenue
disallowing said amount, affirmed by the Court of Tax Appeals, is sustained.
B. Expenses. The next item involves disallowed expenses incurred in 1953, broken as follows:
Miscellaneous expenses
Officer's travelling expenses
Total

P6,759.17
2,300.40
P9,059.57

These were disallowed on the ground that the nature of these expenses could not be satisfactorily
explained nor could the same be supported by appropriate papers.
Felix Gulfin, petitioner's accountant, explained the P6,759.17 was actual expenses credited to the
account of the president of the corporation incurred in the interest of the corporation during the
president's trip to Manila (pp. 33-34 of TSN of Dec. 5, 1962); he stated that the P2,300.40 was the
president's travelling expenses to and from Manila as to the vouchers and receipts of these, he said
the same were made but got burned during the Basilan fire on March 30, 1962 (p. 40 of same TSN).
Petitioner further argues that when it sent its records to Manila in February, 1959, the papers in
support of these miscellaneous and travelling expenses were not included for the reason that by
February 9, 1959, when the Bureau of Internal Revenue decided to investigate, petitioner had no
more obligation to keep the same since five years had lapsed from the time these expenses were
incurred (p. 41 of same TSN). On this ground, the petitioner may be sustained, for under Section
337 of the Tax Code, receipts and papers supporting such expenses need be kept by the taxpayer
for a period of five years from the last entry. At the time of the investigation, said five years had
lapsed. Taxpayer's stand on this issue is therefore sustained.
UNREASONABLY ACCUMULATED PROFITS
Section 25 of the Tax Code which imposes a surtax on profits unreasonably accumulated, provides:
Sec. 25. Additional tax on corporations improperly accumulating profits or surplus (a)
Imposition of tax. If any corporation, except banks, insurance companies, or personal
holding companies, whether domestic or foreign, is formed or availed of for the purpose of
preventing the imposition of the tax upon its shareholders or members or the shareholders or
members of another corporation, through the medium of permitting its gains and profits to
accumulate instead of being divided or distributed, there is levied and assessed against such
corporation, for each taxable year, a tax equal to twenty-five per centum of the undistributed
portion of its accumulated profits or surplus which shall be in addition to the tax imposed by
section twenty-four, and shall be computed, collected and paid in the same manner and
subject to the same provisions of law, including penalties, as that tax.
1awphl.nt

The Commissioner found that in violation of the abovequoted section, petitioner had unreasonably
accumulated profits as of 1953 in the amount of P347,507.01, based on the following circumstances
(Examiner's Report pp. 62-68 of BIR records):

1. Strong financial position of the petitioner as of December 31, 1953. Assets were
P388,617.00 while the liabilities amounted to only P61,117.31 or a ratio of 6:1.
2. As of 1953, the corporation had considerable capital adequate to meet the reasonable
needs of the business amounting to P327,499.69 (assets less liabilities).
3. The P200,000 reserved for electrification of drier and mechanization and the P50,000
reserved for malaria control were reverted to its surplus in 1953.
4. Withdrawal by shareholders, of large sums of money as personal loans.
5. Investment of undistributed earnings in assets having no proximate connection with the
business as hospital building and equipment worth P59,794.72.
6. In 1953, with an increase of surplus amounting to P677,232.01, the capital stock was
increased to P500,000 although there was no need for such increase.
Petitioner tried to show that in considering the surplus, the examiner did not take into account the
possible expenses for cultivation, labor, fertilitation, drainage, irrigation, repair, etc. (pp. 235-237 of
TSN of Dec. 7, 1962). As aptly answered by the examiner himself, however, they were already
included as part of the working capital (pp. 237-238 of TSN of Dec. 7, 1962).
In the unreasonable accumulation of P347,507.01 are included P200,000 for electrification of driers
and mechanization and P50,000 for malaria control which were reserved way back in 1948 (p. 67 of
the BIR records) but reverted to the general fund only in 1953. If there were any plans for these
amounts to be used in further expansion through projects, it did not appear in the records as was
properly indicated in 1948 when such amounts were reserved. Thus, while in 1948 it was already
clear that the money was intended to go to future projects, in 1953 upon reversion to the general
fund, no such intention was shown. Such reversion therefore gave occasion for the Government to
consider the same for tax purposes. The P250,000 reverted to the general fund was sought to be
explained as later used elsewhere: "part of it in the Hilano Industries, Inc. in building the factory site
and buildings to house technical men . . . part of it was spent in the facilities for the waterworks
system and for industrialization of the coconut industry" (p. 117 of TSN of Dec. 6, 1962). This is not
sufficient explanation. Persuasive jurisprudence on the matter such as those in the United States
from where our tax law was derived, 8has it that: "In order to determine whether profits were
accumulated for the reasonable needs of the business or to avoid the surtax upon shareholders, the
controlling intention of the taxpayer is that which is manifested at the time of the accumulation, not
subsequently declared intentions which are merely the products of after-thought." 9 The reversion
here was made because the reserved amount was not enough for the projects intended, without any
intent to channel the same to some particular future projects in mind.
Petitioner argues that since it has P560,717.44 as its expenses for the year 1953, a surplus of
P347,507.01 is not unreasonably accumulated. As rightly contended by the Government, there is no
need to have such a large amount at the beginning of the following year because during the year,
current assets are converted into cash and with the income realized from the business as the year
goes, these expenses may well be taken care of (pp. 238 of TSN of Dec. 7, 1962). Thus, it is
erroneous to say that the taxpayer is entitled to retain enough liquid net assets in amounts
approximately equal to current operating needs for the year to cover "cost of goods sold and
operating expenses" for "it excludes proper consideration of funds generated by the collection of
notes receivable as trade accounts during the course of the year." 10 In fact, just because the fatal
accumulations are less than 70% of the annual operating expenses of the year, it does not mean
that the accumulations are reasonable as a matter of law." 11

Petitioner tried to show that investments were made with Basilan Coconut Producers Cooperative
Association and Basilan Hospital (pp. 103-105 of TSN of Dec. 6, 1962) totalling P59,794.72 as of
December 31, 1953. This shows all the more the unreasonable accumulation. As of December 31,
1953 already P59,794.72 was spent yet as of that date there was still a surplus of P347,507.01.
Petitioner questions why the examiner covered the period from 1948-1953 when the taxable year on
review was 1953. The surplus of P347,507.01 was taken by the examiner from the balance sheet of
petitioner for 1953. To check the figure arrived at, the examiner traced the accumulation process
from 1947 until 1953, and petitioner's figure stood out to be correct. There was no error in the
process applied, for previous accumulations should be considered in determining unreasonable
accumulations for the year concerned. "In determining whether accumulations of earnings or profits
in a particular year are within the reasonable needs of a corporation, it is neccessary to take into
account prior accumulations, since accumulations prior to the year involved may have been
sufficient to cover the business needs and additional accumulations during the year involved would
not reasonably be necessary."12
Another factor that stands out to show unreasonable accumulation is the fact that large amounts
were withdrawn by or advanced to the stockholders. For the year 1953 alone these totalled
P197,229.26. Yet the surplus of P347,507.01 was left as of December 31, 1953. We find
unacceptable petitioner's explanation that these were advances made in furtherance of the business
purposes of the petitioner. As correctly held by the Court of Tax Appeals, while certain expenses of
the corporation were credited against these amounts, the unspent balance was retained by the
stockholders without refunding them to petitioner at the end of each year. These advances were in
fact indirect loans to the stockholders indicating the unreasonable accumulation of surplus beyond
the needs of the business.
ALLEGED EXEMPTION
Petitioner wishes to avail of the exempting proviso in Sec. 25 of the Internal Revenue Code as
amended by R.A. 1823, approved June 22, 1957, whereby accumulated profits or surplus if invested
in any dollar-producing or dollar-earning industry or in the purchase of bonds issued by the Central
Bank, may not be subject to the 25% surtax. We have but to point out that the unreasonable
accumulation was in 1953. The exemption was by virtue of Republic Act 1823 which amended Sec.
25 only on June 22, 1957 more than three years after the period covered by the assessment.
In resume, Basilan Estates, Inc. is liable for the payment of deficiency income tax and surtax for the
year 1953 in the amount of P88,977.42, computed as follows:
Net Income per return
P40,142.90
Add:
Over-claimed
10,500.49
depreciation
Net income per finding

P50,643.39

20% tax on P50,643.39

Less: Tax already assessed

P10,128.67
8,028.00

Deficiency income tax

Add:
25%
surtax
P347,507.01
Total tax due and collectible

P2,100.67
on

86,876.75

P88,977.42
===========
WHEREFORE, the judgment appealed from is modified to the extent that petitioner is allowed its
deductions for travelling and miscellaneous expenses, but affirmed insofar as the petitioner is liable
for P2,100.67 as deficiency income tax for 1953 and P86,876.75 as 25% surtax on the unreasonably
accumulated profit of P347,507.01. No costs. So ordered.