Tuesday, July 01, 2008 Tax notes: Deductibility of bad debts
A COMPANY engaged in project management entered into an agreement with an owner of a mining claim to manage and operate the said mining claim.
Pursuant to the contract, the owner was to provide funds for the management of the mining project while the designated project manager could also transfer its own funds or property to the project when deemed necessary for the management of the project. The project manager was to be entitled to 50 percent of the net profits of the project as a form of compensation.
The manager then made advances of cash and property to the project in accordance with the agreement. However, due to continuing losses of the project that eventually resulted in cessation of the mining operations, the manager withdrew.
Thereafter, the mine owner paid the project manager on the advances that it made. The remaining outstanding indebtedness was written off by the project manager as a loss on the settlement of a receivable from the project owner. Accordingly, this loss was claimed as deduction.
The deduction was disallowed by the Bureau of Internal Revenue (BIR), which was sustained by the Court of Tax Appeals (CTA) and the Court of Appeals (CA) and affirmed by the Supreme Court, on the following grounds: (Philex Mining Corporation versus Commissioner of Internal Revenue, GR No. 148147, April 16, 2008)
1. There was no valid and existing indebtedness between the parties. The alleged indebtedness was actually a capital contribution, not a loan, considering that, under the management contract, the project manager was to share 50 percent of the project’s net profit;
2. Granting that it was a loan, it has not yet been ascertained to be worthless since the owner-company continues to exist and had not filed a petition for bankruptcy;
3. The bank loans of the project owner, which were paid by the project manager as guarantor, could not be allowed as a bad debt deduction. At the time the payments were made, the project owner was not in default since its loans were not yet due and demandable. The project manager only pre-paid the loans as evidenced by the notice sent by the bank showing that it was merely demanding payment of the installment and interests due. (Source: Punongbayan & Araullo)
