December 3, 2009

BIR RULING [DA-(C-296) 727-09]

34 (E) (1); 25-02; DA 537-06 & 008-07

Aranas Consunji Barleta

Unit 106 G/F Le Metropole Building
326 Tordesillas cor. De la Costa Streets
Salcedo Village, Makati City

Attention: Atty. Ma. Louella M. Aranas

Gentlemen :
This refers to your letter dated 17 November 2009, requesting for a ruling
relative to the intention of LG Electronics Philippines, Inc. ("LGEPI") to write-off its
accounts receivables due from PSMT Philippines/CUL Warehouse Stores Phils., Inc.
("PMST") and claim it as a bad debt deduction from its gross income pursuant to
Section 34 (E) (1) of the Tax Code of 1997.
It is represented that LGEPI is a domestic corporation with TIN No. 000-286-
404-000 and with principal place of business at #15 F. Legazpi Street, Maybunga, Pasig
City; that it is engaged in the business of marketing, supplying and trading electronic
home appliances and has gained recognition as a leader in the said eld; that as such
supplier, it has entered into various transactions with big corporations in the Philippines
for the sale of goods on credit; that such buyers include the PSMT; that the continuing
sales on credit arrangement resulted in receivables from PSMT for goods supplied until
the year 2006, in the amount of Four Million Two Hundred Twenty Five Thousand Nine
Hundred Eighty One Pesos and Thirty Eight Centavos (P4,225,981.38); that to date,
PSMT has not ful lled its obligation to pay notwithstanding the many demand letters
sent by LGEPI and its legal counsel.
Based on the above representations, you are requesting for a ruling that LGEPI
can write-off its accounts receivables due from PSMT in the total amount of
P4,225,981.38 and claim it as a bad debt deduction from its gross income pursuant to
Section 34 (E) (1) of the Tax Code of 1997.
In reply thereto, please be informed that Section 34 (E) (1) of the Tax Code of
1997 provides: AcHEaS

"Sec. 34. Deductions from Gross Income. —

(E) Bad Debts. —
(1) In General. — Debts due to the taxpayer actually
ascertained to be worthless and charged off within the taxable
year except those not connected with profession, trade or business
and those sustained in a transaction entered into between parties
mentioned under Section 36(B) of this Code: Provided, That
recovery of bad debts previously allowed as deduction, in the
preceding years shall be included as part of the gross income in
the year of recovery to the extent of the income tax benefit of said
deduction."
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 Similarly, Revenue Regulations No. 25-02, amending Revenue Regulations No. 05-
99, and implementing Section 34 (E) (1) of the Tax Code of 1997, provides the
requisites for valid deduction of bad debts from gross income, to wit:
"Sec. 3. Requisites for valid deduction of bad debts from gross income. —
The requisites for deductibility of bad debts are:
(1) There must be an existing indebtedness due to the taxpayer which
must be valid and legally demandable;
(2) The same must be connected with the taxpayer's trade, business or
practice of profession;
(3) The same must not be sustained in a transaction entered into
between related parties enumerated under Section 36(B) of the Tax Code of
1997;
(4) The same must be actually charged off the books of accounts of the
taxpayer as of the end of the taxable year; and
(5) The same must be actually ascertained to be worthless and
uncollectible as of the end of the taxable year."
The Court of Tax Appeals (CTA) in interpreting the above requisites held that the
taxpayer is not required to be an "incorrigible optimist" in enforcing collection of a debt
(Western Paci c Corporation v. Commissioner of Internal Revenue , CTA Case No. 720,
22 May 1961 citing White Dental Mfg. vs. US, 274 US 398). He may not postpone a bad
debt deduction on the basis of a mere hope of ultimate collection but rather, should
exercise sound business judgment based upon information reasonably obtainable in
determining worthless debts and in the examination of all the circumstances. Thus, this
O ce, in BIR Ruling No. UN097-95 dated March 8, 1995, as reiterated in BIR Ruling Nos.
DA-696-06 dated December 11, 2006 and DA-008-07 dated January 9, 2007 held that —
cHCIDE

". . . [B]ad debts are allowed as deductions in the year when ascertained
to be worthless and not at the time when the taxpayer may finally 'give up' on
the possibility of recovering any part of the debts and decide to charge them off.
(CCH, 60 Vol. 2, p. 21.009, (page 252, updated National Internal Revenue Code
with Notations and Appendices, 1988 Edition, Jose Aranas)
The taxpayer must take reasonable steps to collect the debt. He does not have
to go to court if it can be shown that a judgment once obtained would be worthless
because the debtor is insolvent or 'judgment proof'. If, in the exercise of sound
business judgment a taxpayer believes there is no likelihood of recovery at any time in
the future, the debt has been worthless. (Western Paci c Corporation v. Collector of
Internal Revenue, CTA Case No. 720)
In applying the above principle in this case, LGEPI took reasonable steps to
collect the debt. Considering that there is no likelihood of recovery at any time in the
future, the debt can now be considered worthless. In view of the foregoing, LGEPI may
write-off its accounts receivables due from PSMT in the total amount of
P4,225,981.3884 and claim it as a bad debt deduction from its gross income pursuant
to Section 34 (E) (1) of the Tax Code of 1997. Furthermore, there is no donor's tax due
on the said write off considering that LGEPI did not have donative intent (BIR Ruling
537-06 dated September 5, 2006).
This ruling is being issued on the basis of the foregoing facts as represented.
However, if upon investigation, it will be disclosed that the facts are different, then this
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 ruling shall be considered null and void.

Very truly yours,

Commissioner of Internal Revenue

By:
(SGD.) JAMES H. ROLDAN
Assistant Commissioner
Legal Service

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