Filinvest Development Corporation extended advances in favor of its affiliates and supported the same with instructional letters and cash and journal vouchers. The BIR assessed Filinvest for deficiency income tax by imputing an “arm’s length” interest rate on its advances to affiliates. Filinvest disputed this by saying that the CIR lacks the authority to impute theoretical interest and that the rule is that interests cannot be demanded in the absence of a stipulation to the effect.


Can the CIR impute theoretical interest on the advances made by Filinvest to its affiliates?


NO. Despite the seemingly broad power of the CIR to distribute, apportion and allocate gross income under (now) Section 50 of the Tax Code, the same does not include the power to impute theoretical interests even with regard to controlled taxpayers’ transactions. This is true even if the CIR is able to prove that interest expense (on its own loans) was in fact claimed by the lending entity. The term in the definition of gross income that even those income “from whatever source derived” is covered still requires that there must be actual or at least probable receipt or realization of the item of gross income sought to be apportioned, distributed, or allocated. Finally, the rule under the Civil Code that “no interest shall be due unless expressly stipulated in writing” was also applied in this case.

The Court also ruled that the instructional letters, cash and journal vouchers qualify as loan agreements that are subject to DST.