Denden 1028

G.R. No. 163653 July 19, 2011

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs.FILINVEST DEVELOPMENT CORPORATION, Respondent.

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G.R. No. 167689

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs.FILINVEST DEVELOPMENT CORPORATION, Respondent.

D E C I S I O N

PEREZ, J.:

Assailed in these twin petitions for review on certiorari filed pursuant to Rule 45 of the 1997 Rules of Civil Procedure are the decisions rendered by the Court of Appeals (CA) in the following cases: (a) Decision dated 16 December 2003 of the then Special Fifth Division in CA-G.R. SP No. 72992;1 and, (b) Decision dated 26 January 2005 of the then Fourteenth Division in CA-G.R. SP No. 74510.2

The Facts

The owner of 80% of the outstanding shares of respondent Filinvest Alabang, Inc. (FAI), respondent Filinvest Development Corporation (FDC) is a holding company which also owned 67.42% of the outstanding shares of Filinvest Land, Inc. (FLI). On 29 November 1996, FDC and FAI entered into a Deed of Exchange with FLI whereby the former both transferred in favor of the latter parcels of land appraised at P4,306,777,000.00. In exchange for said parcels which were intended to facilitate development of medium-rise residential and commercial buildings, 463,094,301 shares of stock of FLI were issued to FDC and FAI.3 As a result of the exchange, FLI’s ownership structure was changed to the extent reflected in the following tabular précis, viz.:

Stockholder

Number and Percentage of Shares

Held Prior to the Exchange

Number of Additional

Shares Issued

Number and Percentage of Shares

Held After the Exchange

FDC 2,537,358,000

67.42%

42,217,000 2,579,575,000

61.03%

FAI 0 0 420,877,000

420,877,000 9.96%

OTHERS 1,226,177,00 32.58 0 1,226,177,00 29.01%

0 % 0

3,763,535,000

100% 463,094,301

4,226,629,000

(100%)

On 13 January 1997, FLI requested a ruling from the Bureau of Internal Revenue (BIR) to the effect that no gain or loss should be recognized in the aforesaid transfer of real properties. Acting on the request, the BIR issued Ruling No. S-34-046-97 dated 3 February 1997, finding that the exchange is among those contemplated under Section 34 (c) (2) of the old National Internal Revenue Code (NIRC)4 which provides that "(n)o gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for a stock in such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four (4) persons, gains control of said corporation."5 With the BIR’s reiteration of the foregoing ruling upon the 10 February 1997 request for clarification filed by FLI,6 the latter, together with FDC and FAI, complied with all the requirements imposed in the ruling.7

On various dates during the years 1996 and 1997, in the meantime, FDC also extended advances in favor of its affiliates, namely, FAI, FLI, Davao Sugar Central Corporation (DSCC) and Filinvest Capital, Inc. (FCI).8 Duly evidenced by instructional letters as well as cash and journal vouchers, said cash advances amounted to P2,557,213,942.60 in 19969 and P3,360,889,677.48 in 1997.10 On 15 November 1996, FDC also entered into a Shareholders’ Agreement with Reco Herrera PTE Ltd. (RHPL) for the formation of a Singapore-based joint venture company called Filinvest Asia Corporation (FAC), tasked to develop and manage FDC’s 50% ownership of its PBCom

Office Tower Project (the Project). With their equity participation in FAC respectively pegged at 60% and 40% in the Shareholders’ Agreement, FDC subscribed to P500.7 million worth of shares in said joint venture company to RHPL’s subscription worth P433.8 million. Having paid its subscription by executing a Deed of Assignment transferring to FAC a portion of its rights and interest in the Project worth P500.7 million, FDC eventually reported a net loss of P190,695,061.00 in its Annual Income Tax Return for the taxable year 1996.11

On 3 January 2000, FDC received from the BIR a Formal Notice of Demand to pay deficiency income and documentary stamp taxes, plus interests and compromise penalties,12 covered by the following Assessment Notices, viz.: (a) Assessment Notice No. SP-INC-96-00018-2000 for deficiency income taxes in the sum of P150,074,066.27 for 1996; (b) Assessment Notice No. SP-DST-96-00020-2000 for deficiency documentary stamp taxes in the sum of P10,425,487.06 for 1996; (c) Assessment Notice No. SP-INC-97-00019-2000 for deficiency income taxes in the sum of P5,716,927.03 for 1997; and (d) Assessment Notice No. SP-DST-97-00021-2000 for deficiency documentary stamp taxes in the sum of P5,796,699.40 for 1997.13 The foregoing deficiency taxes were assessed on the taxable gain supposedly realized by FDC from the Deed of Exchange it executed with FAI and FLI, on the dilution resulting from the Shareholders’ Agreement FDC executed with RHPL as well as the "arm’s-length" interest rate and documentary stamp taxes imposable on the advances FDC extended to its affiliates.14

On 3 January 2000, FAI similarly received from the BIR a Formal Letter of Demand for deficiency income taxes in the sum of P1,477,494,638.23 for the year 1997.15 Covered by Assessment Notice No. SP-INC-97-0027-2000,16 said deficiency tax was also assessed on the taxable gain purportedly realized by FAI from the Deed of Exchange it executed with FDC and FLI.17 On 26 January 2000 or within the reglementary period of thirty (30) days from notice of

the assessment, both FDC and FAI filed their respective requests for reconsideration/protest, on the ground that the deficiency income and documentary stamp taxes assessed by the BIR were bereft of factual and legal basis.18 Having submitted the relevant supporting documents pursuant to the 31 January 2000 directive from the BIR Appellate Division, FDC and FAI filed on 11 September 2000 a letter requesting an early resolution of their request for reconsideration/protest on the ground that the 180 days prescribed for the resolution thereof under Section 228 of the NIRC was going to expire on 20 September 2000.19

In view of the failure of petitioner Commissioner of Internal Revenue (CIR) to resolve their request for reconsideration/protest within the aforesaid period, FDC and FAI filed on 17 October 2000 a petition for review with the Court of Tax Appeals (CTA) pursuant to Section 228 of the 1997 NIRC. Docketed before said court as CTA Case No. 6182, the petition alleged, among other matters, that as previously opined in BIR Ruling No. S-34-046-97, no taxable gain should have been assessed from the subject Deed of Exchange since FDC and FAI collectively gained further control of FLI as a consequence of the exchange; that correlative to the CIR's lack of authority to impute theoretical interests on the cash advances FDC extended in favor of its affiliates, the rule is settled that interests cannot be demanded in the absence of a stipulation to the effect; that not being promissory notes or certificates of obligations, the instructional letters as well as the cash and journal vouchers evidencing said cash advances were not subject to documentary stamp taxes; and, that no income tax may be imposed on the prospective gain from the supposed appreciation of FDC's shareholdings in FAC. As a consequence, FDC and FAC both prayed that the subject assessments for deficiency income and documentary stamp taxes for the years 1996 and 1997 be cancelled and annulled.20

On 4 December 2000, the CIR filed its answer, claiming that the transfer of property in question should not be considered tax free since, with the resultant diminution of its shares in FLI, FDC did not gain further control of said corporation. Likewise calling attention to the fact that the cash advances FDC extended to its affiliates were interest free despite the interest bearing loans it obtained from banking institutions, the CIR invoked Section 43 of the old NIRC which, as implemented by Revenue Regulations No. 2, Section 179 (b) and (c), gave him "the power to allocate, distribute or apportion income or deductions between or among such organizations, trades or business in order to prevent evasion of taxes." The CIR justified the imposition of documentary stamp taxes on the instructional letters as well as cash and journal vouchers for said cash advances on the strength of Section 180 of the NIRC and Revenue Regulations No. 9-94 which provide that loan transactions are subject to said tax irrespective of whether or not they are evidenced by a formal agreement or by mere office memo. The CIR also argued that FDC realized taxable gain arising from the dilution of its shares in FAC as a result of its Shareholders' Agreement with RHPL.21

At the pre-trial conference, the parties filed a Stipulation of Facts, Documents and Issues22 which was admitted in the 16 February 2001 resolution issued by the CTA. With the further admission of the Formal Offer of Documentary Evidence subsequently filed by FDC and FAI23 and the conclusion of the testimony of Susana Macabelda anent the cash advances FDC extended in favor of its affiliates,24 the CTA went on to render the Decision dated 10 September 2002 which, with the exception of the deficiency income tax on the interest income FDC supposedly realized from the advances it extended in favor of its affiliates, cancelled the rest of deficiency income and documentary stamp taxes assessed against FDC and FAI for the years 1996 and 1997,25 thus:

WHEREFORE, in view of all the foregoing, the court finds the instant petition partly meritorious. Accordingly, Assessment Notice No. SP-INC-96-00018-2000 imposing deficiency income tax on FDC for taxable year 1996, Assessment Notice No. SP-DST-96-00020-2000 and SP-DST-97-00021-2000 imposing deficiency documentary stamp tax on FDC for taxable years 1996 and 1997, respectively and Assessment Notice No. SP-INC-97-0027-2000 imposing deficiency income tax on FAI for the taxable year 1997 are hereby CANCELLED and SET ASIDE. However, [FDC] is hereby ORDERED to PAY the amount of P5,691,972.03 as deficiency income tax for taxable year 1997. In addition, petitioner is also ORDERED to PAY 20% delinquency interest computed from February 16, 2000 until full payment thereof pursuant to Section 249 (c) (3) of the Tax Code.26

Finding that the collective increase of the equity participation of FDC and FAI in FLI rendered the gain derived from the exchange tax-free, the CTA also ruled that the increase in the value of FDC's shares in FAC did not result in economic advantage in the absence of actual sale or conversion thereof. While likewise finding that the documents evidencing the cash advances FDC extended to its affiliates cannot be considered as loan agreements that are subject to documentary stamp tax, the CTA enunciated, however, that the CIR was justified in assessing undeclared interests on the same cash advances pursuant to his authority under Section 43 of the NIRC in order to forestall tax evasion. For persuasive effect, the CTA referred to the equivalent provision in the Internal Revenue Code of the United States (IRC-US), i.e., Sec. 482, as implemented by Section 1.482-2 of 1965-1969 Regulations of the Law of Federal Income Taxation.27

Dissatisfied with the foregoing decision, FDC filed on 5 November 2002 the petition for review docketed before the CA as CA-G.R. No. 72992, pursuant to Rule 43 of the 1997 Rules of Civil Procedure. Calling attention to the fact that

the cash advances it extended to its affiliates were interest-free in the absence of the express stipulation on interest required under Article 1956 of the Civil Code, FDC questioned the imposition of an arm's-length interest rate thereon on the ground, among others, that the CIR's authority under Section 43 of the NIRC: (a) does not include the power to impute imaginary interest on said transactions; (b) is directed only against controlled taxpayers and not against mother or holding corporations; and, (c) can only be invoked in cases of understatement of taxable net income or evident tax evasion.28 Upholding FDC's position, the CA's then Special Fifth Division rendered the herein assailed decision dated 16 December 2003,29 the decretal portion of which states:

WHEREFORE, premises considered, the instant petition is hereby GRANTED. The assailed Decision dated September 10, 2002 rendered by the Court of Tax Appeals in CTA Case No. 6182 directing petitioner Filinvest Development Corporation to pay the amount of P5,691,972.03 representing deficiency income tax on allegedly undeclared interest income for the taxable year 1997, plus 20% delinquency interest computed from February 16, 2000 until full payment thereof is REVERSED and SET ASIDE and, a new one entered annulling Assessment Notice No. SP-INC-97-00019-2000 imposing deficiency income tax on petitioner for taxable year 1997. No pronouncement as to costs.30

With the denial of its partial motion for reconsideration of the same 11 December 2002 resolution issued by the CTA,31 the CIR also filed the petition for review docketed before the CA as CA-G.R. No. 74510. In essence, the CIR argued that the CTA reversibly erred in cancelling the assessment notices: (a) for deficiency income taxes on the exchange of property between FDC, FAI and FLI; (b) for deficiency documentary stamp taxes on the documents evidencing FDC's cash advances to its affiliates; and (c) for deficiency income tax on the gain FDC purportedly realized from the increase of the value of its shareholdings in FAC.32 The foregoing petition was, however, denied due course and dismissed for

lack of merit in the herein assailed decision dated 26 January 200533 rendered by the CA's then Fourteenth Division, upon the following findings and conclusions, to wit:

1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-046-97, the 29 November 1996 Deed of Exchange resulted in the combined control by FDC and FAI of more than 51% of the outstanding shares of FLI, hence, no taxable gain can be recognized from the transaction under Section 34 (c) (2) of the old NIRC;

2. The instructional letters as well as the cash and journal vouchers evidencing the advances FDC extended to its affiliates are not subject to documentary stamp taxes pursuant to BIR Ruling No. 116-98, dated 30 July 1998, since they do not partake the nature of loan agreements;

3. Although BIR Ruling No. 116-98 had been subsequently modified by BIR Ruling No. 108-99, dated 15 July 1999, to the effect that documentary stamp taxes are imposable on inter-office memos evidencing cash advances similar to those extended by FDC, said latter ruling cannot be given retroactive application if to do so would be prejudicial to the taxpayer;

4. FDC's alleged gain from the increase of its shareholdings in FAC as a consequence of the Shareholders' Agreement it executed with RHPL cannot be considered taxable income since, until actually converted thru sale or disposition of said shares, they merely represent unrealized increase in capital.34

Respectively docketed before this Court as G.R. Nos. 163653 and 167689, the CIR's petitions for review on certiorari assailing the 16 December 2003 decision in CA-G.R. No. 72992 and the 26 January 2005 decision in CA-G.R. SP No. 74510 were consolidated pursuant to the 1 March 2006 resolution issued by this Court’s Third Division.

The Issues

In G.R. No. 163653, the CIR urges the grant of its petition on the following ground:

THE COURT OF APPEALS ERRED IN REVERSING THE DECISION OF THE COURT OF TAX APPEALS AND IN HOLDING THAT THE ADVANCES EXTENDED BY RESPONDENT TO ITS AFFILIATES ARE NOT SUBJECT TO INCOME TAX.35

In G.R. No. 167689, on the other hand, petitioner proffers the following issues for resolution:

I

THE HONORABLE COURT OF APPEALS COMMITTED GRAVE ABUSE OF DISCRETION IN HOLDING THAT THE EXCHANGE OF SHARES OF STOCK FOR PROPERTY AMONG FILINVEST DEVELOPMENT CORPORATION (FDC), FILINVEST ALABANG, INCORPORATED (FAI) AND FILINVEST LAND INCORPORATED (FLI) MET ALL THE REQUIREMENTS FOR THE NON-RECOGNITION OF TAXABLE GAIN UNDER SECTION 34 (c) (2) OF THE OLD NATIONAL INTERNAL REVENUE CODE (NIRC) (NOW SECTION 40 (C) (2) (c) OF THE NIRC.

II

THE HONORABLE COURT OF APPEALS COMMITTED REVERSIBLE ERROR IN HOLDING THAT THE LETTERS OF INSTRUCTION OR CASH VOUCHERS EXTENDED BY FDC TO ITS AFFILIATES ARE NOT DEEMED LOAN AGREEMENTS SUBJECT TO DOCUMENTARY STAMP TAXES UNDER SECTION 180 OF THE NIRC.

III

THE HONORABLE COURT OF APPEALS GRAVELY ERRED IN HOLDING THAT GAIN ON DILUTION AS A RESULT OF THE INCREASE IN THE VALUE OF FDC’S SHAREHOLDINGS IN FAC IS NOT TAXABLE.36

The Court’s Ruling

While the petition in G.R. No. 163653 is bereft of merit, we find the CIR’s petition in G.R. No. 167689 impressed with partial merit.

In G.R. No. 163653, the CIR argues that the CA erred in reversing the CTA’s finding that theoretical interests can be imputed on the advances FDC extended to its affiliates in 1996 and 1997 considering that, for said purpose, FDC resorted to interest-bearing fund borrowings from commercial banks. Since considerable interest expenses were deducted by FDC when said funds were borrowed, the CIR theorizes that interest income should likewise be declared

when the same funds were sourced for the advances FDC extended to its affiliates. Invoking Section 43 of the 1993 NIRC in relation to Section 179(b) of Revenue Regulation No. 2, the CIR maintains that it is vested with the power to allocate, distribute or apportion income or deductions between or among controlled organizations, trades or businesses even in the absence of fraud, since said power is intended "to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades or businesses." In addition, the CIR asseverates that the CA should have accorded weight and respect to the findings of the CTA which, as the specialized court dedicated to the study and consideration of tax matters, can take judicial notice of US income tax laws and regulations.37

Admittedly, Section 43 of the 1993 NIRC38 provides that, "(i)n any case of two or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner of Internal Revenue is authorized to distribute, apportion or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization, trade or business." In amplification of the equivalent provision39 under Commonwealth Act No. 466,40 Sec. 179(b) of Revenue Regulation No. 2 states as follows:

Determination of the taxable net income of controlled taxpayer. – (A) DEFINITIONS. – When used in this section –

(1) The term "organization" includes any kind, whether it be a sole proprietorship, a partnership, a trust, an estate, or a corporation or association, irrespective of the place where organized, where operated, or where its

trade or business is conducted, and regardless of whether domestic or foreign, whether exempt or taxable, or whether affiliated or not.

(2) The terms "trade" or "business" include any trade or business activity of any kind, regardless of whether or where organized, whether owned individually or otherwise, and regardless of the place where carried on.

(3) The term "controlled" includes any kind of control, direct or indirect, whether legally enforceable, and however exercisable or exercised. It is the reality of the control which is decisive, not its form or mode of exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.

(4) The term "controlled taxpayer" means any one of two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests.

(5) The term "group" and "group of controlled taxpayers" means the organizations, trades or businesses owned or controlled by the same interests.

(6) The term "true net income" means, in the case of a controlled taxpayer, the net income (or as the case may be, any item or element affecting net income) which would have resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, any item or element affecting net income) which would have resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the particular contract, transaction, arrangement or other act) dealt with the other members or members of the group at arm’s length. It does not mean the income, the deductions, or the item or element of either, resulting to the

controlled taxpayer by reason of the particular contract, transaction, or arrangement, the controlled taxpayer, or the interest controlling it, chose to make (even though such contract, transaction, or arrangement be legally binding upon the parties thereto).

(B) SCOPE AND PURPOSE. - The purpose of Section 44 of the Tax Code is to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled taxpayer, the true net income from the property and business of a controlled taxpayer. The interests controlling a group of controlled taxpayer are assumed to have complete power to cause each controlled taxpayer so to conduct its affairs that its transactions and accounting records truly reflect the net income from the property and business of each of the controlled taxpayers. If, however, this has not been done and the taxable net income are thereby understated, the statute contemplates that the Commissioner of Internal Revenue shall intervene, and, by making such distributions, apportionments, or allocations as he may deem necessary of gross income or deductions, or of any item or element affecting net income, between or among the controlled taxpayers constituting the group, shall determine the true net income of each controlled taxpayer. The standard to be applied in every case is that of an uncontrolled taxpayer. Section 44 grants no right to a controlled taxpayer to apply its provisions at will, nor does it grant any right to compel the Commissioner of Internal Revenue to apply its provisions.

(C) APPLICATION – Transactions between controlled taxpayer and another will be subjected to special scrutiny to ascertain whether the common control is being used to reduce, avoid or escape taxes. In determining the true net income of a controlled taxpayer, the Commissioner of Internal Revenue is not restricted to the case of improper accounting, to the case of a fraudulent, colorable, or sham transaction, or to the case of a device designed to reduce

or avoid tax by shifting or distorting income or deductions. The authority to determine true net income extends to any case in which either by inadvertence or design the taxable net income in whole or in part, of a controlled taxpayer, is other than it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer dealing at arm’s length with another uncontrolled taxpayer.41

As may be gleaned from the definitions of the terms "controlled" and "controlled taxpayer" under paragraphs (a) (3) and (4) of the foregoing provision, it would appear that FDC and its affiliates come within the purview of Section 43 of the 1993 NIRC. Aside from owning significant portions of the shares of stock of FLI, FAI, DSCC and FCI, the fact that FDC extended substantial sums of money as cash advances to its said affiliates for the purpose of providing them financial assistance for their operational and capital expenditures seemingly indicate that the situation sought to be addressed by the subject provision exists. From the tenor of paragraph (c) of Section 179 of Revenue Regulation No. 2, it may also be seen that the CIR's power to distribute, apportion or allocate gross income or deductions between or among controlled taxpayers may be likewise exercised whether or not fraud inheres in the transaction/s under scrutiny. For as long as the controlled taxpayer's taxable income is not reflective of that which it would have realized had it been dealing at arm's length with an uncontrolled taxpayer, the CIR can make the necessary rectifications in order to prevent evasion of taxes.

Despite the broad parameters provided, however, we find that the CIR's powers of distribution, apportionment or allocation of gross income and deductions under Section 43 of the 1993 NIRC and Section 179 of Revenue Regulation No. 2 does not include the power to impute "theoretical interests" to the controlled taxpayer's transactions. Pursuant to Section 28 of the 1993 NIRC,42 after all, the term "gross income" is understood to mean all income from whatever

source derived, including, but not limited to the following items: compensation for services, including fees, commissions, and similar items; gross income derived from business; gains derived from dealings in property;" interest; rents; royalties; dividends; annuities; prizes and winnings; pensions; and partner’s distributive share of the gross income of general professional partnership.43 While it has been held that the phrase "from whatever source derived" indicates a legislative policy to include all income not expressly exempted within the class of taxable income under our laws, the term "income" has been variously interpreted to mean "cash received or its equivalent", "the amount of money coming to a person within a specific time" or "something distinct from principal or capital."44 Otherwise stated, there must be proof of the actual or, at the very least, probable receipt or realization by the controlled taxpayer of the item of gross income sought to be distributed, apportioned or allocated by the CIR.

Our circumspect perusal of the record yielded no evidence of actual or possible showing that the advances FDC extended to its affiliates had resulted to the interests subsequently assessed by the CIR. For all its harping upon the supposed fact that FDC had resorted to borrowings from commercial banks, the CIR had adduced no concrete proof that said funds were, indeed, the source of the advances the former provided its affiliates. While admitting that FDC obtained interest-bearing loans from commercial banks,45 Susan Macabelda - FDC's Funds Management Department Manager who was the sole witness presented before the CTA - clarified that the subject advances were sourced from the corporation's rights offering in 1995 as well as the sale of its investment in Bonifacio Land in 1997.46 More significantly, said witness testified that said advances: (a) were extended to give FLI, FAI, DSCC and FCI financial assistance for their operational and capital expenditures; and, (b) were all temporarily in nature since they were repaid within the duration of one week to three months and were evidenced by mere journal entries, cash vouchers and instructional letters."47

Even if we were, therefore, to accord precipitate credulity to the CIR's bare assertion that FDC had deducted substantial interest expense from its gross income, there would still be no factual basis for the imputation of theoretical interests on the subject advances and assess deficiency income taxes thereon. More so, when it is borne in mind that, pursuant to Article 1956 of the Civil Code of the Philippines, no interest shall be due unless it has been expressly stipulated in writing. Considering that taxes, being burdens, are not to be presumed beyond what the applicable statute expressly and clearly declares,48 the rule is likewise settled that tax statutes must be construed strictly against the government and liberally in favor of the taxpayer.49 Accordingly, the general rule of requiring adherence to the letter in construing statutes applies with peculiar strictness to tax laws and the provisions of a taxing act are not to be extended by implication.50 While it is true that taxes are the lifeblood of the government, it has been held that their assessment and collection should be in accordance with law as any arbitrariness will negate the very reason for government itself.51

In G.R. No. 167689, we also find a dearth of merit in the CIR's insistence on the imposition of deficiency income taxes on the transfer FDC and FAI effected in exchange for the shares of stock of FLI. With respect to the Deed of Exchange executed between FDC, FAI and FLI, Section 34 (c) (2) of the 1993 NIRC pertinently provides as follows:

Sec. 34. Determination of amount of and recognition of gain or loss.-

x x x x

(c) Exception – x x x x

No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for shares of stock in such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four persons, gains control of said corporation; Provided, That stocks issued for services shall not be considered as issued in return of property.

As even admitted in the 14 February 2001 Stipulation of Facts submitted by the parties,52 the requisites for the non-recognition of gain or loss under the foregoing provision are as follows: (a) the transferee is a corporation; (b) the transferee exchanges its shares of stock for property/ies of the transferor; (c) the transfer is made by a person, acting alone or together with others, not exceeding four persons; and, (d) as a result of the exchange the transferor, alone or together with others, not exceeding four, gains control of the transferee.53 Acting on the 13 January 1997 request filed by FLI, the BIR had, in fact, acknowledged the concurrence of the foregoing requisites in the Deed of Exchange the former executed with FDC and FAI by issuing BIR Ruling No. S-34-046-97.54 With the BIR's reiteration of said ruling upon the request for clarification filed by FLI,55 there is also no dispute that said transferee and transferors subsequently complied with the requirements provided for the non-recognition of gain or loss from the exchange of property for tax, as provided under Section 34 (c) (2) of the 1993 NIRC.56

Then as now, the CIR argues that taxable gain should be recognized for the exchange considering that FDC's controlling interest in FLI was actually decreased as a result thereof. For said purpose, the CIR calls attention to the fact that, prior to the exchange, FDC owned 2,537,358,000 or 67.42% of FLI's 3,763,535,000 outstanding capital stock. Upon the issuance of 443,094,000 additional FLI shares as a consequence of the exchange and with only 42,217,000 thereof accruing in favor of FDC for a total of 2,579,575,000 shares, said corporation’s controlling interest was

supposedly reduced to 61%.03 when reckoned from the transferee's aggregate 4,226,629,000 outstanding shares. Without owning a share from FLI's initial 3,763,535,000 outstanding shares, on the other hand, FAI's acquisition of 420,877,000 FLI shares as a result of the exchange purportedly resulted in its control of only 9.96% of said transferee corporation's 4,226,629,000 outstanding shares. On the principle that the transaction did not qualify as a tax-free exchange under Section 34 (c) (2) of the 1993 NIRC, the CIR asseverates that taxable gain in the sum of P263,386,921.00 should be recognized on the part of FDC and in the sum of P3,088,711,367.00 on the part of FAI.57

The paucity of merit in the CIR's position is, however, evident from the categorical language of Section 34 (c) (2) of the 1993 NIRC which provides that gain or loss will not be recognized in case the exchange of property for stocks results in the control of the transferee by the transferor, alone or with other transferors not exceeding four persons. Rather than isolating the same as proposed by the CIR, FDC's 2,579,575,000 shares or 61.03% control of FLI's 4,226,629,000 outstanding shares should, therefore, be appreciated in combination with the 420,877,000 new shares issued to FAI which represents 9.96% control of said transferee corporation. Together FDC's 2,579,575,000 shares (61.03%) and FAI's 420,877,000 shares (9.96%) clearly add up to 3,000,452,000 shares or 70.99% of FLI's 4,226,629,000 shares. Since the term "control" is clearly defined as "ownership of stocks in a corporation possessing at least fifty-one percent of the total voting power of classes of stocks entitled to one vote" under Section 34 (c) (6) [c] of the 1993 NIRC, the exchange of property for stocks between FDC FAI and FLI clearly qualify as a tax-free transaction under paragraph 34 (c) (2) of the same provision.

Against the clear tenor of Section 34(c) (2) of the 1993 NIRC, the CIR cites then Supreme Court Justice Jose Vitug and CTA Justice Ernesto D. Acosta who, in their book Tax Law and Jurisprudence, opined that said provision could be

inapplicable if control is already vested in the exchangor prior to exchange.58 Aside from the fact that that the 10 September 2002 Decision in CTA Case No. 6182 upholding the tax-exempt status of the exchange between FDC, FAI and FLI was penned by no less than Justice Acosta himself,59 FDC and FAI significantly point out that said authors have acknowledged that the position taken by the BIR is to the effect that "the law would apply even when the exchangor already has control of the corporation at the time of the exchange."60 This was confirmed when, apprised in FLI's request for clarification about the change of percentage of ownership of its outstanding capital stock, the BIR opined as follows:

Please be informed that regardless of the foregoing, the transferors, Filinvest Development Corp. and Filinvest Alabang, Inc. still gained control of Filinvest Land, Inc. The term 'control' shall mean ownership of stocks in a corporation by possessing at least 51% of the total voting power of all classes of stocks entitled to vote. Control is determined by the amount of stocks received, i.e., total subscribed, whether for property or for services by the transferor or transferors. In determining the 51% stock ownership, only those persons who transferred property for stocks in the same transaction may be counted up to the maximum of five (BIR Ruling No. 547-93 dated December 29, 1993.61

At any rate, it also appears that the supposed reduction of FDC's shares in FLI posited by the CIR is more apparent than real. As the uncontested owner of 80% of the outstanding shares of FAI, it cannot be gainsaid that FDC ideally controls the same percentage of the 420,877,000 shares issued to its said co-transferor which, by itself, represents 7.968% of the outstanding shares of FLI. Considered alongside FDC's 61.03% control of FLI as a consequence of the 29 November 1996 Deed of Transfer, said 7.968% add up to an aggregate of 68.998% of said transferee corporation's outstanding

shares of stock which is evidently still greater than the 67.42% FDC initially held prior to the exchange. This much was admitted by the parties in the 14 February 2001 Stipulation of Facts, Documents and Issues they submitted to the CTA.62 Inasmuch as the combined ownership of FDC and FAI of FLI's outstanding capital stock adds up to a total of 70.99%, it stands to reason that neither of said transferors can be held liable for deficiency income taxes the CIR assessed on the supposed gain which resulted from the subject transfer.

On the other hand, insofar as documentary stamp taxes on loan agreements and promissory notes are concerned, Section 180 of the NIRC provides follows:

Sec. 180. Stamp tax on all loan agreements, promissory notes, bills of exchange, drafts, instruments and securities issued by the government or any of its instrumentalities, certificates of deposit bearing interest and others not payable on sight or demand. – On all loan agreements signed abroad wherein the object of the contract is located or used in the Philippines; bill of exchange (between points within the Philippines), drafts, instruments and securities issued by the Government or any of its instrumentalities or certificates of deposits drawing interest, or orders for the payment of any sum of money otherwise than at sight or on demand, or on all promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation, and on each renewal of any such note, there shall be collected a documentary stamp tax of Thirty centavos (P0.30) on each two hundred pesos, or fractional part thereof, of the face value of any such agreement, bill of exchange, draft, certificate of deposit or note: Provided, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan, whichever will yield a higher tax: Provided however, That loan agreements or promissory notes the aggregate of which does not exceed Two hundred fifty thousand pesos (P250,000.00) executed by an individual for his purchase on installment for his personal

use or that of his family and not for business, resale, barter or hire of a house, lot, motor vehicle, appliance or furniture shall be exempt from the payment of documentary stamp tax provided under this Section.

When read in conjunction with Section 173 of the 1993 NIRC,63 the foregoing provision concededly applies to "(a)ll loan agreements, whether made or signed in the Philippines, or abroad when the obligation or right arises from Philippine sources or the property or object of the contract is located or used in the Philippines." Correlatively, Section 3 (b) and Section 6 of Revenue Regulations No. 9-94 provide as follows:

Section 3. Definition of Terms. – For purposes of these Regulations, the following term shall mean:

(b) 'Loan agreement' – refers to a contract in writing where one of the parties delivers to another money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid. The term shall include credit facilities, which may be evidenced by credit memo, advice or drawings.

The terms 'Loan Agreement" under Section 180 and "Mortgage' under Section 195, both of the Tax Code, as amended, generally refer to distinct and separate instruments. A loan agreement shall be taxed under Section 180, while a deed of mortgage shall be taxed under Section 195."

"Section 6. Stamp on all Loan Agreements. – All loan agreements whether made or signed in the Philippines, or abroad when the obligation or right arises from Philippine sources or the property or object of the contract is located in the Philippines shall be subject to the documentary stamp tax of thirty centavos (P0.30) on each two hundred pesos, or

fractional part thereof, of the face value of any such agreements, pursuant to Section 180 in relation to Section 173 of the Tax Code.

In cases where no formal agreements or promissory notes have been executed to cover credit facilities, the documentary stamp tax shall be based on the amount of drawings or availment of the facilities, which may be evidenced by credit/debit memo, advice or drawings by any form of check or withdrawal slip, under Section 180 of the Tax Code.

Applying the aforesaid provisions to the case at bench, we find that the instructional letters as well as the journal and cash vouchers evidencing the advances FDC extended to its affiliates in 1996 and 1997 qualified as loan agreements upon which documentary stamp taxes may be imposed. In keeping with the caveat attendant to every BIR Ruling to the effect that it is valid only if the facts claimed by the taxpayer are correct, we find that the CA reversibly erred in utilizing BIR Ruling No. 116-98, dated 30 July 1998 which, strictly speaking, could be invoked only by ASB Development Corporation, the taxpayer who sought the same. In said ruling, the CIR opined that documents like those evidencing the advances FDC extended to its affiliates are not subject to documentary stamp tax, to wit:

On the matter of whether or not the inter-office memo covering the advances granted by an affiliate company is subject to documentary stamp tax, it is informed that nothing in Regulations No. 26 (Documentary Stamp Tax Regulations) and Revenue Regulations No. 9-94 states that the same is subject to documentary stamp tax. Such being the case, said inter-office memo evidencing the lendings or borrowings which is neither a form of promissory note nor a certificate of indebtedness issued by the corporation-affiliate or a certificate of obligation, which are, more or less, categorized as

'securities', is not subject to documentary stamp tax imposed under Section 180, 174 and 175 of the Tax Code of 1997, respectively. Rather, the inter-office memo is being prepared for accounting purposes only in order to avoid the co-mingling of funds of the corporate affiliates.1avvphi1

In its appeal before the CA, the CIR argued that the foregoing ruling was later modified in BIR Ruling No. 108-99 dated 15 July 1999, which opined that inter-office memos evidencing lendings or borrowings extended by a corporation to its affiliates are akin to promissory notes, hence, subject to documentary stamp taxes.64 In brushing aside the foregoing argument, however, the CA applied Section 246 of the 1993 NIRC65 from which proceeds the settled principle that rulings, circulars, rules and regulations promulgated by the BIR have no retroactive application if to so apply them would be prejudicial to the taxpayers.66 Admittedly, this rule does not apply: (a) where the taxpayer deliberately misstates or omits material facts from his return or in any document required of him by the Bureau of Internal Revenue; (b) where the facts subsequently gathered by the Bureau of Internal Revenue are materially different from the facts on which the ruling is based; or (c) where the taxpayer acted in bad faith.67 Not being the taxpayer who, in the first instance, sought a ruling from the CIR, however, FDC cannot invoke the foregoing principle on non-retroactivity of BIR rulings.

Viewed in the light of the foregoing considerations, we find that both the CTA and the CA erred in invalidating the assessments issued by the CIR for the deficiency documentary stamp taxes due on the instructional letters as well as the journal and cash vouchers evidencing the advances FDC extended to its affiliates in 1996 and 1997. In Assessment Notice No. SP-DST-96-00020-2000, the CIR correctly assessed the sum of P6,400,693.62 for documentary stamp tax, P3,999,793.44 in interests and P25,000.00 as compromise penalty, for a total of P10,425,487.06. Alongside the sum of

P4,050,599.62 for documentary stamp tax, the CIR similarly assessed P1,721,099.78 in interests and P25,000.00 as compromise penalty in Assessment Notice No. SP-DST-97-00021-2000 or a total of P5,796,699.40. The imposition of deficiency interest is justified under Sec. 249 (a) and (b) of the NIRC which authorizes the assessment of the same "at the rate of twenty percent (20%), or such higher rate as may be prescribed by regulations", from the date prescribed for the payment of the unpaid amount of tax until full payment.68 The imposition of the compromise penalty is, in turn, warranted under Sec. 25069 of the NIRC which prescribes the imposition thereof "in case of each failure to file an information or return, statement or list, or keep any record or supply any information required" on the date prescribed therefor.

To our mind, no reversible error can, finally, be imputed against both the CTA and the CA for invalidating the Assessment Notice issued by the CIR for the deficiency income taxes FDC is supposed to have incurred as a consequence of the dilution of its shares in FAC. Anent FDC’s Shareholders’ Agreement with RHPL, the record shows that the parties were in agreement about the following factual antecedents narrated in the 14 February 2001 Stipulation of Facts, Documents and Issues they submitted before the CTA,70 viz.:

"1.11. On November 15, 1996, FDC entered into a Shareholders’ Agreement (‘SA’) with Reco Herrera Pte. Ltd. (‘RHPL’) for the formation of a joint venture company named Filinvest Asia Corporation (‘FAC’) which is based in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and 7, Answer).

1.12. FAC, the joint venture company formed by FDC and RHPL, is tasked to develop and manage the 50% ownership interest of FDC in its PBCom Office Tower Project (‘Project’) with the Philippine Bank of Communications (par. 6.12, Petition; par. 7, Answer).

1.13. Pursuant to the SA between FDC and RHPL, the equity participation of FDC and RHPL in FAC was 60% and 40% respectively.

1.14. In accordance with the terms of the SA, FDC subscribed to P500.7 million worth of shares of stock representing a 60% equity participation in FAC. In turn, RHPL subscribed to P433.8 million worth of shares of stock of FAC representing a 40% equity participation in FAC.

1.15. In payment of its subscription in FAC, FDC executed a Deed of Assignment transferring to FAC a portion of FDC’s right and interests in the Project to the extent of P500.7 million.

1.16. FDC reported a net loss of P190,695,061.00 in its Annual Income Tax Return for the taxable year 1996."71

Alongside the principle that tax revenues are not intended to be liberally construed,72 the rule is settled that the findings and conclusions of the CTA are accorded great respect and are generally upheld by this Court, unless there is a clear showing of a reversible error or an improvident exercise of authority.73 Absent showing of such error here, we find no strong and cogent reasons to depart from said rule with respect to the CTA's finding that no deficiency income tax can be assessed on the gain on the supposed dilution and/or increase in the value of FDC's shareholdings in FAC which the CIR, at any rate, failed to establish. Bearing in mind the meaning of "gross income" as above discussed, it cannot be

gainsaid, even then, that a mere increase or appreciation in the value of said shares cannot be considered income for taxation purposes. Since "a mere advance in the value of the property of a person or corporation in no sense constitute the ‘income’ specified in the revenue law," it has been held in the early case of Fisher vs. Trinidad,74 that it "constitutes and can be treated merely as an increase of capital." Hence, the CIR has no factual and legal basis in assessing income tax on the increase in the value of FDC's shareholdings in FAC until the same is actually sold at a profit.

WHEREFORE, premises considered, the CIR's petition for review on certiorari in G.R. No. 163653 is DENIED for lack of merit and the CA’s 16 December 2003 Decision in G.R. No. 72992 is AFFIRMED in toto. The CIR’s petition in G.R. No. 167689 is PARTIALLY GRANTED and the CA’s 26 January 2005 Decision in CA-G.R. SP No. 74510 is MODIFIED.

Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-97-00021-2000 issued for deficiency documentary stamp taxes due on the instructional letters as well as journal and cash vouchers evidencing the advances FDC extended to its affiliates are declared valid.

The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC-97-00019-2000 and SP-INC-97-0027-2000 issued for deficiency income assessed on (a) the "arms-length" interest from said advances; (b) the gain from FDC’s Deed of Exchange with FAI and FLI; and (c) income from the dilution resulting from FDC’s Shareholders’ Agreement with RHPL is, however, upheld.

SO ORDERED.

G.R. No. L-12954 February 28, 1961

COLLECTOR OF INTERNAL REVENUE, petitioner, vs.ARTHUR HENDERSON, respondent.

x---------------------------------------------------------x

G.R. No. L-13049 February 28, 1961

ARTHUR HENDERSON, petitioner, vs.COLLECTOR OF INTERNAL REVENUE, respondent.

Office of the Solicitor General for petitioner.Formilleza & Latorre for respondent.

PADILLA, J.:

These are petitions filed by the Collector of Internal Revenue (G.R. No. L-12954) and by Arthur Henderson (G.R. No. L-13049) under the provisions of section 18, Republic Act No. 1125, for review of a judgment dated 26 June 1957 and a resolution dated 28 September 1957 rendered and adopted by the Court of Tax Appeals in Case No. 237.

The spouses Artuhur Henderson and Marie B. Henderson (later referred to as the taxpayers) filed with the Bureau of Internal Revenue returns of annual net income for the years 1948 to 1952, inclusive, where the following net incomes, personal exemptions and amounts subject to tax appear:

1948:

Net Income .......................................................

P29,573.79

Less:Personal Exemption ..............................

2,500.00

Amount subject to tax .......................................

P27,073.79

1949:

Net Income .......................................................

P31,817.66

Less:Personal

Exemption .............................. 2,500.00


P29,317.66

1950:

Net Income .......................................................

P34,815.74


3,000.00


P31,815.74

1951:

Net Income ........................................................

P32,605.83

Less:Personal

Exemption .............................. 3,000.00


P29,605.83

1952:

Net Income .......................................................

P36,780.11


3,000.00


P33,780.11

(Exhibits 1, 3, 5, 7, 9, A, F, J, N, R). In due time the taxpayers received from the Bureau of Internal Revenue assessment notices Nos. 15804-48, 25450-49, 15255-50, 25705-51 and 22527-52 and paid the amounts assessed as follows:

1948:

14 May 1949, O.R. No. 52991, Exhibit B P2,068.12

....………..

12 September 1950, O.R. No. 160473, Exhibit B-1 .

2,068.11

Total Paid .........................................................

P4,136.23

1949:

13 May 1950, O.R. No. 232366, Exhibit G ...........…

P2,314.95

15 September 1950, O.R. No. 247918, Exhibit G-1 .

2,314.94

Total Paid .........................................................

P4,629.89

1950:

27 April 1951, O.R. No. 323173, Exhibit K ...……….

P7,273.00

1951:

Amount withheld from salary and paid by P5,780.40

employer .

15 May 1952, O.R. No. 33250, Exhibit O .................

360.50

15 August 1952, O.R. No. 383318, Exhibit O-1 ..…..

361.20

Total Paid .........................................................

P6,502.10

1952:

Amount withheld from salary and paid by employer .

P5,660.40

18 May 1953, O.R. No. 438026, Exhibit T ..…………

1,160.30

13 August 1953, O.R. No. 443483, Exhibit T-1 ...…..

1,160.30

Total Paid .........................................................

P7,981.00

On 28 November 1953, after investigation and verification, the Bureau of Internal Revenue reassessed the taxpayers'income for the years 1948 to 1952, inclusive, as follows:

1948:

Net income per return ..................................………………………

P29,573.79

Add:

Rent expense .........................................................…….. 7,200.00

Additional bonus for 1947 received May 13, 1948 .………

6,500.00

Other income:

Manager's residential expense (2/29/48 a/c/#4.51)

1,400.00

Manager's residential expense (refer to 1948 P & L) ..

1,849.32

Entrance fee — Marikina Gun & Country Club ..……..

200.00

Net income per investigation .........................................………...

P46,723.11

Less: Personal exemption ...............................................……….

2,500.00

Net taxable income ..........................................................………

P44,223.11

Tax due thereon ...............................................................……… P8,562.47

Less: Amount of tax already paid per OR #52991 & 160473 ..………………………………………………………

4,136.23

Deficiency tax still due & assessable ............................

P4,426.24

1949:

Net income per return ..................................……………………… P31,817.66

Add: disallowances —

Capital loss (no capital gain) ................... P3,248.84

Undeclared bonus ...................………….. 3,857.75

Rental allowance from A.I.U. ................... 1,800.00

Subsistence allowance from A.I.U. .……..

6,051.30 14,958.09


P46,775.75

Less: Personal exemption ...............................................………..

2,500.00

Amount of income subject to 43,275.75

tax ..................................………….

Tax due thereon ...............................................................……….

P8,292.21

Less: tax already assessed & paid per OR Nos. 232366 & 247918

4,629.89

Deficiency tax due ............................................................……….

P3,662.23

(Should be) ......................................................................

3,662.32

1950:


Add:

Rent, electricity, water allowances .......................……….. 8,373.73


P43,189.47


3,000.00

Net taxable income ..........................................................………..

P40,189.47

Tax due thereon ...............................................................……….

P10,296.00

Less: tax already paid per OR No. #323173 7,273.00

Deficiency tax due & assessable .................……………………..

P3,023.00

1951:

Net income per return ..................................………………………

P32,605.83

Add: house rental allowance from AIU

5,782.91


P83,388.74


3,000.00

Amount of income subject to tax ..................................…………..

P35,388.74

Tax due thereon ...............................................................………. P 8,560.00

Less: tax already assessed and paid per O.R. Nos. A33250 & 383318 .......................………………………………………

6,502.00

Deficiency tax due .................………………………………………. P2,058.00

1952:


Add:

Withholding tax paid by company ..................................... 600.00

Travelling allowances ....................................................... 3,247.40

Allowances for rent, telephone, water, electricity, etc. ..... 7,044.67


P47,672.18


3,000.00

Net taxable income ..................................…………………………

P44,672.18

Tax due thereon ...............................................................……….

P12,089.00

Less: Tax already withheld P5,660.40

Tax already paid per O.R. Nos. #438026, 443484 2,320.60 7,981.00

Deficiency tax still due & collectible ...............................…………

P4,108.00

(Exhibits 2, 4, 6, 8, 10) and demanded payment of the deficiency taxes on or before 28 February 1954 with respectto those due for the years 1948, 1949, 1950 and 1952and on or before 15 February 1954 with respect to thatdue for the year 1951 (Exhibits B-2, H, L, P, S).

In the foregoing assessments, the Bureau of InternalRevenue considered as part of their taxable income thetaxpayer-husband's allowances for rental, residential expenses,subsistence, water, electricity and telephone; bonuspaid to him; withholding tax and entrance fee to the Marikinagun and Country Bluc paid by his employer for hisaccount; and travelling allowance of his wife. On 26 and27 January 1954 the taxpayers asked for reconsideration of the foregoing assessment (pp. 29, 31, BIR rec.) and on 11 February 1954 and 28 February 1955 stated the grounds and reasons in support of their request for reconsideration (pp. 36-38, 62-66, BIR rec.). The claim that as regards the husband-taxpayer's allowances for rental and utilities such as water, electricity and telephone, he did not receive the money for

said allowances, but that they lived in the apartment furnished and paid for by his employer for its convenience; that they had no choice but live in the said apartment furnished by his employer, otherwise they would have lived in a less expensive one; that as regards his allowances for rental of P7,200 and residential expenses of P1,400 and P1,849.32 in 1948, rentalof P1,800 and subsistence of P6,051.50 (the latter merely consisting of allowances for rent and utilities such as light,water, telephone, etc.) in 1949 rental, electricity and waterof P8,373.73 in 1950, rental of P5,782.91 in 1951 and rental,telephone, water, electricity, etc. of P7,044.67 in 1952, onlythe amount of P3,900 for each year, which is the amountthey would have spent for rental of an apartment including utilities, should be taxed; that as regards the amount ofP200 representing entrance fee to the Marikina Gun and Country Club paid for him by his employer in 1948, thesame should not be considered as part of their income for it was an expense of his employer and his membership therein was merely incidental to his duties of increasingand sustaining the business of his employer; and that as regards the wife-taxpayer's travelling allowance of P3,247.40 in 1952, it should not be considered as part of their income because she merely accompanied him in his business trip to New York as his secretary and, at the behest of her husband's employer, to study and look into the details of the plans and decorations of the building intendedto be constructed byn his employer in its property at Dewey Boulevard. On 15 and 27 February 1954, the taxpayers paid the deficiency taxes assessed under Official Receipts Nos. 451841, 451842, 451843, 451748 and 451844 (Exhibits C, I, M, Q, and Y). After hearing conducted by the Conference Staff of the Bureau of Internal Revenue on5 October 1954 (pp. 74-85, BIR rec.), on 27 May 1955the Staff recommended to the Collector of Internal Revenue that the assessments made on 28 November 1953 (Exhibits2, 4, 6, 8, 10) be sustained except that the amount of P200 as entrance fee to the Marikina Gun and CountryClub paid for the husband-taxpayer's account by his employer in 1948 should not be considered as part of thetaxpayers' taxable income for that year (pp. 95-107, BIRrec.). On 14 July 1955, in line with the

recommendationof the Conference Staff, the Collector of Internal Revenuedenied the taxpayers' request for reconsideration, exceptas regards the assessment of their income tax due for theyear 1948, which was modified as follows:

Net income per return P29,573.79

Add: Rent expense 7,200.00

Additional bonus for 1947 received on May 13, 1948 6,500.00

Manager's residential expense (2/29/48 a/c #4.41) 1,400.00

Manager's residential expense (1948 profit and loss) 1,849.32

Net income per investigation P46,523.11

Less: Personal exemption 2,500.00

Net taxable income P44,023.11

Tax due thereon P 8,506.47

Less; Amount already paid 4,136.23

Deficiency tax still due P 4,370.24

and demanded payment of the deficiency taxes of P4,370.24for 1948, P3,662.23 for 1949, P3,023 for 1950, P2,058 for1951 and P4,108 for 1952, 5% surcharge and 1% monthlyinterest thereon from 1 March 1954 to the date of paymentand P80 as administrative penalty for late payment,to the City Treasurer of Manila not later than 31 July1955 (Exhibit 14). On 30 January 1956 the taxpayersagain sought a reconsideration of the denial of their requestfor reconsideration and offered to settle the case ona more equitable basis by increasing the amount of thetaxable portion of the husband-taxpayer's allowances forrental, etc. from P3,000 yearly to P4,800 yearly, which "isthe value to the employee of the benefits he derived therefrommeasured by what he had saved on account thereof'in the ordinary course of his life ... for which hewould have spent in any case'". The taxpayers also reiteratedtheir previous stand regarding the transportationallowance of the wife-taxpayer of P3,247.40 in 1952 andrequested the refund of the amounts of P3,477.18, P569.33,P1,294, P354 and P2,164, or a total of P7,858.51, (Exhibit Z). On 10 February 1956 the taxpayers again requestedthe Collector of Internal Revenue to refund to them theamounts allegedly paid in excess as income taxes for theyears 1948 to 1952, inclusive (Exhibit Z-1). The Collectorof Internal Revenue did not take any action on the taxpayers'request for refund.

On 15 February 1956 the taxpayers filed in the Court of Tax Appeals a petition to review the decision of theCollector of Internal Revenue (C.T.A. Case No. 237). After hearing, on 26 June 1957 the Court rendered judgment holding "that the inherent nature of petitioner's(the husband-taxpayer) employment as president of theAmerican International Underwriters as president of theAmerican International Underwriters of the Philippines,Inc. does not require him to occupy the apartments suppliedby his employer-corporation;" that, however, only the amount of P4,800 annually, the

ratable value to him ofthe quarters furnished constitutes a part of taxable income; that since the taxpayers did not receive any benefitout of the P3,247.40 traveling expense allowance grantedin 1952 to the wife-taxpayer and that she merely undertookthe trip abroad at the behest of her husband's employer, the same could not be considered as income; andthat even if it were considered as such, still it could not be subject to tax because it was deductible as travel expense;and ordering the Collector of Internal Revenue to refundto the taxpayers the amount of P5,109.33 with interestfrom 27 February 1954, without pronouncement as tocosts. The taxpayers filed a motion for reconsiderationclaiming that the amount of P5,986.61 is the amount refundableto them because the amounts of P1,400 and P1,849.32 as manager's residential expenses in 1948 shouldnot be included in their taxable net income for the reasonthat they are of the same nature as the rentals for theapartment, they being mainly expenses for utilities aslight, water and telephone in the apartment furnished bythe husbant-taxpayer's employer. The Collector of InternalRevenue filed an opposition to their motion for reconsideration.He also filed a separate motion for reconsiderationof the decision claiming that his assessmentunder review was correct and should have been affirmed.The taxpayers filed an opposition to this motion for reconsiderationof the Collector of Internal Revenue; thelatter, a reply thereto. On 28 September 1957 the Courtdenied both motions for reconsideration. On 7 October1957 the Collector of Internal Revenue filed a notice ofappeal in the Court of Tax Appeals and on 21 October1957, within the extension of time previously granted bythis Court, a petition for review (G.R. No. L-12954). On29 October 1957 the taxpayers filed a notice of appealin the Court of Tax Appeals and a petition for review inthis Court (G.R. No. L-13049).

The Collector of Internal Revenue had assigned the followingerrors allegedly committed by the Court of TaxAppeals:

I. The Court of Tax Appeals erred in finding that theherein respondent did not have any choice in the selection ofthe living quarters occupied by him.

II. The Court of Tax Appeals erred in not consideringthe fact that respondent is not a minor company official butthe President of his employer-corporation, in the appreciationof respondent's alleged lack of choice in the matter of the selectionof the quarters occupied by him.

III. The Court of Tax Appeals erred in giving full weightand credence to respondent's allegation, a self-serving and unsupported declaration that the ratable value to him of the living quarters and subsistence allowance was only P400.00 a month.

IV. The Court of Tax Appeals erred in holding that only the ratable value of P4,800.00 per annum, or P400.00 a month constitutes income to respondent.

V. The Court of Tax Appeals erred in arbitrarily fixing the amount of P4,800.00 per annum, or P400.00 a month as the only amount taxable aganst respondent during the five tax years in question.

VI. The Court of Tax Appeals erred in not finding that travelling allowance in the amount of P3,247.40 constituted income to respondent and, therefore, subject to the income tax.

VII. The Court of Tax Appeals erred in ordering the refund of the sum of P5,109.33 with interest from February 17, 1954. (G.R. No. L-12954.)

The taxpayers have assigned the following errors allegedly committed by the Court of Tax Appeals:

I. The Court of Tax Appeals erred in its computation of the 1948 income tax and consequently in the amount that should be refunded for that year.

II. The Court of Tax Appeals erred in denying our motion for reconsideration as contained in its resolution dated September 28, 1957. (G.R. No. L-13049.)

The Government's appeal:

The Collector of Internal Revenue raises questions of fact. He claims that the evidence is not sufficient to support the findings and conclusion of the Court of Tax Appeals that the quarters occupied by the taxpayers were not of their choice but that of the husband-taxpayer's employer; that it did not take into consideration the fact that the husband-taxpayer is not a mere minor company official, but the highest executive of his employer-corporation; and that the wife-taxpayer's trip abroad in 1952 was not, as found by the Court, a business but a vacation trip. In Collector of Internal Revenue vs. Aznar, 56, Off. Gaz. 2386, this Court held that in petitions for review under section 18, Republic Act No. 1125, it may review the findings of fact of the Court of Tax Appeals.

The determination of the main issue in the case requires a review of the evidence. Are the allowances for rental of the apartment furnished by the husband-taxpayer's employer-corporation, including utilities such as light, water, telephone, etc. and the allowance for travel expenses given by his employer-corporation to his wife in 1952 part of taxable income? Section 29, Commonwealth Act No. 466, National Internal Revenue Code, provides:

"Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rents dividend, securities, or the transaction of any business carried on for gain or profit, or gains, profits, and income derived from any source whatever. (Emphasis ours.)

The Court of Tax Appeals found that the husband-taxpayer "is the president of the American International Underwriters for the Philippines, Inc., a domestic corporation engaged in insurance business;" that the taxpayers "entertained officials, guests and customers of his employer-corporation, in apartments furnished by the latter and successively occupied by him as president thereof; that "In 1952, petitioner's wife, Mrs. Marie Henderson, upon request o Mr. C. V. Starr, chairman of the parent corporation of the American International Underwriters for the Philippines, Inc., undertook a trip to New York in connection with the purchase of a lot in Dewey Boulevardby petitioner's employer-corporatio, the construction of a building thereon, the drawing of prospectus and plans for said building, and other related matters."

Arthur H. Henderson testified that he is the President of American International Underwriters for the Philippines, Inc., which representa a group of American insurance companies engagad in the business of general insurance except life insurance; that he receives a basic annual salary of P30,000 and allowance for house rental and utilities like light, water, telephone, etc.; that he and his wife are childless and are the only two in the family; that during the years 1948 to 1952, they lived in apartments chosen by his employer; that from 1948 to the early part of 1950, they lived at the Embassy Apartments on Dakota Street, Manila, where they had a large sala, three bedrooms, dining room, two

bathrooms, kitchen and a large porch, and from the early part of 1950 to 1952, they lived at the Rosaria Apartments on the same street where they had a kitchen, sala, dining room two bedrooms and bathroom; that despite the fact that they were the only two in the family, they had to live in apartments of the size beyond their personal needs because as president of the corporation, he and his wife had to entertain and put up houseguests; that during all those years of 1948 to 1952, inclusive, they entertained and put up houseguests of his company's officials, guests and customers such as the president of C, V. Starr & Company, Inc., who spent four weeks in his apartment, Thomas Cocklin, a lawyer from Washington, D.C., and Manuel Elizalde, a stockholder of AIUPI; that were he not required by his employer to live in those apartments furnished to him, he and his wife would have chosen an apartment only large enough for them and spend from P300 to P400 monthly for rental; that of the allowances granted to him, only the amount of P4,800 annually, the maximum they would have spent for rental, should be considered as taxable income and the excess treated as expense of the company; and that the trip to New York undertaken by his wife in 1952, for which she was granted by his employer-corporation travelling expense allowance of P3,247.40, was made at the behest of his employer to assist its architect in the preparation of the plans for a proposed building in Manila and procurement of supplies and materials for its use, hence the said amount should not be considered as part of taxable income. In support of his claim, letters written by his wife while in New York concerning the proposed building, inquiring about the progress made in the acquisition of the lot, and informing him of the wishes of Mr. C. V. Starr, chairman of the board of directors of the parent-corporation (Exhibits U-1, U-1-A, V, V-1 and W) and a letter written by the witness to Mr. C. V. Starr concerning the proposed building (Exhibits X, X-1) were presented in evidence.

Mrs. Marie Henderson testified that for almost three years, she and her husband gave parties every Friday night at their apartment for about 18 to 20 people; that their guests were officials of her husband's employer-corporation and other

corporations; that during those parties movies for the entertainment of the guests were shown after dinner; that they also entertained during luncheons and breakfasts; that these involved and necessitated the services of additional servants; and that in 1952 she was asked by Mr. C. V. Starr to come to New York to take up problems concerning the proposed building and entertainment because her husband could not make the trip himself, and because "the woman of the family is closer to those problems."

The evidence presented at the hearing of the case substantially supports the findings of the Court of Tax Appeals. The taxpayers are childless and are the only two in the family. The quarters, therefore, that they occupied at the Embassy Apartments consisting of a large sala, three bedrooms, dining room, two bathrooms, kitchen and a large porch, and at the Rosaria Apartments consisting of a kitchen, sala dining room, two bedrooms and a bathroom, exceeded their personal needs. But the exigencies of the husband-taxpayer's high executive position, not to mention social standing, demanded and compelled them to live in amore spacious and pretentious quarters like the ones they had occupied. Although entertaining and putting up houseguests and guests of the husbnad-taxpayer's employer-corporation were not his predominand occupation as president, yet he and his wife had to entertain and put up houseguests in their apartments. That is why his employer-corporation had to grant him allowances for rental and utilities in addition to his annual basic salary to take care of those extra expenses for rental and utilities in excess of their personal needs. Hence, the fact that the taxpayers had to live or did not have to live in the apartments chosen by the husband-taxpayer's employer-corporation is of no moment, for no part of the allowances in question redounded to their personal benefit or was retained by them. Their bills for rental and utilities were paid directly by the employer-corporation to the creditors (Exhibit AA to DDD, inclusive; pp. 104, 170-193, t.s.n.). Nevertheless, as correctly held by the Court of Tax Appeals, the taxpayers are entitled only to a ratable value of the allowances in question, and only the amount of P4,800 annually,

the reasonable amount they would have spent for house rental and utilities such as light, water, telephone, etc., should be the amount subject to tax, and the excess considered as expenses of the corporation.

Likewise, the findings of the Court of Tax Appeals that the wife-taxpayer had to make the trip to New York at the behest of her husband's employer-corporation to help in drawing up the plans and specificatins of a proposed building, is also supported by the evidence. The parts of the letters written by the wife-taxpayer to her husband while in New York and the letter written by the husband-taxpayer to Mr. C. V. Starr support the said findings (Exhibits U-2, V-1, W-1, X). No part of the allowance for travellking expenses redounded to the benefit of the taxpayers. Neither was a part thereof retained by them. The fact that she had herself operated on for tumors while in New York wsa but incidental to her stay there and she must have merely taken advantage of her presence in that city to undergo the operation.

The taxpayers' appeal:

The taxpayers claim that the Court of Tax Appeals erred in considering the amounts of P1,400 and P1,849.32, or a total of P3,249.32, for "manager's residential expense" in 1948 as taxable income despite the fact "that they were of the same nature as the rentals for the apartment, they being expenses for utilities, such as light, water and telephone necessarily incidental to the apartment furnished to him by his employer."

Mrs. Crescencia Perez Ramos, an examiner of the Bureau of Internal Revenue who examined the books of accound of the American International Underwriters for the Philippines, Inc., testified that he total amount of P3,249.32 was reflected in its books as "living expenses of Mr. and Mrs. Arthur Henderson in the quarters they occupied in 1948;" and

that "the amount of P1,400 was included as manager's residential expense while the amount of P1,849.32 was entered as profit and loss account."

Buenaventura Loberiza, acting head of the accouting department of the American International Underwriters for the Philippines, Inc., testified that rentals, utilities, water, telephone and electric bills of executives of the corporation were entered in the books of account as "subsistence allowances and expenses;" that there was a separate account for salaries and wages of employees and officers; and that expenses for rentals and other utilities were not charged to salary accounts.

The taxpayers' claim is supported by the evidence. The total amount of P3,249.32 "for manager's residential expense" in 1948 should be treated as rentals for apartments and utilities and should not form part of the ratable value subject to tax.

The computation made by the taxpayers is correct. Adding to the amount of P29,573.79, their net income per return, the amount of P6,500, the bonus received in 1948, and P4,800, the taxable ratable value of the allowances, brings up their gross income to P40,873.79. Deducting therefrom the amount of P2,500 for personal exemption, the amount of P38,373.79 is the amount subject to income tax. The income tax due on this amount is P6,957.19 only. Deducting the amount of income tax due, P6,957.19, from the amount already paid, P8,562.47 (Exhibits B, B-1, C), the amount of P1,605.28 is the amount refundable to the taxpayers. Add this amount to P563.33, P1,294.00, P354.00 and P2,154.00, refundable to the taxpayers for 1949, 1950, 1951 and 1952 and the total is P5,986.61.

The judgment under review is modified as above indicated. The Collector of Internal Revenue is ordered to refund to the taxpayers the sum of P5,986.61, without pronouncement as to costs.

EN BANC

[G.R. No. L-9276. October 23, 1956.]

THE COLLECTOR OF INTERNAL REVENUE, Petitioner, vs. V. G. SINCO EDUCATIONAL CORPORATION, Respondent.

D E C I S I O N

BAUTISTA ANGELO, J.:

This is an appeal from a decision of the Court of Tax Appeals which orders the Collector of Internal Revenue to refund to Respondent-Appellee the sum of P5,364.77 representing income tax paid by said Appellee for the years 1950 and 1951.

In June, 1949, Vicente G. Sinco established and operated an educational institution known as Foundation College of Dumaguete. Sinco would have continued operating said college were it not for the requirement of the Department of Education that as far as practicable schools and colleges recognized by the government should be incorporated, and so on September 21, 1951, the V. G. Sinco Educational Institution was organized. This corporation was non-stock and was capitalized by V. G. Sinco and members of his immediate family. This corporation continued the operations of Foundation College of Dumaguete. Since its operation, this college derived, by way of tuition fees, the following yearly gross profits:chanroblesvirtuallawlibrary

Year Gross Receipt

1949 P32,684.70

1950 88,341.80

1951 114,499.35

1952 83,259.04

1953 97,907.18

The investigation conducted by an income tax examiner of the Bureau of Internal Revenue revealed that the college realized a taxable net income for the year 1949 in the sum of P3,098.06 and for the year 1950 in the sum of P17,038.59. For the years 1951 to 1953, inclusive, the income tax returns of the college have not as yet been verified but it reported a taxable net profit of P26,868.60 for the year 1951; chan roblesvirtualawlibrarya loss of P9,129.80 for the year 1952 and a profit of P223.56 for the year 1953. The Collector of Internal Revenue assessed against the college an income tax for the years 1950 and 1951 in the aggregate sum of P5,364.77, which was paid by the college. Two years thereafter, the corporation commenced an action in the Court of First Instance of Negros Oriental for the refund of this amount alleging that it is exempt from income tax under section 27 (e) of the National Internal Revenue Code. Pursuant to the provisions of Republic Act 1125, the case was remanded to the Court of Tax Appeals which, after due trial, decided the case in favor of the corporation.

Invoking section 27 (e) of the National Internal Revenue Code, the Appellee claims that it is exempt from the payment of the income tax because it is organized and maintained exclusively for the educational purposes and no part of its net income inures to the benefit of any private individual. On the other hand, the Appellant maintains that part of the net

income accumulated by the Appellee inured to the benefit of V. G. Sinco, president and founder of the corporation, and therefore the Appellee is not entitled to the exemption prescribed by the law.

In support of his stand, Appellant invokes the yearly statements of operation or balance sheets submitted by the corporation. Thus, in the balance sheets for the years 1951, 1952 and 1953, there appear the following entries:chanroblesvirtuallawlibrary

1951

LIABILITIES

ACCOUNTS PAYABLE:chanroblesvirtuallawlibrary

Community Publishers, Inc. P20,751.95

Vicente G. Sinco, Personal 7,435.83

TOTAL LIABILITIES P28,187.78

1952

LIABILITIES.


Vicente G. Sinco, Personal 12,669.07

Community Publishers, Inc. 32,135.50


1953

LIABILITIES


Vicente G. Sinco, Personal

Cash Advanced P9,716.36

Accrued Salaries 7,599.71 P17,316.07

Community Publishers, Inc.

Cash Advanced P18,762.68

Printing Account 13,262.72 P32,025.40


Considering the above quoted entries, Appellant claims that a great portion of the net profits realized by the corporation was channeled and redounded to the personal benefit of V. G. Sinco, who was its founder and president. Another benefit that accrued to Sinco according to Appellant is represented by the several amounts which appear payable to the Community Publishers, Inc. because, being the biggest stockholder of this entity, the money to be paid by the Appellee to that entity as appearing in the above quoted entries would redound to the personal benefit of Sinco.

Is it really correct to say that the Appellee is an educational institution in which part of its income inures to the benefit of one of its stockholders as maintained by Appellant? Considering that this claim is mainly predicated on certain

entries appearing in the balance sheets of the corporation for the years 1950 and 1951, there is need to clarify the purposes for which said entries were made, particularly those referring to the accounts payable to V. G. Sinco and the Community Publishers Inc.

With regard to this accounts, Dean Sinco made the following clarification:chanroblesvirtuallawlibrary He acted as president of the Foundation College and as chairman of its Board of Directors; chan roblesvirtualawlibraryin 1949 he served as its teacher for a time; chan

roblesvirtualawlibrarythe accountant of the college suggested that a certain amount be set aside as his salary for purposes of orderly and practical accounting; chan roblesvirtualawlibrarybut notwithstanding this suggestion, he never collected his salary for which reason it was carried in the books as accrued expenses. With regard to the account of the Community Publishers, Inc., Sinco said that this is a distinct and separate corporation although he is one of its stockholders. The account represents payment for services rendered by this entity to the college. These are two different entities and whatever relation there is between the two is that the former merely extends help to the latter to enable it to comply with the requirements of the law and to fill its needs for educational purposes. This clarification made by Sinco stand undisputed.

Considering this explanation, it is indeed too sweeping if not unfair to conclude that part of the income of the Appellee as an institution inured to the benefit of one of its stockholders simply because part of the income was carried in its books as accumulated salaries of its president and teacher. Much less can it be said that the payments made by the college to the Community Publishers, Inc. redounded to the personal benefit of Sinco simply because he is one of its stockholders. The fact is that, as it has been established, the Appellee is a non-profit institution and since its organization it has never distributed any dividend or profit to its stockholders. Of course, part of its income went to the payment of its teachers or professors and to the other expenses of the college incident to an educational institution but none of the income has ever been channeled to the benefit of any individual stockholder. The authorities are clear to the

effect that whatever payment is made to those who work for a school or college as a remuneration for their services is not considered as distribution of profit as would make the school one conducted for profit. Thus, in the case of Mayor and Common Council of Borough of Princeton vs. State Board of Taxes & Assessments, et al., 115 Atl., 342, wherein the principal officer of the school was formerly its owner and principal and such principal he was given a salary for his services, the court held that school is not conducted for profit merely because moderate salaries were paid to the principal and to the teachers.

Of course, it is not denied that the Appellee charges tuition fees and other fees for the different services it renders to the students and in fact it is its only source of income, but such fact does not in itself make the school a profit-making enterprise that would place it beyond the purview of the law. In this connection, this Court made the following comment:chanroblesvirtuallawlibrary

“Needless to say, every responsible organization must be so run as to, at least, insure its existence, by operating within the limits of its own resources, especially its regular income. In other words, it should always strive, whenever possible, to have a surplus. Upon the other hand, Appellant’s pretense would limit the benefits of the exemption, under said section 27 (e), to institutions which do not hope, or propose, to have such surplus. Under this view, the exemption would apply only to schools which are on the verge of bankruptcy, for — unlike the United States, where a substantial number of institutions of learning are dependent upon voluntary contributions and still enjoy economic stability, such as Harvard, the trust fund of which has been steadily increasing with the years — there are, and there have always been, very few educational enterprises in the Philippines which are supported by donations, and these organizations usually have a very precarious existence. The final result of Appellant’s contention, if adopted, would be to discourage the

establishment of colleges in the Philippines, which is precisely the opposite of the objective consistently sought by our laws.

“Again, the amount of fees charged by a school, college or university depends, ultimately, upon the policy and a given administration, at a particular time. It is not conclusive of the purposes of the institution. Otherwise, such purpose would vary with the particular persons in charge of the administration of the organization.” (Jesus Sacred Heart College vs. Collector of Internal Revenue, 95 Phil., 16)

Another point raised by Appellant to show that Appellee is not entitled to the exemption of the law refers to the use made by it of part of its income in acquiring additional buildings and equipment which, it is claimed would in the end redound to the benefit of its stockholders. Appellant claims that “By capitalizing its earnings in the aforementioned manners, the value of the properties of the corporation was enhanced and, therefore, such profits inured to the benefit of the stockholders or members. The property of the corporation may be sold at any time and the profits thereof divided among the stockholders or members.”

This claim is too speculative. While the acquisition of additional facilities, may redound to the benefit of the institution itself, it cannot be positively asserted that the same will redound to the benefit of its stockholders, for no one can predict the financial condition of the institution upon its dissolution. At any rate, it has been held by several authorities that the mere provision for the distribution of its assets to the stockholders upon dissolution does not remove the right of an educational institution from tax exemption. Thus, in the case of U. S. vs. Picwick Electric Membership Corp., 158 F. 2d 272, 277, it was held — “The fact that the members may receive some benefit on dissolution upon distribution of the assets is a contingency too remote to have any material bearing upon the question where the association is admittedly not a scheme to avoid taxation and its good faith and honesty or purpose is not challenged.”

With regard to the claim of Appellant that Appellee is not entitled to exemption because it has not complied with the requirement of section 24, Regulation No. 2 of the Department of Finance, we find correct the following observation of the Court of Tax Appeals:chanroblesvirtuallawlibrary

“And regarding the proof of exemption required by section 24, Regulation No. 2, Department of Finance which, according to the Defendant, is a condition precedent before an educational institution can avail itself of the exemption under consideration, we understand that it was probably promulgated for the effective enforcement of the provisions of the Tax Code pursuant to Section 338 of the National Internal Revenue Code. Intended to relieve the taxpayer of the duty of filing returns and paying the tax, it cannot be said that the failure to observe the requirement called for therein constitutes a waiver of the right to enjoy the exemption. To hold otherwise would be tantamount to incorporating into our tax laws some legislative matter by administrative regulation.”

Wherefore, the decision appealed from is affirmed, without pronouncement as to costs.

G.R. No. 108067 January 20, 2000

CYANAMID PHILIPPINES, INC., petitioner, vs.THE COURT OF APPEALS, THE COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondent.

QUISUMBING, J.:

Petitioner disputes the decision1 of the Court of Appeals which affirmed the decision2 of the Court of Tax Appeals, ordering petitioner to pay respondent Commissioner of Internal Revenue the amount of three million, seven hundred seventy-four thousand, eight hundred sixty seven pesos and fifty centavos (P3,774,867.50) as 25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987, under Sec. 25 of the National Internal Revenue Code.1âwphi1.nêt

The Court of Tax Appeals made the following factual findings:

Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished goods, and an importer/indentor.

On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the payment of deficiency income tax of one hundred nineteen thousand eight hundred seventeen (P119,817.00) pesos for taxable year 1981, as follows:

Net income disclosed by the return as audited 14,575,210.00

Add: Discrepancies:

Professional fees/yr. 17018 261,877.00

per investigation 110,399.37

Total Adjustment 152,477.00

Net income per Investigation 14,727,687.00

Less: Personal and additional exemptions

Amount subject to tax 14,727,687.00

Income tax due thereon . . . 25% Surtax 2,385,231.50 3,237,495.00

Less: Amount already assessed 5,161,788.00

BALANCE 75,709.00

monthly interest from 1,389,639.00 44,108.00

Compromise penalties

TOTAL AMOUNT DUE 3,774,867.50 119,817.003

On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and 1981 Deficiency Percentage Assessment of P8,846.72.4 Petitioner, through its external accountant, Sycip, Gorres, Velayo & Co., claimed, among others, that the surtax for the undue accumulation of earnings was not proper because the said profits were retained to increase petitioner's working capital and it would be used for reasonable business needs of the company. Petitioner contended that it availed of the tax amnesty under Executive Order No. 41, hence enjoyed amnesty from civil and criminal prosecution granted by the law.

On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the cancellation of the assessment notices and rendered its resolution, as follows:

It appears that your client availed of Executive Order No. 41 under File No. 32A-F-000455-41B as certified and confirmed by our Tax Amnesty Implementation Office on October 6, 1987.

In reply thereto, I have the honor to inform you that the availment of the tax amnesty under Executive Order No. 41, as amended is sufficient basis, in appropriate cases, for the cancellation of the assessment issued after August

21, 1986. (Revenue Memorandum Order No. 4-87) Said availment does not, therefore, result in cancellation of assessments issued before August 21, 1986. as in the instant case. In other words, the assessments in this case issued on January 30, 1985 despite your client's availment of the tax amnesty under Executive Order No. 41, as amended still subsist.

Such being the case, you are therefore, requested to urge your client to pay this Office the aforementioned deficiency income tax and surtax on undue accumulation of surplus in the respective amounts of P119,817.00 and P3,774,867.50 inclusive of interest thereon for the year 1981, within thirty (30) days from receipt hereof, otherwise this office will be constrained to enforce collection thereof thru summary remedies prescribed by law.

This constitutes the final decision of this Office on this matter.5

Petitioner appealed to the Court of Tax Appeals. During the pendency of the case, however, both parties agreed to compromise the 1981 deficiency income tax assessment of P119,817.00. Petitioner paid a reduced amount — twenty-six thousand, five hundred seventy-seven pesos (P26,577.00) — as compromise settlement. However, the surtax on improperly accumulated profits remained unresolved.

Petitioner claimed that CIR's assessment representing the 25% surtax on its accumulated earnings for the year 1981 had no legal basis for the following reasons: (a) petitioner accumulated its earnings and profits for reasonable business requirements to meet working capital needs and retirement of indebtedness; (b) petitioner is a wholly owned subsidiary of American Cyanamid Company, a corporation organized under the laws of the State of Maine, in the United States of

America, whose shares of stock are listed and traded in New York Stock Exchange. This being the case, no individual shareholder income taxes by petitioner's accumulation of earnings and profits, instead of distribution of the same.

In denying the petition, the Court of Tax Appeals made the following pronouncements:

Petitioner contends that it did not declare dividends for the year 1981 in order to use the accumulated earnings as working capital reserve to meet its "reasonable business needs". The law permits a stock corporation to set aside a portion of its retained earnings for specified purposes (citing Section 43, paragraph 2 of the Corporation Code of the Philippines). In the case at bar, however, petitioner's purpose for accumulating its earnings does not fall within the ambit of any of these specified purposes.

More compelling is the finding that there was no need for petitioner to set aside a portion of its retained earnings as working capital reserve as it claims since it had considerable liquid funds. A thorough review of petitioner's financial statement (particularly the Balance Sheet, p. 127, BIR Records) reveals that the corporation had considerable liquid funds consisting of cash accounts receivable, inventory and even its sales for the period is adequate to meet the normal needs of the business. This can be determined by computing the current asset to liability ratio of the company:

current ratio = current assets/ current liabilities

= P 47,052,535.00 / P21,275,544.00

= 2.21: 1========

The significance of this ratio is to serve as a primary test of a company's solvency to meet current obligations from current assets as a going concern or a measure of adequacy of working capital.

x x x x x x x x x

We further reject petitioner's argument that "the accumulated earnings tax does not apply to a publicly-held corporation" citing American jurisprudence to support its position. The reference finds no application in the case at bar because under Section 25 of the NIRC as amended by Section 5 of P.D. No. 1379 [1739] (dated September 17, 1980), the exceptions to the accumulated earnings tax are expressly enumerated, to wit: Bank, non-bank financial intermediaries, corporations organized primarily, and authorized by the Central Bank of the Philippines to hold shares of stock of banks, insurance companies, or personal holding companies, whether domestic or foreign. The law on the matter is clear and specific. Hence, there is no need to resort to applicable cases decided by the American Federal Courts for guidance and enlightenment as to whether the provision of Section 25 of the NIRC should apply to petitioner.

Equally clear and specific are the provisions of E.O. 41 particularly with respect to its effectivity and coverage . . .

. . . Said availment does not result in cancellation of assessments issued before August 21, 1986 as petitioner seeks to do in the case at bar. Therefore, the assessments in this case, issued on January 30, 1985 despite petitioner's availment of the tax amnesty under E.O. 41 as amended, still subsist.

x x x x x x x x x

WHEREFORE, petitioner Cyanamid Philippines, Inc., is ordered to pay respondent Commissioner of Internal Revenue the sum of P3,774,867.50 representing 25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987.6

Petitioner appealed the Court of Tax Appeal's decision to the Court of Appeals. Affirming the CTA decision, the appellate court said:

In reviewing the instant petition and the arguments raised herein, We find no compelling reason to reverse the findings of the respondent Court. The respondent Court's decision is supported by evidence, such as petitioner corporation's financial statement and balance sheets (p. 127, BIR Records). On the other hand the petitioner corporation could only come up with an alternative formula lifted from a decision rendered by a foreign court (Bardahl Mfg. Corp. vs. Commissioner, 24 T.C.M. [CCH] 1030). Applying said formula to its particular financial position, the petitioner corporation attempts to justify its accumulated surplus earnings. To Our mind, the petitioner corporation's alternative formula cannot overturn the persuasive findings and conclusion of the respondent Court based, as it is, on the applicable laws and jurisprudence, as well as standards in the computation of taxes and penalties practiced in this jurisdiction.

WHEREFORE, in view of the foregoing, the instant petition is hereby DISMISSED and the decision of the Court of Tax Appeals dated August 6, 1992 in C.T.A. Case No. 4250 is AFFIRMED in toto.7

Hence, petitioner now comes before us and assigns as sole issue:

WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE PETITIONER IS LIABLE FOR THE ACCUMULATED EARNINGS TAX FOR THE YEAR 1981.8

Sec. 259 of the old National Internal Revenue Code of 1977 states:

Sec. 25. Additional tax on corporation improperly accumulating profits or surplus —

(a) Imposition of tax. — If any corporation 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.

(b) Prima facie evidence. — The fact that any corporation is mere holding company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members. Similar presumption will lie in the case of an

investment company where at any time during the taxable year more than fifty per centum in value of its outstanding stock is owned, directly or indirectly, by one person.

(c) Evidence determinative of purpose. — The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by clear preponderance of evidence, shall prove the contrary.

(d) Exception. — The provisions of this sections shall not apply to banks, non-bank financial intermediaries, corporation organized primarily, and authorized by the Central Bank of the Philippines to hold shares of stock of banks, insurance companies, whether domestic or foreign.

The provision discouraged tax avoidance through corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings by shareholders could, in turn, be taxed.

Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned company.10 Specifically, petitioner cites Golconda Mining Corp. vs. Commissioner, 507 F.2d 594, whereby the U.S. Ninth Circuit Court of Appeals had taken the position that the accumulated earnings tax could only apply to a closely held corporation.

A review of American taxation history on accumulated earnings tax will show that the application of the accumulated earnings tax to publicly held corporations has been problematic. Initially, the Tax Court and the Court of Claims held that the accumulated earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of Appeals ruled in Golconda that the accumulated earnings tax could only apply to closely held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax could be imposed on widely held corporations including those not controlled by a few shareholders or groups of shareholders. The Service indicated it would not follow the Ninth Circuit regarding publicly held corporations.11 In 1984, American legislation nullified the Ninth Circuit's Golconda ruling and made it clear that the accumulated earnings tax is not limited to closely held corporations.12 Clearly, Golconda is no longer a reliable precedent.

The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739, enumerated the corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily and authorized by the Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall among those exempt classes. Besides, the rule on enumeration is that the express mention of one person, thing, act, or consequence is construed to exclude all others.13 Laws granting exemption from tax are construed strictissimi juris against the taxpayer and liberally in favor of the taxing power.14 Taxation is the rule and exemption is the exception.15 The burden of proof rests upon the party claiming exemption to prove that it is, in fact, covered by the exemption so claimed,16 a burden which petitioner here has failed to discharge.

Another point raised by the petitioner in objecting to the assessment, is that increase of working capital by a corporation justifies accumulating income. Petitioner asserts that respondent court erred in concluding that Cyanamid

need not infuse additional working capital reserve because it had considerable liquid funds based on the 2.21:1 ratio of current assets to current liabilities. Petitioner relies on the so-called "Bardahl" formula, which allowed retention, as working capital reserve, sufficient amounts of liquid assets to carry the company through one operating cycle. The "Bardahl"17 formula was developed to measure corporate liquidity. The formula requires an examination of whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and any extraordinary expenses reasonably anticipated, plus enough to operate the business during one operating cycle. Operating cycle is the period of time it takes to convert cash into raw materials, raw materials into inventory, and inventory into sales, including the time it takes to collect payment for thesales.18

Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts that Cyanamid had a working capital deficit of P7,986,633.00.19 Therefore, the P9,540,926.00 accumulated income as of 1981 may be validly accumulated to increase the petitioner's working capital for the succeeding year.

We note, however, that the companies where the "Bardahl" formula was applied, had operating cycles much shorter than that of petitioner. In Atlas Tool Co., Inc, vs. CIR,20 the company's operating cycle was only 3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi vs. United States,21 the corporation's operating cycle was only 56.87 days, or 15.58% of the year. In the case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the operating costs of the business. There are variations in the application of the "Bardahl" formula, such as average operating cycle

or peak operating cycle. In times when there is no recurrence of a business cycle, the working capital needs cannot be predicted with accuracy. As stressed by American authorities, although the "Bardahl" formula is well-established and routinely applied by the courts, it is not a precise rule. It is used only for administrative convenience.22 Petitioner's application of the "Bardahl" formula merely creates a false illusion of exactitude.

Other formulas are also used, e.g. the ratio of current assets to current liabilities and the adoption of the industry standard.23 The ratio of current assets to current liabilities is used to determine the sufficiency of working capital. Ideally, the working capital should equal the current liabilities and there must be 2 units of current assets for every unit of current liability, hence the so-called "2 to 1" rule.24

As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said working capital was expected to increase further when more funds were generated from the succeeding year's sales. Available income covered expenses or indebtedness for that year, and there appeared no reason to expect an impending "working capital deficit" which could have necessitated an increase in working capital, as rationalized by petitioner.

In Basilan Estates, Inc. vs. Commissioner of Internal Revenue,25 we held that:

. . . [T]here 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. [citation omitted]. 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."26

If the CIR determined that the corporation avoided the tax on shareholders by permitting earnings or profits to accumulate, and the taxpayer contested such a determination, the burden of proving the determination wrong, together with the corresponding burden of first going forward with evidence, is on the taxpayer. This applies even if the corporation is not a mere holding or investment company and does not have an unreasonable accumulation of earnings or profits.27

In order to determine whether profits are accumulated for the reasonable needs to avoid the surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifest at the time of accumulation, not intentions declared subsequently, which are mere afterthoughts.28 Furthermore, the accumulated profits must be used within a reasonable time after the close of the taxable year. In the instant case, petitioner did not establish, by clear and convincing evidence, that such accumulation of profit was for the immediate needs of the business.

In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue,29 we ruled:

To determine the "reasonable needs" of the business in order to justify an accumulation of earnings, the Courts of the United States have invented the so-called "Immediacy Test" which construed the words "reasonable needs of the business" to mean the immediate needs of the business, and it was generally held that if the corporation did not prove an immediate need for the accumulation of the earnings and profits, the accumulation was not for the

reasonable needs of the business, and the penalty tax would apply. (Mertens. Law of Federal Income Taxation, Vol. 7, Chapter 39, p, 103).30

In the present case, the Tax Court opted to determine the working capital sufficiency by using the ratio between current assets to current liabilities. The working capital needs of a business depend upon nature of the business, its credit policies, the amount of inventories, the rate of the turnover, the amount of accounts receivable, the collection rate, the availability of credit to the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to impress the tax court with the required definiteness envisioned by the statute. We agree with the tax court that the burden of proof to establish that the profits accumulated were not beyond the reasonable needs of the company, remained on the taxpayer. This Court will not set aside lightly the conclusion reached by the Court of Tax Appeals which, by the very nature of its function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority.31

Unless rebutted, all presumptions generally are indulged in favor of the correctness of the CIR's assessment against the taxpayer. With petitioner's failure to prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold the correctness of tax court's ruling as affirmed by the Court of Appeals.

WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals, sustaining that of the Court of Tax Appeals, is hereby AFFIRMED. Costs against petitioner.1âwphi1.nêt

G.R. No. L-68118 October 29, 1985

JOSE P. OBILLOS, JR., SARAH P. OBILLOS, ROMEO P. OBILLOS and REMEDIOS P. OBILLOS, brothers and sisters, petitioners vs.COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

Demosthenes B. Gadioma for petitioners.

AQUINO, J.:

This case is about the income tax liability of four brothers and sisters who sold two parcels of land which they had acquired from their father.

On March 2, 1973 Jose Obillos, Sr. completed payment to Ortigas & Co., Ltd. on two lots with areas of 1,124 and 963 square meters located at Greenhills, San Juan, Rizal. The next day he transferred his rights to his four children, the petitioners, to enable them to build their residences. The company sold the two lots to petitioners for P178,708.12 on March 13 (Exh. A and B, p. 44, Rollo). Presumably, the Torrens titles issued to them would show that they were co-owners of the two lots.

In 1974, or after having held the two lots for more than a year, the petitioners resold them to the Walled City Securities Corporation and Olga Cruz Canda for the total sum of P313,050 (Exh. C and D). They derived from the sale a total profit of P134,341.88 or P33,584 for each of them. They treated the profit as a capital gain and paid an income tax on one-half thereof or of P16,792.

In April, 1980, or one day before the expiration of the five-year prescriptive period, the Commissioner of Internal Revenue required the four petitioners to pay corporate income tax on the total profit of P134,336 in addition to individual income tax on their shares thereof He assessed P37,018 as corporate income tax, P18,509 as 50% fraud surcharge and P15,547.56 as 42% accumulated interest, or a total of P71,074.56.

Not only that. He considered the share of the profits of each petitioner in the sum of P33,584 as a " taxable in full (not a mere capital gain of which ½ is taxable) and required them to pay deficiency income taxes aggregating P56,707.20 including the 50% fraud surcharge and the accumulated interest.

Thus, the petitioners are being held liable for deficiency income taxes and penalties totalling P127,781.76 on their profit of P134,336, in addition to the tax on capital gains already paid by them.

The Commissioner acted on the theory that the four petitioners had formed an unregistered partnership or joint venture within the meaning of sections 24(a) and 84(b) of the Tax Code (Collector of Internal Revenue vs. Batangas Trans. Co., 102 Phil. 822).

The petitioners contested the assessments. Two Judges of the Tax Court sustained the same. Judge Roaquin dissented. Hence, the instant appeal.

We hold that it is error to consider the petitioners as having formed a partnership under article 1767 of the Civil Code simply because they allegedly contributed P178,708.12 to buy the two lots, resold the same and divided the profit among themselves.

To regard the petitioners as having formed a taxable unregistered partnership would result in oppressive taxation and confirm the dictum that the power to tax involves the power to destroy. That eventuality should be obviated.

As testified by Jose Obillos, Jr., they had no such intention. They were co-owners pure and simple. To consider them as partners would obliterate the distinction between a co-ownership and a partnership. The petitioners were not engaged in any joint venture by reason of that isolated transaction.

Their original purpose was to divide the lots for residential purposes. If later on they found it not feasible to build their residences on the lots because of the high cost of construction, then they had no choice but to resell the same to dissolve the co-ownership. The division of the profit was merely incidental to the dissolution of the co-ownership which was in the nature of things a temporary state. It had to be terminated sooner or later. Castan Tobeñas says:

Como establecer el deslinde entre la comunidad ordinaria o copropiedad y la sociedad?

El criterio diferencial-segun la doctrina mas generalizada-esta: por razon del origen, en que la sociedad presupone necesariamente la convencion, mentras que la comunidad puede existir y existe ordinariamente sin ela; y por razon del fin objecto, en que el objeto de la sociedad es obtener lucro, mientras que el de la indivision es solo mantener en su integridad la cosa comun y favorecer su conservacion.

Reflejo de este criterio es la sentencia de 15 de Octubre de 1940, en la que se dice que si en nuestro Derecho positive se ofrecen a veces dificultades al tratar de fijar la linea divisoria entre comunidad de bienes y contrato de sociedad, la moderna orientacion de la doctrina cientifica señala como nota fundamental de diferenciacion aparte del origen de fuente de que surgen, no siempre uniforme, la finalidad perseguida por los interesados: lucro comun partible en la sociedad, y mera conservacion y aprovechamiento en la comunidad. (Derecho Civil Espanol, Vol. 2, Part 1, 10 Ed., 1971, 328- 329).

Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived". There must be an unmistakable intention to form a partnership or joint venture.*

Such intent was present in Gatchalian vs. Collector of Internal Revenue, 67 Phil. 666, where 15 persons contributed small amounts to purchase a two-peso sweepstakes ticket with the agreement that they would

divide the prize The ticket won the third prize of P50,000. The 15 persons were held liable for income tax as an unregistered partnership.

The instant case is distinguishable from the cases where the parties engaged in joint ventures for profit. Thus, in Oña vs.

** This view is supported by the following rulings of respondent Commissioner:

Co-owership distinguished from partnership.—We find that the case at bar is fundamentally similar to the De Leon case. Thus, like the De Leon heirs, the Longa heirs inherited the 'hacienda' in question pro-indiviso from their deceased parents; they did not contribute or invest additional ' capital to increase or expand the inherited properties; they merely continued dedicating the property to the use to which it had been put by their forebears; they individually reported in their tax returns their corresponding shares in the income and expenses of the 'hacienda', and they continued for many years the status of co-ownership in order, as conceded by respondent, 'to preserve its (the 'hacienda') value and to continue the existing contractual relations with the Central Azucarera de Bais for milling purposes. Longa vs. Aranas, CTA Case No. 653, July 31, 1963).

All co-ownerships are not deemed unregistered pratnership.—Co-Ownership who own properties which produce income should not automatically be considered partners of an unregistered partnership, or a corporation, within the purview of the income tax law. To hold otherwise, would be to subject the income of all

co-ownerships of inherited properties to the tax on corporations, inasmuch as if a property does not produce an income at all, it is not subject to any kind of income tax, whether the income tax on individuals or the income tax on corporation. (De Leon vs. CI R, CTA Case No. 738, September 11, 1961, cited in Arañas, 1977 Tax Code Annotated, Vol. 1, 1979 Ed., pp. 77-78).

Commissioner of Internal Revenue, L-19342, May 25, 1972, 45 SCRA 74, where after an extrajudicial settlement the co-heirs used the inheritance or the incomes derived therefrom as a common fund to produce profits for themselves, it was held that they were taxable as an unregistered partnership.

It is likewise different from Reyes vs. Commissioner of Internal Revenue, 24 SCRA 198, where father and son purchased a lot and building, entrusted the administration of the building to an administrator and divided equally the net income, and from Evangelista vs. Collector of Internal Revenue, 102 Phil. 140, where the three Evangelista sisters bought four pieces of real property which they leased to various tenants and derived rentals therefrom. Clearly, the petitioners in these two cases had formed an unregistered partnership.

In the instant case, what the Commissioner should have investigated was whether the father donated the two lots to the petitioners and whether he paid the donor's tax (See Art. 1448, Civil Code). We are not prejudging this matter. It might have already prescribed.

WHEREFORE, the judgment of the Tax Court is reversed and set aside. The assessments are cancelled. No costs.

G.R. No. 132527. July 29, 2005

COCONUT OIL REFINERS ASSOCIATION, INC. represented by its President, JESUS L. ARRANZA, PHILIPPINE ASSOCIATION OF MEAT PROCESSORS, INC. (PAMPI), represented by its Secretary, ROMEO G. HIDALGO, FEDERATION OF FREE FARMERS (FFF), represented by its President, JEREMIAS U. MONTEMAYOR, and BUKLURAN NG MANGGAGAWANG PILIPINO (BMP), represented by its Chairperson, FELIMON C. LAGMAN, Petitioners, vs.HON. RUBEN TORRES, in his capacity as Executive Secretary; BASES CONVERSION AND DEVELOPMENT AUTHORITY, CLARK DEVELOPMENT CORPORATION, SUBIC BAY METROPOLITAN AUTHORITY, 88 MART DUTY FREE, FREEPORT TRADERS, PX CLUB, AMERICAN HARDWARE, ROYAL DUTY FREE SHOPS, INC., DFS SPORTS, ASIA PACIFIC, MCI DUTY FREE DISTRIBUTOR CORP. (formerly MCI RESOURCES, CORP.), PARK & SHOP, DUTY FREE COMMODITIES, L. FURNISHING, SHAMBURGH, SUBIC DFS, ARGAN TRADING CORP., ASIPINE CORP., BEST BUY, INC., PX CLUB, CLARK TRADING, DEMAGUS TRADING CORP., D.F.S. SPORTS UNLIMITED, INC., DUTY FREE FIRST SUPERSTORE, INC., FREEPORT, JC MALL DUTY FREE INC. (formerly 88 Mart [Clark] Duty Free Corp.), LILLY HILL CORP., MARSHALL, PUREGOLD DUTY FREE, INC., ROYAL DFS and ZAXXON PHILIPPINES, INC., Respondents.

D E C I S I O N

AZCUNA, J.:

This is a Petition for Prohibition and Injunction seeking to enjoin and prohibit the Executive Branch, through the public respondents Ruben Torres in his capacity as Executive Secretary, the Bases Conversion Development Authority (BCDA), the Clark Development Corporation (CDC) and the Subic Bay Metropolitan Authority (SBMA), from allowing, and the private respondents from continuing with, the operation of tax and duty-free shops located at the Subic Special Economic Zone (SSEZ) and the Clark Special Economic Zone (CSEZ), and to declare the following issuances as unconstitutional, illegal, and void:

1. Section 5 of Executive Order No. 80,1 dated April 3, 1993, regarding the CSEZ.

2. Executive Order No. 97-A, dated June 19, 1993, pertaining to the SSEZ.

3. Section 4 of BCDA Board Resolution No. 93-05-034,2 dated May 18, 1993, pertaining to the CSEZ.

Petitioners contend that the aforecited issuances are unconstitutional and void as they constitute executive lawmaking, and that they are contrary to Republic Act No. 72273 and in violation of the Constitution, particularly Section 1, Article III (equal protection clause), Section 19, Article XII (prohibition of unfair competition and combinations in restraint of trade), and Section 12, Article XII (preferential use of Filipino labor, domestic materials and locally produced goods).

The facts are as follows:

http://lawphil.net/judjuris/juri2005/jul2005/gr_132527_2005.html#fnt3



On March 13, 1992, Republic Act No. 7227 was enacted, providing for, among other things, the sound and balanced conversion of the Clark and Subic military reservations and their extensions into alternative productive uses in the form of special economic zones in order to promote the economic and social development of Central Luzon in particular and the country in general. Among the salient provisions are as follows:

SECTION 12. Subic Special Economic Zone. —

. . .

The abovementioned zone shall be subject to the following policies:

(a) Within the framework and subject to the mandate and limitations of the Constitution and the pertinent provisions of the Local Government Code, the Subic Special Economic Zone shall be developed into a self-sustaining, industrial, commercial, financial and investment center to generate employment opportunities in and around the zone and to attract and promote productive foreign investments;

(b) The Subic Special Economic Zone shall be operated and managed as a separate customs territory ensuring free flow or movement of goods and capital within, into and exported out of the Subic Special Economic Zone, as well as provide incentives such as tax and duty-free importations of raw materials, capital and equipment. However, exportation or removal of goods from the territory of the Subic Special Economic Zone to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Customs and Tariff Code and other relevant tax laws of the Philippines;4


(c) The provision of existing laws, rules and regulations to the contrary notwithstanding, no taxes, local and national, shall be imposed within the Subic Special Economic Zone. In lieu of paying taxes, three percent (3%) of the gross income earned by all businesses and enterprises within the Subic Special Ecoomic Zone shall be remitted to the National Government, one percent (1%) each to the local government units affected by the declaration of the zone in proportion to their population area, and other factors. In addition, there is hereby established a development fund of one percent (1%) of the gross income earned by all businesses and enterprises within the Subic Special Economic Zone to be utilized for the development of municipalities outside the City of Olangapo and the Municipality of Subic, and other municipalities contiguous to the base areas.

. . .

SECTION 15. Clark and Other Special Economic Zones. — Subject to the concurrence by resolution of the local government units directly affected, the President is hereby authorized to create by executive proclamation a Special Economic Zone covering the lands occupied by the Clark military reservations and its contiguous extensions as embraced, covered and defined by the 1947 Military Bases Agreement between the Philippines and the United States of America, as amended, located within the territorial jurisdiction of Angeles City, Municipalities of Mabalacat and Porac, Province of Pampanga and the Municipality of Capas, Province of Tarlac, in accordance with the policies as herein provided insofar as applicable to the Clark military reservations.

The governing body of the Clark Special Economic Zone shall likewise be established by executive proclamation with such powers and functions exercised by the Export Processing Zone Authority pursuant to Presidential Decree No. 66 as amended.

The policies to govern and regulate the Clark Special Economic Zone shall be determined upon consultation with the inhabitants of the local government units directly affected which shall be conducted within six (6) months upon approval of this Act.

Similarly, subject to the concurrence by resolution of the local government units directly affected, the President shall create other Special Economic Zones, in the base areas of Wallace Air Station in San Fernando, La Union (excluding areas designated for communications, advance warning and radar requirements of the Philippine Air Force to be determined by the Conversion Authority) and Camp John Hay in the City of Baguio.

Upon recommendation of the Conversion Authority, the President is likewise authorized to create Special Economic Zones covering the Municipalities of Morong, Hermosa, Dinalupihan, Castillejos and San Marcelino.

On April 3, 1993, President Fidel V. Ramos issued Executive Order No. 80, which declared, among others, that Clark shall have all the applicable incentives granted to the Subic Special Economic and Free Port Zone under Republic Act No. 7227. The pertinent provision assailed therein is as follows:

SECTION 5. Investments Climate in the CSEZ. — Pursuant to Section 5(m) and Section 15 of RA 7227, the BCDA shall promulgate all necessary policies, rules and regulations governing the CSEZ, including investment incentives, in consultation with the local government units and pertinent government departments for implementation by the CDC.

Among others, the CSEZ shall have all the applicable incentives in the Subic Special Economic and Free Port Zone under RA 7227 and those applicable incentives granted in the Export Processing Zones, the Omnibus Investments Code of 1987, the Foreign Investments Act of 1991 and new investments laws which may hereinafter be enacted.

The CSEZ Main Zone covering the Clark Air Base proper shall have all the aforecited investment incentives, while the CSEZ Sub-Zone covering the rest of the CSEZ shall have limited incentives. The full incentives in the Clark SEZ Main Zone and the limited incentives in the Clark SEZ Sub-Zone shall be determined by the BCDA.

Pursuant to the directive under Executive Order No. 80, the BCDA passed Board Resolution No. 93-05-034 on May 18, 1993, allowing the tax and duty-free sale at retail of consumer goods imported via Clark for consumption outside the CSEZ. The assailed provisions of said resolution read, as follows:

Section 4. SPECIFIC INCENTIVES IN THE CSEZ MAIN ZONE. – The CSEZ-registered enterprises/businesses shall be entitled to all the incentives available under R.A. No. 7227, E.O. No. 226 and R.A. No. 7042 which shall include, but not limited to, the following:

I. As in Subic Economic and Free Port Zone:

A. Customs:

. . .

4. Tax and duty-free purchase and consumption of goods/articles (duty free shopping) within the CSEZ Main Zone.

5. For individuals, duty-free consumer goods may be brought out of the CSEZ Main Zone into the Philippine Customs territory but not to exceed US$200.00 per month per CDC-registered person, similar to the limits imposed in the Subic SEZ. This privilege shall be enjoyed only once a month. Any excess shall be levied taxes and duties by the Bureau of Customs.

On June 10, 1993, the President issued Executive Order No. 97, "Clarifying the Tax and Duty Free Incentive Within the Subic Special Economic Zone Pursuant to R.A. No. 7227." Said issuance in part states, thus:

SECTION 1. On Import Taxes and Duties – Tax and duty-free importations shall apply only to raw materials, capital goods and equipment brought in by business enterprises into the SSEZ. Except for these items, importations of other goods into the SSEZ, whether by business enterprises or resident individuals, are subject to taxes and duties under relevant Philippine laws.

The exportation or removal of tax and duty-free goods from the territory of the SSEZ to other parts of the Philippine territory shall be subject to duties and taxes under relevant Philippine laws.

Nine days after, on June 19, 1993, Executive Order No. 97-A was issued, "Further Clarifying the Tax and Duty-Free Privilege Within the Subic Special Economic and Free Port Zone." The relevant provisions read, as follows:

SECTION 1. The following guidelines shall govern the tax and duty-free privilege within the Secured Area of the Subic Special Economic and Free Port Zone:

1.1 The Secured Area consisting of the presently fenced-in former Subic Naval Base shall be the only completely tax and duty-free area in the SSEFPZ. Business enterprises and individuals (Filipinos and foreigners) residing within the Secured Area are free to import raw materials, capital goods, equipment, and consumer items tax and duty-free. Consumption items, however, must be consumed within the Secured Area. Removal of raw materials, capital goods, equipment and consumer items out of the Secured Area for sale to non-SSEFPZ registered enterprises shall be subject to the usual taxes and duties, except as may be provided herein.

1.2. Residents of the SSEFPZ living outside the Secured Area can enter the Secured Area and consume any quantity of consumption items in hotels and restaurants within the Secured Area. However, these residents can purchase and bring out of the Secured Area to other parts of the Philippine territory consumer items worth not exceeding US$100 per month per person. Only residents age 15 and over are entitled to this privilege.

1.3. Filipinos not residing within the SSEFPZ can enter the Secured Area and consume any quantity of consumption items in hotels and restaurants within the Secured Area. However, they can purchase and bring out [of] the Secured Area to other parts of the Philippine territory consumer items worth not exceeding US$200 per year per person. Only Filipinos age 15 and over are entitled to this privilege.

Petitioners assail the $100 monthly and $200 yearly tax-free shopping privileges granted by the aforecited provisions respectively to SSEZ residents living outside the Secured Area of the SSEZ and to Filipinos aged 15 and over residing outside the SSEZ.

On February 23, 1998, petitioners thus filed the instant petition, seeking the declaration of nullity of the assailed issuances on the following grounds:

I.

EXECUTIVE ORDER NO. 97-A, SECTION 5 OF EXECUTIVE ORDER NO. 80, AND SECTION 4 OF BCDA BOARD RESOLUTION NO. 93-05-034 ARE NULL AND VOID [FOR] BEING AN EXERCISE OF EXECUTIVE LAWMAKING.

II.

EXECUTIVE ORDER NO. 97-A, SECTION 5 OF EXECUTIVE ORDER NO. 80, AND SECTION 4 OF BCDA BOARD RESOLUTION NO. 93-05-034 ARE UNCONSTITUTIONAL FOR BEING VIOLATIVE OF THE EQUAL PROTECTION CLAUSE AND THE PROHIBITION AGAINST UNFAIR COMPETITION AND PRACTICES IN RESTRAINT OF TRADE.

III.

EXECUTIVE ORDER NO. 97-A, SECTION 5 OF EXECUTIVE ORDER NO. 80, AND SECTION 4 OF BCDA BOARD RESOLUTION NO. 93-05-034 ARE NULL AND VOID [FOR] BEING VIOLATIVE OF REPUBLIC ACT NO. 7227.

IV.

THE CONTINUED IMPLEMENTATION OF THE CHALLENGED ISSUANCES IF NOT RESTRAINED WILL CONTINUE TO CAUSE PETITIONERS TO SUFFER GRAVE AND IRREPARABLE INJURY.5

In their Comments, respondents point out procedural issues, alleging lack of petitioners’ legal standing, the unreasonable delay in the filing of the petition, laches, and the propriety of the remedy of prohibition.

Anent the claim on lack of legal standing, respondents argue that petitioners, being mere suppliers of the local retailers operating outside the special economic zones, do not stand to suffer direct injury in the enforcement of the issuances being assailed herein. Assuming this is true, this Court has nevertheless held that in cases of paramount importance where serious constitutional questions are involved, the standing requirements may be relaxed and a suit may be allowed to prosper even where there is no direct injury to the party claiming the right of judicial review.6

In the same vein, with respect to the other alleged procedural flaws, even assuming the existence of such defects, this Court, in the exercise of its discretion, brushes aside these technicalities and takes cognizance of the petition considering the importance to the public of the present case and in keeping with the duty to determine whether the other branches of the government have kept themselves within the limits of the Constitution.7




Now, on the constitutional arguments raised:

As this Court enters upon the task of passing on the validity of an act of a co-equal and coordinate branch of the Government, it bears emphasis that deeply ingrained in our jurisprudence is the time-honored principle that a statute is presumed to be valid.8 This presumption is rooted in the doctrine of separation of powers which enjoins upon the three coordinate departments of the Government a becoming courtesy for each other’s acts.9 Hence, to doubt is to sustain. The theory is that before the act was done or the law was enacted, earnest studies were made by Congress, or the President, or both, to insure that the Constitution would not be breached.10 This Court, however, may declare a law, or portions thereof, unconstitutional where a petitioner has shown a clear and unequivocal breach of the Constitution, not merely a doubtful or argumentative one.11 In other words, before a statute or a portion thereof may be declared unconstitutional, it must be shown that the statute or issuance violates the Constitution clearly, palpably and plainly, and in such a manner as to leave no doubt or hesitation in the mind of the Court.12

The Issue on Executive Legislation

Petitioners claim that the assailed issuances (Executive Order No. 97-A; Section 5 of Executive Order No. 80; and Section 4 of BCDA Board Resolution No. 93-05-034) constitute executive legislation, in violation of the rule on separation of powers. Petitioners argue that the Executive Department, by allowing through the questioned issuances the setting up of tax and duty-free shops and the removal of consumer goods and items from the zones without payment of corresponding duties and taxes, arbitrarily provided additional exemptions to the limitations imposed by Republic Act No. 7227, which limitations petitioners identify as follows:






(1) [Republic Act No. 7227] allowed only tax and duty-free importation of raw materials, capital and equipment.

(2) It provides that any exportation or removal of goods from the territory of the Subic Special Economic Zone to other parts of the Philippine territory shall be subject to customs duties and taxes under the Customs and Tariff Code and other relevant tax laws of the Philippines.

Anent the first alleged limitation, petitioners contend that the wording of Republic Act No. 7227 clearly limits the grant of tax incentives to the importation of raw materials, capital and equipment only. Hence, they claim that the assailed issuances constitute executive legislation for invalidly granting tax incentives in the importation of consumer goods such as those being sold in the duty-free shops, in violation of the letter and intent of Republic Act No. 7227.

A careful reading of Section 12 of Republic Act No. 7227, which pertains to the SSEZ, would show that it does not restrict the duty-free importation only to "raw materials, capital and equipment." Section 12 of the cited law is partly reproduced, as follows:

SECTION 12. Subic Special Economic Zone. —

. . .


. . .

(b) The Subic Special Economic Zone shall be operated and managed as a separate customs territory ensuring free flow or movement of goods and capital within, into and exported out of the Subic Special Economic Zone, as well as provide incentives such as tax and duty-free importations of raw materials, capital and equipment. However, exportation or removal of goods from the territory of the Subic Special Economic Zone to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Customs and Tariff Code and other relevant tax laws of the Philippines.13

While it is true that Section 12 (b) of Republic Act No. 7227 mentions only raw materials, capital and equipment, this does not necessarily mean that the tax and duty-free buying privilege is limited to these types of articles to the exclusion of consumer goods. It must be remembered that in construing statutes, the proper course is to start out and follow the true intent of the Legislature and to adopt that sense which harmonizes best with the context and promotes in the fullest manner the policy and objects of the Legislature.14

In the present case, there appears to be no logic in following the narrow interpretation petitioners urge. To limit the tax-free importation privilege of enterprises located inside the special economic zone only to raw materials, capital and equipment clearly runs counter to the intention of the Legislature to create a free port where the "free flow of goods or capital within, into, and out of the zones" is insured.

The phrase "tax and duty-free importations of raw materials, capital and equipment" was merely cited as an example of incentives that may be given to entities operating within the zone. Public respondent SBMA correctly argued that the maxim expressio unius est exclusio alterius, on which petitioners impliedly rely to support their restrictive



interpretation, does not apply when words are mentioned by way of example.15 It is obvious from the wording of Republic Act No. 7227, particularly the use of the phrase "such as," that the enumeration only meant to illustrate incentives that the SSEZ is authorized to grant, in line with its being a free port zone.

Furthermore, said legal maxim should be applied only as a means of discovering legislative intent which is not otherwise manifest, and should not be permitted to defeat the plainly indicated purpose of the Legislature.16

The records of the Senate containing the discussion of the concept of "special economic zone" in Section 12 (a) of Republic Act No. 7227 show the legislative intent that consumer goods entering the SSEZ which satisfy the needs of the zone and are consumed there are not subject to duties and taxes in accordance with Philippine laws, thus:

Senator Guingona. . . . The concept of Special Economic Zone is one that really includes the concept of a free port, but it is broader. While a free port is necessarily included in the Special Economic Zone, the reverse is not true that a free port would include a special economic zone.

Special Economic Zone, Mr. President, would include not only the incoming and outgoing of vessels, duty-free and tax-free, but it would involve also tourism, servicing, financing and all the appurtenances of an investment center. So, that is the concept, Mr. President. It is broader. It includes the free port concept and would cater to the greater needs of Olangapo City, Subic Bay and the surrounding municipalities.

Senator Enrile. May I know then if a factory located within the jurisdiction of Morong, Bataan that was originally a part of the Subic Naval reservation, be entitled to a free port treatment or just a special economic zone treatment?



Senator Guingona. As far as the goods required for manufacture is concerned, Mr. President, it would have privileges of duty-free and tax-free. But in addition, the Special Economic Zone could embrace the needs of tourism, could embrace the needs of servicing, could embrace the needs of financing and other investment aspects.

Senator Enrile. When a hotel is constructed, Mr. President, in this geographical unit which we call a special economic zone, will the goods entering to be consumed by the customers or guests of the hotel be subject to duties?

Senator Guingona. That is the concept that we are crafting, Mr. President.

Senator Enrile. No. I am asking whether those goods will be duty-free, because it is constructed within a free port.

Senator Guingona. For as long as it services the needs of the Special Economic Zone, yes.

Senator Enrile. For as long as the goods remain within the zone, whether we call it an economic zone or a free port, for as long as we say in this law that all goods entering this particular territory will be duty-free and tax-free, for as long as they remain there, consumed there or reexported or destroyed in that place, then they are not subject to the duties and taxes in accordance with the laws of the Philippines?

Senator Guingona. Yes.17

Petitioners rely on Committee Report No. 1206 submitted by the Ad Hoc Oversight Committee on Bases Conversion on June 26, 1995. Petitioners put emphasis on the report’s finding that the setting up of duty-free stores never figured in the minds of the authors of Republic Act No. 7227 in attracting foreign investors to the former military baselands. They


maintain that said law aimed to attract manufacturing and service enterprises that will employ the dislocated former military base workers, but not investors who would buy consumer goods from duty-free stores.

The Court is not persuaded. Indeed, it is well-established that opinions expressed in the debates and proceedings of the Legislature, steps taken in the enactment of a law, or the history of the passage of the law through the Legislature, may be resorted to as aids in the interpretation of a statute with a doubtful meaning.18 Petitioners’ posture, however, overlooks the fact that the 1995 Committee Report they are referring to came into being well after the enactment of Republic Act No. 7227 in 1993. Hence, as pointed out by respondent Executive Secretary Torres, the aforementioned report cannot be said to form part of Republic Act No. 7227’s legislative history.

Section 12 of Republic Act No. 7227, provides in part, thus:

SEC. 12. Subic Special Economic Zone. -- . . .


(a) Within the framework and subject to the mandate and limitations of the Constitution and the pertinent provisions of the Local Government Code, the Subic Special Economic Zone shall be developed into a self-sustaining, industrial, commercial, financial and investment center to generate employment opportunities in and around the zone and to attract and promote productive foreign investments. 19

The aforecited policy was mentioned as a basis for the issuance of Executive Order No. 97-A, thus:



WHEREAS, Republic Act No. 7227 provides that within the framework and subject to the mandate and limitations of the Constitution and the pertinent provisions of the Local Government Code, the Subic Special Economic and Free Port Zone (SSEFPZ) shall be developed into a self-sustaining industrial, commercial, financial and investment center to generate employment opportunities in and around the zone and to attract and promote productive foreign investments; and

WHEREAS, a special tax and duty-free privilege within a Secured Area in the SSEFPZ subject, to existing laws has been determined necessary to attract local and foreign visitors to the zone.

Executive Order No. 97-A provides guidelines to govern the "tax and duty-free privileges within the Secured Area of the Subic Special Economic and Free Port Zone." Paragraph 1.6 thereof states that "(t)he sale of tax and duty-free consumer items in the Secured Area shall only be allowed in duly authorized duty-free shops."

The Court finds that the setting up of such commercial establishments which are the only ones duly authorized to sell consumer items tax and duty-free is still well within the policy enunciated in Section 12 of Republic Act No. 7227 that ". . .the Subic Special Economic Zone shall be developed into a self-sustaining, industrial, commercial, financial and investment center to generate employment opportunities in and around the zone and to attract and promote productive foreign investments." (Emphasis supplied.)

However, the Court reiterates that the second sentences of paragraphs 1.2 and 1.3 of Executive Order No. 97-A, allowing tax and duty-free removal of goods to certain individuals, even in a limited amount, from the Secured Area of the SSEZ, are null and void for being contrary to Section 12 of Republic Act No. 7227. Said Section clearly

provides that "exportation or removal of goods from the territory of the Subic Special Economic Zone to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Customs and Tariff Code and other relevant tax laws of the Philippines."

On the other hand, insofar as the CSEZ is concerned, the case for an invalid exercise of executive legislation is tenable.

In John Hay Peoples Alternative Coalition, et al. v. Victor Lim, et al.,20 this Court resolved an issue, very much like the one herein, concerning the legality of the tax exemption benefits given to the John Hay Economic Zone under Presidential Proclamation No. 420, Series of 1994, "CREATING AND DESIGNATING A PORTION OF THE AREA COVERED BY THE FORMER CAMP JOHN AS THE JOHN HAY SPECIAL ECONOMIC ZONE PURSUANT TO REPUBLIC ACT NO. 7227."

In that case, among the arguments raised was that the granting of tax exemptions to John Hay was an invalid and illegal exercise by the President of the powers granted only to the Legislature. Petitioners therein argued that Republic Act No. 7227 expressly granted tax exemption only to Subic and not to the other economic zones yet to be established. Thus, the grant of tax exemption to John Hay by Presidential Proclamation contravenes the constitutional mandate that "[n]o law granting any tax exemption shall be passed without the concurrence of a majority of all the members of Congress."21

This Court sustained the argument and ruled that the incentives under Republic Act No. 7227 are exclusive only to the SSEZ. The President, therefore, had no authority to extend their application to John Hay. To quote from the Decision:



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More importantly, the nature of most of the assailed privileges is one of tax exemption. It is the legislature, unless limited by a provision of a state constitution, that has full power to exempt any person or corporation or class of property from taxation, its power to exempt being as broad as its power to tax. Other than Congress, the Constitution may itself provide for specific tax exemptions, or local governments may pass ordinances on exemption only from local taxes.

The challenged grant of tax exemption would circumvent the Constitution’s imposition that a law granting any tax exemption must have the concurrence of a majority of all the members of Congress. In the same vein, the other kinds of privileges extended to the John Hay SEZ are by tradition and usage for Congress to legislate upon.

Contrary to public respondents’ suggestions, the claimed statutory exemption of the John Hay SEZ from taxation should be manifest and unmistakable from the language of the law on which it is based; it must be expressly granted in a statute stated in a language too clear to be mistaken. Tax exemption cannot be implied as it must be categorically and unmistakably expressed.

If it were the intent of the legislature to grant to John Hay SEZ the same tax exemption and incentives given to the Subic SEZ, it would have so expressly provided in R.A. No. 7227.22

In the present case, while Section 12 of Republic Act No. 7227 expressly provides for the grant of incentives to the SSEZ, it fails to make any similar grant in favor of other economic zones, including the CSEZ. Tax and duty-free incentives being in the nature of tax exemptions, the basis thereof should be categorically and unmistakably expressed from the language of the statute. Consequently, in the absence of any express grant of tax and duty-free privileges to


the CSEZ in Republic Act No. 7227, there would be no legal basis to uphold the questioned portions of two issuances: Section 5 of Executive Order No. 80 and Section 4 of BCDA Board Resolution No. 93-05-034, which both pertain to the CSEZ.

Petitioners also contend that the questioned issuances constitute executive legislation for allowing the removal of consumer goods and items from the zones without payment of corresponding duties and taxes in violation of Republic Act No. 7227 as Section 12 thereof provides for the taxation of goods that are exported or removed from the SSEZ to other parts of the Philippine territory.

On September 26, 1997, Executive Order No. 444 was issued, curtailing the duty-free shopping privileges in the SSEZ and the CSEZ "to prevent abuse of duty-free privilege and to protect local industries from unfair competition." The pertinent provisions of said issuance state, as follows:

SECTION 3. Special Shopping Privileges Granted During the Year-round Centennial Anniversary Celebration in 1998. — Upon effectivity of this Order and up to the Centennial Year 1998, in addition to the permanent residents, locators and employees of the fenced-in areas of the Subic Special Economic and Freeport Zone and the Clark Special Economic Zone who are allowed unlimited duty free purchases, provided these are consumed within said fenced-in areas of the Zones, the residents of the municipalities adjacent to Subic and Clark as respectively provided in R.A. 7227 (1992) and E.O. 97-A s. 1993 shall continue to be allowed One Hundred US Dollars (US$100) monthly shopping privilege until 31 December 1998. Domestic tourists visiting Subic and Clark shall be allowed a shopping privilege of US$25 for consumable goods which shall be consumed only in the fenced-in area during their visit therein.

SECTION 4. Grant of Duty Free Shopping Privileges Limited Only To Individuals Allowed by Law. — Starting 1 January 1999, only the following persons shall continue to be eligible to shop in duty free shops/outlets with their corresponding purchase limits:

a. Tourists and Filipinos traveling to or returning from foreign destinations under E.O. 97-A s. 1993 — One Thousand US Dollars (US$1,000) but not to exceed Ten Thousand US Dollars (US$10,000) in any given year;

b. Overseas Filipino Workers (OFWs) and Balikbayans defined under R.A. 6768 dated 3 November 1989 — Two Thousand US Dollars (US$2,000);

c. Residents, eighteen (18) years old and above, of the fenced-in areas of the freeports under R.A. 7227 (1992) and E.O. 97-A s. 1993 — Unlimited purchase as long as these are for consumption within these freeports.

The term "Residents" mentioned in item c above shall refer to individuals who, by virtue of domicile or employment, reside on permanent basis within the freeport area. The term excludes (1) non-residents who have entered into short- or long-term property lease inside the freeport, (2) outsiders engaged in doing business within the freeport, and (3) members of private clubs (e.g., yacht and golf clubs) based or located within the freeport. In this regard, duty free privileges granted to any of the above individuals (e.g., unlimited shopping privilege, tax-free importation of cars, etc.) are hereby revoked.23

A perusal of the above provisions indicates that effective January 1, 1999, the grant of duty-free shopping privileges to domestic tourists and to residents living adjacent to SSEZ and the CSEZ had been revoked. Residents of the fenced-in


area of the free port are still allowed unlimited purchase of consumer goods, "as long as these are for consumption within these freeports." Hence, the only individuals allowed by law to shop in the duty-free outlets and remove consumer goods out of the free ports tax-free are tourists and Filipinos traveling to or returning from foreign destinations, and Overseas Filipino Workers and Balikbayans as defined under Republic Act No. 6768.24

Subsequently, on October 20, 2000, Executive Order No. 303 was issued, amending Executive Order No. 444. Pursuant to the limited duration of the privileges granted under the preceding issuance, Section 2 of Executive Order No. 303 declared that "[a]ll special shopping privileges as granted under Section 3 of Executive Order 444, s. 1997, are hereby deemed terminated. The grant of duty free shopping privileges shall be restricted to qualified individuals as provided by law."

It bears noting at this point that the shopping privileges currently being enjoyed by Overseas Filipino Workers, Balikbayans, and tourists traveling to and from foreign destinations, draw authority not from the issuances being assailed herein, but from Executive Order No. 4625 and Republic Act No. 6768, both enacted prior to the promulgation of Republic Act No. 7227.

From the foregoing, it appears that petitioners’ objection to the allowance of tax-free removal of goods from the special economic zones as previously authorized by the questioned issuances has become moot and academic.

In any event, Republic Act No. 7227, specifically Section 12 (b) thereof, clearly provides that "exportation or removal of goods from the territory of the Subic Special Economic Zone to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Customs and Tariff Code and other relevant tax laws of the Philippines."



Thus, the removal of goods from the SSEZ to other parts of the Philippine territory without payment of said customs duties and taxes is not authorized by the Act. Consequently, the following italicized provisions found in the second sentences of paragraphs 1.2 and 1.3, Section 1 of Executive Order No. 97-A are null and void:

1.2 Residents of the SSEFPZ living outside the Secured Area can enter and consume any quantity of consumption items in hotels and restaurants within the Secured Area. However, these residents can purchase and bring out of the Secured Area to other parts of the Philippine territory consumer items worth not exceeding US $100 per month per person. Only residents age 15 and over are entitled to this privilege.

1.3 Filipinos not residing within the SSEFPZ can enter the Secured Area and consume any quantity of consumption items in hotels and restaurants within the Secured Area. However, they can purchase and bring out of the Secured Area to other parts of the Philippine territory consumer items worth not exceeding US $200 per year per person. Only Filipinos age 15 and over are entitled to this privilege.26

A similar provision found in paragraph 5, Section 4(A) of BCDA Board Resolution No. 93-05-034 is also null and void. Said Resolution applied the incentives given to the SSEZ under Republic Act No. 7227 to the CSEZ, which, as aforestated, is without legal basis.

Having concluded earlier that the CSEZ is excluded from the tax and duty-free incentives provided under Republic Act No. 7227, this Court will resolve the remaining arguments only with regard to the operations of the SSEZ. Thus, the assailed issuance that will be discussed is solely Executive Order No. 97-A, since it is the only one among the three questioned issuances which pertains to the SSEZ.


Equal Protection of the Laws

Petitioners argue that the assailed issuance (Executive Order No. 97-A) is violative of their right to equal protection of the laws, as enshrined in Section 1, Article III of the Constitution. To support this argument, they assert that private respondents operating inside the SSEZ are not different from the retail establishments located outside, the products sold being essentially the same. The only distinction, they claim, lies in the products’ variety and source, and the fact that private respondents import their items tax-free, to the prejudice of the retailers and manufacturers located outside the zone.

Petitioners’ contention cannot be sustained. It is an established principle of constitutional law that the guaranty of the equal protection of the laws is not violated by a legislation based on a reasonable classification.27 Classification, to be valid, must (1) rest on substantial distinction, (2) be germane to the purpose of the law, (3) not be limited to existing conditions only, and (4) apply equally to all members of the same class.28

Applying the foregoing test to the present case, this Court finds no violation of the right to equal protection of the laws. First, contrary to petitioners’ claim, substantial distinctions lie between the establishments inside and outside the zone, justifying the difference in their treatment. In Tiu v. Court of Appeals,29 the constitutionality of Executive Order No. 97-A was challenged for being violative of the equal protection clause. In that case, petitioners claimed that Executive Order No. 97-A was discriminatory in confining the application of Republic Act No. 7227 within a secured area of the SSEZ, to the exclusion of those outside but are, nevertheless, still within the economic zone.




Upholding the constitutionality of Executive Order No. 97-A, this Court therein found substantial differences between the retailers inside and outside the secured area, thereby justifying a valid and reasonable classification:

Certainly, there are substantial differences between the big investors who are being lured to establish and operate their industries in the so-called "secured area" and the present business operators outside the area. On the one hand, we are talking of billion-peso investments and thousands of new jobs. On the other hand, definitely none of such magnitude. In the first, the economic impact will be national; in the second, only local. Even more important, at this time the business activities outside the "secured area" are not likely to have any impact in achieving the purpose of the law, which is to turn the former military base to productive use for the benefit of the Philippine economy. There is, then, hardly any reasonable basis to extend to them the benefits and incentives accorded in R.A. 7227. Additionally, as the Court of Appeals pointed out, it will be easier to manage and monitor the activities within the "secured area," which is already fenced off, to prevent "fraudulent importation of merchandise" or smuggling.

It is well-settled that the equal-protection guarantee does not require territorial uniformity of laws. As long as there are actual and material differences between territories, there is no violation of the constitutional clause. And of course, anyone, including the petitioners, possessing the requisite investment capital can always avail of the same benefits by channeling his or her resources or business operations into the fenced-off free port zone.30

The Court in Tiu found real and substantial distinctions between residents within the secured area and those living within the economic zone but outside the fenced-off area. Similarly, real and substantial differences exist between the establishments herein involved. A significant distinction between the two groups is that enterprises outside the zones


maintain their businesses within Philippine customs territory, while private respondents and the other duly-registered zone enterprises operate within the so-called "separate customs territory." To grant the same tax incentives given to enterprises within the zones to businesses operating outside the zones, as petitioners insist, would clearly defeat the statute’s intent to carve a territory out of the military reservations in Subic Bay where free flow of goods and capital is maintained.

The classification is germane to the purpose of Republic Act No. 7227. As held in Tiu, the real concern of Republic Act No. 7227 is to convert the lands formerly occupied by the US military bases into economic or industrial areas. In furtherance of such objective, Congress deemed it necessary to extend economic incentives to the establishments within the zone to attract and encourage foreign and local investors. This is the very rationale behind Republic Act No. 7227 and other similar special economic zone laws which grant a complete package of tax incentives and other benefits.

The classification, moreover, is not limited to the existing conditions when the law was promulgated, but to future conditions as well, inasmuch as the law envisioned the former military reservation to ultimately develop into a self-sustaining investment center.

And, lastly, the classification applies equally to all retailers found within the "secured area." As ruled in Tiu, the individuals and businesses within the "secured area," being in like circumstances or contributing directly to the achievement of the end purpose of the law, are not categorized further. They are all similarly treated, both in privileges granted and in obligations required.

With all the four requisites for a reasonable classification present, there is no ground to invalidate Executive Order No. 97-A for being violative of the equal protection clause.

Prohibition against Unfair Competition

and Practices in Restraint of Trade

Petitioners next argue that the grant of special tax exemptions and privileges gave the private respondents undue advantage over local enterprises which do not operate inside the SSEZ, thereby creating unfair competition in violation of the constitutional prohibition against unfair competition and practices in restraint of trade.

The argument is without merit. Just how the assailed issuance is violative of the prohibition against unfair competition and practices in restraint of trade is not clearly explained in the petition. Republic Act No. 7227, and consequently Executive Order No. 97-A, cannot be said to be distinctively arbitrary against the welfare of businesses outside the zones. The mere fact that incentives and privileges are granted to certain enterprises to the exclusion of others does not render the issuance unconstitutional for espousing unfair competition. Said constitutional prohibition cannot hinder the Legislature from using tax incentives as a tool to pursue its policies.

Suffice it to say that Congress had justifiable reasons in granting incentives to the private respondents, in accordance with Republic Act No. 7227’s policy of developing the SSEZ into a self-sustaining entity that will generate employment and attract foreign and local investment. If petitioners had wanted to avoid any alleged unfavorable consequences on their profits, they should upgrade their standards of quality so as to effectively compete in the market.

In the alternative, if petitioners really wanted the preferential treatment accorded to the private respondents, they could have opted to register with SSEZ in order to operate within the special economic zone.

Preferential Use of Filipino Labor, Domestic Materials

and Locally Produced Goods

Lastly, petitioners claim that the questioned issuance (Executive Order No. 97-A) openly violated the State policy of promoting the preferential use of Filipino labor, domestic materials and locally produced goods and adopting measures to help make them competitive.

Again, the argument lacks merit. This Court notes that petitioners failed to substantiate their sweeping conclusion that the issuance has violated the State policy of giving preference to Filipino goods and labor. The mere fact that said issuance authorizes the importation and trade of foreign goods does not suffice to declare it unconstitutional on this ground.

Petitioners cite Manila Prince Hotel v. GSIS 31 which, however, does not apply. That case dealt with the policy enunciated under the second paragraph of Section 10, Article XII of the Constitution,32 applicable to the grant of rights, privileges, and concessions "covering the national economy and patrimony," which is different from the policy invoked in this petition, specifically that of giving preference to Filipino materials and labor found under Section 12 of the same Article of the Constitution. (Emphasis supplied).



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In Tañada v. Angara,33 this Court elaborated on the meaning of Section 12, Article XII of the Constitution in this wise:

[W]hile the Constitution indeed mandates a bias in favor of Filipino goods, services, labor and enterprises, at the same time, it recognizes the need for business exchange with the rest of the world on the bases of equality and reciprocity and limits protection of Filipino enterprises only against foreign competition and trade practices that are unfair. In other words, the Constitution did not intend to pursue an isolationist policy. It did not shut out foreign investments, goods and services in the development of the Philippine economy. While the Constitution does not encourage the unlimited entry of foreign goods, services and investments into the country, it does not prohibit them either. In fact, it allows an exchange on the basis of equality and reciprocity, frowning only on foreign competition that is unfair.34

This Court notes that the Executive Department, with its subsequent issuance of Executive Order Nos. 444 and 303, has provided certain measures to prevent unfair competition. In particular, Executive Order Nos. 444 and 303 have restricted the special shopping privileges to certain individuals.35 Executive Order No. 303 has limited the range of items that may be sold in the duty-free outlets,36 and imposed sanctions to curb abuses of duty-free privileges.37 With these measures, this Court finds no reason to strike down Executive Order No. 97-A for allegedly being prejudicial to Filipino labor, domestic materials and locally produced goods.

WHEREFORE, the petition is PARTLY GRANTED. Section 5 of Executive Order No. 80 and Section 4 of BCDA Board Resolution No. 93-05-034 are hereby declared NULL and VOID and are accordingly declared of no legal force and effect. Respondents are hereby enjoined from implementing the aforesaid void provisions. All portions of






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Executive Order No. 97-A are valid and effective, except the second sentences in paragraphs 1.2 and 1.3 of said Executive Order, which are hereby declared INVALID.

G.R. No. L-19342 May 25, 1972

LORENZO T. OÑA and HEIRS OF JULIA BUÑALES, namely: RODOLFO B. OÑA, MARIANO B. OÑA, LUZ B. OÑA, VIRGINIA B. OÑA and LORENZO B. OÑA, JR., petitioners, vs.THE COMMISSIONER OF INTERNAL REVENUE, respondent.

Orlando Velasco for petitioners.

Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felicisimo R. Rosete, and Special Attorney Purificacion Ureta for respondent.

BARREDO, J.:p

Petition for review of the decision of the Court of Tax Appeals in CTA Case No. 617, similarly entitled as above, holding that petitioners have constituted an unregistered partnership and are, therefore, subject to the payment of the deficiency corporate income taxes assessed against them by respondent Commissioner of Internal Revenue for the years 1955 and 1956 in the total sum of P21,891.00, plus 5% surcharge and 1% monthly interest from December 15, 1958, subject to the provisions of Section 51 (e) (2) of the Internal

Revenue Code, as amended by Section 8 of Republic Act No. 2343 and the costs of the suit, 1 as well as the resolution of said court denying petitioners' motion for reconsideration of said decision.

The facts are stated in the decision of the Tax Court as follows:

Julia Buñales died on March 23, 1944, leaving as heirs her surviving spouse, Lorenzo T. Oña and her five children. In 1948, Civil Case No. 4519 was instituted in the Court of First Instance of Manila for the settlement of her estate. Later, Lorenzo T. Oña the surviving spouse was appointed administrator of the estate of said deceased (Exhibit 3, pp. 34-41, BIR rec.). On April 14, 1949, the administrator submitted the project of partition, which was approved by the Court on May 16, 1949 (See Exhibit K). Because three of the heirs, namely Luz, Virginia and Lorenzo, Jr., all surnamed Oña, were still minors when the project of partition was approved, Lorenzo T. Oña, their father and administrator of the estate, filed a petition in Civil Case No. 9637 of the Court of First Instance of Manila for appointment as guardian of said minors. On November 14, 1949, the Court appointed him guardian of the persons and property of the aforenamed minors (See p. 3, BIR rec.).

The project of partition (Exhibit K; see also pp. 77-70, BIR rec.) shows that the heirs have undivided one-half (1/2) interest in ten parcels of land with a total assessed value of P87,860.00, six houses with a total assessed value of P17,590.00 and an undetermined amount to be collected from the War Damage Commission. Later, they received from said Commission the amount of P50,000.00, more or less. This amount was not divided among them but was used in the rehabilitation of

properties owned by them in common (t.s.n., p. 46). Of the ten parcels of land aforementioned, two were acquired after the death of the decedent with money borrowed from the Philippine Trust Company in the amount of P72,173.00 (t.s.n., p. 24; Exhibit 3, pp. 31-34 BIR rec.).

The project of partition also shows that the estate shares equally with Lorenzo T. Oña, the administrator thereof, in the obligation of P94,973.00, consisting of loans contracted by the latter with the approval of the Court (see p. 3 of Exhibit K; or see p. 74, BIR rec.).

Although the project of partition was approved by the Court on May 16, 1949, no attempt was made to divide the properties therein listed. Instead, the properties remained under the management of Lorenzo T. Oña who used said properties in business by leasing or selling them and investing the income derived therefrom and the proceeds from the sales thereof in real properties and securities. As a result, petitioners' properties and investments gradually increased from P105,450.00 in 1949 to P480,005.20 in 1956 as can be gleaned from the following year-end balances:

Year Investment Land Building

Account Account Account

1949 — P87,860.00 P17,590.00

1950 P24,657.65 128,566.72 96,076.26

1951 51,301.31 120,349.28 110,605.11

1952 67,927.52 87,065.28 152,674.39

1953 61,258.27 84,925.68 161,463.83

1954 63,623.37 99,001.20 167,962.04

1955 100,786.00 120,249.78 169,262.52

1956 175,028.68 135,714.68 169,262.52

(See Exhibits 3 & K t.s.n., pp. 22, 25-26, 40, 50, 102-104)

From said investments and properties petitioners derived such incomes as profits from installment sales of subdivided lots, profits from sales of stocks, dividends, rentals and interests (see p. 3 of Exhibit 3; p. 32, BIR rec.; t.s.n., pp. 37-38). The said incomes are recorded in the books of account kept by Lorenzo T. Oña where the corresponding shares of the petitioners in the net income for the year are also known. Every year, petitioners returned for income tax purposes their shares in the net income derived from said properties and securities and/or from transactions involving them (Exhibit 3, supra; t.s.n., pp. 25-26). However, petitioners did not actually receive their shares in the yearly income. (t.s.n., pp. 25-26, 40, 98, 100). The income was always left in the hands of Lorenzo T. Oña who, as heretofore pointed out, invested them in real properties and securities. (See Exhibit 3, t.s.n., pp. 50, 102-104).

On the basis of the foregoing facts, respondent (Commissioner of Internal Revenue) decided that petitioners formed an unregistered partnership and therefore, subject to the corporate income tax, pursuant to Section 24, in relation to Section 84(b), of the Tax Code. Accordingly, he assessed against the petitioners the amounts of P8,092.00 and P13,899.00 as corporate income taxes for 1955 and 1956, respectively. (See Exhibit 5, amended by Exhibit 17, pp. 50 and 86, BIR rec.). Petitioners protested against the assessment and asked for reconsideration of the ruling of respondent that they have formed an unregistered partnership. Finding no merit in petitioners' request, respondent denied it (See Exhibit 17, p. 86, BIR rec.). (See pp. 1-4, Memorandum for Respondent, June 12, 1961).

The original assessment was as follows:

1955

Net income as per investigation ................ P40,209.89

Income tax due thereon ............................... 8,042.0025% surcharge .............................................. 2,010.50Compromise for non-filing .......................... 50.00Total ............................................................... P10,102.50

1956

Net income as per investigation ................ P69,245.23

Income tax due thereon ............................... 13,849.0025% surcharge .............................................. 3,462.25Compromise for non-filing .......................... 50.00Total ............................................................... P17,361.25

(See Exhibit 13, page 50, BIR records)

Upon further consideration of the case, the 25% surcharge was eliminated in line with the ruling of the Supreme Court in Collector v. Batangas Transportation Co., G.R. No. L-9692, Jan. 6, 1958, so that the questioned assessment refers solely to the income tax proper for the years 1955 and 1956 and the "Compromise for non-filing," the latter item obviously referring to the compromise in lieu of the criminal liability for failure of petitioners to file the corporate income tax returns for said years. (See Exh. 17, page 86, BIR records). (Pp. 1-3, Annex C to Petition)

Petitioners have assigned the following as alleged errors of the Tax Court:

I.

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE PETITIONERS FORMED AN UNREGISTERED PARTNERSHIP;

II.

THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE PETITIONERS WERE CO-OWNERS OF THE PROPERTIES INHERITED AND (THE) PROFITS DERIVED FROM TRANSACTIONS THEREFROM (sic);

III.

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT PETITIONERS WERE LIABLE FOR CORPORATE INCOME TAXES FOR 1955 AND 1956 AS AN UNREGISTERED PARTNERSHIP;

IV.

ON THE ASSUMPTION THAT THE PETITIONERS CONSTITUTED AN UNREGISTERED PARTNERSHIP, THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE PETITIONERS WERE AN UNREGISTERED PARTNERSHIP TO THE EXTENT ONLY THAT THEY INVESTED THE PROFITS FROM THE PROPERTIES OWNED IN COMMON AND THE LOANS RECEIVED USING THE INHERITED PROPERTIES AS COLLATERALS;

V .

ON THE ASSUMPTION THAT THERE WAS AN UNREGISTERED PARTNERSHIP, THE COURT OF TAX APPEALS ERRED IN NOT DEDUCTING THE VARIOUS AMOUNTS PAID BY THE

PETITIONERS AS INDIVIDUAL INCOME TAX ON THEIR RESPECTIVE SHARES OF THE PROFITS ACCRUING FROM THE PROPERTIES OWNED IN COMMON, FROM THE DEFICIENCY TAX OF THE UNREGISTERED PARTNERSHIP.

In other words, petitioners pose for our resolution the following questions: (1) Under the facts found by the Court of Tax Appeals, should petitioners be considered as co-owners of the properties inherited by them from the deceased Julia Buñales and the profits derived from transactions involving the same, or, must they be deemed to have formed an unregistered partnership subject to tax under Sections 24 and 84(b) of the National Internal Revenue Code? (2) Assuming they have formed an unregistered partnership, should this not be only in the sense that they invested as a common fund the profits earned by the properties owned by them in common and the loans granted to them upon the security of the said properties, with the result that as far as their respective shares in the inheritance are concerned, the total income thereof should be considered as that of co-owners and not of the unregistered partnership? And (3) assuming again that they are taxable as an unregistered partnership, should not the various amounts already paid by them for the same years 1955 and 1956 as individual income taxes on their respective shares of the profits accruing from the properties they owned in common be deducted from the deficiency corporate taxes, herein involved, assessed against such unregistered partnership by the respondent Commissioner?

Pondering on these questions, the first thing that has struck the Court is that whereas petitioners' predecessor in interest died way back on March 23, 1944 and the project of partition of her estate was judicially approved as early as May 16, 1949, and presumably petitioners have been holding their respective

shares in their inheritance since those dates admittedly under the administration or management of the head of the family, the widower and father Lorenzo T. Oña, the assessment in question refers to the later years 1955 and 1956. We believe this point to be important because, apparently, at the start, or in the years 1944 to 1954, the respondent Commissioner of Internal Revenue did treat petitioners as co-owners, not liable to corporate tax, and it was only from 1955 that he considered them as having formed an unregistered partnership. At least, there is nothing in the record indicating that an earlier assessment had already been made. Such being the case, and We see no reason how it could be otherwise, it is easily understandable why petitioners' position that they are co-owners and not unregistered co-partners, for the purposes of the impugned assessment, cannot be upheld. Truth to tell, petitioners should find comfort in the fact that they were not similarly assessed earlier by the Bureau of Internal Revenue.

The Tax Court found that instead of actually distributing the estate of the deceased among themselves pursuant to the project of partition approved in 1949, "the properties remained under the management of Lorenzo T. Oña who used said properties in business by leasing or selling them and investing the income derived therefrom and the proceed from the sales thereof in real properties and securities," as a result of which said properties and investments steadily increased yearly from P87,860.00 in "land account" and P17,590.00 in "building account" in 1949 to P175,028.68 in "investment account," P135.714.68 in "land account" and P169,262.52 in "building account" in 1956. And all these became possible because, admittedly, petitioners never actually received any share of the income or profits from Lorenzo T. Oña and instead, they allowed him to continue using said shares as part of the common fund for their ventures, even

as they paid the corresponding income taxes on the basis of their respective shares of the profits of their common business as reported by the said Lorenzo T. Oña.

It is thus incontrovertible that petitioners did not, contrary to their contention, merely limit themselves to holding the properties inherited by them. Indeed, it is admitted that during the material years herein involved, some of the said properties were sold at considerable profit, and that with said profit, petitioners engaged, thru Lorenzo T. Oña, in the purchase and sale of corporate securities. It is likewise admitted that all the profits from these ventures were divided among petitioners proportionately in accordance with their respective shares in the inheritance. In these circumstances, it is Our considered view that from the moment petitioners allowed not only the incomes from their respective shares of the inheritance but even the inherited properties themselves to be used by Lorenzo T. Oña as a common fund in undertaking several transactions or in business, with the intention of deriving profit to be shared by them proportionally, such act was tantamonut to actually contributing such incomes to a common fund and, in effect, they thereby formed an unregistered partnership within the purview of the above-mentioned provisions of the Tax Code.

It is but logical that in cases of inheritance, there should be a period when the heirs can be considered as co-owners rather than unregistered co-partners within the contemplation of our corporate tax laws aforementioned. Before the partition and distribution of the estate of the deceased, all the income thereof does belong commonly to all the heirs, obviously, without them becoming thereby unregistered co-partners, but it does not necessarily follow that such status as co-owners continues until the inheritance is actually and physically distributed among the heirs, for it is easily conceivable that after knowing their respective

shares in the partition, they might decide to continue holding said shares under the common management of the administrator or executor or of anyone chosen by them and engage in business on that basis. Withal, if this were to be allowed, it would be the easiest thing for heirs in any inheritance to circumvent and render meaningless Sections 24 and 84(b) of the National Internal Revenue Code.

It is true that in Evangelista vs. Collector, 102 Phil. 140, it was stated, among the reasons for holding the appellants therein to be unregistered co-partners for tax purposes, that their common fund "was not something they found already in existence" and that "it was not a property inherited by them pro indiviso," but it is certainly far fetched to argue therefrom, as petitioners are doing here, that ergo, in all instances where an inheritance is not actually divided, there can be no unregistered co-partnership. As already indicated, for tax purposes, the co-ownership of inherited properties is automatically converted into an unregistered partnership the moment the said common properties and/or the incomes derived therefrom are used as a common fund with intent to produce profits for the heirs in proportion to their respective shares in the inheritance as determined in a project partition either duly executed in an extrajudicial settlement or approved by the court in the corresponding testate or intestate proceeding. The reason for this is simple. From the moment of such partition, the heirs are entitled already to their respective definite shares of the estate and the incomes thereof, for each of them to manage and dispose of as exclusively his own without the intervention of the other heirs, and, accordingly he becomes liable individually for all taxes in connection therewith. If after such partition, he allows his share to be held in common with his co-heirs under a single management to be used with the intent of making profit thereby in proportion to his share, there can be no

doubt that, even if no document or instrument were executed for the purpose, for tax purposes, at least, an unregistered partnership is formed. This is exactly what happened to petitioners in this case.

In this connection, petitioners' reliance on Article 1769, paragraph (3), of the Civil Code, providing that: "The sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived," and, for that matter, on any other provision of said code on partnerships is unavailing. In Evangelista, supra, this Court clearly differentiated the concept of partnerships under the Civil Code from that of unregistered partnerships which are considered as "corporations" under Sections 24 and 84(b) of the National Internal Revenue Code. Mr. Justice Roberto Concepcion, now Chief Justice, elucidated on this point thus:

To begin with, the tax in question is one imposed upon "corporations", which, strictly speaking, are distinct and different from "partnerships". When our Internal Revenue Code includes "partnerships" among the entities subject to the tax on "corporations", said Code must allude, therefore, to organizations which are not necessarily "partnerships", in the technical sense of the term. Thus, for instance, section 24 of said Code exempts from the aforementioned tax "duly registered general partnerships," which constitute precisely one of the most typical forms of partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said Code, "the term corporation includes partnerships, no matter how created or organized." This qualifying expression clearly indicates that a joint venture need not be undertaken in any of the standard forms, or in confirmity with the usual requirements of the law on partnerships, in order that one could be deemed constituted for

purposes of the tax on corporation. Again, pursuant to said section 84(b),the term "corporation" includes, among others, "joint accounts,(cuentas en participacion)" and "associations", none of which has a legal personality of its own, independent of that of its members. Accordingly, the lawmaker could not have regarded that personality as a condition essential to the existence of the partnerships therein referred to. In fact, as above stated, "duly registered general co-partnerships" — which are possessed of the aforementioned personality — have been expressly excluded by law (sections 24 and 84[b]) from the connotation of the term "corporation." ....

xxx xxx xxx

Similarly, the American Law

... provides its own concept of a partnership. Under the term "partnership" it includes not only a partnership as known in common law but, as well, a syndicate, group, pool, joint venture, or other unincorporated organization which carries on any business, financial operation, or venture, and which is not, within the meaning of the Code, a trust, estate, or a corporation. ... . (7A Merten's Law of Federal Income Taxation, p. 789; emphasis ours.)

The term "partnership" includes a syndicate, group, pool, joint venture or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on. ... . (8 Merten's Law of Federal Income Taxation, p. 562 Note 63; emphasis ours.)

For purposes of the tax on corporations, our National Internal Revenue Code includes these partnerships — with the exception only of duly registered general copartnerships — within the purview of the term "corporation." It is, therefore, clear to our mind that petitioners herein constitute a partnership, insofar as said Code is concerned, and are subject to the income tax for corporations.

We reiterated this view, thru Mr. Justice Fernando, in Reyes vs. Commissioner of Internal Revenue, G. R. Nos. L-24020-21, July 29, 1968, 24 SCRA 198, wherein the Court ruled against a theory of co-ownership pursued by appellants therein.

As regards the second question raised by petitioners about the segregation, for the purposes of the corporate taxes in question, of their inherited properties from those acquired by them subsequently, We consider as justified the following ratiocination of the Tax Court in denying their motion for reconsideration:

In connection with the second ground, it is alleged that, if there was an unregistered partnership, the holding should be limited to the business engaged in apart from the properties inherited by petitioners. In other words, the taxable income of the partnership should be limited to the income derived from the acquisition and sale of real properties and corporate securities and should not include the income derived from the inherited properties. It is admitted that the inherited properties and the income derived therefrom were used in the business of buying and selling other real properties and corporate securities. Accordingly, the partnership income must include not only the

income derived from the purchase and sale of other properties but also the income of the inherited properties.

Besides, as already observed earlier, the income derived from inherited properties may be considered as individual income of the respective heirs only so long as the inheritance or estate is not distributed or, at least, partitioned, but the moment their respective known shares are used as part of the common assets of the heirs to be used in making profits, it is but proper that the income of such shares should be considered as the part of the taxable income of an unregistered partnership. This, We hold, is the clear intent of the law.

Likewise, the third question of petitioners appears to have been adequately resolved by the Tax Court in the aforementioned resolution denying petitioners' motion for reconsideration of the decision of said court. Pertinently, the court ruled this wise:

In support of the third ground, counsel for petitioners alleges:

Even if we were to yield to the decision of this Honorable Court that the herein petitioners have formed an unregistered partnership and, therefore, have to be taxed as such, it might be recalled that the petitioners in their individual income tax returns reported their shares of the profits of the unregistered partnership. We think it only fair and equitable that the various amounts paid by the individual petitioners as income tax on their respective shares of the unregistered partnership should be deducted from the deficiency income tax found by this Honorable Court against the unregistered partnership. (page 7,

Memorandum for the Petitioner in Support of Their Motion for Reconsideration, Oct. 28, 1961.)

In other words, it is the position of petitioners that the taxable income of the partnership must be reduced by the amounts of income tax paid by each petitioner on his share of partnership profits. This is not correct; rather, it should be the other way around. The partnership profits distributable to the partners (petitioners herein) should be reduced by the amounts of income tax assessed against the partnership. Consequently, each of the petitioners in his individual capacity overpaid his income tax for the years in question, but the income tax due from the partnership has been correctly assessed. Since the individual income tax liabilities of petitioners are not in issue in this proceeding, it is not proper for the Court to pass upon the same.

Petitioners insist that it was error for the Tax Court to so rule that whatever excess they might have paid as individual income tax cannot be credited as part payment of the taxes herein in question. It is argued that to sanction the view of the Tax Court is to oblige petitioners to pay double income tax on the same income, and, worse, considering the time that has lapsed since they paid their individual income taxes, they may already be barred by prescription from recovering their overpayments in a separate action. We do not agree. As We see it, the case of petitioners as regards the point under discussion is simply that of a taxpayer who has paid the wrong tax, assuming that the failure to pay the corporate taxes in question was not deliberate. Of course, such taxpayer has the right to be reimbursed what he has erroneously paid, but the law is very clear that the claim and action for such reimbursement are subject to the bar of prescription. And since the

period for the recovery of the excess income taxes in the case of herein petitioners has already lapsed, it would not seem right to virtually disregard prescription merely upon the ground that the reason for the delay is precisely because the taxpayers failed to make the proper return and payment of the corporate taxes legally due from them. In principle, it is but proper not to allow any relaxation of the tax laws in favor of persons who are not exactly above suspicion in their conduct vis-a-vis their tax obligation to the State.

IN VIEW OF ALL THE FOREGOING, the judgment of the Court of Tax Appeals appealed from is affirm with costs against petitioners.

G.R. No. L-9692 January 6, 1958

COLLECTOR OF INTERNAL REVENUE, petitioner, vs.BATANGAS TRANSPORTATION COMPANY and LAGUNA-TAYABAS BUS COMPANY, respondents.

Office of the Solicitor General Ambrosio Padilla, Solicitor Conrado T. Limcaoco and Zoilo R. Zandoval for petitioner.Ozaeta, Lichauco and Picazo for respondents.

MONTEMAYOR, J.:

This is an appeal from the decision of the Court of Tax Appeals (C.T.A.), which reversed the assessment and decision of petitioner Collector of Internal Revenue, later referred to as Collector, assessing and demanding from the respondents Batangas Transportation Company, later referred to as Batangas Transportation, and Laguna-Tayabas Bus Company, later referred to as Laguna Bus, the amount of P54,143.54, supposed to represent the deficiency income tax and compromise for the years 1946 to 1949, inclusive, which amount, pending appeal in the C.T.A., but before the Collector filed his answer in said court, was increased to P148,890.14.

The following facts are undisputed: Respondent companies are two distinct and separate corporations engaged in the business of land transportation by means of motor buses, and operating distinct and separate lines. Batangas Transportation was organized in 1918, while Laguna Bus was organized in 1928. Each company now has a fully paid

up capital of Pl,000,000. Before the last war, each company maintained separate head offices, that of Batangas Transportation in Batangas, Batangas, while the Laguna Bus had its head office in San Pablo Laguna. Each company also kept and maintained separate books, fleets of buses, management, personnel, maintenance and repair shops, and other facilities. Joseph Benedict managed the Batangas Transportation, while Martin Olson was the manager of the Laguna Bus. To show the connection and close relation between the two companies, it should be stated that Max Blouse was the President of both corporations and owned about 30 per cent of the stock in each company. During the war, the American officials of these two corporations were interned in Santo Tomas, and said companies ceased operations. They also lost their respective properties and equipment. After Liberation, sometime in April, 1945, the two companies were able to acquire 56 auto buses from the United States Army, and the two companies divided said equipment equally between themselves, registering the same separately in their respective names. In March, 1947, after the resignation of Martin Olson as Manager of the Laguna Bus, Joseph Benedict, who was then managing the Batangas Transportation, was appointed Manager of both companies by their respective Board of Directors. The head office of the Laguna Bus in San Pablo City was made the main office of both corporations. The placing of the two companies under one sole mangement was made by Max Blouse, President of both companies, by virtue of the authority granted him by resolution of the Board of Directors of the Laguna Bus on August 10, 1945, and ratified by the Boards of the two companies in their respective resolutions of October 27, 1947.

According to the testimony of joint Manager Joseph Benedict, the purpose of the joint management, which was called, "Joint Emergency Operation", was to economize in overhead expenses; that by means of said joint operation, both companies had been able to save the salaries of one manager, one assistant manager, fifteen inspectors, special agents, and one set of office of clerical force, the savings in one year amounting to about P200,000 or about P100,000 for each

company. At the end of each calendar year, all gross receipts and expenses of both companies were determined and the net profits were divided fifty-fifty, and transferred to the book of accounts of each company, and each company "then prepared its own income tax return from this fifty per centum of the gross receipts and expenditures, assets and liabilities thus transferred to it from the `Joint Emergency Operation' and paid the corresponding income taxes thereon separately".

Under the theory that the two companies had pooled their resources in the establishment of the Joint Emergency Operation, thereby forming a joint venture, the Collector wrote the bus companies that there was due from them the amount of P422,210.89 as deficiency income tax and compromise for the years 1946 to 1949, inclusive. Since the Collector caused to be restrained, seized, and advertized for sale all the rolling stock of the two corporations, respondent companies had to file a surety bond in the same amount of P422,210.89 to guarantee the payment of the income tax assessed by him.

After some exchange of communications between the parties, the Collector, on January 8, 1955, informed the respondents "that after crediting the overpayment made by them of their alleged income tax liabilities for the aforesaid years, pursuant to the doctrine of equitable recoupment, the income tax due from the `Joint Emergency Operation' for the years 1946 to 1949, inclusive, is in the total amount of P54,143.54." The respondent companies appealed from said assessment of P54,143.54 to the Court of Tax Appeals, but before filing his answer, the Collector set aside his original assessment of P54,143.54 and reassessed the alleged income tax liability of respondents of P148,890.14, claiming that he had later discovered that said companies had been "erroneously credited in the last assessment with 100 per cent of their income taxes paid when they should in fact have been credited with only 75 per cent thereof, since under Section

24 of the Tax Code dividends received by them from the Joint Operation as a domestic corporation are returnable to the extent of 25 per cent". That corrected and increased reassessment was embodied in the answer filed by the Collector with the Court of Tax Appeals.

The theory of the Collector is the Joint Emergency Operation was a corporation distinct from the two respondent companies, as defined in section 84 (b), and so liable to income tax under section 24, both of the National Internal Revenue Code. After hearing, the C.T.A. found and held, citing authorities, that the Joint Emergency Operation or joint management of the two companies "is not a corporation within the contemplation of section 84 (b) of the National Internal Revenue Code much less a partnership, association or insurance company", and therefore was not subject to the income tax under the provisions of section 24 of the same Code, separately and independently of respondent companies; so, it reversed the decision of the Collector assessing and demanding from the two companies the payment of the amount of P54,143.54 and/or the amount of P148,890.14. The Tax Court did not pass upon the question of whether or not in the appeal taken to it by respondent companies, the Collector could change his original assessment by increasing the same from P54,143.14 to P148,890.14, to correct an error committed by him in having credited the Joint Emergency Operation, totally or 100 per cent of the income taxes paid by the respondent companies for the years 1946 to 1949, inclusive, by reason of the principle of equitable recoupment, instead of only 75 per cent.

The two main and most important questions involved in the present appeal are: (1) whether the two transportation companies herein involved are liable to the payment of income tax as a corporation on the theory that the Joint Emergency Operation organized and operated by them is a corporation within the meaning of Section 84 of the Revised Internal Revenue Code, and (2) whether the Collector of Internal Revenue, after the appeal from his decision has been

perfected, and after the Court of Tax Appeals has acquired jurisdiction over the same, but before said Collector has filed his answer with that court, may still modify his assessment subject of the appeal by increasing the same, on the ground that he had committed error in good faith in making said appealed assessment.

The first question has already been passed upon and determined by this Tribunal in the case of Eufemia Evangelista et al., vs. Collector of Internal Revenue et al.,* G.R. No. L-9996, promulgated on October 15, 1957. Considering the views and rulings embodied in our decision in that case penned by Mr. Justice Roberto Concepcion, we deem it unnecessary to extensively discuss the point. Briefly, the facts in that case are as follows: The three Evangelista sisters borrowed from their father about P59,000 and adding thereto their own personal funds, bought real properties, such as a lot with improvements for the sum of P100,000 in 1943, parcels of land with a total area of almost P4,000 square meters with improvements thereon for P18,000 in 1944, another lot for P108,000 in the same year, and still another lot for P237,000 in the same year. The relatively large amounts invested may be explained by the fact that purchases were made during the Japanese occupation, apparently in Japanese military notes. In 1945, the sisters appointed their brother to manage their properties, with full power to lease, to collect and receive rents, on default of such payment, to bring suits against the defaulting tenants, to sign all letters and contracts, etc. The properties therein involved were rented to various tenants, and the sisters, through their brother as manager, realized a net rental income of P5,948 in 1945, P7,498 in 1946, and P12,615 in 1948.

In 1954, the Collector of Internal Revenue demanded of them among other things, payment of income tax on corporations from the year 1945 to 1949, in the total amount of P6,157, including surcharge and compromise. Dissatisfied with the said assessment, the three sisters appealed to the Court of Tax Appeals, which court decided in

favor of the Collector of Internal Revenue. On appeal to us, we affirmed the decision of the Tax Court. We found and held that considering all the facts and circumstances sorrounding the case, the three sisters had the purpose to engage in real estate transactions for monetary gain and then divide the same among themselves; that they contributed to a common fund which they invested in a series of transactions; that the properties bought with this common fund had been under the management of one person with full power to lease, to collect rents, issue receipts, bring suits, sign letters and contracts, etc., in such a manner that the affairs relative to said properties have been handled as if the same belonged to a corporation or business enterprise operated for profit; and that the said sisters had the intention to constitute a partnership within the meaning of the tax law. Said sisters in their appeal insisted that they were mere co-owners, not co-partners, for the reason that their acts did not create a personality independent of them, and that some of the characteristics of partnerships were absent, but we held that when the Tax Code includes "partnerships" among the entities subject to the tax on corporations, it must refer to organizations which are not necessarily partnerships in the technical sense of the term, and that furthermore, said law defined the term "corporation" as including partnerships no matter how created or organized, thereby indicating that "a joint venture need not be undertaken in any of the standard forms, or in conformity with the usual requirements of the law on partnerships, in order that one could be deemed constituted for purposes of the tax on corporations"; that besides, said section 84 (b) provides that the term "corporation" includes "joint accounts" (cuentas en participacion) and "associations", none of which has a legal personality independent of that of its members. The decision cites 7A Merten's Law of Federal Income Taxation.

In the present case, the two companies contributed money to a common fund to pay the sole general manager, the accounts and office personnel attached to the office of said manager, as well as for the maintenance and operation of a common maintenance and repair shop. Said common fund was also used to buy spare parts, and equipment for both

companies, including tires. Said common fund was also used to pay all the salaries of the personnel of both companies, such as drivers, conductors, helpers and mechanics, and at the end of each year, the gross income or receipts of both companies were merged, and after deducting therefrom the gross expenses of the two companies, also merged, the net income was determined and divided equally between them, wholly and utterly disregarding the expenses incurred in the maintenance and operation of each company and of the individual income of said companies.

From the standpoint of the income tax law, this procedure and practice of determining the net income of each company was arbitrary and unwarranted, disregarding as it did the real facts in the case. There can be no question that the receipts and gross expenses of two, distinct and separate companies operating different lines and in some cases, different territories, and different equipment and personnel at least in value and in the amount of salaries, can at the end of each year be equal or even approach equality. Those familiar with the operation of the business of land transportation can readily see that there are many factors that enter into said operation. Much depends upon the number of lines operated and the length of each line, including the number of trips made each day. Some lines are profitable, others break above even, while still others are operated at a loss, at least for a time, depending, of course, upon the volume of traffic, both passenger and freight. In some lines, the operator may enjoy a more or less exclusive exclusive operation, while in others, the competition is intense, sometimes even what they call "cutthroat competition". Sometimes, the operator is involved in litigation, not only as the result of money claims based on physical injuries ar deaths occassioned by accidents or collisions, but litigations before the Public Service Commission, initiated by the operator itself to acquire new lines or additional service and equipment on the lines already existing, or litigations forced upon said operator by its competitors. Said litigation causes expense to the operator. At other times, operator is denounced by competitors before the Public Service Commission for violation of its franchise or franchises, for making

unauthorized trips, for temporary abandonement of said lines or of scheduled trips, etc. In view of this, and considering that the Batangas Transportation and the Laguna Bus operated different lines, sometimes in different provinces or territories, under different franchises, with different equipment and personnel, it cannot possibly be true and correct to say that the end of each year, the gross receipts and income in the gross expenses of two companies are exactly the same for purposes of the payment of income tax. What was actually done in this case was that, although no legal personality may have been created by the Joint Emergency Operation, nevertheless, said Joint Emergency Operation joint venture, or joint management operated the business affairs of the two companies as though they constituted a single entity, company or partnership, thereby obtaining substantial economy and profits in the operation.

For the foregoing reasons, and in the light of our ruling in the Evangelista vs. Collector of Internal Revenue case, supra, we believe and hold that the Joint Emergency Operation or sole management or joint venture in this case falls under the provisions of section 84 (b) of the Internal Revenue Code, and consequently, it is liable to income tax provided for in section 24 of the same code.

The second important question to determine is whether or not the Collector of Internal Revenue, after appeal from his decision to the Court of Tax Appeals has been perfected, and after the Tax Court Appeals has acquired jurisdiction over the appeal, but before the Collector has filed his answer with the court, may still modify his assessment, subject of the appeal, by increasing the same. This legal point, interesting and vital to the interests of both the Government and the taxpayer, provoked considerable discussion among the members of this Tribunal, a minority of which the writer of this opinion forms part, maintaining that for the information and guidance of the taxpayer, there should be a definite and final assessment on which he can base his decision whether or not to appeal; that when the assessment is appealed by

the taxpayer to the Court of Tax Appeals, the collector loses control and jurisdiction over the same, the jurisdiction being transferred automatically to the Tax Court, which has exclusive appellate jurisdiction over the same; that the jurisdiction of the Tax Court is not revisory but only appellate, and therefore, it can act only upon the amount of assessment subject of the appeal to determine whether it is valid and correct from the standpoint of the taxpayer-appellant; that the Tax Court may only correct errors committed by the Collector against the taxpayer, but not those committed in his favor, unless the Government itself is also an appellant; and that unless this be the rule, the Collector of Internal Revenue and his agents may not exercise due care, prudence and pay too much attention in making tax assessments, knowing that they can at any time correct any error committed by them even when due to negligence, carelessness or gross mistake in the interpretation or application of the tax law, by increasing the assessment, naturally to the prejudice of the taxpayer who would not know when his tax liability has been completely and definitely met and complied with, this knowledge being necessary for the wise and proper conduct and operation of his business; and that lastly, while in the United States of America, on appeal from the decision of the Commissioner of Internal Revenue to the Board or Court of Tax Appeals, the Commissioner may still amend or modify his assessment, even increasing the same the law in that jurisdiction expressly authorizes the Board or Court of Tax Appeals to redetermine and revise the assessment appealed to it.

The majority, however, holds, not without valid arguments and reasons, that the Government is not bound by the errors committed by its agents and tax collectors in making tax assessments, specially when due to a misinterpretation or application of the tax laws, more so when done in good faith; that the tax laws provide for a prescriptive period within which the tax collectors may make assessments and reassessments in order to collect all the taxes due to the Government, and that if the Collector of Internal Revenue is not allowed to amend his assessment before the Court of

Tax Appeals, and since he may make a subsequent reassessment to collect additional sums within the same subject of his original assessment, provided it is done within the prescriptive period, that would lead to multiplicity of suits which the law does not encourage; that since the Collector of Internal Revenue, in modifying his assessment, may not only increase the same, but may also reduce it, if he finds that he has committed an error against the taxpayer, and may even make refunds of amounts erroneously and illegally collected, the taxpayer is not prejudiced; that the hearing before the Court of Tax Appeals partakes of a trial de novo and the Tax Court is authorized to receive evidence, summon witnesses, and give both parties, the Government and the taxpayer, opportunity to present and argue their sides, so that the true and correct amount of the tax to be collected, may be determined and decided, whether resulting in the increase or reduction of the assessment appealed to it. The result is that the ruling and doctrine now being laid by this Court is, that pending appeal before the Court of Tax Appeals, the Collector of Internal Revenue may still amend his appealed assessment, as he has done in the present case.

There is a third question raised in the appeal before the Tax Court and before this Tribunal, namely, the liability of the two respondent transportation companies for 25 per cent surcharge due to their failure to file an income tax return for the Joint Emergency Operation, which we hold to be a corporation within the meaning of the Tax Code. We understand that said 25 per cent surcharge is included in the assessment of P148,890.14. The surcharge is being imposed by the Collector under the provisions of Section 72 of the Tax Code, which read as follows:

The Collector of Internal Revenue shall assess all income taxes. In case of willful neglect to file the return or list within the time prescribed by law, or in case a false or fraudulent return or list is willfully made the collector of internal revenue shall add to the tax or to the deficiency tax, in case any payment has been made on the basis of

such return before the discovery of the falsity or fraud, a surcharge of fifty per centum of the amount of such tax or deficiency tax. In case of any failure to make and file a return list within the time prescribed by law or by the Collector or other internal revenue officer, not due to willful neglect, the Collector, shall add to the tax twenty-five per centum of its amount, except that, when the return is voluntarily and without notice from the Collector or other officer filed after such time, it is shown that the failure was due to a reasonable cause, no such addition shall be made to the tax. The amount so added to any tax shall be collected at the same time in the same manner and as part of the tax unless the tax has been paid before the discovery of the neglect, falsity, or fraud, in which case the amount so added shall be collected in the same manner as the tax.

We are satisfied that the failure to file an income tax return for the Joint Emergency Operation was due to a reasonable cause, the honest belief of respondent companies that there was no such corporation within the meaning of the Tax Code, and that their separate income tax return was sufficient compliance with the law. That this belief was not entirely without foundation and that it was entertained in good faith, is shown by the fact that the Court of Tax Appeals itself subscribed to the idea that the Joint Emergency Operation was not a corporation, and so sustained the contention of respondents. Furthermore, there are authorities to the effect that belief in good faith, on advice of reputable tax accountants and attorneys, that a corporation was not a personal holding company taxable as such constitutes "reasonable cause" for failure to file holding company surtax returns, and that in such a case, the imposition of penalties for failure to file holding company surtax returns, and that in such a case, the imposition of penalties for failure to file return is not warranted1

In view of the foregoing, and with the reversal of the appealed decision of the Court of Tax Appeals, judgment is hereby rendered, holding that the Joint Emergency Operation involved in the present is a corporation within the meaning of section 84 (b) of the Internal Revenue Code, and so is liable to incom tax under section 24 of the code; that pending appeal in the Court of Tax Appeals of an assessment made by the Collector of Internal Revenue, the Collector, pending hearing before said court, may amend his appealed assessment and include the amendment in his answer before the court, and the latter may on the basis of the evidence presented before it, redetermine the assessment; that where the failure to file an income tax return for and in behalf of an entity which is later found to be a corporation within the meaning of section 84 (b) of the Tax Code was due to a reasonable cause, such as an honest belief based on the advice of its attorneys and accountants, a penalty in the form of a surcharge should not be imposed and collected. The respondents are therefore ordered to pay the amount of the reassessment made by the Collector of Internal Revenue before the Tax Court, minus the amount of 25 per cent surcharge. No costs.

G.R. No. L-68375 April 15, 1988

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.WANDER PHILIPPINES, INC. AND THE COURT OF TAX APPEALS, respondents.

The Solicitor General for petitioner.

Felicisimo R. Quiogue and Cirilo P. Noel for respondents.

BIDIN, J.:

This is a petition for review on certiorari of the January 19, 1984 Decision of the Court of Tax Appeals * in C.T.A. Case No.2884, entitled Wander Philippines, Inc. vs. Commissioner of Internal Revenue, holding that Wander Philippines, Inc. is entitled to the preferential rate of 15% withholding tax on the dividends remitted to its foreign parent company, the Glaro S.A. Ltd. of Switzerland, a non-resident foreign corporation.

Herein private respondent, Wander Philippines, Inc. (Wander, for short), is a domestic corporation organized under Philippine laws. It is wholly-owned subsidiary of the Glaro S.A. Ltd. (Glaro for short), a Swiss corporation not engaged in trade or business in the Philippines.

On July 18, 1975, Wander filed its withholding tax return for the second quarter ending June 30, 1975 and remitted to its parent company, Glaro dividends in the amount of P222,000.00, on which 35% withholding tax thereof in the amount of P77,700.00 was withheld and paid to the Bureau of Internal Revenue.

Again, on July 14, 1976, Wander filed a withholding tax return for the second quarter ending June 30, 1976 on the dividends it remitted to Glaro amounting to P355,200.00, on wich 35% tax in the amount of P124,320.00 was withheld and paid to the Bureau of Internal Revenue.

On July 5, 1977, Wander filed with the Appellate Division of the Internal Revenue a claim for refund and/or tax credit in the amount of P115,400.00, contending that it is liable only to 15% withholding tax in accordance with Section 24 (b) (1) of the Tax Code, as amended by Presidential Decree Nos. 369 and 778, and not on the basis of 35% which was withheld and paid to and collected by the government.

Petitioner herein, having failed to act on the above-said claim for refund, on July 15, 1977, Wander filed a petition with respondent Court of Tax Appeals.

On October 6, 1977, petitioner file his Answer.

On January 19, 1984, respondent Court of Tax Appeals rendered a Decision, the decretal portion of which reads:

WHEREFORE, respondent is hereby ordered to grant a refund and/or tax credit to petitioner in the amount of P115,440.00 representing overpaid withholding tax on dividends remitted by it to the Glaro S.A. Ltd. of Switzerland during the second quarter of the years 1975 and 1976.

On March 7, 1984, petitioner filed a Motion for Reconsideration but the same was denied in a Resolution dated August 13, 1984. Hence, the instant petition.

Petitioner raised two (2) assignment of errors, to wit:

I

ASSUMING THAT THE TAX REFUND IN THE CASE AT BAR IS ALLOWABLE AT ALL, THE COURT OF TAX APPEALS ERRED INHOLDING THAT THE HEREIN RESPONDENT WANDER PHILIPPINES, INC. IS ENTITLED TO THE SAID REFUND.

II

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT SWITZERLAND, THE HOME COUNTRY OF GLARO S.A. LTD. (THE PARENT COMPANY OF THE HEREIN RESPONDENT WANDER PHILIPPINES, INC.), GRANTS TO SAID GLARO S.A. LTD. AGAINST ITS SWISS INCOME TAX LIABILITY A TAX CREDIT EQUIVALENT TO THE 20 PERCENTAGE-POINT PORTION (OF THE 35 PERCENT PHILIPPINE

DIVIDEND TAX) SPARED OR WAIVED OR OTHERWISE DEEMED AS IF PAID IN THE PHILIPPINES UNDER SECTION 24 (b) (1) OF THE PHILIPPINE TAX CODE.

The sole issue in this case is whether or not private respondent Wander is entitled to the preferential rate of 15% withholding tax on dividends declared and remitted to its parent corporation, Glaro.

From this issue, two questions were posed by petitioner: (1) Whether or not Wander is the proper party to claim the refund; and (2) Whether or not Switzerland allows as tax credit the "deemed paid" 20% Philippine Tax on such dividends.

Petitioner maintains and argues that it is Glaro the tax payer, and not Wander, the remitter or payor of the dividend income and a mere withholding agent for and in behalf of the Philippine Government, which should be legally entitled to receive the refund if any.

It will be noted, however, that Petitioner's above-entitled argument is being raised for the first time in this Court. It was never raised at the administrative level, or at the Court of Tax Appeals. To allow a litigant to assume a different posture when he comes before the court and challenge the position he had accepted at the administrative level, would be to sanction a procedure whereby the Court—which is supposed to review administrative determinations—would not review, but determine and decide for the first time, a question not raised at the administrative forum. Thus, it is well settled that under the same underlying principle of prior exhaustion of administrative remedies, on the judicial level, issues not raised in the lower court cannot be raised for the first time on appeal (Aguinaldo Industries Corporation vs. Commissioner of Internal Revenue,

112 SCRA 136; Pampanga Sugar Dev. Co., Inc. vs. CIR, 114 SCRA 725; Garcia vs. Court of Appeals, 102 SCRA 597; Matialonzo vs. Servidad, 107 SCRA 726,

In any event, the submission of petitioner that Wander is but a withholding agent of the government and therefore cannot claim reimbursement of the alleged overpaid taxes, is untenable. It will be recalled, that said corporation is first and foremost a wholly owned subsidiary of Glaro. The fact that it became a withholding agent of the government which was not by choice but by compulsion under Section 53 (b) of the Tax Code, cannot by any stretch of the imagination be considered as an abdication of its responsibility to its mother company. Thus, this Court construing Section 53 (b) of the Internal Revenue Code held that "the obligation imposed thereunder upon the withholding agent is compulsory." It is a device to insure the collection by the Philippine Government of taxes on incomes, derived from sources in the Philippines, by aliens who are outside the taxing jurisdiction of this Court (Commissioner of Internal Revenue vs. Malayan Insurance Co., Inc., 21 SCRA 944). In fact, Wander may be assessed for deficiency withholding tax at source, plus penalties consisting of surcharge and interest (Section 54, NLRC). Therefore, as the Philippine counterpart, Wander is the proper entity who should for the refund or credit of overpaid withholding tax on dividends paid or remitted by Glaro.

Closely intertwined with the first assignment of error is the issue of whether or not Switzerland, the foreign country where Glaro is domiciled, grants to Glaro a tax credit against the tax due it, equivalent to 20%, or the difference between the regular 35% rate of the preferential 15% rate. The dispute in this issue lies on the

fact that Switzerland does not impose any income tax on dividends received by Swiss corporation from corporations domiciled in foreign countries.

Section 24 (b) (1) of the Tax Code, as amended by P.D. 369 and 778, the law involved in this case, reads:

Sec. 1. The first paragraph of subsection (b) of Section 24 of the National Internal Revenue Code, as amended, is hereby further amended to read as follows:

(b) Tax on foreign corporations. — 1) Non-resident corporation. A foreign corporation not engaged in trade or business in the Philippines, including a foreign life insurance company not engaged in the life insurance business in the Philippines, shall pay a tax equal to 35% of the gross income received during its taxable year from all sources within the Philippines, as interest (except interest on foreign loans which shall be subject to 15% tax), dividends, premiums, annuities, compensations, remuneration for technical services or otherwise, emoluments or other fixed or determinable, annual, periodical or casual gains, profits, and income, and capital gains: ... Provided, still further That on dividends received from a domestic corporation liable to tax under this Chapter, the tax shall be 15% of the dividends received, which shall be collected and paid as provided in Section 53 (d) of this Code, subject to the condition that the country in which the non-resident foreign corporation is domiciled shall allow a credit against the tax due from the non-resident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20%

which represents the difference between the regular tax (35%) on corporations and the tax (15%) dividends as provided in this section: ...

From the above-quoted provision, the dividends received from a domestic corporation liable to tax, the tax shall be 15% of the dividends received, subject to the condition that the country in which the non-resident foreign corporation is domiciled shall allow a credit against the tax due from the non-resident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20% which represents the difference between the regular tax (35%) on corporations and the tax (15%) dividends.

In the instant case, Switzerland did not impose any tax on the dividends received by Glaro. Accordingly, Wander claims that full credit is granted and not merely credit equivalent to 20%. Petitioner, on the other hand, avers the tax sparing credit is applicable only if the country of the parent corporation allows a foreign tax credit not only for the 15 percentage-point portion actually paid but also for the equivalent twenty percentage point portion spared, waived or otherwise deemed as if paid in the Philippines; that private respondent does not cite anywhere a Swiss law to the effect that in case where a foreign tax, such as the Philippine 35% dividend tax, is spared waived or otherwise considered as if paid in whole or in part by the foreign country, a Swiss foreign-tax credit would be allowed for the whole or for the part, as the case may be, of the foreign tax so spared or waived or considered as if paid by the foreign country.

While it may be true that claims for refund are construed strictly against the claimant, nevertheless, the fact that Switzerland did not impose any tax or the dividends received by Glaro from the Philippines should be

considered as a full satisfaction of the given condition. For, as aptly stated by respondent Court, to deny private respondent the privilege to withhold only 15% tax provided for under Presidential Decree No. 369, amending Section 24 (b) (1) of the Tax Code, would run counter to the very spirit and intent of said law and definitely will adversely affect foreign corporations" interest here and discourage them from investing capital in our country.

Besides, it is significant to note that the conclusion reached by respondent Court is but a confirmation of the May 19, 1977 ruling of petitioner that "since the Swiss Government does not impose any tax on the dividends to be received by the said parent corporation in the Philippines, the condition imposed under the above-mentioned section is satisfied. Accordingly, the withholding tax rate of 15% is hereby affirmed."

Moreover, as a matter of principle, this Court will not set aside the conclusion reached by an agency such as the Court of Tax Appeals which is, by the very nature of its function, dedicated exclusively to the study and consideration of tax problems and has necessarily developed an expertise on the subject unless there has been an abuse or improvident exercise of authority (Reyes vs. Commissioner of Internal Revenue, 24 SCRA 198, which is not present in the instant case.

WHEREFORE, the petition filed is DISMISSED for lack of merit.

G.R. No. L-66838 December 2, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.PROCTER & GAMBLE PHILIPPINE MANUFACTURING CORPORATION and THE COURT OF TAX APPEALS, respondents.

T.A. Tejada & C.N. Lim for private respondent.

R E S O L U T I O N

FELICIANO, J.:p

For the taxable year 1974 ending on 30 June 1974, and the taxable year 1975 ending 30 June 1975, private respondent Procter and Gamble Philippine Manufacturing Corporation ("P&G-Phil.") declared dividends payable to its parent company and sole stockholder, Procter and Gamble Co., Inc. (USA) ("P&G-USA"), amounting to P24,164,946.30, from which dividends the amount of P8,457,731.21 representing the thirty-five percent (35%) withholding tax at source was deducted.

On 5 January 1977, private respondent P&G-Phil. filed with petitioner Commissioner of Internal Revenue a claim for refund or tax credit in the amount of P4,832,989.26 claiming, among other things, that pursuant to Section 24 (b) (1) of the National Internal Revenue Code ("NITC"), 1 as amended by Presidential Decree No. 369, the applicable rate of withholding tax on the dividends remitted was only fifteen percent (15%) (and not thirty-five percent [35%]) of the dividends.

There being no responsive action on the part of the Commissioner, P&G-Phil., on 13 July 1977, filed a petition for review with public respondent Court of Tax Appeals ("CTA") docketed as CTA Case No. 2883. On 31 January 1984, the CTA rendered a decision ordering petitioner Commissioner to refund or grant the tax credit in the amount of P4,832,989.00.

On appeal by the Commissioner, the Court through its Second Division reversed the decision of the CTA and held that:

(a) P&G-USA, and not private respondent P&G-Phil., was the proper party to claim the refund or tax credit here involved;

(b) there is nothing in Section 902 or other provisions of the US Tax Code that allows a credit against the US tax due from P&G-USA of taxes deemed to have been paid in the Philippines equivalent to twenty percent (20%) which represents the difference between the regular tax of thirty-five percent (35%) on corporations and the tax of fifteen percent (15%) on dividends; and

(c) private respondent P&G-Phil. failed to meet certain conditions necessary in order that "the dividends received by its non-resident parent company in the US (P&G-USA) may be subject to the preferential tax rate of 15% instead of 35%."

These holdings were questioned in P&G-Phil.'s Motion for Re-consideration and we will deal with them seriatim in this Resolution resolving that Motion.

I

1. There are certain preliminary aspects of the question of the capacity of P&G-Phil. to bring the present claim for refund or tax credit, which need to be examined. This question was raised for the first time on appeal, i.e., in the proceedings before this Court on the Petition for Review filed by the Commissioner of Internal Revenue. The question was not raised by the Commissioner on the administrative level, and neither was it raised by him before the CTA.

We believe that the Bureau of Internal Revenue ("BIR") should not be allowed to defeat an otherwise valid claim for refund by raising this question of alleged incapacity for the first time on appeal before this Court. This is clearly a matter of procedure. Petitioner does not pretend that P&G-Phil., should it succeed in the claim for refund, is likely to run away, as it were, with the refund instead of transmitting such refund or tax credit to its parent and sole stockholder. It is commonplace that in the absence of explicit statutory provisions to the contrary, the government must follow the same rules of procedure which bind private parties. It is, for instance, clear that the government is held to compliance with the provisions of Circular No.

1-88 of this Court in exactly the same way that private litigants are held to such compliance, save only in respect of the matter of filing fees from which the Republic of the Philippines is exempt by the Rules of Court.

More importantly, there arises here a question of fairness should the BIR, unlike any other litigant, be allowed to raise for the first time on appeal questions which had not been litigated either in the lower court or on the administrative level. For, if petitioner had at the earliest possible opportunity, i.e., at the administrative level, demanded that P&G-Phil. produce an express authorization from its parent corporation to bring the claim for refund, then P&G-Phil. would have been able forthwith to secure and produce such authorization before filing the action in the instant case. The action here was commenced just before expiration of the two (2)-year prescriptive period.

2. The question of the capacity of P&G-Phil. to bring the claim for refund has substantive dimensions as well which, as will be seen below, also ultimately relate to fairness.

Under Section 306 of the NIRC, a claim for refund or tax credit filed with the Commissioner of Internal Revenue is essential for maintenance of a suit for recovery of taxes allegedly erroneously or illegally assessed or collected:

Sec. 306. Recovery of tax erroneously or illegally collected. — No suit or proceeding shall be maintained in any court for the recovery of any national internal revenue tax hereafter alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been

collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Commissioner of Internal Revenue; but such suit or proceeding may be maintained, whether or not such tax, penalty, or sum has been paid under protest or duress. In any case, no such suit or proceeding shall be begun after the expiration of two years from the date of payment of the tax or penalty regardless of any supervening cause that may arise after payment: . . . (Emphasis supplied)

Section 309 (3) of the NIRC, in turn, provides:

Sec. 309. Authority of Commissioner to Take Compromises and to Refund Taxes.—The Commissioner may:

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(3) credit or refund taxes erroneously or illegally received, . . . No credit or refund of taxes or penalties shall be allowed unless the taxpayer files in writing with the Commissioner a claim for credit or refund within two (2) years after the payment of the tax or penalty. (As amended by P.D. No. 69) (Emphasis supplied)

Since the claim for refund was filed by P&G-Phil., the question which arises is: is P&G-Phil. a "taxpayer" under Section 309 (3) of the NIRC? The term "taxpayer" is defined in our NIRC as referring to "any person subject to tax imposed by the Title [on Tax on Income]." 2 It thus becomes important to note that under

Section 53 (c) of the NIRC, the withholding agent who is "required to deduct and withhold any tax" is made " personally liable for such tax" and indeed is indemnified against any claims and demands which the stockholder might wish to make in questioning the amount of payments effected by the withholding agent in accordance with the provisions of the NIRC. The withholding agent, P&G-Phil., is directly and independently liable 3 for the correct amount of the tax that should be withheld from the dividend remittances. The withholding agent is, moreover, subject to and liable for deficiency assessments, surcharges and penalties should the amount of the tax withheld be finally found to be less than the amount that should have been withheld under law.

A "person liable for tax" has been held to be a "person subject to tax" and properly considered a "taxpayer." 4 The terms liable for tax" and "subject to tax" both connote legal obligation or duty to pay a tax. It is very difficult, indeed conceptually impossible, to consider a person who is statutorily made "liable for tax" as not "subject to tax." By any reasonable standard, such a person should be regarded as a party in interest, or as a person having sufficient legal interest, to bring a suit for refund of taxes he believes were illegally collected from him.

In Philippine Guaranty Company, Inc. v. Commissioner of Internal Revenue, 5 this Court pointed out that a withholding agent is in fact the agent both of the government and of the taxpayer, and that the withholding agent is not an ordinary government agent:

The law sets no condition for the personal liability of the withholding agent to attach. The reason is to compel the withholding agent to withhold the tax under all circumstances. In effect, the responsibility for the collection of the tax as well as the payment thereof is concentrated upon the person over whom the Government has jurisdiction. Thus, the withholding agent is constituted the agent of both the Government and the taxpayer. With respect to the collection and/or withholding of the tax, he is the Government's agent. In regard to the filing of the necessary income tax return and the payment of the tax to the Government, he is the agent of the taxpayer. The withholding agent, therefore, is no ordinary government agent especially because under Section 53 (c) he is held personally liable for the tax he is duty bound to withhold; whereas the Commissioner and his deputies are not made liable by law. 6 (Emphasis supplied)

If, as pointed out in Philippine Guaranty, the withholding agent is also an agent of the beneficial owner of the dividends with respect to the filing of the necessary income tax return and with respect to actual payment of the tax to the government, such authority may reasonably be held to include the authority to file a claim for refund and to bring an action for recovery of such claim. This implied authority is especially warranted where, is in the instant case, the withholding agent is the wholly owned subsidiary of the parent-stockholder and therefore, at all times, under the effective control of such parent-stockholder. In the circumstances of this case, it seems particularly unreal to deny the implied authority of P&G-Phil. to claim a refund and to commence an action for such refund.

We believe that, even now, there is nothing to preclude the BIR from requiring P&G-Phil. to show some written or telexed confirmation by P&G-USA of the subsidiary's authority to claim the refund or tax credit and to remit the proceeds of the refund., or to apply the tax credit to some Philippine tax obligation of, P&G-USA, before actual payment of the refund or issuance of a tax credit certificate. What appears to be vitiated by basic unfairness is petitioner's position that, although P&G-Phil. is directly and personally liable to the Government for the taxes and any deficiency assessments to be collected, the Government is not legally liable for a refund simply because it did not demand a written confirmation of P&G-Phil.'s implied authority from the very beginning. A sovereign government should act honorably and fairly at all times, even vis-a-vis taxpayers.

We believe and so hold that, under the circumstances of this case, P&G-Phil. is properly regarded as a "taxpayer" within the meaning of Section 309, NIRC, and as impliedly authorized to file the claim for refund and the suit to recover such claim.

II

1. We turn to the principal substantive question before us: the applicability to the dividend remittances by P&G-Phil. to P&G-USA of the fifteen percent (15%) tax rate provided for in the following portion of Section 24 (b) (1) of the NIRC:

(b) Tax on foreign corporations.—

(1) Non-resident corporation. — A foreign corporation not engaged in trade and business in the Philippines, . . ., shall pay a tax equal to 35% of the gross income receipt during its taxable year from all sources within the Philippines, as . . . dividends . . . Provided, still further, that on dividends received from a domestic corporation liable to tax under this Chapter, the tax shall be 15% of the dividends, which shall be collected and paid as provided in Section 53 (d) of this Code, subject to the condition that the country in which the non-resident foreign corporation, is domiciled shall allow a credit against the tax due from the non-resident foreign corporation, taxes deemed to have been paid in the Philippines equivalent to 20% which represents the difference between the regular tax (35%) on corporations and the tax (15%) on dividends as provided in this Section . . .

The ordinary thirty-five percent (35%) tax rate applicable to dividend remittances to non-resident corporate stockholders of a Philippine corporation, goes down to fifteen percent (15%) if the country of domicile of the foreign stockholder corporation "shall allow" such foreign corporation a tax credit for "taxes deemed paid in the Philippines," applicable against the tax payable to the domiciliary country by the foreign stockholder corporation. In other words, in the instant case, the reduced fifteen percent (15%) dividend tax rate is applicable if the USA "shall allow" to P&G-USA a tax credit for "taxes deemed paid in the Philippines" applicable against the US taxes of P&G-USA. The NIRC specifies that such tax credit for "taxes deemed paid in the Philippines" must, as a minimum, reach an amount equivalent to twenty (20) percentage points which represents the difference between the regular thirty-five percent (35%) dividend tax rate and the preferred fifteen percent (15%) dividend tax rate.

It is important to note that Section 24 (b) (1), NIRC, does not require that the US must give a "deemed paid" tax credit for the dividend tax (20 percentage points) waived by the Philippines in making applicable the preferred divided tax rate of fifteen percent (15%). In other words, our NIRC does not require that the US tax law deem the parent-corporation to have paid the twenty (20) percentage points of dividend tax waived by the Philippines. The NIRC only requires that the US "shall allow" P&G-USA a "deemed paid" tax credit in an amount equivalent to the twenty (20) percentage points waived by the Philippines.

2. The question arises: Did the US law comply with the above requirement? The relevant provisions of the US Intemal Revenue Code ("Tax Code") are the following:

Sec. 901 — Taxes of foreign countries and possessions of United States.

(a) Allowance of credit. — If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the applicable limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under sections 902 and 960. Such choice for any taxable year may be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year. The credit shall not be allowed against the tax imposed by section 531 (relating to the tax on accumulated earnings), against the additional tax imposed for the taxable year under section 1333 (relating to war loss

recoveries) or under section 1351 (relating to recoveries of foreign expropriation losses), or against the personal holding company tax imposed by section 541.

(b) Amount allowed. — Subject to the applicable limitation of section 904, the following amounts shall be allowed as the credit under subsection (a):

(a) Citizens and domestic corporations. — In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; and

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Sec. 902. — Credit for corporate stockholders in foreign corporation.

(A) Treatment of Taxes Paid by Foreign Corporation. — For purposes of this subject, a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall —

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(2) to the extent such dividends are paid by such foreign corporation out of accumulated profits [as defined in subsection (c) (1) (b)] of a year for which such

foreign corporation is a less developed country corporation, be deemed to have paid the same proportion of any income, war profits, or excess profits taxes paid or deemed to be paid by such foreign corporation to any foreign country or to any possession of the United States on or with respect to such accumulated profits, which the amount of such dividends bears to the amount of such accumulated profits.

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(c) Applicable Rules

(1) Accumulated profits defined. — For purposes of this section, the term "accumulated profits" means with respect to any foreign corporation,

(A) for purposes of subsections (a) (1) and (b) (1), the amount of its gains, profits, or income computed without reduction by the amount of the income, war profits, and excess profits taxes imposed on or with respect to such profits or income by any foreign country. . . .; and

(B) for purposes of subsections (a) (2) and (b) (2), the amount of its gains, profits, or income in excess of the income, war profits, and excess profits taxes imposed on or with respect to such profits or income.

The Secretary or his delegate shall have full power to determine from the accumulated profits of what year or years such dividends were paid, treating dividends paid in the first 20 days of any year as having been paid from the accumulated profits of the preceding year or years (unless to his satisfaction shows otherwise), and in other respects treating dividends as having been paid from the most recently accumulated gains, profits, or earning. . . . (Emphasis supplied)

Close examination of the above quoted provisions of the US Tax Code 7 shows the following:

a. US law (Section 901, Tax Code) grants P&G-USA a tax credit for the amount of the dividend tax actually paid (i.e., withheld) from the dividend remittances to P&G-USA;

b. US law (Section 902, US Tax Code) grants to P&G-USA a "deemed paid' tax credit 8 for a proportionate part of the corporate income tax actually paid to the Philippines by P&G-Phil.

The parent-corporation P&G-USA is "deemed to have paid" a portion of the Philippine corporate income tax although that tax was actually paid by its Philippine subsidiary, P&G-Phil., not by P&G-USA. This "deemed paid" concept merely reflects economic reality, since the Philippine corporate income tax was in fact paid and deducted from revenues earned in the Philippines, thus reducing the amount remittable as dividends to P&G-USA. In other words, US tax law treats the Philippine corporate income tax as if it came out of the pocket, as it were, of P&G-USA as a part of the economic cost of carrying on business operations in the

Philippines through the medium of P&G-Phil. and here earning profits. What is, under US law, deemed paid by P&G- USA are not "phantom taxes" but instead Philippine corporate income taxes actually paid here by P&G-Phil., which are very real indeed.

It is also useful to note that both (i) the tax credit for the Philippine dividend tax actually withheld, and (ii) the tax credit for the Philippine corporate income tax actually paid by P&G Phil. but "deemed paid" by P&G-USA, are tax credits available or applicable against the US corporate income tax of P&G-USA. These tax credits are allowed because of the US congressional desire to avoid or reduce double taxation of the same income stream. 9

In order to determine whether US tax law complies with the requirements for applicability of the reduced or preferential fifteen percent (15%) dividend tax rate under Section 24 (b) (1), NIRC, it is necessary:

a. to determine the amount of the 20 percentage points dividend tax waived by the Philippine government under Section 24 (b) (1), NIRC, and which hence goes to P&G-USA;

b. to determine the amount of the "deemed paid" tax credit which US tax law must allow to P&G-USA; and

c. to ascertain that the amount of the "deemed paid" tax credit allowed by US law is at least equal to the amount of the dividend tax waived by the Philippine Government.

Amount (a), i.e., the amount of the dividend tax waived by the Philippine government is arithmetically determined in the following manner:

P100.00 — Pretax net corporate income earned by P&G-Phil.x 35% — Regular Philippine corporate income tax rate———P35.00 — Paid to the BIR by P&G-Phil. as Philippinecorporate income tax.

P100.00-35.00———P65.00 — Available for remittance as dividends to P&G-USA

P65.00 — Dividends remittable to P&G-USAx 35% — Regular Philippine dividend tax rate under Section 24——— (b) (1), NIRCP22.75 — Regular dividend tax

P65.00 — Dividends remittable to P&G-USAx 15% — Reduced dividend tax rate under Section 24 (b) (1), NIRC

———P9.75 — Reduced dividend tax

P22.75 — Regular dividend tax under Section 24 (b) (1), NIRC-9.75 — Reduced dividend tax under Section 24 (b) (1), NIRC———P13.00 — Amount of dividend tax waived by Philippine===== government under Section 24 (b) (1), NIRC.

Thus, amount (a) above is P13.00 for every P100.00 of pre-tax net income earned by P&G-Phil. Amount (a) is also the minimum amount of the "deemed paid" tax credit that US tax law shall allow if P&G-USA is to qualify for the reduced or preferential dividend tax rate under Section 24 (b) (1), NIRC.

Amount (b) above, i.e., the amount of the "deemed paid" tax credit which US tax law allows under Section 902, Tax Code, may be computed arithmetically as follows:

P65.00 — Dividends remittable to P&G-USA- 9.75 — Dividend tax withheld at the reduced (15%) rate———P55.25 — Dividends actually remitted to P&G-USA

P35.00 — Philippine corporate income tax paid by P&G-Phil.to the BIR

Dividends actuallyremitted by P&G-Phil.to P&G-USA P55.25——————— = ——— x P35.00 = P29.75 10

Amount of accumulated P65.00 ======profits earned byP&G-Phil. in excessof income tax

Thus, for every P55.25 of dividends actually remitted (after withholding at the rate of 15%) by P&G-Phil. to its US parent P&G-USA, a tax credit of P29.75 is allowed by Section 902 US Tax Code for Philippine corporate income tax "deemed paid" by the parent but actually paid by the wholly-owned subsidiary.

Since P29.75 is much higher than P13.00 (the amount of dividend tax waived by the Philippine government), Section 902, US Tax Code, specifically and clearly complies with the requirements of Section 24 (b) (1), NIRC.

3. It is important to note also that the foregoing reading of Sections 901 and 902 of the US Tax Code is identical with the reading of the BIR of Sections 901 and 902 of the US Tax Code is identical with the reading of the BIR of Sections 901 and 902 as shown by administrative rulings issued by the BIR.

The first Ruling was issued in 1976, i.e., BIR Ruling No. 76004, rendered by then Acting Commissioner of Intemal Revenue Efren I. Plana, later Associate Justice of this Court, the relevant portion of which stated:

However, after a restudy of the decision in the American Chicle Company case and the provisions of Section 901 and 902 of the U.S. Internal Revenue Code, we find merit in your contention that our computation of the credit which the U.S. tax law allows in such cases is erroneous as the amount of tax "deemed paid" to the Philippine government for purposes of credit against the U.S. tax by the recipient of dividends includes a portion of the amount of income tax paid by the corporation declaring the dividend in addition to the tax withheld from the dividend remitted. In other words, the U.S. government will allow a credit to the U.S. corporation or recipient of the dividend, in addition to the amount of tax actually withheld, a portion of the income tax paid by the corporation declaring the dividend. Thus, if a Philippine corporation wholly owned by a U.S. corporation has a net income of P100,000, it will pay P25,000 Philippine income tax thereon in accordance with Section 24(a) of the Tax Code. The net income, after income tax, which is P75,000, will then be declared as dividend to the U.S. corporation at 15% tax, or P11,250, will be withheld therefrom. Under the aforementioned sections of the U.S. Internal Revenue Code, U.S. corporation receiving the

dividend can utilize as credit against its U.S. tax payable on said dividends the amount of P30,000 composed of:

(1) The tax "deemed paid" or indirectly paid on the dividend arrived at as follows:

P75,000 x P25,000 = P18,750———100,000 **

(2) The amount of 15% ofP75,000 withheld = 11,250———P30,000

The amount of P18,750 deemed paid and to be credited against the U.S. tax on the dividends received by the U.S. corporation from a Philippine subsidiary is clearly more than 20% requirement of Presidential Decree No. 369 as 20% of P75,000.00 the dividends to be remitted under the above example, amounts to P15,000.00 only.

In the light of the foregoing, BIR Ruling No. 75-005 dated September 10, 1975 is hereby amended in the sense that the dividends to be remitted by your client to its parent company shall be subject to the withholding tax at the rate of 15% only.

This ruling shall have force and effect only for as long as the present pertinent provisions of the U.S. Federal Tax Code, which are the bases of the ruling, are not revoked, amended and modified, the effect of which will reduce the percentage of tax deemed paid and creditable against the U.S. tax on dividends remitted by a foreign corporation to a U.S. corporation. (Emphasis supplied)

The 1976 Ruling was reiterated in, e.g., BIR Ruling dated 22 July 1981 addressed to Basic Foods Corporation and BIR Ruling dated 20 October 1987 addressed to Castillo, Laman, Tan and Associates. In other words, the 1976 Ruling of Hon. Efren I. Plana was reiterated by the BIR even as the case at bar was pending before the CTA and this Court.

4. We should not overlook the fact that the concept of "deemed paid" tax credit, which is embodied in Section 902, US Tax Code, is exactly the same "deemed paid" tax credit found in our NIRC and which Philippine tax law allows to Philippine corporations which have operations abroad (say, in the United States) and which, therefore, pay income taxes to the US government.

Section 30 (c) (3) and (8), NIRC, provides:

(d) Sec. 30. Deductions from Gross Income.—In computing net income, there shall be allowed as deductions — . . .

(c) Taxes. — . . .

xxx xxx xxx

(3) Credits against tax for taxes of foreign countries. — If the taxpayer signifies in his return his desire to have the benefits of this paragraphs, the tax imposed by this Title shall be credited with . . .

(a) Citizen and Domestic Corporation. — In the case of a citizen of the Philippines and of domestic corporation, the amount of net income, war profits or excess profits, taxes paid or accrued during the taxable year to any foreign country. (Emphasis supplied)

Under Section 30 (c) (3) (a), NIRC, above, the BIR must give a tax credit to a Philippine corporation for taxes actually paid by it to the US government—e.g., for taxes collected by the US government on dividend remittances to the Philippine corporation. This Section of the NIRC is the equivalent of Section 901 of the US Tax Code.

Section 30 (c) (8), NIRC, is practically identical with Section 902 of the US Tax Code, and provides as follows:

(8) Taxes of foreign subsidiary. — For the purposes of this subsection a domestic corporation which owns a majority of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall be deemed to have paid the same proportion of any income, war-profits,

or excess-profits taxes paid by such foreign corporation to any foreign country, upon or with respect to the accumulated profits of such foreign corporation from which such dividends were paid, which the amount of such dividends bears to the amount of such accumulated profits: Provided, That the amount of tax deemed to have been paid under this subsection shall in no case exceed the same proportion of the tax against which credit is taken which the amount of such dividends bears to the amount of the entire net income of the domestic corporation in which such dividends are included. The term "accumulated profits" when used in this subsection reference to a foreign corporation, means the amount of its gains, profits, or income in excess of the income, war-profits, and excess-profits taxes imposed upon or with respect to such profits or income; and the Commissioner of Internal Revenue shall have full power to determine from the accumulated profits of what year or years such dividends were paid; treating dividends paid in the first sixty days of any year as having been paid from the accumulated profits of the preceding year or years (unless to his satisfaction shown otherwise), and in other respects treating dividends as having been paid from the most recently accumulated gains, profits, or earnings. In the case of a foreign corporation, the income, war-profits, and excess-profits taxes of which are determined on the basis of an accounting period of less than one year, the word "year" as used in this subsection shall be construed to mean such accounting period. (Emphasis supplied)

Under the above quoted Section 30 (c) (8), NIRC, the BIR must give a tax credit to a Philippine parent corporation for taxes "deemed paid" by it, that is, e.g., for taxes paid to the US by the US subsidiary of a Philippine-parent corporation. The Philippine parent or corporate stockholder is "deemed" under our

NIRC to have paid a proportionate part of the US corporate income tax paid by its US subsidiary, although such US tax was actually paid by the subsidiary and not by the Philippine parent.

Clearly, the "deemed paid" tax credit which, under Section 24 (b) (1), NIRC, must be allowed by US law to P&G-USA, is the same "deemed paid" tax credit that Philippine law allows to a Philippine corporation with a wholly- or majority-owned subsidiary in (for instance) the US. The "deemed paid" tax credit allowed in Section 902, US Tax Code, is no more a credit for "phantom taxes" than is the "deemed paid" tax credit granted in Section 30 (c) (8), NIRC.

III

1. The Second Division of the Court, in holding that the applicable dividend tax rate in the instant case was the regular thirty-five percent (35%) rate rather than the reduced rate of fifteen percent (15%), held that P&G-Phil. had failed to prove that its parent, P&G-USA, had in fact been given by the US tax authorities a "deemed paid" tax credit in the amount required by Section 24 (b) (1), NIRC.

We believe, in the first place, that we must distinguish between the legal question before this Court from questions of administrative implementation arising after the legal question has been answered. The basic legal issue is of course, this: which is the applicable dividend tax rate in the instant case: the regular thirty-five percent (35%) rate or the reduced fifteen percent (15%) rate? The question of whether or not P&G-USA is in fact given by the US tax authorities a "deemed paid" tax credit in the required amount, relates to the administrative implementation of the applicable reduced tax rate.

In the second place, Section 24 (b) (1), NIRC, does not in fact require that the "deemed paid" tax credit shall have actually been granted before the applicable dividend tax rate goes down from thirty-five percent (35%) to fifteen percent (15%). As noted several times earlier, Section 24 (b) (1), NIRC, merely requires, in the case at bar, that the USA "shall allow a credit against the tax due from [P&G-USA for] taxes deemed to have been paid in the Philippines . . ." There is neither statutory provision nor revenue regulation issued by the Secretary of Finance requiring the actual grant of the "deemed paid" tax credit by the US Internal Revenue Service to P&G-USA before the preferential fifteen percent (15%) dividend rate becomes applicable. Section 24 (b) (1), NIRC, does not create a tax exemption nor does it provide a tax credit; it is a provision which specifies when a particular (reduced) tax rate is legally applicable.

In the third place, the position originally taken by the Second Division results in a severe practical problem of administrative circularity. The Second Division in effect held that the reduced dividend tax rate is not applicable until the US tax credit for "deemed paid" taxes is actually given in the required minimum amount by the US Internal Revenue Service to P&G-USA. But, the US "deemed paid" tax credit cannot be given by the US tax authorities unless dividends have actually been remitted to the US, which means that the Philippine dividend tax, at the rate here applicable, was actually imposed and collected. 11 It is this practical or operating circularity that is in fact avoided by our BIR when it issues rulings that the tax laws of particular foreign jurisdictions (e.g., Republic of Vanuatu 12 Hongkong, 13 Denmark, 14 etc.) comply with the requirements set out in Section 24 (b) (1), NIRC, for applicability of the fifteen percent (15%) tax rate. Once such a ruling is rendered, the Philippine subsidiary begins to withhold at the reduced dividend tax rate.

A requirement relating to administrative implementation is not properly imposed as a condition for the applicability, as a matter of law, of a particular tax rate. Upon the other hand, upon the determination or recognition of the applicability of the reduced tax rate, there is nothing to prevent the BIR from issuing implementing regulations that would require P&G Phil., or any Philippine corporation similarly situated, to certify to the BIR the amount of the "deemed paid" tax credit actually subsequently granted by the US tax authorities to P&G-USA or a US parent corporation for the taxable year involved. Since the US tax laws can and do change, such implementing regulations could also provide that failure of P&G-Phil. to submit such certification within a certain period of time, would result in the imposition of a deficiency assessment for the twenty (20) percentage points differential. The task of this Court is to settle which tax rate is applicable, considering the state of US law at a given time. We should leave details relating to administrative implementation where they properly belong — with the BIR.

2. An interpretation of a tax statute that produces a revenue flow for the government is not, for that reason alone, necessarily the correct reading of the statute. There are many tax statutes or provisions which are designed, not to trigger off an instant surge of revenues, but rather to achieve longer-term and broader-gauge fiscal and economic objectives. The task of our Court is to give effect to the legislative design and objectives as they are written into the statute even if, as in the case at bar, some revenues have to be foregone in that process.

The economic objectives sought to be achieved by the Philippine Government by reducing the thirty-five percent (35%) dividend rate to fifteen percent (15%) are set out in the preambular clauses of P.D. No. 369 which amended Section 24 (b) (1), NIRC, into its present form:

WHEREAS, it is imperative to adopt measures responsive to the requirements of a developing economy foremost of which is the financing of economic development programs;

WHEREAS, nonresident foreign corporations with investments in the Philippines are taxed on their earnings from dividends at the rate of 35%;

WHEREAS, in order to encourage more capital investment for large projects an appropriate tax need be imposed on dividends received by non-resident foreign corporations in the same manner as the tax imposed on interest on foreign loans;

xxx xxx xxx

(Emphasis supplied)

More simply put, Section 24 (b) (1), NIRC, seeks to promote the in-flow of foreign equity investment in the Philippines by reducing the tax cost of earning profits here and thereby increasing the net dividends remittable to the investor. The foreign investor, however, would not benefit from the reduction of the Philippine dividend tax rate unless its home country gives it some relief from double taxation (i.e., second-

tier taxation) (the home country would simply have more "post-R.P. tax" income to subject to its own taxing power) by allowing the investor additional tax credits which would be applicable against the tax payable to such home country. Accordingly, Section 24 (b) (1), NIRC, requires the home or domiciliary country to give the investor corporation a "deemed paid" tax credit at least equal in amount to the twenty (20) percentage points of dividend tax foregone by the Philippines, in the assumption that a positive incentive effect would thereby be felt by the investor.

The net effect upon the foreign investor may be shown arithmetically in the following manner:

P65.00 — Dividends remittable to P&G-USA (pleasesee page 392 above- 9.75 — Reduced R.P. dividend tax withheld by P&G-Phil.———P55.25 — Dividends actually remitted to P&G-USA

P55.25x 46% — Maximum US corporate income tax rate———P25.415—US corporate tax payable by P&G-USAwithout tax credits

P25.415- 9.75 — US tax credit for RP dividend tax withheld by P&G-Phil.at 15% (Section 901, US Tax Code)———P15.66 — US corporate income tax payable after Section 901——— tax credit.

P55.25- 15.66———P39.59 — Amount received by P&G-USA net of R.P. and U.S.===== taxes without "deemed paid" tax credit.

P25.415- 29.75 — "Deemed paid" tax credit under Section 902 US——— Tax Code (please see page 18 above)

- 0 - — US corporate income tax payable on dividends====== remitted by P&G-Phil. to P&G-USA after Section 902 tax credit.

P55.25 — Amount received by P&G-USA net of RP and US====== taxes after Section 902 tax credit.

It will be seen that the "deemed paid" tax credit allowed by Section 902, US Tax Code, could offset the US corporate income tax payable on the dividends remitted by P&G-Phil. The result, in fine, could be that P&G-USA would after US tax credits, still wind up with P55.25, the full amount of the dividends remitted to P&G-USA net of Philippine taxes. In the calculation of the Philippine Government, this should encourage additional investment or re-investment in the Philippines by P&G-USA.

3. It remains only to note that under the Philippines-United States Convention "With Respect to Taxes on Income," 15 the Philippines, by a treaty commitment, reduced the regular rate of dividend tax to a maximum of twenty percent (20%) of the gross amount of dividends paid to US parent corporations:

Art 11. — Dividends

xxx xxx xxx

(2) The rate of tax imposed by one of the Contracting States on dividends derived from sources within that Contracting State by a resident of the other Contracting State shall not exceed —

(a) 25 percent of the gross amount of the dividend; or

(b) When the recipient is a corporation, 20 percent of the gross amount of the dividend if during the part of the paying corporation's taxable year which precedes the date of payment of the dividend and during the whole of its prior taxable year (if any), at least 10 percent of the outstanding shares of the voting stock of the paying corporation was owned by the recipient corporation.

xxx xxx xxx

(Emphasis supplied)

The Tax Convention, at the same time, established a treaty obligation on the part of the United States that it "shall allow" to a US parent corporation receiving dividends from its Philippine subsidiary "a [tax] credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine [subsidiary] —.16 This is, of course, precisely the "deemed paid" tax credit provided for in Section 902, US Tax Code, discussed above. Clearly, there is here on the part of the Philippines a deliberate undertaking to reduce the regular dividend tax rate of twenty percent (20%) is a maximum rate, there is still a differential or additional reduction of five (5) percentage points which compliance of US law (Section 902) with the requirements of Section 24 (b) (1), NIRC, makes available in respect of dividends from a Philippine subsidiary.

We conclude that private respondent P&G-Phil, is entitled to the tax refund or tax credit which it seeks.

WHEREFORE, for all the foregoing, the Court Resolved to GRANT private respondent's Motion for Reconsideration dated 11 May 1988, to SET ASIDE the Decision of the and Division of the Court promulgated on 15 April 1988, and in lieu thereof, to REINSTATE and AFFIRM the Decision of the Court of Tax Appeals in CTA Case No. 2883 dated 31 January 1984 and to DENY the Petition for Review for lack of merit. No pronouncement as to costs.

[G. R. No. 119775. October 24, 2003]

JOHN HAY PEOPLES ALTERNATIVE COALITION, MATEO CARIÑO FOUNDATION INC., CENTER FOR ALTERNATIVE SYSTEMS FOUNDATION INC., REGINA VICTORIA A. BENAFIN REPRESENTED AND JOINED BY HER MOTHER MRS. ELISA BENAFIN, IZABEL M. LUYK REPRESENTED AND JOINED BY HER MOTHER MRS. REBECCA MOLINA LUYK, KATHERINE PE REPRESENTED AND JOINED BY HER MOTHER ROSEMARIE G. PE, SOLEDAD S. CAMILO, ALICIA C. PACALSO ALIAS “KEVAB,” BETTY I. STRASSER, RUBY C. GIRON, URSULA C. PEREZ ALIAS “BA-YAY,” EDILBERTO T. CLARAVALL, CARMEN CAROMINA, LILIA G. YARANON, DIANE MONDOC, petitioners, vs. VICTOR LIM, PRESIDENT, BASES CONVERSION DEVELOPMENT AUTHORITY; JOHN HAY PORO POINT DEVELOPMENT CORPORATION, CITY OF BAGUIO, TUNTEX (B.V.I.) CO. LTD., ASIAWORLD INTERNATIONALE GROUP, INC., DEPARTMENT OF ENVIRONMENT AND NATURAL RESOURCES, respondents.

D E C I S I O N

CARPIO MORALES, J.:

By the present petition for prohibition, mandamus and declaratory relief with prayer for a temporary restraining order (TRO) and/or writ of preliminary injunction, petitioners assail, in the main, the constitutionality of Presidential Proclamation No. 420, Series of 1994, “CREATING AND DESIGNATING A PORTION OF THE AREA COVERED

BY THE FORMER CAMP JOHN [HAY] AS THE JOHN HAY SPECIAL ECONOMIC ZONE PURSUANT TO REPUBLIC ACT NO. 7227.”

Republic Act No. 7227, AN ACT ACCELERATING THE CONVERSION OF MILITARY RESERVATIONS INTO OTHER PRODUCTIVE USES, CREATING THE BASES CONVERSION AND DEVELOPMENT AUTHORITY FOR THIS PURPOSE, PROVIDING FUNDS THEREFOR AND FOR OTHER PURPOSES, otherwise known as the “Bases Conversion and Development Act of 1992,” which was enacted on March 13, 1992, set out the policy of the government to accelerate the sound and balanced conversion into alternative productive uses of the former military bases under the 1947 Philippines-United States of America Military Bases Agreement, namely, the Clark and Subic military reservations as well as their extensions including the John Hay Station (Camp John Hay or the camp) in the City of Baguio.[1]

As noted in its title, R.A. No. 7227 created public respondent Bases Conversion and Development Authority[2] (BCDA), vesting it with powers pertaining to the multifarious aspects of carrying out the ultimate objective of utilizing the base areas in accordance with the declared government policy.

R.A. No. 7227 likewise created the Subic Special Economic [and Free Port] Zone (Subic SEZ) the metes and bounds of which were to be delineated in a proclamation to be issued by the President of the Philippines.[3]

R.A. No. 7227 granted the Subic SEZ incentives ranging from tax and duty-free importations, exemption of businesses therein from local and national taxes, to other hallmarks of a liberalized financial and business climate.[4]

http://sc.judiciary.gov.ph/jurisprudence/2003/oct2003/119775.htm#_ftn4




And R.A. No. 7227 expressly gave authority to the President to create through executive proclamation, subject to the concurrence of the local government units directly affected, other Special Economic Zones (SEZ) in the areas covered respectively by the Clark military reservation, the Wallace Air Station in San Fernando, La Union, and Camp John Hay.[5]

On August 16, 1993, BCDA entered into a Memorandum of Agreement and Escrow Agreement with private respondents Tuntex (B.V.I.) Co., Ltd (TUNTEX) and Asiaworld Internationale Group, Inc. (ASIAWORLD), private corporations registered under the laws of the British Virgin Islands, preparatory to the formation of a joint venture for the development of Poro Point in La Union and Camp John Hay as premier tourist destinations and recreation centers. Four months later or on December 16, 1993, BCDA, TUNTEX and ASIAWORD executed a Joint Venture Agreement[6] whereby they bound themselves to put up a joint venture company known as the Baguio International Development and Management Corporation which would lease areas within Camp John Hay and Poro Point for the purpose of turning such places into principal tourist and recreation spots, as originally envisioned by the parties under their Memorandum of Agreement.

The Baguio City government meanwhile passed a number of resolutions in response to the actions taken by BCDA as owner and administrator of Camp John Hay.

By Resolution[7] of September 29, 1993, the Sangguniang Panlungsod of Baguio City (the sanggunian) officially asked BCDA to exclude all the barangays partly or totally located within Camp John Hay from the reach or coverage of any plan or program for its development.




By a subsequent Resolution[8] dated January 19, 1994, the sanggunian sought from BCDA an abdication, waiver or quitclaim of its ownership over the home lots being occupied by residents of nine (9) barangays surrounding the military reservation.

Still by another resolution passed on February 21, 1994, the sanggunian adopted and submitted to BCDA a 15-point concept for the development of Camp John Hay.[9] The sanggunian’s vision expressed, among other things, a kind of development that affords protection to the environment, the making of a family-oriented type of tourist destination, priority in employment opportunities for Baguio residents and free access to the base area, guaranteed participation of the city government in the management and operation of the camp, exclusion of the previously named nine barangays from the area for development, and liability for local taxes of businesses to be established within the camp.[10]

BCDA, TUNTEX and ASIAWORLD agreed to some, but rejected or modified the other proposals of the sanggunian.[11] They stressed the need to declare Camp John Hay a SEZ as a condition precedent to its full development in accordance with the mandate of R.A. No. 7227.[12]

On May 11, 1994, the sanggunian passed a resolution requesting the Mayor to order the determination of realty taxes which may otherwise be collected from real properties of Camp John Hay.[13] The resolution was intended to intelligently guide the sanggunian in determining its position on whether Camp John Hay be declared a SEZ, it (the sanggunian) being of the view that such declaration would exempt the camp’s property and the economic activity therein from local or national taxation.







More than a month later, however, the sanggunian passed Resolution No. 255, (Series of 1994),[14] seeking and supporting, subject to its concurrence, the issuance by then President Ramos of a presidential proclamation declaring an area of 288.1 hectares of the camp as a SEZ in accordance with the provisions of R.A. No. 7227. Together with this resolution was submitted a draft of the proposed proclamation for consideration by the President.[15]

On July 5, 1994 then President Ramos issued Proclamation No. 420,[16] the title of which was earlier indicated, which established a SEZ on a portion of Camp John Hay and which reads as follows:

x x x

Pursuant to the powers vested in me by the law and the resolution of concurrence by the City Council of Baguio, I, FIDEL V. RAMOS, President of the Philippines, do hereby create and designate a portion of the area covered by the former John Hay reservation as embraced, covered, and defined by the 1947 Military Bases Agreement between the Philippines and the United States of America, as amended, as the John Hay Special Economic Zone, and accordingly order:

SECTION 1. Coverage of John Hay Special Economic Zone. – The John Hay Special Economic Zone shall cover the area consisting of Two Hundred Eighty Eight and one/tenth (288.1) hectares, more or less, of the total of Six Hundred Seventy-Seven (677) hectares of the John Hay Reservation, more or less, which have been surveyed and verified by the Department of Environment and Natural Resources (DENR) as defined by the following technical description:




A parcel of land, situated in the City of Baguio, Province of Benguet, Island of Luzon, and particularly described in survey plans Psd-131102-002639 and Ccs-131102-000030 as approved on 16 August 1993 and 26 August 1993, respectively, by the Department of Environment and Natural Resources, in detail containing :

Lot 1, Lot 2, Lot 3, Lot 4, Lot 5, Lot 6, Lot 7, Lot 13, Lot 14, Lot 15, and Lot 20 of Ccs-131102-000030

-and-

Lot 3, Lot 4, Lot 5, Lot 6, Lot 7, Lot 8, Lot 9, Lot 10, Lot 11, Lot 14, Lot 15, Lot 16, Lot 17, and Lot 18 of Psd-131102-002639 being portions of TCT No. T-3812, LRC Rec. No. 87.

With a combined area of TWO HUNDRED EIGHTY EIGHT AND ONE/TENTH HECTARES (288.1 hectares); Provided that the area consisting of approximately Six and two/tenth (6.2) hectares, more or less, presently occupied by the VOA and the residence of the Ambassador of the United States, shall be considered as part of the SEZ only upon turnover of the properties to the government of the Republic of the Philippines.

Sec. 2. Governing Body of the John Hay Special Economic Zone. – Pursuant to Section 15 of Republic Act No. 7227, the Bases Conversion and Development Authority is hereby established as the governing body of the John Hay Special Economic Zone and, as such, authorized to determine the utilization and disposition of the lands comprising it, subject to private rights, if any, and in consultation and coordination with the City Government of Baguio after consultation with its inhabitants, and to promulgate the necessary policies, rules, and regulations to govern and regulate the zone

thru the John Hay Poro Point Development Corporation, which is its implementing arm for its economic development and optimum utilization.

Sec. 3. Investment Climate in John Hay Special Economic Zone. – Pursuant to Section 5(m) and Section 15 of Republic Act No. 7227, the John Hay Poro Point Development Corporation shall implement all necessary policies, rules, and regulations governing the zone, including investment incentives, in consultation with pertinent government departments. Among others, the zone shall have all the applicable incentives of the Special Economic Zone under Section 12 of Republic Act No. 7227 and those applicable incentives granted in the Export Processing Zones, the Omnibus Investment Code of 1987, the Foreign Investment Act of 1991, and new investment laws that may hereinafter be enacted.

Sec. 4. Role of Departments, Bureaus, Offices, Agencies and Instrumentalities. – All Heads of departments, bureaus, offices, agencies, and instrumentalities of the government are hereby directed to give full support to Bases Conversion and Development Authority and/or its implementing subsidiary or joint venture to facilitate the necessary approvals to expedite the implementation of various projects of the conversion program.

Sec. 5. Local Authority. – Except as herein provided, the affected local government units shall retain their basic autonomy and identity.

Sec. 6. Repealing Clause. – All orders, rules, and regulations, or parts thereof, which are inconsistent with the provisions of this Proclamation, are hereby repealed, amended, or modified accordingly.

Sec. 7. Effectivity. This proclamation shall take effect immediately.

Done in the City of Manila, this 5th day of July, in the year of Our Lord, nineteen hundred and ninety-four.

The issuance of Proclamation No. 420 spawned the present petition[17] for prohibition, mandamus and declaratory relief which was filed on April 25, 1995 challenging, in the main, its constitutionality or validity as well as the legality of the Memorandum of Agreement and Joint Venture Agreement between public respondent BCDA and private respondents TUNTEX and ASIAWORLD.

Petitioners allege as grounds for the allowance of the petition the following:

I. PRESIDENTIAL PROCLAMATION NO. 420, SERIES OF 1990 (sic) IN SO FAR AS IT GRANTS TAX EXEMPTIONS IS INVALID AND ILLEGAL AS IT IS AN UNCONSTITUTIONAL EXERCISE BY THE PRESIDENT OF A POWER GRANTED ONLY TO THE LEGISLATURE.

II. PRESIDENTIAL PROCLAMATION NO. 420, IN SO FAR AS IT LIMITS THE POWERS AND INTERFERES WITH THE AUTONOMY OF THE CITY OF BAGUIO IS INVALID, ILLEGAL AND UNCONSTITUTIONAL.

III. PRESIDENTIAL PROCLAMATION NO. 420, SERIES OF 1994 IS UNCONSTITUTIONAL IN THAT IT VIOLATES THE RULE THAT ALL TAXES SHOULD BE UNIFORM AND EQUITABLE.


IV. THE MEMORANDUM OF AGREEMENT ENTERED INTO BY AND BETWEEN PRIVATE AND PUBLIC RESPONDENTS BASES CONVERSION DEVELOPMENT AUTHORITY HAVING BEEN ENTERED INTO ONLY BY DIRECT NEGOTIATION IS ILLEGAL.

V. THE TERMS AND CONDITIONS OF THE MEMORANDUM OF AGREEMENT ENTERED INTO BY AND BETWEEN PRIVATE AND PUBLIC RESPONDENT BASES CONVERSION DEVELOPMENT AUTHORITY IS (sic) ILLEGAL.

VI. THE CONCEPTUAL DEVELOPMENT PLAN OF RESPONDENTS NOT HAVING UNDERGONE ENVIRONMENTAL IMPACT ASSESSMENT IS BEING ILLEGALLY CONSIDERED WITHOUT A VALID ENVIRONMENTAL IMPACT ASSESSMENT.

A temporary restraining order and/or writ of preliminary injunction was prayed for to enjoin BCDA, John Hay Poro Point Development Corporation and the city government from implementing Proclamation No. 420, and TUNTEX and ASIAWORLD from proceeding with their plan respecting Camp John Hay’s development pursuant to their Joint Venture Agreement with BCDA.[18]

Public respondents, by their separate Comments, allege as moot and academic the issues raised by the petition, the questioned Memorandum of Agreement and Joint Venture Agreement having already been deemed abandoned by the inaction of the parties thereto prior to the filing of the petition as in fact, by letter of November 21, 1995, BCDA formally notified TUNTEX and ASIAWORLD of the revocation of their said agreements.[19]



In maintaining the validity of Proclamation No. 420, respondents contend that by extending to the John Hay SEZ economic incentives similar to those enjoyed by the Subic SEZ which was established under R.A. No. 7227, the proclamation is merely implementing the legislative intent of said law to turn the US military bases into hubs of business activity or investment. They underscore the point that the government’s policy of bases conversion can not be achieved without extending the same tax exemptions granted by R.A. No. 7227 to Subic SEZ to other SEZs.

Denying that Proclamation No. 420 is in derogation of the local autonomy of Baguio City or that it is violative of the constitutional guarantee of equal protection, respondents assail petitioners’ lack of standing to bring the present suit even as taxpayers and in the absence of any actual case or controversy to warrant this Court’s exercise of its power of judicial review over the proclamation.

Finally, respondents seek the outright dismissal of the petition for having been filed in disregard of the hierarchy of courts and of the doctrine of exhaustion of administrative remedies.

Replying,[20] petitioners aver that the doctrine of exhaustion of administrative remedies finds no application herein since they are invoking the exclusive authority of this Court under Section 21 of R.A. No. 7227 to enjoin or restrain implementation of projects for conversion of the base areas; that the established exceptions to the aforesaid doctrine obtain in the present petition; and that they possess the standing to bring the petition which is a taxpayer’s suit.

Public respondents have filed their Rejoinder[21] and the parties have filed their respective memoranda.



Before dwelling on the core issues, this Court shall first address the preliminary procedural questions confronting the petition.

The judicial policy is and has always been that this Court will not entertain direct resort to it except when the redress sought cannot be obtained in the proper courts, or when exceptional and compelling circumstances warrant availment of a remedy within and calling for the exercise of this Court’s primary jurisdiction.[22] Neither will it entertain an action for declaratory relief, which is partly the nature of this petition, over which it has no original jurisdiction.

Nonetheless, as it is only this Court which has the power under Section 21[23] of R.A. No. 7227 to enjoin implementation of projects for the development of the former US military reservations, the issuance of which injunction petitioners pray for, petitioners’ direct filing of the present petition with it is allowed. Over and above this procedural objection to the present suit, this Court retains full discretionary power to take cognizance of a petition filed directly to it if compelling reasons, or the nature and importance of the issues raised, warrant.[24] Besides, remanding the case to the lower courts now would just unduly prolong adjudication of the issues.

The transformation of a portion of the area covered by Camp John Hay into a SEZ is not simply a re-classification of an area, a mere ascription of a status to a place. It involves turning the former US military reservation into a focal point for investments by both local and foreign entities. It is to be made a site of vigorous business activity, ultimately serving as a spur to the country’s long awaited economic growth. For, as R.A. No. 7227 unequivocally declares, it is the government’s policy to enhance the benefits to be derived from the base areas in order to promote the economic and




social development of Central Luzon in particular and the country in general.[25] Like the Subic SEZ, the John Hay SEZ should also be turned into a “self-sustaining, industrial, commercial, financial and investment center.”[26]

More than the economic interests at stake, the development of Camp John Hay as well as of the other base areas unquestionably has critical links to a host of environmental and social concerns. Whatever use to which these lands will be devoted will set a chain of events that can affect one way or another the social and economic way of life of the communities where the bases are located, and ultimately the nation in general.

Underscoring the fragility of Baguio City’s ecology with its problem on the scarcity of its water supply, petitioners point out that the local and national government are faced with the challenge of how to provide for an ecologically sustainable, environmentally sound, equitable transition for the city in the wake of Camp John Hay’s reversion to the mass of government property.[27] But that is why R.A. No. 7227 emphasizes the “sound and balanced conversion of the Clark and Subic military reservations and their extensions consistent with ecological and environmental standards.”[28]

It cannot thus be gainsaid that the matter of conversion of the US bases into SEZs, in this case Camp John Hay, assumes importance of a national magnitude.

Convinced then that the present petition embodies crucial issues, this Court assumes jurisdiction over the petition.

As far as the questioned agreements between BCDA and TUNTEX and ASIAWORLD are concerned, the legal questions being raised thereon by petitioners have indeed been rendered moot and academic by the revocation of such agreements. There are, however, other issues posed by the petition, those which center on the constitutionality of





Proclamation No. 420, which have not been mooted by the said supervening event upon application of the rules for the judicial scrutiny of constitutional cases. The issues boil down to:

(1) Whether the present petition complies with the requirements for this Court’s exercise of jurisdiction over constitutional issues;

(2) Whether Proclamation No. 420 is constitutional by providing for national and local tax exemption within and granting other economic incentives to the John Hay Special Economic Zone; and

(3) Whether Proclamation No. 420 is constitutional for limiting or interfering with the local autonomy of Baguio City;

It is settled that when questions of constitutional significance are raised, the court can exercise its power of judicial review only if the following requisites are present: (1) the existence of an actual and appropriate case; (2) a personal and substantial interest of the party raising the constitutional question; (3) the exercise of judicial review is pleaded at the earliest opportunity; and (4) the constitutional question is the lis mota of the case.[29]

An actual case or controversy refers to an existing case or controversy that is appropriate or ripe for determination, not conjectural or anticipatory.[30] The controversy needs to be definite and concrete, bearing upon the legal relations of parties who are pitted against each other due to their adverse legal interests.[31] There is in the present case a real clash of interests and rights between petitioners and respondents arising from the issuance of a presidential proclamation that




converts a portion of the area covered by Camp John Hay into a SEZ, the former insisting that such proclamation contains unconstitutional provisions, the latter claiming otherwise.

R.A. No. 7227 expressly requires the concurrence of the affected local government units to the creation of SEZs out of all the base areas in the country.[32] The grant by the law on local government units of the right of concurrence on the bases’ conversion is equivalent to vesting a legal standing on them, for it is in effect a recognition of the real interests that communities nearby or surrounding a particular base area have in its utilization. Thus, the interest of petitioners, being inhabitants of Baguio, in assailing the legality of Proclamation No. 420, is personal and substantial such that they have sustained or will sustain direct injury as a result of the government act being challenged.[33] Theirs is a material interest, an interest in issue affected by the proclamation and not merely an interest in the question involved or an incidental interest,[34] for what is at stake in the enforcement of Proclamation No. 420 is the very economic and social existence of the people of Baguio City.

Petitioners’ locus standi parallels that of the petitioner and other residents of Bataan, specially of the town of Limay, in Garcia v. Board of Investments[35] where this Court characterized their interest in the establishment of a petrochemical plant in their place as actual, real, vital and legal, for it would affect not only their economic life but even the air they breathe.

Moreover, petitioners Edilberto T. Claravall and Lilia G. Yaranon were duly elected councilors of Baguio at the time, engaged in the local governance of Baguio City and whose duties included deciding for and on behalf of their constituents the question of whether to concur with the declaration of a portion of the area covered by Camp John Hay





as a SEZ. Certainly then, petitioners Claravall and Yaranon, as city officials who voted against[36] the sanggunian Resolution No. 255 (Series of 1994) supporting the issuance of the now challenged Proclamation No. 420, have legal standing to bring the present petition.

That there is herein a dispute on legal rights and interests is thus beyond doubt. The mootness of the issues concerning the questioned agreements between public and private respondents is of no moment.

“By the mere enactment of the questioned law or the approval of the challenged act, the dispute is deemed to have

ripened into a judicial controversy even without any other overt act. Indeed, even a singular violation of the Constitution and/or the law is enough to awaken judicial duty.”[37]

As to the third and fourth requisites of a judicial inquiry, there is likewise no question that they have been complied with in the case at bar. This is an action filed purposely to bring forth constitutional issues, ruling on which this Court must take up. Besides, respondents never raised issues with respect to these requisites, hence, they are deemed waived.

Having cleared the way for judicial review, the constitutionality of Proclamation No. 420, as framed in the second and third issues above, must now be addressed squarely.

The second issue refers to petitioners’ objection against the creation by Proclamation No. 420 of a regime of tax exemption within the John Hay SEZ. Petitioners argue that nowhere in R. A. No. 7227 is there a grant of tax exemption to SEZs yet to be established in base areas, unlike the grant under Section 12 thereof of tax exemption and investment incentives to the therein established Subic SEZ. The grant of tax exemption to the John Hay SEZ,



petitioners conclude, thus contravenes Article VI, Section 28 (4) of the Constitution which provides that “No law granting any tax exemption shall be passed without the concurrence of a majority of all the members of Congress.”

Section 3 of Proclamation No. 420, the challenged provision, reads:

Sec. 3. Investment Climate in John Hay Special Economic Zone. – Pursuant to Section 5(m) and Section 15 of Republic Act No. 7227, the John Hay Poro Point Development Corporation shall implement all necessary policies, rules, and regulations governing the zone, including investment incentives, in consultation with pertinent government departments. Among others, the zone shall have all the applicable incentives of the Special Economic Zone under Section 12 of Republic Act No. 7227 and those applicable incentives granted in the Export Processing Zones, the Omnibus Investment Code of 1987, the Foreign Investment Act of 1991, and new investment laws that may hereinafter be enacted. (Emphasis and underscoring supplied)

Upon the other hand, Section 12 of R.A. No. 7227 provides:

x x x

(a) Within the framework and subject to the mandate and limitations of the Constitution and the pertinent provisions of the Local Government Code, the Subic Special Economic Zone shall be developed into a self-sustaining, industrial, commercial, financial and investment center to generate employment opportunities in and around the zone and to attract and promote productive foreign investments;

b) The Subic Special Economic Zone shall be operated and managed as a separate customs territory ensuring free flow or movement of goods and capital within, into and exported out of the Subic Special Economic Zone, as well as provide incentives such as tax and duty free importations of raw materials, capital and equipment. However, exportation or removal of goods from the territory of the Subic Special Economic Zone to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Customs and Tariff Code and other relevant tax laws of the Philippines;

(c) The provisions of existing laws, rules and regulations to the contrary notwithstanding, no taxes, local and national, shall be imposed within the Subic Special Economic Zone. In lieu of paying taxes, three percent (3%) of the gross income earned by all businesses and enterprises within the Subic Special Economic Zone shall be remitted to the National Government, one percent (1%) each to the local government units affected by the declaration of the zone in proportion to their population area, and other factors. In addition, there is hereby established a development fund of one percent (1%) of the gross income earned by all businesses and enterprises within the Subic Special Economic Zone to be utilized for the Municipality of Subic, and other municipalities contiguous to be base areas. In case of conflict between national and local laws with respect to tax exemption privileges in the Subic Special Economic Zone, the same shall be resolved in favor of the latter;

(d) No exchange control policy shall be applied and free markets for foreign exchange, gold, securities and futures shall be allowed and maintained in the Subic Special Economic Zone;

(e) The Central Bank, through the Monetary Board, shall supervise and regulate the operations of banks and other financial institutions within the Subic Special Economic Zone;

(f) Banking and Finance shall be liberalized with the establishment of foreign currency depository units of local commercial banks and offshore banking units of foreign banks with minimum Central Bank regulation;

(g) Any investor within the Subic Special Economic Zone whose continuing investment shall not be less than Two Hundred fifty thousand dollars ($250,000), his/her spouse and dependent children under twenty-one (21) years of age, shall be granted permanent resident status within the Subic Special Economic Zone. They shall have freedom of ingress and egress to and from the Subic Special Economic Zone without any need of special authorization from the Bureau of Immigration and Deportation. The Subic Bay Metropolitan Authority referred to in Section 13 of this Act may also issue working visas renewable every two (2) years to foreign executives and other aliens possessing highly-technical skills which no Filipino within the Subic Special Economic Zone possesses, as certified by the Department of Labor and Employment. The names of aliens granted permanent residence status and working visas by the Subic Bay Metropolitan Authority shall be reported to the Bureau of Immigration and Deportation within thirty (30) days after issuance thereof;

x x x (Emphasis supplied)

It is clear that under Section 12 of R.A. No. 7227 it is only the Subic SEZ which was granted by Congress with tax exemption, investment incentives and the like. There is no express extension of the aforesaid benefits to other SEZs still to be created at the time via presidential proclamation.

The deliberations of the Senate confirm the exclusivity to Subic SEZ of the tax and investment privileges accorded it under the law, as the following exchanges between our lawmakers show during the second reading of the precursor bill of R.A. No. 7227 with respect to the investment policies that would govern Subic SEZ which are now embodied in the aforesaid Section 12 thereof:

x x x

Senator Maceda: This is what I was talking about. We get into problems here because all of these following policies are centered around the concept of free port. And in the main paragraph above, we have declared both Clark and Subic as special economic zones, subject to these policies which are, in effect, a free-port arrangement.

Senator Angara: The Gentleman is absolutely correct, Mr. President. So we must confine these policies only to Subic.

May I withdraw then my amendment, and instead provide that “THE SPECIAL ECONOMIC ZONE OF SUBIC SHALL BE ESTABLISHED IN ACCORDANCE WITH THE FOLLOWING POLICIES.” Subject to style, Mr. President.

Thus, it is very clear that these principles and policies are applicable only to Subic as a free port.

Senator Paterno: Mr. President.

The President: Senator Paterno is recognized.

Senator Paterno: I take it that the amendment suggested by Senator Angara would then prevent the establishment of other special economic zones observing these policies.

Senator Angara: No, Mr. President, because during our short caucus, Senator Laurel raised the point that if we give this delegation to the President to establish other economic zones, that may be an unwarranted delegation.

So we agreed that we will simply limit the definition of powers and description of the zone to Subic, but that does not exclude the possibility of creating other economic zones within the baselands.

Senator Paterno: But if that amendment is followed, no other special economic zone may be created under authority of this particular bill. Is that correct, Mr. President?

Senator Angara: Under this specific provision, yes, Mr. President. This provision now will be confined only to Subic.[38]

x x x (Underscoring supplied).

As gathered from the earlier-quoted Section 12 of R.A. No. 7227, the privileges given to Subic SEZ consist principally of exemption from tariff or customs duties, national and local taxes of business entities therein (paragraphs (b) and (c)), free market and trade of specified goods or properties (paragraph d), liberalized banking and finance (paragraph f), and relaxed immigration rules for foreign investors (paragraph g). Yet, apart from these, Proclamation No. 420 also makes available to the John Hay SEZ benefits existing in other laws such as the privilege of export processing zone-based


businesses of importing capital equipment and raw materials free from taxes, duties and other restrictions;[39] tax and duty exemptions, tax holiday, tax credit, and other incentives under the Omnibus Investments Code of 1987;[40] and the applicability to the subject zone of rules governing foreign investments in the Philippines.[41]

While the grant of economic incentives may be essential to the creation and success of SEZs, free trade zones and the like, the grant thereof to the John Hay SEZ cannot be sustained. The incentives under R.A. No. 7227 are exclusive only to the Subic SEZ, hence, the extension of the same to the John Hay SEZ finds no support therein. Neither does the same grant of privileges to the John Hay SEZ find support in the other laws specified under Section 3 of Proclamation No. 420, which laws were already extant before the issuance of the proclamation or the enactment of R.A. No. 7227.

More importantly, the nature of most of the assailed privileges is one of tax exemption. It is the legislature, unless limited by a provision of the state constitution, that has full power to exempt any person or corporation or class of property from taxation, its power to exempt being as broad as its power to tax.[42] Other than Congress, the Constitution may itself provide for specific tax exemptions,[43] or local governments may pass ordinances on exemption only from local taxes.[44]

The challenged grant of tax exemption would circumvent the Constitution’s imposition that a law granting any tax exemption must have the concurrence of a majority of all the members of Congress.[45] In the same vein, the other kinds of privileges extended to the John Hay SEZ are by tradition and usage for Congress to legislate upon.

Contrary to public respondents’ suggestions, the claimed statutory exemption of the John Hay SEZ from taxation should be manifest and unmistakable from the language of the law on which it is based; it must be expressly granted in








a statute stated in a language too clear to be mistaken.[46] Tax exemption cannot be implied as it must be categorically and unmistakably expressed.[47]

If it were the intent of the legislature to grant to the John Hay SEZ the same tax exemption and incentives given to the Subic SEZ, it would have so expressly provided in the R.A. No. 7227.

This Court no doubt can void an act or policy of the political departments of the government on either of two grounds–infringement of the Constitution or grave abuse of discretion.[48]

This Court then declares that the grant by Proclamation No. 420 of tax exemption and other privileges to the John Hay SEZ is void for being violative of the Constitution. This renders it unnecessary to still dwell on petitioners’ claim that the same grant violates the equal protection guarantee.

With respect to the final issue raised by petitioners — that Proclamation No. 420 is unconstitutional for being in derogation of Baguio City’s local autonomy, objection is specifically mounted against Section 2 thereof in which BCDA is set up as the governing body of the John Hay SEZ.[49]

Petitioners argue that there is no authority of the President to subject the John Hay SEZ to the governance of BCDA which has just oversight functions over SEZ; and that to do so is to diminish the city government’s power over an area within its jurisdiction, hence, Proclamation No. 420 unlawfully gives the President power of control over the local government instead of just mere supervision.





Petitioners’ arguments are bereft of merit. Under R.A. No. 7227, the BCDA is entrusted with, among other things, the following purpose:[50]

x x x

(a) To own, hold and/or administer the military reservations of John Hay Air Station, Wallace Air Station, O’Donnell Transmitter Station, San Miguel Naval Communications Station, Mt. Sta. Rita Station (Hermosa, Bataan) and those portions of Metro Manila Camps which may be transferred to it by the President;

x x x (Underscoring supplied)

With such broad rights of ownership and administration vested in BCDA over Camp John Hay, BCDA virtually has control over it, subject to certain limitations provided for by law. By designating BCDA as the governing agency of the John Hay SEZ, the law merely emphasizes or reiterates the statutory role or functions it has been granted.

The unconstitutionality of the grant of tax immunity and financial incentives as contained in the second sentence of Section 3 of Proclamation No. 420 notwithstanding, the entire assailed proclamation cannot be declared unconstitutional, the other parts thereof not being repugnant to law or the Constitution. The delineation and declaration of a portion of the area covered by Camp John Hay as a SEZ was well within the powers of the President to do so by means of a proclamation.[51] The requisite prior concurrence by the Baguio City government to such proclamation appears to have been given in the form of a duly enacted resolution by the sanggunian. The other provisions of the proclamation had been proven to be consistent with R.A. No. 7227.



Where part of a statute is void as contrary to the Constitution, while another part is valid, the valid portion, if separable from the invalid, may stand and be enforced.[52] This Court finds that the other provisions in Proclamation No. 420 converting a delineated portion of Camp John Hay into the John Hay SEZ are separable from the invalid second sentence of Section 3 thereof, hence they stand.

WHEREFORE, the second sentence of Section 3 of Proclamation No. 420 is hereby declared NULL AND VOID and is accordingly declared of no legal force and effect. Public respondents are hereby enjoined from implementing the aforesaid void provision.

Proclamation No. 420, without the invalidated portion, remains valid and effective.


G.R. No. L-12798 May 30, 1960

VISAYAN CEBU TERMINAL CO., INC., petitioner-appellant, vs.COLLECTOR OF INTERNAL REVENUE, respondent-appellee.

Duterte and Rodriguez for petitioner.Assistant Solicitor General Jose P. Alejandro and Atty. Sixto J. Javier for respondent.

CONCEPCION, J.:

Petitioner Visayan Cebu Terminal Co., Inc., seeks a review of the decision of the Court of Tax Appeals in the above entitled case. The dispositive part of said decision reads as follows:

FOR THE FOREGOING CONSIDERATIONS, the decision appealed from is hereby modified, and appellant is hereby ordered to pay the Collector of Internal Revenue, within a reasonable period to be fixed by the latter, the sum of P15,517.00, computed below:

Net income per return P41,596.45Disallowances:(1) Salaries 500.00(2) Representation Expenses:

As claimed by appellant 75,855.88Allowed 10,000.00 65,855.88(3) Miscellaneous expenses 5,768.00————Net income subject to tax P113,720.33Tax due on P113,720.33:P100,000.00 at 20% P20,000.00P13,720.00 at 28% 3,842.00 P23,842.00Less tax previously assessed and paid 8,325.00————Deficiency tax P15,517.00

With costs against appellant.

The facts, which are not disputed, are set forth in the aforementioned decision, from which we quote:

"The appellant, Visayan Terminal Co. Inc., is a corporation organized for the purpose of handling arrastre operations in the port of Cebu. It was awarded the contract for the said arrastre operations by the Bureau of Customs, pursuant to Act No. 3002, as amended.

"On March 1, 1952, appellant filed its income tax return for 1951 reporting a gross income of P420,633.40 and claimed deductions amounting to P379,036.95, leaving a net income of P41,596.45 on which it paid income tax in the sum of

P8,319.20. The sum of P379,036.95 claimed as deductions consisted of various items, among which were the following:

1. Salaries —(a) Salary and bonus of JuanEugenio Lo P1,875.00(b) Salary of Felix Go Chan 250.00(c) Salary of Teomino TiuTiam 250.00 P 2,375.002. Representation expenses 75,855.883. Miscellaneous expenses(a) Christmas bonus given tovarious persons P1,500.00(b) Tips to ships' officers 4,800.00 6,300.00TOTAL P84,530.88

The said sums of P2,375.00, P75,855.88 and P6,300.00, representing salaries, representation expenses and miscellaneous expenses, respectively, or a total of P84,530.88, were disallowed by the Collector of Internal Revenue, thus giving rise to a deficiency assessment of P18,991.00.

x x x x x x x x x

Upon request for reconsideration, the Collector modified the deficiency income tax assessment by allowing the deduction from appellant's gross income of the salary of Juan Eugenio Lo in the sum of P1,875.00 and miscellaneous expenses amounting to P532.00, at the same time maintaining the disallowance of the full amount of P75,855.88 as representation expenses. The revised deficiency assessment is itemized in the letter of the Collector dated March 26, 1955, and is reproduced below:

Net income as per return P41.596.45Disallowances:per investigation:salaries of officers P 2,375.00allowed per reaudit 1,875.00 500.00per investigation and reaudit,representation expenses 75,855.88per investigation, miscellaneousexpenses 6,300.00allowed per reaudit 532.00 5,768.00——— ————Net income subject to tax perreaudit P123,720.33Tax due on P123,720.33:P100,000.00 at 20% P20,000.00

P23,720.00 at 28% 6,642.00 P26,642.00————Less tax previously assessed and paid 8,325.00—————Deficiency tax P18,317.00Add: 5% surcharge 915.851% monthly interest from5/31/53 to 4/30/55 4,212.91Compromise for late payment 40.00—————Total amount due on April 30,1955 P23,485.76

Appellant has agreed to the disallowance of the sum P500.00 representing the salaries of Felix Go Chan and Teotimo Tiu Tiam at P250.00 each, and the sum of P5,768.00, representing miscellaneous expenses. The only issue raised in this appeal relates to the deductibility of the sum of P75,855.88 as representation expenses.

Passing upon said issue, which is, also, the only one raised in this appeal, the lower court held that "representation ... expenses fall under the category of business expenses which" are allowable deductions from gross income if they meet the conditions prescribed by law", particularly section 30(a) (1) of the National Internal Revenue Code; that, to be deductible, said business expenses must "ordinary and necessary expenses paid or incurred in carrying on any trade or business"; that those expenses "must also, meet the further test of reasonableness in amount", this test being "inherent

in the phase `ordinary and necessary'"; that some of the representation expenses claimed by appellant had been evidenced by vouchers or chits, but others were reimbursed "without presentation of supporting papers; that the aforementioned vouchers or chits were allegedly "destroyed when the house of Buenaventura M. Veloso, treasurer of appellant, where the records were kept was burned"; that, accordingly, "it is not possible to determine the actual amount covered by supporting papers and the amount without supporting papers"; that the court should, therefore, "determine from all available data the amount properly deductible as representation expenses"; that "during the period of four (4) years from 1949 to 1952, appellant had gross income, net income, net profits and claimed representation expenses as follows:

Year Gross Income Net Profit RepresentationExpenses1949 P722,135.42 P61,257.53 P83,703.541950 451,303.21 33,023.78 10,424.391951 420,479.39 41,596.45 75,855.881952 425,326.86 34,207.31 63,618.64

and that "from the above figures, we may infer that the sum of P10,000 may be considered reasonably necessary for entertainment expenses of appellant in 1951, it having claimed a little over the amount in 1950, when its gross income was more than its gross income in 1951 and 1952", and because "it allegedly spent for entertainment purposes in 1948 the sum of P500.00 only." Hence, the lower court modified the assessment of the taxes due from appellant herein the manner set forth in the beginning of this decision.

In its brief, appellant does not assail any of the premises upon which the aforementioned conclusion of the lower court was predicated. What is more, it relied upon, and, even, quoted some of the views expressed in the decision appealed from. Appellant, however, maintains that said court had acted arbitrarily in considering the representation expenses in 1950, not those incurred in 1949 and 1952, in fixing the amount deductible in 1951. This pretense is clearly untenable. It appears: (a) that part of the alleged representation expenses had never had any supporting paper; (b) that the vouchers and chits covering other representation expenses had been allegedly destroyed; (c) that there is no documentary evidence on record of any of the representation expenses in question; (d) that no testimonial evidence has been introduced on any specific item of said alleged expenses; (e) that there is no more than oral proof to the effect that payments had been made to appellant's officers for representation expenses allegedly made by the latter and about the general nature of such alleged expenses; (f) that the gross income in 1950 exceeded the gross income in 1951 and 1952, and (g) that the representation expenses in 1948 amounted to P500 only. Under these circumstances, the lower court was fully justified in concluding that the representation expenses in 1951 should be slightly less than those incurred in 1950.

Upon the other hand, appellant has not even tried to show why its representation expenses in 1951 should be deemed bigger than the amount allowed by the lower court. In fact, the latter had been patently fair and reasonable, if not rather liberal, in allowing appellant to deduct P10,000.00 as representation expenses for 1951, there being absolutely no concrete evidence of the sums then actually spent for purposes of representation. It may not be amiss to note that the explanation to the effect that the supporting paper of some of those expenses had been destroyed when the house of the treasurer was burned, can hardly be regarded as satisfactory, for appellant's records are supposed to be kept in its offices, not in the residence of one of its officers.

Being in accordance with the facts and the law, the decision appealed from is hereby affirmed, with costs against petitioner-appellant, Visayan Cebu Terminal Co., Inc. It is so ordered.

G.R. Nos. L-9738 and L-9771 May 31, 1957

BLAS GUTIERREZ, and MARIA MORALES, petitioners, vs.HONORABLE COURT OF TAX APPEALS, and THE COLLECTOR OF INTERNAL REVENUE, respondents.

COLLECTOR OF INTERNAL REVENUE, petitioner, vs.BLAS GUTIERREZ, MARIA MORALES, and COURT OF TAX APPEALS, respondents.

Rafael Morales for petitioners.Assistant Solicitor General Ramon L. Avanceña and Solicitor Jose P. Alejandro for respondents.

FELIX, J.:

Maria Morales was the registered owner of an agricultural land designated as Lot No. 724-C of the cadastral survey of Mabalacat, Pampanga. The Republic of the Philippines, at the request of the U.S. Government and pursuant to the terms of the Military Bases Agreement of March 14, 1947, instituted condemnation proceedings in the Court of the First Instance of Pampanga, docketed, as Civil Case No. 148, for the purpose of expropriating the lands owned by Maria Morales and others needed for the expansion of the Clark Field Air Base, which project is necessary for the

mutual protection and defense of the Philippines and the United States. Blas Gutierrez was also made a party defendant in said Civil Case No. 148 for being the husband of the landowner Maria Morales. At the commencement of the action, the Republic of the Philippines, therein plaintiff deposited with the Clerk of the Court of First Instance of Pampanga the sum of P156,960, which was provisionally fixed as the value of the lands sought to be expropriated, in order that it could take immediate possession of the same.

On January 27, 1949, upon order of the Court, the sum of P34,580 (PNB Check 721520-Exh. R) was paid by the Provincial treasurer of Pampanga to Maria Morales out of the original deposit of P156,960 made by therein plaintiff. After due hearing, the Court of First Instance of Pampanga rendered decision dated November 29, 1949, wherein it fixed as just compensation P2,500 per hectare for some of the lots and P3,000 per hectare for the others, which values were based on the reports of the Commission on Appraisal whose members were chosen by both parties and by the Court, which took into consideration the different conditions affecting, the value of the condemned properties in making their findings.

In virtue of said decision, defendant Maria Morales was to receive the amount of P94,305.75 as compensation for Lot No. 724-C which was one of the expropriated lands. But the Court disapproved defendants' claims for consequential damages considering them amply compensated by the price awarded to their said properties. In order to avoid further litigation expenses and delay inherent to an appeal, the parties entered into a compromise agreement on January 7, 1950, modifying in part the decision rendered by the Court in the sense of fixing the compensation for all the lands, without distinction, at P2,500 per hectare, which compromise agreement was approved by the Court on January 9, 1950. This reduction of the price to P2,500 per hectare did not affect Lot No. 724-C of defendant Maria Morales.

Sometime in 1950, the spouses Blas Gutierrez and Maria Morales received the sum of P59.785.75 presenting the balance remaining in their favor after deducting the amount of P34,580 already withdrawn from the compensation to them.

In a notice of assessment dated January 28, 1953, the Collector of Internal Revenue demanded of the petitioners the payment of P8,481 as alleged deficiency income tax for the year 1950, inclusive of surcharges and penalties. On March 5, 1953, counsel for petitioner sent a letter to the Collector of Internal Revenue requesting the letter to withdraw and reconsider said assessment, contending among others, that the compensation paid to the spouses by the Government for their property was not "income derived from sale, dealing or disposition of property" referred to by section 29 of the Tax Code and therefore not taxable; that even granting that condemnation of private properties is embraced within the meaning of the word "sale" or "dealing", the compensation received by the taxpayers must be considered as income for 1948 and not for 1950 since the amount deposited and paid in 1948 represented more than 25 per cent of the total compensation awarded by the court; that the assessment was made after the lapse of the 3-year prescriptive period provided for in section 51-(d) of the Tax Code; that the compensation in question should be exempted from taxation by reason of the provision of section 29 (b)-6 of the Tax Code; that the spouses Blas Gutierrez and Maria Morales did not realize any profit in said transaction as there were improvements on the land already made and that the purchasing value of the peso at the time of the expropriation proceeding had depreciated if compared to the value of the pre-war peso; and that penalties should not be imposed on said spouses because granting the assessment was correct, the emission of the compensation awarded therein was due to an honest mistake.

This request was denied by the Collector of Internal Revenue, in a letter dated April 26, 1954, refuting point by point the arguments advanced by the taxpayers. The record further shows that a warrant of distraint and levy was issued by the Collector of Internal Revenue on the properties of Mr. & Mrs. Blas Gutierrez found in Mabalacat, Pampanga, and a notice of tax lien was duly registered with the Register of Deeds of San Fernando, Pampanga, on the same date Counsel for the spouses then requested that the matter be referred to the Conference Staff of the Bureau of Internal Revenue for proper hearing to which the Collector answered in a letter dated December 24, 1954, stating that the request would be granted upon compliance by the taxpayers with the requirements of Department of Finance order No. 213, i.e., the filing of a verified petition to that effect and that one half of the total assessment should be guaranteed by a bond, provided that the taxpayers would agree in writing to the suspension of the running of the period of prescription.

The taxpayers then served notice that the case would be brought on appeal to the Court of Tax Appeals, which they did by filing a petition with said Court to review the assessment made by the Collector, of Internal Revenue, docketed as C.T.A. Case No. 65. In that instance, it was prayed that the Court render judgment declaring that the taking of petitioners' land by the Government was not a sale or dealing in property; that the amount paid to, petitioners as just compensation for their property should not be dismissed by, way of taxation; that said compensation was by law exempt from taxation and that the period to collect the income taxes by summary methods had prescribed; that respondent Collector of Internal Revenue be enjoined from carrying out further steps to collect from petitioners methods the said taxes which they alleged to be erroneously assessed and for remedies which would serve the ends of law and justice.

The Solicitor General, in representation of the respondent Collector of Internal Revenue, filed an answer on February 11, 1955, admitting some of the allegations of petitioners and denying some of them, and as special defenses, he advanced the contention that Court had no jurisdiction to entertain the petition; profit realized by petitioners from the sale of the land in question was subject to income tax, that the full compensation received by petitioners should be included in the income received in 1950, same having been paid in 1950 by the Government; that under the Bases Agreement only residents of the United states are exempt from the payment of income tax in the Philippines in respects to profits derived under a contract with the U.S. Government in connection with the construction, maintenance and operation of the bases; that in the determination of the gain or loss from the sale of property acquired on or after March 1, 1913, the cost of acquisition and the selling price shall be taken into account without qualification as to the purchasing power of the currency; that the imposition of the 50 per cent surcharge was in accordance with the Tax Code, that the Collector of Internal Revenue was empowered to collect petitioners' deficiency income tax; and prayed that the petition for review be dismissed; petitioners be ordered to pay the amount of P8,481 plus the delinquency penalty of 5 per cent for late payment and monthly interest at the rate of 1 per cent from April 1, 1953, up to the date of actual payment and for such other relief that may be deemed just and equitable in the premises.

After due hearing and after the parties filed their respective memoranda, the Court of Tax Appeals rendered decision on August 31, 1955, holding that it had jurisdiction to hear and determine the case; that the gain derived by the petitioners from the expropriation of their property constituted taxable income and as such was capital gain; and that said gain was taxable in 1950 when it realized. It was also found by said Court that the evidence did not warrant the imposition of the 50 per cent surcharge because the petitioners acted in good faith and without intent to defraud the Government when they failed to include in their gross income the proceeds they received from the expropriated property, and, therefore,

modified the assessment made by respondent, requiring petitioners to pay only the sum of P5,654. From this decision, both parties appealed to this Court and in this instance, petitioners Blas Gutierrez and Maria Morales, as appellants in G.R. No. L-9738, made the following assessments of error:

1. That the Court of Tax Appeals erred in holding that, for income tax purposes, income from expropriation should be deemed as income from sale, any profit derived therefrom is subject to income tax as capital gain pursuant to the provisions of Section 37-(a)-(5) in relation to Section 29-(a) of the Tax Code;

2. That the Court of Tax Appeals erred in not holding that, under the particular circumstances in which the property of the appellants was taken by the Philippine Government, the amount paid to them as just compensation is exempt from income tax pursuant to Section 29-(b)-(6) of the Tax Code;

3. That the Court of Tax Appeals erred in not holding that the respondent Collector is definitely barred by the Statute of Limitations from collecting the deficiency income tax in question, whether administratively thru summary methods, or judicially thru the ordinary court procedures;

4. That the Court of Tax Appeals erred in not holding that the capital gain found by the respondent Collector as have been derived by the petitioners-appellants from the expropriation of their property is merely nominal not subject to income tax, and in not holding that the pronouncement of the court in the expropriation case in this respect is binding upon the respondent Collector of Internal Revenue; and

5. That the Court of Tax Appeals erred in not pronouncing upon the pleadings of the parties that the petitioners-appellants did not derive any capital gain from the expropriation of their property.

The appeal of the respondent Collector of the Internal Revenue was docketed in this Court as G.R. No. L-9771, and in this case the Solicitor General ascribed to the lower court the commission of the following error:

That the Court of Tax Appeals erred in holding that respondents are not subject to the payment of the 50 per cent surcharge in spite of the fact that the latter's income tax return for the year 1950 is false and/or fraudulent.

The facts just narrated are not disputed and the controversy only arose from the assertion by the Collector of Internal Revenue that petitioners-appellants failed to include from their gross income, in filing their income tax return for 1950, the amount of P94,305.75 which they had received as compensation for their land taken by the Government by expropriation proceedings. It is the contention of respondent Collector of Internal Revenue that such transfer of property, for taxation purposes, is "sale" and that the income derived therefrom is taxable. The pertinent provisions of the National Internal Revenue Code applicable to the instant cases are the following:

SEC. 29. GROSS INCOME. — (a) General definition. — "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, sales or dealings in property, whether real or personal, growing out of ownership or use of or interest in such property; also from interests, rents, dividends, securities, or the transactions of any business carried on for gain or profit, or gains, profits, and income derived from any source whatsoever.

SEC. 37. INCOME FROM SOURCES WITHIN THE PHILIPPINES. —

(a) Gross income from sources within the Philippines. — The following items of gross income shall be treated as gross income from sources within the Philippines:

x x x x x x x x x

(5) SALE OF REAL PROPERTY. — Gains, profits, and income from the sale of real property located in the Philippines;

x x x x x x x x x

There is no question that the property expropriated being located in the Philippines, compensation or income derived therefrom ordinarily has to be considered as income from sources within the Philippines and subject to the taxing jurisdiction of the Philippines. However, it is to be remembered that said property was acquired by the Government through condemnation proceedings and appellants' stand is, therefore, that same cannot be considered as sale as said acquisition was by force, there being practically no meeting of the minds between the parties. Consequently, the taxpayers contend, this kind of transfer of ownership must perforce be distinguished from sale, for the purpose of Section 29-(a) of the Tax Code. But the authorities in the United States on the matter sustain the view expressed by the Collector of Internal Revenue, for it is held that:

The transfer of property through condemnation proceedings is a sale or exchange within the meaning of section 117 (a) of the 1936 Revenue Act and profit from the transaction constitutes capital gain" (1942. Com. Int. Revenue vs. Kieselbach (CCA 3) 127 F. (24) 359). "The taking of property by condemnation and the, payment of just compensation therefore is a "sale" or "exchange" within the meaning of section 117 (a) of the Revenue Act of 1936, and profits from that transaction is capital gain (David S. Brown vs. Comm., 1942, 42 BTA 139).

The proposition that income from expropriation proceedings is income from sales or exchange and therefore taxable has been likewise upheld in the case of Lapham vs. U.S. (1949, 40 AFTR 1370) and in Kneipp vs. U.S. (1949, 85 F Suppl. 902). It appears then that the acquisition by the Government of private properties through the exercise of the power of eminent domain, said properties being JUSTLY compensated, is embraced within the meaning of the term "sale" "disposition of property", and the proceeds from said transaction clearly fall within the definition of gross income laid down by Section 29 of the Tax Code of the Philippines.

Petitioners-appellants also averred that granting that the compensation thus received is "income", same is exempted under Section 29-(b)-6 of the Tax Code, which reads as follows:

SEC. 29. GROSS INCOME. —

x x x x x x x x x

(b) EXCLUSIONS FROM GROSS INCOME. — The following items shall not be included in gross income and shall exempt from taxation under this Title;

x x x x x x x x x

(6) Income exempt under treaty. — Income of any kind, to the extent required by any treaty obligation binding upon government of the Philippines.

The taxpayers maintain that since, at the of the U.S. Government, the proceeding to expropriate the land in question necessary for the expansion of the Clark Field Air Base was instituted by the Philippine Government as part of its obligation under the Military Bases Agreement, the compensation accruing therefrom must necessarily fall under the exemption provided for by Section 29-(b)-6 of the Tax Code. We find this stand untenable, for the same Military Bases Agreement cited by appellants contains the following:

ARTICLE XXIICONDEMNATION OR EXPROPRIATION

1. Whenever it is necessary to acquire by condemnation or expropriation proceedings real property belonging to private persons, association, or corporations located in bases named in Annex "A" and Annex "B" in order to carry out the purposes of this agreement, the Philippines, will institute and prosecute such condemnation proceeding in accordance with the laws of the Philippines. The United States agrees to reimburse the Philippines for all the reasonable expenses, damages, and costs thereby incurred, including title value of the property as determined by the Court. In addition, subject to mutual agreements of the two governments, the United States shall reimburse the Philippines for the reasonable costs of transportation and removal of any occupants displaced or ejected by reason of the condemnation or expropriation.

ARTICLE XIIINTERNAL REVENUE EXEMPTION

(1) No member of the United States Armed Forces except Filipino citizens, serving in the Philippines in connection with the bases and residing in the Philippines by reason only of such service, or his dependents, shall be liable to pay income tax in the Philippines except in respect of income derived from Philippine sources.

(2) No National of the United States serving in the Philippines in connection with the construction, maintenance, operation or defense of the bases and residing in the Philippines by reason only of such employment, or his spouse and minor children and dependent parents of either spouse, shall be liable to pay income tax in the Philippines except in respect of income derived from Philippine sources or sources other than the United States.

(3) No person referred to in paragraphs 1 and 2 of this said Article shall be liable to pay the government or local authorities of the Philippines any poll or residence tax, or any imports or exports duties, or any other tax on personal property imported for his own use provided, that private owned vehicles shall be subject to payment of the following only: when certified as being used for military purposes by appropriate United States Authorities, the normal license plate fee; otherwise, the normal license and registration fees.

(4) No national of the United States, or corporation organized under the laws of the United States, shall be liable to pay income tax in the Philippines in respect of any profits derived under a contract made in the United States with the government of the United States in connection with the construction, maintenance, operation and defense of

the bases, or any tax in the nature of a license in respect of any service of work for the United, States in connection with the construction, maintenance, operation and defense of the bases.

x x x x x x x x x

The facts brought about by the aforementioned terms of the said treaty need no further elucidation. It is unmistakable that although the condemnation or expropriation of properties was provided for, the exemption from tax of the compensation to be paid for the expropriation of privately owned lands located in the Philippines was not given any attention, and the internal revenue exemptions specifically taken care of by said Agreement applies only to members of the U.S. Armed Forces serving in the Philippines and U.S. nationals working in these Islands in connection with the construction, maintenance, operation and defense of said bases.

Anent appellant taxpayers' allegation that the respondent Collector of Internal Revenue was barred from collecting the deficiency income tax assessment, it having been made beyond the 3-year period prescribed by section 51-(d) of the Tax Code, We have this much to say. Although it is true that by order of the Court of First Instance of Pampanga, the amount of P34,580 out of the original deposit made by the Government was withdrawn in favor of appellants on January 27, 1949, the same cannot be considered as income for 1950 when the balance of P59,785.75 was actually received. Before that date (1950), appellant taxpayers were still the owners of their whole property that was subject of condemnation proceedings and said amount of P34,580 was not paid to, but merely deposited in court and withdrawn by them. Therefore, the payment of the value of Maria Morales' Lot 724-C was actually made by the Republic of the Philippines in 1950 and it has to be credited as income for 1950 for it was then when title over said property passed to

the Republic of the Philippines. Appellant taxpayers cannot say that the title over the property expropriated already passed to the Government when the latter was placed in possession thereof, for in condemnation proceedings, title to the land does not pass to the plaintiff until the indemnity is paid (Calvo vs. Zandueta, 49 Phil. 605), and notwithstanding possession acquired by the expropriator, title does not actually pass to him until payment of the amount adjudged by the Court and the registration of the judgment with the Register of Deeds (See Visayan Refining Company vs. Camus et al., 40 Phil. 550; Metropolitan Water District vs. De los Angeles, 55 Phil. 783). Now, if said amount should have been reported as income for 1950 in the return that must have been filed on or before March 1, 1951, the assessment made by the Collector on January 28, 1953, is still within the 3-year prescriptive period provided for by Section 51-d and could, therefore, be collected either by the administrative methods of distraint and levy or by judicial action (See Collector of Internal Revenue vs. A P. Reyes et al., 100 Phil., 872; Collector of Internal Revenue vs. Zulueta et al., 100 Phil., 872; and Sambrano vs. Court of Tax Appeals et al., supra, p. 1).

As to appellant taxpayers' proposition that the profit, derived by them from the expropriation of their property is merely nominal and not subject to income tax, We find Section 35 of the Tax Code illuminating. Said section reads as follows:

SEC. 35. DETERMINATION OF GAIN OR LOSS FROM THE SALE OR OTHER DISPOSITION OF PROPERTY. — The gain derived or loss sustained from the sale or other disposition of property, real or personal, or mixed, shall be determined in accordance with the following schedule:

(a) xxx xxx xxx

(b) In the case of property acquired on or after March first, nineteen hundred and thirteen, the cost thereof if such property was acquired by purchase or the fair market price or value as of the date of the acquisition if the same was acquired by gratuitous title.

x x x x x x x x x

The records show that the property in question was adjudicated to Maria Morales by order of the Court of First Instance of Pampanga on March 23, 1929, and in accordance with the aforequoted section of the National Internal Revenue Code, only the fair market price or value of the property as of the date of the acquisition thereof should be considered in determining the gain or loss sustained by the property owner when the property was disposed, without taking into account the purchasing power of the currency used in the transaction. The records placed the value of the said property at the time of its acquisition by appellant Maria Morales P28,291.73 and it is a fact that same was compensated with P94,305.75 when it was expropriated. The resulting difference is surely a capital gain and should be correspondingly taxed.

As to the only question raised by appellant Collector of Internal Revenue in case L-9771, assailing the lower Court's order exonerating petitioners from the 50 per cent surcharge imposed on the latter, on the ground that the taxpayers' income tax return for 1950 is false and/or fraudulent, it should be noted that the Court of Tax Appeals found that the evidence did not warrant the imposition of said surcharge because the petitioners therein acted in good faith and without intent to defraud the Government.

The question of fraud is a question of fact which frequently requires a nicely balanced judgement to answer. All the facts and circumstances surrounding the conduct of the tax payer's business and all the facts incident to the preparation of the alleged fraudulent return should be considered. (Mertens, Federal Income Taxation, Chapter 55).

The question of fraud being a question of fact and the lower court having made the finding that "the evidence of this case does not warrant the imposition of the 50 per cent surcharge", We are constrained to refrain from giving any consideration to the question raised by the Solicitor General, for it is already settled in this jurisdiction that in passing upon petitions to review decisions of the Court of Tax Appeals, We have to confine ourselves to questions of law.

WHEREFORE, the decision appealed from by both parties is hereby affirmed, without pronouncement as to costs. It is so ordered.

G.R. No. 108576 January 20, 1999

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.THE COURT OF APPEALS, COURT OF TAX APPEALS and A. SORIANO CORP., respondents.

MARTINEZ, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of the Court of Appeals (CA) 1 which affirmed the ruling of the Court of Tax Appeals (CTA)

2 that private respondent A. Soriano Corporation's (hereinafter ANSCOR) redemption and exchange of the stocks of its foreign stockholders cannot be considered as "essentially equivalent to a distribution of taxable dividends" under, Section 83(b) of the 1939 Internal Revenue Act. 3

The undisputed facts are as follows:

Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the corporation "A. Soriano Y Cia", predecessor of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is wholly owned and controlled by the family

of Don Andres, who are all non-resident aliens. 4 In 1937, Don Andres subscribed to 4,963 shares of the

5,000 shares originally issued. 5

On September 12, 1945, ANSCOR's authorized capital stock was increased to P2,500,000.00 divided into 25,000 common shares with the same par value of the additional 15,000 shares, only 10,000 was issued which were all subscribed by Don Andres, after the other stockholders waived in favor of the former their pre-emptive rights to subscribe to the new issues. 6 This increased his subscription to 14,963 common

shares. 7 A month later, 8 Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr.,

as their initial investments in ANSCOR. 9 Both sons are foreigners. 10

By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949 and December 20, 1963. 11 On December 30, 1964 Don Andres died. As of that date, the records revealed

that he has a total shareholdings of 185,154 shares 12 — 50,495 of which are original issues and the

balance of 134.659 shares as stock dividend declarations. 13 Correspondingly, one-half of that shareholdings

or 92,577 14 shares were transferred to his wife, Doña Carmen Soriano, as her conjugal share. The other

half formed part of his estate. 15

A day after Don Andres died, ANSCOR increased its capital stock to P20M 16 and in 1966 further increased

it to P30M. 17 In the same year (December 1966), stock dividends worth 46,290 and 46,287 shares were

respectively received by the Don Andres estate 18 and Doña Carmen from ANSCOR. Hence, increasing

their accumulated shareholdings to 138,867 and 138,864 19 common shares each. 20

On December 28, 1967, Doña Carmen requested a ruling from the United States Internal Revenue Service (IRS), inquiring if an exchange of common with preferred shares may be considered as a tax avoidance scheme 21 under Section 367 of the 1954 U.S. Revenue Act. 22 By January 2, 1968, ANSCOR reclassified

its existing 300,000 common shares into 150,000 common and 150,000 preferred shares. 23

In a letter-reply dated February 1968, the IRS opined that the exchange is only a recapitalization scheme and not tax avoidance. 24 Consequently, 25 on March 31, 1968 Doña Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares, for the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to 127,727. 26

On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres' estate. By November 1968, the Board further increased ANSCOR's capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. 27 About a year later, ANSCOR again

redeemed 80,000 common shares from the Don Andres' estate, 28 further reducing the latter's common shareholdings to 19,727. As stated in the Board Resolutions, ANSCOR's business purpose for both

redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce the company's foreign exchange remittances in case cash dividends are declared. 29

In 1973, after examining ANSCOR's books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-source, pursuant to Sections 53 and 54 of the 1939 Revenue Code, 30

for the year 1968 and the second quarter of 1969 based on the

transactions of exchange 31 and redemption of stocks. 31 The Bureau of Internal Revenue (BIR) made the corresponding assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree (P.D.) 23 32 which were amended by P.D.'s 67 and 157. 33 However, petitioner ruled that the invoked decrees do not cover Sections 53 and 54 in relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR was assessed. 34 ANSCOR's subsequent protest on the assessments was denied in 1983 by petitioner. 35

Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax assessments on the redemptions and exchange of stocks. In its decision, the Tax Court reversed petitioner's ruling, after finding sufficient evidence to overcome the prima facie correctness of the questioned assessments. 36 In a petition

for review the CA as mentioned, affirmed the ruling of the CTA. 37 Hence, this petition.

The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue Act 38

which provides:

Sec. 83. Distribution of dividends or assets by corporations. —

(b) Stock dividends — A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis supplied)

Specifically, the issue is whether ANSCOR's redemption of stocks from its stockholder as well as the exchange of common with preferred shares can be considered as "essentially equivalent to the distribution of taxable dividend" making the proceeds thereof taxable under the provisions of the above-quoted law.

Petitioner contends that the exchange transaction a tantamount to "cancellation" under Section 83(b) making the proceeds thereof taxable. It also argues that the Section applies to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner claims that under the "net effect test," the estate of Don Andres gained from the redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising from the two transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act. 39

ANSCOR, however, avers that it has no duty to withhold any tax either from the Don Andres estate or from Doña Carmen based on the two transactions, because the same were done for legitimate business purposes which are (a) to reduce its foreign exchange remittances in the event the company would declare cash dividends, 40 and to (b) subsequently "filipinized" ownership of ANSCOR, as allegedly, envisioned by

Don Andres. 41 It likewise invoked the amnesty provisions of P.D. 67.

We must emphasize that the application of Sec. 83(b) depends on the special factual circumstances of each case. 42 The findings of facts of a special court (CTA) exercising particular expertise on the subject of tax,

generally binds this Court, 43 considering that it is substantially similar to the findings of the CA which is the

final arbiter of questions of facts. 44 The issue in this case does not only deal with facts but whether the law applies to a particular set of facts. Moreover, this Court is not necessarily bound by the lower courts' conclusions of law drawn from such facts. 45

AMNESTY:

We will deal first with the issue of tax amnesty. Section 1 of P.D. 67 46 provides:

1. In all cases of voluntary disclosures of previously untaxed income and/or wealth such as earnings, receipts, gifts, bequests or any other acquisitions from any source whatsoever which are taxable under the National Internal Revenue Code, as amended, realized here or abroad by any

taxpayer, natural or judicial; the collection of all internal revenue taxes including the increments or penalties or account of non-payment as well as all civil, criminal or administrative liabilities arising from or incident to such disclosures under the National Internal Revenue Code, the Revised Penal Code, the Anti-Graft and Corrupt Practices Act, the Revised Administrative Code, the Civil Service laws and regulations, laws and regulations on Immigration and Deportation, or any other applicable law or proclamation, are hereby condoned and, in lieu thereof, a tax of ten (10%) per centum on such previously untaxed income or wealth, is hereby imposed, subject to the following conditions: (conditions omitted) [Emphasis supplied].

The decree condones "the collection of all internal revenue taxes including the increments or penalties or account of non-payment as well as all civil, criminal or administrative liable arising from or incident to" (voluntary) disclosures under the NIRC of previously untaxed income and/or wealth "realized here or abroad by any taxpayer, natural or juridical."

May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the amnesty? An income taxpayer covers all persons who derive taxable income. 47 ANSCOR was assessed by petitioner for deficiency withholding tax under Section 53 and 54 of the 1939 Code. As such, it is being held liable in its capacity as a withholding agent and not its personality as a taxpayer.

In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting no more than an agent of the government for the collection of the tax 48 in order to ensure its payments; 49 the

payer is the taxpayer — he is the person subject to tax impose by law; 50 and the payee is the taxing

authority. 51 In other words, the withholding agent is merely a tax collector, not a taxpayer. Under the withholding system, however, the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent from the taxpayer, 52 because the income tax is still impose on and due from the latter. The agent is not liable for the tax as no wealth flowed into him — he earned no income. The Tax Code only makes the agent personally liable for the tax 53 arising from the breach of its legal duty to withhold as distinguish from its duty to pay tax since:

the government's cause of action against the withholding is not for the collection of income tax, but for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with which is imposed on the withholding agent and not upon the taxpayer. 54

Not being a taxpayer, a withholding agent, like ANSCOR in this transaction is not protected by the amnesty under the decree.

Codal provisions on withholding tax are mandatory and must be complied with by the withholding agent. 55 The taxpayer should not answer for the non-performance by the withholding agent of its legal duty to withhold unless there is collusion or bad faith. The former could not be deemed to have evaded the tax had the withholding agent performed its duty. This could be the situation for which the amnesty decree was intended. Thus, to curtail tax evasion and give tax evaders a chance to reform, 56 it was deemed

administratively feasible to grant tax amnesty in certain instances. In addition, a "tax amnesty, much like a tax exemption, is never favored nor presumed in law and if granted by a statute, the term of the amnesty like that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of the taxing authority. 57 The rule on strictissimi juris equally applies. 58 So that, any doubt in the application of an amnesty law/decree should be resolved in favor of the taxing authority.

Furthermore, ANSCOR's claim of amnesty cannot prosper. The implementing rules of P.D. 370 which expanded amnesty on previously untaxed income under P.D. 23 is very explicit, to wit:

Sec. 4. Cases not covered by amnesty. — The following cases are not covered by the amnesty subject of these regulations:

xxx xxx xxx

(2) Tax liabilities with or without assessments, on withholding tax at source provided under Section 53 and 54 of the National Internal Revenue Code, as amended; 59

ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by specific provision of law, it is not covered by the amnesty.

TAX ON STOCK DIVIDENDS

General Rule

Sec. 83(b) of the 1939 NIRC was taken from the Section 115(g)(1) of the U.S. Revenue Code of 1928. 60 It

laid down the general rule known as the proportionate test 61 wherein stock dividends once issued form part of the capital and, thus, subject to income tax. 62 Specifically, the general rule states that:

A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.

Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US Revenue Code, this provision originally referred to "stock dividends" only, without any exception. Stock dividends, strictly speaking, represent capital and do not constitute income to itsrecipient. 63 So that the mere issuance thereof is not yet subject to income tax 64 as they are nothing but an "enrichment through increase in value of capital investment."

65 As capital, the stock dividends postpone the realization of profits because the "fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution." 66 Income in tax law is "an amount of money coming to a person within a specified time,

whether as payment for services, interest, or profit from investment." 67 It means cash or its equivalent. 68 It

is gain derived and severed from capital, 69 from labor or from both combined 70 — so that to tax a stock

dividend would be to tax a capital increase rather than the income. 71 In a loose sense, stock dividends

issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties. 72 As capital, it is not yet subject to income tax. It should be noted that capital

and income are different. Capital is wealth or fund; whereas income is profit or gain or the flow of wealth. 73

The determining factor for the imposition of income tax is whether any gain or profit was derived from a transaction. 74

The Exception

However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis supplied).

In a response to the ruling of the American Supreme Court in the case of Eisner v. Macomber 75 (that pro rata stock dividends are not taxable income), the exempting clause above quoted was added because provision corporation found a loophole in the original provision. They resorted to devious means to circumvent the law and evade the tax. Corporate earnings would be distributed under the guise of its initial capitalization by declaring the stock dividends previously issued and later redeem said dividends by paying

cash to the stockholder. This process of issuance-redemption amounts to a distribution of taxable cash dividends which was lust delayed so as to escape the tax. It becomes a convenient technical strategy to avoid the effects of taxation.

Thus, to plug the loophole — the exempting clause was added. It provides that the redemption or cancellation of stock dividends, depending on the "time" and "manner" it was made, is essentially equivalent to a distribution of taxable dividends," making the proceeds thereof "taxable income" "to the extent it represents profits". The exception was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally not taxable, from being made use of as a device for the actual distribution of cash dividends, which is taxable. 76 Thus,

the provision had the obvious purpose of preventing a corporation from avoiding dividend tax treatment by distributing earnings to its shareholders in two transactions — a pro rata stock dividend followed by a pro rata redemption — that would have the same economic consequences as a simple dividend. 77

Although redemption and cancellation are generally considered capital transactions, as such. they are not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from such transactions. 78 Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and

can exercise the freedom of choice. 79 Having realized gain from that redemption, the income earner

cannot escape income tax. 80

As qualified by the phrase "such time and in such manner," the exception was not intended to characterize as taxable dividend every distribution of earnings arising from the redemption of stock dividend. 81 So that, whether the amount distributed in the redemption should be treated as the equivalent of a "taxable dividend" is a question of fact, 82 which is determinable on "the basis of the particular facts of the transaction in

question. 83 No decisive test can be used to determine the application of the exemption under Section 83(b). The use of the words "such manner" and "essentially equivalent" negative any idea that a weighted formula can resolve a crucial issue — Should the distribution be treated as taxable dividend. 84 On this aspect,

American courts developed certain recognized criteria, which includes the following: 85

1) the presence or absence of real business purpose,

2) the amount of earnings and profits available for the declaration of a regular dividends and the corporation's past record with respect to the declaration of dividends,

3) the effect of the distribution, as compared with the declaration of regular dividend,

4) the lapse of time between issuance and redemption, 86

5) the presence of a substantial surplus 87

and a generous supply of cash which invites suspicion as does a meager policy in relation both to current earnings and accumulated surplus, 88

REDEMPTION AND CANCELLATION

For the exempting clause of Section, 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation; (b) the transaction involves stock dividends and (c) the "time and manner" of the transaction makes it "essentially equivalent to a distribution of taxable dividends." Of these, the most important is the third.

Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock 89 in exchange

for property, whether or not the acquired stock is cancelled, retired or held in the treasury. 90 Essentially, the corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock, and continues in business as before. The redemption of stock dividends previously issued is used as a veil for the constructive distribution of cash dividends. In the instant case, there is no dispute that ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares redeemed come from? If its source is the original capital subscriptions upon establishment of the corporation or from initial capital investment in an existing enterprise, its redemption to the concurrent value of acquisition may not invite the application of Sec. 83(b) under the 1939

Tax Code, as it is not income but a mere return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain thereon.

It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. Here, it is undisputed that at the time of the last redemption, the original common shares owned by the estate were only 25,247.5 91 This means that from the total of 108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 less 25,247.5) must have come from stock dividends. Besides, in the absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of corporate profits 92 such as stock dividends. The capital cannot be distributed in the form of redemption of stock dividends without violating the trust fund doctrine — wherein the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors. 93 Once capital, it is always capital. 94 That doctrine was intended for the protection of corporate

creditors. 95

With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The time alone that lapsed from the issuance to the redemption is not a sufficient indicator to determine taxability. It is a must to consider the factual circumstances as to the manner of both the issuance and the redemption. The "time" element is a factor to show a device to evade tax and the scheme of cancelling or redeeming the same shares is a method usually adopted to accomplish the end sought. 96 Was this

transaction used as a "continuing plan," "device" or "artifice" to evade payment of tax? It is necessary to determine the "net effect" of the transaction between the shareholder-income taxpayer and the acquiring (redeeming) corporation. 97 The "net effect" test is not evidence or testimony to be considered; it is rather an

inference to be drawn or a conclusion to be reached. 98 It is also important to know whether the issuance of stock dividends was dictated by legitimate business reasons, the presence of which might negate a tax evasion plan. 99

The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not related, for the redemption to be considered a legitimate tax scheme. 100 Redemption cannot be used as a cloak to

distribute corporate earnings. 101 Otherwise, the apparent intention to avoid tax becomes doubtful as the intention to evade becomes manifest. It has been ruled that:

[A]n operation with no business or corporate purpose — is a mere devise which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to a stockholder. 102

Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may not be applicable if the redeemed shares were issued with bona fide business purpose, 103 which is judged after each and every

step of the transaction have been considered and the whole transaction does not amount to a tax evasion scheme.

ANSCOR invoked two reasons to justify the redemptions — (1) the alleged "filipinization" program and (2) the reduction of foreign exchange remittances in case cash dividends are declared. The Court is not concerned with the wisdom of these purposes but on their relevance to the whole transaction which can be inferred from the outcome thereof. Again, it is the "net effect rather than the motives and plans of the taxpayer or his corporation" 104 that is the fundamental guide in administering Sec. 83(b). This tax provision

is aimed at the result. 105 It also applies even if at the time of the issuance of the stock dividend, there was

no intention to redeem it as a means of distributing profit or avoiding tax on dividends. 106 The existence of

legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation. It has no relevance in determining "dividend equivalence". 107 Such purposes may be material only upon the issuance of the stock dividends. The test of taxability under the exempting clause, when it provides "such time and manner" as would make the redemption "essentially equivalent to the distribution of a taxable dividend", is whether the redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a dividend equivalence treatment. In the metaphor of Eisner v. Macomber, income is not deemed "realize" until the fruit has fallen or been plucked from the tree.

The three elements in the imposition of income tax are: (1) there must be gain or and profit, (2) that the gain or profit is realized or received, actually or constructively, 108 and (3) it is not exempted by law or treaty from

income tax. Any business purpose as to why or how the income was earned by the taxpayer is not a requirement. Income tax is assessed on income received from any property, activity or service that produces the income because the Tax Code stands as an indifferent neutral party on the matter of where income comesfrom. 109

As stated above, the test of taxability under the exempting clause of Section 83(b) is, whether income was realized through the redemption of stock dividends. The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the stockholder's separate property. 110 Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption. Otherwise, to rule that the said proceeds are exempt from income tax when the redemption is supported by legitimate business reasons would defeat the very purpose of imposing tax on income. Such argument would open the door for income earners not to pay tax so long as the person from whom the income was derived has legitimate business reasons. In other words, the payment of tax under the exempting clause of Section 83(b) would be made to depend not on the income of the taxpayer, but on the business purposes of a third party (the corporation herein) from whom the income was earned. This is absurd, illogical and impractical considering that the Bureau of Internal Revenue (BIR) would be pestered with instances in determining the legitimacy of business reasons that every income earner may interposed. It is not administratively feasible and cannot therefore be allowed.

The ruling in the American cases cited and relied upon by ANSCOR that "the redeemed shares are the equivalent of dividend only if the shares were not issued for genuine business purposes", 111 or the

"redeemed shares have been issued by a corporation bona fide" 112 bears no relevance in determining the non-taxability of the proceeds of redemption ANSCOR, relying heavily and applying said cases, argued that so long as the redemption is supported by valid corporate purposes the proceeds are not subject to tax. 113

The adoption by the courts below 114 of such argument is misleading if not misplaced. A review of the cited American cases shows that the presence or absence of "genuine business purposes" may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance and the redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes may justify a corporation's acquisition of its own shares under Section 41 of the Corporation Code, 115 such purposes cannot excuse the stockholder from the effects of taxation arising from the redemption. If the issuance of stock dividends is part of a tax evasion plan and thus, without legitimate business reasons, the redemption becomes suspicious which exempting clause. The substance of the whole transaction, not its form, usually controls the tax consequences. 116

The two purposes invoked by ANSCOR, under the facts of this case are no excuse for its tax liability. First, the alleged "filipinization" plan cannot be considered legitimate as it was not implemented until the BIR started making assessments on the proceeds of the redemption. Such corporate plan was not stated in nor supported by any Board Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a

separate entity, the corporation can act only through its Board of Directors. 117 The Board Resolutions authorizing the redemptions state only one purpose — reduction of foreign exchange remittances in case cash dividends are declared. Not even this purpose can be given credence. Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970's. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet when no cash dividends was issued for about three decades, this circumstance negates the legitimacy of ANSCOR's alleged purposes. Moreover, to issue stock dividends is to increase the shareholdings of ANSCOR's foreign stockholders contrary to its "filipinization" plan. This would also increase rather than reduce their need for foreign exchange remittances in case of cash dividend declaration, considering that ANSCOR is a family corporation where the majority shares at the time of redemptions were held by Don Andres' foreign heirs.

Secondly, assuming arguendo, that those business purposes are legitimate, the same cannot be a valid excuse for the imposition of tax. Otherwise, the taxpayer's liability to pay income tax would be made to depend upon a third person who did not earn the income being taxed. Furthermore, even if the said purposes support the redemption and justify the issuance of stock dividends, the same has no bearing whatsoever on the imposition of the tax herein assessed because the proceeds of the redemption are deemed taxable dividends since it was shown that income was generated therefrom.

Thirdly, ANSCOR argued that to treat as "taxable dividend" the proceeds of the redeemed stock dividends would be to impose on such stock an undisclosed lien and would be extremely unfair to intervening

purchase, i.e. those who buys the stock dividends after their issuance. 118 Such argument, however, bears

no relevance in this case as no intervening buyer is involved. And even if there is an intervening buyer, it is necessary to look into the factual milieu of the case if income was realized from the transaction. Again, we reiterate that the dividend equivalence test depends on such "time and manner" of the transaction and its net effect. The undisclosed lien 119 may be unfair to a subsequent stock buyer who has no capital interest in the company. But the unfairness may not be true to an original subscriber like Don Andres, who holds stock dividends as gains from his investments. The subsequent buyer who buys stock dividends is investing capital. It just so happen that what he bought is stock dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely to return his capital subscription, which is income if redeemed from the original subscriber.

After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As "taxable dividend" under Section 83(b), it is part of the "entire income" subject to tax under Section 22 in relation to Section 21 120 of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in "gross income". As income, it is subject to income tax which is required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition.

EXCHANGE OF COMMON WITH PREFERRED SHARES 121

Exchange is an act of taking or giving one thing for another involving 122 reciprocal transfer 123 and is

generally considered as a taxable transaction. The exchange of common stocks with preferred stocks, or preferred for common or a combination of either for both, may not produce a recognized gain or loss, so long as the provisions of Section 83(b) is not applicable. This is true in a trade between two (2) persons as well as a trade between a stockholder and a corporation. In general, this trade must be parts of merger, transfer to controlled corporation, corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on exchange of property, stock or securities related to reorganizations. 124

Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and preferred, and that parts of the common shares of the Don Andres estate and all of Doña Carmen's shares were exchanged for the whole 150.000 preferred shares. Thereafter, both the Don Andres estate and Doña Carmen remained as corporate subscribers except that their subscriptions now include preferred shares. There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. Under the facts herein, any difference in their market value would be immaterial at the time of exchange because no income is yet realized — it was a mere corporate paper transaction. It would have been different, if the exchange transaction resulted into a flow of wealth, in which case income tax may be imposed. 125

Reclassification of shares does not always bring any substantial alteration in the subscriber's proportional interest. But the exchange is different — there would be a shifting of the balance of stock features, like

priority in dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per se, yields realize income for tax purposes. A common stock represents the residual ownership interest in the corporation. It is a basic class of stock ordinarily and usually issued without extraordinary rights or privileges and entitles the shareholder to a pro rata division of profits. 126 Preferred stocks are those which entitle the

shareholder to some priority on dividends and asset distribution. 127

Both shares are part of the corporation's capital stock. Both stockholders are no different from ordinary investors who take on the same investment risks. Preferred and common shareholders participate in the same venture, willing to share in the profits and losses of the enterprise. 128 Moreover, under the doctrine of equality of shares — all stocks issued by the corporation are presumed equal with the same privileges and liabilities, provided that the Articles of Incorporation is silent on such differences. 129

In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is only a modification of the subscriber's rights and privileges — which is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a subscriber disposes of his entire interest and not when there is still maintenance of proprietary interest. 130

WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in that ANSCOR's redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of

taxable dividends for which it is LIABLE for the withholding tax-at-source. The decision is AFFIRMED in all other respects.

G.R. No. 48231 p June 30, 1947

WISE & CO., INC., ET AL., plaintiffs-appellants, vs.BIBIANO L. MEER, Collector of Internal Revenue, defendant-appellee.

Ross, Selph, Carrascoso and Janda for appellants.Office of the Solicitor General for appellee.

HILADO, J.:

This is an appeal by Wise & Co., Inc. and its co-plaintiff from the judgment of the Court of First Instance of Manila in civil case No. 56200 of said court, absolving the defendant Collector of Internal Revenue from the complaint without costs. The complaint was for recovery of certain amounts therein specified, which had been paid by said plaintiffs under written protest to said defendant, who had previously assessed said amounts against the respective plaintiffs by way of deficiency income taxes for the year 1937, as detailed under paragraph 6 of defendant's special defense (Record of Appeal, pp. 7-10). Appellants made eight assignments of error, to wit:

The trial court erred in finding:

I. That the Manila Wine Merchants, Ltd., a Hongkong corporation, was in liquidation beginning June 1, 1937, and that all dividends declared and paid thereafter were distributions of all its assets in complete liquidation.

II. That all distributions made by the Hongkong corporation after June 1, 1937, were subject to both normal tax and surtax.

III. That income received by one corporation from another was taxable under the Income Tax Law, and that Wise & Co., Inc., was taxable on the distribution of its share of the same net profits on which the Hongkong Company had already paid Philippine tax, despite the clear provisions of section 10 of the Income Tax Law then in effect.

IV. That the non-resident individual stockholder appellants were subject to both normal and additional tax on the distributions received despite the clear provisions of section 5 (b) of the Income Tax Law then in effect.

V. That section 25 (a) of the Income Tax Law makes distributions in liquidation of a foreign corporation, dissolution proceedings of which were conducted in a foreign country, taxable income to a non-resident individual stockholder.

VI. That section 199 of the Income Tax regulations, providing that in a distribution by a corporation in complete liquidation of its assets the gain realized by a stockholder, whether individual or corporate, is taxable as a dividend, is ineffective.

VII. That the deficiency assessment was properly collected.

VIII. That the refunds claimed by plaintiffs were not in order, and in rendering judgment absolving the Collector of Internal Revenue from making such refunds.

The facts have been stipulated in writing, as quoted verbatim in the decision of the trial court thus:

I

That the allegations of paragraphs I and II of the complaint are true and correct.

II

That during the year 1937, plaintiffs, except Mr. E.M.G. Strickland (who, as husband of the plaintiff Mrs. E.M.G. Strickland, is only a nominal party herein), were stockholders of Manila Wine Merchants, Ltd., a foreign corporation duly authorized to do business in the Philippines.

III

That on May 27, 1937, the Board of Directors of Manila Wine Merchants, Ltd., (hereinafter referred to as the Hongkong Company), recommended to the stockholders of the company that they adopt the resolutions necessary to enable the company to sell its business and assets to Manila Wine Merchants, Inc., a Philippine corporation formed on May 27, 1937, (hereinafter referred to as the Manila Company), for the sum of P400,000 Philippine currency; that this sale was duly authorized by the stockholders of the Hongkong Company at a meeting held on July 22, 1937; that the contract of sale between the two companies was executed on the same date, a copy of the contract being attached hereto as Schedule "A"; and that the final resolutions completing the said sale and transferring the business and assets of the Hongkong Company to the Manila Company were adopted on August 3,

1937, on which date the Manila Company were adopted on August 3, 1937, on which date the Manila Company paid the Hongkong company the P400,000 purchase price.

IV

That pursuant to a resolution by its Board of Directors purporting to declare a dividend, the Hongkong Company made a distribution from its earnings for the year 1937 to its stockholders, plaintiffs receiving the following:

Declared and paidJune 8, 1937

Wise & Co., Inc.

P7,677.82

Mr. J.F. MacGregor

2,554.86

Mr. N.C. MacGregor

2,369.48

Mr. C.J. Lafrentz

529.51

Mrs. E.M.G. Strickland

2,369.48

Mrs. M.J.G. Mullins

2,369.48

P17,870.63

That the Hongkong Company has paid Philippine income tax on the entire earnings from which the said distributions were paid.

V

That after deducting the said dividend of June 8, 1937, the surplus of the Hongkong Company resulting from the active conduct of its business was P74,182.12. That as a result of the sale of its business and assets to the Manila Company, the surplus of the Hongkong Company was increased to a total of P270,116.59.

That pursuant to resolutions of its Board of Directors, and of its shareholders, purporting to declare dividends, copies of which are attached hereto as Schedules "B" and "B-1", the Hongkong Company distributed this surplus to its stockholders, plaintiffs receiving the following sums on the following dates:

Declared Declared

July 22, 1937Paid

August 4, 1937

July 22, 1937Paid

October 28, 1937

Wise & Co., Inc. P113,851.85 P 2,198.24

Mr. J.F. MacGregor 37,885.20 731.48Mr. N.C. MacGregor 35,137.03 678.42Mr. C.J. Lafrentz 7,851.86 151.61Mrs. E.M.G. Strickland

35,137.03 678.42

Mrs. M.J.G. Mullins 35,137.03 678.42P265,000.00 P

5,116.59

That Philippine income tax had been paid by the Hongkong Company on the said surplus from which the said distributions were made.

VI

That on August 19, 1937, at a special general meeting of the shareholders of the Hongkong Company, the stockholders by proper resolution directed that the company be voluntarily liquidated and its capital distributed among the stockholders; that the stockholders at such meeting appointed a liquidator duly paid off the remaining debts of the Hongkong Company and distributed its capital among the stockholders including plaintiffs; that the liquidator duly filed his accounting on January 12, 1938, and in accordance with the provisions of Hongkong Law, the Hongkong Company was duly dissolved at the expiration of three moths from that date.

VII

That plaintiffs duly filed Philippine income tax returns. That defendant subsequently made the following deficiency assessments against plaintiffs:

WISE & COMPANY, INC.Net income as per return P87,649.67Add: Deductions disallowed — Loss on shares of pstock in the Manila Wine Merchants, Ltd. presulting from the

44,515.00

liquidation of said firmIncome not declared: Return of capital Share of surplus

P51,185.00123,727.88

Total liquidating dividends received Less value of shares as per books

P174,912.8895,700.00

Profits realized on shares of stock in the Manila Wine Merchants Ltd. resulting from the liquidation of the said firm P79,212.88Accrued income tax as per return 5,258.98 Total P216,636.53Deduct accrued income tax 12,262.45Net income as per investigation 204,374.08

6 per cent Normal tax 12,262.45Less amount already paid 6,307.92Balance still due and collectible 7,003.47

J. F. MACGREGORNet income as per return P47,479.44Deduct: Ordinary dividends 6,307.92Net income as per investigation subject to normal tax: Return of capital Share of surplus

P17,032,2541,171.52

Total liquidating dividends received P58,203.77 Less cost of shares 17,032.25 Profit realized on shares of stock in the Manila Wine Merchants., Ltd.

P41,171.52

Resulting from the liquidation of said firmNormal tax at 3 per cent 1,235.15Additional tax due 549.59 Total normal and additional taxes 1,784.74Less: Amount already paid 549.59 Balance still due and collectible 1,235.15

N. C. MACGREGORNet income as per return P44,177.06Deduct: Ordinary dividends 5,992.11Net income as per investigation subject to normal tax: Return of capital Share of surplus

P15,796.7538,184.95

Total liquidating dividends received.

P53,981.7015,796.75

Less cost of shares Profit realized on shares of stock in the Manila Wine Merchants, Ltd. Resulting from the liquidation of the said firm P38,184.95Normal tax at 3 per cent 1,145.55Additional tax due 483.54 Total normal and additional taxes 1,629.09Less amount already paid 483.55 Balance still due and collectible 1,145.54

C. J. LAFRENTZNet income as per return P9,778.18Deduct: Ordinary dividends 1,245.20 Net income as per investigation subject to

normal tax: Return of capital Share of surplus

P3,530.00 8,532.98

Total liquidating dividends received Less cost of shares

P12,062.98 3,530.00

Profit realized on shares of stock in the Manila Wine Merchants, Ltd. Resulting from the liquidation of the said firm P8,532.98 3 per cent normal tax due and collectible 255.99

MRS. E. M. G. STRICKLANDNet income as per return P44,057.06Deduct: Ordinary dividends 5,872.11 Net income as per investigation

subject to normal tax: Return of capital Share of surplus

P15,796.7538,184.95


P53,981.70 15,796.75

Profit realized on shares of stock in the Manila Wine Merchants, Ltd. Resulting from the liquidation of the said firm P38,184.95Normal tax at 3 per cent 1,145.55Additional tax due 481.14 Total normal and additional taxes 1,626.69Balance still due and collectible 1,145.54

MRS. M. J. G. MULLINS

Net income per return P44,057.06Deduct: Ordinary dividends 5,872.11Net income as per investigation subject to normal tax: Return of capital Share of surplus

P15,796.7538,184.95


P53,981.7015,796.75

Profit realized on shares of stock in the Manila Wine Merchants, Ltd. Resulting from the liquidation of the said firm P38,184.95Normal tax at 3 per cent 1,145.55Additional tax due 481.14 Total normal and additional 1,626.69

taxesLess amount already paid 481.15 Balance still due and collectible P1,145.54

VIII

That said plaintiffs duly paid the said amounts demanded by defendant under written protest, which was overruled in due course; that the plaintiffs have since July 1, 1939 requested from defendant a refund of the said amounts which defendant has refused and still refuses to refund.

IX

That this stipulation is equally the work of both parties and shall be fairly interpreted to give effect to their intention that this case shall be decided solely upon points of law.

X

The parties incorporate the Corporation Law and Companies Act of Hongkong and the applicable decisions made thereunder, into this stipulation by reference, and either party may at any stage in the proceedings in this case cite applicable sections of the law and the authorities decided thereunder as though the same had been duly proved in evidence.

XI

That the parties hereto reserve the right to submit other and further evidence at the trial of this case. (Record on Appeal, pp. 19-26.)

1. The first assignment of error. — Appellants maintain that the amounts received by them and on which the taxes in question were assessed and collected were ordinary dividends; while upon the other hand, appellee contends that they were liquidating dividends. If the first proposition is correct, this assignment would be well-taken, otherwise, the decision of the court upon the point must be upheld.

It appears that on May 27, 1937, the Board of Directors of the Manila Wine Merchants, Ltd. (hereafter called the Hongkong Co.), recommended to the stockholders of said company "that the Company should be wound up voluntarily by the members and the business sold as a going concern to a new company incorporated under the laws of the Philippine Islands under the style of "The Manila Wine Merchants, Inc." (Annex A defendant's answer, Record on Appeal, p. 12), and that they adopt the resolutions necessary to enable the company to sell its business and assets to said new company (hereafter called the Manila Company), organized on that same date, for the price of P400,000, Philippine currency; that the sale was duly authorized by the stockholders of the Hongkong Co. at a meeting held on July 22, 1937; and that the contract of sale between the two companies was executed on the same day, as appears from the copy of the contract, Schedule A of the Stipulation of Facts (par. III, Stipulation of Facts, Record on Appeal, pp. 19-20). It will be noted that the Board of Directors of the Hongkong Co., in recommending the sale, specifically mentioned "a new Company incorporated under the laws of the Philippine Islands under the style of "The Manila Wine

Merchants, Inc." as the purchaser, which fact shows that at the time of the recommendation the Manila Company had already been formed, although on the very same day; and this and the further fact that it was really the latter corporation that became the purchaser should clearly point to the conclusion that the Manila Company was organized for the express purpose of succeeding the Hongkong Co. The stipulated facts would admit of no saner interpretation.

While it is true that the contract of sale was signed on July 22, 1937, it contains in its paragraph 4 of the express provision that the transfer "will take effect as on and from the first day of June, One thousand nine hundred and thirty-seven, and until completion thereof, the Company shall stand possessed of the property hereby agreed to be transferred and shall carry on its business in trust for the Corporation" (Schedule A of Stipulation of Facts, Record on Appeal, p. 15). "The Company" was the Hongkong Company and "the Corporation" was the Manila Company. For "the Company" to carry on business in trust for the "Corporation," it was necessary for the latter to be the owner of the business. It is plain that the parties considered the sale as made as on and from June 1, 1937 — for the purposes of said sale and transfer, both parties agreed that the deed of July 22, 1937, was to retroact to the first day of the preceding month.

The cited provision could not have served any other purpose than to consider the sale as made as of June 1, 1937. If it had not been for this purpose, if the intention had been that the sale was to be effective upon the date of the written contract or subsequently, said provision would certainly never have been written, for how could the transfer or sale take effect as of June 1, 1937, if it were to be considered as made at a later date?

The first distribution made after June 1, 1937, of what plaintiffs call ordinary dividends but what defendant denominates liquidating dividends was declared and paid on June 8, 1937 (Stipulation, Paragraph IV, Record on Appeal, p. 20). It will be recalled that the recommendation of the Board of Directors of the Hongkong Company, at their meeting on May 27, 1937, was first of all "that the company should be wound up voluntarily by the members"(Record on Appeal, p.12), and in pursuance of that purpose, it was further recommended that the Company's business be sold as a going concern to the Manila Company (ibid). Complying with the Companies Ordinance 1932 for companies registered in Hongkong for the voluntary winding up by members, a Declaration of Solvency was drawn up duly signed before the British Consul-General in Manila by the same directors, and said declaration was returned to Hongkong for filing with the Registrar of Companies (ibid.) Both recommendations were in due course approved and ratified. The later execution of the formal deed of sale and the successive distributions of the amounts in question among the stockholders of the Hongkong Company were obviously other steps in its complete liquidation. And they leave no room for doubt in the mind of the court that said distributions were not in the ordinary course of business and with intent to maintain the corporation as a going concern — in which case they would have been distributions of ordinary dividends — but after the liquidation of the business had been decided upon, which makes them payments for the surrender and relinquishment of the stockholders' interest in the corporation, or so-called liquidating dividends.

More than with the distribution of June 8, 1937, is this true with those declared on July 22, 1937, and paid on August 4 and October 28, 1937, respectively (Stipulation of Facts, par. 5, Record on Appeal, p. 21). The distributions thus declared on July 22, 1937, and paid on August 4 and October 28, 1937, were from the surplus of the Hongkong Company resulting from the active conduct of its business and amounting to P74,182.12, which surplus was augmented to a total of P270,116.59 as a result of the sale of its business and assets to the Manila Company (ibid.). In both

Schedules B and B-1 of the Stipulation of Facts (Record on appeal, pp. 16-18), being minutes of directors' meetings of the Hongkong Co., where authorization and instruction were given to declare and pay in the form of "dividends" to the shareholders the amounts in question, it was specifically provided that the surplus to be so distributed be that resulting after providing for return of capital and necessary or various expenses, as shown in the balance sheet prepared as of June 1, 1937, and in the reconstructed balance sheet of the same date presented by the company's auditors, it having been resolved in Schedule B-1 that "any balance remaining to be distributed when final liquidator's account has been rendered and paid" (Record on Appeal, p. 18; emphasis supplied). It thus becomes more evident that those distributions were to be made in the course or as a result of the Hongkong Company's liquidation and that said liquidation was to be complete and final. And although the various resolutions above-mentioned speak of distributions of dividends when referring to those already alluded to, "a distribution does not necessarily become a dividend by reason of the fact that it is called a dividend by the distributing corporation." (Holmes Federal Taxes, 6th edition, 774.)

The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its stockholders upon dissolution. (Klein, Federal Income Taxation, 253-254.)

But it is contended by plaintiffs that as of August 4, 1937, the Hongkong Company "had taken no steps toward dissolution or liquidation and still retained on hand liquid assets in excess of its capitalization." They also assert that it was only on August 19, 1937, that said company took the first corporate steps toward liquidation (Appellant's Brief, pp. 9-10). The fact, however, is that since July 22, 1937, when the formal deed of sale of all the properties, assets, and business of the Hongkong Company to the Manila Company was made, it was expressly stipulated that the sale or transfer shall take effect as of June 1, 1937. As already indicated, the transfer of what was sold, like the sale itself, was,

by the mutual agreement of the parties, considered as made on and from that date, and that, if thereafter and until final completion of the transfer, the Hongkong Company continued to run the business, it did so in trust for the new owner, the Manila Company. In the case of Canal-Commercial T. & S. Bk. vs. Comm'r (63 Fed. [2d], 619, 620) it was held that:

. . . The determining element therefore is whether the distribution was in the ordinary course of business and with intent to maintain the corporation as a going concern, or after deciding to quit with intent to liquidate the business. Proceedings actually begun to dissolve the corporation or formal action taken to liquidate it are but evidentiary and not indispensable. Tootle vs. Commissioner (C.C.A. 58 F. [2d, 576.) The fact that the distribution is wholly from surplus and not from capital, and therefore lawful as a dividend is only evidence. In Hellmich vs. Hellman, and Tootle vs. Commissioner, supra, the distribution was wholly from profits yet held to be one in liquidation . . . (Emphasis Supplied.)

In the case at bar, when in the deed of July 22, 1937, by authority of its stockholders, the Hongkong Company thru its authorized representative declared and agreed that the aforesaid sale and transfer shall take effect as of June 1, 1937, and distribution from its assets to those same stockholders made after June 1, 1937, altho before July 22, 1937, must have been considered by them as liquidating dividends; for how could they consistently deem all the business and assets of the corporation sold as of June 1, 1937, and still say that said corporation, as a going concern, distributed ordinary dividends to them thereafter?

In Holmby Corporation vs. Comm'r (83 Fed. [2d], 548-550), the court said:

. . . the fact that the distributions were called "dividends" and were made, in part, from earnings and profits, and that some of them were made before liquidation or dissolution proceedings were commenced, is not controlling. . . . The determining element is whether the distributions were in the ordinary course of business and with intent to maintain the corporation as a going concern, or after deciding to quit and with intent to liquidate the business . . .. (Emphasis supplied.)

The directors or representatives of the Hongkong Company or the Manila Company, or both, could of course not convert into ordinary dividends what in law and in reality were not such. As aptly stated by Chief Justice Shaw in Comm. vs. Hunt (38 Am. Dec., 354-355),

The law is not to be hoodwinked by colorable pretenses. It looks at truth and reality through whatever disguise they may assume.

The amounts thus distributed among the plaintiffs were not in the nature of a recurring return on stock — in fact, they surrendered and relinquished their stock in return for said distributions, thus ceasing to be stockholders of the Hongkong Company, which in turn ceased to exist in its own right as a going concern during its more or less brief administration of the business as trustee for the Manila Company, and finally disappeared even as such trustee.

The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock it is an ordinary dividend. However, if the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as in complete or

partial liquidation and as payment by the corporation to the stockholder for his stock. The corporation is, in the latter instances, wiping out all parts of the stockholders' interest in the company . . .. (Montgomery, Federal Income Tax Handbook [1938-1939], 258; emphasis supplied.)

It is our considered opinion that we are not dealing here with "the legal right of a taxpayer to decrease the amount of what otherwise will be his taxes, or altogether avoid them, by means which the law permits" (St. Louis Union Co. vs. U.S., 82 Fed. [2d], 61), but with a situation where we have to apply in favor of the government the principle that the "liability for taxes cannot be evaded by a transaction constituting a colorable subterfuge" (61 C.J., 173), it being clear that the distributions under consideration were not ordinary dividends and were taxable in the manner, form and amounts decreed by the court below.

2. The second assignment of error. — In disposing of the first assignment of error, we held that the distributions in the instant case were not ordinary dividends but payments for surrendered or relinquished stock in a corporation in complete liquidation, sometimes called liquidating dividends. The question is whether such amounts were taxable income. The Income Tax Law, Act No. 2833 section 25 (a), as amended by section 4 of Act. No. 3761, inter alia stipulated:

Where a corporation, partnership, association, joint-account, or insurance company distributes all of its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether individual or corporation, is a taxable income or a deductible loss as the case may be. (Emphasis supplied.)

Partial source of the foregoing provision was section 201 (c) of the U.S. Revenue Act of 1918, approved February 24, 1919, providing:

Amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for the stock or share, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits.

It is a familiar rule of statutory construction that the judicial construction attached to the sources of statutes adopted in a jurisdiction are of authoritative value in the interpretation of such local laws. The Supreme Court of the United States has had occasion to construe certain pertinent parts of the Federal Revenue Act above-mentioned on February 20, 1928, when it decided the case of Hellmich vs. Hellman (276 U.S., 233; 72 Law. ed., 544). The case involved the recovery of additional income taxes assessed against the plaintiffs under protest. And its determination hinged around the construction of parts of said act after which those of our own law now under discussion were patterned. Justice Sanford said:

The question here is whether the gains realized by stockholders from the amounts distributed in the liquidation of the assets of a dissolved corporation, out of its earnings or profits accumulated since February 28, 1913, were taxable to them as other "gains or profits", or whether the amounts so distributed were "dividends" exempt from the normal tax.

Section 201 (a) of the act defined the term "dividend" as "any distribution made by a corporation . . . to its shareholders . . . whether in cash or in other property .. out of its earnings or profits accumulated since February 28, 1913 . . .." Section 201 (c) provided that "amounts distributed in the liquidation of a corporation shall be

treated as payments in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits."

Our law at the time of the transactions in question, in providing that where a corporation, etc. distributes all its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder is a taxable income or a deductible loss as the case may be, in effect treated such distributions as payments in exchange for the stock or share. Thus, in making the deficiency assessments under consideration, the Collector, among other items, made proper deduction of the "value of shares" or "cost of shares" in the case of each individual plaintiff, assessing the tax only on the resulting "profit realized" (Stipulation, par. VII, Record on Appeal, pp. 22-25); and of course in case the value or cost of the shares should exceed the distribution received by the stockholder, the resulting difference will be treated as a "deductible loss."

In the same case the Supreme Court of the United States made the following quotation, which is here relevant, from Treasury Regulations 45, article 1548:

. . . So-called liquidation or dissolution dividends are not dividends within the meaning of the statute, and amounts so distributed, whether or not including any surplus earned since February 28, 1913, are to be regarded as payments for the stock of the dissolved corporation. Any excess so received over the cost of his stock to the stockholder, or over its fair market value as of March 1, 1913, if acquired prior thereto, is a taxable profit. A distribution in liquidation of the assets and business of a corporation, which is a return to the stockholders of the value of his stock upon a surrender of his interest in the corporation, is distinguishable from a dividend paid by a

going corporation out of current earnings or accumulated surplus when declared by the directors in their discretion, which is in the nature of a recurrent return upon the stock. (72 Law. ed., 546.)

The Income Tax Law of the Philippines in force at the time defined the term "dividend" in section 25 (a), as amended, as "any distribution made by a corporation . . . out of its earnings or profits accumulated since March 1, 1913, and payable to its shareholders whether in cash or other property." This definition is substantially the same as that given to the same term by the U.S. Revenue Act of 1918 quoted by Justice Sanford in the passage above inserted.

Plaintiffs contend that defendant's position would result in double taxation. A similar contention has been adversely disposed of against the taxpayer in the Hellmich case in these words:

The gains realized by the stockholders from the distribution of the assets in liquidation were subject to the normal tax in like manner as if they had sold their stock to third persons. The objection that this results in double taxation of the accumulated earnings and profits is no more available in the one case than it would have been in the other. See Merchants' Loan & T. Co. vs. Smietanki, 255 U.S., 509; 65 Law. ed., 751; 15 A.L.R., 1305; 41 Sup. Ct. Rep., 386; Goodrich vs. Edwards, 255 U.S. 527; 65 Law. ed., 758; 41 Sup. Ct. Rep., 390. When, as here, Congress clearly expressed its intention, the statute must be sustained even though double taxation results. See Patton vs. Brady , 184 U.S., 608; 46 Law ed., 713; 22 Sup. Ct. Rep., 493; Cream of Wheat Co. vs. Grand Forks County, 253 U.S., 325, 330; 64 Law. ed., 931, 934; 40 Sup. Ct. Rep., 558. (Hellmich vs. Hellman, supra; 72 Law. ed., 547.)

It should be borne in mind that plaintiffs received the distributions in question in exchange for the surrender and relinquishment by them of their stock in the Hongkong Company which was dissolved and in process of complete

liquidation. That money in the hands of the corporation formed a part of its income and was properly taxable to it under the then existing Income Tax Law. When the corporation was dissolved and in process of complete liquidation and its shareholders surrendered their stock to it and it paid the sums in question to them in exchange, a transaction took place, which was no different in its essence from a sale of the same stock to a third party who paid therefor. In either case the shareholder who received the consideration for the stock earned that much money as income of his own, which again was properly taxable to him under the same Income Tax Law. In the case of the sale to a third person, it is not perceived how the objection of double taxation could have been successfully raised. Neither can we conceive how it could be available where, as in this case, the stock was transferred back to the dissolved corporation.

3. The third assignment of error. — In view of what has been said in our consideration of the second assignment of error, the third can be briefly disposed of. Having held that the distributions involved herein were not ordinary dividends but payments for stock surrendered and relinquished by the shareholders to the dissolved corporation, or so-called liquidating dividends, we have the road clear to declaring that under section 25 (a) of the former Income Tax Law, as amended, said distributions were taxable alike to Wise and Co., Inc. and to the other plaintiffs. We hold that both the proviso of section 10 (a) of said Income Tax Law and section 198 of Regulations No. 81 refer to ordinary dividends, not to distributions made in complete liquidation or dissolution of a corporation which result in the realization of a gain as specifically contemplated in section 25 (a) of the same law, as amended, which as aforesaid expressly provides for the taxability of such gain as income, whether the stockholder happens to be an individual or a corporation. By analogy, we can cite the following additional passages from the Hellmich case:

The controlling question is whether the amounts distributed to the stockholders out of the earnings and profits accumulated by the corporation since February 28, 1913, were to be treated under section 201 (a) as "dividends," which were exempt from the normal tax; or under section 201 (c) as payments made by the corporation in exchange for its stock, which were taxable "as other gains or profits.

It is true that if section 201 (a) stood alone its broad definition of the term "dividend" would apparently include distributions made to stockholders in the liquidation of a corporation — although this term, as generally understood and used, refers to the recurrent return upon stock paid to stockholders by a going corporation in the ordinary course of business, which does not reduce their stockholdings and leaves them in a position to enjoy future returns upon the same stock. (See Lynch vs. Hornby, 247 U.S., 339, 344-346; and Langstaff vs. Lucas [D. C.], 9 Fed. [2d], 691, 694.)

However, when section 201 (a) and section 201 (c) are read together, under the long-established rule that the intention of the lawmakers is to be deduced from a view of every material part of the statute (Kohlsaat vs. Murphy, 96 U.S., 153, 159; 24 Law. ed., 846), we think it clear that the general definition of a dividend in section 201 (a) was not intended to apply to distributions made to stockholders in the liquidation of a corporation, but that it was intended that such distributions should be governed by section 201 (c), which, dealing specifically with such liquidation, provided that the amounts distributed should "be treated as payments in exchange for stock," and that any gain realized thereby should be taxed to the stockholders "as other gains or profits." This brings the two sections into entire harmony and gives to each its natural meaning and due effect. . . . (Hellmich vs. Hellman, supra; emphasis supplied.)

4. The fourth assignment of error. — Under this assignment it is contended by the non-resident individual stockholder appellants that they were not subject to the normal tax as regards the distributions received by them and involved in the instant case. They "reported these distributions as dividends from profits on which Philippine income tax had been paid . . .." (Appellants' brief, p. 21.) They assert that the distributions were subject only to the additional tax; whereas the Collector contends that they were subject to both the normal and the additional tax. After what has been said above, it hardly needs stating that the manner and form of reporting these distributions employed by said appellants could not, under the Law, change their real nature as payments for surrendered stock, or so-called liquidating dividends, provided for in section 25 (a) of the then Income Tax Law. Such distributions under the law were subject to both the normal and the additional tax provided for.

. . . Loosely speaking, the distribution to the stockholders of a corporation's assets, upon liquidation, might be termed a dividend; but this is not what is generally meant and understood by that word. As generally understood and used, a dividend is a return upon the stock of its stockholders, paid to them by a going corporation without reducing their stockholdings, leaving them in a position to enjoy future returns upon the same stock . . .. In other words, it is earnings paid to him by the corporation upon his invested capital therein, without wiping out his capital. On the other hand, when a solvent corporation dissolves and liquidates, it distributes to its stockholders not only any earnings it may have on hand, but it also pays to them their invested capital, namely, the amount which they had paid in for their stocks, thus wiping out their interest in the company . . .. (Langstaff vs. Lucas, 9 Fed. [2d], 691, 694.)

5. The fifth assignment of error. — This assignment is made in behalf of those appellants who were non-resident alien individuals, and for them it is in effect said that if the distributions received by them were to be considered as a sale of their stock to the Hongkong Company, the profit realized by them does not constitute income from Philippine sources and is not subject to Philippine taxes, "since all steps in the carrying out of this so-called sale took place outside the Philippines." (Appellants' brief, p. 26.) We do not think this contention is tenable under the facts and circumstances of record. The Hongkong Company was at the time of the sale of its business in the Philippines, and the Manila Company was a domestic corporation domiciled and doing business also in the Philippines. Schedule A of the Stipulation of Facts (Record on Appeal, p. 13) declares, among other things, that the Hongkong Company was incorporated for the purpose of carrying on in the Philippine Islands the business of wine, beer, and spirit merchants and the other objects set out in its memorandum of association. Hence, its earnings, profits, and assets, including those from whose proceeds the distributions in question were made, the major part of which consisted in the purchase price of the business, had been earned and acquired in the Philippines. From aught that appears in the record it is clear that said distributions were income "from Philippine sources."

6. The sixth assignment of error. — Section 199 of Regulations No. 81, deleting immaterial parts, reads:

SEC. 199. Distributions in liquidation. — In all cases where a corporation . . . distributes all of its property or assets in complete liquidation or dissolution, the gain realized from the transaction by the stockholder . . . is taxable as a dividend to the extent that it is paid out of earnings or profits of the corporation . . .. If the amount received by the stockholder in liquidation is less than the cost or other basis of the stock, a deductible loss is sustained.

This regulation would seem to support the contention that the distributions in question, at least those proceeding from sources other than the earnings or profits of the dissolved corporation, were not taxable. Placing the above-quoted section of Regulations No. 81 side by side with section 25 (a) of the amended Income Tax Law then in force, we notice that while the regulation limits the taxability of the gain realized by the stockholder "to the extent that it is paid out of earnings or profits of the corporation, "section 25 (a) of the law, far from so limiting its taxability, provides that the gain thus realized, is a "taxable income" — under the law so long as a gain is realized, it will be taxable income whether the distribution comes from the earnings or profits of the corporation or from the sale of all of its assets in general, so long as the distribution is made "in complete liquidation or dissolution". The regulation makes the gain taxable as a dividend, while the law makes it a taxable income. An inevitable conflict between the two provisions seems to exist, and in such a case, of course, the law prevails.

Treasury Department cannot impose or exempt from income taxes, and regulations purporting to exempt from taxation income specifically taxes would be void.

x x x x x x x x x

Any erroneous interpretation of revenue act by regulation of Treasury Department would not estop government from asserting tax on income, though taxpayer had been misled by such interpretation, and by it induced to expose property to taxation. (Langstaff vs. Lucas, 9 Fed. [2d], 691.)

7 and 8. The seventh and eight assignments of error. — In view of what has been said above, these two assignments need no separate treatment.

For the foregoing consideration, the judgment appealed from will be affirmed with the costs of both instances against the appellants. So ordered.

Moran, C.J., Paras, Feria, Pablo, Perfecto, Bengzon, Briones, Hontiveros, Padilla, and Tuason, JJ., concur.

——————

RESOLUTION ON MOTION FOR RECONSIDERATION

July 28, 1947

HILADO, J.:

Plaintiffs and appellants have filed a motion for reconsideration dated July 10, 1947. After carefully considering said motion, which makes particular reference to appellants' fifth assignment of error, the Court does not consider the arguments therein adduced tenable. Stripped to their bare essentials, the movants' contentions are summarized in the following propositions found on pages 3-4 of their motto, to wit:

Since appellants J.F. MacGregor, N.C. MacGregor, C.J. Lafrentz, E.M.G. Strickland, and Mrs. M.J.G. Mullins were all non-resident aliens and since the court has held that the transaction in this case amounted to a sale or exchange of their shares in a foreign corporation, which sale or exchange took place entirely outside of the Philippine Islands, it follows that they have not derived income from the Philippine sources and are not subject to the taxes which have been collected from them by defendant.

x x x x x x x x x

. . . On the other hand if the income results from the sale or exchange of the shares in question then the non-resident alien stockholders who converted their shares abroad have received no income from Philippine sources and are not subject to any tax whatsoever on their profits from the transaction.

Leaving aside the other portions of the above-quoted propositions as sufficiently covered in the court's decision, let us direct attention to those parts thereof wherein it is pretended that the transaction took place "entirely outside the Philippine Islands" or "abroad."

In the minutes, Schedule B of the stipulation of facts (Rec. on Appeal, pp. 16-17), it appears that on July 22, 1937, an extraordinary meeting of shareholders of the Manila Wine Merchants, Ltd. was held and in said meeting, among other things, it was resolved that the Directors of said company "be authorized and instructed to declare and pay in the form of dividend to the shareholders the amount of any surplus existing after the above-referred to sale has been consummated. This surplus, after providing for return of capital and necessary expense, as shown in the Balance Sheet prepared as of June 1, 1937, after giving effect to the sale transaction above-referred to, amounts to approximately P270,000." While Schedule B does not state the place where the meeting was held, Schedule B-1 of the same stipulation of facts (Record on Appeal, pp. 17-18) furnishes us the information that it was held in Manila. Schedule B-1 in this connection says:

Sale of Company: In accordance with resolution passed at an Extraordinary Meeting of Shareholders held in Manila (underscoring supplied) on July 22, 1937, at 3 o'clock, the Directors of the Manila Wine Merchants Ltd.,

were authorized to sell the Company as a going concern in accordance with sale agreement presented at the Meeting.

Later in the same Schedule B-1 we find that the declaration of dividends authorized in the previous meeting, as stated in the minutes Schedule B, was made by the Board of Directors of the same Manila Wine Merchants, Ltd., of whose meeting on that same date, July 22, 1937, Schedule B-1 constitutes the minutes. The pertinent parts to the minutes of said meeting read as follows:

Dividend: The second matter before the Meeting was the question of declaring a dividend to enable a distribution in cash to be made, the dividend to be the entire amount standing at surplus after providing for return of capital and various expenses in accordance with reconstructed balance sheet as at June 1, 1937 presented by our auditors.

x x x x x x x x x

Resolved that as after the Manila Wine Merchants Ltd. has been sold for the stipulated sum of P400,000 and money received, there will be after providing for return of capital, payment of income tax and other charges, a sum of approximately P270,000 standing at surplus account, a dividend is now hereby declared in amount covering the entire balance remaining at surplus account after the concern has been wound up, and we hereby authorize the distribution of P265,000 as and when funds are available, any balance remaining to be distributed when final Liquidator's account has been rendered and paid."

Again, while the minutes Schedule B-1 do not reveal the place where that board meeting was held, the fact stated therein that it was held on July 22,1937, the self-same date of the extraordinary meeting of shareholders referred to in the minutes Schedule B, at 3 o'clock (presumably p.m.), as recorded in Schedule B-1, clearly shows that the said board meeting was held also in Manila, and not in Hongkong or elsewhere abroad, for J.F. Macgregor and E. Heybrook, both of whom appear in both Schedules B and B-1 to have participated in both meetings, could not, so far as the record discloses, very well be in Manila and Hongkong or elsewhere abroad on that same date. There is no showing, nor is it even pretended that these two gentlemen after the meeting held in Manila on July 22, 1937, at 3 o'clock, took an airplane or other mode of conveyance, as fast or faster, and hurried to Hongkong or elsewhere abroad and attended the other meeting that very same day. Indeed, that both meetings must have been held in Manila would seem to be the only natural and logical supposition from the fact that the Manila Wine Merchants, Ltd., was admittedly conducting its business in said city and the Philippines in general (Schedule A, Rec. on Appeal, p. 13). It seems clear, therefore, that the dividends in question were declared in the Philippine Islands.

What was the legal effect of that declaration? Paragraph V of the stipulation of facts (Rec. on Appeal, pp. 20-21) states that, pursuant to these resolutions, "the Hongkong Company (the same Manila Wine Merchants, Ltd.) distributed this surplus to its stockholders, plaintiffs receiving (underscoring supplied) the following sums on the following dates" (then follow plaintiffs' names with the respective amounts in Philippine pesos received by them on the dates stated). It is not stated that they received their dividends in Hongkong or other foreign money. And in their own brief (p. 25) they say that the payments or distributions thus received by them, as a result of the liquidation and sale of said company, "were included as gross income in their Philippine income tax returns". This fact further tends to show that those payments or distributions were received in the Philippine Islands, either by plaintiffs personally or through their

proxies or agents. Besides, in paragraph V of the stipulation of facts (Rec. on Appeal, p. 21) it appears that the dividends or distributions pertaining to these individual plaintiffs as well as that pertaining to their co-plaintiff Wise and Co., Inc., were paid on the same dates, namely, August 24, 1937, and October 28, 1937; and it being undisputed that Wise and Co., Inc. was domiciled and had its principal office in Manila (complaint, par. I, Rec. on Appeal, p.2), in which city it was presumably paid, it would seem obvious that the concomitant payments thus made to the other plaintiffs were likewise effected in the same place, whether the individual plaintiffs acted personally or through proxies or agents. It should also be remembered that while the "registered office" of the Manila Wine Merchants, Ltd. was situated in the colony of Hongkong (Schedule A, Rec. on Appeal, p. 13), the fact is that the only business for which it was incorporated was the wine, beer, and spirit business, which had been and was being conducted exclusively within the Philippine Islands, and from the record we deduce that it had also office in Manila where, so far as the record discloses, the payments were made. Finally, the fact that payment was made in Philippine pesos would strongly corroborate the conclusion that it was made in this country — if it had been made in Hongkong or elsewhere abroad, the reasonable assumption is that it would have been made in Hongkong dollars or in the currency of such other place abroad.

. . . However, where a corporation has not only declared a dividend but has specifically appropriated and set apart from its other assets a fund out of which the dividend is to be paid, such action constitutes the assets to set apart a trust fund in the hands of the corporation for the payment of the stockholders to the exclusion of other creditors. . . . (18 C.J.S., p. 1115; emphasis supplied.)

As between successive owners of shares of stock in a corporation, the general rule is that dividends belong to the persons who are the owners of the stock at the time they are declared, without regard to the time during which the dividends were earned, and this is true although the dividends are made payable at a future date. (18 C.J.S., 119, sec. 470 [a]; emphasis supplied.)

There is no controversy about the legal proposition that dividends declared belong to the owner of the stock at the time the dividend is declared. (Livingstone County Bank vs. First State Bank, 136 Ky., 546, 554, cited in footnote 36, p. 818, 14 C.J.; emphasis supplied.)

The moment the dividend is declared, it becomes then separate and distinct from the stock and the dividend falls to him who is proprietor of the stock of which it was theretofore incident.

The doctrine is that a dividend is considered parcel of the mass of corporate property until declared and therefore incident to and parcel of the stock up to the time it is declared; and before its declaration, will pass with the sale or devise of the stock. Whosoever owns the stock prior to the declaration of a dividend, owns the dividend also. (McLaren vs. Crescent Planning Mill Co., 117 Mo. A., 40, 47, cited in note 36, p. 818, 14 C.J.; emphasis supplied.)

In De Koven vs. Alsop (205 Ill., 309; 63 L.R.A., 587), the court said:

A dividend is defined as "a corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time. Until the dividend is declared, these corporate profits belong to the corporation, not to the stockholders, and are liable for corporate indebtedness." (Emphasis supplied.)

We are fully satisfied from the facts and data furnished here by the parties themselves that the dividends in question were paid to plaintiffs, personally or thru their proxies or agents, in the Philippines. But aside from this, from the moment they were declared and a definite fund specified for their payment (all surplus remaining "after providing for return of capital and various expenses") — and all of this was done in the Philippines — to all legal intents and purposes they earned those dividends in this country. From the record we deduce that the funds and assets of the Manila Wine Merchants, Ltd., from which those dividends proceeded, were in the Philippines where its business was located. So far as the record discloses, its liquidation was effected in terms of Philippine pesos, indicating that it was made here. And this in turn would lead to the deduction that the funds and assets liquidated were here.

G.R. No. 178788 September 29, 2010

UNITED AIRLINES, INC., Petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, Respondent.

D E C I S I O N

VILLARAMA, JR., J.:

Before us is a petition for review on certiorari under Rule 45 of the 1997 Rules of Civil Procedure, as amended, of the Decision1 dated July 5, 2007 of the Court of Tax Appeals En Banc (CTA En Banc) in C.T.A. EB No. 227 denying petitioner’s claim for tax refund of P5.03 million.

The undisputed facts are as follows:

Petitioner United Airlines, Inc. is a foreign corporation organized and existing under the laws of the State of Delaware, U.S.A., engaged in the international airline business.

Petitioner used to be an online international carrier of passenger and cargo, i.e., it used to operate passenger and cargo flights originating in the Philippines. Upon cessation of its passenger flights in and out of the Philippines beginning February 21, 1998, petitioner appointed a sales agent in the Philippines -- Aerotel Ltd. Corp., an independent general

http://www.lawphil.net/judjuris/juri2010/sep2010/gr_178788_2010.html#fnt1

sales agent acting as such for several international airline companies.2 Petitioner continued operating cargo flights from the Philippines until January 31, 2001.3

On April 12, 2002, petitioner filed with respondent Commissioner a claim for income tax refund, pursuant to Section 28(A)(3)(a)4 of the National Internal Revenue Code of 1997 (NIRC) in relation to Article 4(7)5 of the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with respect to Income Taxes (RP-US Tax Treaty). Petitioner sought to refund the total amount of P15,916,680.69 pertaining to income taxes paid on gross passenger and cargo revenues for the taxable years 1999 to 2001, which included the amount of P5,028,813.23 allegedly representing income taxes paid in 1999 on passenger revenue from tickets sold in the Philippines, the uplifts of which did not originate in the Philippines. Citing the change in definition of Gross Philippine Billings (GPB) in the NIRC, petitioner argued that since it no longer operated passenger flights originating from the Philippines beginning February 21, 1998, its passenger revenue for 1999, 2000 and 2001 cannot be considered as income from sources within the Philippines, and hence should not be subject to Philippine income tax under Article 96 of the RP-US Tax Treaty.7

As no resolution on its claim for refund had yet been made by the respondent and in view of the two (2)-year prescriptive period (from the time of filing the Final Adjustment Return for the taxable year 1999) which was about to expire on April 15, 2002, petitioner filed on said date a petition for review with the Court of Tax Appeals (CTA).8

Petitioner asserted that under the new definition of GPB under the 1997 NIRC and Article 4(7) of the RP-US Tax Treaty, Philippine tax authorities have jurisdiction to tax only the gross revenue derived by US air and shipping carriers








from outgoing traffic in the Philippines. Since the Bureau of Internal Revenue (BIR) erroneously imposed and collected income tax in 1999 based on petitioner’s gross passenger revenue, as beginning 1998 petitioner no longer flew passenger flights to and from the Philippines, petitioner is entitled to a refund of such erroneously collected income tax in the amount of P5,028,813.23.9

In its Decision10 dated May 18, 2006, the CTA’s First Division11 ruled that no excess or erroneously paid tax may be refunded to petitioner because the income tax on GPB under Section 28(A)(3)(a) of the NIRC applies as well to gross revenue from carriage of cargoes originating from the Philippines. It agreed that petitioner cannot be taxed on its 1999 passenger revenue from flights originating outside the Philippines. However, in reporting a cargo revenue of P740.33 million in 1999, it was found that petitioner deducted two (2) items from its gross cargo revenue of P2.84 billion: P141.79 million as commission and P1.98 billion as other incentives of its agent. These deductions were erroneous because the gross revenue referred to in Section 28(A)(3)(a) of the NIRC was total revenue before any deduction of commission and incentives. Petitioner’s gross cargo revenue in 1999, being P2.84 billion, the GPB tax thereon was P42.54 million and not P11.1 million, the amount petitioner paid for the reported net cargo revenue of P740.33 million. The CTA First Division further noted that petitioner even underpaid its taxes on cargo revenue by P31.43 million, which amount was much higher than the P5.03 million it asked to be refunded.

A motion for reconsideration was filed by petitioner but the First Division denied the same. It held that petitioner’s claim for tax refund was not offset with its tax liability; that petitioner’s tax deficiency was due to erroneous deductions from its gross cargo revenue; that it did not make an assessment against petitioner; and that it merely determined if




petitioner was entitled to a refund based on the undisputed facts and whether petitioner had paid the correct amount of tax.12

Petitioner elevated the case to the CTA En Banc which affirmed the decision of the First Division.

Hence, this petition anchored on the following grounds:

I. THE CTA EN BANC GROSSLY ERRED IN DENYING THE PETITIONER’S CLAIM FOR REFUND OF ERRONEOUSLY PAID INCOME TAX ON GROSS PHILIPPINE BILLINGS [GPB] BASED ON ITS FINDING THAT PETITIONER’S UNDERPAYMENT OF [P31.43 MILLION] GPB TAX ON CARGO REVENUES IS A LOT HIGHER THAN THE GPB TAX OF [P5.03 MILLION] ON PASSENGER REVENUES, WHICH IS THE SUBJECT OF THE INSTANT CLAIM FOR REFUND. THE DENIAL OF PETITIONER’S CLAIM ON SUCH GROUND CLEARLY AMOUNTS TO AN OFF-SETTING OF TAX LIABILITIES, CONTRARY TO WELL-SETTLED JURISPRUDENCE.

II. THE DECISION OF THE CTA EN BANC VIOLATED PETITIONER’S RIGHT TO DUE PROCESS.

III. THE CTA EN BANC ACTED IN EXCESS OF ITS JURISDICTION BY DENYING PETITIONER’S CLAIM FOR REFUND OF ERRONEOUSLY PAID INCOME TAX ON GROSS PHILIPPINE BILLINGS BASED ON ITS FINDING THAT PETITIONER UNDERPAID GPB TAX ON CARGO REVENUES IN THE AMOUNT OF [P31.43 MILLION] FOR THE TAXABLE YEAR 1999.


IV. THE CTA EN BANC HAS NO AUTHORITY UNDER THE LAW TO MAKE ANY ASSESSMENTS FOR DEFICIENCY TAXES. THE AUTHORITY TO MAKE ASSESSMENTS FOR DEFICIENCY NATIONAL INTERNAL REVENUE TAXES IS VESTED BY THE 1997 NIRC UPON RESPONDENT.

V. ANY ASSESSMENT AGAINST PETITIONER FOR DEFICIENCY INCOME TAX FOR THE TAXABLE YEAR 1999 IS ALREADY BARRED BY PRESCRIPTION.13

The main issue to be resolved is whether the petitioner is entitled to a refund of the amount of P5,028,813.23 it paid as income tax on its passenger revenues in 1999.

Petitioner argues that its claim for refund of erroneously paid GPB tax on off-line passenger revenues cannot be denied based on the finding of the CTA that petitioner allegedly underpaid the GPB tax on cargo revenues by P31,431,171.09, which underpayment is allegedly higher than the GPB tax of P5,028,813.23 on passenger revenues, the amount of the instant claim. The denial of petitioner’s claim for refund on such ground is tantamount to an offsetting of petitioner’s claim for refund of erroneously paid GPB against its alleged tax liability. Petitioner thus cites the well-entrenched rule in taxation cases that internal revenue taxes cannot be the subject of set-off or compensation.14

According to petitioner, the offsetting of the liabilities is very clear in the instant case because the amount of petitioner’s claim for refund of erroneously paid GPB tax of P5,028,813.23 for the taxable year 1999 is being offset against petitioner’s alleged deficiency GPB tax liability on cargo revenues for the same year, which was not even the subject of an investigation nor any valid assessment issued by respondent against the petitioner. Under Section 22815 of the NIRC, the "taxpayer shall be informed in writing of the law and the facts on which the assessment is made;




otherwise, the assessment shall be void." This administrative process of issuing an assessment is part of procedural due process enshrined in the 1987 Constitution. Records do not show that petitioner has been assessed by the BIR for any deficiency GBP tax for 1999, nor was there any finding or investigation being conducted by respondent of any liability of petitioner for GPB tax for the said taxable period. Clearly, petitioner’s right to due process was violated.16

Petitioner further argues that the CTA acted in excess of its jurisdiction because the exclusive appellate jurisdiction of the CTA covers only decisions or inactions of the respondent in cases involving disputed assessments. The CTA has effectively assessed petitioner with a P31.43 million tax deficiency when it concluded that petitioner underpaid its GPB tax on cargo revenue. Since respondent did not issue an assessment for any deficiency tax, the alleged deficiency tax on its cargo revenue in 1999 cannot be considered a disputed assessment that may be passed upon by the CTA. Petitioner stresses that the authority to issue an assessment for deficiency internal revenue taxes is vested by law on respondent, not with the CTA.17

Lastly, petitioner argues that any assessment against it for deficiency income tax for taxable year 1999 is barred by prescription. Petitioner claims that the prescriptive period within which an assessment for deficiency income tax may be made has prescribed on April 17, 2003, three (3) years after it filed its 1999 tax return.18

Respondent Commissioner maintains that the CTA acted within its jurisdiction in denying petitioner’s claim for tax refund. It points out that the objective of the CTA’s determination of whether petitioner correctly paid its GPB tax for the taxable year 1999 was to ascertain the latter’s entitlement to the claimed refund and not for the purpose of imposing




any deficiency tax. Hence, petitioner’s arguments regarding the propriety of the CTA’s determination of its deficiency tax on its GPB for gross cargo revenues for 1999 are clearly misplaced.19

The petition has no merit.

As correctly pointed out by petitioner, inasmuch as it ceased operating passenger flights to or from the Philippines in 1998, it is not taxable under Section 28(A)(3)(a) of the NIRC for gross passenger revenues. This much was also found by the CTA. In South African Airways v. Commissioner of Internal Revenue,20 we ruled that the correct interpretation of the said provisions is that, if an international air carrier maintains flights to and from the Philippines, it shall be taxed at the rate of 2½% of its GPB, while international air carriers that do not have flights to and from the Philippines but nonetheless earn income from other activities in the country will be taxed at the rate of 32% of such income.

Here, the subject of claim for tax refund is the tax paid on passenger revenue for taxable year 1999 at the time when petitioner was still operating cargo flights originating from the Philippines although it had ceased passenger flight operations. The CTA found that petitioner had underpaid its GPB tax for 1999 because petitioner had made deductions from its gross cargo revenues in the income tax return it filed for the taxable year 1999, the amount of underpayment even greater than the refund sought for erroneously paid GPB tax on passenger revenues for the same taxable period. Hence, the CTA ruled petitioner is not entitled to a tax refund.

Petitioner’s arguments regarding the propriety of such determination by the CTA are misplaced.



Under Section 72 of the NIRC, the CTA can make a valid finding that petitioner made erroneous deductions on its gross cargo revenue; that because of the erroneous deductions, petitioner reported a lower cargo revenue and paid a lower income tax thereon; and that petitioner's underpayment of the income tax on cargo revenue is even higher than the income tax it paid on passenger revenue subject of the claim for refund, such that the refund cannot be granted.

Section 72 of the NIRC reads:

SEC. 72. Suit to Recover Tax Based on False or Fraudulent Returns. - When an assessment is made in case of any list, statement or return, which in the opinion of the Commissioner was false or fraudulent or contained any understatement or undervaluation, no tax collected under such assessment shall be recovered by any suit, unless it is proved that the said list, statement or return was not false nor fraudulent and did not contain any understatement or undervaluation; but this provision shall not apply to statements or returns made or to be made in good faith regarding annual depreciation of oil or gas wells and mines.

In the afore-cited case of South African Airways, this Court rejected similar arguments on the denial of claim for tax refund, as follows:

Precisely, petitioner questions the offsetting of its payment of the tax under Sec. 28(A)(3)(a) with their liability under Sec. 28(A)(1), considering that there has not yet been any assessment of their obligation under the latter provision. Petitioner argues that such offsetting is in the nature of legal compensation, which cannot be applied under the circumstances present in this case.

Article 1279 of the Civil Code contains the elements of legal compensation, to wit:

Art. 1279. In order that compensation may be proper, it is necessary:

(1) That each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other;

(2) That both debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and also of the same quality if the latter has been stated;

(3) That the two debts be due;

(4) That they be liquidated and demandable;

(5) That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor.

And we ruled in Philex Mining Corporation v. Commissioner of Internal Revenue, thus:

In several instances prior to the instant case, we have already made the pronouncement that taxes cannot be subject to compensation for the simple reason that the government and the taxpayer are not creditors and debtors of each other. There is a material distinction between a tax and debt. Debts are due to the Government in its corporate capacity, while

taxes are due to the Government in its sovereign capacity. We find no cogent reason to deviate from the aforementioned distinction.

Prescinding from this premise, in Francia v. Intermediate Appellate Court, we categorically held that taxes cannot be subject to set-off or compensation, thus:

We have consistently ruled that there can be no off-setting of taxes against the claims that the taxpayer may have against the government. A person cannot refuse to pay a tax on the ground that the government owes him an amount equal to or greater than the tax being collected. The collection of a tax cannot await the results of a lawsuit against the government.

The ruling in Francia has been applied to the subsequent case of Caltex Philippines, Inc. v. Commission on Audit, which reiterated that:

. . . a taxpayer may not offset taxes due from the claims that he may have against the government. Taxes cannot be the subject of compensation because the government and taxpayer are not mutually creditors and debtors of each other and a claim for taxes is not such a debt, demand, contract or judgment as is allowed to be set-off.

Verily, petitioner’s argument is correct that the offsetting of its tax refund with its alleged tax deficiency is unavailing under Art. 1279 of the Civil Code.

Commissioner of Internal Revenue v. Court of Tax Appeals, however, granted the offsetting of a tax refund with a tax deficiency in this wise:

Further, it is also worth noting that the Court of Tax Appeals erred in denying petitioner’s supplemental motion for reconsideration alleging bringing to said court’s attention the existence of the deficiency income and business tax assessment against Citytrust. The fact of such deficiency assessment is intimately related to and inextricably intertwined with the right of respondent bank to claim for a tax refund for the same year. To award such refund despite the existence of that deficiency assessment is an absurdity and a polarity in conceptual effects. Herein private respondent cannot be entitled to refund and at the same time be liable for a tax deficiency assessment for the same year.1avvphi1

The grant of a refund is founded on the assumption that the tax return is valid, that is, the facts stated therein are true and correct. The deficiency assessment, although not yet final, created a doubt as to and constitutes a challenge against the truth and accuracy of the facts stated in said return which, by itself and without unquestionable evidence, cannot be the basis for the grant of the refund.

Section 82, Chapter IX of the National Internal Revenue Code of 1977, which was the applicable law when the claim of Citytrust was filed, provides that "(w)hen an assessment is made in case of any list, statement, or return, which in the opinion of the Commissioner of Internal Revenue was false or fraudulent or contained any understatement or undervaluation, no tax collected under such assessment shall be recovered by any suits unless it is proved that the said list, statement, or return was not false nor fraudulent and did not contain any understatement or undervaluation; but this

provision shall not apply to statements or returns made or to be made in good faith regarding annual depreciation of oil or gas wells and mines."

Moreover, to grant the refund without determination of the proper assessment and the tax due would inevitably result in multiplicity of proceedings or suits. If the deficiency assessment should subsequently be upheld, the Government will be forced to institute anew a proceeding for the recovery of erroneously refunded taxes which recourse must be filed within the prescriptive period of ten years after discovery of the falsity, fraud or omission in the false or fraudulent return involved. This would necessarily require and entail additional efforts and expenses on the part of the Government, impose a burden on and a drain of government funds, and impede or delay the collection of much-needed revenue for governmental operations.

Thus, to avoid multiplicity of suits and unnecessary difficulties or expenses, it is both logically necessary and legally appropriate that the issue of the deficiency tax assessment against Citytrust be resolved jointly with its claim for tax refund, to determine once and for all in a single proceeding the true and correct amount of tax due or refundable.

In fact, as the Court of Tax Appeals itself has heretofore conceded, it would be only just and fair that the taxpayer and the Government alike be given equal opportunities to avail of remedies under the law to defeat each other’s claim and to determine all matters of dispute between them in one single case. It is important to note that in determining whether or not petitioner is entitled to the refund of the amount paid, it would [be] necessary to determine how much the Government is entitled to collect as taxes. This would necessarily include the determination of the correct liability of

the taxpayer and, certainly, a determination of this case would constitute res judicata on both parties as to all the matters subject thereof or necessarily involved therein. (Emphasis supplied.)

Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI of the 1997 NIRC. The above pronouncements are, therefore, still applicable today.

Here, petitioner’s similar tax refund claim assumes that the tax return that it filed was correct. Given, however, the finding of the CTA that petitioner, although not liable under Sec. 28(A)(3)(a) of the 1997 NIRC, is liable under Sec. 28(A)(1), the correctness of the return filed by petitioner is now put in doubt. As such, we cannot grant the prayer for a refund.21 (Additional emphasis supplied.)

In the case at bar, the CTA explained that it merely determined whether petitioner is entitled to a refund based on the facts. On the assumption that petitioner filed a correct return, it had the right to file a claim for refund of GPB tax on passenger revenues it paid in 1999 when it was not operating passenger flights to and from the Philippines. However, upon examination by the CTA, petitioner’s return was found erroneous as it understated its gross cargo revenue for the same taxable year due to deductions of two (2) items consisting of commission and other incentives of its agent. Having underpaid the GPB tax due on its cargo revenues for 1999, petitioner is not entitled to a refund of its GPB tax on its passenger revenue, the amount of the former being even much higher (P31.43 million) than the tax refund sought (P5.2 million). The CTA therefore correctly denied the claim for tax refund after determining the proper assessment and the tax due. Obviously, the matter of prescription raised by petitioner is a non-issue. The prescriptive periods under Sections 20322 and 22223 of the NIRC find no application in this case.




We must emphasize that tax refunds, like tax exemptions, are construed strictly against the taxpayer and liberally in favor of the taxing authority.24 In any event, petitioner has not discharged its burden of proof in establishing the factual basis for its claim for a refund and we find no reason to disturb the ruling of the CTA. It has been a long-standing policy and practice of the Court to respect the conclusions of quasi-judicial agencies such as the CTA, a highly specialized body specifically created for the purpose of reviewing tax cases.25

WHEREFORE, we DENY the petition for lack of merit and AFFIRM the Decision dated July 5, 2007 of the Court of Tax Appeals En Banc in C.T.A. EB No. 227.



G.R. No. 164050 July 20, 2011

MERCURY DRUG CORPORATION, Petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, Respondent.

D E C I S I O N

PEREZ, J.:

This petition for review on certiorari calls for an interpretation of the term "cost" as used in Section 4(a) of Republic Act No. 7432, otherwise known as "An Act to Maximize the Contribution of Senior Citizens to Nation Building, Grant Benefits and Special Privileges and For Other Purposes."

A rundown of the pertinent facts is presented below.

Pursuant to Republic Act No. 7432, petitioner Mercury Drug Corporation (petitioner), a retailer of pharmaceutical products, granted a 20% sales discount to qualified senior citizens on their purchases of medicines. For the taxable year April to December 1993 and January to December 1994, the amounts representing the 20% sales discount totalled P3,719,287.681 and P35,500,593.44,2 respectively, which petitioner claimed as deductions from its gross income.

Realizing that Republic Act No. 7432 allows a tax credit for sales discounts granted to senior citizens, petitioner filed with the Commissioner of Internal Revenue (CIR) claims for refund in the amount of P2,417,536.00 for the year 1993 and P23,075,386.00 for the year 1994. Petitioner presented a computation3 of its overpayment of income tax, thus:

TAXABLE YEAR 1993

SALES, Net P10,228,518,335.00

Add: Cost of 20% Discount to Senior Citizens 3,719,288.00

SALES, Gross P10,232,237,623.00

COST OF SALES

Merchandise Inventory, Beg. P2,427,972,150.00

Purchases 8,717,393,710.00

Goods Available for Sales P11,145,365,860.00

Merchandise Inventory, End 2,458,743,127.00 8,686,622,733.00

GROSS PROFIT P1,545,614,890.00

Add: Miscellaneous Income 58,247,973.00

TOTAL INCOME P1,603,862,863.00

OPERATING EXPENSES 1,226,816,343.00

NET INCOME BEFORE TAX P 377,046,520.00

Less: Income subjected to final income tax 20,966,602.00

NET TAXABLE INCOME P 356,079,918.00

INCOME TAX PAYABLE P 124,627,972.00

LESS: TAX CREDIT

(20% Sales Discount to Senior Citizens)

P 3,719,288.00

TAX ACTUALLY PAID 123,326,220.00 127,045,508.00

TAX REFUNDABLE P 2,417,536.00

x x x x

TAXABLE YEAR 1994

SALES, Net P 11,671,366,402.00

Add: Cost of 20% Sales Discount to Senior Citizens 35,500,594.00

SALES, Gross P11,706,866,996.00

COST OF SALES


Purchases 10,316,941,308.00


Less: Merchandise Inventory, End

2,928,397,228.00 9,847,287,207.00





NET INCOME BEFORE TAX 428,967,008.00

Less: Income subjected to final Income tax 25,591,586.00

NET TAXABLE INCOME P 403, 375,422.00


LESS: TAX CREDIT

(Cost of 20% Discount to Senior Citizens)

P 35,500,594.00



When the CIR failed to act upon petitioner’s claims, the latter filed a petition for review with the Court of Tax Appeals. On 6 September 2000, the Court of Tax Appeals rendered the following judgment:4

WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby PARTIALLY GRANTED. Accordingly, Revenue Regulations No. 2-94 of the Respondent is declared null and void insofar as it treats the 20% discount given by private establishments as a deduction from gross sales. Respondent is hereby ORDERED to GRANT A REFUND OR ISSUE A TAX CREDIT CERTIFICATE to Petitioner in the reduced amount of P1,688,178.43 representing the latter’s overpaid income tax for the taxable year 1993. However, the claim for refund for taxable year 1994 is denied for lack of merit.5

The Court of Tax Appeals favored petitioner by declaring that the 20% sales discount should be treated as tax credit rather than a mere deduction from gross income. The Court of Tax Appeals however found some discrepancies and irregularities in the cash slips submitted by petitioner as basis for the tax refund. Hence, it disallowed the claim for taxable year 1994 and some portion of the amount claimed for 1993 by petitioner, viz:

So, contrary to the allegation of Petitioner that it granted 20% sales discounts to senior citizens in the total amount of P3,719,888.00 for taxable year 1993 and P35,500,554.00 for taxable year 1994, this Court’s study and evaluation of the evidence show that for taxable year 1993 only the amounts of P3,522,123.25 and for 1994, the amount of P8,789,792.27 were properly substantiated. The amount of P3,522,123.25 corresponding to 1993 will be further

reduced to P2,989,930.43 as this Court’s computation is based on the cost of the 20% discount and not on the total amount of the 20% discount based on the decision of the Court of Appeals in Commissioner of Internal Revenue v. Elmas Drug Corporation, CA-SP No. 49946 promulgated on October 19, 1999, where it ruled:

"Thus the cost of the 20% discount represents the actual amount spent by drug corporations in complying with the mandate of RA 7432. Working on this premise, it could not have been the intention of the lawmakers to grant these companies the full amount of the 20% discount as this could be extending to them more than what they actually sacrificed when they gave the 20% discount to senior citizens." (Underscoring supplied).

Similarly the amount of P8,789,792.27 corresponding to taxable year 1994 will be reduced to P7,393,094.28 based on the aforequoted Court of Appeals decision. These reductions are illustrated as follows:

TAXABLE YEAR 1993

Cost of Sales P 8,686,622,733.00

Divided by Gross Sales 10,232,237,623.00

Cost of Sales Percentage 84.89%

Adjusted Amount of 20% 3,522,123.25

Discount given to Senior Citizens

Multiply by 84.89%

Allowable Tax Credit P 2,989,930.43

TAXABLE YEAR 1994

Cost of Sales P9,847,287,207.00



Adjusted Amount of 20% Discount given to Senior Citizens

P 8,789,792.27

Multiply by 84.11%

Allowable Tax Credit P 7,393,094.28

With the foregoing changes in the amount of discounts granted by Petitioner in 1993 and 1994, it necessarily follows that adjustments have to be made in the computation of the refundable amount which is entirely different from the computation presented by the Petitioner. This Court’s conclusion is that Petitioner is only entitled to a tax credit of P1,688,178.43 for taxable year 1993 detailed as follows:

TAXABLE YEAR 1993

1avvphil

Sales, Net P10,228,518,335.00

Add: Cost of 20% Discount given to Senior Citizens 3,719,288.00

SALES, Gross P10,232,237,623.00

COST OF SALES


Add: Purchases 8,717,393,710.00

Total goods available for sale P1,145,365,860.00


2,458,743,127.00 8,686,622,733.00

GROSS PROFIT P 1,545,614,890.00


TOTAL INCOME P 1,603,862,863.00






LESS: TAX CREDIT

(20% Sales Discountgiven to Senior Citizens) P 2,989,930.43



and no refund or tax credit for taxable year 1994 as the computation below shows that Petitioner, instead of having a tax credit of P23,075,386.00 as claimed in the Petition, still has a tax due of P5,032,113.72 detailed as follows:

TAXABLE YEAR 1994

SALES, Net P11,671,366,402.00

Add: Cost of 20% Sales Discountgiven to Senior Citizens 35,500,594.00

SALES, Gross 11,706,866,996.00

COST OF SALES


Add: Purchases 10,316,941,308.00

Total goods available for sale P12,775,684,435.00


2,928,397,228.00 9,847,287,207.00

GROSS PROFIT P 1,859,579,789.00


TOTAL INCOME P 1,928,389,653.00



Less: Income subjected to final income 25,591,586.00

Tax



LESS: TAX CREDIT

(Cost of 20% Discount given to Senior Citizens)

P7,393,094.28


TAX STILL DUE P 5,032,113.72

The conclusion of tax liability instead of tax overpayment pertaining to taxable year 1994 has the effect of negating the tax refund of Petitioner because the basis of such refund is the fact that there is tax credit. Under the circumstances, instead to tax credit, Petitioner has a tax liability of P5,032,113.72, hence the refund for the period must fail.6

Moreover, the Court of Tax Appeals stated that the claim for tax credit must be based on the actual cost of the medicine and not the whole amount of the 20% senior citizens discount. It applied the formula: cost of sales/gross sales x amount of 20% sales discount.

Petitioner moved for partial reconsideration. In a Resolution dated 20 December 2000, the Court of Tax Appeals modified its earlier ruling by increasing the creditable tax amount to P18,038,489.71, inclusive of the taxable years 1993 and 1994. The Court of Tax Appeals finally granted the claim for refund for the taxable year 1994 on the basis of the cash slips submitted by petitioner, in the sum of P16,350,311.28, thus:

TAXABLE YEAR 1994

a) Computation of adjusted amount of 20% discount given to senior citizens:

Sales discount to be considered as basis for disallowance

P35,414,211.68

Less: Disallowances

a) Sales discount without supporting documents

P224,269.15

b) Sales discounts twice recorded 7,462.66

c) Overstatement of sales discount 648,988.28 880,720.09

Adjusted amount of 20% sales discount P34,211,769.45

b) Computation of the allowable tax credit on the 20% sales discount:

Cost of Sales P9,847,287,207.00



Adjusted Amount of 20% discountgiven to Senior Citizens P34,211,769.45

Multiply by 84.11%

P28,775,519.28

c) Computation of the refundable amount:

SALES, Net P11,671,366,402.00

Add: Cost of 20% Sales discount givento Senior Citizens 35,500,594.00

SALES, Gross P11,706,866,996.00

COST OF SALES 9,847,287,207.00

GROSS PROFIT P 1,859,579,789.00


TOTAL INCOME P 1,928,389,653.00






LESS: TAX CREDIT

(Cost of 20% Discount given to Senior Citizens)

P28,775,519.28


AMOUNT REFUNDABLE FORTAXABLE YEAR 1994 P 16,350,311.287

Petitioner elevated the case to the Court of Appeals via a Petition for Review under Rule 43. Petitioner sought a partial modification of the above resolution raising as legal issue the basis of the computation of tax credit. Petitioner contended that the actual discount granted to the senior citizens, rather than the acquisition cost of the item availed by senior citizens, should be the basis for computation of tax credit.

On 20 October 2003, the Court of Appeals rendered a Decision8 sustaining the Court of Tax Appeals and dismissing the petition. Citing the Court of Appeals cases of Commissioner of Internal Revenue v. Elmas Drug Corporation and Trinity Franchising and Management Corp. v. Commissioner of Internal Revenue, the appellate court interpreted the term "cost" as used in Section 4(a) of Republic Act No. 7432 to mean the acquisition cost of the medicines sold to senior citizens. Therefore, it upheld the computation provided by the Court of Tax Appeals in its 20 December 2000 Resolution.

Petitioner filed a motion for partial reconsideration which the Court of Appeals denied in a Resolution9 dated 23 June 2004. This prompted petitioner to file the instant petition for review. Petitioner raises the following legal grounds for the allowance of its petition:

I.

LIMITING THE TAX CREDIT ON THE ACQUISITION COST OF THE MEDICINES SOLD AMOUNTS TO A TAKING OF PROPERTY FOR PUBLIC USE WITHOUT JUST COMPENSATION.

II.

FORCING PETITIONER TO GRANT 20% DISCOUNT ON SALE OF MEDICINE TO SENIOR CITIZENS WITHOUT FULLY REIMBURSING IT FOR THE AMOUNT OF DISCOUNT GRANTED VIOLATES THE DUE PROCESS CLAUSE FOR BEING OPPRESSIVE, UNREASONABLE, CONFISCATORY, AND AN UNDUE RESTRAINT OF TRADE.

III.

EVEN THE COURT OF APPEALS HAD AN INTERPRETATION OF THE TERM "COST" THAT IS DIFFERENT FROM, AND BROADER THAN THE INTERPRETATION OF THE COURT OF TAX APPEALS. YET, THE COURT OF APPEALS AFFIRMED IN TOTO THE COURT OF TAX APPEALS’ DECISION.

IV.

THE COURT MAY CONSIDER THE SPIRIT AND REASON OF THE LAW WHERE A LITERAL MEANING WOULD LEAD TO INJUSTICE OR DEFEAT THE CLEAR INTENT OF THE LAWMAKERS.

V.

RESPONDENT MUST ACCORD PETITIONER THE SAME TREATMENT AS MAR-TESS DRUG IN ACCORDANCE WITH THE PRINCIPLE OF EQUAL PROTECTION OF LAWS.10

Petitioner adopts a two-tiered approach towards defending its thesis. First, petitioner explains that in addition to the direct expenses incurred in acquiring the medicine intended for re-sale to senior citizens, operating expenses or administrative overhead are likewise incurred. Limiting the tax credit on the acquisition cost of the medicines sold amounts to a taking of property for public use without just compensation, petitioner argues. Moreover, petitioner contends that to compel it to grant 20% discount on sale of medicine to senior citizens without fully reimbursing it for the amount of discount granted violates the due process clause for being oppressive, unreasonable, confiscatory and an undue restraint of trade. In the second tier, petitioner maintains that the term "cost" should at least include all business expenses directly incurred to produce the merchandise and to bring them to their present location and use. Petitioner alleges that while the Court of Appeals subscribes to the above interpretation, it nevertheless affirmed in toto the Court of Tax Appeals’ erroneous decision.

In lieu of its Comment, the Office of the Solicitor General (OSG) filed a Manifestation and Motion supporting petitioner’s theory that the amount of tax credit should be computed based on sales discounts properly substantiated by petitioner. The OSG adverted to the case of Bicolandia Drug Corporation (Formerly Elmas Drug Corporation) v. Commissioner of Internal Revenue11 wherein we held that the term "cost" refers to the amount of the 20% discount extended by a private establishment to senior citizens in their purchase of medicines, which amount should be applied

as a tax credit. The OSG opines that the allowance of claim for additional tax credits should be based on sales discounts properly substantiated before the Court of Appeals.

The main thrust of the petition is to determine whether the claim for tax credit should be based on the full amount of the 20% senior citizens’ discount or the acquisition cost of the merchandise sold.

Preliminarily, Republic Act No. 7432 is a piece of social legislation aimed to grant benefits and privileges to senior citizens. Among the highlights of this Act is the grant of sales discounts on the purchase of medicines to senior citizens. Section 4(a) of Republic Act No. 7432 reads:

SEC. 4. Privileges for the Senior Citizens. — The senior citizens shall be entitled to the following:

a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost as tax credit;

The burden imposed on private establishments amounts to the taking of private property for public use with just compensation in the form of a tax credit.12

The foregoing proviso specifically allows the 20% senior citizens' discount to be claimed by the private establishment as a tax credit and not merely as a tax deduction from gross sales or gross income. The law however is silent as to how the "cost of the discount" as tax credit should be construed.

Indeed, there is nothing novel in the issues raised in this petition. Our rulings in Bicolandia Drug Corporation (Formerly Elmas Drug Corporation) v. Commissioner of Internal Revenue,13 Cagayan Valley Drug Corporation v. Commissioner of Internal Revenue,14 and M.E. Holding Corporation v. Court of Appeals15 operate as stare decisis16 with respect to this legal question.

In Bicolandia, we construed the term "cost" as referring to the amount of the 20% discount extended by a private establishment to senior citizens in their purchase of medicines.17 The Court of Appeals’ decision in Commissioner of Internal Revenue v. Elmas Drug Corporation dated 19 October 1999 was relied upon by the Court of Appeals as basis for its interpretation of the term "cost" when it decided the instant case in 20 October 2003. As correctly pointed out by the OSG, said case had been elevated to this Court and had been eventually resolved with finality on 22 June 2006 in the case entitled Bicolandia Drug Corporation v. Commissioner of Internal Revenue.lawphi1

We reiterated this ruling in the 2008 case of Cagayan Valley Drug by holding that petitioner therein is entitled to a tax credit for the full 20% sales discounts it extended to qualified senior citizens. This holds true despite the fact that petitioner suffered a net loss for that taxable year.18

The most recent case in point is M.E. Holding Corporation which bears a strikingly similar set of facts and issues with the case at bar. Both petitioners filed their respective income tax return initially treating the 20% sales discount to senior citizens as deductions from its gross income. When advised that the discount should be treated as tax credit, they both filed a claim for overpayment. The Bureau of Internal Revenue on both occasions failed to act timely on the claims, hence they appealed before the Court of Tax Appeals. The Court of Tax Appeals in M.E. Holding concedes that

the 20% sales discount granted to qualified senior citizens should be treated as tax credit but it placed reliance on the Court of Appeals’ decision in Commissioner of Internal Revenue v. Elmas Drug Corporation where the term "cost of the discount" was interpreted to mean only the direct acquisition cost, excluding administrative and other incremental costs. This was the very same case relied upon by the Court of Appeals in the present case. We finally affirmed in M.E. Holding that the tax credit should be equivalent to the actual 20% sales discount granted to qualified senior citizens.

It is worthy to mention that Republic Act No. 7432 had undergone two (2) amendments; first in 2003 by Republic Act No. 9257 and most recently in 2010 by Republic Act No. 9994. The 20% sales discount granted by establishments to qualified senior citizens is now treated as tax deduction and not as tax credit. As we have likewise declared in Commissioner of Internal Revenue v. Central Luzon Drug Corporation,19 this case covers the taxable years 1993 and 1994, thus, Republic Act No. 7432 applies.

Based on the foregoing, we sustain petitioner’s argument that the cost of discount should be computed on the actual amount of the discount extended to senior citizens. However, we give full accord to the factual findings of the Court of Tax Appeals with respect to the actual amount of the 20% sales discount, i.e., the sum of P3,522,123.25. for the year 1993 and P34,211,769.45 for the year 1994. Therefore, petitioner is entitled to a tax credit equivalent to the actual amounts of the 20% sales discount as determined by the Court of Tax Appeals. A new computation for tax refund is in order, to wit:

TAXABLE YEAR 1993

SALES, Net P10,228,518,335.00

Add: Cost of 20% Discount to Senior Citizens 3,522,123.25

SALES, Gross P10,232,040,458.25

COST OF SALES


Purchases 8,717,393,710.00


Merchandise Inventory, End 2,458,743,127.00 8,686,622,733.00









LESS: TAX CREDIT

(20% Sales Discount to Senior Citizens)

P 3,522,123.25



TAXABLE YEAR 1994

SALES, Net P 11,671,366,402.00

Add: Cost of 20% Sales Discountto Senior Citizens

34,211,769.45

SALES, Gross P11,705,578,171.45

COST OF SALES


Purchases 10,316,941,308.00



2,928,397,228.00 9,847,287,207.00






Less: Income subjected to final Income tax 25,591,586.00



LESS: TAX CREDIT

(Cost of 20% Discount to Senior Citizens)

P 34,211,769.45



WHEREFORE, the petition is GRANTED. The assailed Decision and Resolution of the Court of Appeals are REVERSED and SET ASIDE. Respondent Commissioner of Internal Revenue is ORDERED to issue tax credit certificates in favor of petitioner in the amounts of P2,289,381.71 and P22,237,650.34.

G.R. No. 166494 June 29, 2007

CARLOS SUPERDRUG CORP., doing business under the name and style "Carlos Superdrug," ELSIE M. CANO, doing business under the name and style "Advance Drug," Dr. SIMPLICIO L. YAP, JR., doing business under the name and style "City Pharmacy," MELVIN S. DELA SERNA, doing business under the name and style "Botica dela Serna," and LEYTE SERV-WELL CORP., doing business under the name and style "Leyte Serv-Well Drugstore," petitioners, vs.DEPARTMENT OF SOCIAL WELFARE and DEVELOPMENT (DSWD), DEPARTMENT OF HEALTH (DOH), DEPARTMENT OF FINANCE (DOF), DEPARTMENT OF JUSTICE (DOJ), and DEPARTMENT OF INTERIOR and LOCAL GOVERNMENT (DILG), respondents.

D E C I S I O N

AZCUNA, J.:

This is a petition1 for Prohibition with Prayer for Preliminary Injunction assailing the constitutionality of Section 4(a) of Republic Act (R.A.) No. 9257,2 otherwise known as the "Expanded Senior Citizens Act of 2003."

Petitioners are domestic corporations and proprietors operating drugstores in the Philippines.

http://www.lawphil.net/judjuris/juri2007/jun2007/gr_166494_2007.html#fnt2


Public respondents, on the other hand, include the Department of Social Welfare and Development (DSWD), the Department of Health (DOH), the Department of Finance (DOF), the Department of Justice (DOJ), and the Department of Interior and Local Government (DILG) which have been specifically tasked to monitor the drugstores’ compliance with the law; promulgate the implementing rules and regulations for the effective implementation of the law; and prosecute and revoke the licenses of erring drugstore establishments.

The antecedents are as follows:

On February 26, 2004, R.A. No. 9257, amending R.A. No. 7432,3 was signed into law by President Gloria Macapagal-Arroyo and it became effective on March 21, 2004. Section 4(a) of the Act states:

SEC. 4. Privileges for the Senior Citizens. – The senior citizens shall be entitled to the following:

(a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of services in hotels and similar lodging establishments, restaurants and recreation centers, and purchase of medicines in all establishments for the exclusive use or enjoyment of senior citizens, including funeral and burial services for the death of senior citizens;

. . .

The establishment may claim the discounts granted under (a), (f), (g) and (h) as tax deduction based on the net cost of the goods sold or services rendered: Provided, That the cost of the discount shall be allowed as deduction from gross


income for the same taxable year that the discount is granted. Provided, further, That the total amount of the claimed tax deduction net of value added tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as amended.4

On May 28, 2004, the DSWD approved and adopted the Implementing Rules and Regulations of R.A. No. 9257, Rule VI, Article 8 of which states:

Article 8. Tax Deduction of Establishments. – The establishment may claim the discounts granted under Rule V, Section 4 – Discounts for Establishments;5 Section 9, Medical and Dental Services in Private Facilities[,]6 and Sections 107 and 118 – Air, Sea and Land Transportation as tax deduction based on the net cost of the goods sold or services rendered. Provided, That the cost of the discount shall be allowed as deduction from gross income for the same taxable year that the discount is granted; Provided, further, That the total amount of the claimed tax deduction net of value added tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as amended; Provided, finally, that the implementation of the tax deduction shall be subject to the Revenue Regulations to be issued by the Bureau of Internal Revenue (BIR) and approved by the Department of Finance (DOF).9

On July 10, 2004, in reference to the query of the Drug Stores Association of the Philippines (DSAP) concerning the meaning of a tax deduction under the Expanded Senior Citizens Act, the DOF, through Director IV Ma. Lourdes B. Recente, clarified as follows:







1) The difference between the Tax Credit (under the Old Senior Citizens Act) and Tax Deduction (under the Expanded Senior Citizens Act).

1.1. The provision of Section 4 of R.A. No. 7432 (the old Senior Citizens Act) grants twenty percent (20%) discount from all establishments relative to the utilization of transportation services, hotels and similar lodging establishment, restaurants and recreation centers and purchase of medicines anywhere in the country, the costs of which may be claimed by the private establishments concerned as tax credit.

Effectively, a tax credit is a peso-for-peso deduction from a taxpayer’s tax liability due to the government of the amount of discounts such establishment has granted to a senior citizen. The establishment recovers the full amount of discount given to a senior citizen and hence, the government shoulders 100% of the discounts granted.

It must be noted, however, that conceptually, a tax credit scheme under the Philippine tax system, necessitates that prior payments of taxes have been made and the taxpayer is attempting to recover this tax payment from his/her income tax due. The tax credit scheme under R.A. No. 7432 is, therefore, inapplicable since no tax payments have previously occurred.

1.2. The provision under R.A. No. 9257, on the other hand, provides that the establishment concerned may claim the discounts under Section 4(a), (f), (g) and (h) as tax deduction from gross income, based on the net cost of goods sold or services rendered.

Under this scheme, the establishment concerned is allowed to deduct from gross income, in computing for its tax liability, the amount of discounts granted to senior citizens. Effectively, the government loses in terms of foregone revenues an amount equivalent to the marginal tax rate the said establishment is liable to pay the government. This will be an amount equivalent to 32% of the twenty percent (20%) discounts so granted. The establishment shoulders the remaining portion of the granted discounts.

It may be necessary to note that while the burden on [the] government is slightly diminished in terms of its percentage share on the discounts granted to senior citizens, the number of potential establishments that may claim tax deductions, have however, been broadened. Aside from the establishments that may claim tax credits under the old law, more establishments were added under the new law such as: establishments providing medical and dental services, diagnostic and laboratory services, including professional fees of attending doctors in all private hospitals and medical facilities, operators of domestic air and sea transport services, public railways and skyways and bus transport services.

A simple illustration might help amplify the points discussed above, as follows:

Tax Deduction Tax Credit

Gross Sales x x x x x x x x x x x x

Less : Cost of goods sold x x x x x x x x x x

Net Sales x x x x x x x x x x x x

Less: Operating Expenses:

Tax Deduction on Discounts x x x x --

Other deductions: x x x x x x x x

Net Taxable Income x x x x x x x x x x

Tax Due x x x x x x

Less: Tax Credit -- ______x x

Net Tax Due -- x x

As shown above, under a tax deduction scheme, the tax deduction on discounts was subtracted from Net Sales together with other deductions which are considered as operating expenses before the Tax Due was computed based on the Net Taxable Income. On the other hand, under a tax credit scheme, the amount of discounts which is the tax credit item, was deducted directly from the tax due amount.10

Meanwhile, on October 1, 2004, Administrative Order (A.O.) No. 171 or the Policies and Guidelines to Implement the Relevant Provisions of Republic Act 9257, otherwise known as the "Expanded Senior Citizens Act of 2003"11 was issued by the DOH, providing the grant of twenty percent (20%) discount in the purchase of unbranded generic medicines from all establishments dispensing medicines for the exclusive use of the senior citizens.



On November 12, 2004, the DOH issued Administrative Order No 17712 amending A.O. No. 171. Under A.O. No. 177, the twenty percent discount shall not be limited to the purchase of unbranded generic medicines only, but shall extend to both prescription and non-prescription medicines whether branded or generic. Thus, it stated that "[t]he grant of twenty percent (20%) discount shall be provided in the purchase of medicines from all establishments dispensing medicines for the exclusive use of the senior citizens."

Petitioners assail the constitutionality of Section 4(a) of the Expanded Senior Citizens Act based on the following grounds:13

1) The law is confiscatory because it infringes Art. III, Sec. 9 of the Constitution which provides that private property shall not be taken for public use without just compensation;

2) It violates the equal protection clause (Art. III, Sec. 1) enshrined in our Constitution which states that "no person shall be deprived of life, liberty or property without due process of law, nor shall any person be denied of the equal protection of the laws;" and

3) The 20% discount on medicines violates the constitutional guarantee in Article XIII, Section 11 that makes "essential goods, health and other social services available to all people at affordable cost."14

Petitioners assert that Section 4(a) of the law is unconstitutional because it constitutes deprivation of private property. Compelling drugstore owners and establishments to grant the discount will result in a loss of profit




and capital because 1) drugstores impose a mark-up of only 5% to 10% on branded medicines; and 2) the law failed to provide a scheme whereby drugstores will be justly compensated for the discount.

Examining petitioners’ arguments, it is apparent that what petitioners are ultimately questioning is the validity of the tax deduction scheme as a reimbursement mechanism for the twenty percent (20%) discount that they extend to senior citizens.

Based on the afore-stated DOF Opinion, the tax deduction scheme does not fully reimburse petitioners for the discount privilege accorded to senior citizens. This is because the discount is treated as a deduction, a tax-deductible expense that is subtracted from the gross income and results in a lower taxable income. Stated otherwise, it is an amount that is allowed by law15 to reduce the income prior to the application of the tax rate to compute the amount of tax which is due.16 Being a tax deduction, the discount does not reduce taxes owed on a peso for peso basis but merely offers a fractional reduction in taxes owed.

Theoretically, the treatment of the discount as a deduction reduces the net income of the private establishments concerned. The discounts given would have entered the coffers and formed part of the gross sales of the private establishments, were it not for R.A. No. 9257.

The permanent reduction in their total revenues is a forced subsidy corresponding to the taking of private property for public use or benefit.17 This constitutes compensable taking for which petitioners would ordinarily become entitled to a just compensation.




Just compensation is defined as the full and fair equivalent of the property taken from its owner by the expropriator. The measure is not the taker’s gain but the owner’s loss. The word just is used to intensify the meaning of the word compensation, and to convey the idea that the equivalent to be rendered for the property to be taken shall be real, substantial, full and ample.18

A tax deduction does not offer full reimbursement of the senior citizen discount. As such, it would not meet the definition of just compensation.19

Having said that, this raises the question of whether the State, in promoting the health and welfare of a special group of citizens, can impose upon private establishments the burden of partly subsidizing a government program.

The Court believes so.

The Senior Citizens Act was enacted primarily to maximize the contribution of senior citizens to nation-building, and to grant benefits and privileges to them for their improvement and well-being as the State considers them an integral part of our society.20

The priority given to senior citizens finds its basis in the Constitution as set forth in the law itself. Thus, the Act provides:

SEC. 2. Republic Act No. 7432 is hereby amended to read as follows:




SECTION 1. Declaration of Policies and Objectives. – Pursuant to Article XV, Section 4 of the Constitution, it is the duty of the family to take care of its elderly members while the State may design programs of social security for them. In addition to this, Section 10 in the Declaration of Principles and State Policies provides: "The State shall provide social justice in all phases of national development." Further, Article XIII, Section 11, provides: "The State shall adopt an integrated and comprehensive approach to health development which shall endeavor to make essential goods, health and other social services available to all the people at affordable cost. There shall be priority for the needs of the underprivileged sick, elderly, disabled, women and children." Consonant with these constitutional principles the following are the declared policies of this Act:

. . .

(f) To recognize the important role of the private sector in the improvement of the welfare of senior citizens and to actively seek their partnership.21

To implement the above policy, the law grants a twenty percent discount to senior citizens for medical and dental services, and diagnostic and laboratory fees; admission fees charged by theaters, concert halls, circuses, carnivals, and other similar places of culture, leisure and amusement; fares for domestic land, air and sea travel; utilization of services in hotels and similar lodging establishments, restaurants and recreation centers; and purchases of medicines for the exclusive use or enjoyment of senior citizens. As a form of reimbursement, the law provides that business establishments extending the twenty percent discount to senior citizens may claim the discount as a tax deduction.


The law is a legitimate exercise of police power which, similar to the power of eminent domain, has general welfare for its object. Police power is not capable of an exact definition, but has been purposely veiled in general terms to underscore its comprehensiveness to meet all exigencies and provide enough room for an efficient and flexible response to conditions and circumstances, thus assuring the greatest benefits. 22 Accordingly, it has been described as "the most essential, insistent and the least limitable of powers, extending as it does to all the great public needs."23 It is "[t]he power vested in the legislature by the constitution to make, ordain, and establish all manner of wholesome and reasonable laws, statutes, and ordinances, either with penalties or without, not repugnant to the constitution, as they shall judge to be for the good and welfare of the commonwealth, and of the subjects of the same."24

For this reason, when the conditions so demand as determined by the legislature, property rights must bow to the primacy of police power because property rights, though sheltered by due process, must yield to general welfare.25

Police power as an attribute to promote the common good would be diluted considerably if on the mere plea of petitioners that they will suffer loss of earnings and capital, the questioned provision is invalidated. Moreover, in the absence of evidence demonstrating the alleged confiscatory effect of the provision in question, there is no basis for its nullification in view of the presumption of validity which every law has in its favor.26

Given these, it is incorrect for petitioners to insist that the grant of the senior citizen discount is unduly oppressive to their business, because petitioners have not taken time to calculate correctly and come up with a financial report, so that they have not been able to show properly whether or not the tax deduction scheme really works greatly to their disadvantage.27







In treating the discount as a tax deduction, petitioners insist that they will incur losses because, referring to the DOF Opinion, for every P1.00 senior citizen discount that petitioners would give, P0.68 will be shouldered by them as only P0.32 will be refunded by the government by way of a tax deduction.

To illustrate this point, petitioner Carlos Super Drug cited the anti-hypertensive maintenance drug Norvasc as an example. According to the latter, it acquires Norvasc from the distributors at P37.57 per tablet, and retails it at P39.60 (or at a margin of 5%). If it grants a 20% discount to senior citizens or an amount equivalent to P7.92, then it would have to sell Norvasc at P31.68 which translates to a loss from capital of P5.89 per tablet. Even if the government will allow a tax deduction, only P2.53 per tablet will be refunded and not the full amount of the discount which is P7.92. In short, only 32% of the 20% discount will be reimbursed to the drugstores.28

Petitioners’ computation is flawed. For purposes of reimbursement, the law states that the cost of the discount shall be deducted from gross income,29 the amount of income derived from all sources before deducting allowable expenses, which will result in net income. Here, petitioners tried to show a loss on a per transaction basis, which should not be the case. An income statement, showing an accounting of petitioners’ sales, expenses, and net profit (or loss) for a given period could have accurately reflected the effect of the discount on their income. Absent any financial statement, petitioners cannot substantiate their claim that they will be operating at a loss should they give the discount. In addition, the computation was erroneously based on the assumption that their customers consisted wholly of senior citizens. Lastly, the 32% tax rate is to be imposed on income, not on the amount of the discount.



Furthermore, it is unfair for petitioners to criticize the law because they cannot raise the prices of their medicines given the cutthroat nature of the players in the industry. It is a business decision on the part of petitioners to peg the mark-up at 5%. Selling the medicines below acquisition cost, as alleged by petitioners, is merely a result of this decision. Inasmuch as pricing is a property right, petitioners cannot reproach the law for being oppressive, simply because they cannot afford to raise their prices for fear of losing their customers to competition.

The Court is not oblivious of the retail side of the pharmaceutical industry and the competitive pricing component of the business. While the Constitution protects property rights, petitioners must accept the realities of business and the State, in the exercise of police power, can intervene in the operations of a business which may result in an impairment of property rights in the process.

Moreover, the right to property has a social dimension. While Article XIII of the Constitution provides the precept for the protection of property, various laws and jurisprudence, particularly on agrarian reform and the regulation of contracts and public utilities, continuously serve as a reminder that the right to property can be relinquished upon the command of the State for the promotion of public good.30

Undeniably, the success of the senior citizens program rests largely on the support imparted by petitioners and the other private establishments concerned. This being the case, the means employed in invoking the active participation of the private sector, in order to achieve the purpose or objective of the law, is reasonably and directly related. Without sufficient proof that Section 4(a) of R.A. No. 9257 is arbitrary, and that the continued implementation of the same would be unconscionably detrimental to petitioners, the Court will refrain from quashing a legislative act.31



WHEREFORE, the petition is DISMISSED for lack of merit.

Eisner v. Macomber, 252 U.S. 189 (1920)

Eisner v. Macomber

No. 318

Argued April 16, 1919

Restored to docket for reargument May 19, 1919

Reargued October 17, 20, 1919

Decided March 8, 1920

252 U.S. 189

ERROR TO THE DISTRICT COURT OF THE UNITED STATES

FOR THE SOUTHERN DISTRICT OF NEW YORK

Syllabus

Congress was not empowered by the Sixteenth Amendment to tax, as income of the stockholder, without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913. P. 252 U. S. 201. Towne v. Eisner, 245 U. S. 418.

The Revenue Act of September 8, 1916, c. 463, 39 Stat. 756, plainly evinces the purpose of Congress to impose such taxes, and is to that extent in conflict with Art. I, § 2, cl. 3, and Art. I, § 9, cl. 4, of the Constitution. Pp. 252 U. S. 199, 252 U. S. 217.

These provisions of the Constitution necessarily limit the extension, by construction, of the Sixteenth Amendment. P. 252 U. S. 205.

What is or is not "income" within the meaning of the Amendment must be determined in each case according to truth and substance, without regard to form. P. 252 U. S. 206.

Income may be defined as the gain derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital. P. 252 U. S. 207.

Mere growth or increment of value in a capital investment is not income; income is essentially a gain or profit, in itself, of exchangeable value, proceeding from capital, severed from it, and derived or received by the taxpayer for his separate use, benefit, and disposal. Id.

http://supreme.justia.com/cases/federal/us/252/189/case.html#207





http://supreme.justia.com/cases/federal/us/245/418/case.html


A stock dividend, evincing merely a transfer of an accumulated surplus to the capital account of the corporation, takes nothing from the property of the corporation and adds nothing to that of the shareholder; a tax on such dividends is a tax an capital increase, and not on income, and, to be valid under the Constitution, such taxes must be apportioned according to population in the several states. P. 252 U. S. 208.

Affirmed.

Page 252 U. S. 190

The case is stated in the opinion.

Page 252 U. S. 199

MR. JUSTICE PITNEY delivered the opinion of the Court.

This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has the power to tax, as income of the stockholder and without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913.

It arises under the Revenue Act of September 8, 1916, 39 Stat. 756 et seq., which, in our opinion (notwithstanding a contention of the government that will be

Page 252 U. S. 200


noticed), plainly evinces the purpose of Congress to tax stock dividends as income. *

The facts, in outline, are as follows:

On January 1, 1916, the Standard Oil Company of California, a corporation of that state, out of an authorized capital stock of $100,000,000, had shares of stock outstanding, par value $100 each, amounting in round figures to $50,000,000. In addition, it had surplus and undivided profits invested in plant, property, and business and required for the purposes of the corporation, amounting to about $45,000,000, of which about $20,000,000 had been earned prior to March 1, 1913, the balance thereafter. In January, 1916, in order to readjust the capitalization, the board of directors decided to issue additional shares sufficient to constitute a stock dividend of 50 percent of the outstanding stock, and to transfer from surplus account to capital stock account an amount equivalent to such issue. Appropriate resolutions were adopted, an amount equivalent to the par value of the proposed new stock was transferred accordingly, and the new stock duly issued against it and divided among the stockholders.

Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1, 100 additional

Page 252 U. S. 201

shares, of which 18.07 percent, or 198.77 shares, par value $19,877, were treated as representing surplus earned between March 1, 1913, and January 1, 1916. She was called upon to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed income of $19,877 because of the new shares, and, an appeal to the Commissioner of Internal Revenue having been disallowed, she brought action against the Collector to recover the


tax. In her complaint, she alleged the above facts and contended that, in imposing such a tax the Revenue Act of 1916 violated article 1, § 2, cl. 3, and Article I, § 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned according to population, and that the stock dividend was not income within the meaning of the Sixteenth Amendment. A general demurrer to the complaint was overruled upon the authority of Towne v. Eisner, 245 U. S. 418, and, defendant having failed to plead further, final judgment went against him. To review it, the present writ of error is prosecuted.

The case was argued at the last term, and reargued at the present term, both orally and by additional briefs.

We are constrained to hold that the judgment of the district court must be affirmed, first, because the question at issue is controlled by Towne v. Eisner, supra; secondly, because a reexamination of the question with the additional light thrown upon it by elaborate arguments has confirmed the view that the underlying ground of that decision is sound, that it disposes of the question here presented, and that other fundamental considerations lead to the same result.

In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus earned prior to January 1, 1913, was taxable against the stockholder under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, which provided (§ B, p. 167) that net income should include "dividends," and also "gains or profits and income derived

Page 252 U. S. 202

from any source whatever." Suit having been brought by a stockholder to recover the tax assessed against him by reason of the dividend, the district court sustained a demurrer to the complaint. 242 F. 702. The court treated the


construction of the act as inseparable from the interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, and quoted the Amendment, proceeded very properly to say (p. 704):

"It is manifest that the stock dividend in question cannot be reached by the Income Tax Act and could not, even though Congress expressly declared it to be taxable as income, unless it is in fact income."

It declined, however, to accede to the contention that, in Gibbons v. Mahon, 136 U. S. 549, "stock dividends" had received a definition sufficiently clear to be controlling, treated the language of this Court in that case as obiter dictum in respect of the matter then before it (p. 706), and examined the question as res nova, with the result stated. When the case came here, after overruling a motion to dismiss made by the government upon the ground that the only question involved was the construction of the statute, and not its constitutionality, we dealt upon the merits with the question of construction only, but disposed of it upon consideration of the essential nature of a stock dividend disregarding the fact that the one in question was based upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not only so, but we rejected the reasoning of the district court, saying (245 U.S. 245 U. S. 426):

"Notwithstanding the thoughtful discussion that the case received below we cannot doubt that the dividend was capital as well for the purposes of the Income Tax Law as for distribution between tenant for life and remainderman. What was said by this Court upon the latter question is equally true for the former."

"A stock dividend really takes nothing from the property of the corporation, and adds nothing to the




Page 252 U. S. 203

interests of the shareholders. Its property is not diminished, and their interests are not increased. . . . The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones."

"Gibbons v. Mahon, 136 U. S. 549, 136 U. S. 559-560. In short, the corporation is no poorer and the stockholder is no richer than they were before. Logan County v. United States, 169 U. S. 255, 169 U. S. 261. If the plaintiff gained any small advantage by the change, it certainly was not an advantage of $417,450, the sum upon which he was taxed. . . . What has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new."

This language aptly answered not only the reasoning of the district court, but the argument of the Solicitor General in this Court, which discussed the essential nature of a stock dividend. And if, for the reasons thus expressed, such a dividend is not to be regarded as "income" or "dividends" within the meaning of the Act of 1913, we are unable to see how it can be brought within the meaning of "incomes" in the Sixteenth Amendment, it being very clear that Congress intended in that act to exert its power to the extent permitted by the amendment. In Towne v. Eisner, it was not contended that any construction of the statute could make it narrower than the constitutional grant; rather the contrary.

The fact that the dividend was charged against profits earned before the Act of 1913 took effect, even before the amendment was adopted, was neither relied upon nor alluded to in our consideration of the merits in that case. Not only

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so, but had we considered that a stock dividend constituted income in any true sense, it would have been held taxable under the Act of 1913 notwithstanding it was

Page 252 U. S. 204

based upon profits earned before the amendment. We ruled at the same term, in Lynch v. Hornby, 247 U. S. 339, that a cash dividend extraordinary in amount, and in Peabody v. Eisner, 247 U. S. 347, that a dividend paid in stock of another company, were taxable as income although based upon earnings that accrued before adoption of the amendment. In the former case, concerning "corporate profits that accumulated before the act took effect," we declared (pp. 247 U. S. 343-344):

"Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations only if and when, and to the extent that, his interest in them comes to fruition as income, that is, in dividends declared, so we can perceive no constitutional obstacle that stands in the way of carrying out this intent when dividends are declared out of a preexisting surplus. . . . Congress was at liberty under the amendment to tax as income, without apportionment, everything that became income, in the ordinary sense of the word, after the adoption of the amendment, including dividends received in the ordinary course by a stockholder from a corporation, even though they were extraordinary in amount and might appear upon analysis to be a mere realization in possession of an inchoate and contingent interest that the stockholder had in a surplus of corporate assets previously existing."

In Peabody v. Eisner, 247 U. S. 349, 247 U. S. 350, we observed that the decision of the district court in Towne v. Eisner had been reversed






"only upon the ground that it related to a stock dividend which in fact took nothing from the property of the corporation and added nothing to the interest of the shareholder, but merely changed the evidence which represented that interest,"

and we distinguished the Peabody case from the Towne case upon the ground that "the dividend of Baltimore & Ohio shares was not a stock dividend but a distribution in specie of a portion of the assets of the Union Pacific."

Therefore, Towne v. Eisner cannot be regarded as turning

Page 252 U. S. 205

upon the point that the surplus accrued to the company before the act took effect and before adoption of the amendment. And what we have quoted from the opinion in that case cannot be regarded as obiter dictum, it having furnished the entire basis for the conclusion reached. We adhere to the view then expressed, and might rest the present case there not because that case in terms decided the constitutional question, for it did not, but because the conclusion there reached as to the essential nature of a stock dividend necessarily prevents its being regarded as income in any true sense.

Nevertheless, in view of the importance of the matter, and the fact that Congress in the Revenue Act of 1916 declared (39 Stat. 757) that a "stock dividend shall be considered income, to the amount of its cash value," we will deal at length with the constitutional question, incidentally testing the soundness of our previous conclusion.

The Sixteenth Amendment must be construed in connection with the taxing clauses of the original Constitution and the effect attributed to them before the amendment was adopted. In Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, under the Act of August 27, 1894, c. 349, § 27, 28 Stat. 509, 553, it was held that taxes upon rents and profits of real estate and upon returns from investments of personal property were in effect direct taxes upon the property from which such income arose, imposed by reason of ownership, and that Congress could not impose such taxes without apportioning them among the states according to population, as required by Article I, § 2, cl. 3, and § 9, cl. 4, of the original Constitution.

Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object to be accomplished:

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among

Page 252 U. S. 206

the several states and without regard to any census or enumeration."

As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the necessity which otherwise might exist for an apportionment among the states of taxes laid on income. Brushaber v. Union Pacific R. Co., 240 U. S. 1, 240 U. S. 17-19; Stanton v. Baltic Mining Co., 240 U. S. 103, 240 U. S. 112 et seq.; Peck & Co. v. Lowe, 247 U. S. 165, 247 U. S. 172-173.








A proper regard for its genesis, as well as its very clear language, requires also that this amendment shall not be extended by loose construction, so as to repeal or modify, except as applied to income, those provisions of the Constitution that require an apportionment according to population for direct taxes upon property, real and personal. This limitation still has an appropriate and important function, and is not to be overridden by Congress or disregarded by the courts.

In order, therefore, that the clauses cited from Article I of the Constitution may have proper force and effect, save only as modified by the amendment, and that the latter also may have proper effect, it becomes essential to distinguish between what is and what is not "income," as the term is there used, and to apply the distinction, as cases arise, according to truth and substance, without regard to form. Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised.

The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. For the present purpose, we require only a clear definition of the term "income,"

Page 252 U. S. 207

as used in common speech, in order to determine its meaning in the amendment, and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue.

After examining dictionaries in common use (Bouv. L.D.; Standard Dict.; Webster's Internat. Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert, 231 U. S. 399, 231 U. S. 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 247 U. S. 185), "Income may be defined as the gain derived from capital, from labor, or from both combined," provided it be understood to include profit gained through a sale or conversion of capital assets, to which it was applied in the Doyle case, pp. 247 U. S. 183-185.

Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word "gain," which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. "Derived from capital;" "the gain derived from capital," etc. Here, we have the essential matter: not a gain accruing to capital; not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being "derived" -- that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal -- that is income derived from property. Nothing else answers the description.

The same fundamental conception is clearly set forth in the Sixteenth Amendment -- "incomes, from whatever source derived" -- the essential thought being expressed

Page 252 U. S. 208

with a conciseness and lucidity entirely in harmony with the form and style of the Constitution.







Can a stock dividend, considering its essential character, be brought within the definition? To answer this, regard must be had to the nature of a corporation and the stockholder's relation to it. We refer, of course, to a corporation such as the one in the case at bar, organized for profit, and having a capital stock divided into shares to which a nominal or par value is attributed.

Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but the evidence of it. They state the number of shares to which he is entitled and indicate their par value and how the stock may be transferred. They show that he or his assignors, immediate or remote, have contributed capital to the enterprise, that he is entitled to a corresponding interest proportionate to the whole, entitled to have the property and business of the company devoted during the corporate existence to attainment of the common objects, entitled to vote at stockholders' meetings, to receive dividends out of the corporation's profits if and when declared, and, in the event of liquidation, to receive a proportionate share of the net assets, if any, remaining after paying creditors. Short of liquidation, or until dividend declared, he has no right to withdraw any part of either capital or profits from the common enterprise; on the contrary, his interest pertains not to any part, divisible or indivisible, but to the entire assets, business, and affairs of the company. Nor is it the interest of an owner in the assets themselves, since the corporation has full title, legal and equitable, to the whole. The stockholder has the right to have the assets employed in the enterprise, with the incidental rights mentioned; but, as stockholder, he has no right to withdraw, only the right to persist, subject to the risks of the enterprise, and looking only to dividends for his return. If he desires to dissociate himself

Page 252 U. S. 209

from the company, he can do so only by disposing of his stock.

For bookkeeping purposes, the company acknowledges a liability in form to the stockholders equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If profits have been made and not divided, they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus account," or the like. None of these, however, gives to the stockholders as a body, much less to any one of them, either a claim against the going concern for any particular sum of money or a right to any particular portion of the assets or any share in them unless or until the directors conclude that dividends shall be made and a part of the company's assets segregated from the common fund for the purpose. The dividend normally is payable in money, under exceptional circumstances in some other divisible property, and when so paid, then only (excluding, of course, a possible advantageous sale of his stock or winding-up of the company) does the stockholder realize a profit or gain which becomes his separate property, and thus derive income from the capital that he or his predecessor has invested.

In the present case, the corporation had surplus and undivided profits invested in plant, property, and business, and required for the purposes of the corporation, amounting to about $45,000,000, in addition to outstanding capital stock of $50,000,000. In this, the case is not extraordinary. The profits of a corporation, as they appear upon the balance sheet at the end of the year, need not be in the form of money on hand in excess of what is required to meet current liabilities and finance current operations of the company. Often, especially in a growing business, only a part, sometimes a small part, of the year's profits is in property capable of division, the remainder having been absorbed in the acquisition of increased plant,

Page 252 U. S. 210

equipment, stock in trade, or accounts receivable, or in decrease of outstanding liabilities. When only a part is available for dividends, the balance of the year's profits is carried to the credit of undivided profits, or surplus, or some other account having like significance. If thereafter the company finds itself in funds beyond current needs, it may declare dividends out of such surplus or undivided profits; otherwise it may go on for years conducting a successful business, but requiring more and more working capital because of the extension of its operations, and therefore unable to declare dividends approximating the amount of its profits. Thus, the surplus may increase until it equals or even exceeds the par value of the outstanding capital stock. This may be adjusted upon the books in the mode adopted in the case at bar -- by declaring a "stock dividend." This, however, is no more than a book adjustment, in essence -- not a dividend, but rather the opposite; no part of the assets of the company is separated from the common fund, nothing distributed except paper certificates that evidence an antecedent increase in the value of the stockholder's capital interest resulting from an accumulation of profits by the company, but profits so far absorbed in the business as to render it impracticable to separate them for withdrawal and distribution. In order to make the adjustment, a charge is made against surplus account with corresponding credit to capital stock account, equal to the proposed "dividend;" the new stock is issued against this and the certificates delivered to the existing stockholders in proportion to their previous holdings. This, however, is merely bookkeeping that does not affect the aggregate assets of the corporation or its outstanding liabilities; it affects only the form, not the essence, of the "liability" acknowledged by the corporation to its own shareholders, and this through a readjustment of accounts on one side of the balance sheet only, increasing "capital stock" at the expense of

Page 252 U. S. 211

"surplus"; it does not alter the preexisting proportionate interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increase the number of the shares, with consequent dilution of the value of each share.

A "stock dividend" shows that the company's accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution in money or in kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone such realization, in that the fund represented by the new stock has been transferred from surplus to capital, and no longer is available for actual distribution.

The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.

Being concerned only with the true character and effect of such a dividend when lawfully made, we lay aside the question whether, in a particular case, a stock dividend may be authorized by the local law governing the corporation, or whether the capitalization of profits may be the result of correct judgment and proper business policy on the part of

its management, and a due regard for the interests of the stockholders. And we are considering the taxability of bona fide stock dividends only.

Page 252 U. S. 212

We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital, at the same time shows he has not realized or received any income in the transaction.

It is said that a stockholder may sell the new shares acquired in the stock dividend, and so he may, if he can find a buyer. It is equally true that, if he does sell, and in doing so realizes a profit, such profit, like any other, is income, and, so far as it may have arisen since the Sixteenth Amendment, is taxable by Congress without apportionment. The same would be true were he to sell some of his original shares at a profit. But if a shareholder sells dividend stock, he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a corporation should receive in common with other stockholders a 50 percent stock dividend, and should sell his part, he thereby would be reduced from a majority to a minority stockholder, having six-fifteenths instead of six-tenths of the total stock outstanding. A corresponding and proportionate decrease in capital interest and in voting power would befall a minority holder should he sell dividend stock, it being in the nature of things impossible

for one to dispose of any part of such an issue without a proportionate disturbance of the distribution of the entire capital stock and a like diminution of the seller's comparative voting power -- that "right preservative of rights" in the control of a corporation.

Page 252 U. S. 213

Yet, without selling, the shareholder, unless possessed of other resources, has not the wherewithal to pay an income tax upon the dividend stock. Nothing could more clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that, in the nature of things, it requires conversion of capital in order to pay the tax.

Throughout the argument of the government, in a variety of forms, runs the fundamental error already mentioned -- a failure to appraise correctly the force of the term "income" as used in the Sixteenth Amendment, or at least to give practical effect to it. Thus, the government contends that the tax "is levied on income derived from corporate earnings," when in truth the stockholder has "derived" nothing except paper certificates, which, so far as they have any effect, deny him present participation in such earnings. It contends that the tax may be laid when earnings "are received by the stockholder," whereas he has received none; that the profits are "distributed by means of a stock dividend," although a stock dividend distributes no profits; that, under the Act of 1916, "the tax is on the stockholder's share in corporate earnings," when in truth a stockholder has no such share, and receives none in a stock dividend; that "the profits are segregated from his former capital, and he has a separate certificate representing his invested profits or gains," whereas there has been no segregation of profits, nor has he any separate certificate representing a personal gain, since the certificates, new and old, are alike in what they represent -- a capital interest in the entire concerns of the corporation.

We have no doubt of the power or duty of a court to look through the form of the corporation and determine the question of the stockholder's right in order to ascertain whether he has received income taxable by Congress without apportionment. But, looking through the form,

Page 252 U. S. 214

we cannot disregard the essential truth disclosed, ignore the substantial difference between corporation and stockholder, treat the entire organization as unreal, look upon stockholders as partners when they are not such, treat them as having in equity a right to a partition of the corporate assets when they have none, and indulge the fiction that they have received and realized a share of the profits of the company which in truth they have neither received nor realized. We must treat the corporation as a substantial entity separate from the stockholder not only because such is the practical fact, but because it is only by recognizing such separateness that any dividend -- even one paid in money or property -- can be regarded as income of the stockholder. Did we regard corporation and stockholders as altogether identical, there would be no income except as the corporation acquired it, and while this would be taxable against the corporation as income under appropriate provisions of law, the individual stockholders could not be separately and additionally taxed with respect to their several shares even when divided, since, if there were entire identity between them and the company, they could not be regarded as receiving anything from it, any more than if one's money were to be removed from one pocket to another.

Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the government nevertheless contends that the new certificates measure the extent to which the gains accumulated by the corporation

have made him the richer. There are two insuperable difficulties with this. In the first place, it would depend upon how long he had held the stock whether the stock dividend indicated the extent to which he had been enriched by the operations of the company; unless he had held it throughout such operations, the measure would not hold true. Secondly, and more important for present purposes, enrichment through increase in value

Page 252 U. S. 215

of capital investment is not income in any proper meaning of the term.

The complaint contains averments respecting the market prices of stock such as plaintiff held, based upon sales before and after the stock dividend, tending to show that the receipt of the additional shares did not substantially change the market value of her entire holdings. This tends to show that, in this instance, market quotations reflected intrinsic values -- a thing they do not always do. But we regard the market prices of the securities as an unsafe criterion in an inquiry such as the present, when the question must be not what will the thing sell for, but what is it in truth and in essence.

It is said there is no difference in principle between a simple stock dividend and a case where stockholders use money received as cash dividends to purchase additional stock contemporaneously issued by the corporation. But an actual cash dividend, with a real option to the stockholder either to keep the money for his own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend, such as the one we have under consideration, where nothing of value is taken from the company's assets and transferred to the individual ownership of the several stockholders and thereby subjected to their disposal.

The government's reliance upon the supposed analogy between a dividend of the corporation's own shares and one made by distributing shares owned by it in the stock of another company calls for no comment beyond the statement that the latter distributes assets of the company among the shareholders, while the former does not, and for no citation of authority except Peabody v. Eisner, 247 U. S. 347, 247 U. S. 349-350.

Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the position of the government.

Page 252 U. S. 216

Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose under the Dividend Duties Act of Western Australia, which provided that "dividend" should include "every dividend, profit, advantage, or gain intended to be paid or credited to or distributed among any members or directors of any company," except, etc. There was a stock dividend, the new shares being allotted among the shareholders pro rata, and the question was whether this was a distribution of a dividend within the meaning of the act. The Judicial Committee of the Privy Council sustained the dividend duty upon the ground that, although "in ordinary language the new shares would not be called a dividend, nor would the allotment of them be a distribution of a dividend," yet, within the meaning of the act, such new shares were an "advantage" to the recipients. There being no constitutional restriction upon the action of the lawmaking body, the case presented merely a question of statutory construction, and manifestly the decision is not a precedent for the guidance of this Court when acting under a duty to test an act of Congress by the limitations of a written Constitution having superior force.



In Tax Commissioner v. Putnam, (1917) 227 Mass. 522, it was held that the Forty-Fourth amendment to the Constitution of Massachusetts, which conferred upon the legislature full power to tax incomes, "must be interpreted as including every item which by any reasonable understanding can fairly be regarded as income" (pp. 526, 531), and that under it, a stock dividend was taxable as income, the court saying (p. 535):

"In essence, the thing which has been done is to distribute a symbol representing an accumulation of profits, which, instead of being paid out in cash, is invested in the business, thus augmenting its durable assets. In this aspect of the case, the substance of the transaction is no different from what it would be if a cash dividend had been declared with the privilege of subscription to an equivalent amount of new shares. "

Page 252 U. S. 217

We cannot accept this reasoning. Evidently, in order to give a sufficiently broad sweep to the new taxing provision, it was deemed necessary to take the symbol for the substance, accumulation for distribution, capital accretion for its opposite, while a case where money is paid into the hand of the stockholder with an option to buy new shares with it, followed by acceptance of the option, was regarded as identical in substance with a case where the stockholder receives no money and has no option. The Massachusetts court was not under an obligation, like the one which binds us, of applying a constitutional amendment in the light of other constitutional provisions that stand in the way of extending it by construction.

Upon the second argument, the government, recognizing the force of the decision in Towne v. Eisner, supra, and virtually abandoning the contention that a stock dividend increases the interest of the stockholder or otherwise enriches

him, insisted as an alternative that, by the true construction of the Act of 1916, the tax is imposed not upon the stock dividend, but rather upon the stockholder's share of the undivided profits previously accumulated by the corporation, the tax being levied as a matter of convenience at the time such profits become manifest through the stock dividend. If so construed, would the act be constitutional?

That Congress has power to tax shareholders upon their property interests in the stock of corporations is beyond question, and that such interests might be valued in view of the condition of the company, including its accumulated and undivided profits, is equally clear. But that this would be taxation of property because of ownership, and hence would require apportionment under the provisions of the Constitution, is settled beyond peradventure by previous decisions of this Court.

The government relies upon Collector v. Hubbard, (1870)

Page 252 U. S. 218

12 Wall. 1, which arose under § 117 of the Act of June 30, 1864, c. 173, 13 Stat. 223, 282, providing that

"The gains and profits of all companies, whether incorporated or partnership, other than the companies specified in that section, shall be included in estimating the annual gains, profits, or income of any person, entitled to the same, whether divided or otherwise."


The court held an individual taxable upon his proportion of the earnings of a corporation although not declared as dividends and although invested in assets not in their nature divisible. Conceding that the stockholder for certain purposes had no title prior to dividend declared, the court nevertheless said (p. 79 U. S. 18):

"Grant all that, still it is true that the owner of a share of stock in a corporation holds the share with all its incidents, and that among those incidents is the right to receive all future dividends -- that is, his proportional share of all profits not then divided. Profits are incident to the share to which the owner at once becomes entitled provided he remains a member of the corporation until a dividend is made. Regarded as an incident to the shares, undivided profits are property of the shareholder, and as such are the proper subject of sale, gift, or devise. Undivided profits invested in real estate, machinery, or raw material for the purpose of being manufactured are investments in which the stockholders are interested, and when such profits are actually appropriated to the payment of the debts of the corporation, they serve to increase the market value of the shares, whether held by the original subscribers or by assignees."

Insofar as this seems to uphold the right of Congress to tax without apportionment a stockholder's interest in accumulated earnings prior to dividend declared, it must be regarded as overruled by Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, 158 U. S. 627-628, 158 U. S. 637. Conceding Collector v. Hubbard was inconsistent with the doctrine of that case, because it sustained a direct tax upon property not apportioned

Page 252 U. S. 219

among the states, the government nevertheless insists that the sixteenth Amendment removed this obstacle, so that now the Hubbard case is authority for the power of Congress to levy a tax on the stockholder's share in the accumulated





profits of the corporation even before division by the declaration of a dividend of any kind. Manifestly this argument must be rejected, since the amendment applies to income only, and what is called the stockholder's share in the accumulated profits of the company is capital, not income. As we have pointed out, a stockholder has no individual share in accumulated profits, nor in any particular part of the assets of the corporation, prior to dividend declared.

Thus, from every point of view, we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder. The Revenue Act of 1916, insofar as it imposes a tax upon the stockholder because of such dividend, contravenes the provisions of Article I, § 2, cl. 3, and Article I, § 9, cl. 4, of the Constitution, and to this extent is invalid notwithstanding the Sixteenth Amendment.

Judgment affirmed.

*

"Title I. -- Income Tax"

"Part I. -- On Individuals"

"Sec. 2. (a) That, subject only to such exemptions and deductions as are hereinafter allowed, the net income of a taxable person shall include gains, profits, and income derived, . . . also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source

whatever: Provided, that the term 'dividends' as used in this title shall be held to mean any distribution made or ordered to be made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether, in cash or in stock of the corporation, . . . which stock dividend shall be considered income, to the amount of its cash value."

MR. JUSTICE HOLMES, dissenting.

I think that Towne v. Eisner, 245 U. S. 418, was right in its reasoning and result, and that, on sound principles, the stock dividend was not income. But it was clearly intimated in that case that the construction of the statute then before the Court might be different from that of the Constitution. 245 U.S. 245 U. S. 425. I think that the word "incomes" in the Sixteenth Amendment should be read in

Page 252 U. S. 220

"a sense most obvious to the common understanding at the time of its adoption." Bishop v. State, 149 Ind. 223, 230; State v. Butler, 70 Fla. 102, 133. For it was for public adoption that it was proposed. McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407. The known purpose of this Amendment was to get rid of nice questions as to what might be direct taxes, and I cannot doubt that most people not lawyers would suppose when they voted for it that they put a question like the present to rest. I am of opinion that the Amendment justifies the tax. See Tax Commissioner v. Putnam, 227 Mass. 522, 532, 533.

MR. JUSTICE DAY concurs in this opinion.





MR. JUSTICE BRANDEIS delivered the following opinion, in which MR. JUSTICE CLARKE concurred.

Financiers, with the aid of lawyers, devised long ago two different methods by which a corporation can, without increasing its indebtedness, keep for corporate purposes accumulated profits, and yet, in effect, distribute these profits among its stockholders. One method is a simple one. The capital stock is increased; the new stock is paid up with the accumulated profits, and the new shares of paid-up stock are then distributed among the stockholders pro rata as a dividend. If the stockholder prefers ready money to increasing his holding of the stock in the company, he sells the new stock received as a dividend. The other method is slightly more complicated. .arrangements are made for an increase of stock to be offered to stockholders pro rata at par, and at the same time for the payment of a cash dividend equal to the amount which the stockholder will be required to pay to

Page 252 U. S. 221

the company, if he avails himself of the right to subscribe for his pro rata of the new stock. If the stockholder takes the new stock, as is expected, he may endorse the dividend check received to the corporation, and thus pay for the new stock. In order to ensure that all the new stock so offered will be taken, the price at which it is offered is fixed far below what it is believed will be its market value. If the stockholder prefers ready money to an increase of his holdings of stock, he may sell his right to take new stock pro rata, which is evidenced by an assignable instrument. In that event the purchaser of the rights repays to the corporation, as the subscription price of the new stock, an amount equal to that which it had paid as a cash dividend to the stockholder.

Both of these methods of retaining accumulated profits while in effect distributing them as a dividend had been in common use in the United States for many years prior to the adoption of the Sixteenth Amendment. They were recognized equivalents. Whether a particular corporation employed one or the other method was determined sometimes by requirements of the law under which the corporation was organized; sometimes it was determined by preferences of the individual officials of the corporation, and sometimes by stock market conditions. Whichever method was employed, the resultant distribution of the new stock was commonly referred to as a stock dividend. How these two methods have been employed may be illustrated by the action in this respect (as reported in Moody's Manual, 1918 Industrial, and the Commercial and Financial Chronicle) of some of the Standard Oil companies since the disintegration pursuant to the decision of this Court in 1911. Standard Oil Co. v. United States, 221 U. S. 1.

(a) Standard Oil Co. (of Indiana), an Indiana corporation. It had on December 31, 1911, $1,000,000 capital stock (all common), and a large surplus. On May 15,

Page 252 U. S. 222

1912, it increased its capital stock to $30,000,000, and paid a simple stock dividend of 2,900 percent in stock. [Footnote 1]

(b) Standard Oil Co. (of Nebraska), a Nebraska corporation. It had on December 31, 1911, $600,000 capital stock (all common), and a substantial surplus. On April 15, 1912, it paid a simple stock dividend of 33 1/3 percent, increasing the outstanding capital to $800,000. During the calendar year 1912, it paid cash dividends aggregating 20 percent, but it

http://supreme.justia.com/cases/federal/us/252/189/case.html#F1


earned considerably more, and had at the close of the year again a substantial surplus. On June 20, 1913, it declared a further stock dividend of 25 percent, thus increasing the capital to $1,000,000. [Footnote 2]

(c) The Standard Oil Co. (of Kentucky), a Kentucky corporation. It had on December 31, 1913, $1,000,000 capital stock (all common) and $3,701,710 surplus. Of this surplus, $902,457 had been earned during the calendar year 1913, the net profits of that year having been $1,002,457 and the dividends paid only $100,000 (10 percent). On December 22, 1913, a cash dividend of $200 per share was declared payable on February 14, 1914, to stockholders of record January 31, 1914, and these stockholders were offered the right to subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor. The outstanding stock was thus increased to $3,000,000. During the calendar years 1914, 1915, and 1916, quarterly dividends were paid on this stock at an annual rate of between 15 percent and 20 percent, but the company's surplus increased by $2,347,614, so that, on December 31, 1916, it had a large surplus over its $3,000,000 capital stock. On December 15, 1916, the company issued a circular to the stockholders, saying:

"The company's business for this year has shown a

Page 252 U. S. 223

very good increase in volume and a proportionate increase in profits, and it is estimated that, by January 1, 1917, the company will have a surplus of over $4,000,000. The board feels justified in stating that, if the proposition to increase the capital stock is acted on favorably, it will be proper in the near future to declare a cash dividend of 100 percent and


to allow the stockholders the privilege pro rata according to their holdings, to purchase the new stock at par, the plan being to allow the stockholders, if they desire, to use their cash dividend to pay for the new stock."

The increase of stock was voted. The company then paid a cash dividend of 100 percent, payable May 1, 1917, again offering to such stockholders the right to subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor.

Moody's Manual, describing the transaction with exactness, says first that the stock was increased from $3,000,000 to $6,000,000, "a cash dividend of 100 percent, payable May 1, 1917, being exchanged for one share of new stock, the equivalent of a 100 percent stock dividend." But later in the report giving, as customary in the Manual, the dividend record of the company, the Manual says: "A stock dividend of 200 percent was paid February 14, 1914, and one of 100 percent on May 1, 1197." And, in reporting specifically the income account of the company for a series of years ending December 31, covering net profits, dividends paid, and surplus for the year, it gives, as the aggregate of dividends for the year 1917, $660,000 (which was the aggregate paid on the quarterly cash dividend -- 5 percent January and April; 6 percent July and October), and adds in a note: "In addition, a stock dividend of 100 percent was paid during the year." [Footnote 3] The Wall Street Journal of

Page 252 U. S. 224

May 2, 1917, p. 2, quotes the 1917 "high" price for Standard Oil of Kentucky as "375 ex stock dividend."


It thus appears that, among financiers and investors, the distribution of the stock, by whichever method effected, is called a stock dividend; that the two methods by which accumulated profits are legally retained for corporate purposes and at the same time distributed as dividends are recognized by them to be equivalents, and that the financial results to the corporation and to the stockholders of the two methods are substantially the same, unless a difference results from the application of the federal income tax law.

Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder in the Standard Oil Company (of California), a corporation organized under the laws of California and having its principal place of business in that state. During that year, she received from the company a stock dividend representing profits earned since March 1, 1913. The dividend was paid by direct issue of the stock to her according to the simple method described above, pursued also by the Indiana and Nebraska companies. In 1917, she was taxed under the federal law on the stock dividend so received at its par value of $100 a share, as income received during the year 1916. Such a stock dividend is income, as distinguished from capital, both under the law of New York and under the law of California, because in both states every dividend representing profits is deemed to be income, whether paid in cash or in stock. It had been so held in New York, where the question arose as between life tenant and remainderman, Lowry v. Farmers' Loan & Trust Co., 172 N.Y. 137; Matter of Osborne, 209 N.Y. 450, and also, where the question arose in matters of taxation, People v. Glynn,

Page 252 U. S. 225

130 App.Div. 332, 198 N.Y. 605. It has been so held in California, where the question appears to have arisen only in controversies between life tenant and remainderman. Estate of Duffill, 58 Cal.Dec. 97, 180 Cal. 748.

It is conceded that, if the stock dividend paid to Mrs. Macomber had been made by the more complicated method pursued by the Standard Oil Company of Kentucky -- that is, issuing rights to take new stock pro rata and paying to each stockholder simultaneously a dividend in cash sufficient in amount to enable him to pay for this pro rata of new stock to be purchased -- the dividend so paid to him would have been taxable as income, whether he retained the cash or whether he returned it to the corporation in payment for his pro rata of new stock. But it is contended that, because the simple method was adopted of having the new stock issued direct to the stockholders as paid-up stock, the new stock is not to be deemed income, whether she retained it or converted it into cash by sale. If such a different result can flow merely from the difference in the method pursued, it must be because Congress is without power to tax as income of the stockholder either the stock received under the latter method or the proceeds of its sale, for Congress has, by the provisions in the Revenue Act of 1916, expressly declared its purpose to make stock dividends, by whichever method paid, taxable as income.

The Sixteenth Amendment, proclaimed February 25, 1913, declares:

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration."

The Revenue Act of September 8, 1916, c. 463, § 2a, 39 Stat. 756, 757, provided:

"That the term 'dividends' as used in this title shall

Page 252 U. S. 226

be held to mean any distribution made or ordered to be made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, . . . which stock dividend shall be considered income, to the amount of its cash value."

Hitherto, powers conferred upon Congress by the Constitution have been liberally construed, and have been held to extend to every means appropriate to attain the end sought. In determining the scope of the power, the substance of the transaction, not its form, has been regarded. Martin v. Hunter, 1 Wheat. 304, 14 U. S. 326; McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407, 17 U. S. 415; Brown v. Maryland, 12 Wheat. 419, 25 U. S. 446; Craig v. Missouri, 4 Pet. 410, 29 U. S. 433; Jarrolt v. Moberly, 103 U. S. 580, 103 U. S. 585-587; Legal Tender Case, 110 U. S. 421, 110 U. S. 444; Lithograph Co. v. Sarony, 111 U. S. 53, 111 U. S. 58; United States v. Realty Co., 163 U. S. 427, 163 U. S. 440-442; South Carolina v. United States, 199 U. S. 437, 199 U. S. 448-449. Is there anything in the phraseology of the Sixteenth Amendment or in the nature of corporate dividends which should lead to a departure from these rules of construction and compel this Court to hold that Congress is powerless to prevent a result so extraordinary as that here contended for by the stockholder?

First. The term "income," when applied to the investment of the stockholder in a corporation, had, before the adoption of the Sixteenth Amendment, been commonly understood to mean the returns from time to time received by the stockholder from gains or earnings of the corporation. A dividend received by a stockholder from a corporation may be





















either in distribution of capital assets or in distribution of profits. Whether it is the one or the other is in no way affected by the medium in which it is paid, nor by the method or means through which the particular thing distributed as a dividend was procured. If the

Page 252 U. S. 227

dividend is declared payable in cash, the money with which to pay it is ordinarily taken from surplus cash in the treasury. But (if there are profits legally available for distribution and the law under which the company was incorporated so permits) the company may raise the money by discounting negotiable paper, or by selling bonds, scrip or stock of another corporation then in the treasury, or by selling its own bonds, scrip or stock then in the treasury, or by selling its own bonds, scrip or stock issued expressly for that purpose. How the money shall be raised is wholly a matter of financial management. The manner in which it is raised in no way affects the question whether the dividend received by the stockholder is income or capital, nor can it conceivably affect the question whether it is taxable as income.

Likewise whether a dividend declared payable from profits shall be paid in cash or in some other medium is also wholly a matter of financial management. If some other medium is decided upon, it is also wholly a question of financial management whether the distribution shall be, for instance, in bonds, scrip or stock of another corporation or in issues of its own. And if the dividend is paid in its own issues, why should there be a difference in result dependent upon whether the distribution was made from such securities then in the treasury or from others to be created and issued by the company expressly for that purpose? So far as the distribution may be made from its own issues of bonds,

or preferred stock created expressly for the purpose, it clearly would make no difference, in the decision of the question whether the dividend was a distribution of profits, that the securities had to be created expressly for the purpose of distribution. If a dividend paid in securities of that nature represents a distribution of profits, Congress may, of course, tax it as income of the stockholder. Is the result different where the security distributed is common stock?

Page 252 U. S. 228

Suppose that a corporation having power to buy and sell its own stock purchases, in the interval between its regular dividend dates, with moneys derived from current profits, some of its own common stock as a temporary investment, intending at the time of purchase to sell it before the next dividend date and to use the proceeds in paying dividends, but later, deeming it inadvisable either to sell this stock or to raise by borrowing the money necessary to pay the regular dividend in cash, declares a dividend payable in this stock; can anyone doubt that, in such a case, the dividend in common stock would be income of the stockholder and constitutionally taxable as such? See Green v. Bissell, 79 Conn. 547; Leland v. Hayden, 102 Mass. 542. And would it not likewise be income of the stockholder subject to taxation if the purpose of the company in buying the stock so distributed had been from the beginning to take it off the market and distribute it among the stockholders as a dividend, and the company actually did so? And, proceeding a short step further, suppose that a corporation decided to capitalize some of its accumulated profits by creating additional common stock and selling the same to raise working capital, but after the stock has been issued and certificates therefor are delivered to the bankers for sale, general financial conditions make it undesirable to market the stock, and the company concludes that it is wiser to husband, for working capital, the cash which it had intended to use in paying stockholders a dividend, and, instead, to pay the dividend in the common stock which it had planned to sell; would not the stock so

distributed be a distribution of profits, and hence, when received, be income of the stockholder and taxable as such? If this be conceded, why should it not be equally income of the stockholder, and taxable as such, if the common stock created by capitalizing profits had been originally created for the express purpose of being distributed

Page 252 U. S. 229

as a dividend to the stockholder who afterwards received it?

Second. It has been said that a dividend payable in bonds or preferred stock created for the purpose of distributing profits may be income and taxable as such, but that the case is different where the distribution is in common stock created for that purpose. Various reasons are assigned for making this distinction. One is that the proportion of the stockholder's ownership to the aggregate number of the shares of the company is not changed by the distribution. But that is equally true where the dividend is paid in its bonds or in its preferred stock. Furthermore, neither maintenance nor change in the proportionate ownership of a stockholder in a corporation has any bearing upon the question here involved. Another reason assigned is that the value of the old stock held is reduced approximately by the value of the new stock received, so that the stockholder, after receipt of the stock dividend, has no more than he had before it was paid. That is equally true whether the dividend be paid in cash or in other property -- for instance, bonds, scrip, or preferred stock of the company. The payment from profits of a large cash dividend, and even a small one, customarily lowers the then market value of stock because the undivided property represented by each share has been correspondingly reduced. The argument which appears to be most strongly urged for the stockholders is that, when a stock dividend is made, no portion of the assets of the company is thereby segregated for the stockholder. But does the

issue of new bonds or of preferred stock created for use as a dividend result in any segregation of assets for the stockholder? In each case, he receives a piece of paper which entitles him to certain rights in the undivided property. Clearly, segregation of assets in a physical sense is not an essential of income. The year's gains of a partner is taxable as income although there likewise no

Page 252 U. S. 230

segregation of his share in the gains from that of his partners is had.

The objection that there has been no segregation is presented also in another form. It is argued that, until there is a segregation, the stockholder cannot know whether he has really received gains, since the gains may be invested in plant or merchandise or other property, and perhaps be later lost. But is not this equally true of the share of a partner in the year's profits of the firm or, indeed, of the profits of the individual who is engaged in business alone? And is it not true also when dividends are paid in cash? The gains of a business, whether conducted by an individual, by a firm, or by a corporation are ordinarily reinvested in large part. Many a cash dividend honestly declared as a distribution of profits proves later to have been paid out of capital because errors in forecast prevent correct ascertainment of values. Until a business adventure has been completely liquidated, it can never be determined with certainty whether there have been profits unless the returns at least exceeded the capital originally invested. Businessmen, dealing with the problem practically, fix necessarily periods and rules for determining whether there have been net profits -- that is, income or gains. They protect themselves from being seriously misled by adopting a system of depreciation charges and reserves.

Then they act upon their own determination whether profits have been made. Congress, in legislating, has wisely adopted their practices as its own rules of action.

Third. The government urges that it would have been within the power of Congress to have taxed as income of the stockholder his pro rata share of undistributed profits earned even if no stock dividend representing it had been paid. Strong reasons may be assigned for such a view. See Collector v. Hubbard, 12 Wall. 1. The undivided share of a partner in the year's undistributed profits of his firm

Page 252 U. S. 231

is taxable as income of the partner although the share in the gain is not evidenced by any action taken by the firm. Why may not the stockholder's interest in the gains of the company? The law finds no difficulty in disregarding the corporate fiction whenever that is deemed necessary to attain a just result. Linn Timber Co. v. United States, 236 U. S. 574. See Morawetz on Corporations, 2d ed., §§ 227-231; Cook on Corporations, 7th ed., §§ 663, 664. The stockholder's interest in the property of the corporation differs not fundamentally, but in form only, from the interest of a partner in the property of the firm. There is much authority for the proposition that, under our law, a partnership or joint stock company is just as distinct and palpable an entity in the idea of the law, as distinguished from the individuals composing it, as is a corporations. [Footnote 4] No reason appears, why Congress, in legislating under a grant of power so comprehensive as that authorizing the levy of an income tax, should be limited by the particular view of the relation of the stockholder to the corporation and its property which may, in the absence of legislation, have been taken by this Court. But we have no occasion to decide the question whether Congress might have taxed to the stockholder his




undivided share of the corporation's earnings. For Congress has in this act limited the income tax to that share of the stockholder in the earnings which is, in effect, distributed by means of the stock dividend paid. In other words, to render the stockholder taxable, there must be both earnings made and a dividend paid. Neither earnings without dividend nor a dividend without earnings subjects the

Page 252 U. S. 232

stockholder to taxation under the Revenue Act of 1916.

Fourth. The equivalency of all dividends representing profits, whether paid of all dividends in stock, is so complete that serious question of the taxability of stock dividends would probably never have been made if Congress had undertaken to tax only those dividends which represented profits earned during the year in which the dividend was paid or in the year preceding. But this Court, construing liberally not only the constitutional grant of power but also the revenue Act of 1913, held that Congress might tax, and had taxed, to the stockholder dividends received during the year, although earned by the company long before, and even prior to the adoption of the Sixteenth Amendment. Lynch v. Hornby, 247 U. S. 339. [Footnote 5] That rule, if indiscriminatingly applied to all stock dividends representing profits earned, might, in view of corporate practice, have worked considerable hardship and have raised serious questions. Many corporations, without legally capitalizing any part of their profits, had assigned definitely some part or all of the annual balances remaining after paying the usual cash dividends to the uses to which permanent capital is ordinarily applied. Some of the corporations doing this transferred such balances on their books to "surplus" account -- distinguishing between such permanent "surplus" and the "undivided profits" account. Other corporations, without this formality, had




assumed that the annual accumulating balances carried as undistributed profits were to be treated as capital permanently invested in the business. And still others, without definite assumption of any kind, had

Page 252 U. S. 233

so used undivided profits for capital purposes. To have made the revenue law apply retroactively so as to reach such accumulated profits, if and whenever it should be deemed desirable to capitalize them legally by the issue of additional stock distributed as a dividend to stockholders, would have worked great injustice. Congress endeavored in the Revenue Act of 1916 to guard against any serious hardship which might otherwise have arisen from making taxable stock dividends representing accumulated profits. It did not limit the taxability to stock dividends representing profits earned within the tax year or in the year preceding, but it did limit taxability to such dividends representing profits earned since March 1, 1913. Thereby stockholders were given notice that their share also in undistributed profits accumulating thereafter was at some time to be taxed as income. And Congress sought by § 3 to discourage the postponement of distribution for the illegitimate purpose of evading liability to surtaxes.

Fifth. The decision of this Court that earnings made before the adoption of the Sixteenth Amendment, but paid out in cash dividend after its adoption, were taxable as income of the stockholder involved a very liberal construction of the amendment. To hold now that earnings both made and paid out after the adoption of the Sixteenth Amendment cannot be taxed as income of the stockholder, if paid in the form of a stock dividend, involves an exceedingly narrow construction of it. As said by Mr. Chief Justice Marshall in Brown v. Maryland, 12 Wheat. 419, 25 U. S. 446:



"To construe the power so as to impair its efficacy would tend to defeat an object in the attainment of which the American public took, and justly took, that strong interest which arose from a full conviction of its necessity."

No decision heretofore rendered by this Court requires us to hold that Congress, in providing for the taxation of

Page 252 U. S. 234

stock dividends, exceeded the power conferred upon it by the Sixteenth Amendment. The two cases mainly relied upon to show that this was beyond the power of Congress are Towne v. Eisner, 245 U. S. 418, which involved a question not of constitutional power, but of statutory construction, and Gibbons v. Mahon, 136 U. S. 549, which involved a question arising between life tenant and remainderman. So far as concerns Towne v. Eisner, we have only to bear in mind what was there said (p. 245 U. S. 425): "But it is not necessarily true that income means the same thing in the Constitution and the [an] act." [Footnote 6] Gibbons v. Mahon is even less an authority for a narrow construction of the power to tax incomes conferred by the Sixteenth Amendment. In that case, the court was required to determine how, in the administration of an estate in the District of Columbia, a stock dividend, representing profits, received after the decedent's death, should be disposed of as between life tenant and remainderman. The question was, in essence, what shall the intention of the testator be presumed to have been? On this question, there was great diversity of opinion and practice in the courts of English-speaking countries. Three well defined rules were then competing for acceptance. Two of these involves an arbitrary rule of distribution, the third equitable apportionment. See Cook on Corporations, 7th ed., §§ 552-558.

1. The so-called English rule, declared in 1799 by Brander v. Brander, 4 Ves. Jr. 800, that a dividend representing





Page 252 U. S. 235

profits, whether in cash, stock or other property, belongs to the life tenant if it was a regular or ordinary dividend, and belongs to the remainderman if it was an extraordinary dividend.

2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, that a dividend representing profits, whether regular, ordinary, or extraordinary, if in cash belongs to the life tenant, and if in stock belongs to the remainderman.

3. The so-called Pennsylvania rule, declared in 1857 by Earp's Appeal, 28 Pa. 368, that, where a stock dividend is paid, the court shall inquire into the circumstances under which the fund had been earned and accumulated out of which the dividend, whether a regular, an ordinary, or an extraordinary one, was paid. If it finds that the stock dividend was paid out of profits earned since the decedent's death, the stock dividend belongs to the life tenant; if the court finds that the stock dividend was paid from capital or from profits earned before the decedent's death, the stock dividend belongs to the remainderman.

This Court adopted in Gibbons v. Mahon as the rule of administration for the District of Columbia the so-called Massachusetts rule, the opinion being delivered in 1890 by Mr. Justice Gray. Since then, the same question has come up for decision in many of the states. The so-called Massachusetts rule, although approved by this Court, has found favor in only a few states. The so-called Pennsylvania rule, on the other hand, has been adopted since by so many of the states (including New York and California) that it has come to be known as the "American rule." Whether, in view of these facts and the practical results of the operation of the two rules as shown by the experience of the 30 years which

have elapsed since the decision in Gibbons v. Mahon, it might be desirable for this Court to reconsider the question there decided, as

Page 252 U. S. 236

some other courts have done (see 29 Harvard Law Review 551), we have no occasion to consider in this case. For, as this Court there pointed out (p. 136 U. S. 560), the question involved was one "between the owners of successive interests in particular shares," and not, as in Bailey v. Railroad Co., 22 Wall. 604, a question

"between the corporation and the government, and [which] depended upon the terms of a statute carefully framed to prevent corporations from evading payment of the tax upon their earnings."

We have, however, not merely argument; we have examples which should convince us that "there is no inherent, necessary and immutable reason why stock dividends should always be treated as capital." Tax Commissioner v. Putnam, 227 Mass. 522, 533. The Supreme Judicial Court of Massachusetts has steadfastly adhered, despite ever-renewed protest, to the rule that every stock dividend is, as between life tenant and remainderman, capital, and not income. But, in construing the Massachusetts Income Tax Amendment, which is substantially identical with the federal amendment, that court held that the legislature was thereby empowered to levy an income tax upon stock dividends representing profits. The courts of England have, with some relaxation, adhered to their rule that every extraordinary dividend is, as between life tenant and remainderman, to be deemed capital. But, in 1913, the Judicial Committee of the Privy Council held that a stock dividend representing accumulated profits was taxable like an ordinary cash dividend, Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231. In dismissing the appeal, these words of the Chief Justice of the



Supreme Court of Western Australia were quoted (p. 236), which show that the facts involved were identical with those in the case at bar:

"Had the company distributed the �101,450 among the shareholders, and had the shareholders repaid such sums to the company as the price of the 81, 160 new shares, the duty on the �101,450

Page 252 U. S. 237

would clearly have been payable. Is not this virtually the effect of what was actually done? I think it is."

Sixth. If stock dividends representing profits are held exempt from taxation under the Sixteenth Amendment, the owners of the most successful businesses in America will, as the facts in this case illustrate, be able to escape taxation on a large part of what is actually their income. So far as their profits are represented by stock received as dividends, they will pay these taxes not upon their income, but only upon the income of their income. That such a result was intended by the people of the United States when adopting the Sixteenth Amendment is inconceivable. Our sole duty is to ascertain their intent as therein expressed. [Footnote 7] In terse, comprehensive language befitting the Constitution, they empowered Congress "to lay and collect taxes on incomes from whatever source derived." They intended to include thereby everything which by reasonable understanding can fairly be regarded as income. That stock dividends representing profits are so regarded not only by the plain people, but by investors and financiers and by most of the courts of the country, is shown beyond peradventure by their acts and by their utterances. It seems to me clear, therefore, that Congress possesses the power which it exercised to make dividends representing profits taxable as


income whether the medium in which the dividend is paid be cash or stock, and that it may define, as it has done, what dividends representing

Page 252 U. S. 238

profits shall be deemed income. It surely is not clear that the enactment exceeds the power granted by the Sixteenth Amendment. And, as this Court has so often said, the high prerogative of declaring an act of Congress invalid should never be exercised except in a clear case. [Footnote 8]

"It is but a decent respect due to the wisdom, the integrity, and the patriotism of the legislative body by which any law is passed to presume in favor of its validity until its violation of the Constitution is proved beyond all reasonable doubt."


G.R. Nos. L-12010 and L-12113 October 20, 1959

KUENZLE & STREIFF, INC., petitioner, vs.THE COLLECTOR OF INTERNAL REVENUE, respondents.

Angel S. Gamboa for petitioner.Office of the Solicitor General Ambrosio Padilla, Assistant Solicitor General Jose P. Alejandro and Special Attorney Librada del Rosario-Natividad for respondent.

BAUTISTA ANGELO, J.:

This is a petition for review of a decision of the Court of Tax Appeals, as later modified, declaring petitioner liable for the total sum of P33,187.00 as deficiency income tax due for the years 1950, 1951 and 1952.

Petitioner is a domestic corporation engaged in the importation of textiles, hardware, sundries, chemicals, pharmaceuticals, lumbers, groceries, wines and liquor; in insurance and lumber; and in some exports. In the income tax returns for the years 1950, 1951 and 1952 it filed with respondent, petitioner deducted from its gross income certain items representing salaries, directors' fees and bonuses of its non-resident president and vice-president; bonuses of its resident officers and employees; and interests on earned but unpaid salaries and bonuses of its officers and employees. The income tax computed in accordance with these returns was duly paid by petitioner.

On July 2, 1953, after disallowing the deductions of the items representing director's fees, salaries and bonuses of petitioner's non-resident president and vice-president; the bonus participation of certain resident officers and employees; and the interests on earned but unpaid salaries and bonuses, respondent assessed and demanded from petitioner the payment of deficiency income taxes in the sums of P26,370.00, P53,865.00 and P44,112.00 for the years 1950, 1951 and 1952, respectively. Petitioner requested for the re-examination of this assessment, and June 8, 1955, respondent modified the same by allowing as deductible all items comprising directors' fees and salaries of the non-resident president and vice-president, but disallowing the bonuses insofar as they exceed the salaries of the recipients, as well as the interests on earned but unpaid salaries and bonuses. Hence, for the years 1950, 1951 and 1952, respondent made a new assessment and demanded from petitioner as deficiency income taxes the amounts of P10,147.00, P26,783.00 and P20,481.00, respectively. Petitioner having taken the case on appeal to the Court of Tax Appeals, the latter modified the assessment of respondent as stated in the early part of this decision.

From this decision both parties have appealed, petitioner from that portion which holds that the measure of the reasonableness of the bonuses paid to its non-resident president and vice-president should be applied to the bonuses given to resident officers and employees in determining their deductibility and so only so much of said bonuses as applied to the latter should be allowed as deduction, and respondent from that portion of the decision which allows the deduction of so much of the bonuses which is in excess of the yearly salaries paid to the respective recipients thereof.

The law involved here is Section 30 (a)(1) and (b)(1) of the National Internal Revenue Code, the pertinent provisions of which we quote:

SEC. 30. Deductions from gross income. — In computing net income there shall be allowed as deductions —

(a) Expenses:

(1) In general. — All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered;

(b) Interest:

(1) In general. — The amount of interest paid within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt from taxation as income under this Title.

It would appear that all ordinary and necessary expenses paid or incurred in carrying on a trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, may be allowed as deductions in computing the taxable income during the year. It likewise appears that the amount of interests paid within the taxable year on any indebtedness may also be deducted from the gross income. Here it is admitted that the bonuses paid to the officers and employees of petitioner, whether resident or non-resident, were paid to them as additional compensation for personal services actually rendered and as such can be considered as ordinary and necessary expenses incurred in the business within the meaning of the law, the only question in dispute being how much of said bonuses may be considered reasonable in order that it may be allowed as deduction.

It should be noted that petitioner gave to its non-resident president and vice president for the years 1950 and 1951 bonuses equal to 133-1/2% of their annual salaries and bonuses equal to 125-2/3% for the year 1952, whereas with regard to its resident officers and employees it gave them much more on the alleged reason that they deserved them because of their valuable contribution to the business of the corporation which has made it possible for it to realize huge profits during the aforesaid years. And the Court of Tax Appeals ruled that while the bonuses given to the non-resident officers are reasonable considering their yearly salaries and the services actually rendered by them, the bonuses given to the resident officers and employees are, however, quite excessive, the court saying on this point that "there is no special reason for granting greater bonuses to such lower ranking officers than those given to Messrs. Kuenzle and Streiff." Petitioner now disputes this ruling insofar as the resident officers and employees are concerned contending that the same is not in accordance with the usual pattern to be followed in determining the reasonableness of a given compensation because it ignores the nature, extent and quality of the services actually rendered by its resident officers and employees.

It is a general rule that "Bonuses to employees made in good faith and as additional compensation for the services actually rendered by the employees are deductible, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered" (4 Mertens, Law of Federal Income Taxation, Sec. 25.50, p. 410). The condition precedents to the deduction of bonuses to employees are: (1) the payment of the bonuses is in fact compensation; (2) it must be for personal services actually rendered; and (3) the bonuses, when added to the salaries, are reasonable when measured by the amount and quality of the services performed with relation to the business of the particular taxpayer" (Idem, Sec. 25.44, p. 395). Here it is admitted that the bonuses are in fact

compensation and were paid for services actually rendered. The only question is whether the payment of said bonuses is reasonable.

There is no fixed test for determining the reasonableness of a given bonus as compensation. This depends upon many factors, one of them being "the amount and the quality of the services performed with relation to the business." Other tests suggested are: payment must be "made in good faith"; "the character of the taxpayer's business, the volume and amount of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation"; "the size of the particular business"; "the employees' qualifications and contributions to the business venture"; and "general economic conditions" (4 Mertens, Law of Federal Income Taxation, Sec. 25.44, 25.49, 25.50, 25.51, pp. 407-412). However, "in determining whether the particular salary or compensation payment is reasonable, the situation must be considered as a whole.

Ordinarily, no single factor is decisive. It is important to keep in mind that it seldom happens that the application of one test can give satisfactory answer, and that ordinarily it is the interplay of several factors, properly weighted for the particular case, which must furnish the final answer" (Idem.).

Considering the different tests formulated above, was the trial court justified in holding that the reasonableness of the amount of bonuses given to resident officers and employees should follow the same pattern for determining the reasonableness of the amount of bonuses given to non-resident officers?

Petitioner contends that it is error to apply the same measure of reasonableness to both resident and non-resident officers because the nature, extent and quality of the services performed by each with relation to the business of the

corporation widely differ, as can be plainly seen by considering the factors already mentioned above, to wit, the character, size and volume of the business of the taxpayer, the profits made, the volume and amount of its earnings, the salary policy of the taxpayer, the amount and quality of the services performed, the employees qualifications and contributions to the business venture, and the general economic conditions prevailing in the place of business. And elaborating on these factors in connection with the business of petitioner, its counsel made a detailed exposition of the facts and figures showing in a nutshell that through the efficient management, personal effort and valuable contribution rendered by the resident officers and employees, the corporation realized huge profits during the year 1950, 1951 and 1952, which entitle them to the bonuses that were given to them for those years, especially having in mind the after-liberation policy of the corporation of giving salaries at low levels because of the unsettled conditions that prevailed after the war and the imposition of controls on exports and imports and in the uses of foreign exchange without prejudice of making up later for that shortcoming by giving them additional compensation in the form of bonuses if the financial situation of the corporation would warrant. As the General Manager Jung testified, the payments of bonuses were strictly based on the amount of work performed, the nature of responsibility, the years of service, and the cost of living.

While it may be admitted that the resident officers and employees had performed their duty well and rendered efficient service and for that reason were given greater amount of additional compensation in the form of bonuses than what was given to the non-resident officers. The reason for this is that, in the opinion of the management itself of the corporation, said non-resident officers had rendered the same amount of efficient personal service and contribution to deserve equal treatment in compensation and other emoluments with the particularity that their liberation yearly salaries had been much smaller.

Thus, according to counsel for petitioner, the following is the contribution made by said non-resident officers of the corporation: "A.P. Kuenzle and H.A. Streiff, had dedicated abroad, especially in New York City, New York, U.S.A. and Zurich, Switzerland, their full time and attention to the services of Kuenzle & Streiff, Inc.; engaging themselves exclusively in the purchases abroad of the merchandise for the supply of the import business of the Kuenzle & Streiff, Inc., taking care of its orders of the importation of the merchandise and also of their shipments to the said company, making contacts and effecting transactions with the suppliers abroad, and directing, controlling and supervising the business operations and affairs of the company by directives. They have been the policy-makers for the company. All decisions to be made by the company on important matters and anything and everything outside of the routinary have always been determined by them and made only upon their instructions which had been strictly adhered to by the management of the Company. A.P. Kuenzle and H.A. Streiff have been the president and vice president, respectively, of the company for many years before 1950, 1951 and 1952 and during these particular years up to the present." Indeed, the trial court was justified in expressing the view that "there is no special reason for granting greater bonuses to such lower ranking officers than those given to Messrs. Kuenzle and Streiff." We concur in this observation.

The contention of respondent that the trial court erred also in allowing the deduction bonuses in excess of the yearly salaries of their respective recipients predicated upon his own decision that the deductible amount of said bonuses should be only equal to their respective yearly salaries cannot also be sustained. This claim cannot be justified considering the factors we have already mentioned that play in the determination of the reasonableness of the bonuses or additional compensation that may be given to an officer or an employee which, if properly considered, warrant the payment of the bonuses in question to the extent allowed by the trial court. This is specially so considering the post-war policy of the corporation in giving salaries at low levels because of the unsettled conditions resulting from war and the

imposition of government controls on imports and exports and on the use of foreign exchange which resulted in the diminution of the amount of business and the consequent loss of profits on the part of the corporation. The payment of bonuses in amounts a little more than the yearly salaries received considering the prevailing circumstances is in our opinion reasonable.

As regards the amount of interests disallowed, we also find the ruling of the trial court justified. There is no dispute that these items accrued on unclaimed salaries and bonus participation of shareholders and employees. Under the law, in order that interest may be deductible, it must be paid "on indebtedness" (Section 30, (b)(1) of the National Internal Revenue Code). It is therefore imperative to show that there is an existing indebtedness which may be subjected to the payment of interest. Here the items involved are unclaimed salaries and bonus participation which in our opinion cannot constitute indebtedness within the meaning of the law because while they constitute an obligation on the part of the corporation, it is not the latter's fault if they remained unclaimed. It is well settled rule that the term indebtedness is restricted to its usual import which "is the amount which one has contracted to pay the use of borrowed money." Since the corporation had at all times sufficient funds to pay the salaries of its employees, whatever an employee may fail to collect cannot be considered an indebtedness for it is the concern of the employee to collect it in due time. The willingness of the corporation to pay interest thereon cannot be considered a justification to warrant deduction.

Wherefore, the decision appealed from is affirmed, without pronouncement as to costs.

G.R. No. L-12287 August 7, 1918

VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants, vs.JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION, Deputy Collector of Internal Revenue, defendants-appellees.

Gregorio Araneta for appellants.Assistant Attorney Round for appellees.

MALCOLM, J.:

This appeal calls for consideration of the Income Tax Law, a law of American origin, with reference to the Civil Code, a law of Spanish origin.

STATEMENT OF THE CASE.

Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The marriage was contracted under the provisions of law concerning conjugal partnerships (sociedad de gananciales). On February 25, 1915, Vicente Madrigal filed sworn declaration on the prescribed form with the Collector of Internal Revenue, showing, as his total net income for the year 1914, the sum of P296,302.73. Subsequently Madrigal submitted the claim that the said P296,302.73 did not represent his income for the year 1914, but was in fact the income of the conjugal partnership

existing between himself and his wife Susana Paterno, and that in computing and assessing the additional income tax provided by the Act of Congress of October 3, 1913, the income declared by Vicente Madrigal should be divided into two equal parts, one-half to be considered the income of Vicente Madrigal and the other half of Susana Paterno. The general question had in the meantime been submitted to the Attorney-General of the Philippine Islands who in an opinion dated March 17, 1915, held with the petitioner Madrigal. The revenue officers being still unsatisfied, the correspondence together with this opinion was forwarded to Washington for a decision by the United States Treasury Department. The United States Commissioner of Internal Revenue reversed the opinion of the Attorney-General, and thus decided against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided adversely by the Collector of Internal Revenue, action was begun by Vicente Madrigal and his wife Susana Paterno in the Court of First Instance of the city of Manila against Collector of Internal Revenue and the Deputy Collector of Internal Revenue for the recovery of the sum of P3,786.08, alleged to have been wrongfully and illegally collected by the defendants from the plaintiff, Vicente Madrigal, under the provisions of the Act of Congress known as the Income Tax Law. The burden of the complaint was that if the income tax for the year 1914 had been correctly and lawfully computed there would have been due payable by each of the plaintiffs the sum of P2,921.09, which taken together amounts of a total of P5,842.18 instead of P9,668.21, erroneously and unlawfully collected from the plaintiff Vicente Madrigal, with the result that plaintiff Madrigal has paid as income tax for the year 1914, P3,786.08, in excess of the sum lawfully due and payable.

The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and the stipulation, sets forth the basis of defendants' stand in the following way: The income of Vicente Madrigal and his wife Susana Paterno

of the year 1914 was made up of three items: (1) P362,407.67, the profits made by Vicente Madrigal in his coal and shipping business; (2) P4,086.50, the profits made by Susana Paterno in her embroidery business; (3) P16,687.80, the profits made by Vicente Madrigal in a pawnshop company. The sum of these three items is P383,181.97, the gross income of Vicente Madrigal and Susana Paterno for the year 1914. General deductions were claimed and allowed in the sum of P86,879.24. The resulting net income was P296,302.73. For the purpose of assessing the normal tax of one per cent on the net income there were allowed as specific deductions the following: (1) P16,687.80, the tax upon which was to be paid at source, and (2) P8,000, the specific exemption granted to Vicente Madrigal and Susana Paterno, husband and wife. The remainder, P271,614.93 was the sum upon which the normal tax of one per cent was assessed. The normal tax thus arrived at was P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax provided for in the Income Tax Law. The trial court in an exhausted decision found in favor of defendants, without costs.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional income tax, is that is should be divided into two equal parts, because of the conjugal partnership existing between them. The learned argument of counsel is mostly based upon the provisions of the Civil Code establishing the sociedad de gananciales. The counter contentions of appellees are that the taxes imposed by the Income Tax Law are as the name implies taxes upon income tax and not upon capital and property; that the fact that Madrigal was a married man, and his marriage contracted under the provisions governing the conjugal partnership, has no bearing on income considered as income, and that the

distinction must be drawn between the ordinary form of commercial partnership and the conjugal partnership of spouses resulting from the relation of marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have been given the course of history. The final stage has been the selection of income as the norm of taxation. (See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the United States, extended to the Philippine Islands, is the result of an effect on the part of the legislators to put into statutory form this canon of taxation and of social reform. The aim has been to mitigate the evils arising from inequalities of wealth by a progressive scheme of taxation, which places the burden on those best able to pay. To carry out this idea, public considerations have demanded an exemption roughly equivalent to the minimum of subsistence. With these exceptions, the income tax is supposed to reach the earnings of the entire non-governmental property of the country. Such is the background of the Income Tax Law.

Income as contrasted with capital or property is to be the test. The essential difference between capital and income is that capital is a fund; income is a flow. A fund of property existing at an instant of time is called capital. A flow of services rendered by that capital by the payment of money from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time is called an income. Capital is wealth, while income is the service of wealth. (See Fisher, "The Nature of Capital and Income.") The Supreme Court of Georgia expresses the thought in the following figurative language: "The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on income is not a tax on

property. "Income," as here used, can be defined as "profits or gains." (London County Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition [1915], Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon [1890], 136 U.S., 549; and Towne vs. Eisner, decided by the United States Supreme Court, January 7, 1918.)

A regulation of the United States Treasury Department relative to returns by the husband and wife not living apart, contains the following:

The husband, as the head and legal representative of the household and general custodian of its income, should make and render the return of the aggregate income of himself and wife, and for the purpose of levying the income tax it is assumed that he can ascertain the total amount of said income. If a wife has a separate estate managed by herself as her own separate property, and receives an income of more than $3,000, she may make return of her own income, and if the husband has other net income, making the aggregate of both incomes more than $4,000, the wife's return should be attached to the return of her husband, or his income should be included in her return, in order that a deduction of $4,000 may be made from the aggregate of both incomes. The tax in such case, however, will be imposed only upon so much of the aggregate income of both shall exceed $4,000. If either husband or wife separately has an income equal to or in excess of $3,000, a return of annual net income is required under the law, and such return must include the income of both, and in such case the return must be made even though the combined income of both be less than $4,000. If the aggregate net income of both exceeds $4,000, an annual return of their combined incomes must be made in the manner stated, although neither one separately has an income of $3,000 per annum. They are jointly and separately liable for

such return and for the payment of the tax. The single or married status of the person claiming the specific exemption shall be determined as one of the time of claiming such exemption which return is made, otherwise the status at the close of the year."

With these general observations relative to the Income Tax Law in force in the Philippine Islands, we turn for a moment to consider the provisions of the Civil Code dealing with the conjugal partnership. Recently in two elaborate decisions in which a long line of Spanish authorities were cited, this court in speaking of the conjugal partnership, decided that "prior to the liquidation the interest of the wife and in case of her death, of her heirs, is an interest inchoate, a mere expectancy, which constitutes neither a legal nor an equitable estate, and does not ripen into title until there appears that there are assets in the community as a result of the liquidation and settlement." (Nable Jose vs. Nable Jose [1916], 15 Off. Gaz., 871; Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)

Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband Vicente Madrigal during the life of the conjugal partnership. She has an interest in the ultimate property rights and in the ultimate ownership of property acquired as income after such income has become capital. Susana Paterno has no absolute right to one-half the income of the conjugal partnership. Not being seized of a separate estate, Susana Paterno cannot make a separate return in order to receive the benefit of the exemption which would arise by reason of the additional tax. As she has no estate and income, actually and legally vested in her and entirely distinct from her husband's property, the income cannot properly be considered the separate income of the wife for the purposes of the additional tax. Moreover, the Income Tax Law does not look on the spouses as individual partners in an ordinary partnership. The husband and wife are only entitled to the exemption of P8,000 specifically granted by the law. The higher schedules of the additional

tax directed at the incomes of the wealthy may not be partially defeated by reliance on provisions in our Civil Code dealing with the conjugal partnership and having no application to the Income Tax Law. The aims and purposes of the Income Tax Law must be given effect.

The point we are discussing has heretofore been considered by the Attorney-General of the Philippine Islands and the United States Treasury Department. The decision of the latter overruling the opinion of the Attorney-General is as follows:

TREASURY DEPARTMENT, Washington.

Income Tax.

FRANK MCINTYRE,Chief, Bureau of Insular Affairs, War Department,Washington, D. C.

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of correspondence "from the Philippine authorities relative to the method of submission of income tax returns by marred person."

You advise that "The Governor-General, in forwarding the papers to the Bureau, advises that the Insular Auditor has been authorized to suspend action on the warrants in question until an authoritative decision on the points raised can be secured from the Treasury Department."

From the correspondence it appears that Gregorio Araneta, married and living with his wife, had an income of an amount sufficient to require the imposition of the net income was properly computed and then both income and deductions and the specific exemption were divided in half and two returns made, one return for each half in the names respectively of the husband and wife, so that under the returns as filed there would be an escape from the additional tax; that Araneta claims the returns are correct on the ground under the Philippine law his wife is entitled to half of his earnings; that Araneta has dominion over the income and under the Philippine law, the right to determine its use and disposition; that in this case the wife has no "separate estate" within the contemplation of the Act of October 3, 1913, levying an income tax.

It appears further from the correspondence that upon the foregoing explanation, tax was assessed against the entire net income against Gregorio Araneta; that the tax was paid and an application for refund made, and that the application for refund was rejected, whereupon the matter was submitted to the Attorney-General of the Islands who holds that the returns were correctly rendered, and that the refund should be allowed; and thereupon the question at issue is submitted through the Governor-General of the Islands and Bureau of Insular Affairs for the advisory opinion of this office.

By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be administered as in the United States but by the appropriate internal-revenue officers of the Philippine Government. You are therefore advised that upon the facts as stated, this office holds that for the Federal Income Tax (Act of October 3, 1913), the entire net income in this case was taxable to Gregorio Araneta, both for the normal and additional tax, and that the application for refund was properly rejected.

The separate estate of a married woman within the contemplation of the Income Tax Law is that which belongs to her solely and separate and apart from her husband, and over which her husband has no right in equity. It may consist of lands or chattels.

The statute and the regulations promulgated in accordance therewith provide that each person of lawful age (not excused from so doing) having a net income of $3,000 or over for the taxable year shall make a return showing the facts; that from the net income so shown there shall be deducted $3,000 where the person making the return is a single person, or married and not living with consort, and $1,000 additional where the person making the return is married and living with consort; but that where the husband and wife both make returns (they living together), the amount of deduction from the aggregate of their several incomes shall not exceed $4,000.

The only occasion for a wife making a return is where she has income from a sole and separate estate in excess of $3,000, but together they have an income in excess of $4,000, in which the latter event either the husband or wife may make the return but not both. In all instances the income of husband and wife whether from separate estates or not, is taken as a whole for the purpose of the normal tax. Where the wife has income from a separate estate makes return made by her husband, while the incomes are added together for the purpose of the normal tax they are taken separately for the purpose of the additional tax. In this case, however, the wife has no separate income within the contemplation of the Income Tax Law.

Respectfully,

DAVID A. GATES.Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas. The Income Tax Law was drafted by the Congress of the United States and has been by the Congress extended to the Philippine Islands. Being thus a law of American origin and being peculiarly intricate in its provisions, the authoritative decision of the official who is charged with enforcing it has peculiar force for the Philippines. It has come to be a well-settled rule that great weight should be given to the construction placed upon a revenue law, whose meaning is doubtful, by the department charged with its execution. (U.S. vs. Cerecedo Hermanos y Cia. [1907], 209 U.S., 338; In re Allen [1903], 2 Phil., 630; Government of the Philippine Islands vs. Municipality of Binalonan, and Roman Catholic Bishop of Nueva Segovia [1915], 32 Phil., 634.) We conclude that the judgment should be as it is hereby affirmed with costs against appellants. So ordered.

G.R. No. L-17518 October 30, 1922

FREDERICK C. FISHER, plaintiff-appellant, vs.WENCESLAO TRINIDAD, Collector of Internal Revenue, defendant-appellee.

Fisher and De Witt and Antonio M. Opisso for appellants. Acting Attorney-General Tuason for appellee.

JOHNSON, J.:

The only question presented by this appeal is: Are the "stock dividends" in the present case "income" and taxable as such under the provisions of section 25 of Act No. 2833? While the appellant presents other important questions, under the view which we have taken of the facts and the law applicable to the present case, we deem it unnecessary to discuss them now.

The defendant demurred to the petition in the lower court. The facts are therefore admitted. They are simple and may be stated as follows:

That during the year 1919 the Philippine American Drug Company was a corporation duly organized and existing under the laws of the Philippine Islands, doing business in the City of Manila; that he appellant was a stockholder in said corporation; that said corporation, as result of the business for that year, declared a "stock

dividend"; that the proportionate share of said stock divided of the appellant was P24,800; that the stock dividend for that amount was issued to the appellant; that thereafter, in the month of March, 1920, the appellant, upon demand of the appellee, paid under protest, and voluntarily, unto the appellee the sum of P889.91 as income tax on said stock dividend. For the recovery of that sum (P889.91) the present action was instituted. The defendant demurred to the petition upon the ground that it did not state facts sufficient to constitute cause of action. The demurrer was sustained and the plaintiff appealed.

To sustain his appeal the appellant cites and relies on some decisions of the Supreme Court of the United States as will as the decisions of the supreme court of some of the states of the Union, in which the questions before us, based upon similar statutes, was discussed. Among the most important decisions may be mentioned the following: Towne vs. Eisner, 245 U.S., 418; Doyle vs. Mitchell Bors. Co., 247 U.S., 179; Eisner vs. Macomber, 252 U.S., 189; Dekoven vs Alsop, 205 Ill., 309; 63 L.R.A., 587; Kaufman vs. Charlottesville Woolen Mills, 93 Va., 673.

In each of said cases an effort was made to collect an "income tax" upon "stock dividends" and in each case it was held that "stock dividends" were capital and not an "income" and therefore not subject to the "income tax" law.

The appellee admits the doctrine established in the case of Eisner vs. Macomber (252 U.S., 189) that a "stock dividend" is not "income" but argues that said Act No. 2833, in imposing the tax on the stock dividend, does not violate the provisions of the Jones Law. The appellee further argues that the statute of the United States providing for tax upon stock dividends is different from the statute of the Philippine Islands, and therefore the decision of the Supreme Court of the United States should not be followed in interpreting the statute in force here.

For the purpose of ascertaining the difference in the said statutes ( (United States and Philippine Islands), providing for an income tax in the United States as well as that in the Philippine Islands, the two statutes are here quoted for the purpose of determining the difference, if any, in the language of the two statutes.

Chapter 463 of an Act of Congress of September 8, 1916, in its title 1 provides for the collection of an "income tax." Section 2 of said Act attempts to define what is an income. The definition follows:

That the term "dividends" as used in this title shall be held to mean any distribution made or ordered to made by a corporation, . . . which stock dividend shall be considered income, to the amount of its cash value.

Act No. 2833 of the Philippine Legislature is an Act establishing "an income tax." Section 25 of said Act attempts to define the application of the income tax. The definition follows:

The term "dividends" as used in this Law shall be held to mean any distribution made or ordered to be made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, . . . . Stock dividend shall be considered income, to the amount of the earnings or profits distributed.

It will be noted from a reading of the provisions of the two laws above quoted that the writer of the law of the Philippine Islands must have had before him the statute of the United States. No important argument can be based upon the slight different in the wording of the two sections.

It is further argued by the appellee that there are no constitutional limitations upon the power of the Philippine Legislature such as exist in the United States, and in support of that contention, he cites a number of decisions. There is no question that the Philippine Legislature may provide for the payment of an income tax, but it cannot, under the guise of an income tax, collect a tax on property which is not an "income." The Philippine Legislature can not impose a tax upon "property" under a law which provides for a tax upon "income" only. The Philippine Legislature has no power to provide a tax upon "automobiles" only, and under that law collect a tax upon a carreton or bull cart. Constitutional limitations, that is to say, a statute expressly adopted for one purpose cannot, without amendment, be applied to another purpose which is entirely distinct and different. A statute providing for an income tax cannot be construed to cover property which is not, in fact income. The Legislature cannot, by a statutory declaration, change the real nature of a tax which it imposes. A law which imposes an important tax on rice only cannot be construed to an impose an importation tax on corn.

It is true that the statute in question provides for an income tax and contains a further provision that "stock dividends" shall be considered income and are therefore subject to income tax provided for in said law. If "stock dividends" are not "income" then the law permits a tax upon something not within the purpose and intent of the law.

It becomes necessary in this connection to ascertain what is an "income in order that we may be able to determine whether "stock dividends" are "income" in the sense that the word is used in the statute. Perhaps it would be more logical to determine first what are "stock dividends" in order that we may more clearly understand their relation to "income." Generally speaking, stock dividends represent undistributed increase in the capital of corporations or firms, joint stock companies, etc., etc., for a particular period. They are used to show the increased interest or proportional

shares in the capital of each stockholder. In other words, the inventory of the property of the corporation, etc., for particular period shows an increase in its capital, so that the stock theretofore issued does not show the real value of the stockholder's interest, and additional stock is issued showing the increase in the actual capital, or property, or assets of the corporation, etc.

To illustrate: A and B form a corporation with an authorized capital of P10,000 for the purpose of opening and conducting a drug store, with assets of the value of P2,000, and each contributes P1,000. Their entire assets are invested in drugs and put upon the shelves in their place of business. They commence business without a cent in the treasury. Every dollar contributed is invested. Shares of stock to the amount of P1,000 are issued to each of the incorporators, which represent the actual investment and entire assets of the corporation. Business for the first year is good. Merchandise is sold, and purchased, to meet the demands of the growing trade. At the end of the first year an inventory of the assets of the corporation is made, and it is then ascertained that the assets or capital of the corporation on hand amount to P4,000, with no debts, and still not a cent in the treasury. All of the receipts during the year have been reinvested in the business. Neither of the stockholders have withdrawn a penny from the business during the year. Every peso received for the sale of merchandise was immediately used in the purchase of new stock — new supplies. At the close of the year there is not a centavo in the treasury, with which either A or B could buy a cup of coffee or a pair of shoes for his family. At the beginning of the year they were P2,000, and at the end of the year they were P4,000, and neither of the stockholders have received a centavo from the business during the year. At the close of the year, when it is discovered that the assets are P4,000 and not P2,000, instead of selling the extra merchandise on hand and thereby reducing the business to its original capital, they agree among themselves to increase the capital they agree among themselves to increase the capital issued and for that purpose issue additional stock in the form of "stock

dividends" or additional stock of P1,000 each, which represents the actual increase of the shares of interest in the business. At the beginning of the year each stockholder held one-half interest in the capital. At the close of the year, and after the issue of the said stock dividends, they each still have one-half interest in the business. The capital of the corporation increased during the year, but has either of them received an income? It is not denied, for the purpose of ordinary taxation, that the taxable property of the corporation at the beginning of the year was P2,000, that at the close of the year it was P4,000, and that the tax rolls should be changed in accordance with the changed conditions in the business. In other words, the ordinary tax should be increased by P2,000.

Another illustration: C and D organized a corporation for agricultural purposes with an authorized capital stock of P20,000 each contributing P5,000. With that capital they purchased a farm and, with it, one hundred head of cattle. Every peso contributed is invested. There is no money in the treasury. Much time and labor was expanded during the year by the stockholders on the farm in the way of improvements. Neither received a centavo during the year from the farm or the cattle. At the beginning of the year the assets of the corporation, including the farm and the cattle, were P10,000, and at the close of the year and inventory of the property of the corporation is made and it is then found that they have the same farm with its improvements and two hundred head of cattle by natural increase. At the end of the year it is also discovered that, by reason of business changes, the farm and the cattle both have increased in value, and that the value of the corporate property is now P20,000 instead of P10,000 as it was at the beginning of the year. The incorporators instead of reducing the property to its original capital, by selling off a part of its, issue to themselves "stock dividends" to represent the proportional value or interest of each of the stockholders in the increased capital at the close of the year. There is still not a centavo in the treasury and neither has withdrawn a peso from the business

during the year. No part of the farm or cattle has been sold and not a single peso was received out of the rents or profits of the capital of the corporation by the stockholders.

Another illustration: A, an individual farmer, buys a farm with one hundred head of cattle for the sum of P10,000. At the end of the first year, by reason of business conditions and the increase of the value of both real estate and personal property, it is discovered that the value of the farm and the cattle is P20,000. A, during the year, has received nothing from the farm or the cattle. His books at the beginning of the year show that he had property of the value of P10,000. His books at the close of the year show that he has property of the value of P20,000. A is not a corporation. The assets of his business are not shown therefore by certificates of stock. His books, however, show that the value of his property has increased during the year by P10,000, under any theory of business or law, be regarded as an "income" upon which the farmer can be required to pay an income tax? Is there any difference in law in the condition of A in this illustration and the condition of A and B in the immediately preceding illustration? Can the increase of the value of the property in either case be regarded as an "income" and be subjected to the payment of the income tax under the law?

Each of the foregoing illustrations, it is asserted, is analogous to the case before us and, in view of that fact, let us ascertain how lexicographers and the courts have defined an "income." The New Standard Dictionary, edition of 1915, defines an income as "the amount of money coming to a person or corporation within a specified time whether as payment or corporation within a specified time whether as payment for services, interest, or profit from investment." Webster's International Dictionary defines an income as "the receipt, salary; especially, the annual receipts of a private person or a corporation from property." Bouvier, in his law dictionary, says that an "income" in the federal constitution

and income tax act, is used in its common or ordinary meaning and not in its technical, or economic sense. (146 Northwestern Reporter, 812) Mr. Black, in his law dictionary, says "An income is the return in money from one's business, labor, or capital invested; gains, profit or private revenue." "An income tax is a tax on the yearly profits arising from property , professions, trades, and offices."

The Supreme Court of the United States, in the case o Gray vs. Darlington (82 U.S., 653), said in speaking of income that mere advance in value in no sense constitutes the "income" specified in the revenue law as "income" of the owner for the year in which the sale of the property was made. Such advance constitutes and can be treated merely as an increase of capital. (In re Graham's Estate, 198 Pa., 216; Appeal of Braun, 105 Pa., 414.)

Mr. Justice Hughes, later Associate Justice of the Supreme Court of the United States and now Secretary of State of the United States, in his argument before the Supreme Court of the United States in the case of Towne vs. Eisner, supra, defined an "income" in an income tax law, unless it is otherwise specified, to mean cash or its equivalent. It does not mean choses in action or unrealized increments in the value of the property, and cites in support of the definition, the definition given by the Supreme Court in the case of Gray vs. Darlington, supra.

In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, speaking for the court, said: "Notwithstanding the thoughtful discussion that the case received below, we cannot doubt that the dividend was capital as well for the purposes of the Income Tax Law. . . . 'A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. Its property is not diminished and their interest are not increased. . . . The proportional interest of each shareholder remains the same. . . .' In short, the corporation is no poorer and the

stockholder is no richer then they were before." (Gibbons vs. Mahon, 136 U.S., 549, 559, 560; Logan County vs. U.S., 169 U.S., 255, 261).

In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179, Mr. Justice Pitney, speaking for the court, said that the act employs the term "income" in its natural and obvious sense, as importing something distinct from principal or capital and conveying the idea of gain or increase arising from corporate activity.

Mr. Justice Pitney, in the case of Eisner vs. Macomber (252 U.S., 189), again speaking for the court said: "An income may be defined as the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets."

For bookkeeping purposes, when stock dividends are declared, the corporation or company acknowledges a liability, in form, to the stockholders, equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If profits have been made by the corporation during a particular period and not divided, they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus account," etc., or the like. None of these, however, gives to the stockholders as a body, much less to any one of them, either a claim against the going concern or corporation, for any particular sum of money, or a right to any particular portion of the asset, or any shares sells or until the directors conclude that dividends shall be made a part of the company's assets segregated from the common fund for that purpose. The dividend normally is payable in money and when so paid, then only does the stockholder realize a profit or gain, which becomes his separate property, and thus derive an income from the capital

that he has invested. Until that, is done the increased assets belong to the corporation and not to the individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution, in money or in kind, should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone said realization, in that the fund represented by the new stock has been transferred from surplus to assets, and no longer is available for actual distribution. The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations resulting from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out of the entire investment. Having regard to the very truth of the matter, to substance and not to form, the stockholder by virtue of the stock dividend has in fact received nothing that answers the definition of an "income." (Eisner vs. Macomber, 252 U.S., 189, 209, 211.)

The stockholder who receives a stock dividend has received nothing but a representation of his increased interest in the capital of the corporation. There has been no separation or segregation of his interest. All the property or capital of the corporation still belongs to the corporation. There has been no separation of the interest of the stockholder from the general capital of the corporation. The stockholder, by virtue of the stock dividend, has no separate or individual control over the interest represented thereby, further than he had before the stock dividend was issued. He cannot use it for the reason that it is still the property of the corporation and not the property of the individual holder of stock

dividend. A certificate of stock represented by the stock dividend is simply a statement of his proportional interest or participation in the capital of the corporation. For bookkeeping purposes, a corporation, by issuing stock dividend, acknowledges a liability in form to the stockholders, evidenced by a capital stock account. The receipt of a stock dividend in no way increases the money received of a stockholder nor his cash account at the close of the year. It simply shows that there has been an increase in the amount of the capital of the corporation during the particular period, which may be due to an increased business or to a natural increase of the value of the capital due to business, economic, or other reasons. We believe that the Legislature, when it provided for an "income tax," intended to tax only the "income" of corporations, firms or individuals, as that term is generally used in its common acceptation; that is that the income means money received, coming to a person or corporation for services, interest, or profit from investments. We do not believe that the Legislature intended that a mere increase in the value of the capital or assets of a corporation, firm, or individual, should be taxed as "income." Such property can be reached under the ordinary from of taxation.

Mr. Justice Pitney, in the case of the Einer vs. Macomber, supra, said in discussing the difference between "capital" and "income": "That the fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs; the latter as the outlet stream, to be measured by its flow during a period of time." It may be argued that a stockholder might sell the stock dividend which he had acquired. If he does, then he has received, in fact, an income and such income, like any other profit which he realizes from the business, is an income and he may be taxed thereon.

There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock dividends declared, as in the present case. The one is a disbursement to the stockholder of accumulated earnings, and the corporation at once parts irrevocably with all interest thereon. The other involves no disbursement by the corporation. It parts with nothing to the stockholder. The latter receives, not an actual dividend, but certificate of stock which simply evidences his interest in the entire capital, including such as by investment of accumulated profits has been added to the original capital. They are not income to him, but represent additions to the source of his income, namely, his invested capital. (DeKoven vs. Alsop, 205, Ill., 309; 63 L.R.A. 587). Such a person is in the same position, so far as his income is concerned, as the owner of young domestic animal, one year old at the beginning of the year, which is worth P50 and, which, at the end of the year, and by reason of its growth, is worth P100. The value of his property has increased, but has had an income during the year? It is true that he had taxable property at the beginning of the year of the value of P50, and the same taxable property at another period, of the value of P100, but he has had no income in the common acceptation of that word. The increase in the value of the property should be taken account of on the tax duplicate for the purposes of ordinary taxation, but not as income for he has had none.

The question whether stock dividends are income, or capital, or assets has frequently come before the courts in another form — in cases of inheritance. A is a stockholder in a large corporation. He dies leaving a will by the terms of which he give to B during his lifetime the "income" from said stock, with a further provision that C shall, at B's death, become the owner of his share in the corporation. During B's life the corporation issues a stock dividend. Does the stock dividend belong to B as an income, or does it finally belong to C as a part of his share in the capital or assets of the corporation, which had been left to him as a remainder by A? While there has been some difference of opinion on that question, we believe that a great weight of authorities hold that the stock dividend is capital or assets belonging to

C and not an income belonging to B. In the case of D'Ooge vs. Leeds (176 Mass., 558, 560) it was held that stock dividends in such cases were regarded as capital and not as income (Gibbons vs. Mahon, 136 U.S., 549.)

In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray said: "The distinction between the title of a corporation, and the interest of its members or stockholders in the property of the corporation, is familiar and well settled. The ownership of that property is in the corporation, and not in the holders of shares of its stock. The interest of each stockholder consists in the right to a proportionate part of the profits whenever dividends are declared by the corporation, during its existence, under its charter, and to a like proportion of the property remaining, upon the termination or dissolution of the corporation, after payment of its debts." (Minot vs. Paine, 99 Mass., 101; Greeff vs. Equitable Life Assurance Society, 160 N. Y., 19.) In the case of Dekoven vs. Alsop (205 Ill ,309, 63 L. R. A. 587) Mr. Justice Wilkin said: "A dividend is defined as a corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time. Until the dividend is declared, these corporate profits belong to the corporation, not to the stockholders, and are liable for corporate indebtedness.

There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock dividends declared. The one is a disbursement to the stockholders of accumulated earning, and the corporation at once parts irrevocably with all interest thereon. The other involves no disbursement by the corporation. It parts with nothing to the stockholders. The latter receives, not an actual dividend, but certificates of stock which evidence in a new proportion his interest in the entire capital. When a cash becomes the absolute property of the stockholders and cannot be reached by the creditors of the corporation in the absence of fraud. A stock dividend however, still being the property of the corporation and not the stockholder, it may be reached by an execution against the corporation, and sold as a part of the

property of the corporation. In such a case, if all the property of the corporation is sold, then the stockholder certainly could not be charged with having received an income by virtue of the issuance of the stock dividend. Until the dividend is declared and paid, the corporate profits still belong to the corporation, not to the stockholders, and are liable for corporate indebtedness. The rule is well established that cash dividend, whether large or small, are regarded as "income" and all stock dividends, as capital or assets (Cook on Corporation, Chapter 32, secs. 534, 536; Davis vs. Jackson, 152 Mass., 58; Mills vs. Britton, 64 Conn., 4; 5 Am., and Eng. Encycl. of Law, 2d ed., p. 738.)

If the ownership of the property represented by a stock dividend is still in the corporation and to in the holder of such stock, then it is difficult to understand how it can be regarded as income to the stockholder and not as a part of the capital or assets of the corporation. (Gibbsons vs. Mahon, supra.) the stockholder has received nothing but a representation of an interest in the property of the corporation and, as a matter of fact, he may never receive anything, depending upon the final outcome of the business of the corporation. The entire assets of the corporation may be consumed by mismanagement, or eaten up by debts and obligations, in which case the holder of the stock dividend will never have received an income from his investment in the corporation. A corporation may be solvent and prosperous today and issue stock dividends in representation of its increased assets, and tomorrow be absolutely insolvent by reason of changes in business conditions, and in such a case the stockholder would have received nothing from his investment. In such a case, if the holder of the stock dividend is required to pay an income tax on the same, the result would be that he has paid a tax upon an income which he never received. Such a conclusion is absolutely contradictory to the idea of an income. An income subject to taxation under the law must be an actual income and not a promised or prospective income.

The appelle argues that there is nothing in section 25 of Act No 2833 which contravenes the provisions of the Jones Law. That may be admitted. He further argues that the Act of Congress (U.S. Revenue Act of 1918) expressly authorized the Philippine Legislatures to provide for an income tax. That fact may also be admitted. But a careful reading of that Act will show that, while it permitted a tax upon income, the same provided that income shall include gains, profits, and income derived from salaries, wages, or compensation for personal services, as well as from interest, rent, dividends, securities, etc. The appellee emphasizes the "income from dividends." Of course, income received as dividends is taxable as an income but an income from "dividends" is a very different thing from receipt of a "stock dividend." One is an actual receipt of profits; the other is a receipt of a representation of the increased value of the assets of corporation.

In all of the foregoing argument we have not overlooked the decisions of a few of the courts in different parts of the world, which have reached a different conclusion from the one which we have arrived at in the present case. Inasmuch, however, as appeals may be taken from this court to the Supreme Court of the United States, we feel bound to follow the same doctrine announced by that court.

Having reached the conclusion, supported by the great weight of the authority, that "stock dividends" are not "income," the same cannot be taxes under that provision of Act No. 2833 which provides for a tax upon income. Under the guise of an income tax, property which is not an income cannot be taxed. When the assets of a corporation have increased so as to justify the issuance of a stock dividend, the increase of the assets should be taken account of the Government in the ordinary tax duplicates for the purposes of assessment and collection of an additional tax. For all of

the foregoing reasons, we are of the opinion, and so decide, that the judgment of the lower court should be revoked, and without any finding as to costs, it is so ordered.

G.R. No. 127105 June 25, 1999

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.S.C. JOHNSON AND SON, INC., and COURT OF APPEALS, respondents.

GONZAGA-REYES, J.:

This is a petition for review on certiorari under Rule 45 of the Rules of Court seeking to set aside the decision of the Court of Appeals dated November 7, 1996 in CA-GR SP No. 40802 affirming the decision of the Court of Tax Appeals in CTA Case No. 5136.

The antecedent facts as found by the Court of Tax Appeals are not disputed, to wit:

[Respondent], a domestic corporation organized and operating under the Philippine laws, entered into a license agreement with SC Johnson and Son, United States of America (USA), a non-resident foreign corporation based in the U.S.A. pursuant to which the [respondent] was granted the right to use the trademark, patents and technology owned by the latter including the right to manufacture, package and distribute the products covered by the Agreement and secure assistance in management, marketing and production from SC Johnson and Son, U. S. A.

The said License Agreement was duly registered with the Technology Transfer Board of the Bureau of Patents, Trade Marks and Technology Transfer under Certificate of Registration No. 8064 (Exh. "A").

For the use of the trademark or technology, [respondent] was obliged to pay SC Johnson and Son, USA royalties based on a percentage of net sales and subjected the same to 25% withholding tax on royalty payments which [respondent] paid for the period covering July 1992 to May 1993 in the total amount of P1,603,443.00 (Exhs. "B" to "L" and submarkings).

On October 29, 1993, [respondent] filed with the International Tax Affairs Division (ITAD) of the BIR a claim for refund of overpaid withholding tax on royalties arguing that, "the antecedent facts attending [respondent's] case fall squarely within the same circumstances under which said MacGeorge and Gillete rulings were issued. Since the agreement was approved by the Technology Transfer Board, the preferential tax rate of 10% should apply to the [respondent]. We therefore submit that royalties paid by the [respondent] to SC Johnson and Son, USA is only subject to 10% withholding tax pursuant to the most-favored nation clause of the RP-US Tax Treaty [Article 13 Paragraph 2 (b) (iii)] in relation to the RP-West Germany Tax Treaty [Article 12 (2) (b)]" (Petition for Review [filed with the Court of Appeals], par. 12). [Respondent's] claim for there fund of P963,266.00 was computed as follows:

Gross 25% 10%

Month/ Royalty Withholding Withholding

Year Fee Tax Paid Tax Balance

——— ——— ——— ——— ———

July 1992 559,878 139,970 55,988 83,982

August 567,935 141,984 56,794 85,190

September 595,956 148,989 59,596 89,393

October 634,405 158,601 63,441 95,161

November 620,885 155,221 62,089 93,133

December 383,276 95,819 36,328 57,491

Jan 1993 602,451 170,630 68,245 102,368

February 565,845 141,461 56,585 84,877

March 547,253 136,813 54,725 82,088

April 660,810 165,203 66,081 99,122

May 603,076 150,769 60,308 90,461

———— ———— ———— ———

P6,421,770 P1,605,443 P642,177 P963,266 1

======== ======== ======== ========

The Commissioner did not act on said claim for refund. Private respondent S.C. Johnson & Son, Inc. (S.C. Johnson) then filed a petition for review before the Court of Tax Appeals (CTA) where the case was docketed as CTA Case No. 5136, to claim a refund of the overpaid withholding tax on royalty payments from July 1992 to May 1993.

On May 7, 1996, the Court of Tax Appeals rendered its decision in favor of S.C. Johnson and ordered the Commissioner of Internal Revenue to issue a tax credit certificate in the amount of P963,266.00 representing overpaid withholding tax on royalty payments, beginning July, 1992 to May, 1993. 2

The Commissioner of Internal Revenue thus filed a petition for review with the Court of Appeals which rendered the decision subject of this appeal on November 7, 1996 finding no merit in the petition and affirming in toto the CTA ruling. 3

This petition for review was filed by the Commissioner of Internal Revenue raising the following issue:

THE COURT OF APPEALS ERRED IN RULING THAT SC JOHNSON AND SON, USA IS ENTITLED TO THE "MOST FAVORED NATION" TAX RATE OF 10% ON ROYALTIES AS PROVIDED IN THE RP-US TAX TREATY IN RELATION TO THE RP-WEST GERMANY TAX TREATY.

Petitioner contends that under Article 13(2) (b) (iii) of the RP-US Tax Treaty, which is known as the "most favored nation" clause, the lowest rate of the Philippine tax at 10% may be imposed on royalties derived by a resident of the United States from sources within the Philippines only if the circumstances of the resident of the United States are similar to those of the resident of West Germany. Since the RP-US Tax Treaty contains no "matching credit" provision as that provided under Article 24 of the RP-West Germany Tax Treaty, the tax on royalties under the RP-US Tax Treaty is not paid under similar circumstances as those obtaining in the RP-West Germany Tax Treaty. Even assuming that the phrase "paid under similar circumstances" refers to the payment of royalties, and not taxes, as held by the Court of Appeals, still, the "most favored nation" clause cannot be invoked for the reason that when a tax treaty contemplates circumstances attendant to the payment of a tax, or royalty remittances for that matter, these must necessarily refer to circumstances that are tax-related. Finally, petitioner argues that since S.C. Johnson's invocation of the "most favored nation" clause is in the nature of a claim for exemption from the application of the regular tax rate of 25% for royalties, the provisions of the treaty must be construed strictly against it.

In its Comment, private respondent S.C. Johnson avers that the instant petition should be denied (1) because it contains a defective certification against forum shopping as required under SC Circular No. 28-91, that is, the certification was not executed by the petitioner herself but by her counsel; and (2) that the "most favored nation" clause under the RP-US Tax Treaty refers to royalties paid under similar circumstances as those royalties subject to tax in other treaties; that the phrase "paid under similar circumstances" does not refer to payment of the tax but to the subject matter of the tax, that is, royalties, because the "most favored nation" clause is intended to allow the taxpayer in one state to avail of more liberal provisions contained in another tax treaty wherein the country of residence of such taxpayer is also a party thereto, subject to the basic condition that the subject matter of taxation in that other tax treaty is the same as that in the original tax treaty under which the taxpayer is liable; thus, the RP-US Tax Treaty speaks of "royalties of the same kind paid under similar circumstances". S.C. Johnson also contends that the Commissioner is estopped from insisting on her interpretation that the phrase "paid under similar circumstances" refers to the manner in which the tax is paid, for the reason that said interpretation is embodied in Revenue Memorandum Circular ("RMC") 39-92 which was already abandoned by the Commissioner's predecessor in 1993; and was expressly revoked in BIR Ruling No. 052-95 which stated that royalties paid to an American licensor are subject only to 10% withholding tax pursuant to Art 13(2)(b)(iii) of the RP-US Tax Treaty in relation to the RP-West Germany Tax Treaty. Said ruling should be given retroactive effect except if such is prejudicial to the taxpayer pursuant to Section 246 of the National Internal Revenue Code.

Petitioner filed Reply alleging that the fact that the certification against forum shopping was signed by petitioner's counsel is not a fatal defect as to warrant the dismissal of this petition since Circular No. 28-91 applies only to original actions and not to appeals, as in the instant case. Moreover, the requirement that the certification should be signed by petitioner and not by counsel does not apply to petitioner who has only the Office of the Solicitor General as statutory counsel. Petitioner reiterates that even if the phrase "paid under similar circumstances" embodied in the most favored nation clause of the RP-US Tax Treaty refers to the payment of royalties and not taxes, still the presence or absence of a "matching credit" provision in the said RP-US Tax Treaty would constitute a material circumstance to such payment and would be determinative of the said clause's application.1âwphi1.nêt

We address first the objection raised by private respondent that the certification against forum shopping was not executed by the petitioner herself but by her counsel, the Office of the Solicitor General (O.S.G.) through one of its Solicitors, Atty. Tomas M. Navarro.

SC Circular No. 28-91 provides:

SUBJECT: ADDITIONAL REQUISITES FOR PETITIONS FILED WITH THE SUPREME COURT AND THE COURT OF APPEALS TO PREVENT FORUM SHOPPING OR MULTIPLE FILING OF PETITIONS AND COMPLAINTS

TO: xxx xxx xxx

The attention of the Court has been called to the filing of multiple petitions and complaints involving the same issues in the Supreme Court, the Court of Appeals or other tribunals or agencies, with the result that said courts, tribunals or agencies have to resolve the same issues.

(1) To avoid the foregoing, in every petition filed with the Supreme Court or the Court of Appeals, the petitioner aside from complying with pertinent provisions of the Rules of Court and existing circulars, must certify under oath to all of the following facts or undertakings: (a) he has not theretofore commenced any other action or proceeding involving the same issues in the Supreme Court, the Court of Appeals, or any tribunal oragency; . . .

(2) Any violation of this revised Circular will entail the following sanctions: (a) it shall be a cause for the summary dismissal of the multiple petitions or complaints; . . .

The circular expressly requires that a certificate of non-forum shopping should be attached to petitions filed before this Court and the Court of Appeals. Petitioner's allegation that Circular No. 28-91 applies only to original actions and not to appeals as in the instant case is not supported by the text nor by the obvious intent of the Circular which is to prevent multiple petitions that will result in the same issue being resolved by different courts.

Anent the requirement that the party, not counsel, must certify under oath that he has not commenced any other action involving the same issues in this Court or the Court of Appeals or any other tribunal or agency,

we are inclined to accept petitioner's submission that since the OSG is the only lawyer for the petitioner, which is a government agency mandated under Section 35, Chapter 12, title III, Book IV of the 1987 Administrative Code 4 to be represented only by the Solicitor General, the certification executed by the OSG in this case constitutes substantial compliance with Circular No. 28-91.

With respect to the merits of this petition, the main point of contention in this appeal is the interpretation of Article 13 (2) (b) (iii) of the RP-US Tax Treaty regarding the rate of tax to be imposed by the Philippines upon royalties received by a non-resident foreign corporation. The provision states insofar as pertinentthat —

1) Royalties derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States.

2) However, the tax imposed by that Contracting State shall not exceed.

a) In the case of the United States, 15 percent of the gross amount of the royalties, and

b) In the case of the Philippines, the least of:

(i) 25 percent of the gross amount of the royalties;

(ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities; and

(iii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State.

xxx xxx xxx

(emphasis supplied)

Respondent S. C. Johnson and Son, Inc. claims that on the basis of the quoted provision, it is entitled to the concessional tax rate of 10 percent on royalties based on Article 12 (2) (b) of the RP-Germany Tax Treaty which provides:

(2) However, such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State, but the tax so charged shall not exceed:

xxx xxx xxx

b) 10 percent of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process,

or from the use of or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience.

For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities.

Unlike the RP-US Tax Treaty, the RP-Germany Tax Treaty allows a tax credit of 20 percent of the gross amount of such royalties against German income and corporation tax for the taxes payable in the Philippines on such royalties where the tax rate is reduced to 10 or 15 percent under such treaty. Article 24 of the RP-Germany Tax Treaty states —

1) Tax shall be determined in the case of a resident of the Federal Republic of Germany as follows:

xxx xxx xxx

b) Subject to the provisions of German tax law regarding credit for foreign tax, there shall be allowed as a credit against German income and corporation tax payable in respect of the following items of income arising in the Republic of the

Philippines, the tax paid under the laws of the Philippines in accordance with this Agreement on:

xxx xxx xxx

dd) royalties, as defined in paragraph 3 of Article 12;

xxx xxx xxx

c) For the purpose of the credit referred in subparagraph; b) the Philippine tax shall be deemed to be

xxx xxx xxx

cc) in the case of royalties for which the tax is reduced to 10 or 15 per cent according to paragraph 2 of Article 12, 20 percent of the gross amount of such royalties.

xxx xxx xxx

According to petitioner, the taxes upon royalties under the RP-US Tax Treaty are not paid under circumstances similar to those in the RP-West Germany Tax Treaty since there is no provision for a 20 percent matching credit in the former convention and private respondent cannot invoke the concessional tax

rate on the strength of the most favored nation clause in the RP-US Tax Treaty. Petitioner's position is explained thus:

Under the foregoing provision of the RP-West Germany Tax Treaty, the Philippine tax paid on income from sources within the Philippines is allowed as a credit against German income and corporation tax on the same income. In the case of royalties for which the tax is reduced to 10 or 15 percent according to paragraph 2 of Article 12 of the RP-West Germany Tax Treaty, the credit shall be 20% of the gross amount of such royalty. To illustrate, the royalty income of a German resident from sources within the Philippines arising from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, is taxed at 10% of the gross amount of said royalty under certain conditions. The rate of 10% is imposed if credit against the German income and corporation tax on said royalty is allowed in favor of the German resident. That means the rate of 10% is granted to the German taxpayer if he is similarly granted a credit against the income and corporation tax of West Germany. The clear intent of the "matching credit" is to soften the impact of double taxation by different jurisdictions.

The RP-US Tax Treaty contains no similar "matching credit" as that provided under the RP-West Germany Tax Treaty. Hence, the tax on royalties under the RP-US Tax Treaty is not paid under similar circumstances as those obtaining in the RP-West Germany Tax Treaty. Therefore, the "most favored nation" clause in the RP-West Germany Tax Treaty cannot be availed of in interpreting the provisions of the RP-US Tax Treaty. 5

The petition is meritorious.

We are unable to sustain the position of the Court of Tax Appeals, which was upheld by the Court of Appeals, that the phrase "paid under similar circumstances in Article 13 (2) (b), (iii) of the RP-US Tax Treaty should be interpreted to refer to payment of royalty, and not to the payment of the tax, for the reason that the phrase "paid under similar circumstances" is followed by the phrase "to a resident of a third state". The respondent court held that "Words are to be understood in the context in which they are used", and since what is paid to a resident of a third state is not a tax but a royalty "logic instructs" that the treaty provision in question should refer to royalties of the same kind paid under similar circumstances.

The above construction is based principally on syntax or sentence structure but fails to take into account the purpose animating the treaty provisions in point. To begin with, we are not aware of any law or rule pertinent to the payment of royalties, and none has been brought to our attention, which provides for the payment of royalties under dissimilar circumstances. The tax rates on royalties and the circumstances of payment thereof are the same for all the recipients of such royalties and there is no disparity based on nationality in the circumstances of such payment. 6 On the other hand, a cursory reading of the various tax treaties will show that there is no similarity in the provisions on relief from or avoidance of double taxation 7 as this is a matter of negotiation between the contracting parties. 8 As will be shown later, this dissimilarity is true particularly in the treaties between the Philippines and the United States and between the Philippines and West Germany.

The RP-US Tax Treaty is just one of a number of bilateral treaties which the Philippines has entered into for the avoidance of double taxation. 9 The purpose of these international agreements is to reconcile the national fiscal legislations of the contracting parties in order to help the taxpayer avoid simultaneous taxation in two different jurisdictions. 10 More precisely, the tax conventions are drafted with a view towards the elimination of international juridical double taxation, which is defined as the imposition of comparable taxes in two or more states on the same taxpayer in respect of the same subject matter and for identical periods. 11

The apparent rationale for doing away with double taxation is of encourage the free flow of goods and services and the movement of capital, technology and persons between countries, conditions deemed vital in creating robust and dynamic economies. 12 Foreign investments will only thrive in a fairly predictable and reasonable international investment climate and the protection against double taxation is crucial in creating such a climate. 13

Double taxation usually takes place when a person is resident of a contracting state and derives income from, or owns capital in, the other contracting state and both states impose tax on that income or capital. In order to eliminate double taxation, a tax treaty resorts to several methods. First, it sets out the respective rights to tax of the state of source or situs and of the state of residence with regard to certain classes of income or capital. In some cases, an exclusive right to tax is conferred on one of the contracting states; however, for other items of income or capital, both states are given the right to tax, although the amount of tax that may be imposed by the state of source is limited. 14

The second method for the elimination of double taxation applies whenever the state of source is given a full or limited right to tax together with the state of residence. In this case, the treaties make it incumbent upon the state of residence to allow relief in order to avoid double taxation. There are two methods of relief — the exemption method and the credit method. In the exemption method, the income or capital which is taxable in the state of source or situs is exempted in the state of residence, although in some instances it may be taken into account in determining the rate of tax applicable to the taxpayer's remaining income or capital. On the other hand, in the credit method, although the income or capital which is taxed in the state of source is still taxable in the state of residence, the tax paid in the former is credited against the tax levied in the latter. The basic difference between the two methods is that in the exemption method, the focus is on the income or capital itself, whereas the credit method focuses upon the tax. 15

In negotiating tax treaties, the underlying rationale for reducing the tax rate is that the Philippines will give up a part of the tax in the expectation that the tax given up for this particular investment is not taxed by the othercountry. 16 Thus the petitioner correctly opined that the phrase "royalties paid under similar circumstances" in the most favored nation clause of the US-RP Tax Treaty necessarily contemplated "circumstances that are tax-related".

In the case at bar, the state of source is the Philippines because the royalties are paid for the right to use property or rights, i.e. trademarks, patents and technology, located within the Philippines. 17 The United States is the state of residence since the taxpayer, S. C. Johnson and Son, U. S. A., is based there. Under

the RP-US Tax Treaty, the state of residence and the state of source are both permitted to tax the royalties, with a restraint on the tax that may be collected by the state of source. 18 Furthermore, the method employed to give relief from double taxation is the allowance of a tax credit to citizens or residents of the United States (in an appropriate amount based upon the taxes paid or accrued to the Philippines) against the United States tax, but such amount shall not exceed the limitations provided by United States law for the taxable year. 19 Under Article 13 thereof, the Philippines may impose one of three rates — 25 percent of the gross amount of the royalties; 15 percent when the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities; or the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third state.

Given the purpose underlying tax treaties and the rationale for the most favored nation clause, the concessional tax rate of 10 percent provided for in the RP-Germany Tax Treaty should apply only if the taxes imposed upon royalties in the RP-US Tax Treaty and in the RP-Germany Tax Treaty are paid under similar circumstances. This would mean that private respondent must prove that the RP-US Tax Treaty grants similar tax reliefs to residents of the United States in respect of the taxes imposable upon royalties earned from sources within the Philippines as those allowed to their German counterparts under the RP-Germany Tax Treaty.

The RP-US and the RP-West Germany Tax Treaties do not contain similar provisions on tax crediting. Article 24 of the RP-Germany Tax Treaty, supra, expressly allows crediting against German income and

corporation tax of 20% of the gross amount of royalties paid under the law of the Philippines. On the other hand, Article 23 of the RP-US Tax Treaty, which is the counterpart provision with respect to relief for double taxation, does not provide for similar crediting of 20% of the gross amount of royalties paid. Said Article 23 reads:

Article 23

Relief from double taxation

Double taxation of income shall be avoided in the following manner:

1) In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle thereof), the United States shall allow to a citizen or resident of the United States as a credit against the United States tax the appropriate amount of taxes paid or accrued to the Philippines and, in the case of a United States corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine corporation paying such dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the United States tax on income from

sources within the Philippines or on income from sources outside the United States) provided by United States law for the taxable year. . . .

The reason for construing the phrase "paid under similar circumstances" as used in Article 13 (2) (b) (iii) of the RP-US Tax Treaty as referring to taxes is anchored upon a logical reading of the text in the light of the fundamental purpose of such treaty which is to grant an incentive to the foreign investor by lowering the tax and at the same time crediting against the domestic tax abroad a figure higher than what was collected in the Philippines.

In one case, the Supreme Court pointed out that laws are not just mere compositions, but have ends to be achieved and that the general purpose is a more important aid to the meaning of a law than any rule which grammar may lay down. 20 It is the duty of the courts to look to the object to be accomplished, the evils to be remedied, or the purpose to be subserved, and should give the law a reasonable or liberal construction which will best effectuate its purpose. 21 The Vienna Convention on the Law of Treaties states that a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object andpurpose. 22

As stated earlier, the ultimate reason for avoiding double taxation is to encourage foreign investors to invest in the Philippines — a crucial economic goal for developing countries. 23 The goal of double taxation conventions would be thwarted if such treaties did not provide for effective measures to minimize, if not

completely eliminate, the tax burden laid upon the income or capital of the investor. Thus, if the rates of tax are lowered by the state of source, in this case, by the Philippines, there should be a concomitant commitment on the part of the state of residence to grant some form of tax relief, whether this be in the form of a tax credit or exemption. 24 Otherwise, the tax which could have been collected by the Philippine government will simply be collected by another state, defeating the object of the tax treaty since the tax burden imposed upon the investor would remain unrelieved. If the state of residence does not grant some form of tax relief to the investor, no benefit would redound to the Philippines, i.e., increased investment resulting from a favorable tax regime, should it impose a lower tax rate on the royalty earnings of the investor, and it would be better to impose the regular rate rather than lose much-needed revenues to another country.

At the same time, the intention behind the adoption of the provision on "relief from double taxation" in the two tax treaties in question should be considered in light of the purpose behind the most favored nation clause.

The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the "most favored" among other countries. 25 The most favored nation clause is intended to establish the principle of equality of international treatment by providing that the citizens or subjects of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. 26 The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is

also a party provided that the subject matter of taxation, in this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and Article 12 (2) (b) of the RP-West Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent, and technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment.

We accordingly agree with petitioner that since the RP-US Tax Treaty does not give a matching tax credit of 20 percent for the taxes paid to the Philippines on royalties as allowed under the RP-West Germany Tax Treaty, private respondent cannot be deemed entitled to the 10 percent rate granted under the latter treaty for the reason that there is no payment of taxes on royalties under similar circumstances.

It bears stress that tax refunds are in the nature of tax exemptions. As such they are regarded as in derogation of sovereign authority and to be construed strictissimi juris against the person or entity claiming the exemption. 27 The burden of proof is upon him who claims the exemption in his favor and he must be able to justify his claim by the clearest grant of organic or statute law. 28 Private respondent is claiming for a refund of the alleged overpayment of tax on royalties; however, there is nothing on record to support a claim that the tax on royalties under the RP-US Tax Treaty is paid under similar circumstances as the tax on royalties under the RP-West Germany Tax Treaty.

WHEREFORE, for all the foregoing, the instant petition is GRANTED. The decision dated May 7, 1996 of the Court of Tax Appeals and the decision dated November 7, 1996 of the Court of Appeals are hereby SET ASIDE.

G.R. No. 76573 September 14, 1989

MARUBENI CORPORATION (formerly Marubeni — Iida, Co., Ltd.), petitioner, vs.COMMISSIONER OF INTERNAL REVENUE AND COURT OF TAX APPEALS, respondents.

Melquiades C. Gutierrez for petitioner.

The Solicitor General for respondents.

FERNAN, C.J.:

Petitioner, Marubeni Corporation, representing itself as a foreign corporation duly organized and existing under the laws of Japan and duly licensed to engage in business under Philippine laws with branch office at the 4th Floor, FEEMI Building, Aduana Street, Intramuros, Manila seeks the reversal of the decision of the Court of Tax Appeals 1 dated February 12, 1986 denying its claim for refund or tax credit in the amount of P229,424.40 representing alleged overpayment of branch profit remittance tax withheld from dividends by Atlantic Gulf and Pacific Co. of Manila (AG&P).

The following facts are undisputed: Marubeni Corporation of Japan has equity investments in AG&P of Manila. For the first quarter of 1981 ending March 31, AG&P declared and paid cash dividends to petitioner in the amount of P849,720 and withheld the corresponding 10% final dividend tax thereon. Similarly, for the third quarter of 1981 ending September 30, AG&P declared and paid P849,720 as cash dividends to petitioner and withheld the corresponding 10% final dividend tax thereon. 2

AG&P directly remitted the cash dividends to petitioner's head office in Tokyo, Japan, net not only of the 10% final dividend tax in the amounts of P764,748 for the first and third quarters of 1981, but also of the withheld 15% profit remittance tax based on the remittable amount after deducting the final withholding tax of 10%. A schedule of dividends declared and paid by AG&P to its stockholder Marubeni Corporation of Japan, the 10% final intercorporate dividend tax and the 15% branch profit remittance tax paid thereon, is shown below:

1981 FIRST QUARTER

(three months ended

3.31.81) (In Pesos)

THIRD QUARTER

(three months ended

9.30.81)

TOTAL OF FIRST and

THIRD quarters

Cash Dividends Paid

849,720.44 849,720.00 1,699,440.00

10% Dividend Tax Withheld

84,972.00 84,972.00 169,944.00

Cash Dividend net of 10% Dividend Tax Withheld

764,748.00 764,748.00 1,529,496.00

15% Branch Profit Remittance Tax Withheld

114,712.20 114,712.20 229,424.40 3

Net Amount Remitted to Petitioner

650,035.80 650,035.80 1,300,071.60

The 10% final dividend tax of P84,972 and the 15% branch profit remittance tax of P114,712.20 for the first quarter of 1981 were paid to the Bureau of Internal Revenue by AG&P on April 20, 1981 under Central Bank Receipt No. 6757880. Likewise, the 10% final dividend tax of P84,972 and the 15% branch profit remittance

tax of P114,712 for the third quarter of 1981 were paid to the Bureau of Internal Revenue by AG&P on August 4, 1981 under Central Bank Confirmation Receipt No. 7905930. 4

Thus, for the first and third quarters of 1981, AG&P as withholding agent paid 15% branch profit remittance on cash dividends declared and remitted to petitioner at its head office in Tokyo in the total amount of P229,424.40 on April 20 and August 4, 1981. 5

In a letter dated January 29, 1981, petitioner, through the accounting firm Sycip, Gorres, Velayo and Company, sought a ruling from the Bureau of Internal Revenue on whether or not the dividends petitioner received from AG&P are effectively connected with its conduct or business in the Philippines as to be considered branch profits subject to the 15% profit remittance tax imposed under Section 24 (b) (2) of the National Internal Revenue Code as amended by Presidential Decrees Nos. 1705 and 1773.

In reply to petitioner's query, Acting Commissioner Ruben Ancheta ruled:

Pursuant to Section 24 (b) (2) of the Tax Code, as amended, only profits remitted abroad by a branch office to its head office which are effectively connected with its trade or business in the Philippines are subject to the 15% profit remittance tax. To be effectively connected it is not necessary that the income be derived from the actual operation of taxpayer-corporation's trade or business; it is sufficient that the income arises from the business activity in which the corporation is engaged. For example, if a resident foreign corporation is engaged in the buying and selling of machineries in the Philippines and invests in some shares of stock on which dividends are

subsequently received, the dividends thus earned are not considered 'effectively connected' with its trade or business in this country. (Revenue Memorandum Circular No. 55-80).

In the instant case, the dividends received by Marubeni from AG&P are not income arising from the business activity in which Marubeni is engaged. Accordingly, said dividends if remitted abroad are not considered branch profits for purposes of the 15% profit remittance tax imposed by Section 24 (b) (2) of the Tax Code, as amended . . . 6

Consequently, in a letter dated September 21, 1981 and filed with the Commissioner of Internal Revenue on September 24, 1981, petitioner claimed for the refund or issuance of a tax credit of P229,424.40 "representing profit tax remittance erroneously paid on the dividends remitted by Atlantic Gulf and Pacific Co. of Manila (AG&P) on April 20 and August 4, 1981 to ... head office in Tokyo. 7

On June 14, 1982, respondent Commissioner of Internal Revenue denied petitioner's claim for refund/credit of P229,424.40 on the following grounds:

While it is true that said dividends remitted were not subject to the 15% profit remittance tax as the same were not income earned by a Philippine Branch of Marubeni Corporation of Japan; and neither is it subject to the 10% intercorporate dividend tax, the recipient of the dividends, being a non-resident stockholder, nevertheless, said dividend income is subject to the 25 % tax pursuant to Article 10 (2) (b) of the Tax Treaty dated February 13, 1980 between the Philippines and Japan.

Inasmuch as the cash dividends remitted by AG&P to Marubeni Corporation, Japan is subject to 25 % tax, and that the taxes withheld of 10 % as intercorporate dividend tax and 15 % as profit remittance tax totals (sic) 25 %, the amount refundable offsets the liability, hence, nothing is left to be refunded. 8

Petitioner appealed to the Court of Tax Appeals which affirmed the denial of the refund by the Commissioner of Internal Revenue in its assailed judgment of February 12, 1986. 9

In support of its rejection of petitioner's claimed refund, respondent Tax Court explained:

Whatever the dialectics employed, no amount of sophistry can ignore the fact that the dividends in question are income taxable to the Marubeni Corporation of Tokyo, Japan. The said dividends were distributions made by the Atlantic, Gulf and Pacific Company of Manila to its shareholder out of its profits on the investments of the Marubeni Corporation of Japan, a non-resident foreign corporation. The investments in the Atlantic Gulf & Pacific Company of the Marubeni Corporation of Japan were directly made by it and the dividends on the investments were likewise directly remitted to and received by the Marubeni Corporation of Japan. Petitioner Marubeni Corporation Philippine Branch has no participation or intervention, directly or indirectly, in the investments and in the receipt of the dividends. And it appears that the funds invested in the Atlantic Gulf & Pacific Company did not come out of the funds infused by the Marubeni Corporation of Japan to the Marubeni Corporation Philippine Branch. As a matter of fact, the Central Bank of the Philippines, in

authorizing the remittance of the foreign exchange equivalent of (sic) the dividends in question, treated the Marubeni Corporation of Japan as a non-resident stockholder of the Atlantic Gulf & Pacific Company based on the supporting documents submitted to it.

Subject to certain exceptions not pertinent hereto, income is taxable to the person who earned it. Admittedly, the dividends under consideration were earned by the Marubeni Corporation of Japan, and hence, taxable to the said corporation. While it is true that the Marubeni Corporation Philippine Branch is duly licensed to engage in business under Philippine laws, such dividends are not the income of the Philippine Branch and are not taxable to the said Philippine branch. We see no significance thereto in the identity concept or principal-agent relationship theory of petitioner because such dividends are the income of and taxable to the Japanese corporation in Japan and not to the Philippine branch. 10

Hence, the instant petition for review.

It is the argument of petitioner corporation that following the principal-agent relationship theory, Marubeni Japan is likewise a resident foreign corporation subject only to the 10 % intercorporate final tax on dividends received from a domestic corporation in accordance with Section 24(c) (1) of the Tax Code of 1977 which states:

Dividends received by a domestic or resident foreign corporation liable to tax under this Code — (1) Shall be subject to a final tax of 10% on the total amount thereof, which shall be collected and paid as provided in Sections 53 and 54 of this Code ....

Public respondents, however, are of the contrary view that Marubeni, Japan, being a non-resident foreign corporation and not engaged in trade or business in the Philippines, is subject to tax on income earned from Philippine sources at the rate of 35 % of its gross income under Section 24 (b) (1) of the same Code which reads:

(b) Tax on foreign corporations — (1) Non-resident corporations. — A foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five per cent of the gross income received during each taxable year from all sources within the Philippines as ... dividends ....

but expressly made subject to the special rate of 25% under Article 10(2) (b) of the Tax Treaty of 1980 concluded between the Philippines and Japan. 11 Thus:

Article 10 (1) Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other Contracting State.

(2) However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed;

(a) . . .

(b) 25 per cent of the gross amount of the dividends in all other cases.

Central to the issue of Marubeni Japan's tax liability on its dividend income from Philippine sources is therefore the determination of whether it is a resident or a non-resident foreign corporation under Philippine laws.

Under the Tax Code, a resident foreign corporation is one that is "engaged in trade or business" within the Philippines. Petitioner contends that precisely because it is engaged in business in the Philippines through its Philippine branch that it must be considered as a resident foreign corporation. Petitioner reasons that since the Philippine branch and the Tokyo head office are one and the same entity, whoever made the investment in AG&P, Manila does not matter at all. A single corporate entity cannot be both a resident and a non-resident corporation depending on the nature of the particular transaction involved. Accordingly, whether the dividends are paid directly to the head office or coursed through its local branch is of no moment for after all, the head office and the office branch constitute but one corporate entity, the Marubeni Corporation, which, under both Philippine tax and corporate laws, is a resident foreign corporation because it is transacting business in the Philippines.

The Solicitor General has adequately refuted petitioner's arguments in this wise:

The general rule that a foreign corporation is the same juridical entity as its branch office in the Philippines cannot apply here. This rule is based on the premise that the business of the foreign corporation is conducted through its branch office, following the principal agent relationship theory. It is understood that the branch becomes its agent here. So that when the foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside. The transaction becomes one of the foreign corporation, not of the branch. Consequently, the taxpayer is the foreign corporation, not the branch or the resident foreign corporation.

Corollarily, if the business transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign corporation. 12

In other words, the alleged overpaid taxes were incurred for the remittance of dividend income to the head office in Japan which is a separate and distinct income taxpayer from the branch in the Philippines. There can be no other logical conclusion considering the undisputed fact that the investment (totalling 283.260 shares including that of nominee) was made for purposes peculiarly germane to the conduct of the corporate affairs of Marubeni Japan, but certainly not of the branch in the Philippines. It is thus clear that petitioner, having made this independent investment attributable only to the head office, cannot now claim the

increments as ordinary consequences of its trade or business in the Philippines and avail itself of the lower tax rate of 10 %.

But while public respondents correctly concluded that the dividends in dispute were neither subject to the 15 % profit remittance tax nor to the 10 % intercorporate dividend tax, the recipient being a non-resident stockholder, they grossly erred in holding that no refund was forthcoming to the petitioner because the taxes thus withheld totalled the 25 % rate imposed by the Philippine-Japan Tax Convention pursuant to Article 10 (2) (b).

To simply add the two taxes to arrive at the 25 % tax rate is to disregard a basic rule in taxation that each tax has a different tax basis. While the tax on dividends is directly levied on the dividends received, "the tax base upon which the 15 % branch profit remittance tax is imposed is the profit actually remitted abroad." 13

Public respondents likewise erred in automatically imposing the 25 % rate under Article 10 (2) (b) of the Tax Treaty as if this were a flat rate. A closer look at the Treaty reveals that the tax rates fixed by Article 10 are the maximum rates as reflected in the phrase "shall not exceed." This means that any tax imposable by the contracting state concerned should not exceed the 25 % limitation and that said rate would apply only if the tax imposed by our laws exceeds the same. In other words, by reason of our bilateral negotiations with Japan, we have agreed to have our right to tax limited to a certain extent to attain the goals set forth in the Treaty.

Petitioner, being a non-resident foreign corporation with respect to the transaction in question, the applicable provision of the Tax Code is Section 24 (b) (1) (iii) in conjunction with the Philippine-Japan Treaty of 1980. Said section provides:

(b) Tax on foreign corporations. — (1) Non-resident corporations — ... (iii) On dividends received from a domestic corporation liable to tax under this Chapter, the tax shall be 15% of the dividends received, which shall be collected and paid as provided in Section 53 (d) of this Code, subject to the condition that the country in which the non-resident foreign corporation is domiciled shall allow a credit against the tax due from the non-resident foreign corporation, taxes deemed to have been paid in the Philippines equivalent to 20 % which represents the difference between the regular tax (35 %) on corporations and the tax (15 %) on dividends as provided in this Section; ....

Proceeding to apply the above section to the case at bar, petitioner, being a non-resident foreign corporation, as a general rule, is taxed 35 % of its gross income from all sources within the Philippines. [Section 24 (b) (1)].

However, a discounted rate of 15% is given to petitioner on dividends received from a domestic corporation (AG&P) on the condition that its domicile state (Japan) extends in favor of petitioner, a tax credit of not less than 20 % of the dividends received. This 20 % represents the difference between the regular tax of 35 % on non-resident foreign corporations which petitioner would have ordinarily paid, and the 15 % special rate on dividends received from a domestic corporation.

Consequently, petitioner is entitled to a refund on the transaction in question to be computed as follows:

Total cash dividend paid ................P1,699,440.00less 15% under Sec. 24(b) (1) (iii ) .........................................254,916.00------------------

Cash dividend net of 15 % taxdue petitioner ...............................P1,444.524.00less net amountactually remitted .............................1,300,071.60-------------------

Amount to be refunded to petitionerrepresenting overpayment oftaxes on dividends remitted ..............P 144 452.40===========

It is readily apparent that the 15 % tax rate imposed on the dividends received by a foreign non-resident stockholder from a domestic corporation under Section 24 (b) (1) (iii) is easily within the maximum ceiling of 25 % of the gross amount of the dividends as decreed in Article 10 (2) (b) of the Tax Treaty.

There is one final point that must be settled. Respondent Commissioner of Internal Revenue is laboring under the impression that the Court of Tax Appeals is covered by Batas Pambansa Blg. 129, otherwise known as the Judiciary Reorganization Act of 1980. He alleges that the instant petition for review was not perfected in accordance with Batas Pambansa Blg. 129 which provides that "the period of appeal from final orders, resolutions, awards, judgments, or decisions of any court in all cases shall be fifteen (15) days counted from the notice of the final order, resolution, award, judgment or decision appealed from ....

This is completely untenable. The cited BP Blg. 129 does not include the Court of Tax Appeals which has been created by virtue of a special law, Republic Act No. 1125. Respondent court is not among those courts specifically mentioned in Section 2 of BP Blg. 129 as falling within its scope.

Thus, under Section 18 of Republic Act No. 1125, a party adversely affected by an order, ruling or decision of the Court of Tax Appeals is given thirty (30) days from notice to appeal therefrom. Otherwise, said order, ruling, or decision shall become final.

Records show that petitioner received notice of the Court of Tax Appeals's decision denying its claim for refund on April 15, 1986. On the 30th day, or on May 15, 1986 (the last day for appeal), petitioner filed a motion for reconsideration which respondent court subsequently denied on November 17, 1986, and notice of which was received by petitioner on November 26, 1986. Two days later, or on November 28, 1986, petitioner simultaneously filed a notice of appeal with the Court of Tax Appeals and a petition for review with the Supreme Court. 14 From the foregoing, it is evident that the instant appeal was perfected well within the

30-day period provided under R.A. No. 1125, the whole 30-day period to appeal having begun to run again from notice of the denial of petitioner's motion for reconsideration.

WHEREFORE, the questioned decision of respondent Court of Tax Appeals dated February 12, 1986 which affirmed the denial by respondent Commissioner of Internal Revenue of petitioner Marubeni Corporation's claim for refund is hereby REVERSED. The Commissioner of Internal Revenue is ordered to refund or grant as tax credit in favor of petitioner the amount of P144,452.40 representing overpayment of taxes on dividends received. No costs.

G.R. No. L-66838 December 2, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.PROCTER & GAMBLE PHILIPPINE MANUFACTURING CORPORATION and THE COURT OF TAX APPEALS, respondents.

T.A. Tejada & C.N. Lim for private respondent.

R E S O L U T I O N

FELICIANO, J.:p

For the taxable year 1974 ending on 30 June 1974, and the taxable year 1975 ending 30 June 1975, private respondent Procter and Gamble Philippine Manufacturing Corporation ("P&G-Phil.") declared dividends payable to its parent company and sole stockholder, Procter and Gamble Co., Inc. (USA) ("P&G-USA"), amounting to P24,164,946.30, from which dividends the amount of P8,457,731.21 representing the thirty-five percent (35%) withholding tax at source was deducted.

On 5 January 1977, private respondent P&G-Phil. filed with petitioner Commissioner of Internal Revenue a claim for refund or tax credit in the amount of P4,832,989.26 claiming, among other things, that pursuant to Section 24 (b) (1) of the National Internal Revenue Code ("NITC"), 1 as amended by Presidential Decree No. 369, the applicable rate of withholding tax on the dividends remitted was only fifteen percent (15%) (and not thirty-five percent [35%]) of the dividends.

There being no responsive action on the part of the Commissioner, P&G-Phil., on 13 July 1977, filed a petition for review with public respondent Court of Tax Appeals ("CTA") docketed as CTA Case No. 2883. On 31 January 1984, the CTA rendered a decision ordering petitioner Commissioner to refund or grant the tax credit in the amount of P4,832,989.00.

On appeal by the Commissioner, the Court through its Second Division reversed the decision of the CTA and held that:

(a) P&G-USA, and not private respondent P&G-Phil., was the proper party to claim the refund or tax credit here involved;

(b) there is nothing in Section 902 or other provisions of the US Tax Code that allows a credit against the US tax due from P&G-USA of taxes deemed to have been paid in the Philippines equivalent to twenty percent (20%) which represents the difference between the regular tax of thirty-five percent (35%) on corporations and the tax of fifteen percent (15%) on dividends; and

(c) private respondent P&G-Phil. failed to meet certain conditions necessary in order that "the dividends received by its non-resident parent company in the US (P&G-USA) may be subject to the preferential tax rate of 15% instead of 35%."

These holdings were questioned in P&G-Phil.'s Motion for Re-consideration and we will deal with them seriatim in this Resolution resolving that Motion.

I

1. There are certain preliminary aspects of the question of the capacity of P&G-Phil. to bring the present claim for refund or tax credit, which need to be examined. This question was raised for the first time on appeal, i.e., in the proceedings before this Court on the Petition for Review filed by the Commissioner of Internal Revenue. The question was not raised by the Commissioner on the administrative level, and neither was it raised by him before the CTA.

We believe that the Bureau of Internal Revenue ("BIR") should not be allowed to defeat an otherwise valid claim for refund by raising this question of alleged incapacity for the first time on appeal before this Court. This is clearly a matter of procedure. Petitioner does not pretend that P&G-Phil., should it succeed in the claim for refund, is likely to run away, as it were, with the refund instead of transmitting such refund or tax credit to its parent and sole stockholder. It is commonplace that in the absence of explicit statutory provisions to the contrary, the government must follow the same rules of procedure which bind private parties. It is, for instance, clear that the government is held to compliance with the provisions of Circular No.

1-88 of this Court in exactly the same way that private litigants are held to such compliance, save only in respect of the matter of filing fees from which the Republic of the Philippines is exempt by the Rules of Court.

More importantly, there arises here a question of fairness should the BIR, unlike any other litigant, be allowed to raise for the first time on appeal questions which had not been litigated either in the lower court or on the administrative level. For, if petitioner had at the earliest possible opportunity, i.e., at the administrative level, demanded that P&G-Phil. produce an express authorization from its parent corporation to bring the claim for refund, then P&G-Phil. would have been able forthwith to secure and produce such authorization before filing the action in the instant case. The action here was commenced just before expiration of the two (2)-year prescriptive period.

2. The question of the capacity of P&G-Phil. to bring the claim for refund has substantive dimensions as well which, as will be seen below, also ultimately relate to fairness.

Under Section 306 of the NIRC, a claim for refund or tax credit filed with the Commissioner of Internal Revenue is essential for maintenance of a suit for recovery of taxes allegedly erroneously or illegally assessed or collected:

Sec. 306. Recovery of tax erroneously or illegally collected. — No suit or proceeding shall be maintained in any court for the recovery of any national internal revenue tax hereafter alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been

collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Commissioner of Internal Revenue; but such suit or proceeding may be maintained, whether or not such tax, penalty, or sum has been paid under protest or duress. In any case, no such suit or proceeding shall be begun after the expiration of two years from the date of payment of the tax or penalty regardless of any supervening cause that may arise after payment: . . . (Emphasis supplied)

Section 309 (3) of the NIRC, in turn, provides:

Sec. 309. Authority of Commissioner to Take Compromises and to Refund Taxes.—The Commissioner may:

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(3) credit or refund taxes erroneously or illegally received, . . . No credit or refund of taxes or penalties shall be allowed unless the taxpayer files in writing with the Commissioner a claim for credit or refund within two (2) years after the payment of the tax or penalty. (As amended by P.D. No. 69) (Emphasis supplied)

Since the claim for refund was filed by P&G-Phil., the question which arises is: is P&G-Phil. a "taxpayer" under Section 309 (3) of the NIRC? The term "taxpayer" is defined in our NIRC as referring to "any person subject to tax imposed by the Title [on Tax on Income]." 2 It thus becomes important to note that under

Section 53 (c) of the NIRC, the withholding agent who is "required to deduct and withhold any tax" is made " personally liable for such tax" and indeed is indemnified against any claims and demands which the stockholder might wish to make in questioning the amount of payments effected by the withholding agent in accordance with the provisions of the NIRC. The withholding agent, P&G-Phil., is directly and independently liable 3 for the correct amount of the tax that should be withheld from the dividend remittances. The withholding agent is, moreover, subject to and liable for deficiency assessments, surcharges and penalties should the amount of the tax withheld be finally found to be less than the amount that should have been withheld under law.

A "person liable for tax" has been held to be a "person subject to tax" and properly considered a "taxpayer." 4 The terms liable for tax" and "subject to tax" both connote legal obligation or duty to pay a tax. It is very difficult, indeed conceptually impossible, to consider a person who is statutorily made "liable for tax" as not "subject to tax." By any reasonable standard, such a person should be regarded as a party in interest, or as a person having sufficient legal interest, to bring a suit for refund of taxes he believes were illegally collected from him.

In Philippine Guaranty Company, Inc. v. Commissioner of Internal Revenue, 5 this Court pointed out that a withholding agent is in fact the agent both of the government and of the taxpayer, and that the withholding agent is not an ordinary government agent:

The law sets no condition for the personal liability of the withholding agent to attach. The reason is to compel the withholding agent to withhold the tax under all circumstances. In effect, the responsibility for the collection of the tax as well as the payment thereof is concentrated upon the person over whom the Government has jurisdiction. Thus, the withholding agent is constituted the agent of both the Government and the taxpayer. With respect to the collection and/or withholding of the tax, he is the Government's agent. In regard to the filing of the necessary income tax return and the payment of the tax to the Government, he is the agent of the taxpayer. The withholding agent, therefore, is no ordinary government agent especially because under Section 53 (c) he is held personally liable for the tax he is duty bound to withhold; whereas the Commissioner and his deputies are not made liable by law. 6 (Emphasis supplied)

If, as pointed out in Philippine Guaranty, the withholding agent is also an agent of the beneficial owner of the dividends with respect to the filing of the necessary income tax return and with respect to actual payment of the tax to the government, such authority may reasonably be held to include the authority to file a claim for refund and to bring an action for recovery of such claim. This implied authority is especially warranted where, is in the instant case, the withholding agent is the wholly owned subsidiary of the parent-stockholder and therefore, at all times, under the effective control of such parent-stockholder. In the circumstances of this case, it seems particularly unreal to deny the implied authority of P&G-Phil. to claim a refund and to commence an action for such refund.

We believe that, even now, there is nothing to preclude the BIR from requiring P&G-Phil. to show some written or telexed confirmation by P&G-USA of the subsidiary's authority to claim the refund or tax credit and to remit the proceeds of the refund., or to apply the tax credit to some Philippine tax obligation of, P&G-USA, before actual payment of the refund or issuance of a tax credit certificate. What appears to be vitiated by basic unfairness is petitioner's position that, although P&G-Phil. is directly and personally liable to the Government for the taxes and any deficiency assessments to be collected, the Government is not legally liable for a refund simply because it did not demand a written confirmation of P&G-Phil.'s implied authority from the very beginning. A sovereign government should act honorably and fairly at all times, even vis-a-vis taxpayers.

We believe and so hold that, under the circumstances of this case, P&G-Phil. is properly regarded as a "taxpayer" within the meaning of Section 309, NIRC, and as impliedly authorized to file the claim for refund and the suit to recover such claim.

II

1. We turn to the principal substantive question before us: the applicability to the dividend remittances by P&G-Phil. to P&G-USA of the fifteen percent (15%) tax rate provided for in the following portion of Section 24 (b) (1) of the NIRC:

(b) Tax on foreign corporations.—

(1) Non-resident corporation. — A foreign corporation not engaged in trade and business in the Philippines, . . ., shall pay a tax equal to 35% of the gross income receipt during its taxable year from all sources within the Philippines, as . . . dividends . . . Provided, still further, that on dividends received from a domestic corporation liable to tax under this Chapter, the tax shall be 15% of the dividends, which shall be collected and paid as provided in Section 53 (d) of this Code, subject to the condition that the country in which the non-resident foreign corporation, is domiciled shall allow a credit against the tax due from the non-resident foreign corporation, taxes deemed to have been paid in the Philippines equivalent to 20% which represents the difference between the regular tax (35%) on corporations and the tax (15%) on dividends as provided in this Section . . .

The ordinary thirty-five percent (35%) tax rate applicable to dividend remittances to non-resident corporate stockholders of a Philippine corporation, goes down to fifteen percent (15%) if the country of domicile of the foreign stockholder corporation "shall allow" such foreign corporation a tax credit for "taxes deemed paid in the Philippines," applicable against the tax payable to the domiciliary country by the foreign stockholder corporation. In other words, in the instant case, the reduced fifteen percent (15%) dividend tax rate is applicable if the USA "shall allow" to P&G-USA a tax credit for "taxes deemed paid in the Philippines" applicable against the US taxes of P&G-USA. The NIRC specifies that such tax credit for "taxes deemed paid in the Philippines" must, as a minimum, reach an amount equivalent to twenty (20) percentage points which represents the difference between the regular thirty-five percent (35%) dividend tax rate and the preferred fifteen percent (15%) dividend tax rate.

It is important to note that Section 24 (b) (1), NIRC, does not require that the US must give a "deemed paid" tax credit for the dividend tax (20 percentage points) waived by the Philippines in making applicable the preferred divided tax rate of fifteen percent (15%). In other words, our NIRC does not require that the US tax law deem the parent-corporation to have paid the twenty (20) percentage points of dividend tax waived by the Philippines. The NIRC only requires that the US "shall allow" P&G-USA a "deemed paid" tax credit in an amount equivalent to the twenty (20) percentage points waived by the Philippines.

2. The question arises: Did the US law comply with the above requirement? The relevant provisions of the US Intemal Revenue Code ("Tax Code") are the following:

Sec. 901 — Taxes of foreign countries and possessions of United States.

(a) Allowance of credit. — If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the applicable limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under sections 902 and 960. Such choice for any taxable year may be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year. The credit shall not be allowed against the tax imposed by section 531 (relating to the tax on accumulated earnings), against the additional tax imposed for the taxable year under section 1333 (relating to war loss

recoveries) or under section 1351 (relating to recoveries of foreign expropriation losses), or against the personal holding company tax imposed by section 541.

(b) Amount allowed. — Subject to the applicable limitation of section 904, the following amounts shall be allowed as the credit under subsection (a):

(a) Citizens and domestic corporations. — In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; and

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Sec. 902. — Credit for corporate stockholders in foreign corporation.

(A) Treatment of Taxes Paid by Foreign Corporation. — For purposes of this subject, a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall —

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(2) to the extent such dividends are paid by such foreign corporation out of accumulated profits [as defined in subsection (c) (1) (b)] of a year for which such

foreign corporation is a less developed country corporation, be deemed to have paid the same proportion of any income, war profits, or excess profits taxes paid or deemed to be paid by such foreign corporation to any foreign country or to any possession of the United States on or with respect to such accumulated profits, which the amount of such dividends bears to the amount of such accumulated profits.

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(c) Applicable Rules

(1) Accumulated profits defined. — For purposes of this section, the term "accumulated profits" means with respect to any foreign corporation,

(A) for purposes of subsections (a) (1) and (b) (1), the amount of its gains, profits, or income computed without reduction by the amount of the income, war profits, and excess profits taxes imposed on or with respect to such profits or income by any foreign country. . . .; and

(B) for purposes of subsections (a) (2) and (b) (2), the amount of its gains, profits, or income in excess of the income, war profits, and excess profits taxes imposed on or with respect to such profits or income.

The Secretary or his delegate shall have full power to determine from the accumulated profits of what year or years such dividends were paid, treating dividends paid in the first 20 days of any year as having been paid from the accumulated profits of the preceding year or years (unless to his satisfaction shows otherwise), and in other respects treating dividends as having been paid from the most recently accumulated gains, profits, or earning. . . . (Emphasis supplied)

Close examination of the above quoted provisions of the US Tax Code 7 shows the following:

a. US law (Section 901, Tax Code) grants P&G-USA a tax credit for the amount of the dividend tax actually paid (i.e., withheld) from the dividend remittances to P&G-USA;

b. US law (Section 902, US Tax Code) grants to P&G-USA a "deemed paid' tax credit 8 for a proportionate part of the corporate income tax actually paid to the Philippines by P&G-Phil.

The parent-corporation P&G-USA is "deemed to have paid" a portion of the Philippine corporate income tax although that tax was actually paid by its Philippine subsidiary, P&G-Phil., not by P&G-USA. This "deemed paid" concept merely reflects economic reality, since the Philippine corporate income tax was in fact paid and deducted from revenues earned in the Philippines, thus reducing the amount remittable as dividends to P&G-USA. In other words, US tax law treats the Philippine corporate income tax as if it came out of the pocket, as it were, of P&G-USA as a part of the economic cost of carrying on business operations in the

Philippines through the medium of P&G-Phil. and here earning profits. What is, under US law, deemed paid by P&G- USA are not "phantom taxes" but instead Philippine corporate income taxes actually paid here by P&G-Phil., which are very real indeed.

It is also useful to note that both (i) the tax credit for the Philippine dividend tax actually withheld, and (ii) the tax credit for the Philippine corporate income tax actually paid by P&G Phil. but "deemed paid" by P&G-USA, are tax credits available or applicable against the US corporate income tax of P&G-USA. These tax credits are allowed because of the US congressional desire to avoid or reduce double taxation of the same income stream. 9

In order to determine whether US tax law complies with the requirements for applicability of the reduced or preferential fifteen percent (15%) dividend tax rate under Section 24 (b) (1), NIRC, it is necessary:

a. to determine the amount of the 20 percentage points dividend tax waived by the Philippine government under Section 24 (b) (1), NIRC, and which hence goes to P&G-USA;

b. to determine the amount of the "deemed paid" tax credit which US tax law must allow to P&G-USA; and

c. to ascertain that the amount of the "deemed paid" tax credit allowed by US law is at least equal to the amount of the dividend tax waived by the Philippine Government.

Amount (a), i.e., the amount of the dividend tax waived by the Philippine government is arithmetically determined in the following manner:

P100.00 — Pretax net corporate income earned by P&G-Phil.x 35% — Regular Philippine corporate income tax rate———P35.00 — Paid to the BIR by P&G-Phil. as Philippinecorporate income tax.

P100.00-35.00———P65.00 — Available for remittance as dividends to P&G-USA

P65.00 — Dividends remittable to P&G-USAx 35% — Regular Philippine dividend tax rate under Section 24——— (b) (1), NIRCP22.75 — Regular dividend tax

P65.00 — Dividends remittable to P&G-USAx 15% — Reduced dividend tax rate under Section 24 (b) (1), NIRC

———P9.75 — Reduced dividend tax

P22.75 — Regular dividend tax under Section 24 (b) (1), NIRC-9.75 — Reduced dividend tax under Section 24 (b) (1), NIRC———P13.00 — Amount of dividend tax waived by Philippine===== government under Section 24 (b) (1), NIRC.

Thus, amount (a) above is P13.00 for every P100.00 of pre-tax net income earned by P&G-Phil. Amount (a) is also the minimum amount of the "deemed paid" tax credit that US tax law shall allow if P&G-USA is to qualify for the reduced or preferential dividend tax rate under Section 24 (b) (1), NIRC.

Amount (b) above, i.e., the amount of the "deemed paid" tax credit which US tax law allows under Section 902, Tax Code, may be computed arithmetically as follows:

P65.00 — Dividends remittable to P&G-USA- 9.75 — Dividend tax withheld at the reduced (15%) rate———P55.25 — Dividends actually remitted to P&G-USA

P35.00 — Philippine corporate income tax paid by P&G-Phil.to the BIR

Dividends actuallyremitted by P&G-Phil.to P&G-USA P55.25——————— = ——— x P35.00 = P29.75 10

Amount of accumulated P65.00 ======profits earned byP&G-Phil. in excessof income tax

Thus, for every P55.25 of dividends actually remitted (after withholding at the rate of 15%) by P&G-Phil. to its US parent P&G-USA, a tax credit of P29.75 is allowed by Section 902 US Tax Code for Philippine corporate income tax "deemed paid" by the parent but actually paid by the wholly-owned subsidiary.

Since P29.75 is much higher than P13.00 (the amount of dividend tax waived by the Philippine government), Section 902, US Tax Code, specifically and clearly complies with the requirements of Section 24 (b) (1), NIRC.

3. It is important to note also that the foregoing reading of Sections 901 and 902 of the US Tax Code is identical with the reading of the BIR of Sections 901 and 902 of the US Tax Code is identical with the reading of the BIR of Sections 901 and 902 as shown by administrative rulings issued by the BIR.

The first Ruling was issued in 1976, i.e., BIR Ruling No. 76004, rendered by then Acting Commissioner of Intemal Revenue Efren I. Plana, later Associate Justice of this Court, the relevant portion of which stated:

However, after a restudy of the decision in the American Chicle Company case and the provisions of Section 901 and 902 of the U.S. Internal Revenue Code, we find merit in your contention that our computation of the credit which the U.S. tax law allows in such cases is erroneous as the amount of tax "deemed paid" to the Philippine government for purposes of credit against the U.S. tax by the recipient of dividends includes a portion of the amount of income tax paid by the corporation declaring the dividend in addition to the tax withheld from the dividend remitted. In other words, the U.S. government will allow a credit to the U.S. corporation or recipient of the dividend, in addition to the amount of tax actually withheld, a portion of the income tax paid by the corporation declaring the dividend. Thus, if a Philippine corporation wholly owned by a U.S. corporation has a net income of P100,000, it will pay P25,000 Philippine income tax thereon in accordance with Section 24(a) of the Tax Code. The net income, after income tax, which is P75,000, will then be declared as dividend to the U.S. corporation at 15% tax, or P11,250, will be withheld therefrom. Under the aforementioned sections of the U.S. Internal Revenue Code, U.S. corporation receiving the

dividend can utilize as credit against its U.S. tax payable on said dividends the amount of P30,000 composed of:

(1) The tax "deemed paid" or indirectly paid on the dividend arrived at as follows:

P75,000 x P25,000 = P18,750———100,000 **

(2) The amount of 15% ofP75,000 withheld = 11,250———P30,000

The amount of P18,750 deemed paid and to be credited against the U.S. tax on the dividends received by the U.S. corporation from a Philippine subsidiary is clearly more than 20% requirement of Presidential Decree No. 369 as 20% of P75,000.00 the dividends to be remitted under the above example, amounts to P15,000.00 only.

In the light of the foregoing, BIR Ruling No. 75-005 dated September 10, 1975 is hereby amended in the sense that the dividends to be remitted by your client to its parent company shall be subject to the withholding tax at the rate of 15% only.

This ruling shall have force and effect only for as long as the present pertinent provisions of the U.S. Federal Tax Code, which are the bases of the ruling, are not revoked, amended and modified, the effect of which will reduce the percentage of tax deemed paid and creditable against the U.S. tax on dividends remitted by a foreign corporation to a U.S. corporation. (Emphasis supplied)

The 1976 Ruling was reiterated in, e.g., BIR Ruling dated 22 July 1981 addressed to Basic Foods Corporation and BIR Ruling dated 20 October 1987 addressed to Castillo, Laman, Tan and Associates. In other words, the 1976 Ruling of Hon. Efren I. Plana was reiterated by the BIR even as the case at bar was pending before the CTA and this Court.

4. We should not overlook the fact that the concept of "deemed paid" tax credit, which is embodied in Section 902, US Tax Code, is exactly the same "deemed paid" tax credit found in our NIRC and which Philippine tax law allows to Philippine corporations which have operations abroad (say, in the United States) and which, therefore, pay income taxes to the US government.

Section 30 (c) (3) and (8), NIRC, provides:

(d) Sec. 30. Deductions from Gross Income.—In computing net income, there shall be allowed as deductions — . . .

(c) Taxes. — . . .

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(3) Credits against tax for taxes of foreign countries. — If the taxpayer signifies in his return his desire to have the benefits of this paragraphs, the tax imposed by this Title shall be credited with . . .

(a) Citizen and Domestic Corporation. — In the case of a citizen of the Philippines and of domestic corporation, the amount of net income, war profits or excess profits, taxes paid or accrued during the taxable year to any foreign country. (Emphasis supplied)

Under Section 30 (c) (3) (a), NIRC, above, the BIR must give a tax credit to a Philippine corporation for taxes actually paid by it to the US government—e.g., for taxes collected by the US government on dividend remittances to the Philippine corporation. This Section of the NIRC is the equivalent of Section 901 of the US Tax Code.

Section 30 (c) (8), NIRC, is practically identical with Section 902 of the US Tax Code, and provides as follows:

(8) Taxes of foreign subsidiary. — For the purposes of this subsection a domestic corporation which owns a majority of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall be deemed to have paid the same proportion of any income, war-profits,

or excess-profits taxes paid by such foreign corporation to any foreign country, upon or with respect to the accumulated profits of such foreign corporation from which such dividends were paid, which the amount of such dividends bears to the amount of such accumulated profits: Provided, That the amount of tax deemed to have been paid under this subsection shall in no case exceed the same proportion of the tax against which credit is taken which the amount of such dividends bears to the amount of the entire net income of the domestic corporation in which such dividends are included. The term "accumulated profits" when used in this subsection reference to a foreign corporation, means the amount of its gains, profits, or income in excess of the income, war-profits, and excess-profits taxes imposed upon or with respect to such profits or income; and the Commissioner of Internal Revenue shall have full power to determine from the accumulated profits of what year or years such dividends were paid; treating dividends paid in the first sixty days of any year as having been paid from the accumulated profits of the preceding year or years (unless to his satisfaction shown otherwise), and in other respects treating dividends as having been paid from the most recently accumulated gains, profits, or earnings. In the case of a foreign corporation, the income, war-profits, and excess-profits taxes of which are determined on the basis of an accounting period of less than one year, the word "year" as used in this subsection shall be construed to mean such accounting period. (Emphasis supplied)

Under the above quoted Section 30 (c) (8), NIRC, the BIR must give a tax credit to a Philippine parent corporation for taxes "deemed paid" by it, that is, e.g., for taxes paid to the US by the US subsidiary of a Philippine-parent corporation. The Philippine parent or corporate stockholder is "deemed" under our

NIRC to have paid a proportionate part of the US corporate income tax paid by its US subsidiary, although such US tax was actually paid by the subsidiary and not by the Philippine parent.

Clearly, the "deemed paid" tax credit which, under Section 24 (b) (1), NIRC, must be allowed by US law to P&G-USA, is the same "deemed paid" tax credit that Philippine law allows to a Philippine corporation with a wholly- or majority-owned subsidiary in (for instance) the US. The "deemed paid" tax credit allowed in Section 902, US Tax Code, is no more a credit for "phantom taxes" than is the "deemed paid" tax credit granted in Section 30 (c) (8), NIRC.

III

1. The Second Division of the Court, in holding that the applicable dividend tax rate in the instant case was the regular thirty-five percent (35%) rate rather than the reduced rate of fifteen percent (15%), held that P&G-Phil. had failed to prove that its parent, P&G-USA, had in fact been given by the US tax authorities a "deemed paid" tax credit in the amount required by Section 24 (b) (1), NIRC.

We believe, in the first place, that we must distinguish between the legal question before this Court from questions of administrative implementation arising after the legal question has been answered. The basic legal issue is of course, this: which is the applicable dividend tax rate in the instant case: the regular thirty-five percent (35%) rate or the reduced fifteen percent (15%) rate? The question of whether or not P&G-USA is in fact given by the US tax authorities a "deemed paid" tax credit in the required amount, relates to the administrative implementation of the applicable reduced tax rate.

In the second place, Section 24 (b) (1), NIRC, does not in fact require that the "deemed paid" tax credit shall have actually been granted before the applicable dividend tax rate goes down from thirty-five percent (35%) to fifteen percent (15%). As noted several times earlier, Section 24 (b) (1), NIRC, merely requires, in the case at bar, that the USA "shall allow a credit against the tax due from [P&G-USA for] taxes deemed to have been paid in the Philippines . . ." There is neither statutory provision nor revenue regulation issued by the Secretary of Finance requiring the actual grant of the "deemed paid" tax credit by the US Internal Revenue Service to P&G-USA before the preferential fifteen percent (15%) dividend rate becomes applicable. Section 24 (b) (1), NIRC, does not create a tax exemption nor does it provide a tax credit; it is a provision which specifies when a particular (reduced) tax rate is legally applicable.

In the third place, the position originally taken by the Second Division results in a severe practical problem of administrative circularity. The Second Division in effect held that the reduced dividend tax rate is not applicable until the US tax credit for "deemed paid" taxes is actually given in the required minimum amount by the US Internal Revenue Service to P&G-USA. But, the US "deemed paid" tax credit cannot be given by the US tax authorities unless dividends have actually been remitted to the US, which means that the Philippine dividend tax, at the rate here applicable, was actually imposed and collected. 11 It is this practical or operating circularity that is in fact avoided by our BIR when it issues rulings that the tax laws of particular foreign jurisdictions (e.g., Republic of Vanuatu 12 Hongkong, 13 Denmark, 14 etc.) comply with the requirements set out in Section 24 (b) (1), NIRC, for applicability of the fifteen percent (15%) tax rate. Once such a ruling is rendered, the Philippine subsidiary begins to withhold at the reduced dividend tax rate.

A requirement relating to administrative implementation is not properly imposed as a condition for the applicability, as a matter of law, of a particular tax rate. Upon the other hand, upon the determination or recognition of the applicability of the reduced tax rate, there is nothing to prevent the BIR from issuing implementing regulations that would require P&G Phil., or any Philippine corporation similarly situated, to certify to the BIR the amount of the "deemed paid" tax credit actually subsequently granted by the US tax authorities to P&G-USA or a US parent corporation for the taxable year involved. Since the US tax laws can and do change, such implementing regulations could also provide that failure of P&G-Phil. to submit such certification within a certain period of time, would result in the imposition of a deficiency assessment for the twenty (20) percentage points differential. The task of this Court is to settle which tax rate is applicable, considering the state of US law at a given time. We should leave details relating to administrative implementation where they properly belong — with the BIR.

2. An interpretation of a tax statute that produces a revenue flow for the government is not, for that reason alone, necessarily the correct reading of the statute. There are many tax statutes or provisions which are designed, not to trigger off an instant surge of revenues, but rather to achieve longer-term and broader-gauge fiscal and economic objectives. The task of our Court is to give effect to the legislative design and objectives as they are written into the statute even if, as in the case at bar, some revenues have to be foregone in that process.

The economic objectives sought to be achieved by the Philippine Government by reducing the thirty-five percent (35%) dividend rate to fifteen percent (15%) are set out in the preambular clauses of P.D. No. 369 which amended Section 24 (b) (1), NIRC, into its present form:

WHEREAS, it is imperative to adopt measures responsive to the requirements of a developing economy foremost of which is the financing of economic development programs;

WHEREAS, nonresident foreign corporations with investments in the Philippines are taxed on their earnings from dividends at the rate of 35%;

WHEREAS, in order to encourage more capital investment for large projects an appropriate tax need be imposed on dividends received by non-resident foreign corporations in the same manner as the tax imposed on interest on foreign loans;

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(Emphasis supplied)

More simply put, Section 24 (b) (1), NIRC, seeks to promote the in-flow of foreign equity investment in the Philippines by reducing the tax cost of earning profits here and thereby increasing the net dividends remittable to the investor. The foreign investor, however, would not benefit from the reduction of the Philippine dividend tax rate unless its home country gives it some relief from double taxation (i.e., second-

tier taxation) (the home country would simply have more "post-R.P. tax" income to subject to its own taxing power) by allowing the investor additional tax credits which would be applicable against the tax payable to such home country. Accordingly, Section 24 (b) (1), NIRC, requires the home or domiciliary country to give the investor corporation a "deemed paid" tax credit at least equal in amount to the twenty (20) percentage points of dividend tax foregone by the Philippines, in the assumption that a positive incentive effect would thereby be felt by the investor.

The net effect upon the foreign investor may be shown arithmetically in the following manner:

P65.00 — Dividends remittable to P&G-USA (pleasesee page 392 above- 9.75 — Reduced R.P. dividend tax withheld by P&G-Phil.———P55.25 — Dividends actually remitted to P&G-USA

P55.25x 46% — Maximum US corporate income tax rate———P25.415—US corporate tax payable by P&G-USAwithout tax credits

P25.415- 9.75 — US tax credit for RP dividend tax withheld by P&G-Phil.at 15% (Section 901, US Tax Code)———P15.66 — US corporate income tax payable after Section 901——— tax credit.

P55.25- 15.66———P39.59 — Amount received by P&G-USA net of R.P. and U.S.===== taxes without "deemed paid" tax credit.

P25.415- 29.75 — "Deemed paid" tax credit under Section 902 US——— Tax Code (please see page 18 above)

- 0 - — US corporate income tax payable on dividends====== remitted by P&G-Phil. to P&G-USA after Section 902 tax credit.

P55.25 — Amount received by P&G-USA net of RP and US====== taxes after Section 902 tax credit.

It will be seen that the "deemed paid" tax credit allowed by Section 902, US Tax Code, could offset the US corporate income tax payable on the dividends remitted by P&G-Phil. The result, in fine, could be that P&G-USA would after US tax credits, still wind up with P55.25, the full amount of the dividends remitted to P&G-USA net of Philippine taxes. In the calculation of the Philippine Government, this should encourage additional investment or re-investment in the Philippines by P&G-USA.

3. It remains only to note that under the Philippines-United States Convention "With Respect to Taxes on Income," 15 the Philippines, by a treaty commitment, reduced the regular rate of dividend tax to a maximum of twenty percent (20%) of the gross amount of dividends paid to US parent corporations:

Art 11. — Dividends

xxx xxx xxx

(2) The rate of tax imposed by one of the Contracting States on dividends derived from sources within that Contracting State by a resident of the other Contracting State shall not exceed —

(a) 25 percent of the gross amount of the dividend; or

(b) When the recipient is a corporation, 20 percent of the gross amount of the dividend if during the part of the paying corporation's taxable year which precedes the date of payment of the dividend and during the whole of its prior taxable year (if any), at least 10 percent of the outstanding shares of the voting stock of the paying corporation was owned by the recipient corporation.

xxx xxx xxx

(Emphasis supplied)

The Tax Convention, at the same time, established a treaty obligation on the part of the United States that it "shall allow" to a US parent corporation receiving dividends from its Philippine subsidiary "a [tax] credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine [subsidiary] —.16 This is, of course, precisely the "deemed paid" tax credit provided for in Section 902, US Tax Code, discussed above. Clearly, there is here on the part of the Philippines a deliberate undertaking to reduce the regular dividend tax rate of twenty percent (20%) is a maximum rate, there is still a differential or additional reduction of five (5) percentage points which compliance of US law (Section 902) with the requirements of Section 24 (b) (1), NIRC, makes available in respect of dividends from a Philippine subsidiary.

We conclude that private respondent P&G-Phil, is entitled to the tax refund or tax credit which it seeks.

WHEREFORE, for all the foregoing, the Court Resolved to GRANT private respondent's Motion for Reconsideration dated 11 May 1988, to SET ASIDE the Decision of the and Division of the Court promulgated on 15 April 1988, and in lieu thereof, to REINSTATE and AFFIRM the Decision of the Court of Tax Appeals in CTA Case No. 2883 dated 31 January 1984 and to DENY the Petition for Review for lack of merit. No pronouncement as to costs.

Narvasa, Gutierrez, Jr., Griño-Aquino, Medialdea and Romero, JJ., concur.

Fernan, C.J., is on leave.

Separate Opinions

CRUZ, J., concurring:

I join Mr. Justice Feliciano in his excellent analysis of the difficult issues we are now asked to resolve.

As I understand it, the intention of Section 24 (b) of our Tax Code is to attract foreign investors to this country by reducing their 35% dividend tax rate to 15% if their own state allows them a deemed paid tax credit at least equal in amount to the 20% waived by the Philippines. This tax credit would offset the tax payable by them on their profits to their home state. In effect, both the Philippines and the home state of the foreign investors reduce their respective tax "take" of those profits and the investors wind up with more left in their pockets. Under this arrangement, the total taxes to be paid by the foreign investors may be confined to the 35% corporate income tax and 15% dividend tax only, both payable to the Philippines, with the US tax liability being offset wholly or substantially by the US "deemed paid" tax credits.

Without this arrangement, the foreign investors will have to pay to the local state (in addition to the 35% corporate income tax) a 35% dividend tax and another 35% or more to their home state or a total of 70% or more on the same amount of dividends. In this circumstance, it is not likely that many such foreign investors, given the onerous burden of the two-tier system, i.e., local state plus home state, will be encouraged to do business in the local state.

It is conceded that the law will "not trigger off an instant surge of revenue," as indeed the tax collectible by the Republic from the foreign investor is considerably reduced. This may appear unacceptable to the superficial viewer. But this reduction is in fact the price we have to offer to persuade the foreign company to invest in our country and contribute to our economic development. The benefit to us may not be immediately available in instant revenues but it will be realized later, and in greater measure, in terms of a more stable and robust economy.

BIDIN, J., concurring:

I agree with the opinion of my esteemed brother, Mr. Justice Florentino P. Feliciano. However, I wish to add some observations of my own, since I happen to be the ponente in Commissioner of Internal Revenue v. Wander Philippines, Inc. (160 SCRA 573 [1988]), a case which reached a conclusion that is diametrically opposite to that sought to be reached in the instant Motion for Reconsideration.

1. In page 5 of his dissenting opinion, Mr. Justice Edgardo L. Paras argues that the failure of petitioner Commissioner of Internal Revenue to raise before the Court of Tax Appeals the issue of who should be the real party in interest in claiming a refund cannot prejudice the government, as such failure is merely a procedural defect; and that moreover, the government can never be in estoppel, especially in matters involving taxes. In a word, the dissenting opinion insists that errors of its agents should not jeopardize the government's position.

The above rule should not be taken absolutely and literally; if it were, the government would never lose any litigation which is clearly not true. The issue involved here is not merely one of procedure; it is also one of fairness: whether the government should be subject to the same stringent conditions applicable to an ordinary litigant. As the Court had declared in Wander:

. . . To allow a litigant to assume a different posture when he comes before the court and challenge the position he had accepted at the administrative level, would be to sanction a procedure whereby the Court — which is supposed to review administrative determinations — would not review, but determine and decide for the first time, a question not raised at the administrative forum. . . . (160 SCRA at 566-577)

Had petitioner been forthright earlier and required from private respondent proof of authority from its parent corporation, Procter and Gamble USA, to prosecute the claim for refund, private respondent would doubtless have been able to show proof of such authority. By any account, it would be rank injustice not at this stage to require petitioner to submit such proof.

2. In page 8 of his dissenting opinion, Paras, J., stressed that private respondent had failed: (1) to show the actual amount credited by the US government against the income tax due from P & G USA on the dividends received from private respondent; (2) to present the 1975 income tax return of P & G USA when the dividends were received; and (3) to submit any duly authenticated document showing that the US government credited the 20% tax deemed paid in the Philippines.

I agree with the main opinion of my colleague, Feliciano J., specifically in page 23 et seq. thereof, which, as I understand it, explains that the US tax authorities are unable to determine the amount of the "deemed paid" credit to be given P & G USA so long as the numerator of the fraction, i.e., dividends actually remitted by P

& G-Phil. to P & G USA, is still unknown. Stated in other words, until dividends have actually been remitted to the US (which presupposes an actual imposition and collection of the applicable Philippine dividend tax rate), the US tax authorities cannot determine the "deemed paid" portion of the tax credit sought by P & G USA. To require private respondent to show documentary proof of its parent corporation having actually received the "deemed paid" tax credit from the proper tax authorities, would be like putting the cart before the horse. The only way of cutting through this (what Feliciano, J., termed) "circularity" is for our BIR to issue rulings (as they have been doing) to the effect that the tax laws of particular foreign jurisdictions, e.g., USA, comply with the requirements in our tax code for applicability of the reduced 15% dividend tax rate. Thereafter, the taxpayer can be required to submit, within a reasonable period, proof of the amount of "deemed paid" tax credit actually granted by the foreign tax authority. Imposing such a resolutory condition should resolve the knotty problem of circularity.

3. Page 8 of the dissenting opinion of Paras, J., further declares that tax refunds, being in the nature of tax exemptions, are to be construed strictissimi juris against the person or entity claiming the exemption; and that refunds cannot be permitted to exist upon "vague implications."

Notwithstanding the foregoing canon of construction, the fundamental rule is still that a judge must ascertain and give effect to the legislative intent embodied in a particular provision of law. If a statute (including a tax statute reducing a certain tax rate) is clear, plain and free from ambiguity, it must be given its ordinary meaning and applied without interpretation. In the instant case, the dissenting opinion of Paras, J., itself concedes that the basic purpose of Pres. Decree No. 369, when it was promulgated in 1975 to amend

Section 24(b), [11 of the National Internal Revenue Code, was "to decrease the tax liability" of the foreign capital investor and thereby to promote more inward foreign investment. The same dissenting opinion hastens to add, however, that the granting of a reduced dividend tax rate "is premised on reciprocity."

4. Nowhere in the provisions of P.D. No. 369 or in the National Internal Revenue Code itself would one find reciprocity specified as a condition for the granting of the reduced dividend tax rate in Section 24 (b), [1], NIRC. Upon the other hand, where the law-making authority intended to impose a requirement of reciprocity as a condition for grant of a privilege, the legislature does so expressly and clearly. For example, the gross estate of non-citizens and non-residents of the Philippines normally includes intangible personal property situated in the Philippines, for purposes of application of the estate tax and donor's tax. However, under Section 98 of the NIRC (as amended by P.D. 1457), no taxes will be collected by the Philippines in respect of such intangible personal property if the law or the foreign country of which the decedent was a citizen and resident at the time of his death allows a similar exemption from transfer or death taxes in respect of intangible personal property located in such foreign country and owned by Philippine citizens not residing in that foreign country.

There is no statutory requirement of reciprocity imposed as a condition for grant of the reduced dividend tax rate of 15% Moreover, for the Court to impose such a requirement of reciprocity would be to contradict the basic policy underlying P.D. 369 which amended Section 24(b), [1], NIRC, P.D. 369 was promulgated in the effort to promote the inflow of foreign investment capital into the Philippines. A requirement of reciprocity, i.e., a requirement that the U.S. grant a similar reduction of U.S. dividend taxes on remittances by the U.S.

subsidiaries of Philippine corporations, would assume a desire on the part of the U.S. and of the Philippines to attract the flow of Philippine capital into the U.S.. But the Philippines precisely is a capital importing, and not a capital exporting country. If the Philippines had surplus capital to export, it would not need to import foreign capital into the Philippines. In other words, to require dividend tax reciprocity from a foreign jurisdiction would be to actively encourage Philippine corporations to invest outside the Philippines, which would be inconsistent with the notion of attracting foreign capital into the Philippines in the first place.

5. Finally, in page 15 of his dissenting opinion, Paras, J., brings up the fact that:

Wander cited as authority a BIR ruling dated May 19, 1977, which requires a remittance tax of only 15%. The mere fact that in this Procter and Gamble case, the BIR desires to charge 35% indicates that the BIR ruling cited in Wander has been obviously discarded today by the BIR. Clearly, there has been a change of mind on the part of the BIR.

As pointed out by Feliciano, J., in his main opinion, even while the instant case was pending before the Court of Tax Appeals and this Court, the administrative rulings issued by the BIR from 1976 until as late as 1987, recognized the "deemed paid" credit referred to in Section 902 of the U.S. Tax Code. To date, no contrary ruling has been issued by the BIR.

For all the foregoing reasons, private respondent's Motion for Reconsideration should be granted and I vote accordingly.

PARAS, J., dissenting:

I dissent.

The decision of the Second Division of this Court in the case of "Commissioner of Internal Revenue vs. Procter & Gamble Philippine Manufacturing Corporation, et al.," G.R. No. 66838, promulgated on April 15, 1988 is sought to be reviewed in the Motion for Reconsideration filed by private respondent. Procter & Gamble Philippines (PMC-Phils., for brevity) assails the Court's findings that:

(a) private respondent (PMC-Phils.) is not a proper party to claim the refund/tax credit;

(b) there is nothing in Section 902 or other provision of the US Tax Code that allows a credit against the U.S. tax due from PMC-U.S.A. of taxes deemed to have been paid in the Phils. equivalent to 20% which represents the difference between the regular tax of 35% on corporations and the tax of 15% on dividends;

(c) private respondent failed to meet certain conditions necessary in order that the dividends received by the non-resident parent company in the U.S. may be subject to the preferential 15% tax instead of 35%. (pp. 200-201, Motion for Reconsideration)

Private respondent's position is based principally on the decision rendered by the Third Division of this Court in the case of "Commissioner of Internal Revenue vs. Wander Philippines, Inc. and the Court of Tax Appeals," G.R. No. 68375, promulgated likewise on April 15, 1988 which bears the same issues as in the case at bar, but held an apparent contrary view. Private respondent advances the theory that since the Wander decision had already become final and executory it should be a precedent in deciding similar issues as in this case at hand.

Yet, it must be noted that the Wander decision had become final and executory only by reason of the failure of the petitioner therein to file its motion for reconsideration in due time. Petitioner received the notice of judgment on April 22, 1988 but filed a Motion for Reconsideration only on June 6, 1988, or after the decision had already become final and executory on May 9, 1988. Considering that entry of final judgment had already been made on May 9, 1988, the Third Division resolved to note without action the said Motion. Apparently therefore, the merits of the motion for reconsideration were not passed upon by the Court.

The 1987 Constitution provides that a doctrine or principle of law previously laid down either en banc or in Division may be modified or reversed by the court en banc. The case is now before this Court en banc and the decision that will be handed down will put to rest the present controversy.

It is true that private respondent, as withholding agent, is obliged by law to withhold and to pay over to the Philippine government the tax on the income of the taxpayer, PMC-U.S.A. (parent company). However, such fact does not necessarily connote that private respondent is the real party in interest to claim reimbursement

of the tax alleged to have been overpaid. Payment of tax is an obligation physically passed off by law on the withholding agent, if any, but the act of claiming tax refund is a right that, in a strict sense, belongs to the taxpayer which is private respondent's parent company. The role or function of PMC-Phils., as the remitter or payor of the dividend income, is merely to insure the collection of the dividend income taxes due to the Philippine government from the taxpayer, "PMC-U.S.A.," the non-resident foreign corporation not engaged in trade or business in the Philippines, as "PMC-U.S.A." is subject to tax equivalent to thirty five percent (35%) of the gross income received from "PMC-Phils." in the Philippines "as . . . dividends . . ." (Sec. 24 [b], Phil. Tax Code). Being a mere withholding agent of the government and the real party in interest being the parent company in the United States, private respondent cannot claim refund of the alleged overpaid taxes. Such right properly belongs to PMC-U.S.A. It is therefore clear that as held by the Supreme Court in a series of cases, the action in the Court of Tax Appeals as well as in this Court should have been brought in the name of the parent company as petitioner and not in the name of the withholding agent. This is because the action should be brought under the name of the real party in interest. (See Salonga v. Warner Barnes, & Co., Ltd., 88 Phil. 125; Sutherland, Code Pleading, Practice, & Forms, p. 11; Ngo The Hua v. Chung Kiat Hua, L-17091, Sept. 30, 1963, 9 SCRA 113; Gabutas v. Castellanes, L-17323, June 23, 1965, 14 SCRA 376; Rep. v. PNB, L-16485, January 30, 1945).

Rule 3, Sec. 2 of the Rules of Court provides:

Sec. 2. Parties in interest. — Every action must be prosecuted and defended in the name of the real party in interest. All persons having an interest in the subject of the action and in obtaining the

relief demanded shall be joined as plaintiffs. All persons who claim an interest in the controversy or the subject thereof adverse to the plaintiff, or who are necessary to a complete determination or settlement of the questions involved therein shall be joined as defendants.

It is true that under the Internal Revenue Code the withholding agent may be sued by itself if no remittance tax is paid, or if what was paid is less than what is due. From this, Justice Feliciano claims that in case of an overpayment (or claim for refund) the agent must be given the right to sue the Commissioner by itself (that is, the agent here is also a real party in interest). He further claims that to deny this right would be unfair. This is not so. While payment of the tax due is an OBLIGATION of the agent the obtaining of a refund is a RIGHT. While every obligation has a corresponding right (and vice-versa), the obligation to pay the complete tax has the corresponding right of the government to demand the deficiency; and the right of the agent to demand a refund corresponds to the government's duty to refund. Certainly, the obligation of the withholding agent to pay in full does not correspond to its right to claim for the refund. It is evident therefore that the real party in interest in this claim for reimbursement is the principal (the mother corporation) and NOT the agent.

This suit therefore for refund must be DISMSSED.

In like manner, petitioner Commissioner of Internal Revenue's failure to raise before the Court of Tax Appeals the issue relating to the real party in interest to claim the refund cannot, and should not, prejudice the government. Such is merely a procedural defect. It is axiomatic that the government can never be in estoppel, particularly in matters involving taxes. Thus, for example, the payment by the tax-payer of income

taxes, pursuant to a BIR assessment does not preclude the government from making further assessments. The errors or omissions of certain administrative officers should never be allowed to jeopardize the government's financial position. (See: Phil. Long Distance Tel. Co. v. Coll. of Internal Revenue, 90 Phil. 674; Lewin v. Galang, L-15253, Oct. 31, 1960; Coll. of Internal Revenue v. Ellen Wood McGrath, L-12710, L-12721, Feb. 28, 1961; Perez v. Perez, L-14874, Sept, 30, 1960; Republic v. Caballero, 79 SCRA 179; Favis v. Municipality of Sabongan, L-26522, Feb. 27, 1963).

As regards the issue of whether PMC-U.S.A. is entitled under the U.S. Tax Code to a United States Foreign Tax Credit equivalent to at least 20 percentage paid portion spared or waived as otherwise deemed waived by the government, We reiterate our ruling that while apparently, a tax-credit is given, there is actually nothing in Section 902 of the U.S. Internal Revenue Code, as amended by Public Law-87-834 that would justify tax return of the disputed 15% to the private respondent. This is because the amount of tax credit purportedly being allowed is not fixed or ascertained, hence we do not know whether or not the tax credit contemplated is within the limits set forth in the law. While the mathematical computations in Justice Feliciano's separate opinion appear to be correct, the computations suffer from a basic defect, that is we have no way of knowing or checking the figure used as premises. In view of the ambiguity of Sec. 902 itself, we can conclude that no real tax credit was really intended. In the interpretation of tax statutes, it is axiomatic that as between the interest of multinational corporations and the interest of our own government, it would be far better, in the absence of definitive guidelines, to favor the national interest. As correctly pointed out by the Solicitor General:

. . . the tax-sparing credit operates on dummy, fictional or phantom taxes, being considered as if paid by the foreign taxing authority, the host country.

In the context of the case at bar, therefore, the thirty five (35%) percent on the dividend income of PMC-U.S.A. would be reduced to fifteen (15%) percent if & only if reciprocally PMC-U.S.A's home country, the United States, not only would allow against PMC-U.SA.'s U.S. income tax liability a foreign tax credit for the fifteen (15%) percentage-point portion of the thirty five (35%) percent Phil. dividend tax actually paid or accrued but also would allow a foreign tax "sparing" credit for the twenty (20%)' percentage-point portion spared, waived, forgiven or otherwise deemed as if paid by the Phil. govt. by virtue of the "tax credit sparing" proviso of Sec. 24(b), Phil. Tax Code." (Reply Brief, pp. 23-24; Rollo, pp. 239-240).

Evidently, the U.S. foreign tax credit system operates only on foreign taxes actually paid by U.S. corporate taxpayers, whether directly or indirectly. Nowhere under a statute or under a tax treaty, does the U.S. government recognize much less permit any foreign tax credit for spared or ghost taxes, as in reality the U.S. foreign-tax credit mechanism under Sections 901-905 of the U.S. Intemal Revenue Code does not apply to phantom dividend taxes in the form of dividend taxes waived, spared or otherwise considered "as if" paid by any foreign taxing authority, including that of the Philippine government.

Beyond, that, the private respondent failed: (1) to show the actual amount credited by the U.S. government against the income tax due from PMC-U.S.A. on the dividends received from private respondent; (2) to

present the income tax return of its parent company for 1975 when the dividends were received; and (3) to submit any duly authenticated document showing that the U.S. government credited the 20% tax deemed paid in the Philippines.

Tax refunds are in the nature of tax exemptions. As such, they are regarded as in derogation of sovereign authority and to be construed strictissimi juris against the person or entity claiming the exemption. The burden of proof is upon him who claims the exemption in his favor and he must be able to justify his claim by the clearest grant of organic or statute law . . . and cannot be permitted to exist upon vague implications. (Asiatic Petroleum Co. v. Llanes, 49 Phil. 466; Northern Phil Tobacco Corp. v. Mun. of Agoo, La Union, 31 SCRA 304; Rogan v. Commissioner, 30 SCRA 968; Asturias Sugar Central, Inc. v. Commissioner of Customs, 29 SCRA 617; Davao Light and Power Co. Inc. v. Commissioner of Custom, 44 SCRA 122). Thus, when tax exemption is claimed, it must be shown indubitably to exist, for every presumption is against it, and a well founded doubt is fatal to the claim (Farrington v. Tennessee & Country Shelby, 95 U.S. 679, 686; Manila Electric Co. v. Vera, L-29987, Oct. 22, 1975; Manila Electric Co. v. Tabios, L-23847, Oct. 22, 1975, 67 SCRA 451).

It will be remembered that the tax credit appertaining to remittances abroad of dividend earned here in the Philippines was amplified in Presidential Decree No. 369 promulgated in 1975, the purpose of which was to "encourage more capital investment for large projects." And its ultimate purpose is to decrease the tax liability of the corporation concerned. But this granting of a preferential right is premised on reciprocity, without which there is clearly a derogation of our country's financial sovereignty. No such reciprocity has

been proved, nor does it actually exist. At this juncture, it would be useful to bear in mind the following observations:

The continuing and ever-increasing transnational movement of goods and services, the emergence of multinational corporations and the rise in foreign investments has brought about tremendous pressures on the tax system to strengthen its competence and capability to deal effectively with issues arising from the foregoing phenomena.

International taxation refers to the operationalization of the tax system on an international level. As it is, international taxation deals with the tax treatment of goods and services transferred on a global basis, multinational corporations and foreign investments.

Since the guiding philosophy behind international trade is free flow of goods and services, it goes without saying that the principal objective of international taxation is to see through this ideal by way of feasible taxation arrangements which recognize each country's sovereignty in the matter of taxation, the need for revenue and the attainment of certain policy objectives.

The institution of feasible taxation arrangements, however, is hard to come by. To begin with, international tax subjects are obviously more complicated than their domestic counter-parts. Hence, the devise of taxation arrangements to deal with such complications requires a welter of information and data build-up which generally are not readily obtainable and available. Also, caution must be exercised so that whatever taxation

arrangements are set up, the same do not get in the way of free flow of goods and services, exchange of technology, movement of capital and investment initiatives.

A cardinal principle adhered to in international taxation is the avoidance of double taxation. The phenomenon of double taxation (i.e., taxing an item more than once) arises because of global movement of goods and services. Double taxation also occurs because of overlaps in tax jurisdictions resulting in the taxation of taxable items by the country of source or location (source or situs rule) and the taxation of the same items by the country of residence or nationality of the taxpayer (domiciliary or nationality principle).

An item may, therefore, be taxed in full in the country of source because it originated there, and in another country because the recipient is a resident or citizen of that country. If the taxes in both countries are substantial and no tax relief is offered, the resulting double taxation would serve as a discouragement to the activity that gives rise to the taxable item.

As a way out of double taxation, countries enter into tax treaties. A tax treaty 1 is a bilateral convention (but may be made multilateral) entered into between sovereign states for purposes of eliminating double taxation on income and capital, preventing fiscal evasion, promoting mutual trade and investment, and according fair and equitable tax treatment to foreign residents or nationals. 2

A more general way of mitigating the impact of double taxation is to recognize the foreign tax either as a tax credit or an item of deduction.

Whether the recipient resorts to tax credit or deduction is dependent on the tax advantage or savings that would be derived therefrom.

A principal defect of the tax credit system is when low tax rates or special tax concessions are granted in a country for the obvious reason of encouraging foreign investments. For instance, if the usual tax rate is 35 percent but a concession rate accrues to the country of the investor rather than to the investor himself To obviate this, a tax sparing provision may be stipulated. With tax sparing, taxes exempted or reduced are considered as having been fully paid.

To illustrate:

"X" Foreign Corporation income 100Tax rate (35%) 35RP income 100Tax rate (general, 35% concession rate, 15%) 15

1. "X" Foreign Corp. Tax Liability without Tax Sparing"X" Foreign Corporation income 100RP income 100Total Income 200"X" tax payable 70

Less: RP tax 15Net "X" tax payable 55

2. "X" Foreign Corp. Tax Liability with Tax Sparing"X" Foreign Corp. income 100RP income 100Total income 200"X" Foreign Corp. tax payable 70Less: RP tax (35% of 100, thedifference of 20% between 35% and 15%,deemed paid to RP)Net "X" Foreign Corp.tax payable 35

By way of resume, We may say that the Wander decision of the Third Division cannot, and should not result in the reversal of the Procter & Gamble decision for the following reasons:

1) The Wander decision cannot serve as a precedent under the doctrine of stare decisis. It was promulgated on the same day the decision of the Second Division was promulgated, and while Wander has attained finality this is simply because no motion for reconsideration thereof was filed within a reasonable period. Thus, said Motion for Reconsideration was theoretically never taken into account by said Third Division.

2) Assuming that stare decisis can apply, We reiterate what a former noted jurist Mr. Justice Sabino Padilla aptly said: "More pregnant than anything else is that the court shall be right." We hereby cite settled doctrines from a treatise on Civil Law:

We adhere in our country to the doctrine of stare decisis (let it stand, et non quieta movere) for reasons of stability in the law. The doctrine, which is really "adherence to precedents," states that once a case has been decided one way, then another case, involving exactly the same point at issue, should be decided in the same manner.

Of course, when a case has been decided erroneously such an error must not be perpetuated by blind obedience to the doctrine of stare decisis. No matter how sound a doctrine may be, and no matter how long it has been followed thru the years, still if found to be contrary to law, it must be abandoned. The principle of stare decisis does not and should not apply when there is a conflict between the precedent and the law (Tan Chong v. Sec. of Labor, 79 Phil. 249).

While stability in the law is eminently to be desired, idolatrous reverence for precedent, simply, as precedent, no longer rules. More pregnant than anything else is that the court shall be right (Phil. Trust Co. v. Mitchell, 59 Phil. 30).

3) Wander deals with tax relations between the Philippines and Switzerland, a country with which we have a pending tax treaty; our Procter & Gamble case deals with relations between the Philippines and the United States, a country with which we had no tax treaty, at the time the taxes herein were collected.

4) Wander cited as authority a BIR Ruling dated May 19, 1977, which requires a remittance tax of only 15%. The mere fact that in this Procter and Gamble case the B.I.R. desires to charge 35% indicates that the B.I.R. Ruling cited in Wander has been obviously discarded today by the B.I.R. Clearly, there has been a change of mind on the part of the B.I.R.

5) Wander imposes a tax of 15% without stating whether or not reciprocity on the part of Switzerland exists. It is evident that without reciprocity the desired consequences of the tax credit under P.D. No. 369 would be rendered unattainable.

6) In the instant case, the amount of the tax credit deductible and other pertinent financial data have not been presented, and therefore even were we inclined to grant the tax credit claimed, we find ourselves unable to compute the proper amount thereof.

7) And finally, as stated at the very outset, Procter & Gamble Philippines or P.M.C. (Phils.) is not the proper party to bring up the case.

ACCORDINGLY, the decision of the Court of Tax Appeals should be REVERSED and the motion for reconsideration of our own decision should be DENIED.

G.R. Nos. 118498 & 124377 October 12, 1999

FILIPINAS SYNTHETIC FIBER CORPORATION, petitioner,vs.COURT OF APPEALS, COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.

PURISIMA, J.:

Before the Court are two consolidated Petitions for Review on Certiorari under Rule 45 of the Revised Rules of Court seeking to set aside the Decisions of the Court of Appeals in CA-GR. SP Nos. 32922 1 and 32022. 2

In G.R. No. 118498, the Court of Appeals culled the antecedent facts that matter as follows:

The basic operative facts are not in dispute, to wit: Filipinas Synthetic Fiber Corporation . . ., a domestic corporation received on December 27, 1979 a letter of demand . . . from the Commissioner of Internal Revenue . . . assessing it for deficiency withholding tax at source in the total amount of P829,748.77, inclusive of interest and compromise penalties, for the period from the fourth quarter of 1974 to the fourth quarter of 1975. The bulk of the deficiency withholding tax assessment, however, consisted of interest and compromise penalties for alleged late payment of withholding taxes due on interest loans, royalties and guarantee fees paid by the petitioner to non-

resident corporations. The assessment was seasonably protested by the petitioner through its auditor, SGV and Company. Respondent denied the protest in a letter dated 14 May 1985 . . . on the following ground: "For Philippine internal revenue tax purposes, the liability to withhold and pay income tax withheld at source from certain payments due to a foreign corporation is at the time of accrual and not at the time of actual payment or remittance thereof", citing BIR Ruling No. 71-003 and BIR Ruling No. 24-71-003-154-84 dated 12 September 1984 as well as the decision of the Court of Tax Appeals . . . in CTA Case No. 3307 entitled "Construction Resources of Asia, Inc., versus Commissioner of Internal Revenue". The aforementioned case held that "the liability of the taxpayer to withhold and pay the income tax withheld at source from certain payments due to a non-resident foreign corporation attaches at the time of accrual payment or remittance thereof" and "the withholding agent/corporation is obliged to remit the tax to the government since it already and properly belongs to the government. Since the taxpayer failed to pay the withholding tax on interest, royalties, and guarantee fee at the time of their accrual and in the books of the corporation the aforesaid assessment is therefore legal and proper.

On June 28, 1985, petitioner brought a Petition for Review 3 before the Court of Tax Appeals, docketed as CTA Case No. 3951. On June 15, 1993, the said court came out with its Decision, ruling thus:

IN VIEW OF THE FOREGOING, judgment is hereby rendered ordering petitioner to pay respondent the amount of P306,165.35 as deficiency withholding tax at source for the fourth quarter of 1974 to the third quarter of 1975 plus 10% surcharge and 14% annual interest from

November 29, 1979 to July 31, 1980, plus 20% interest from August 1, 1980 until fully paid but not to exceed that which corresponds to a period of three (3) years pursuant to P.D. No. 1705.1âwphi1.nêt

SO ORDERED.

With the denial of its motion for reconsideration, petitioner appealed the CTA disposition to the Court of Appeals, which affirmed in toto the appealed decision.

Dissatisfied therewith, petitioner found its way to this Court via the present Petition; contending that:

THE CA ERRED IN HOLDING THAT FILSYN'S LIABILITY TO WITHHOLD THE INCOME TAX FOR INTEREST, ROYALTIES AND DIVIDENDS, WHICH WERE PAYABLE TO NON-RESIDENT FOREIGN CORPORATIONS, ATTACHED UPON "SETTING-UP" OR ACCRUAL OF THESE AMOUNTS RATHER THAN WHEN SAID AMOUNTS BECOME DUE AND DEMANDABLE UNDER THE APPLICABLE CONTRACTS.

In G.R. No. 124377, what is being questioned by petitioner is the assessed deficiency withholding tax at source for the period from the fourth quarter of 1975 to the fourth quarter of 1976 amounting to P379,700.68.

The pivot of inquiry here is — whether the liability to withhold tax at source on income payments to non-resident foreign corporations arises upon remittance of the amounts due to the foreign creditors or upon accrual thereof.

It is petitioner's submission that the withholding taxes on the said interest income and royalties were paid to the government when the subject interest and royalties were actually remitted abroad. Stated otherwise, whatever amount has accrued in the books, the withholding tax due thereon is ultimately paid to the government upon remittance abroad of the amount accrued.

Sec. 53 of the National Internal Revenue Code, in force at that time (1975), reads:

Withholding Tax at source . . .

xxx xxx xxx

(b) Non-resident aliens and foreign corporations — Every individual, corporation, partnership, or association, in whatever capacity acting, including a lessee or mortgagor of real or personal property, trustee acting in any trust capacity, executor, administrator, receiver, conservator, fiduciary, employer, and every officer or employee of the Government of the Republic of the Philippines having the control, receipt, custody, disposal, or payment of interest, dividends, rents, royalties, salaries, wages, premiums, annuities, compensation, remunerations, emoluments, or other fixed or determinable annual, periodical, or casual gains, profits, and income, and capital

gains, of any non-resident alien not engaged in trade or business within the Philippines, shall (except in the case provided in sub-section (a) (1) of this Section) deduct and withhold from the annual, periodical, or casual gains, profits, and income, and capital gains, a tax equal to 30 per cent thereof.

xxx xxx xxx

(2) Non-resident foreign corporations — In the case of foreign corporations subject to tax under this Title, not engaged in trade or business within the Philippines, there shall be deducted and withheld at the source in the same manner and upon the same items as is provided in subsection (b) (1) of this section, as well as on remunerations for technical services or otherwise, a tax equal to thirty-five (35) per cent thereof. This tax shall be returned and paid in and subject to the same conditions as provided in Section 54.

On the other hand, Section 54 of the same law, provides:

Returns and payments of taxes withheld at source —

(a) Quarterly return and payment of taxes withheld — Taxes deducted and withheld under Section 53 shall be covered by a return and paid to the Commissioner of Internal Revenue or his collection agent in the province, city, or municipality where the withholding agent has his legal residence or principal place of business, or where the withholding agent is a corporation, where the principal

office is located. The taxes deducted and withheld by the withholding agent shall be held as a special fund in trust for the Government until paid to the collecting officers. The Commissioner of Internal Revenue may, with the approval of the Secretary of Finance, require these withholding agents to pay or deposit the taxes deducted and withheld at more frequent intervals when necessary to protect the interest of the Government. The return shall be filed and the payment made within 25 days from the close of each calendar quarter . . .

The aforecited provisions of law are silent as to when does the duty to withhold the taxes arise. And to determine the same, an inquiry as to the nature of accrual method of accounting, the procedure used by the herein petitioner, and to the modus vivendi of withholding tax at source come to the fore.

The method of withholding tax at source is a procedure of collecting income tax sanctioned by the National Internal Revenue Code. Section 53 (c) of which, provides:

Return and Payment — Every person required to deduct and withhold any tax under this section shall make return thereof, . . . for the payment of the tax, shall pay the amount withheld to the officer of the Government of the Philippines authorized to receive it. Every such person is made personally liable for such tax, and is indemnified against the claims and demands of any person for the amount of any payments made in accordance with the provision of this section.

In the aforecited provision of law, the withholding agent is explicitly made personally liable for the income tax withheld under Section 54. In Phil. Guaranty Co., Inc. vs. Commissioner of Internal Revenue, 4 the Court, has ratiocinated:

The law sets no condition for the personal liability of the withholding agent to attach. The reason is to compel the withholding agent to withhold the tax under all circumstances. In effect, the responsibility for the collection of the tax as well as the payment thereof is concentrated upon the person over whom the Government has jurisdiction. Thus, the withholding agent is constituted the agent both the government and the taxpayer. With respect to the collection and/or withholding of the tax, he is the Government's agent. In regard to the filing of the necessary income tax return and the payment of the tax to the Government, he is the agent of the taxpayer. The withholding agent, therefore, is no ordinary government agent especially because under Section 53 (c) he is held personally liable for the tax he is duty bound to withhold; whereas, the Commissioner of Internal Revenue and his deputies are not made liable to law.

On the other hand, "under the accrual basis method of accounting, income is reportable when all the events have occurred that fix the taxpayer's right to receive the income, and the amount can be determined with reasonable accuracy. Thus, it is the right to receive income, and not the actual receipt, that determines when to include the amount in gross income." 5 Gleanable from this notion are the following requisites of accrual method of accounting, to wit: "(1) that the right to receive the amount must be valid, unconditional and enforceable, i.e., not contingent upon future time; (2) the amount must be reasonably susceptible of

accurate estimate; and (3) there must be a reasonable expectation that the amount will be paid in due course." 6

In the case at bar, after a careful examination of pertinent records, the Court concurred in the finding by the Court of Appeals in CA GR. SP No. 32922 "that there was a definite liability, a clear and imminent certainty that at the maturity of the loan contracts, the foreign corporation was going to earn income in an ascertained amount, so much so that petitioner already deducted as business expense the said amount as interests due to the foreign corporation. This is allowed under the law, petitioner having adopted the "accrual method" of accounting in reporting its incomes."

All things studiedly considered, the Court is of the opinion, and holds, that the Court of Appeals erred not in ruling that:

. . . Petitioner cannot now claim that there is no duty to withhold and remit income taxes as yet because the loan contract was not yet due and demandable. Having "written-off" the amounts as business expense in its books, it had taken advantage of the benefit provided in the law allowing for deductions from gross income. Moreover, it had represented to the BIR that the amounts so deducted were incurred as a business expense in the form of interest and royalties paid to the foreign corporations. It is estopped from claiming otherwise now. 7

WHEREFORE, the decisions of the Court of Appeals in CA GR. SP Nos. 32922 and 32022 are hereby AFFIRMED in toto. No pronouncement as to costs.

G.R. No. 160949 April 4, 2011

COMMISSIONER OF INTERNAL REVENUE Petitioner, vs.PL MANAGEMENT INTERNATIONAL PHILIPPINES, INC., Respondent.

D E C I S I O N

BERSAMIN, J.:

How may the respondent taxpayer still recover its unutilized creditable withholding tax for taxable year 1997 after its written claim for refund was not acted upon by the petitioner, whose inaction was upheld by the Court of Tax Appeals (CTA) on the ground of the claim for tax refund being already barred by prescription?

Nature of the Case

The inaction of petitioner Commissioner of Internal Revenue (Commissioner) on the respondent's written claim for tax refund or tax credit impelled the latter to commence judicial action for that purpose in the CTA. However, the CTA denied the claim on December 10, 2001 for being brought beyond two years from the accrual of the claim.

On appeal, the Court of Appeals (CA) reversed the CTA's denial through the decision promulgated in C.A.-G.R. Sp. No. 68461 on November 28, 2002, and directed the petitioner to refund the unutilized creditable withholding tax to the respondent.1

Hence, the petitioner appeals.

Antecedents

In 1997, the respondent, a Philippine corporation, earned an income of P24,000,000.00 from its professional services rendered to UEM-MARA Philippines Corporation (UMPC), from which income UMPC withheld P1,200,000.00 as the respondent's withholding agent.2

In its 1997 income tax return (ITR) filed on April 13, 1998, the respondent reported a net loss of P983,037.00, but expressly signified that it had a creditable withholding tax of P1,200,000.00 for taxable year 1997 to be claimed as tax credit in taxable year 1998.3

On April 13, 1999, the respondent submitted its ITR for taxable year 1998, in which it declared a net loss of P2,772,043.00. Due to its net-loss position, the respondent was unable to claim the P1,200,000.00 as tax credit.

On April 12, 2000, the respondent filed with the petitioner a written claim for the refund of the P1,200,000.00 unutilized creditable withholding tax for taxable year 1997.4 However, the petitioner did not act on the claim.

Ruling of the CTA

http://www.lawphil.net/judjuris/juri2011/apr2011/gr_160949_2011.html#fnt4




Due to the petitioner's inaction, the respondent filed a petition for review in the CTA (CTA Case No. 6107) on April 14, 2000, thereby commencing its judicial action.

On December 10, 2001, the CTA denied the respondent's claim on the ground of prescription,5 to wit:

Records reveal that Petitioner filed its Annual Income Tax Return for taxable year 1997 on April 13, 1998 (Exhibit "A") and its claim for refund with the BIR on April 12, 2000 (Exhibit "D" and No. 2 of the Statement of Admitted Facts and Issues). Several days thereafter, or on April 14, 2000, Petitioner filed an appeal with this Court.

The aforementioned facts clearly show that the judicial claim for refund via this Petition for Review was already filed beyond the two-year prescriptive period mandated by Sections 204 (C) and 229 of the Tax Code xxx

xxx

As earlier mentioned, Petitioner filed its Annual ITR on April 13, 1998 and filed its judicial claim for refund only on April 14, 2000 which is beyond the two-year period earlier discussed. The aforequoted Sections 204 (C) and 229 of the Tax Code mandates that both the administrative and judicial claims for refund must be filed within the two-year period, otherwise the taxpayer's cause of action shall be barred by prescription. Unfortunately, this lapse on the part of Petitioner proved fatal to its claim.

xxx

WHEREFORE, in view of the foregoing the Petition for Review is hereby DENIED due to prescription.


Ruling of the CA

Aggrieved, the respondent appealed to the CA, assailing the correctness of the CTA's denial of its judicial claim for refund on the ground of bar by prescription.

As earlier mentioned, the CA promulgated its decision on November 28, 2002, holding that the two-year prescriptive period, which was not jurisdictional (citing Oral and Dental College v. Court of Tax Appeal6and Commissioner of Internal Revenue v. Philippine American Life Insurance Company7), might be suspended for reasons of equity.8 The CA thus disposed as follows:

WHEREFORE, the petition is partly GRANTED and the assailed CTA Decision partly ANNULLED. Respondent Commissioner of Internal Revenue is hereby ordered to refund to petitioner PL Management International Phils., Inc., the amount of P1,200,000.00 representing its unutilized creditable withholding tax in taxable year 1997.9

The CA rejected the petitioner's motion for reconsideration.10

Issues

In this appeal, the petitioner insists that:

I. THE COURT OF APPEALS ERRED IN HOLDING THAT THE TWO-YEAR PRESCRIPTIVE PERIOD UNDER SECTION 229 OF THE TAX CODE IS NOT JURISDICTIONAL, THUS THE CLAIM FOR REFUND OF RESPONDENT IS SUSPENDED FOR REASONS OF EQUITY.






II. THE COURT OF APPEALS ERRED IN HOLDING THAT RESPONDENT'S JUDICIAL RIGHT TO CLAIM FOR REFUND BROUGHT BEFORE THE COURT OF APPEALS ON APRIL 14, 2000 WAS ONE DAY LATE ONLY.11

The petitioner argues that the decision of the CA suspending the running of the two-year period set by Section 229 of the National Internal Revenue Code of 1997 (NIRC of 1997) on ground of equity was erroneous and had no legal basis; that equity could not supplant or replace a clear mandate of a law that was still in force and effect; that a claim for a tax refund or tax credit, being in the nature of a tax exemption to be treated as in derogation of sovereign authority, must be construed in strictissimi juris against the taxpayer; that the respondent's two-year prescriptive period under Section 229 of the NIRC of 1997 commenced to run on April 13, 1998, the date it filed its ITR for taxable year 1997; that by reckoning the period from April 13, 1998, the respondent had only until April 12, 2000 within which to commence its judicial action for refund with the CTA, the year 2000 being a leap year; that its filing of the judicial action on April 14, 2000 was already tardy; and that the factual findings of the CTA, being supported by substantial evidence, should be accorded the highest respect.

In its comment, the respondent counters that it filed its judicial action for refund within the statutory two-year period because the correct reckoning started from April 15, 1998, the last day for the filing of the ITR for taxable year 1997; that the two-year prescriptive period was also not jurisdictional and might be relaxed on equitable reasons; and that a disallowance of its claim for refund would result in the unjust enrichment of the Government at its expense.1avvphi1

Ruling of the Court


We reverse and set aside the decision of the CA to the extent that it orders the petitioner to refund to the respondent the P1,200,000.00 representing the unutilized creditable withholding tax in taxable year 1997, but permit the respondent to apply that amount as tax credit in succeeding taxable years until fully exhausted.

Section 76 of the NIRC of 1997 provides:

Section 76. Final Adjustment Return. - Every corporation liable to tax under Section 27 shall file a final adjustment return covering the total taxable income for the preceding calendar or fiscal year. If the sum of the quarterly tax payments made during the said taxable year is not equal to the total tax due on the entire taxable income of that year the corporation shall either:

(A) Pay the balance of tax still due; or

(B) Carry over the excess credit; or

(C) Be credited or refunded with the excess amount paid, as the case may be.

In case the corporation is entitled to a refund of the excess estimated quarterly income taxes paid, the refundable amount shown on its final adjustment return may be credited against the estimated quarterly income tax liabilities for the taxable quarters of the succeeding taxable years. Once the option to carry-over and apply the excess quarterly income tax against income tax due for the taxable quarters of the succeeding taxable years has been made, such option

shall be considered irrevocable for that taxable period and no application for tax refund or issuance of a tax credit certificate shall be allowed therefor.

The predecessor provision of Section 76 of the NIRC of 1997 is Section 79 of the NIRC of 1985, which provides:

Section 79. Final Adjustment Return. - Every corporation liable to tax under Section 24 shall file a final adjustment return covering the total net income for the preceding calendar or fiscal year. If the sum of the quarterly tax payments made during the said taxable year is not equal to the total tax due on the entire taxable net income of that year the corporation shall either:

(a) Pay the excess tax still due; or

(b) Be refunded the excess amount paid, as the case may be.

In case the corporation is entitled to a refund of the excess estimated quarterly income taxes-paid, the refundable amount shown on its final adjustment return may be credited against the estimated quarterly income tax liabilities for the taxable quarters of the succeeding taxable year.

As can be seen, Congress added a sentence to Section 76 of the NIRC of 1997 in order to lay down the irrevocability rule, to wit:

xxx Once the option to carry-over and apply the excess quarterly income tax against income tax due for the taxable quarters of the succeeding taxable years has been made, such option shall be considered irrevocable for that taxable period and no application for tax refund or issuance of a tax credit certificate shall be allowed therefor.

In Philam Asset Management, Inc. v. Commissioner of Internal Revenue,12 the Court expounds on the two alternative options of a corporate taxpayer whose total quarterly income tax payments exceed its tax liability, and on how the choice of one option precludes the other, viz:

The first option is relatively simple. Any tax on income that is paid in excess of the amount due the government may be refunded, provided that a taxpayer properly applies for the refund.

The second option works by applying the refundable amount, as shown on the FAR of a given taxable year, against the estimated quarterly income tax liabilities of the succeeding taxable year.

These two options under Section 76 are alternative in nature. The choice of one precludes the other. Indeed, in Philippine Bank of Communications v. Commissioner of Internal Revenue, the Court ruled that a corporation must signify its intention - whether to request a tax refund or claim a tax credit - by marking the corresponding option box provided in the FAR. While a taxpayer is required to mark its choice in the form provided by the BIR, this requirement is only for the purpose of facilitating tax collection.

One cannot get a tax refund and a tax credit at the same time for the same excess income taxes paid. xxx


In Commissioner of Internal Revenue v. Bank of the Philippine Islands,13 the Court, citing the aforequoted pronouncement in Philam Asset Management, Inc., points out that Section 76 of the NIRC of 1997 is clear and unequivocal in providing that the carry-over option, once actually or constructively chosen by a corporate taxpayer, becomes irrevocable. The Court explains:

Hence, the controlling factor for the operation of the irrevocability rule is that the taxpayer chose an option; and once it had already done so, it could no longer make another one. Consequently, after the taxpayer opts to carry-over its excess tax credit to the following taxable period, the question of whether or not it actually gets to apply said tax credit is irrelevant. Section 76 of the NIRC of 1997 is explicit in stating that once the option to carry over has been made, "no application for tax refund or issuance of a tax credit certificate shall be allowed therefor."

The last sentence of Section 76 of the NIRC of 1997 reads: "Once the option to carry-over and apply the excess quarterly income tax against income tax due for the taxable quarters of the succeeding taxable years has been made, such option shall be considered irrevocable for that taxable period and no application for tax refund or issuance of a tax credit certificate shall be allowed therefor." The phrase "for that taxable period" merely identifies the excess income tax, subject of the option, by referring to the taxable period when it was acquired by the taxpayer. In the present case, the excess income tax credit, which BPI opted to carry over, was acquired by the said bank during the taxable year 1998. The option of BPI to carry over its 1998 excess income tax credit is irrevocable; it cannot later on opt to apply for a refund of the very same 1998 excess income tax credit.


The Court of Appeals mistakenly understood the phrase "for that taxable period" as a prescriptive period for the irrevocability rule. This would mean that since the tax credit in this case was acquired in 1998, and BPI opted to carry it over to 1999, then the irrevocability of the option to carry over expired by the end of 1999, leaving BPI free to again take another option as regards its 1998 excess income tax credit. This construal effectively renders nugatory the irrevocability rule. The evident intent of the legislature, in adding the last sentence to Section 76 of the NIRC of 1997, is to keep the taxpayer from flip-flopping on its options, and avoid confusion and complication as regards said taxpayer's excess tax credit. The interpretation of the Court of Appeals only delays the flip-flopping to the end of each succeeding taxable period.

The Court similarly disagrees in the declaration of the Court of Appeals that to deny the claim for refund of BPI, because of the irrevocability rule, would be tantamount to unjust enrichment on the part of the government. The Court addressed the very same argument in Philam, where it elucidated that there would be no unjust enrichment in the event of denial of the claim for refund under such circumstances, because there would be no forfeiture of any amount in favor of the government. The amount being claimed as a refund would remain in the account of the taxpayer until utilized in succeeding taxable years, as provided in Section 76 of the NIRC of 1997. It is worthy to note that unlike the option for refund of excess income tax, which prescribes after two years from the filing of the FAR, there is no prescriptive period for the carrying over of the same. Therefore, the excess income tax credit of BPI, which it acquired in 1998 and opted to carry over, may be repeatedly carried over to succeeding taxable years, i.e., to 1999, 2000, 2001, and so on and so forth, until actually applied or credited to a tax liability of BPI.

Inasmuch as the respondent already opted to carry over its unutilized creditable withholding tax of P1,200,000.00 to taxable year 1998, the carry-over could no longer be converted into a claim for tax refund because of the irrevocability rule provided in Section 76 of the NIRC of 1997. Thereby, the respondent became barred from claiming the refund.

However, in view of it irrevocable choice, the respondent remained entitled to utilize that amount of P1,200,000.00 as tax credit in succeeding taxable years until fully exhausted. In this regard, prescription did not bar it from applying the amount as tax credit considering that there was no prescriptive period for the carrying over of the amount as tax credit in subsequent taxable years.14

The foregoing result has rendered unnecessary any discussion of the assigned errors committed by the CA.

WHEREFORE, we reverse and set aside the decision dated November 28, 2002 promulgated in C.A.-G.R. Sp. No. 68461 by the Court of Appeals, and declare that PL Management International Phils., Inc. is not entitled to the refund of the unutilized creditable withholding tax of P1,200,000.00 on account of the irrevocability rule provided in Section 76 of the National Internal Revenue Code of 1997.

We rule that PL Management International Phils., Inc. may still use the creditable withholding tax of P1,200,000.00 as tax credit in succeeding taxable years until fully exhausted.


G.R. No. 178490 July 7, 2009

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs.BANK OF THE PHILIPPINE ISLANDS, Respondent.

D E C I S I O N

CHICO-NAZARIO, J.:

This is a Petition for Review assailing the Decision1 dated 29 April 2005 and the Resolution dated 20 April 2007 of the Court of Appeals in CA-G.R. SP No. 77655, which annulled and set aside the Decision dated 12 March 2003 of the Court of Tax Appeals (CTA) in CTA Case No. 6276, wherein the CTA held that respondent Bank of the Philippine Islands (BPI) already exercised the irrevocable option to carry over its excess tax credits for the year 1998 to the succeeding years 1999 and 2000 and was, therefore, no longer entitled to claim the refund or issuance of a tax credit certificate for the amount thereof.

On 15 April 1999, BPI filed with the Bureau of Internal Revenue (BIR) its final adjusted Corporate Annual Income Tax Return (ITR) for the taxable year ending on 31 December 1998, showing a taxable income of P1,773,236,745.00 and a total tax due of P602,900,493.00.

For the same taxable year 1998, BPI already made income tax payments for the first three quarters, which amounted to P563,547,470.46.2 The bank also received income in 1998 from various third persons, which, were already subjected to expanded withholding taxes amounting to P7,685,887.90. BPI additionally acquired foreign tax credit when it paid the United States government taxes in the amount of $151,467.00, or the equivalent of P6,190,014.46, on the operations of former’s New York Branch. Finally, respondent BPI had carried over excess tax credit from the prior year, 1997, amounting to P59,424,222.00.

Crediting the aforementioned amounts against the total tax due from it at the end of 1998, BPI computed an overpayment to the BIR of income taxes in the amount of P33,947,101.00. The computation of BPI is reproduced below:

Total Income Taxes Due P602,900,493.00

Less: Tax Credits:

Prior year’s tax credits P59,424,222.00

Quarterly payments 563,547,470.46

Creditable taxes withheld 7,685,887.90

Foreign tax credit 6,190,014.00 636,847,594.00

Net Tax Payable/(Refundable) P(33,947,101.00)

BPI opted to carry over its 1998 excess tax credit, in the amount of P33,947,101.00, to the succeeding taxable year ending 31 December 1999.3 For 1999, however, respondent BPI ended up with (1) a net loss in the amount of P615,742,102.00; (2) its still unapplied excess tax credit carried over from 1998, in the amount of P33,947,101.00; and (3) more excess tax credit, acquired in 1999, in the sum of P12,975,750.00. So in 1999, the total excess tax credits of BPI increased to P46,922,851.00, which it once more opted to carry over to the following taxable year.

For the taxable year ending 31 December 2000, respondent BPI declared in its Corporate Annual ITR: (1) zero taxable income; (2) excess tax credit carried over from 1998 and 1999, amounting to P46,922,851.00; and (3) even more excess tax credit, gained in 2000, in the amount of P25,207,939.00. This time, BPI failed to indicate in its ITR its choice of whether to carry over its excess tax credits or to claim the refund of or issuance of a tax credit certificate for the amounts thereof.

On 3 April 2001, BPI filed with petitioner Commissioner of Internal Revenue (CIR) an administrative claim for refund in the amount of P33,947,101.00, representing its excess creditable income tax for 1998.

The CIR failed to act on the claim for tax refund of BPI. Hence, BPI filed a Petition for Review before the CTA, docketed as CTA Case No. 6276.

The CTA promulgated its Decision in CTA Case No. 6276 on 12 March 2003, ruling therein that since BPI had opted to carry over its 1998 excess tax credit to 1999 and 2000, it was barred from filing a claim for the refund of the same.

The CTA relied on the irrevocability rule laid down in Section 76 of the National Internal Revenue Code (NIRC) of 1997, which states that once the taxpayer opts to carry over and apply its excess income tax to succeeding taxable years, its option shall be irrevocable for that taxable period and no application for tax refund or issuance of a tax credit shall be allowed for the same.

The CTA Decision adjudged:

A close scrutiny of the 1998 income tax return of [BPI] reveals that it opted to carry over its excess tax credits, the amount subject of this claim, to the succeeding taxable year by placing an "x" mark on the corresponding box of said return (Exhibits A-2 & 3-a). For the year 1999, [BPI] again manifested its intention to carry over to the succeeding taxable period the subject claim together with the current excess tax credits (Exhibit J). Still unable to apply its prior year’s excess credits in 1999 as it ended up in a net loss position, petitioner again carried over the said excess credits in the year 2000 (Exhibit K).

The court already categorically ruled in a number of cases that once the option to carry-over and apply the excess quarterly income tax against the income tax due for the taxable quarters of the succeeding taxable years has been made, such option shall be considered irrevocable and no application for cash refund or issuance of a tax credit certificate shall be allowed therefore (Pilipinas Transport Industries vs. Commissioner of Internal Revenue, CTA Case No. 6073, dated March 1, 2002; Pilipinas Hino, Inc. vs. Commissioner of Internal Revenue, CTA Case No. 6074, dated April 19, 2002; Philam Asset Management, Inc. vs. Commissioner of Internal Revenue, CTA Case No. 6210, dated May 2, 2002; The Philippine Banking Corporation (now known as Global Business Bank, Inc.) vs. Commissioner of Internal

Revenue, CTA Resolution, CTA Case No. 6280, August 16, 2001. Since [BPI] already exercised the irrevocable option to carry over its excess tax credits for the year 1998 to the succeeding years 1999 and 2000, it is, therefore, no longer entitled to claim for a refund or issuance of a tax credit certificate.4

In the end, the CTA decreed:

IN VIEW OF ALL THE FOREGOING, the instant petition for review is hereby DENIED for lack of merit.5

BPI filed a Motion for Reconsideration of the foregoing Decision, but the CTA denied the same in a Resolution dated 3 June 2003.

BPI filed an appeal with the Court of Appeals, docketed as CA-G.R. SP No. 77655. On 29 April 2005, the Court of Appeals rendered its Decision, reversing that of the CTA and holding that BPI was entitled to a refund of the excess income tax it paid for 1998.

The Court of Appeals conceded that BPI indeed opted to carry over its excess tax credit in 1998 to 1999 by placing an "x" mark on the corresponding box of its 1998 ITR. Nonetheless, there was no actual carrying over of the excess tax credit, given that BPI suffered a net loss in 1999, and was not liable for any income tax for said taxable period, against which the 1998 excess tax credit could have been applied.

The Court of Appeals added that even if Section 76 was to be construed strictly and literally, the irrevocability rule would still not bar BPI from seeking a tax refund of its 1998 excess tax credit despite previously opting to carry over

the same. The phrase "for that taxable period" qualified the irrevocability of the option of BIR to carry over its 1998 excess tax credit to only the 1999 taxable period; such that, when the 1999 taxable period expired, the irrevocability of the option of BPI to carry over its excess tax credit from 1998 also expired.

The Court of Appeals further reasoned that the government would be unjustly enriched should the appellate court hold that the irrevocability rule barred the claim for refund of a taxpayer, who previously opted to carry-over its excess tax credit, but was not able to use the same because it suffered a net loss in the succeeding year.

Finally, the appellate court cited BPI-Family Savings Bank, Inc. v. Court of Appeals6 wherein this Court held that if a taxpayer suffered a net loss in a year, thus, incurring no tax liability to which the tax credit from the previous year could be applied, there was no reason for the BIR to withhold the tax refund which rightfully belonged to the taxpayer.7

In a Resolution dated 20 April 2007, the Court of Appeals denied the Motion for Reconsideration of the CIR.8

Hence, the CIR filed the instant Petition for Review, alleging that:

I

THE COURT OF APPEALS COMMITTED A REVERSIBLE ERROR IN HOLDING THAT THE "IRREVOCABILITY RULE" UNDER SECTION 76 OF THE TAX CODE DOES NOT OPERATE TO BAR PETITIONER FROM ASKING FOR A TAX REFUND.

II

THE COURT OF APPEALS COMMITTED GRAVE ERROR WHEN IT REVERSED AND SET ASIDE THE DECISION OF THE COURT OF TAX APPEALS AND HELD THAT RESPONDENT IS ENTITLED TO THE CLAIMED TAX REFUND.

The Court finds merit in the instant Petition.

The Court of Appeals erred in relying on BPI-Family, missing significant details that rendered said case inapplicable to the one at bar.

In BPI-Family, therein petitioner BPI-Family declared in its Corporate Annual ITR for 1989 excess tax credits of P185,001.00 from 1988 and P112,491.00 from 1989, totaling P297,492.00. BPI-Family clearly indicated in the same ITR that it was carrying over said excess tax credits to the following year. But on 11 October 1990, BPI-Family filed a claim for refund of its P112,491.00 tax credit from 1989. When no action from the BIR was forthcoming, BPI-Family filed its claim with the CTA. The CTA denied the claim for refund of BPI-Family on the ground that, since the bank declared in its 1989 ITR that it would carry over its tax credits to the following year, it should be presumed to have done so. In its Motion for Reconsideration filed with the CTA, BPI-Family submitted its final adjusted ITR for 1989 showing that it incurred P52,480,173.00 net loss in 1990. Still, the CTA denied the Motion for Reconsideration of BPI-Family. The Court of Appeals likewise denied the appeal of BPI-Family and merely affirmed the judgment of the CTA. The Court, however, reversed the CTA and the Court of Appeals.

This Court decided to grant the claim for refund of BPI-Family after finding that the bank had presented sufficient evidence to prove that it incurred a net loss in 1990 and, thus, had no tax liability to which its tax credit from 1989

could be applied. The Court stressed in BPI Family that "the undisputed fact is that [BPI-Family] suffered a net loss in 1990; accordingly, it incurred no tax liability to which the tax credit could be applied. Consequently, there is no reason for the BIR and this Court to withhold the tax refund which rightfully belongs to the [BPI-Family]." It was on the basis of this fact that the Court granted the appeal of BPI-Family, brushing aside all procedural and technical objections to the same through the following pronouncements:

Finally, respondents argue that tax refunds are in the nature of tax exemptions and are to be construed strictissimi juris against the claimant. Under the facts of this case, we hold that [BPI-Family] has established its claim. [BPI-Family] may have failed to strictly comply with the rules of procedure; it may have even been negligent. These circumstances, however, should not compel the Court to disregard this cold, undisputed fact: that petitioner suffered a net loss in 1990, and that it could not have applied the amount claimed as tax credits.

Substantial justice, equity and fair play are on the side of [BPI-Family]. Technicalities and legalisms, however exalted, should not be misused by the government to keep money not belonging to it and thereby enrich itself at the expense of its law-abiding citizens. If the State expects its taxpayers to observe fairness and honesty in paying their taxes, so must it apply the same standard against itself in refunding excess payments of such taxes. Indeed, the State must lead by its own example of honor, dignity and uprightness.9

It is necessary for this Court, however, to emphasize that BPI-Family involved tax credit acquired by the bank in 1989, which it initially opted to carry over to 1990. The prevailing tax law then was the NIRC of 1985, Section 7910 of which provided:

Sec. 79. Final Adjustment Return. - Every corporation liable to tax under Section 24 shall file a final adjustment return covering the total net income for the preceding calendar or fiscal year. If the sum of the quarterly tax payments made during the said taxable year is not equal to the total tax due on the entire taxable net income of that year the corporation shall either:



In case the corporation is entitled to a refund of the excess estimated quarterly income taxes-paid, the refundable amount shown on its final adjustment return may be credited against the estimated quarterly income tax liabilities for the taxable quarters of the succeeding taxable year. (Emphases ours.)

By virtue of the afore-quoted provision, the taxpayer with excess income tax was given the option to either (1) refund the amount; or (2) credit the same to its tax liability for succeeding taxable periods.

Section 79 of the NIRC of 1985 was reproduced as Section 76 of the NIRC of 1997,11 with the addition of one important sentence, which laid down the irrevocability rule:

Section 76. Final Adjustment Return. - Every corporation liable to tax under Section 24 shall file a final adjustment return covering the total net income for the preceding calendar or fiscal year. If the sum of the quarterly tax payments

made during the said taxable year is not equal to the total tax due on the entire taxable net income of that year the corporation shall either:



In case the corporation is entitled to a refund of the excess estimated quarterly income taxes paid, the refundable amount shown on its final adjustment return may be credited against the estimated quarterly income tax liabilities for the taxable quarters of the succeeding taxable years. Once the option to carry-over and apply the excess quarterly income tax against income tax due for the taxable quarters of the succeeding taxable years has been made, such option shall be considered irrevocable for that taxable period and no application for tax refund or issuance of a tax credit certificate shall be allowed therefor. (Emphases ours.)

When BPI-Family was decided by this Court, it did not yet have the irrevocability rule to consider. Hence, BPI-Family cannot be cited as a precedent for this case.

The factual background of Philam Asset Management, Inc. v. Commissioner of Internal Revenue,12 cited by the CIR, is closer to the instant Petition. Both involve tax credits acquired and claims for refund filed more than a decade after those in BPI-Family, to which Section 76 of the NIRC of 1997 already apply.

The Court, in Philam, recognized the two options offered by Section 76 of the NIRC of 1997 to a taxable corporation whose total quarterly income tax payments in a given taxable year exceeds its total income tax due. These options are: (1) filing for a tax refund or (2) availing of a tax credit. The Court further explained:

The first option is relatively simple. Any tax on income that is paid in excess of the amount due the government may be refunded, provided that a taxpayer properly applies for the refund.

The second option works by applying the refundable amount, as shown on the [Final Adjustment Return (FAR)] of a given taxable year, against the estimated quarterly income tax liabilities of the succeeding taxable year.

These two options under Section 76 are alternative in nature. The choice of one precludes the other. Indeed, in Philippine Bank of Communications v. Commissioner of Internal Revenue, the Court ruled that a corporation must signify its intention -- whether to request a tax refund or claim a tax credit -- by marking the corresponding option box provided in the FAR. While a taxpayer is required to mark its choice in the form provided by the BIR, this requirement is only for the purpose of facilitating tax collection.

One cannot get a tax refund and a tax credit at the same time for the same excess income taxes paid.13 x x x

The Court categorically declared in Philam that: "Section 76 remains clear and unequivocal. Once the carry-over option is taken, actually or constructively, it becomes irrevocable." It mentioned no exception or qualification to the irrevocability rule.

Hence, the controlling factor for the operation of the irrevocability rule is that the taxpayer chose an option; and once it had already done so, it could no longer make another one. Consequently, after the taxpayer opts to carry-over its excess tax credit to the following taxable period, the question of whether or not it actually gets to apply said tax credit is irrelevant. Section 76 of the NIRC of 1997 is explicit in stating that once the option to carry over has been made, "no application for tax refund or issuance of a tax credit certificate shall be allowed therefor."

The last sentence of Section 76 of the NIRC of 1997 reads: "Once the option to carry-over and apply the excess quarterly income tax against income tax due for the taxable quarters of the succeeding taxable years has been made, such option shall be considered irrevocable for that taxable period and no application for tax refund or issuance of a tax credit certificate shall be allowed therefor." The phrase "for that taxable period" merely identifies the excess income tax, subject of the option, by referring to the taxable period when it was acquired by the taxpayer. In the present case, the excess income tax credit, which BPI opted to carry over, was acquired by the said bank during the taxable year 1998. The option of BPI to carry over its 1998 excess income tax credit is irrevocable; it cannot later on opt to apply for a refund of the very same 1998 excess income tax credit.

The Court of Appeals mistakenly understood the phrase "for that taxable period" as a prescriptive period for the irrevocability rule. This would mean that since the tax credit in this case was acquired in 1998, and BPI opted to carry it over to 1999, then the irrevocability of the option to carry over expired by the end of 1999, leaving BPI free to again take another option as regards its 1998 excess income tax credit. This construal effectively renders nugatory the irrevocability rule. The evident intent of the legislature, in adding the last sentence to Section 76 of the NIRC of 1997, is to keep the taxpayer from flip-flopping on its options, and avoid confusion and complication as regards said

taxpayer’s excess tax credit. The interpretation of the Court of Appeals only delays the flip-flopping to the end of each succeeding taxable period.

The Court similarly disagrees in the declaration of the Court of Appeals that to deny the claim for refund of BPI, because of the irrevocability rule, would be tantamount to unjust enrichment on the part of the government. The Court addressed the very same argument in Philam, where it elucidated that there would be no unjust enrichment in the event of denial of the claim for refund under such circumstances, because there would be no forfeiture of any amount in favor of the government. The amount being claimed as a refund would remain in the account of the taxpayer until utilized in succeeding taxable years,14 as provided in Section 76 of the NIRC of 1997. It is worthy to note that unlike the option for refund of excess income tax, which prescribes after two years from the filing of the FAR, there is no prescriptive period for the carrying over of the same. Therefore, the excess income tax credit of BPI, which it acquired in 1998 and opted to carry over, may be repeatedly carried over to succeeding taxable years, i.e., to 1999, 2000, 2001, and so on and so forth, until actually applied or credited to a tax liability of BPI.

Finally, while the Court, in Philam, was firm in its position that the choice of option as regards the excess income tax shall be irrevocable, it was less rigid in the determination of which option the taxpayer actually chose. It did not limit itself to the indication by the taxpayer of its option in the ITR.

Thus, failure of the taxpayer to make an appropriate marking of its option in the ITR does not automatically mean that the taxpayer has opted for a tax credit. The Court ratiocinated in G.R. No. 15663715 of Philam:

One cannot get a tax refund and a tax credit at the same time for the same excess income taxes paid. Failure to signify one’s intention in the FAR does not mean outright barring of a valid request for a refund, should one still choose this option later on. A tax credit should be construed merely as an alternative remedy to a tax refund under Section 76, subject to prior verification and approval by respondent.

The reason for requiring that a choice be made in the FAR upon its filing is to ease tax administration, particularly the self-assessment and collection aspects. A taxpayer that makes a choice expresses certainty or preference and thus demonstrates clear diligence. Conversely, a taxpayer that makes no choice expresses uncertainty or lack of preference and hence shows simple negligence or plain oversight.

x x x x

x x x Despite the failure of [Philam] to make the appropriate marking in the BIR form, the filing of its written claim effectively serves as an expression of its choice to request a tax refund, instead of a tax credit. To assert that any future claim for a tax refund will be instantly hindered by a failure to signify one’s intention in the FAR is to render nugatory the clear provision that allows for a two-year prescriptive period.16 (Emphases ours.)

Philam reveals a meticulous consideration by the Court of the evidence submitted by the parties and the circumstances surrounding the taxpayer’s option to carry over or claim for refund. When circumstances show that a choice has been made by the taxpayer to carry over the excess income tax as credit, it should be respected; but when indubitable circumstances clearly show that another choice – a tax refund – is in order, it should be granted. "Technicalities and

legalisms, however exalted, should not be misused by the government to keep money not belonging to it and thereby enrich itself at the expense of its law-abiding citizens."

Therefore, as to which option the taxpayer chose is generally a matter of evidence. It is axiomatic that a claimant has the burden of proof to establish the factual basis of his or her claim for tax credit or refund. Tax refunds, like tax exemptions, are construed strictly against the taxpayer.17

In the Petition at bar, BPI was unable to discharge the burden of proof necessary for the grant of a refund. BPI expressly indicated in its ITR for 1998 that it was carrying over, instead of refunding, the excess income tax it paid during the said taxable year. BPI consistently reported the said amount in its ITRs for 1999 and 2000 as credit to be applied to any tax liability the bank may incur; only, no such opportunity arose because it suffered a net loss in 1999 and incurred zero tax liability in 2000. In G.R. No. 162004 of Philam, the Court found:

First, the fact that it filled out the portion "Prior Year’s Excess Credits" in its 1999 FAR means that it categorically availed itself of the carry-over option. In fact, the line that precedes that phrase in the BIR form clearly states "Less: Tax Credits/Payments." The contention that it merely filled out that portion because it was a requirement – and that to have done otherwise would have been tantamount to falsifying the FAR – is a long shot.

The FAR is the most reliable firsthand evidence of corporate acts pertaining to income taxes. In it are found the itemization and summary of additions to and deductions from income taxes due. These entries are not without rhyme or reason. They are required, because they facilitate the tax administration process.18

BPI itself never denied that its original intention was to carry over the excess income tax credit it acquired in 1998, and only chose to refund the said amount when it was unable to apply the same to any tax liability in the succeeding taxable years. There can be no doubt that BPI opted to carry over its excess income tax credit from 1998; it only subsequently changed its mind – which it was barred from doing by the irrevocability rule.

The choice by BPI of the option to carry over its 1998 excess income tax credit to succeeding taxable years, which it explicitly indicated in its 1998 ITR, is irrevocable, regardless of whether it was able to actually apply the said amount to a tax liability. The reiteration by BPI of the carry over option in its ITR for 1999 was already a superfluity, as far as its 1998 excess income tax credit was concerned, given the irrevocability of the initial choice made by the bank to carry over the said amount. For the same reason, the failure of BPI to indicate any option in its ITR for 2000 was already immaterial to its 1998 excess income tax credit.

WHEREFORE, the instant Petition for Review of the Commissioner for Internal Revenue is GRANTED. The Decision dated 29 April 2005 and the Resolution dated 20 April 2007 of the Court of Appeals in CA-G.R. SP No. 77655 are REVERSED and SET ASIDE. The Decision dated 12 March 2003 of the Court of Tax Appeals in CTA Case No. 6276, denying the claim of respondent Bank of the Philippine Islands for the refund of its 1998 excess income tax credits, is REINSTATED. No costs.

G.R. Nos. L-18843 and L-18844 August 29, 1974

CONSOLIDATED MINES, INC., petitioner, vs.COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.

G.R. Nos. L-18853 & L-18854 August 29, 1974

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.CONSOLIDATED MINES, INC., respondent.

Office of the Solicitor General for Commissioner of Internal Revenue.

Tañada, Carreon & Tañada for Consolidated Mines, Inc.

MAKALINTAL, C.J.:p

These are appeals from the amended decision of the Court of Tax Appeals dated August 7, 1961, in CTA Cases No. 565 and 578, both entitled "Consolidated Mines, Inc. vs. Commissioner of Internal Revenue,"

ordering the Consolidated Mines, Inc., hereinafter referred to as the Company, to pay the Commissioner of Internal Revenue the amounts of P79,812.93, P51,528.24 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and 1956, respectively, or the total sum of P202,733.99, plus 5% surcharge and 1% monthly interest from the date of finality of the decision.

The Company, a domestic corporation engaged in mining, had filed its income tax returns for 1951, 1952, 1953 and 1956. In 1957 examiners of the Bureau of Internal Revenue investigated the income tax returns filed by the Company because on August 10, 1954, its auditor, Felipe Ollada claimed the refund of the sum of P107,472.00 representing alleged overpayments of income taxes for the year 1951. After the investigation the examiners reported that (A) for the years 1951 to 1954 (1) the Company had not accrued as an expense the share in the company profits of Benguet Consolidated Mines as operator of the Company's mines, although for income tax purposes the Company had reported income and expenses on the accrual basis; (2) depletion and depreciation expenses had been overcharged; and (3) the claims for audit and legal fees and miscellaneous expenses for 1953 and 1954 had not been properly substantiated; and that (B) for the year 1956 (1) the Company had overstated its claim for depletion; and (2) certain claims for miscellaneous expenses were not duly supported by evidence.

In view of said reports the Commissioner of Internal Revenue sent the Company a letter of demand requiring it to pay certain deficiency income taxes for the years 1951 to 1954, inclusive, and for the year 1956. Deficiency income tax assessment notices for said years were also sent to the Company. The Company requested a reconsideration of the assessment, but the Commissioner refused to reconsider, hence the

Company appealed to the Court of Tax Appeals. The assessments for 1951 to 1954 were contested in CTA Case No. 565, while that for 1956 was contested in CTA Case No. 578. Upon agreement of the parties the two cases were heard and decided jointly.

On May 6, 1961 the Tax Court rendered judgment ordering the Company to pay the amounts of P107,846.56, P134,033.01 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and 1956, respectively. The Tax Court nullified the assessments for the years 1951 and 1952 on the ground that they were issued beyond the five-year period prescribed by Section 331 of the National Internal Revenue Code.

However, on August 7, 1961, upon motion of the Company, the Tax Court reconsidered its decision and further reduced the deficiency income tax liabilities of the Company to P79,812.93, P51,528.24 and P71,382.82 for the years 1953, 1954 and 1956, respectively. In this amended decision the Tax Court subscribed to the theory of the Company that Benguet Consolidated Mining Company, hereafter referred to as Benguet, had no right to share in "Accounts Receivable," hence one-half thereof may not be accrued as an expense of the Company for a given year.

Both the Company and the Commissioner appealed to this Court. The Company questions the rate of mine depletion adopted by the Court of Tax Appeals and the disallowance of depreciation charges and certain miscellaneous expenses (G.R. Nos. L-18843 & L-18844). The Commissioner, on the other hand, questions what he characterizes as the "hybrid" or "mixed" method of accounting utilized by the Company, and approved by the Tax Court, in treating the

share of Benguet in the net profits from the operation of the mines in connection with its income tax returns (G.R. Nos. L-18853 & L-18854).

With respect to methods of accounting, the Tax Code states:

Sec. 38. General Rules. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer but if no such method of accounting has been so employed or if the method employed does not clearly reflect the income the computation shall be made in accordance with such methods as in the opinion of the Commissioner of Internal Revenue does clearly reflect the income ...

Sec. 39. Period in which items of gross income included. — The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the methods of accounting permitted under section 38, any such amounts are to be properly accounted for as of a different period ...

Sec. 40. Period for which deductions and credits taken. — The deductions provided for in this Title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred" dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions should be taken as of a different period ...

It is said that accounting methods for tax purposes 1 comprise a set of rules for determining when and how to report income and deductions. The U.S. Internal Revenue Code 2 allows each taxpayer to adopt the accounting method most suitable to his business, and requires only that taxable income generally be based on the method of accounting regularly employed in keeping the taxpayer's books, provided that the method clearly reflects income. 3

The Company used the accrual method of accounting in computing its income. One of its expenses is the amount-paid to Benguet as mine operator, which amount is computed as 50% of "net income." The Company deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the end of each calendar year what the Commissioner alleges is "50% of the share of Benguet" in the "accounts receivable." However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid. It would seem, therefore, that the Company has been deducting a portion of this expense (Benguet's share as mine operator) on the "cash & carry" basis. The question is whether or not the accounting system used by the Company justifies such a treatment of this item; and if not, whether said method used by the Company, and characterized by the Commissioner as a "hybrid method," may be allowed under the aforequoted provisions of our tax code. 4

For a proper understanding of the situation the following facts are stated: The Company has certain mining claims located in Masinloc, Zambales. Because it wanted to relieve itself of the work and expense necessary for developing the claims, the Company, on July 9, 1934, entered into an agreement (Exhibit L) with

Benguet, a domestic anonymous partnership engaged in the production and marketing of chromite, whereby the latter undertook to "explore, develop, mine, concentrate and market" the pay ore in said mining claims.

The pertinent provisions of their agreement, as amended by the supplemental agreements of September 14, 1939 (Exhibit L-1) and October 2, 1941 (Exhibit L-2), are as follows:

IV. Benguet further agrees to provide such funds from its own resources as are in its judgment necessary for the exploration and development of said claims and properties, for the purchase and construction of said concentrator plant and for the installation of the proper transportation facilities as provided in paragraphs I, II and III hereof until such time as the said properties are on a profit producing basis and agrees thereafter to expand additional funds from its own resources, if the income from the said claims is insufficient therefor, in the exploration and development of said properties or in the enlargement or extension of said concentration and transportation facilities if in its judgment good mining practice requires such additional expenditures. Such expenditures from its own resources prior to the time the said properties are put on a profit producing basis shall be reimbursed as provided in paragraph VIII hereof. Expenditures from its own resources thereafter shall be charged against the subsequent gross income of the properties as provided in paragraph X hereof.

VII. As soon as practicable after the close of each month Benguet shall furnish Consolidated with a statement showing its expenditures made and ore settlements received under this agreement for

the preceding month which statement shall betaken as accepted by Consolidated unless exception is taken thereto or to any item thereof within ten days in writing in which case the dispute shall be settled by agreement or by arbitration as provided in paragraph XXII hereof.

VIII. While Benguet is being reimbursed for all its expenditures, advances and disbursements hereunder as evidenced by said statements of accounts, the net profits resulting from the operation of the aforesaid claims or properties shall be divided ninety per cent (90%) to Benguet and ten per cent (10%) to Consolidated. Such division of net profits shall be based on the receipts, and expenditures during each calendar year, and shall continue until such time as the ninety per cent (90%) of the net profits pertaining to Benguet hereunder shall equal the amount of such expenditures, advances and disbursements. The net profits shall be computed as provided in Paragraph X hereof.

X. After Benguet has been fully reimbursed for its expenditures, advances and disbursements as aforesaid the net profits from the operation shall be divided between Benguet and Consolidated share and share alike, it being understood however, that the net profits as the term is used in this agreement shall be computed by deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of this agreement.

XIII. It is understood that Benguet shall receive no compensation for services rendered as manager or technical consultants in connection with the carrying out of this agreement. It may, however, charge against the operation actual additional expenses incurred in its Manila Office in connection with the carrying out of the terms of this agreement including traveling expenses of consulting staff to the mines. Such expenses, however, shall not exceed the sum of One Thousand Pesos (P1,000.00) per month. Otherwise, the sole compensation of Benguet shall be its proportion of the net profits of the operation as herein above set forth.

XIV. All payments due Consolidated by Benguet under the terms of this agreement with respect to expenditures made and ore settlements received during the preceding calendar month, shall be payable on or before the twentieth day of each month.

There is no question with respect to the 90%-10% sharing of profits while Benguet was being reimbursed the expenses disbursed during the period it was trying to put the mines on a profit-producing basis. 5 It appears that by 1953 Benguet had completely recouped said advances, because they were then dividing the profits share and share alike. .

As heretofore stated the question is: Under the arrangement between the Company and Benguet, when did Benguet's 50% share in the "Accounts Receivable accrue? 6

The following table (summary, Exhibit A, of examiner's report of January 28, 1967, Exh. 8) prepared for the Commissioner graphically illustrates the effect of the inclusion of one-half of "Accounts Receivable" as expense in the computation of the net income of the Company:

SUMMARY: 1951 1952 1953 1954

Original share of Benguet

1,313,640.26 3,521,751,94 2,340,624.59 2,622,968.58

Additional share of Rec'bles

383,829.87 677,504.76 577,394.66 282,724.76

Total share of Benguet

1,697,470.13 4,199,256.70 2,918,009.25 2,905,693.34

Less: Receipts due from prior year operation

269,619.00 383,829.87 677,504.76 577,384.66

Share of Benguet as adjusted (Acc'rd)

1,427,851.13 3,815,426.83 2,240,504.49 2,328,308.68

Less: Participation of Benguet already deducted

1,313,640.26 3,521,751.94 2,340,624.59 2,622,968.58

Additional 114,210.87 293,674.89 (100,120.10) (294,659.90)

Expense (Income)

In the aforesaid table "Additional share on Rec'bles" is one-half of "Total Rec'bles minus "Total Payables." It indicates, from the Commissioner's viewpoint, that there were years when the Company had been overstating its income (1951 and 1952) and there were years when it had been understating its income (1953 and 1954). 7 The Commissioner is not interested in the taxes for 1951 and 1952 (which had prescribed anyway) when the Company had overstated its income, but in those for 1953 and 1954, in each of which years the amount of the "Accounts Receivable" was less than that of the previous year, and the Company, therefore, appears to have deducted, as expense, compensation to Benguet bigger (than what the Commissioner claims is due) by one-half of the difference between the year's "Accounts Receivable" and the previous year's "Accounts Receivable," thus apparently understating its income to that extent.

According to the agreement between the Company and Benguet the net profits "shall be computed by deducting from gross income all operating expenses and all expenses of any nature whatsoever." Periodically, Benguet was to furnish the Company with the statement of accounts for a given month "as soon as practicable after the close" of that month. The Company had ten days from receipt of the statement to register its objections thereto. Thereafter, the statement was considered binding on the Company. And all payments due the Company "with respect to the expenditures made and ore settlements received during the calendar month shall be payable on or before the twentieth of each month."

The agreement does not say that Benguet was to share in "Accounts Receivable." But may this be implied from the terms of the agreement? The statement of accounts (par. VIII) and the payment part (XIV) that Benguet 8 must make are both with respect to "expenditures made and ore settlements received." "Expenditures" are payments of money. 9 This is the meaning intended by the parties, considering the provision that Benguet agreed to "provide such funds from its own resources, etc."; and that "such expenditures from its own resources" were to be reimbursed first as provided in par. VIII, and later as provided in par. X. "Settlement" does not necessarily mean payment or satisfaction, though it may mean that; it frequently means adjustment or arrangement. 10 The term "settlement" may be used in the sense of "payment," or it may be used in the sense of "adjustment" or "ascertainment," or it may be used in the sense of "adjustment" or "ascertainment of a balance between contending parties," depending upon the circumstances under which, and the connection in which, use of the term is made. 11 In the term "ore settlements received," the word "settlement" was not used in the concept of "adjustment," "arrangement" or "ascertainment of a balance between contending parties," since all these are "made," not "received." "Payment," then, is the more appropriate equivalent of, and interchangeable with, the term "Settlement." Hence, "ore settlements received" means "ore payments received," which excludes "Accounts Receivable." Thus, both par. VIII and par. XIV refer to "payment," either received or paid by Benguet.

According to par. X, the 50-50 sharing should be on "net profits;" and "net profits" shall be computed "by deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of the agreement." The term "gross profit" was not defined. In the accrual method of accounting "gross income" would include both "cash receipts" and "Accounts

Receivable." But the term "gross income" does not carry a definite and inflexible meaning under all circumstances, and should be defined in such a way as to ascertain the sense in which the parties have used it in contracting. 12 According to par. VIII 13 the "division of net profits shall be based on the receipts and expenditures." The term "expenditures" we have already analyzed. As used, receipts" means "money received." 14 The same par. VIII uses the term "expenditures, advances and disbursements." "Disbursements" means "payment," 15 while the word "advances" when used in a contract ordinarily means money furnished with an expectation that it shall be returned. 16 It is thus clear from par. VIII that in the computation of "net profits" (to be divided on the 90%-10% sharing arrangement) only "cash payments" received and "cash disbursements" made by Benguet were to be considered. On the presumption that the parties were consistent in the use of the term, the same meaning must be given to "net profits" as used in par. X, and "gross income," accordingly, must be equated with "cash receipts." The language used by the parties show their intention to compute Benguet's 50% share on the excess of actual receipts over disbursements, without considering "Accounts Receivable" and "Accounts Payable" as factors in the computation. Benguet then did not have a right to share in "Accounts Receivable," and, correspondingly, the Company did not have the liability to pay Benguet any part of that item. And a deduction cannot be accrued until an actual liability is incurred, even if payment has not been made. 17

Here we have to distinguish between (1) the method of accounting used by the Company in determining its net income for tax purposes; and (2) the method of computation agreed upon between the Company and Benguet in determining the amount of compensation that was to be paid by the former to the latter. The parties, being free to do so, had contracted that in the method of computing compensation the basis were

"cash receipts" and "cash payments." Once determined in accordance with the stipulated bases and procedure, then the amount due Benguet for each month accrued at the end of that month, whether the Company had made payment or not (see par. XIV of the agreement). To make the Company deduct as an expense one-half of the "Accounts Receivable" would, in effect, be equivalent to giving Benguet a right which it did not have under the contract, and to substitute for the parties' choice a mode of computation of compensation not contemplated by them. 18

Since Benguet had no right to one-half of the "Accounts Receivable," the Company was correct in not accruing said one-half as a deduction. The Company was not using a hybrid method of accounting, but was consistent in its use of the accrual method of accounting. The first issue raised by the Company is with respect to the rate of mine depletion used by the Court of Tax Appeals. The Tax Code provides that in computing net income there shall be allowed as deduction, 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 is made [Sec. 30(g) (1) (B)]. 19

The formula 20 for computing the rate of depletion is:

Cost of Mine Property ---------------------- = Rate of Depletion Per Unit Estimated ore Deposit of Product Mined and sold

The Commissioner and the Company do not agree as to the figures corresponding to either factor that affects the rate of depletion per unit. The figures according to the Commissioner are:

P2,646,878.44 (mine cost) P0.59189 (rate of ------------------------- = depletion per ton)4,471,892 tons (estimated ore deposit)

while the Company insists they are:P4,238,974.57 (mine cost) P1.0197 (rate of ------------------------- - = depletion per ton)4,156,888 tons (estimatedore deposit)

They agree, however, that the "cost of the mine property" consists of (1) mine cost; and (2) expenses of development before production. As to mine cost, the parties are practically in agreement — the Commissioner says it is P2,515,000 (the Company puts it at P2,500,000). As to expenses of development before production the Commissioner and the Company widely differ. The Company claims it is P1,738,974.56, while the Commissioner says it is only P131,878.44. The Company argues that the Commissioner's figure is "a patently insignificant and inadequate figure when one considers the tens of millions of pesos of revenue and production that petitioner's chromite mine fields have finally produced."

As an income tax concept, depletion is wholly a creation of the statute 21 — "solely a matter of legislative grace." 22 Hence, the taxpayer has the burden of justifying the allowance of any deduction claimed. 23 As in connection with all other tax controversies, the burden of proof to show that a disallowance of depletion by

the Commissioner is incorrect or that an allowance made is inadequate is upon the taxpayer, and this is true with respect to the value of the property constituting the basis of the deduction. 24 This burden-of-proof rule has been frequently applied and a value claimed has been disallowed for lack of evidence. 25

As proof that the amount spent for developing the mines was P1,738,974.56, the Company relies on the testimony of Eligio S. Garcia and on Exhibits 1, 31 and 38.

Exhibit I is the Company's report to its stockholders for the year 1947. It contains the Company's balance sheet as of December 31, 1946 (Exhibit I-1). Among the assets listed is "Mines, Improvement & Dev." in the amount of P4,238,974.57, which, according to the Company, consisted of P2,500,000, purchase price of the mine, and P1,738,974.56, cost of developing it. The Company also points to the statement therein that "Benguet invested approximately P2,500,000 to put the property in operation, the greater part of such investment being devoted to the construction of a 25-kilometer road and the installation of port facilities." This amount of P2,500,000 was only an estimate. The Company has not explained in detail in what this amount or the lesser amount of P1,738,974.56 consisted. Nor has it explained how that bigger amount became P1,738,974.56 in the balance sheet for December 31, 1946.

According to the Company the total sum of P4,238,974.57 as "Mines, Improvement & Dev." was taken from its pre-war balance sheet of December 31, 1940. As proof of this it cites the sworn certification (Exhibit 38) executed on October 25, 1946 by R.P. Flood, in his capacity as treasurer of the Company, and attached to other papers of the Company filed with the Securities and Exchange Commission in compliance with the

provisions of Republic Act No. 62 (An Act to require the presentation of proof of ownership of securities and the reconstruction of corporate and partnership records, and for other purposes). In said certification there are statements to the effect that "the Statement of Assets & Liabilities of Consolidated Mines, Incorporated, submitted to the Securities & Exchange Commission as a requirement for the reconstitution of the records of the said corporation, is as of September 4, 1946;" and that "the figure P4,238,974.57 representing the value of Mines, Improvements and Developments appearing therein, was taken from the Balance Sheet as of December 31, 1940, which is the only available source of information of the Corporation regarding the above and consequently the undersigned considers the stated figure to be only an estimate of the value of those items at the present time. "This figure, the Company claims, is based on entries made in the ordinary and regular course of its business dating as far back as before the war. The Company places reliance on Sec. 39, Rule 130, Revised Rules of Court (formerly Sec. 34, Rule 123), which provides that entries made at, or near the time of the transactions to which they refer, by a person deceased, outside of the Philippines or unable to testify, who was in a position to know the facts therein stated, may be received as prima facie evidence, if such person made the entries in his professional capacity or in the performance of duty and in the ordinary or regular course of business or duty."

Note that Exhibit 38 is not the "entries," covered by the rule. The Company, however, urges, unreasonably, we think, that it should be afforded the same probative value since it is based on such "entries" meaning the balance sheet of December 31, 1940, which was not presented in evidence. Even with the presentation of said balance sheet the Company would still have had to prove (1) that the person who made the entry did so in his professional capacity or in the performance of a duty; (2) that the entry was made in the ordinary

course of business or duty; (3) that the entry was made at or near the time of the transaction to which it related; (4) that the one who made it was in a position to know the facts stated in the entry; and (5) that he is dead, outside the Philippines or unable to testify 26

A balance sheet may not be considered as "entries made in the ordinary course of business," which, according to Moran:

means that the entries have been made regularly, as is usual, in the management of the trade or business. It is essential, therefore, that there be regularity in the entries. The entry which is being introduced in evidence should appear to be part of a group of regular entries. ... The regularity of the entries maybe proved by the form in which they appear in the corresponding book. 27

A balance sheet, as that word is uniformly used by bookkeepers and businessmen, is a paper which shows "a summation or general balance of all accounts," but not the particular items going to make up the several accounts; and it is therefore essentially different from a paper embracing "a full and complete statement of all the disbursements and receipts, showing from what sources such receipts were derived, and for what and to whom such disbursements or payments were made, and for what object or purpose the same were made;" but such matters may find an appropriate place in an itemized account. 28 Neither can it be said that a balance sheet complies with the third requisite, since the entries therein were not made at or near the time of the transactions to which they related.

In order to render admissible books of account it must appear that they are books of original entry, that the entries were made in the ordinary course of business, contemporaneously with the facts recorded, and by one who had knowledge of the facts. San Francisco Teaming Co v Gray (1909) 11 CA 314, 104 P 999. See Brown v Ball (1932) 123 CA 758, 12 P2d 28, to the effect that the books must be kept in the regular course of business. 29

A "ledger" is a book of accounts in which are collected and arranged, each under its appropriate head, the various transactions scattered throughout the journal or daybook, land is not a "book of original entries," within the rule making such books competent evidence. First Nat. Building Co. v. Vanderberg, 119 P 224, 227; 29 Okl. 583. 30

Code Iowa, No. 3658, providing that "books of account" are receivable in evidence, etc., means a book containing charges, and showing a continuous dealing with persons generally. A book, to be admissible, must be kept as an account book, and the charges made in the usual course of business. Security Co. v. Graybeal, 52 NW 497, 85 Iowa 543, 39 Am St Rep 311. 31

Books of account may therefore be admissible under the rule. In tax cases, however, this Court appears not to place too high a probative value on them, considering the statement in the case of Collector of Internal Revenue v. Reyes 32 that "books of account do not prove per se that they are veracious; in fact they may be more consistent than truthful." Indeed, books of account may be used to carry out a plan of tax evasion. 33

At most, therefore, the presentation of the balance sheet of December 31, 1940 would only prove that the figure P4,238,974.57 appears therein as corresponding to mine cost. But the Company would still need to present proof to justify its adoption of that figure. It had burden of establishing the components of the amount of P1,738,974.57: what were the particular expenses made and the corresponding amount of each, so that it may be determined whether the expenses were actually made and whether the items are properly part of cost of mine development, or are actually depreciable items.

In this connection we take up Exhibit 31 of the Commissioner. This is the memorandum of BIR Examiner Cesar P. Aguirre to the Chief of the Investigating Division of the Bureau of Internal Revenue. According to this report "the counsel of the taxpayer alleges that the cost of Masinloc Mine properties and improvement is P4,238,974.56 instead of P2,646,879.44 as taken up in this report," and that the expenses as of 1941 were as follows:

Assets subject to:

1941

1. Depletion P2,646,878.44

2. 10 years depreciation 1,188,987.76

3. 3 years depreciation 78,283.75

4. 20 years depreciation 9,143.63

5. 10% amortization 171,985.00

Less: Cost Chromite Field P4,085,277.58

Expenses by operator 2,515,000.00 P1,570,277.58

The examiner concluded that "in the light of the figures listed above, the counsel for the taxpayer fairly stated the amount disbursed by the operator until the mine property was put to production in 1939." The Company capitalizes on this conclusion, completely disregarding the examiner's other statements, as follows:

The counsel, however, is not aware of the fact that the expenses made by the operator are those which are depreciable and\or amortizable instead of depletable expenditures. The first post-war Balance Sheet (12/31/46) of the taxpayer shows that its Mines, Improvement & Dev. is P4,328,974.57. Considering the expenditures incurred by Benguet Consolidated as of 1941 (P1,570,277.58); the rehabilitation expenses in 1946 (P211,223.72); and the cost of the Masinloc Chromite Field, the total cost would only be P4,296,501.30. Of the total expenditure of P1,570,277.58 as of 1941, P1,438,389.124 were spent on depreciable and/or amortizable expenses and P131,878.44 were made for the direct improvement of the mine property.

In as much as the expenditure of the operator as of 1941 and the cost of the mine property were taken up in the account Mines, Improvement & Rehabilitation in 1946, all its assets that were rightfully subject to depletion was P2,646,878.44.

Because of the above qualification a large part of the amount spent by the operator 34 may not be allowed for purpose of depletion deduction, 35 depletion being different from depreciation. 36

The Company's balance sheet for December 31, 1947 lists the "mine cost" of P2,500,000 as "development cost" and the amount of P1,738,974.37 as "suspense account (mining properties subject to war losses)." The Company claims that its accountant, Mr. Calpo, made these errors, because he was then new at the job. Granting that was what had happened, it does not affect the fact that the, evidence on hand is insufficient to prove the cost of development alleged by the Company.

Nor can we rely on the statements of Eligio S. Garcia, who was the Company's treasurer and assistant secretary at the time he testified on August 14, 1959. He admitted that he did not know how the figure P4,238,974.57 was arrived at, explaining: "I only know that it is the figure appearing on the balance sheet as of December 31, 1946 as certified by the Company's auditors; and this we made as the basis of the valuation of the depletable value of the mines." (p. 94, t.s.n.)

We, therefore, have to rely on the Commissioner's assertion that the "development cost" was P131,878.44, broken down as follows: assessment, P34,092.12; development, P61,484.63; exploration, P13,966.62; and diamond drilling, P22,335.07.

The question as to which figure should properly correspond to "mine cost" is one of fact. 37 The findings of fact of the Tax Court, where reasonably supported by evidence, are conclusive upon the Supreme Court. 38

As regards the estimated ore deposit of the Company's mines, the Company's figure is "4,156,888 tons," while that of the Commissioner is the larger figure "4,471,892 tons." The difference of 315,004 tons was due to the fact that the Commissioner took into account all the ore that could probably be removed and marketed by the Company, utilizing the total tonnage shipped before and after the war (933,180 tons) and the total reserve of shipping material pegged at 3,583,712 tons. On the other hand the Company's estimate was arrived at by taking into consideration only the quantity shipped from solid ore namely, 733,180 tons (deducting from the total tonnage shipped before and after the war an estimated float of 200,000 tons), and then adding the total recoverable ore which was assessed at 3,423,708 tons.

The above-stated figures were obtained from the report 39 of geologist Paul A. Schaeffer, who had been earlier commissioned by the Company to conduct a study of the metallurgical possibilities of the Company's mines. In order to have a fair understanding of how the contending parties arrived at their respective figures, We quote a pertinent portion of the geologist's report:

Milling Data

Ore mined before the war ............... 336,850 tons

Ore mined after the war ............... 1,779,350 tons

Total ........................................... 2,116,200 tons

x Ore shipped before the war ......... 337,611 tons

xx Ore shipped after the war ............ 595,569 tons

Total ................................................ 933,180 tons

Less an estimated float of .................. 200,000 tons

Total shipped from solid ore .............. 733,180 tons

Proportion shipped 733,180 -------- = ----------- mined 2,116,200

or approximately 35% of mine ore is shipped.

Dumps

Material on dumps now total 383,346 tons. Using the above tonnage for ore shipped from mining (excluding float) there should have been a total of 1,383,020 tons of waste produced of which almost 1,000,00 tons has been removed from the mining area of the hill. I believe that half still remains as alluviuma long the three

principal intermittent creeks which head in the mining area, and the remaining half million has washed into the river. Of course this is pure speculation.

x — much was float material, probably about one half, leaving about 170.000 tons mined from the hill.

xx — some float included.

xxx xxx xxx

Ore Reserve

The A and B ore is considered sufficiently developed by drilling and tunnels to constitute the ore reserve. C ore must be checked by drilling.

Tons

A . . . . . . . . . . . . . 7,729,800 B . . . . . . . . . . . . . 1,780,500 Total . . . . . . . . . . 9,510,300 C . . . . . . . . . . . . . 2,212,00 Grand Total . . . . 11,722,300

Therefore, the total ore reserve may be considered to be 9,510,300 tons. Based on past experience 35% is shipping ore.

With the present mill there is considerably more recovery. The ore is mined selectively (between dikes). The results are about as follows:

Of 1,500 tons mined, 500 tons are sorted and shipped direct, the remaining 1,000 tons going to the mill from which 250 tons ore recovered for shipment. Thus 50% of the selectively mined ore is recovered.

Thus for the reserve tonnage:

Total reserve . . . . . . . . . . . . . . . 9,510,300 Less 20% dike material . . . . . . . 1,902,060 7,608,240 Less 10% low grade ore . . . . . . 760,8246,847,416 x .50 =

Total recoverable ore . . . . . . . . . . 3,423,708 tons

It is probable that 30% of the dump material could be recovered by milling. So adding to the above 115,004 ore recoverable from the dumps, we get a total reserve of shipping material of 3,538,712 tons. With the sink float section added to the mill this should be increased by perhaps 20%.

On the basis of the above report the Company faults the Tax Court is sustaining the Commissioner's estimate of the ore deposit. While the figures corresponding to the total gross tonnage shipped before and after the war have not been assailed as erroneous, the Company maintains that the estimated float 40 of 200,000 tons as reported in the geologist's study should have been deducted therefrom, such that the combined total of the ore shipped should have been placed at a net of 733,180 tons instead of 933,180 tons. The other figure the Company assails as having been improperly included by the Commissioner in his statement of ore reserve refers to the "Recoverable ore from dump material — 115,004 tons." The Company's argument in this regard runs thus:

... This apparently was included by respondent by virtue of the geologist's report that "it is probable that 30% of the dump material should be recovered by milling." Actually, however, such recovery from dump or waste material is problematical and is merely a contingency, and hence, the item of 115,004 tons should not be included in the statement of the ore reserves. Taking out these two items improperly and erroneously included in respondent Commissioner of Internal Revenue's examiner's report, to wit, float or waste material of 200,060 tons and supposedly recoverable ore from dump materials of 115,004 tons, totaling 315,004 tons, from the total figure of 4,471,892 tons

given by him, the figure of 4,156.888 tons results as the proper statement of the total estimated ore as correctly used by petitioner in its statement of ore reserves for purposes of depletion. 41

We agree with the Company's observation on this point. The geological report appears clear enough: the estimated float of 200,000 tons consisting of pieces of ore that had broken loose and become detached by erosion from their original position could hardly be viewed as still forming part of the total estimated ore deposit. Having already been broken up into numerous small pieces and practically rendered useless for mining purposes, the same could not appreciably increase the ore potentials of the Company's mines. As to the 115,004 tons which geologist Paul A. Schaeffer believed could still be recovered by milling from the material on dumps, there are no sufficient data on which to affirm or deny the accuracy of the said figure. It may, however, be taken as correct, considering that it came from the Company's own commissioned geologist and that by the Company's own admission 42 by 1957 it had mined and sold much more than its original estimated ore deposit of 4,156,888 tons. We think that 4,271,892 tons 43 would be a fair estimate of the ore deposit in the Company's mines.

The correct figures therefore are:P2,515,000.00 (mine cost proper) + P131,878.44 (development cost) 4,271,892 (estimated ore deposit)

or

P2,646,878.44 (mine cost) = P0.6196 (rate of depletion 4,271,892 (estimated ore per ton)deposit)

In its second assigned error, the Company questions the disallowance by the Tax Court of the depreciation charges claimed by the Company as deductions from its gross income 44 The items thus disallowed consist mainly of depreciation expenses for the years 1953 and 1954 allegedly sustained as a result of the deterioration of some of the Company's incomplete constructions.

The initial memorandum 45 of the BIR examiner assigned to verify the income tax liabilities of the Company pursuant to the latter's claim of having overpaid its income taxes states the basic reason why the Company's claimed depreciation should be disallowed or re-adjusted, thus: since "..., up to its completion (the incomplete asset) has not been and is not capable of use in the operation, the depreciation claimed could not, in fairness to the Government and the taxpayer, be considered as proper deduction for income tax purposes as the said asset is still under construction." Vis-a-Vis the Commissioner's consistent position in this regard the company simply repeatedly requested for time 46 — in view of the alleged voluminous working sheets that had to be re-evaluated and recomputed to justify its claimed depreciation items within which to submit a separate memorandum in itemized form detailing the Company's objections to the items of depreciation adjustments or disallowances for the years involved. Strangely enough, despite the period granted, the record is bare that the Company ever submitted its itemized objection as proposed. Inasmuch as the taxpayer has the burden of justifying the deductions claimed for depreciation, the Company's failure

to discharge the burden prevents this Court, from disturbing the Commissioner's computation. For taxation purposes the phrase "out of its not being used," with reference to depreciation allowable on assets which are idle or the use of which is temporarily suspended, should be understood to refer only to property that has once been used in the trade or business, not to property that has never been actually devoted to the taxpayer's business, particularly incomplete assets that have yet to be used. .

The Company's third assigned error assails the Court of Tax Appeals in not allowing the deduction from its gross income of certain miscellaneous business expenditures in the course of its operation for the years 1954 and 1956. For 1954 the deduction claimed amounted to P38,081.20, of which the Court allowed P25,600.00 and disallowed P13,481.20, 47 "for lack of any supporting paper or evidence." For the year 1956 the claim amounted to P20,050.00 of which the Court allowed P2,460.00, representing the one-month salary Christmas bonus given to some of the employees, and upheld the disallowance of P17,590.00 on the ground that the Company "failed to prove substantially that said expenses were actually incurred and are legally deductible expenses."

Regarding the disallowed amount of P13,481.20 the year 1954, the Company submits that it consisted of expenses supported by "vouchers and cancelled checks evidencing payments of these amounts," and were necessary and ordinary expenses of business for that year. On the disallowance by the Tax Court of the sum of P17,590.00 out of a total deduction for miscellaneous expenses for 1956 among to P20,050.00, the Company advances the same argument, namely, that the amount consisted of normal and regular expenses for that year as evidenced by vouchers and cancelled checks.

These vouchers and cancelled checks of the Company, however, only show that the amounts claimed had indeed been spent, and confirm the fact of disbursement, but do not necessarily prove that the expenses for which they we're disbursed are deductible items. In the case of Collector of Internal Revenue vs. Goodrich International Rubber Co. 48 this Court rejected the taxpayer's similar claim for deduction of alleged representation expenses, based upon receipts issued not by the entities to which the alleged expenses but by the officers of taxpayer corporation who allegedly paid them. It was there stated:

If the expenses had really been incurred, receipts or chits would have been issued by the entities to which the payments have been made, and it would have been easy for Goodrich or its officers to produce such receipts. These receipts issued by said officers merely attest to their claim that they had incurred and paid said expenses. They do not establish payment of said alleged expenses to the entities in which the same are said to have been incurred.

In the case before Us, except for the Company's own vouchers and cancelled checks, together with the Company treasurer's lone and uncorroborated testimony regarding the purpose of said disbursements, there is no other supporting evidence to show that the expenses were legally deductible items. We therefore affirm the Tax Court's disallowance of the same.

In resume, this Court finds:

(1) that the Company was not using a "hybrid" method of accounting in the preparation of its income tax returns, but was consistent in its use of the accrual method of accounting;

(2) that the rate of depletion per ton of the ore deposit mined and sold by the Company is P0.6196 per ton 49 not P0.59189 as contended by the Commissioner nor P1.0197 as claimed by the Company;

(3) that the disallowance by the Tax Court of the depreciation charges claimed by the Company is correct in view of the latter's failure to itemize and/or substantiate with definite proof that the Commissioner's own method of determining depreciation is unreasonable or inaccurate;

(4) that for lack of supporting evidence to show that the Company's claimed expenses were legally deductible items, the Tax Court's disallowance of the same is affirmed.

As recomputed then, the deficiency income taxes due from the Company are as follows:

1953

Net income as per audited return _________________ P5,193,716.89Unallowable deductions & additional income

Depletion overcharged _________________________ P178,477.04 Depreciation adjustment ________________________ 93,862.96

Total adjustments _____________________________ 272,340.00 Net income as per investigation ___________________ 5,466,056.89 Income tax due thereon 50 _______________________ 1,522,495.92

Less amount already assessed ____________________ 1,446,241.00 DEFICIENCY TAX DUE ______________________ 76,254.92

1954

Net income as per audited return _________________ P3,320,307.68 Unallowable deductions & additionalincome Depletion overcharged _________________________ P147,895.72 Depreciation adjustment ________________________ 11,878.12 Miscellaneous expenses ________________________ 13,481.20

Total adjustments _____________________________ 173,255.04 Net income as per investigation ___________________ 3,493,562.72 Income tax due thereon _________________________ 970,197.56 Less amount already assessed ____________________ 921,686.00 DEFICIENCY TAX DUE ______________________ 48,511.56

1956

Net income as per audited return _________________ P11,504,483.97 Unallowable deductions & additional

income Depletion overcharged _________________________ P221,272.98 Miscellaneous expenses

________________________ 17,590.00 Total adjustments _____________________________ 238,862.98 Net income as per investigation __________________ 11,743,346.95 Income tax due thereon ________________________ 3,280,137.14 Less amount already assessed ___________________ 3,213,256.00 DEFICIENCY TAX DUE ______________________ 66,881.14 TOTAL DEFICIENCY TAXES DUE _____________ 191,647.62

WHEREFORE, the appealed decision is hereby modified by ordering Consolidated Mines, Inc. to pay the Commissioner of Internal Revenue the amounts of P76,254.92, P48,511.56 and P66,881.14 as deficiency income taxes for the years 1953, 1954 and 1956, respectively, or the total sum of P191,647.62 under the terms specified by the Tax Court, without pronouncement as to costs.

G.R. No. 137377 December 18, 2001

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.MARUBENI CORPORATION, respondent.

PUNO, J.:

In this petition for review, the Commissioner of Internal Revenue assails the decision dated January 15, 1999 of the Court of Appeals in CA-G.R. SP No. 42518 which affirmed the decision dated July 29, 1996 of the Court of Tax Appeals in CTA Case No. 4109. The tax court ordered the Commissioner of Internal Revenue to desist from collecting the 1985 deficiency income, branch profit remittance and contractor's taxes from Marubeni Corporation after finding the latter to have properly availed of the tax amnesty under Executive Orders Nos. 41 and 64, as amended.

Respondent Marubeni Corporation is a foreign corporation organized and existing under the laws of Japan. It is engaged in general import and export trading, financing and the construction business. It is duly registered to engage in such business in the Philippines and maintains a branch office in Manila.

Sometime in November 1985, petitioner Commissioner of Internal Revenue issued a letter of authority to examine the books of accounts of the Manila branch office of respondent corporation for the fiscal year ending March 1985. In the course of the examination, petitioner found respondent to have undeclared income from two (2) contracts in the

Philippines, both of which were completed in 1984. One of the contracts was with the National Development Company (NDC) in connection with the construction and installation of a wharf/port complex at the Leyte Industrial Development Estate in the municipality of Isabel, province of Leyte. The other contract was with the Philippine Phosphate Fertilizer Corporation (Philphos) for the construction of an ammonia storage complex also at the Leyte Industrial Development Estate.

On March 1, 1986, petitioner's revenue examiners recommended an assessment for deficiency income, branch profit remittance, contractor's and commercial broker's taxes. Respondent questioned this assessment in a letter dated June 5, 1986.

On August 27, 1986, respondent corporation received a letter dated August 15, 1986 from petitioner assessing respondent several deficiency taxes. The assessed deficiency internal revenue taxes, inclusive of surcharge and interest, were as follows:

I. DEFICIENCY INCOME TAX

FY ended March 31, 1985

Undeclared gross income (Philphos and NDC construction projects) P967,269,811.14

Less: Cost and expenses (50%) 483,634,905.57

Net undeclared income 483,634,905.57

Income tax due thereon 169,272,217.00

Add: 50% surcharge 84,636,108.50

20% int. p.a.fr. 7-15-85 to 8-15-86 36,675,646.90

TOTAL AMOUNT DUE P290,583,972.40

II. DEFICIENCY BRANCH PROFIT REMITTANCE TAX


Undeclared gross income from Philphos and NDC construction projects P483,634,905.57

Less: Income tax thereon 169,272,217.00

Amount subject to Tax 314,362,688.57

Tax due thereon 47,154,403.00

Add: 50% surcharge 23,577,201.50

20% int. p.a.fr. 4-26-85 to 12,305,360.66

8-15-86


III. DEFICIENCY CONTRACTOR'S TAX


Undeclared gross receipts/gross income from Philphos and NDC construction projects P967,269,811.14

Contractor's tax due thereon (4%) 38,690,792.00

Add:50% surcharge for non-declaration 19,345,396.00

20% surcharge for late payment 9,672,698.00

Sub-total 67,708,886.00

Add:20% int. p.a.fr. 4-21-85 to 8-15-86 17,854,739.46


IV. DEFICIENCY COMMERCIAL BROKER'S

TAX


Undeclared share from commission income(denominated as "subsidy from Home Office") P24,683,114.50

Tax due thereon 1,628,569.00

Add:50% surcharge for non-declaration 814,284.50

20% surcharge for late payment 407,142.25

Sub-total 2,849,995.75

Add:20% int. p.a.fr. 4-21-85 to 8-15-86 751,539.98


The 50% surcharge was imposed for your client's failure to report for tax purposes the aforesaid taxable revenues while the 25% surcharge was imposed because of your client's failure to pay on time the above deficiency percentage taxes.

xxx xxx xxx"1

Petitioner found that the NDC and Philphos contracts were made on a "turn-key" basis and that the gross income from the two projects amounted to P967,269,811.14. Each contract was for a piece of work and since the projects called for the construction and installation of facilities in the Philippines, the entire income therefrom constituted income from Philippine sources, hence, subject to internal revenue taxes. The assessment letter further stated that the same was petitioner's final decision and that if respondent disagreed with it, respondent may file an appeal with the Court of Tax Appeals within thirty (30) days from receipt of the assessment.

On September 26, 1986, respondent filed two (2) petitions for review with the Court of Tax Appeals. The first petition, CTA Case No. 4109, questioned the deficiency income, branch profit remittance and contractor's tax assessments in petitioner's assessment letter. The second, CTA Case No. 4110, questioned the deficiency commercial broker's assessment in the same letter.

Earlier, on August 2, 1986, Executive Order (E.O.) No. 412 declaring a one-time amnesty covering unpaid income taxes for the years 1981 to 1985 was issued. Under this E.O., a taxpayer who wished to avail of the income tax amnesty should, on or before October 31, 1986: (a) file a sworn statement declaring his net worth as of December 31, 1985; (b) file a certified true copy of his statement declaring his net worth as of December 31, 1980 on record with the Bureau of Internal Revenue (BIR), or if no such record exists, file a statement of said net worth subject to verification by the BIR; and (c) file a return and pay a tax equivalent to ten per cent (10%) of the increase in net worth from December 31, 1980 to December 31, 1985.

In accordance with the terms of E.O. No. 41, respondent filed its tax amnesty return dated October 30, 1986 and attached thereto its sworn statement of assets and liabilities and net worth as of Fiscal Year (FY) 1981 and FY 1986. The return was received by the BIR on November 3, 1986 and respondent paid the amount of P2,891,273.00 equivalent to ten percent (10%) of its net worth increase between 1981 and 1986.

The period of the amnesty in E.O. No. 41 was later extended from October 31, 1986 to December 5, 1986 by E.O. No. 54 dated November 4, 1986.

On November 17, 1986, the scope and coverage of E.O. No. 41 was expanded by Executive Order (E.O.) No. 64. In addition to the income tax amnesty granted by E.O. No. 41 for the years 1981 to 1985, E.O. No. 64 3 included estate and donor's taxes under Title III and the tax on business under Chapter II, Title V of the National Internal Revenue Code, also covering the years 1981 to 1985. E.O. No. 64 further provided that the immunities and privileges under E.O. No. 41 were extended to the foregoing tax liabilities, and the period within which the taxpayer could avail of the amnesty was extended to December 15, 1986. Those taxpayers who already filed their amnesty return under E.O. No. 41, as amended, could avail themselves of the benefits, immunities and privileges under the new E.O. by filing an amended return and paying an additional 5% on the increase in net worth to cover business, estate and donor's tax liabilities.

The period of amnesty under E.O. No. 64 was extended to January 31, 1987 by E.O No. 95 dated December 17, 1986.

On December 15, 1986, respondent filed a supplemental tax amnesty return under the benefit of E.O. No. 64 and paid a further amount of P1,445,637.00 to the BIR equivalent to five percent (5%) of the increase of its net worth between 1981 and 1986.

On July 29, 1996, almost ten (10) years after filing of the case, the Court of Tax Appeals rendered a decision in CTA Case No. 4109. The tax court found that respondent had properly availed of the tax amnesty under E.O. Nos. 41 and 64 and declared the deficiency taxes subject of said case as deemed cancelled and withdrawn. The Court of Tax Appeals disposed of as follows:

"WHEREFORE, the respondent Commissioner of Internal Revenue is hereby ORDERED to DESIST from collecting the 1985 deficiency taxes it had assessed against petitioner and the same are deemed considered [sic] CANCELLED and WITHDRAWN by reason of the proper availment by petitioner of the amnesty under Executive Order No. 41, as amended."4

Petitioner challenged the decision of the tax court by filing CA-G.R. SP No. 42518 with the Court of Appeals.

On January 15, 1999, the Court of Appeals dismissed the petition and affirmed the decision of the Court of Tax Appeals. Hence, this recourse.

Before us, petitioner raises the following issues:

"(1) Whether or not the Court of Appeals erred in affirming the Decision of the Court of Tax Appeals which ruled that herein respondent's deficiency tax liabilities were extinguished upon respondent's availment of tax amnesty under Executive Orders Nos. 41 and 64.

(2) Whether or not respondent is liable to pay the income, branch profit remittance, and contractor's taxes assessed by petitioner."5

The main controversy in this case lies in the interpretation of the exception to the amnesty coverage of E.O. Nos. 41 and 64. There are three (3) types of taxes involved herein — income tax, branch profit remittance tax and contractor's tax. These taxes are covered by the amnesties granted by E.O. Nos. 41 and 64. Petitioner claims, however, that respondent is disqualified from availing of the said amnesties because the latter falls under the exception in Section 4 (b) of E.O. No. 41.

Section 4 of E.O. No. 41 enumerates which taxpayers cannot avail of the amnesty granted thereunder, viz:

"Sec. 4. Exceptions. — The following taxpayers may not avail themselves of the amnesty herein granted:

a) Those falling under the provisions of Executive Order Nos. 1, 2 and 14;

b) Those with income tax cases already filed in Court as of the effectivity hereof;

c) Those with criminal cases involving violations of the income tax law already filed in court as of the effectivity hereof;

d) Those that have withholding tax liabilities under the National Internal Revenue Code, as amended, insofar as the said liabilities are concerned;

e) Those with tax cases pending investigation by the Bureau of Internal Revenue as of the effectivity hereof as a result of information furnished under Section 316 of the National Internal Revenue Code, as amended;

f) Those with pending cases involving unexplained or unlawfully acquired wealth before the Sandiganbayan;

g) Those liable under Title Seven, Chapter Three (Frauds, Illegal Exactions and Transactions) and Chapter Four (Malversation of Public Funds and Property) of the Revised Penal Code, as amended."

Petitioner argues that at the time respondent filed for income tax amnesty on October 30, 1986, CTA Case No. 4109 had already been filed and was pending; before the Court of Tax Appeals. Respondent therefore fell under the exception in Section 4 (b) of E.O. No. 41.

Petitioner's claim cannot be sustained. Section 4 (b) of E.O. No. 41 is very clear and unambiguous. It excepts from income tax amnesty those taxpayers "with income tax cases already filed in court as of the effectivity hereof." The point of reference is the date of effectivity of E.O. No. 41. The filing of income tax cases in court must have been made before and as of the date of effectivity of E.O. No. 41. Thus, for a taxpayer not to be disqualified under Section 4 (b) there must have been no income tax cases filed in court against him when E.O. No. 41 took effect. This is regardless of when the taxpayer filed for income tax amnesty, provided of course he files it on or before the deadline for filing.

E.O. No. 41 took effect on August 22, 1986. CTA Case No. 4109 questioning the 1985 deficiency income, branch profit remittance and contractor's tax assessments was filed by respondent with the Court of Tax Appeals on September 26, 1986. When E.O. No. 41 became effective on August 22, 1986, CTA Case No. 4109 had not yet been filed in court. Respondent corporation did not fall under the said exception in Section 4 (b), hence, respondent was not disqualified from availing of the amnesty for income tax under E.O. No. 41.

The same ruling also applies to the deficiency branch profit remittance tax assessment. A branch profit remittance tax is defined and imposed in Section 24 (b) (2) (ii), Title II, Chapter III of the National Internal Revenue Code.6 In the tax code, this tax falls under Title II on Income Tax. It is a tax on income. Respondent therefore did not fall under the exception in Section 4 (b) when it filed for amnesty of its deficiency branch profit remittance tax assessment.

The difficulty herein is with respect to the contractor's tax assessment and respondent's availment of the amnesty under E.O. No. 64. E.O. No. 64 expanded the coverage of E.O. No. 41 by including estate and donor's taxes and tax on business. Estate and donor's taxes fall under Title III of the Tax Code while business taxes fall under Chapter II, Title V of the same. The contractor's tax is provided in Section 205, Chapter II, Title V of the Tax Code; it is defined and imposed under the title on business taxes, and is therefore a tax on business.7

When E.O. No. 64 took effect on November 17, 1986, it did not provide for exceptions to the coverage of the amnesty for business, estate and donor's taxes. Instead, Section 8 of E.O. No. 64 provided that:

"Section 8. The provisions of Executive Orders Nos. 41 and 54 which are not contrary to or inconsistent with this amendatory Executive Order shall remain in full force and effect."

By virtue of Section 8 as afore-quoted, the provisions of E.O. No. 41 not contrary to or inconsistent with the amendatory act were reenacted in E.O. No. 64. Thus, Section 4 of E.O. No. 41 on the exceptions to amnesty coverage also applied to E.O. No. 64. With respect to Section 4 (b) in particular, this provision excepts from tax amnesty coverage a taxpayer who has "income tax cases already filed in court as of the effectivity hereof." As to what Executive Order the exception refers to, respondent argues that because of the words "income" and "hereof," they refer to Executive Order No. 41.8

In view of the amendment introduced by E.O. No. 64, Section 4 (b) cannot be construed to refer to E.O. No. 41 and its date of effectivity. The general rule is that an amendatory act operates prospectively.9 While an amendment is generally construed as becoming a part of the original act as if it had always been contained therein,10 it may not be given a retroactive effect unless it is so provided expressly or by necessary implication and no vested right or obligations of contract are thereby impaired.11

There is nothing in E.O. No. 64 that provides that it should retroact to the date of effectivity of E.O. No. 41, the original issuance. Neither is it necessarily implied from E.O. No. 64 that it or any of its provisions should apply retroactively. Executive Order No. 64 is a substantive amendment of E.O. No. 41. It does not merely change provisions in E.O. No. 41. It supplements the original act by adding other taxes not covered in the first.12 It has been held that where a statute amending a tax law is silent as to whether it operates retroactively, the amendment will not be given a retroactive effect so as to subject to tax past transactions not subject to tax under the original act.13 In an amendatory act, every case of doubt must be resolved against its retroactive effect.14

Moreover, E.O. Nos. 41 and 64 are tax amnesty issuances. A tax amnesty is a general pardon or intentional overlooking by the State of its authority to impose penalties on persons otherwise guilty of evasion or violation of a revenue or tax law.15 It partakes of an absolute forgiveness or waiver by the government of its right to collect what is due it and to give tax evaders who wish to relent a chance to start with a clean slate.16 A tax amnesty, much like a tax exemption, is never favored nor presumed in law.17 If granted, the terms of the amnesty, like that of a tax exemption, must be construed strictly against the taxpayer and liberally in favor of the taxing authority.18 For the right of taxation is inherent in government. The State cannot strip itself of the most essential power of taxation by doubtful words. He who claims an exemption (or an amnesty) from the common burden must justify his claim by the clearest grant of organic or state law. It cannot be allowed to exist upon a vague implication. If a doubt arises as to the intent of the legislature, that doubt must be resolved in favor of the state.19

In the instant case, the vagueness in Section 4 (b) brought about by E.O. No. 64 should therefore be construed strictly against the taxpayer. The term "income tax cases" should be read as to refer to estate and donor's taxes and taxes on business while the word "hereof," to E.O. No. 64. Since Executive Order No. 64 took effect on November 17, 1986, consequently, insofar as the taxes in E.O. No. 64 are concerned, the date of effectivity referred to in Section 4 (b) of E.O. No. 41 should be November 17, 1986.

Respondent filed CTA Case No. 4109 on September 26, 1986. When E.O. No. 64 took effect on November 17, 1986, CTA Case No. 4109 was already filed and pending in court. By the time respondent filed its supplementary tax amnesty return on December 15, 1986, respondent already fell under the exception in Section 4 (b) of E.O. Nos. 41 and 64 and was disqualified from availing of the business tax amnesty granted therein.

It is respondent's other argument that assuming it did not validly avail of the amnesty under the two Executive Orders, it is still not liable for the deficiency contractor's tax because the income from the projects came from the "Offshore Portion" of the contracts. The two contracts were divided into two parts, i.e., the Onshore Portion and the Offshore Portion. All materials and equipment in the contract under the "Offshore Portion" were manufactured and completed in Japan, not in the Philippines, and are therefore not subject to Philippine taxes.

Before going into respondent's arguments, it is necessary to discuss the background of the two contracts, examine their pertinent provisions and implementation.

The NDC and Philphos are two government corporations. In 1980, the NDC, as the corporate investment arm of the Philippine Government, established the Philphos to engage in the large-scale manufacture of phosphatic fertilizer for the local and foreign markets.20 The Philphos plant complex which was envisioned to be the largest phosphatic fertilizer operation in Asia, and among the largest in the world, covered an area of 180 hectares within the 435-hectare Leyte Industrial Development Estate in the municipality of Isabel, province of Leyte.

In 1982, the NDC opened for public bidding a project to construct and install a modern, reliable, efficient and integrated wharf/port complex at the Leyte Industrial Development Estate. The wharf/port complex was intended to be one of the major facilities for the industrial plants at the Leyte Industrial Development Estate. It was to be specifically adapted to the site for the handling of phosphate rock, bagged or bulk fertilizer products, liquid materials and other products of Philphos, the Philippine Associated Smelting and Refining Corporation (Pasar),21 and other industrial plants within the Estate. The bidding was participated in by Marubeni Head Office in Japan.

Marubeni, Japan pre-qualified and on March 22, 1982, the NDC and respondent entered into an agreement entitled "Turn-Key Contract for Leyte Industrial Estate Port Development Project Between National Development Company and Marubeni Corporation."22 The Port Development Project would consist of a wharf, berths, causeways, mechanical and liquids unloading and loading systems, fuel oil depot, utilities systems, storage and service buildings, offsite facilities, harbor service vessels, navigational aid system, fire-fighting system, area lighting, mobile equipment, spare parts and other related facilities.23 The scope of the works under the contract covered turn-key supply, which included grants of licenses and the transfer of technology and know-how,24 and:

". . . the design and engineering, supply and delivery, construction, erection and installation, supervision, direction and control of testing and commissioning of the Wharf-Port Complex as set forth in Annex I of this Contract, as well as the coordination of tie-ins at boundaries and schedule of the use of a part or the whole of the Wharf/Port Complex through the Owner, with the design and construction of other facilities around the site. The scope of works shall also include any activity, work and supply necessary for, incidental to or appropriate under present international industrial port practice, for the timely and successful implementation of the object of this Contract, whether or not expressly referred to in the abovementioned Annex I."25

The contract price for the wharf/port complex was ¥12,790,389,000.00 and P44,327,940.00. In the contract, the price in Japanese currency was broken down into two portions: (1) the Japanese Yen Portion I; (2) the Japanese Yen Portion II, while the price in Philippine currency was referred to as the Philippine Pesos Portion. The Japanese Yen Portions I and II were financed in two (2) ways: (a) by yen credit loan provided by the Overseas Economic Cooperation Fund (OECF); and (b) by supplier's credit in favor of Marubeni from the Export-Import Bank of Japan. The OECF is a Fund

under the Ministry of Finance of Japan extended by the Japanese government as assistance to foreign governments to promote economic development.26 The OECF extended to the Philippine Government a loan of ¥7,560,000,000.00 for the Leyte Industrial Estate Port Development Project and authorized the NDC to implement the same.27 The other type of financing is an indirect type where the supplier, i.e., Marubeni, obtained a loan from the Export-Import Bank of Japan to advance payment to its sub-contractors.28

Under the financing schemes, the Japanese Yen Portions I and II and the Philippine Pesos Portion were further broken down and subdivided according to the materials, equipment and services rendered on the project. The price breakdown and the corresponding materials, equipment and services were contained in a list attached as Annex III to the contract.29

A few months after execution of the NDC contract, Philphos opened for public bidding a project to construct and install two ammonia storage tanks in Isabel. Like the NDC contract, it was Marubeni Head Office in Japan that participated in and won the bidding. Thus, on May 2, 1982, Philphos and respondent corporation entered into an agreement entitled "Turn-Key Contract for Ammonia Storage Complex Between Philippine Phosphate Fertilizer Corporation and Marubeni Corporation."30 The object of the contract was to establish and place in operating condition a modern, reliable, efficient and integrated ammonia storage complex adapted to the site for the receipt and storage of liquid anhydrous ammonia31 and for the delivery of ammonia to an integrated fertilizer plant adjacent to the storage complex and to vessels at the dock.32 The storage complex was to consist of ammonia storage tanks, refrigeration system, ship unloading system, transfer pumps, ammonia heating system, fire-fighting system, area lighting, spare parts, and other related facilities.33 The scope of the works required for the completion of the ammonia storage complex covered the supply, including grants of licenses and transfer of technology and know-how,34 and:

". . . the design and engineering, supply and delivery, construction, erection and installation, supervision, direction and control of testing and commissioning of the Ammonia Storage Complex as set forth in Annex I of this Contract, as well as the coordination of tie-ins at boundaries and schedule of the use of a part or the whole of the Ammonia Storage Complex through the Owner with the design and construction of other facilities at and around the Site. The scope of works shall also include any activity, work and supply necessary for, incidental to or appropriate under present international industrial practice, for the timely and successful implementation of the object of this Contract, whether or not expressly referred to in the abovementioned Annex I."35

The contract price for the project was ¥3,255,751,000.00 and P17,406,000.00. Like the NDC contract, the price was divided into three portions. The price in Japanese currency was broken down into the Japanese Yen Portion I and Japanese Yen Portion II while the price in Philippine currency was classified as the Philippine Pesos Portion. Both Japanese Yen Portions I and II were financed by supplier's credit from the Export-Import Bank of Japan. The price stated in the three portions were further broken down into the corresponding materials, equipment and services required for the project and their individual prices. Like the NDC contract, the breakdown in the Philphos contract is contained in a list attached to the latter as Annex III.36

The division of the price into Japanese Yen Portions I and II and the Philippine Pesos Portion under the two contracts corresponds to the two parts into which the contracts were classified — the Foreign Offshore Portion and the Philippine Onshore Portion. In both contracts, the Japanese Yen Portion I corresponds to the Foreign Offshore Portion.37 Japanese Yen Portion II and the Philippine Pesos Portion correspond to the Philippine Onshore Portion.38

Under the Philippine Onshore Portion, respondent does not deny its liability for the contractor's tax on the income from the two projects. In fact respondent claims, which petitioner has not denied, that the income it derived from the Onshore Portion of the two projects had been declared for tax purposes and the taxes thereon already paid to the Philippine government.39 It is with regard to the gross receipts from the Foreign Offshore Portion of the two contracts that the liabilities involved in the assessments subject of this case arose. Petitioner argues that since the two agreements are turn-key,40 they call for the supply of both materials and services to the client, they are contracts for a piece of work and are indivisible. The situs of the two projects is in the Philippines, and the materials provided and services rendered were all done and completed within the territorial jurisdiction of the Philippines.41 Accordingly, respondent's entire receipts from the contracts, including its receipts from the Offshore Portion, constitute income from Philippine sources. The total gross receipts covering both labor and materials should be subjected to contractor's tax in accordance with the ruling in Commissioner of Internal Revenue v. Engineering Equipment & Supply Co.42

A contractor's tax is imposed in the National Internal Revenue Code (NIRC) as follows:

"Sec. 205. Contractors, proprietors or operators of dockyards, and others. —A contractor's tax of four percent of the gross receipts is hereby imposed on proprietors or operators of the following business establishments and/or persons engaged in the business of selling or rendering the following services for a fee or compensation:

(a) General engineering, general building and specialty contractors, as defined in Republic Act No. 4566;

xxx xxx xxx

(q) Other independent contractors. The term "independent contractors" includes persons (juridical or natural) not enumerated above (but not including individuals subject to the occupation tax under the Local Tax Code) whose activity consists essentially of the sale of all kinds of services for a fee regardless of whether or not the performance of the service calls for the exercise or use of the physical or mental faculties of such contractors or their employees. It does not include regional or area headquarters established in the Philippines by multinational corporations, including their alien executives, and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating centers for their affiliates, subsidiaries or branches in the Asia-Pacific Region.

xxx xxx xxx43

Under the afore-quoted provision, an independent contractor is a person whose activity consists essentially of the sale of all kinds of services for a fee, regardless of whether or not the performance of the service calls for the exercise or use of the physical or mental faculties of such contractors or their employees. The word "contractor" refers to a person who, in the pursuit of independent business, undertakes to do a specific job or piece of work for other persons, using his own means and methods without submitting himself to control as to the petty details.44

A contractor's tax is a tax imposed upon the privilege of engaging in business.45 It is generally in the nature of an excise tax on the exercise of a privilege of selling services or labor rather than a sale on products;46 and is directly collectible from the person exercising the privilege.47 Being an excise tax, it can be levied by the taxing authority only when the

acts, privileges or business are done or performed within the jurisdiction of said authority.48 Like property taxes, it cannot be imposed on an occupation or privilege outside the taxing district.49

In the case at bar, it is undisputed that respondent was an independent contractor under the terms of the two subject contracts. Respondent, however, argues that the work therein were not all performed in the Philippines because some of them were completed in Japan in accordance with the provisions of the contracts.

An examination of Annex III to the two contracts reveals that the materials and equipment to be made and the works and services to be performed by respondent are indeed classified into two. The first part, entitled "Breakdown of Japanese Yen Portion I" provides:

"Japanese Yen Portion I of the Contract Price has been subdivided according to discrete portions of materials and equipment which will be shipped to Leyte as units and lots. This subdivision of price is to be used by owner to verify invoice for Progress Payments under Article 19.2.1 of the Contract. The agreed subdivision of Japanese Yen Portion I is as follows:

xxx xxx xxx50

The subdivision of Japanese Yen Portion I covers materials and equipment while Japanese Yen Portion II and the Philippine Pesos Portion enumerate other materials and equipment and the construction and installation work on the project. In other words, the supplies for the project are listed under Portion I while labor and other supplies are listed under Portion II and the Philippine Pesos Portion. Mr. Takeshi Hojo, then General Manager of the Industrial Plant

Section II of the Industrial Plant Department of Marubeni Corporation in Japan who supervised the implementation of the two projects, testified that all the machines and equipment listed under Japanese Yen Portion I in Annex III were manufactured in Japan.51 The machines and equipment were designed, engineered and fabricated by Japanese firms sub-contracted by Marubeni from the list of sub-contractors in the technical appendices to each contract.52 Marubeni sub-contracted a majority of the equipment and supplies to Kawasaki Steel Corporation which did the design, fabrication, engineering and manufacture thereof;53 Yashima & Co. Ltd. which manufactured the mobile equipment; Bridgestone which provided the rubber fenders of the mobile equipment;54 and B.S. Japan for the supply of radio equipment.55 The engineering and design works made by Kawasaki Steel Corporation included the lay-out of the plant facility and calculation of the design in accordance with the specifications given by respondent.56 All sub-contractors and manufacturers are Japanese corporations and are based in Japan and all engineering and design works were performed in that country.57

The materials and equipment under Portion I of the NDC Port Project is primarily composed of two (2) sets of ship unloader and loader; several boats and mobile equipment.58 The ship unloader unloads bags or bulk products from the ship to the port while the ship loader loads products from the port to the ship. The unloader and loader are big steel structures on top of each is a large crane and a compartment for operation of the crane. Two sets of these equipment were completely manufactured in Japan according to the specifications of the project. After manufacture, they were rolled on to a barge and transported to Isabel, Leyte.59 Upon reaching Isabel, the unloader and loader were rolled off the barge and pulled to the pier to the spot where they were installed.60 Their installation simply consisted of bolting them onto the pier.61

Like the ship unloader and loader, the three tugboats and a line boat were completely manufactured in Japan. The boats sailed to Isabel on their own power. The mobile equipment, consisting of three to four sets of tractors, cranes and dozers, trailers and forklifts, were also manufactured and completed in Japan. They were loaded on to a shipping vessel and unloaded at the Isabel Port. These pieces of equipment were all on wheels and self-propelled. Once unloaded at the port, they were ready to be driven and perform what they were designed to do.62

In addition to the foregoing, there are other items listed in Japanese Yen Portion I in Annex III to the NDC contract. These other items consist of supplies and materials for five (5) berths, two (2) roads, a causeway, a warehouse, a transit shed, an administration building and a security building. Most of the materials consist of steel sheets, steel pipes, channels and beams and other steel structures, navigational and communication as well as electrical equipment.63

In connection with the Philphos contract, the major pieces of equipment supplied by respondent were the ammonia storage tanks and refrigeration units.64 The steel plates for the tank were manufactured and cut in Japan according to drawings and specifications and then shipped to Isabel. Once there, respondent's employees put the steel plates together to form the storage tank. As to the refrigeration units, they were completed and assembled in Japan and thereafter shipped to Isabel. The units were simply installed there. 65 Annex III to the Philphos contract lists down under the Japanese Yen Portion I the materials for the ammonia storage tank, incidental equipment, piping facilities, electrical and instrumental apparatus, foundation material and spare parts.

All the materials and equipment transported to the Philippines were inspected and tested in Japan prior to shipment in accordance with the terms of the contracts.66 The inspection was made by representatives of respondent corporation, of

NDC and Philphos. NDC, in fact, contracted the services of a private consultancy firm to verify the correctness of the tests on the machines and equipment67 while Philphos sent a representative to Japan to inspect the storage equipment.68

The sub-contractors of the materials and equipment under Japanese Yen Portion I were all paid by respondent in Japan. In his deposition upon oral examination, Kenjiro Yamakawa, formerly the Assistant General Manager and Manager of the Steel Plant Marketing Department, Engineering & Construction Division, Kawasaki Steel Corporation, testified that the equipment and supplies for the two projects provided by Kawasaki under Japanese Yen Portion I were paid by Marubeni in Japan. Receipts for such payments were duly issued by Kawasaki in Japanese and English.69 Yashima & Co. Ltd. and B.S. Japan were likewise paid by Marubeni in Japan.70

Between Marubeni and the two Philippine corporations, payments for all materials and equipment under Japanese Yen Portion I were made to Marubeni by NDC and Philphos also in Japan. The NDC, through the Philippine National Bank, established letters of credit in favor of respondent through the Bank of Tokyo. The letters of credit were financed by letters of commitment issued by the OECF with the Bank of Tokyo. The Bank of Tokyo, upon respondent's submission of pertinent documents, released the amount in the letters of credit in favor of respondent and credited the amount therein to respondent's account within the same bank.71

Clearly, the service of "design and engineering, supply and delivery, construction, erection and installation, supervision, direction and control of testing and commissioning, coordination. . . "72 of the two projects involved two taxing jurisdictions. These acts occurred in two countries — Japan and the Philippines. While the construction and installation work were completed within the Philippines, the evidence is clear that some pieces of equipment and

supplies were completely designed and engineered in Japan. The two sets of ship unloader and loader, the boats and mobile equipment for the NDC project and the ammonia storage tanks and refrigeration units were made and completed in Japan. They were already finished products when shipped to the Philippines. The other construction supplies listed under the Offshore Portion such as the steel sheets, pipes and structures, electrical and instrumental apparatus, these were not finished products when shipped to the Philippines. They, however, were likewise fabricated and manufactured by the sub-contractors in Japan. All services for the design, fabrication, engineering and manufacture of the materials and equipment under Japanese Yen Portion I were made and completed in Japan. These services were rendered outside the taxing jurisdiction of the Philippines and are therefore not subject to contractor's tax.

Contrary to petitioner's claim, the case of Commissioner of Internal Revenue v. Engineering Equipment & Supply Co73 is not in point. In that case, the Court found that Engineering Equipment, although an independent contractor, was not engaged in the manufacture of air conditioning units in the Philippines. Engineering Equipment designed, supplied and installed centralized air-conditioning systems for clients who contracted its services. Engineering, however, did not manufacture all the materials for the air-conditioning system. It imported some items for the system it designed and installed.74 The issues in that case dealt with services performed within the local taxing jurisdiction. There was no foreign element involved in the supply of materials and services.

With the foregoing discussion, it is unnecessary to discuss the other issues raised by the parties.

IN VIEW WHEREOF, the petition is denied. The decision in CA-G.R. SP No. 42518 is affirmed.

G.R. No. L-54108 January 17, 1984

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.COURT OF TAX APPEALS and SMITH KLINE & FRENCH OVERSEAS CO. (PHILIPPINE BRANCH), respondents.

The Solicitor General for petitioner.

Siguion Reyna, Montecillo & Ongsiako and J.C. Castañeda, Jr. and E.C. Alcantara for respondents.

AQUINO, J.:

This case is about the refund of a 1971 income tax amounting to P324,255. Smith Kline and French Overseas Company, a multinational firm domiciled in Philadelphia, Pennsylvania, is licensed to do business in the Philippines. It is engaged in the importation, manufacture and sale of pharmaceuticals drugs and chemicals.

In its 1971 original income tax return, Smith Kline declared a net taxable income of P1,489,277 (Exh. A) and paid P511,247 as tax due. Among the deductions claimed from gross income was P501,040 ($77,060) as its

share of the head office overhead expenses. However, in its amended return filed on March 1, 1973, there was an overpayment of P324,255 "arising from underdeduction of home office overhead" (Exh. E). It made a formal claim for the refund of the alleged overpayment.

It appears that sometime in October, 1972, Smith Kline received from its international independent auditors, Peat, Marwick, Mitchell and Company, an authenticated certification to the effect that the Philippine share in the unallocated overhead expenses of the main office for the year ended December 31, 1971 was actually $219,547 (P1,427,484). It further stated in the certification that the allocation was made on the basis of the percentage of gross income in the Philippines to gross income of the corporation as a whole. By reason of the new adjustment, Smith Kline's tax liability was greatly reduced from P511,247 to P186,992 resulting in an overpayment of P324,255.

On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on its claim Smith Kline filed a petition for review with the Court of Tax Appeals.

In its decision of March 21, 1980, the Tax Court ordered the Commissioner to refund the overpayment or grant a tax credit to Smith Kline. The Commissioner appealed to this Court.

The governing law is found in section 37 of the old National Internal Revenue Code, Commonwealth Act No. 466, which is reproduced in Presidential Decree No. 1158, the National Internal Revenue Code of 1977 and which reads:

SEC. 37. Income form sources within the Philippines. —

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(b) Net income from sources in the Philippines. — From the items of gross income specified in subsection (a) of this section there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the Philippines.

xxx xxx xxx

Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to be made to determine the net income from Philippine sources:

SEC. 160. Apportionment of deductions. — From the items specified in section 37(a), as being derived specifically from sources within the Philippines there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any other expenses, losses or deductions which can not definitely be allocated to some item or class of gross income. The remainder shall be included in full as net income from sources within the Philippines. The ratable part is based upon the ratio of gross income from sources within the Philippines to the total gross income.

Example: A non-resident alien individual whose taxable year is the calendar year, derived gross income from all sources for 1939 of P180,000, including therein:

Interest on bonds of a domestic corporation P9,000

Dividends on stock of a domestic corporation 4,000

Royalty for the use of patents within the Philippines 12,000

Gain from sale of real property located within the Philippines 11,000

Total P36,000

that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of the gross income was from sources without the Philippines, determined under section 37(c).

The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount of P8,000 is properly allocated to income from sources within the Philippines and the amount of P40,000 is properly allocated to income from sources without the Philippines.

The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A ratable part thereof, based upon the relation of gross income from sources within the Philippines to the total gross income, shall be deducted in computing net income from sources within the

Philippines. Thus, these are deducted from the P36,000 of gross income from sources within the Philippines expenses amounting to P14,000 [representing P8,000 properly apportioned to the income from sources within the Philippines and P6,000, a ratable part (one-fifth) of the expenses which could not be allocated to any item or class of gross income.] The remainder, P22,000, is the net income from sources within the Philippines.

From the foregoing provisions, it is manifest that where an expense is clearly related to the production of Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building in the Philippines), that expense can be deducted from the gross income acquired in the Philippines without resorting to apportionment.

The overhead expenses incurred by the parent company in connection with finance, administration, and research and development, all of which direct benefit its branches all over the world, including the Philippines, fall under a different category however. These are items which cannot be definitely allocated or Identified with the operations of the Philippine branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can claim as its deductible share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross income, worldwide, of the multinational corporation.

In his petition for review, the Commissioner does not dispute the right of Smith Kline to avail itself of section 37(b) of the Tax Code and section 160 of the regulations. But the Commissioner maintains that such right is

not absolute and that as there exists a contract (in this case a service agreement) which Smith Kline has entered into with its home office, prescribing the amount that a branch can deduct as its share of the main office's overhead expenses, that contract is binding.

The Commissioner contends that since the share of the Philippine branch has been fixed at $77,060, Smith Kline itself cannot claim more than the said amount. To allow Smith Kline to deduct more than what was expressly provided in the agreement would be to ignore its existence. It is a cardinal rule that a contract is the law between the contracting parties and the stipulations therein must be respected unless these are proved to be contrary to law, morals, good customs and public policy. There being allegedly no showing to the contrary, the provisions thereof must be followed.

The Commissioner also argues that the Tax Court erred in relying on the certification of Peat, Marwick, Mitchell and Company that Smith Kline is entitled to deduct P1,427,484 ($219,547) as its allotted share and that Smith Kline has not presented any evidence to show that the home office expenses chargeable to Philippine operations exceeded $77,060.

On the other hand, Smith Kline submits that the contract between itself and its home office cannot amend tax laws and regulations. The matter of allocated expenses which are deductible under the law cannot be the subject of an agreement between private parties nor can the Commissioner acquiesce in such an agreement.

Smith Kline had to amend its return because it is of common knowledge that audited financial statements are generally completed three or four months after the close of the accounting period. There being no financial statements yet when the certification of January 11, 1972 was made the treasurer could not have correctly computed Smith Kline's share in the home office overhead expenses in accordance with the gross income formula prescribed in section 160 of the Revenue Regulations. What the treasurer certified was a mere estimate.

Smith Kline likewise submits that it has presented ample evidence to support its claim for refund. To this end, it has presented before the Tax Court the authenticated statement of Peat, Marwick, Mitchell and Company to show that since the gross income of the Philippine branch was P7,143,155 ($1,098,617) for 1971 as per audit report prepared by Sycip, Gorres, Velayo and Company, and the gross income of the corporation as a whole was $6,891,052, Smith Kline's share at 15.94% of the home office overhead expenses was P1,427,484 ($219,547) (Exh. G to G-2, BIR Records, 4-5).

Clearly, the weight of evidence bolsters its position that the amount of P1,427,484 represents the correct ratable share, the same having been computed pursuant to section 37(b) and section 160.

In a manifestation dated July 19, 1983, Smith Kline declared that with respect to its share of the head office overhead expenses in its income tax returns for the years 1973 to 1981, it deducted its ratable share of the total overhead expenses of its head office for those years as computed by the independent auditors hired by

the parent company in Philadelphia, Pennsylvania U.S.A., as soon as said computations were made available to it.

We hold that Smith Kline's amended 1971 return is in conformity with the law and regulations. The Tax Court correctly held that the refund or credit of the resulting overpayment is in order.

WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs.

Gregory v. Helvering, 293 U.S. 465 (1935)

Gregory v. Helvering

No. 127

Argued December 4, 5, 1934

Decided January 7, 1935

293 U.S. 465

CERTIORARI TO THE CIRCUIT COURT OF APPEALS

FOR THE SECOND CIRCUIT

Syllabus

1. A corporation wholly owned by a taxpayer transferred 1000 shares of stock in another corporation held by it among its assets to a new corporation, which thereupon issued all of its shares to the

Page 293 U. S. 466

taxpayer. Within a few days, the new corporation was dissolved and was liquidated by the distribution of the 1000 shares to the taxpayer, who immediately sold them for her individual profit. No other business was transacted, or intended to be transacted, by the new corporation. The whole plan was designed to conform to § 112 of the Revenue Act of 1928 as a "reorganization," but for the sole purpose of transferring the shares in question to the taxpayer, with a resulting tax liability less than that which would have ensued from a direct transfer by way of dividend. Held: while the plan conformed to the terms of the statute, there was no reorganization within the intent of the statute. P. 293 U. S. 468.

2. By means which the law permits, a taxpayer has the right to decrease the amount of what otherwise would be his taxes, or altogether to avoid them. P. 293 U. S. 469.

3. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation here, because the transaction upon its face lies outside the plain intent of the statute. P. 293 U. S. 470.

69 F.2d 809 affirmed.

Certiorari to review a judgment reversing a decision of the Board of Tax Appeals, 27 B.T.A. 223, which set aside an order of the Commissioner determining a deficiency in income tax.

Page 293 U. S. 467

MR. JUSTICE SUTHERLAND delivered the opinion of the Court.




Petitioner, in 1928, was the owner of all the stock of United Mortgage Corporation. That corporation held among its assets 1,000 shares of the Monitor Securities Corporation. For the sole purpose of procuring a transfer of these shares to herself in order to sell them for her individual profit, and at the same time, diminish the amount of income tax which would result from a direct transfer by way of dividend, she sought to bring about a "reorganization" under § 112(g) of the Revenue Act of 1928, c. 852, 45 Stat. 791, 816, 818, set forth later in this opinion. To that end, she caused the Averill Corporation to be organized under the laws of Delaware on September 18, 1928. Three days later, the United Mortgage Corporation transferred to the Averill Corporation the 1,000 shares of Monitor stock, for which all the shares of the Averill Corporation were issued to the petitioner. On September 24, the Averill Corporation was dissolved, and liquidated by distributing all its assets, namely, the Monitor shares, to the petitioner. No other business was ever transacted, or intended to be transacted, by that company. Petitioner immediately sold the Monitor shares for $133,333.33. She returned for taxation, as capital net gain, the sum of $76,007.88, based upon an apportioned cost of $57,325.45. Further details are unnecessary. It is not disputed that, if the interposition of the so-called reorganization was ineffective, petitioner became liable for a much larger tax as a result of the transaction.

The Commissioner of Internal Revenue, being of opinion that the reorganization attempted was without substance and must be disregarded, held that petitioner was liable for a tax as though the United corporation had paid her a dividend consisting of the amount realized from the sale of the Monitor shares. In a proceeding before the

Page 293 U. S. 468

Board of Tax Appeals, that body rejected the commissioner's view and upheld that of petitioner. 27 B.T.A. 223. Upon a review of the latter decision, the Circuit Court of Appeals sustained the commissioner and reversed the board, holding that there had been no "reorganization" within the meaning of the statute. 69 F.2d 809. Petitioner applied to this Court for a writ of certiorari, which the government, considering the question one of importance, did not oppose. We granted the writ.

Section 112 of the Revenue Act of 1928 deals with the subject of gain or loss resulting from the sale or exchange of property. Such gain or loss is to be recognized in computing the tax, except as provided in that section. The provisions of the section, so far as they are pertinent to the question here presented, follow:

"Sec. 112. (g) Distribution of Stock on Reorganization. If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock of securities shall be recognized. . . ."

"(i) Definition of Reorganization. -- As used in this section . . ."

"(1) The term 'reorganization' means . . . (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred. . . ."

It is earnestly contended on behalf of the taxpayer that, since every element required by the foregoing subdivision (B) is to be found in what was done, a statutory reorganization was effected, and that the motive of the taxpayer thereby to escape payment of a tax will not alter the result

Page 293 U. S. 469

or make unlawful what the statute allows. It is quite true that, if a reorganization in reality was effected within the meaning of subdivision (B), the ulterior purpose mentioned will be disregarded. The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. United States v. Isham, 17 Wall. 496, 84 U. S. 506; Superior Oil Co. v. Mississippi, 280 U. S. 390, 280 U. S. 395-396; Jones v. Helvering, 63 App.D.C. 204, 71 F.2d 214, 217. But the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended. The reasoning of the court below in justification of a negative answer leaves little to be said.

When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a transfer made "in pursuance of a plan of reorganization" [§ 112(g)] of corporate business, and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either, as plainly is the case here. Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find? Simply an operation having no business or corporate purpose -- a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part





of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function.

Page 293 U. S. 470

When that limited function had been exercised, it immediately was put to death.

In these circumstances, the facts speak for themselves, and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of subdivision (B), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction, upon its face, lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.

Judgment affirmed.

G.R. No. 170389 October 20, 2010

COMMISSION OF INTERNAL REVENUE, Petitioner, vs.AQUAFRESH SEAFOODS, INC., Respondent.

D E C I S I O N

PERALTA, J.:

Before this Court is a petition for review on certiorari,1 under Rule 45 of the Rules of Court, seeking to set aside the November 9, 2005 Decision2 of the Court of Tax Appeals (CTA) En Banc in CTA-E.B. No. 77. The CTA En Banc affirmed the December 22, 2004 Decision of the CTA First Division.

The facts of the case are as follows:

On June 7, 1999, respondent Aquafresh Seafoods Inc. sold to Philips Seafoods, Inc. two parcels of land, including improvements thereon, located at Barrio Banica, Roxas City, for the consideration of Three Million One Hundred Thousand Pesos (Php 3,100, 000.00). Said properties were covered under Transfer Certificate of Titles Nos. T-21799 and T-21804.

http://www.lawphil.net/judjuris/juri2010/oct2010/gr_170389_2010.html#fnt2


Respondent then filed a Capital Gains Tax Return/Application for Certification Authorizing Registration and paid the amount of Php186,000.00, representing the Capital Gains Tax (CGT) and the amount of Php46,500.00, representing the Documentary Stamp Tax (DST) due from the said sale. Subsequently, Revenue District Officer Gil G. Tabanda issued Certificate Authorizing Registration No. 1071477.

The Bureau of Internal Revenue (BIR), however, received a report that the lots sold were undervalued for taxation purposes. This prompted the Special Investigation Division (SID) of the BIR to conduct an occular inspection over the properties. After the investigation, the SID concluded that the subject properties were commercial with a zonal value of Php2,000.00 per square meter.

On September 15, 2000, Regional Director Leonardo Q. Sacamos (Director Sacamos) of the Revenue Region Iloilo City sent two Assessment Notices apprising respondent of CGT and DST defencies in the sum of Php1,372,171.46 and Php356,267.62, respectively. Director Sacamos relied on the findings of the SID that the subject properties were commercial with a zonal valuation of Php2,000.00 per square meter.

On October 1, 2000, respondent sent a letter protesting the assessments made by Director Sacamos. On December 1, 2000, Director Sacamos denied respondent's protest for lack of legal basis. Respondent appealed, but the same was denied with finality on February 13, 2002.

On March 19, 2002, respondent filed a petition for review3 before the CTA seeking the reversal of the denial of its protest. The main thrust of respondent's petition was that the subject properties were located in Barrio Banica, Roxas, where the pre-defined zonal value was Php650.00 per square meter based on the "Revised Zonal Values of Real


Properties in the City of Roxas under Revenue District Office No. 72 – Roxas City" (1995 Revised Zonal Values of Real Properties). Respondent asserted that the subject properties were classified as "RR" or residential and not commercial. Respondent argued that since there was already a pre-defined zonal value for properties located in Barrio Banica, the BIR officials had no business re-classifying the subject properties to commercial.

On December 22, 2004, the CTA promulgated a Decision4 ruling in favor of respondent, the dispositive portion of which reads:

IN VIEW OF THE FOREGOING, respondent's assessments for deficiency capital against tax and documentary stamp taxes are hereby CANCELLED and SET ASIDE. x x x

SO ORDERED.5

Ruling in favor of respondent, the CTA opined that that the existing Revised Zonal Values in the City of Roxas should prevail for purposes of determining respondent's tax liabilities, thus:

While respondent is given the authority to determine the fair market value of the subject properties for the purpose of computing internal revenue taxes, such authority is not without restriction or limitation. The first sentence of Section 6(E) sets the limitation or condition in the exercise of such power by requiring respondent to consult with competent appraisers both from private and public sectors. As there was no re-evaluation and no revision of the zonal values of the subject properties in Roxas City at the time of the sale, respondent cannot unilaterally determine the zonal values of the subject properties by invoking his powers of obtaining information and making assessments under



Sections 5 and 6 of the NIRC. The existing Revised Zonal Values of Real Properties in the City of Roxas shall prevail for the purpose of determining the proper tax liabilities of petitioner.6

Petitioner Commissioner of Internal Revenue filed a Motion for Reconsideration, which was, however, denied by the CTA in a Resolution7 dated April 4, 2005.

Petitioner then appealed to the CTA En Banc.

In a Decision dated November 9, 2005, the CTA En Banc dismissed petitioner's appeal, the dispositive portion of which reads:

WHEREFORE, premises considered, the Petition for Review is DISMISSED for lack of merit.

SO ORDERED.8

The CTA En Banc ruled that the 1995 Revised Zonal Values of Real Properties should prevail. Said court relied on Section 6 (E) of the National Internal Revenue Code (NIRC) which requires consultation from appraisers, from both the public and private sectors, in fixing the zonal valuation of properties. The CTA En Banc held that petitioner failed to prove any amendment effected on the 1995 Revised Zonal Values of Real Properties at the time of the sale of the subject properties.

Hence, herein petition, with petitioner raising the following issues for this Court's resolution, to wit:




I.

WHETHER OR NOT THE REQUIREMENT OF CONSULTATION WITH COMPETENT APPRAISERS BOTH FROM THE PRIVATE AND PUBLIC SECTORS IN DETERMINING THE FAIR MARKET VALUE OF THE SUBJECT LOTS IS APPLICABLE IN THE CASE AT BAR.

II.

WHETHER OR NOT THE COURT OF TAX APPEALS EN BANC COMMITTED GRAVE ERROR IN APPLYING THE FAIR MARKET VALUE BASED ON THE ZONAL VALUATION OF A RESIDENTIAL LAND AS TAX BASE IN THE COMPUTATION OF CAPITAL GAINS TAX AND DOCUMENTARY STAMP TAX DEFICIENCIES OF RESPONDENT.9

The petition is not meritorious. The issues being interrelated, this Court shall discuss the same in seriatim.

Under Section 27(D)(5) of the NIRC of 1997, a CGT of six (6%) percent is imposed on the gains presumed to have been realized in the sale, exchange or disposition of lands and/or buildings which are not actively used in the business of a corporation and which are treated as capital assets based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the NIRC, whichever is higher.

On the other hand, under Section 196 of the NIRC, DST is based on the consideration contracted to be paid or on its fair market value determined in accordance with Section 6(E) of the NIRC, whichever is higher.


Thus, in determining the value of CGT and DST arising from the sale of a property, the power of the CIR to assess is subject to Section 6(E) of the NIRC, which provides:

Section 6. Power of the Commissioner to Make Assessments and Prescribe Additional Requirements for Tax Administration and Enforcement. -

x x x x

(E) Authority of the Commissioner to Prescribe Real Property Values – The Commissioner is hereby authorized to divide the Philippines into different zones or area and shall, upon consultation with competent appraisers both from the private and public sectors, determine the fair market value of real properties located in each zone or area. For purposes of computing internal revenue tax, the value of the property shall be, whichever is higher of:

(1) the fair market value as determined by the Commissioner; or

(2) the fair market value as shown in the schedule of values of the Provincial and City Assessors.

While the CIR has the authority to prescribe real property values and divide the Philippines into zones, the law is clear that the same has to be done upon consultation with competent appraisers both from the public and private sectors. It is undisputed that at the time of the sale of the subject properties found in Barrio Banica, Roxas City, the same were classified as "RR," or residential, based on the 1995 Revised Zonal Value of Real Properties. Petitioner, thus, cannot

unilaterally change the zonal valuation of such properties to "commercial" without first conducting a re-evaluation of the zonal values as mandated under Section 6(E) of the NIRC.

Petitioner argues, however, that the requirement of consultation with competent appraisers is mandatory only when it is prescribing real property values – that is when a formulation or change is made in the schedule of zonal values. Petitioner also contends that what it did in the instant case was not to prescribe the zonal value, but merely classify the same as commercial and apply the corresponding zonal value for such classification based on the existing schedule of zonal values in Roxas City.10

We disagree.

To this Court's mind, petitioner's act of re-classifying the subject properties from residential to commercial cannot be done without first complying with the procedures prescribed by law. It bears to stress that ALL the properties in Barrio Banica were classified as residential, under the 1995 Revised Zonal Values of Real Properties. Thus, petitioner's act of classifying the subject properties involves a re-classification and revision of the prescribed zonal values.

In addition, Revenue Memorandum No. 58-69 provides for the procedures on the establishment of the zonal values of real properties, viz.:

(1) The submission or review by the Revenue District Offices Sub-Technical Committee of the schedule of recommended zonal values to the TCRPV;


(2) The evaluation by TCRPV of the submitted schedule of recommended zonal values of real properties;

(3) Except in cases of correction or adjustment, the TCRPV finalizes the schedule and submits the same to the Executive Committee on Real Property Valuation (ECRPV);

(3) Upon approval of the schedule of zonal values by the ECRPV, the same is embodied in a Department Order for implementation and signed by the Secretary of Finance. Thereafter, the schedule takes effect (15) days after its publication in the Official Gazette or in any newspaper of general circulation.

Petitioner failed to prove that it had complied with Revenue Memorandum No. 58-69 and that a revision of the 1995 Revised Zonal Values of Real Properties was made prior to the sale of the subject properties. Thus, notwithstanding petitioner's disagreement to the classification of the subject properties, the same must be followed for purposes of computing the CGT and DST. It bears stressing, and as observed by the CTA En Banc, that the 1995 Revised Zonal Values of Real Properties was drafted by petitioner, BIR personnel, representatives from the Department of Finance, National Tax Research Center, Institute of Philippine Real Estate Appraisers and Philippine Association of Realtors Board, which duly satisfied the requirement of consultation with public and private appraisers.11

Petitioner contends, nevertheless, that its act of classifying the subject properties based on actual use was in accordance with guidelines number 1-b and 2 as set forth in "Certain Guidelines in the Implementation of Zonal Valuation of Real Properties for RDO 72 Roxas City" (Zonal Valuation Guidelines).12

Section 1 (b) of the Zonal Valuation Guidelines reads:



1. No zonal value has been prescribed for a particular classification of real property.

Where in the approved schedule of zonal values for a particular barangay -

x x x x

b) No zonal value has been prescribed for a particular classification of real property in one barangay, the zonal value prescribed for the same classification of real property located in an adjacent barangay of similar conditions shall be used.

Section 1 (b) does not apply to the case at bar for the simple reason that said proviso operates only when "no zonal valuation has been prescribed." The properties located in Barrio Banica, Roxas City were already subject to a zonal valuation, a fact which even petitioner has admitted in its petition, thus:

It must be noted that under the schedule of zonal values, Barangay Banica, where the subject lots are situated, has a single classification only – that of a residential area. Accordingly, it has a prescribed zonal value of Php650.00 per square meter.13

Petitioner, however, also relies on Section 2 (a) of the Zonal Valuation Guidelines, to justify its action. Said section states:

2. Predominant Use of Property.


a) All real properties, regardless of actual use, located in a street/barangay zone, the use of which are predominantly commercial shall be classified as "Commercial" for purposes of zonal valuation.

In BIR Ruling No. 041-2001, issued on September 18, 2001, the BIR tackled the application of a provision which is identical to Section 2 (a) of the Zonal Valuation Guidelines. BIR Ruling No. 041-2001 involved a request by the Iglesia Ni Cristo that the re-computation of CGT and DST based on the predominant use of the real properties located at Mindanao Avenue, Quezon City, be set aside. In said case, the Iglesia ni Cristo paid the CGT and DST based on the zonal value of residential lots in Quezon City. The Revenue District Officer, however, ordered a re-computation of the CGT and DST based on the ground that the real property is located in a predominantly commercial area and must be classified as commercial for purposes of zonal valuation. The BIR ruled in favor of Iglesia ni Cristo stating that "Certain Guidelines in the Implementation of Zonal Valuation of Real Properties for RDO No. 38, applying the predominant use of property as the basis for the computation of the Capital Gains and Documentary Stamp Taxes, shall apply only when the real property is located in an area or zone where the properties are not yet classified and their respective zonal valuation are not yet determined." The pertinent portion of BIR Ruling No. 041-2001 reads:

In reply, please be informed that this Office finds your request meritorious. The number 2 guideline laid down in Certain Guidelines in the implementation of Zonal valuation of Real Properties for RDO No. 38- North Quezon City xxx does not apply to this case.

Number 2 of the CERTAIN GUIDELINES IN THE IMPLEMENTATION OF ZONAL VALUATION OF REAL PROPERTIES FOR RD NO. 38 – NORTH QUEZON CITY" provides:

"2. PREDOMINANT USE OF PROPERTY:

ALL REAL PROPERTIES REGARDLESS OF ACTUAL USE, LOCATED IN A STREET/BARANGAY ZONE, THE USE OF WHICH ARE PREDOMINANTLY COMMERCIAL SHALL BE CLASSIFIED AS 'COMMERICIAL'FOR PURPOSES OF ZONAL VALUATION."

It is the considered opinion of this Office that the guideline applies when the real property is located in an area or zone where the properties are not yet classified and their respective zonal valuation are not yet determined.

In the instant case, however, the classification and valuation of the properties located in Mindanao Avenue, Bagong Bantay, have already been determined. Under Department of Finance Order No. 6-2000, the properties along Mindanao Avenue had already been classified as residential and commercial. The zonal valuation thereof had already been determined. x x x Therefore, the Revenue District Officer of RDO No. 38 has no discretion to determine the classification or valuation of the properties located in the pertinent area. The computation of the capital gains and documentary stamp taxes shall be based on the zonal of residential properties located at Mindanao Avenue, Bago Bantay, Quezon City.141avvphil

Based on the foregoing, this Court need not belabour on the applicability of Section 2 (a), as the BIR itself has already ruled that the same shall apply only when the real property is located in an area or zone where the properties are not yet classified and their respective zonal valuation are not yet determined. As mentioned earlier, the subject properties were already part of the 1995 Revised Zonal Value of Real Properties which classified the same as residential with a zonal value of Php650.00 per square meter; thus, Section 2 (a) clearly has no application.


This Court agrees with the observation of the CTA that "zonal valuation was established with the objective of having an ‘efficient tax administration by minimizing the use of discretion in the determination of the tax based on the part of the administrator on one hand and the taxpayer on the other hand.’"15 Zonal value is determined for the purpose of establishing a more realistic basis for real property valuation. Since internal revenue taxes, such as CGT and DST, are assessed on the basis of valuation, the zonal valuation existing at the time of the sale should be taken into account.16

If petitioner feels that the properties in Barrio Banica should also be classified as commercial, then petitioner should work for its revision in accordance with Revenue Memorandum Order No. 58-69. The burden was on petitioner to prove that the classification and zonal valuation in Barrio Banica have been revised in accordance with the prevailing memorandum. In the absence of proof to the contrary, the 1995 Revised Zonal Values of Real Properties must be followed.

Lastly, this Court takes note of the wording of Section 2 (b) of the Zonal Valuation Guidelines, to wit:

2. Predominant Use of Property.

b) The predominant use of other classification of properties located in a street/barangay zone, regardless of actual use shall be considered for purposes of zonal valuation.

Based thereon, this Court rules that even assuming arguendo that the subject properties were used for commercial purposes, the same remains to be residential for zonal value purposes. It appears that actual use is not considered for



zonal valuation, but the predominant use of other classification of properties located in the zone. Again, it is undisputed that the entire Barrio Banica has been classified as residential.

WHEREFORE, premises considered, the petition is denied. The November 9, 2005 Decision of the Court of Tax Appeals En Banc, in CTA-E.B. No. 77, is hereby AFFIRMED.

G.R. No. L-26284 October 8, 1986

TOMAS CALASANZ, ET AL., petitioners, vs.THE COMMISSIONER OF INTERNAL REVENUE and the COURT OF TAX APPEALS, respondents.

San Juan, Africa, Gonzales & San Agustin Law Office for petitioners.

FERNAN, J.:

Appeal taken by Spouses Tomas and Ursula Calasanz from the decision of the Court of Tax Appeals in CTA No. 1275 dated June 7, 1966, holding them liable for the payment of P3,561.24 as deficiency income tax and interest for the calendar year 1957 and P150.00 as real estate dealer's fixed tax.

Petitioner Ursula Calasanz inherited from her father Mariano de Torres an agricultural land located in Cainta, Rizal, containing a total area of 1,678,000 square meters. In order to liquidate her inheritance, Ursula Calasanz had the land surveyed and subdivided into lots. Improvements, such as good roads, concrete gutters, drainage and lighting system, were introduced to make the lots saleable. Soon after, the lots were sold to the public at a profit.

In their joint income tax return for the year 1957 filed with the Bureau of Internal Revenue on March 31, 1958, petitioners disclosed a profit of P31,060.06 realized from the sale of the subdivided lots, and reported fifty per centum thereof or P15,530.03 as taxable capital gains.

Upon an audit and review of the return thus filed, the Revenue Examiner adjudged petitioners engaged in business as real estate dealers, as defined in Section

194 [s] 1 of the National Internal Revenue Code, required them to pay the real estate dealer's tax

2 and assessed a deficiency income tax on profits derived from

the sale of the lots based on the rates for ordinary income.

On September 29, 1962, petitioners received from respondent Commissioner of Internal Revenue:

a. Demand No. 90-B-032293-57 in the amount of P160.00 representing real estate dealer's fixed tax of P150.00 and P10.00 compromise penalty for late payment; and

b. Assessment No. 90-5-35699 in the amount of P3,561.24 as deficiency income tax on ordinary gain of P3,018.00 plus interest of P 543.24.

On October 17, 1962, petitioners filed with the Court of Tax Appeals a petition for review contesting the aforementioned assessments.

On June 7, 1966, the Tax Court upheld the respondent Commissioner except for that portion of the assessment regarding the compromise penalty of P10.00 for the reason that in this jurisdiction, the same cannot be collected in the absence of a valid and binding compromise agreement.

Hence, the present appeal.

The issues for consideration are:

a. Whether or not petitioners are real estate dealers liable for real estate dealer's fixed tax; and

b. Whether the gains realized from the sale of the lots are taxable in full as ordinary income or capital gains taxable at capital gain rates.

The issues are closely interrelated and will be taken jointly.

Petitioners assail their liabilities as "real estate dealers" and seek to bring the profits from the sale of the lots under Section 34 [b] [2] 3 of the Tax Code.

The theory advanced by the petitioners is that inherited land is a capital asset within the meaning of Section 34[a] [1] of the Tax Code and that an heir who liquidated his inheritance cannot be said to have engaged in the real estate business and may not be denied the preferential tax treatment given to gains from sale of capital assets, merely because he disposed of it in the only possible and advantageous way.

Petitioners averred that the tract of land subject of the controversy was sold because of their intention to effect a liquidation. They claimed that it was parcelled out into smaller lots because its size proved difficult, if not impossible, of disposition in one single transaction. They pointed out that once subdivided, certainly, the lots

cannot be sold in one isolated transaction. Petitioners, however, admitted that roads and other improvements were introduced to facilitate its sale. 4

On the other hand, respondent Commissioner maintained that the imposition of the taxes in question is in accordance with law since petitioners are deemed to be in the real estate business for having been involved in a series of real estate transactions pursued for profit. Respondent argued that property acquired by inheritance may be converted from an investment property to a business property if, as in the present case, it was subdivided, improved, and subsequently sold and the number, continuity and frequency of the sales were such as to constitute "doing business." Respondent likewise contended that inherited property is by itself neutral and the fact that the ultimate purpose is to liquidate is of no moment for the important inquiry is what the taxpayer did with the property. Respondent concluded that since the lots are ordinary assets, the profits realized therefrom are ordinary gains, hence taxable in full.

We agree with the respondent.

The assets of a taxpayer are classified for income tax purposes into ordinary assets and capital assets. Section 34[a] [1] of the National Internal Revenue Code broadly defines capital assets as follows:

[1] Capital assets.-The term 'capital assets' means property held by the taxpayer [whether or not connected with his trade or business], but does not include, stock in trade of the taxpayer or other property of a kind which would properly be included, in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business of a character which is subject to the allowance for depreciation provided in subsection [f] of section thirty; or real property used in the trade or business of the taxpayer.

The statutory definition of capital assets is negative in nature. 5 If the asset is not among the exceptions, it is a capital asset; conversely, assets falling within the

exceptions are ordinary assets. And necessarily, any gain resulting from the sale or exchange of an asset is a capital gain or an ordinary gain depending on the kind of asset involved in the transaction.

However, there is no rigid rule or fixed formula by which it can be determined with finality whether property sold by a taxpayer was held primarily for sale to

customers in the ordinary course of his trade or business or whether it was sold as a capital asset. 6 Although several factors or indices

7 have been recognized as

helpful guides in making a determination, none of these is decisive; neither is the presence nor the absence of these factors conclusive. Each case must in the last

analysis rest upon its own peculiar facts and circumstances. 8

Also a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a combination of the factors indubitably tend to show that the activity was in furtherance of or in the course of the taxpayer's trade or business. Thus, a sale of inherited real property usually gives capital gain or loss even

though the property has to be subdivided or improved or both to make it salable. However, if the inherited property is substantially improved or very actively sold or

both it may be treated as held primarily for sale to customers in the ordinary course of the heir's business. 9

Upon an examination of the facts on record, We are convinced that the activities of petitioners are indistinguishable from those invariably employed by one engaged in the business of selling real estate.

One strong factor against petitioners' contention is the business element of development which is very much in evidence. Petitioners did not sell the land in the

condition in which they acquired it. While the land was originally devoted to rice and fruit trees, 10

it was subdivided into small lots and in the process converted into a residential subdivision and given the name Don Mariano Subdivision. Extensive improvements like the laying out of streets, construction of concrete gutters and installation of lighting system and drainage facilities, among others, were undertaken to enhance the value of the lots and make them more attractive to

prospective buyers. The audited financial statements 11

submitted together with the tax return in question disclosed that a considerable amount was expended to cover the cost of improvements. As a matter of fact, the estimated improvements of the lots sold reached P170,028.60 whereas the cost of the land is only P 4,742.66. There is authority that a property ceases to be a capital asset if the amount expended to improve it is double its original cost, for the extensive

improvement indicates that the seller held the property primarily for sale to customers in the ordinary course of his business. 12

Another distinctive feature of the real estate business discernible from the records is the existence of contracts receivables, which stood at P395,693.35 as of the year ended December 31, 1957. The sizable amount of receivables in comparison with the sales volume of P446,407.00 during the same period signifies that the lots were sold on installment basis and suggests the number, continuity and frequency of the sales. Also of significance is the circumstance that the lots were

advertised 13

for sale to the public and that sales and collection commissions were paid out during the period in question.

Petitioners, likewise, urge that the lots were sold solely for the purpose of liquidation.

In Ehrman vs. Commissioner, 14 the American court in clear and categorical terms rejected the liquidation test in determining whether or not a taxpayer is carrying

on a trade or business The court observed that the fact that property is sold for purposes of liquidation does not foreclose a determination that a "trade or business" is being conducted by the seller. The court enunciated further:

We fail to see that the reasons behind a person's entering into a business-whether it is to make money or whether it is to liquidate-should be determinative of the question of whether or not the gains resulting from the sales are ordinary gains or capital gains. The sole question is-were the

taxpayers in the business of subdividing real estate? If they were, then it seems indisputable that the property sold falls within the exception in the definition of capital assets . . . that is, that it constituted 'property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

Additionally, in Home Co., Inc. vs. Commissioner, 15

the court articulated on the matter in this wise:

One may, of course, liquidate a capital asset. To do so, it is necessary to sell. The sale may be conducted in the most advantageous manner to the seller and he will not lose the benefits of the capital gain provision of the statute unless he enters the real estate business and carries on the sale in the manner in which such a business is ordinarily conducted. In that event, the liquidation constitutes a business and a sale in the ordinary course of such a business and the preferred tax status is lost.

In view of the foregoing, We hold that in the course of selling the subdivided lots, petitioners engaged in the real estate business and accordingly, the gains from the sale of the lots are ordinary income taxable in full.

WHEREFORE, the decision of the Court of Tax Appeals is affirmed. No costs.

G.R. No. L-26911 January 27, 1981

ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION, petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, respondent.

G.R. No. L-26924 January 27, 1981

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION and COURT OF TAX APPEALS, respondents.

DE CASTRO, J.:

These are two (2) petitions for review from the decision of the Court of Tax Appeals of October 25, 1966 in CTA Case No. 1312 entitled "Atlas Consolidated Mining and Development Corporation vs. Commissioner of Internal Revenue." One (L-26911) was filed by the Atlas Consolidated Mining & Development Corporation, and in the other L-26924), the Commissioner of Internal Revenue is the petitioner.

This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income tax assessments made by the Commissioner of Internal Revenue, hereinafter referred to as Commissioner, where the Atlas Consolidated Mining and Development Corporation, hereinafter referred to as Atlas, was assessed P546,295.16 for 1957 and P215,493.96 for 1958 deficiency income taxes.

Atlas is a corporation engaged in the mining industry registered under the laws of the Philippines. On August 20, 1962, the Commissioner assessed against Atlas the sum of P546,295.16 and P215,493.96 or a total of P761,789.12 as deficiency income taxes for the years 1957 and 1958. For the year 1957, it was the opinion of the Commissioner that Atlas is not entitled to exemption from the income tax under Section 4 of Republic Act 909 1 because same covers only gold mines, the provision of which reads:

New mines, and old mines which resume operation, when certified to as such by the Secretary of Agriculture and Natural Resources upon the recommendation of the Director of Mines, shall be exempt from the payment of income tax during the first three (3) years of actual commercial production. Provided that, any such mine and/or mines making a complete return of its capital investment at any time within the said period, shall pay income tax from that year.

For the year 1958, the assessment of deficiency income tax of P761,789.12 covers the disallowance of items claimed by Atlas as deductible from gross income.

On October 9, 1962, Atlas protested the assessment asking for its reconsideration and cancellation. 2 Acting on the protest, the Commissioner conducted a reinvestigation of the case.

On October 25, 1962, the Secretary of Finance ruled that the exemption provided in Republic Act 909 embraces all new mines and old mines whether gold or other minerals. 3 Accordingly, the Commissioner recomputed Atlas deficiency income tax liabilities in the light of the ruling of the Secretary of Finance. On June 9, 1964, the Commissioner issued a revised assessment entirely eliminating the assessment of P546,295.16 for the year 1957. The assessment for 1958 was reduced from P215,493.96 to P39,646.82 from which Atlas appealed to the Court of Tax Appeals, assailing the disallowance of the following items claimed as deductible from its gross income for 1958:

Transfer agent's fee.........................................................P59,477.42

Stockholders relation service fee....................................25,523.14

U.S. stock listing expenses..................................................8,326.70

Suit expenses..........................................................................6,666.65

Provision for contingencies..................................... .........60,000.00

Total....................................................................P159,993.91

After hearing, the Court of Tax Appeals rendered a decision on October 25, 1966 allowing the above mentioned disallowed items, except the items denominated by Atlas as stockholders relation service fee and suit expenses. 4 Pertinent portions of the decision of the Court of Tax Appeals read as follows:

Under the facts, circumstances and applicable law in this case, the unallowable deduction from petitioner's gross income in 1958 amounted to P32,189.79.

Stockholders relation service fee.................................... P25,523.14

Suit and litigation expenses................................................ 6,666.65

Total................................................................................... P32,189.79

As the exemption of petitioner from the payment of corporate income tax under Section 4, Republic Act 909, was good only up to the Ist quarter of 1958 ending on March 31 of the same year, only three-fourth (3/4) of the net taxable income of petitioner is subject to income tax, computed as follows:

1958

Total net income for 1958.................................P1,968,898.27

Net income corresponding to

taxable period April 1 to

Dec. 31, 1958, 3/4 of

P1,968,898.27..........................................................1,476,673.70

Add: 3/4 of promotion fees

of P25,523.14..............................................................P19,142.35

Litigation

expenses.........................................................................6, 666.65

Net income per decision..........................................11, 02,4 2.70

Tax due thereon.........................................................412,695.00

Less: Amount already assessed .............................405,468.00

DEFICIENCY INCOME TAX DUE............................P7,227.00

Add: 1/2 % monthly interest

from 6-20-59 to 6-20-62 (18%)....................................P1,300.89

TOTAL AMOUNT DUE & COLLECTIBLE............P8,526.22

From the Court of Tax Appeals' decision of October 25, 1966, both parties appealed to this Court by way of two (2) separate petitions for review docketed as G. R. No. L-26911 (Atlas, petitioner) and G. R. No. L-29924 (Commissioner, petitioner).

G. R. No. L-26911—Atlas appealed only that portion of the Court of Tax Appeals' decision disallowing the deduction from gross income of the so-called stockholders relation service fee amounting to P25,523.14, making a lone assignment of error that —

THE COURT OF TAX APPEALS ERRED IN ITS CONCLUSION THAT THE EXPENSE IN THE AMOUNT OF P25,523.14 PAID BY PETITIONER IN 1958 AS ANNUAL PUBLIC RELATIONS EXPENSES WAS INCURRED FOR ACQUISITION OF ADDITIONAL CAPITAL, THE SAME NOT BEING SUPPORTED BY THE EVIDENCE.

It is the contention of Atlas that the amount of P25,523.14 paid in 1958 as annual public relations expenses is a deductible expense from gross income under Section 30 (a) (1) of the National Internal Revenue Code. Atlas claimed that it was paid for services of a public relations firm, P.K Macker & Co., a reputable public relations consultant in New York City, U.S.A., hence, an ordinary and necessary business expense in order to compete with other corporations also interested in the investment market in the United States. 5 It is the stand of Atlas that information given out to the public in general and to the stockholder in particular by the P.K MacKer & Co. concerning the operation of the Atlas was aimed at creating a favorable image and goodwill to gain or maintain their patronage.

The decisive question, therefore, in this particular appeal taken by Atlas to this Court is whether or not the expenses paid for the services rendered by a public relations firm P.K MacKer & Co. labelled as stockholders relation service fee is an allowable deduction as business expense under Section 30 (a) (1) of the National Internal Revenue Code.

The principle is recognized that when a taxpayer claims a deduction, he must point to some specific provision of the statute in which that deduction is authorized and must be able to prove that he is entitled to the deduction which the law allows. As previously adverted to, the law allowing expenses as deduction from gross income for purposes of the income tax is Section 30 (a) (1) of the National Internal Revenue which allows a deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." An item of expenditure, in order to be deductible under this section of the statute, must fall squarely within its language.

We come, then, to the statutory test of deductibility where it is axiomatic that to be deductible as a business expense, three conditions are imposed, namely: (1) the expense must be ordinary and necessary, (2) it must be paid or incurred within the taxable year, and (3) it must be paid or incurred in carrying in a trade or business. 6 In addition, not only must the taxpayer meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise, the same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction. 7

While it is true that there is a number of decisions in the United States delving on the interpretation of the terms "ordinary and necessary" as used in the federal tax laws, no adequate or satisfactory definition of those terms is possible. Similarly, this Court has never attempted to define with precision the terms "ordinary and necessary." There are however, certain guiding principles worthy of serious consideration in the proper adjudication of conflicting claims. Ordinarily, an expense will be considered "necessary" where the expenditure is appropriate and helpful in the development of the taxpayer's business. 8 It is "ordinary" when it connotes a payment which is normal in relation to the business of the taxpayer and the surrounding circumstances. 9 The term "ordinary" does not require that the payments be habitual or normal in the sense that the same taxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected. 10

There is thus no hard and fast rule on the matter. The right to a deduction depends in each case on the particular facts and the relation of the payment to the type of business in which the taxpayer is engaged. The intention of the taxpayer often may be the controlling fact in making the determination. 11 Assuming that the expenditure is ordinary and necessary in the operation of the taxpayer's business, the answer to the question as to whether the expenditure is an allowable deduction as a business expense must be determined from the nature of the expenditure itself, which in turn depends on the extent and permanency of the work accomplished by the expenditure. 12

It appears that on December 27, 1957, Atlas increased its capital stock from P15,000,000 to P18,325,000. 13

It was claimed by Atlas that its shares of stock worth P3,325,000 were sold in the United States because of

the services rendered by the public relations firm, P. K. Macker & Company. The Court of Tax Appeals ruled that the information about Atlas given out and played up in the mass communication media resulted in full subscription of the additional shares issued by Atlas; consequently, the questioned item, stockholders relation service fee, was in effect spent for the acquisition of additional capital, ergo, a capital expenditure.

We sustain the ruling of the tax court that the expenditure of P25,523.14 paid to P.K. Macker & Co. as compensation for services carrying on the selling campaign in an effort to sell Atlas' additional capital stock of P3,325,000 is not an ordinary expense in line with the decision of U.S. Board of Tax Appeals in the case of Harrisburg Hospital Inc. vs. Commissioner of Internal Revenue. 14 Accordingly, as found by the Court of Tax Appeals, the said expense is not deductible from Atlas gross income in 1958 because expenses relating to recapitalization and reorganization of the corporation (Missouri-Kansas Pipe Line vs. Commissioner of Internal Revenue, 148 F. (2d), 460; Skenandos Rayon Corp. vs. Commissioner of Internal Revenue, 122 F. (2d) 268, Cert. denied 314 U.S. 6961), the cost of obtaining stock subscription (Simons Co., 8 BTA 631), promotion expenses (Beneficial Industrial Loan Corp. vs. Handy, 92 F. (2d) 74), and commission or fees paid for the sale of stock reorganization (Protective Finance Corp., 23 BTA 308) are capital expenditures.

That the expense in question was incurred to create a favorable image of the corporation in order to gain or maintain the public's and its stockholders' patronage, does not make it deductible as business expense. As held in the case of Welch vs. Helvering, 15 efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures.

We do not agree with the contention of Atlas that the conclusion of the Court of Tax Appeals in holding that the expense of P25,523.14 was incurred for acquisition of additional capital is not supported by the evidence. The burden of proof that the expenses incurred are ordinary and necessary is on the taxpayer 16 and does not rest upon the Government. To avail of the claimed deduction under Section 30(a) (1) of the National Internal Revenue Code, it is incumbent upon the taxpayer to adduce substantial evidence to establish a reasonably proximate relation petition between the expenses to the ordinary conduct of the business of the taxpayer. A logical link or nexus between the expense and the taxpayer's business must be established by the taxpayer.

G. R. No. L-26924-In his petition for review, the Commissioner of Internal Revenue assigned as errors the following:

I

THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OF THE SO- CALLED TRANSFER AGENT'S FEES ALLEGEDLY PAID BY RESPONDENT;

II

THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OF LISTING EXPENSES ALLEGEDLY INCURRED BY RESPONDENT;

III

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE AMOUNT OF P60,000 REPRESENTED BY RESPONDENT AS "PROVISION FOR CONTINGENCIES" WAS ADDED BACK BY RESPONDENT TO ITS GROSS INCOME IN COMPUTING THE INCOME TAX DUE FROM IT FOR 1958;

IV

THE COURT OF TAX APPEALS ERRED IN DISALLOWING ONLY THE AMOUNT OF P6,666.65 AS SUIT EXPENSES, THE CORRECT AMOUNT THAT SHOULD HAVE BEEN DISALLOWED BEING P17,499.98.

It is well to note that only in the Court of Tax Appeals did the Commissioner raise for the first time (in his memorandum) the question of whether or not the business expenses deducted from Atlas gross income in 1958 may be allowed in the absence of proof of payments. 17 Before this Court, the Commissioner reiterated the same as ground against deductibility when he claimed that the Court of Tax Appeals erred in allowing the deduction of transfer agent's fee and stock listing fee from gross income in the absence of proof of payment thereof.

The Commissioner contended that under Section 30 (a) (1) of the National Internal Revenue Code, it is a requirement for an expense to be deductible from gross income that it must have been "paid or incurred

during the year" for which it is claimed; that in the absence of convincing and satisfactory evidence of payment, the deduction from gross income for the year 1958 income tax return cannot be sustained; and that the best evidence to prove payment, if at all any has been made, would be the vouchers or receipts issued therefor which ATLAS failed to present.

Atlas admitted that it failed to adduce evidence of payment of the deduction claimed in its 1958 income tax return, but explains the failure with the allegation that the Commissioner did not raise that question of fact in his pleadings, or even in the report of the investigating examiner and/or letters of demand and assessment notices of ATLAS which gave rise to its appeal to the Court of Tax Appeal. 18 It was emphasized by Atlas that it went to trial and finally submitted this case for decision on the assumption that inasmuch as the fact of payment was never raised as a vital issue by the Commissioner in his answer to the petition for review in the Court of Tax Appeal, the issues is limited only to pure question of law—whether or not the expenses deducted by petitioner from its gross income for 1958 are sanctioned by Section 30 (a) (1) of the National Internal Revenue Code.

On this issue of whether or not the Commissioner can raise the fact of payment for the first time on appeal in its memorandum in the Court of Tax Appeal, we fully agree with the ruling of the tax court that the Commissioner on appeal cannot be allowed to adopt a theory distinct and different from that he has previously pursued, as shown by the BIR records and the answer to the amended petition for review. 19 As this Court said in the case of Commissioner of Customs vs. Valencia 20 such change in the nature of the case may not be made on appeal, specially when the purpose of the latter is to seek a review of the action

taken by an administrative body, forming part of a coordinate branch of the Government, such as the Executive department. In the case at bar, the Court of Tax Appeal found that the fact of payment of the claimed deduction from gross income was never controverted by the Commissioner even during the initial stages of routinary administrative scrutiny conducted by BIR examiners. 21 Specifically, in his answer to the amended petition for review in the Court of Tax Appeal, the Commissioner did not deny the fact of payment, merely contesting the legitimacy of the deduction on the ground that same was not ordinary and necessary business expenses. 22

As consistently ruled by this Court, the findings of facts by the Court of Tax Appeal will not be reviewed in the absence of showing of gross error or abuse. 23 We, therefore, hold that it was too late for the Commissioner to raise the issue of fact of payment for the first time in his memorandum in the Court of Tax Appeals and in this instant appeal to the Supreme Court. If raised earlier, the matter ought to have been seriously delved into by the Court of Tax Appeals. On this ground, we are of the opinion that under all the attendant circumstances of the case, substantial justice would be served if the Commissioner be held as precluded from now attempting to raise an issue to disallow deduction of the item in question at this stage. Failure to assert a question within a reasonable time warrants a presumption that the party entitled to assert it either has abandoned or declined to assert it.

On the second assignment of error, aside from alleging lack of proof of payment of the expense deducted, the Commissioner contended that such expense should be disallowed for not being ordinary and necessary and not incurred in trade or business, as required under Section 30 (a) (1) of the National Internal Revenue

Code. He asserted that said fees were therefore incurred not for the production of income but for the acquisition petition of capital in view of the definition that an expense is deemed to be incurred in trade or business if it was incurred for the production of income, or in the expectation of producing income for the business. In support of his contention, the Commissioner cited the ruling in Dome Mines, Ltd vs. Commisioner of Internal Revenue 24 involving the same issue as in the case at bar where the U.S. Board of Tax Appeal ruled that expenses for listing capital stock in the stock exchange are not ordinary and necessary expenses incurred in carrying on the taxpayer's business which was gold mining and selling, which business is strikingly similar to Atlas.

On the other hand, the Court of Tax Appeal relied on the ruling in the case of Chesapeake Corporation of Virginia vs. Commissioner of Internal Revenue 25 where the Tax Court allowed the deduction of stock exchange fee in dispute, which is an annually recurring cost for the annual maintenance of the listing.

We find the Chesapeake decision controlling with the facts and circumstances of the instant case. In Dome Mines, Ltd case the stock listing fee was disallowed as a deduction not only because the expenditure did not meet the statutory test but also because the same was paid only once, and the benefit acquired thereby continued indefinitely, whereas, in the Chesapeake Corporation case, fee paid to the stock exchange was annual and recurring. In the instant case, we deal with the stock listing fee paid annually to a stock exchange for the privilege of having its stock listed. It must be noted that the Court of Tax Appeal rejected the Dome Mines case because it involves a payment made only once, hence, it was held therein that the single payment made to the stock exchange was a capital expenditure, as distinguished from the instant

case, where payments were made annually. For this reason, we hold that said listing fee is an ordinary and necessary business expense

On the third assignment of error, the Commissioner contended that the Court of Tax Appeal erred when it held that the amount of P60,000 as "provisions for contingencies" was in effect added back to Atlas income.

On this issue, this Court has consistently ruled in several cases adverted to earlier, that in the absence of grave abuse of discretion or error on the part of the tax court its findings of facts may not be disturbed by the Supreme Court. 26 It is not within the province of this Court to resolve whether or not the P60,000 representing "provision for contingencies" was in fact added to or deducted from the taxable income. As ruled by the Court of Tax Appeals, the said amount was in effect added to Atlas taxable income. 27 The same being factual in nature and supported by substantial evidence, such findings should not be disturbed in this appeal.

Finally, in its fourth assignment of error, the Commissioner contended that the CTA erred in disallowing only the amount of P6,666.65 as suit expenses instead of P17,499.98.

It appears that petitioner deducted from its 1958 gross income the amount of P23,333.30 as attorney's fees and litigation expenses in the defense of title to the Toledo Mining properties purchased by Atlas from Mindanao Lode Mines Inc. in Civil Case No. 30566 of the Court of First Instance of Manila for annulment of the sale of said mining properties. On the ground that the litigation expense was a capital expenditure under Section 121 of the Revenue Regulation No. 2, the investigating revenue examiner recommended the

disallowance of P13,333.30. The Commissioner, however, reduced this amount of P6,666.65 which latter amount was affirmed by the respondent Court of Tax Appeals on appeal.

There is no question that, as held by the Court of Tax Ap- peals, the litigation expenses under consideration were incurred in defense of Atlas title to its mining properties. In line with the decision of the U.S. Tax Court in the case of Safety Tube Corp. vs. Commissioner of Internal Revenue, 28 it is well settled that litigation expenses incurred in defense or protection of title are capital in nature and not deductible. Likewise, it was ruled by the U.S. Tax Court that expenditures in defense of title of property constitute a part of the cost of the property, and are not deductible as expense. 29

Surprisingly, however, the investigating revenue examiner recommended a partial disallowance of P13,333.30 instead of the entire amount of P23,333.30, which, upon review, was further reduced by the Commissioner of Internal Revenue. Whether it was due to mistake, negligence or omission of the officials concerned, the arithmetical error committed herein should not prejudice the Government. This Court will pass upon this particular question since there is a clear error committed by officials concerned in the computation of the deductible amount. As held in the case of Vera vs. Fernandez, 30 this Court emphatically said that taxes are the lifeblood of the Government and their prompt and certain availability are imperious need. Upon taxation depends the Government's ability to serve the people for whose benefit taxes are collected. To safeguard such interest, neglect or omission of government officials entrusted with the collection of taxes should not be allowed to bring harm or detriment to the people, in the same manner as private persons may be made to suffer individually on account of his own negligence, the presumption being

that they take good care of their personal affair. This should not hold true to government officials with respect to matters not of their own personal concern. This is the philosophy behind the government's exception, as a general rule, from the operation of the principle of estoppel. 31

WHEREFORE, judgment appealed from is hereby affirmed with modification that the amount of P17,499.98 (3/4 of P23,333.00) representing suit expenses be disallowed as deduction instead of P6,666.65 only. With this amount as part of the net income, the corresponding income tax shall be paid thereon, with interest of 6% per annum from June 20, 1959 to June 20,1962.

G.R. No. L-15290 May 31, 1963

MARIANO ZAMORA, petitioner, vs.COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

-----------------------------

G.R. No. L-15280 May 31, 1963

COLLECTOR OF INTERNAL REVENUE, petitioner, vs.MARIANO ZAMORA, respondent.

-----------------------------

G.R. No. L-15289 May 31, 1963

ESPERANZA A. ZAMORA, as Special Administratrix of Estate of FELICIDAD ZAMORA, petitioner, vs.COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

-----------------------------

G.R. No. L-15281 May 31, 1963

COLLECTOR OF INTERNAL REVENUE, petitioner, vs.ESPERANZA A. ZAMORA, as Special Administratrix, etc. respondent.

Office of the Solicitor General for petitioner.Rodegelio M. Jalandoni for respondents.

PAREDES, J.:

In the above-entitled cases, a joint decision was rendered by the lower court because they involved practically the same issues. We do so, likewise, for the same reason.

Cases Nos. L-15290 and L-15280

Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed his income tax returns the years 1951 and 1952. The Collector of Internal Revenue found that he failed to file his return of the capital gains derived from the sale of certain real properties and claimed deductions which were not allowable. The collector required him to pay the sums of P43,758.50 and P7,625.00, as deficiency income tax for the years 1951 and 1952, respectively (C.T.A. Case No. 234, now L-15290). On appeal by Zamora, the Court of Tax Appeals on December 29, 1958, modified the

decision appealed from and ordered him to pay the reduced total sum of P30,258.00 (P22,980.00 and P7,278.00, as deficiency income tax for the years 1951 and 1952, respectively), within thirty (30) days from the date the decision becomes final, plus the corresponding surcharges and interest in case of delinquency, pursuant to section 51(e), Int. Revenue Code. With costs against petitioner.

Having failed to obtain a reconsideration of the decision, Mariano Zamora appealed (L-15290), alleging that the Court of Tax Appeals erred —

(1) In dissallowing P10,478.50, as promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora (which is ½ of P20,957.00, supposed business expenses):

(2) In disallowing 3-½% per annum as the rate of depreciation of the Bay View Hotel Building;

(3) In disregarding the price stated in the deed of sale, as the costs of a Manila property, for the purpose of determining alleged capital gains; and

(4) In applying the Ballantyne scale of values in determining the cost of said property.

The Collector of Internal Revenue (L-15280) also appealed, claiming that the Court of Tax Appeals erred —

(1) In giving credence to the uncorroborated testimony of Mariano Zamora that he bought the said real property in question during the Japanese occupation, partly in Philippine currency and partly in Japanese war notes, and

(2) In not holding that Mariano Zamora is liable for the payment of the sums of P43,758.00 and P7,625.00 as deficiency income taxes, for the years 1951 and 1952, plus the 5% surcharge and 1% monthly interest, from the date said amounts became due to the date of actual payment.

Wherefore, the parties respectfully pray that the foregoing stipulation of facts be admitted and approved by this Honorable Court, without prejudice to the parties adducing other evidence to prove their case not covered by this stipulation of facts. 1äwphï1.ñët

Cases Nos. L-15289 and L-15281

Mariano Zamora and his deceased sister Felicidad Zamora, bought a piece of land located in Manila on May 16, 1944, for P132,000.00 and sold it for P75,000.00 on March 5, 1951. They also purchased a lot located in Quezon City for P68,959.00 on January 19, 1944, which they sold for P94,000 on February 9, 1951. The CTA ordered the estate of the late Felicidad Zamora (represented by Esperanza A. Zamora, as special administratrix of her estate), to pay the sum of P235.50, representing alleged deficiency income tax and surcharge due from said estate. Esperanza A. Zamora appealed and alleged that the CTA erred: —

The Commissioner of Internal Revenue likewise appealed from the decision, claiming that the lower court erred: —

(1) In giving credence to the uncorroborated testimony of Mariano Zamora that he bought the real property involved during the Japanese occupation, partly in genuine Philippine currency and partly in Japanese war notes; and

(2) In not holding that Esperanza A. Zamora, as administratrix, is liable for the payment of the sum of P613.00 as deficiency income tax and 50% surcharge for 1951, plus 50% surcharge and 1% monthly interest from the date said amount became due, to the date of actual payment.

It is alleged by Mariano Zamora that the CTA erred in disallowing P10,478.50 as promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora. He contends that the whole amount of P20,957.00 as promotion expenses in his 1951 income tax returns, should be allowed and not merely one-half of it or P10,478.50, on the ground that, while not all the itemized expenses are supported by receipts, the absence of some supporting receipts has been sufficiently and satisfactorily established. For, as alleged, the said amount of P20,957.00 was spent by Mrs. Esperanza A. Zamora (wife of Mariano), during her travel to Japan and the United States to purchase machinery for a new Tiki-Tiki plant, and to observe hotel management in modern hotels. The CTA, however, found that for said trip Mrs. Zamora obtained only the sum of P5,000.00 from the Central Bank and that in her application for dollar allocation, she stated that she was going abroad on a combined medical and business trip, which facts were not denied by Mariano Zamora. No evidence had been submitted as to where Mariano had obtained the amount in excess of P5,000.00 given to his wife which she spent abroad. No explanation had been made either that the statement contained in Mrs. Zamora's application for dollar allocation that she was going abroad on a combined medical and business trip, was not correct. The alleged expenses were not supported by receipts. Mrs. Zamora could not even remember how much money she had when she left abroad in 1951, and how the alleged amount of P20,957.00 was spent.

Section 30, of the Tax Code, provides that in computing net income, there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year, in carrying on any trade or business (Vol. 4,

Mertens, Law of Federal Income Taxation, sec. 25.03, p. 307). Since promotion expenses constitute one of the deductions in conducting a business, same must testify these requirements. Claim for the deduction of promotion expenses or entertainment expenses must also be substantiated or supported by record showing in detail the amount and nature of the expenses incurred (N.H. Van Socklan, Jr. v. Comm. of Int. Rev.; 33 BTA 544). Considering, as heretofore stated, that the application of Mrs. Zamora for dollar allocation shows that she went abroad on a combined medical and business trip, not all of her expenses came under the category of ordinary and necessary expenses; part thereof constituted her personal expenses. There having been no means by which to ascertain which expense was incurred by her in connection with the business of Mariano Zamora and which was incurred for her personal benefit, the Collector and the CTA in their decisions, considered 50% of the said amount of P20,957.00 as business expenses and the other 50%, as her personal expenses. We hold that said allocation is very fair to Mariano Zamora, there having been no receipt whatsoever, submitted to explain the alleged business expenses, or proof of the connection which said expenses had to the business or the reasonableness of the said amount of P20,957.00. While in situations like the present, absolute certainty is usually no possible, the CTA should make as close an approximation as it can, bearing heavily, if it chooses, upon the taxpayer whose inexactness is of his own making.

In the case of Visayan Cebu Terminal Co., Inc. v. Collector of Int. Rev., G.R. No. L-12798, May 30, 1960, it was declared that representation expenses fall under the category of business expenses which are allowable deductions from gross income, if they meet the conditions prescribed by law, particularly section 30 (a) [1], of the Tax Code; that to be deductible, said business expenses must be ordinary and necessary expenses paid or incurred in carrying on any trade or business; that those expenses must also meet the further test of reasonableness in amount; that when some of the representation expenses claimed by the taxpayer were evidenced by vouchers or chits, but others were without

vouchers or chits, documents or supporting papers; that there is no more than oral proof to the effect that payments have been made for representation expenses allegedly made by the taxpayer and about the general nature of such alleged expenses; that accordingly, it is not possible to determine the actual amount covered by supporting papers and the amount without supporting papers, the court should determine from all available data, the amount properly deductible as representation expenses.

In view hereof, We are of the opinion that the CTA, did not commit error in allowing as promotion expenses of Mrs. Zamora claimed in Mariano Zamora's 1951 income tax returns, merely one-half or P10,478.50.

Petitioner Mariano Zamora alleges that the CTA erred in disallowing 3-½% per annum as the rate of depreciation of the Bay View Hotel Building but only 2-½%. In justifying depreciation deduction of 3-½%, Mariano Zamora contends that (1) the Ermita District, where the Bay View Hotel is located, is now becoming a commercial district; (2) the hotel has no room for improvement; and (3) the changing modes in architecture, styles of furniture and decorative designs, "must meet the taste of a fickle public". It is a fact, however, that the CTA, in estimating the reasonable rate of depreciation allowance for hotels made of concrete and steel at 2-½%, the three factors just mentioned had been taken into account already. Said the CTA—

Normally, an average hotel building is estimated to have a useful life of 50 years, but inasmuch as the useful life of the building for business purposes depends to a large extent on the suitability of the structure to its use and location, its architectural quality, the rate of change in population, the shifting of land values, as well as the extent and maintenance and rehabilitation. It is allowed a depreciation rate of 2-½% corresponding to a normal useful life

of only 40 years (1955 PH Federal Taxes, Par 14 160-K). Consequently, the stand of the petitioners can not be sustained.

As the lower court based its findings on Bulletin F, petitioner Zamora, argues that the same should have been first proved as a law, to be subject to judicial notice. Bulletin F, is a publication of the US Federal Internal Revenue Service, which was made after a study of the lives of the properties. In the words of the lower court: "It contains the list of depreciable assets, the estimated average useful lives thereof and the rates of depreciation allowable for each kind of property. (See 1955 PH Federal Taxes, Par. 14, 160 to Par. 14, 163-0). It is true that Bulletin F has no binding force, but it has a strong persuasive effect considering that the same has been the result of scientific studies and observation for a long period in the United States after whose Income Tax Law ours is patterned." Verily, courts are permitted to look into and investigate the antecedents or the legislative history of the statutes involved (Director of Lands v. Abaya, et al., 63 Phil. 559). Zamora also contends that his basis for applying the 3-½% rate is the testimony of its witness Mariano Katipunan, who cited a book entitled "Hotel Management — Principles and Practice" by Lucius Boomer, President, Hotel Waldorf Astoria Corporation. As well commented by the Solicitor General, "while the petitioner would deny us the right to use Bulletin F, he would insist on using as authority, a book in Hotel management written by a man who knew more about hotels than about taxation. All that the witness did (Katipunan) . . . is to read excerpts from the said book (t.s.n. pp. 99-101), which admittedly were based on the decision of the U.S. Tax Courts, made in 1928 (t.s.n. p. 106)". In view hereof, We hold that the 2-½% rate of depreciation of the Bay View Hotel building, is approximately correct.

The next items in dispute are the undeclared capital gains derived from the sales in 1951 of certain real properties in Malate, Manila and in Quezon City, acquired during the Japanese occupation.

The Manila property (Esperanza Zamora v. Coll. of Int. Rev., Case No. L-15289). The CTA held in this case, that the cost basis of property acquired in Japanese war notes is the equivalent of the war notes in genuine Philippine currency in accordance with the Ballantyne Scale of values, and that the determination of the gain derived or loss sustained in the sale of such property is not affected by the decline at the time of sale, in the purchasing power of the Philippine currency. It was found by the CTA that the purchase price of P132,000.00 was not entirely paid in Japanese War notes but ½ thereof or P66,000.00 was in Philippine currency, and that during certain periods of the enemy occupation, the value of the Japanese war notes was very much less than the value of the genuine Philippine currency. On this point, the CTA declared —

Finally, it is alleged that the purchase price of P132,000.00 was not entirely paid in Japanese war notes, Mariano Zamora, co-owner of the property in question, testified that P66,000.00 was paid in Philippine currency and the other P66,000.00 was paid in Japanese war notes. No evidence was presented by respondent to rebut the testimony of Mariano Zamora; it is assailed merely as being improbable. We have examined this question thoroughly and we are inclined to give credence to the allegation that a portion of the purchase price of the property was paid in Philippine money. In the first place, it appears that the Zamoras owned the Farmacia Zamora which continued to engage in business during the war years and that a considerable portion of its sales was paid for in genuine Philippine currency. This circumstance enabled the Zamoras to accumulate Philippine money which they used in acquiring the property in question and another property in Quezon City. In the second place, P132,000.00 in

Japanese war notes in May, 1944 is equivalent to only P11,000.00. The property in question had at the time an assessed value of P27,031.00 (in Philippine currency). Considering the well known fact that the assessed value of real property is very much below the fair market value, it is incredible that said property should have been sold by the owner thereof for less than one-half of its assessed value. These facts have convinced us of the veracity of the allegation that of the purchase price of P132,000.00 the sum of P66,000.00 was paid in Philippine currency, so that only the sum of P66,000.00 was paid in Japanese War notes.

This being the case, the Ballantyne Scale of values, which was the result of an impartial scientific study, adopted and given judicial recognition, should be applied. As the value of the Japanese war notes in May, 1944 when the Manila property was bought, was 1 ½ of the genuine Philippine Peso (Ballantyne Scale), and since the gain derived or loss sustained in the disposition of this property is to reckoned in terms of Philippine Peso, the value of the Japanese war notes used in the purchase of the property, must be reduced in terms of the genuine Philippine Peso to determine the cost of acquisition. It, therefore, results that since the sum of P66,000.00 in Japanese war notes in May, 1944 is equivalent to P5,500.00 in Philippine currency (P66,000.00 divided by 12), the acquisition cost of the property in question is P66,000.00 plus P5,500.00 or P71,500.00 and that as the property was sold for P75,000.00 in 1951, the owners thereof Mariano and Felicidad Zamora derived a capital gain of P3,500.00 or P1,750.00 each.

The Quezon City Property (Mariano Zamora v. Coll. of Customs, Case No. 15290). The Zamoras alleged that the entire purchase price of P68,959.00 was paid in Philippine currency. The collector, on the other hand, contends that the purchase price of P68,959.00 was paid in Japanese war notes. The CTA, however, giving credence to Zamora's version, said —

. . . If , as contended by respondent, the purchase price of P68,959.00 was paid in Japanese war notes, the purchase price in Philippine currency would be only P17,239.75 (P68,959.00 divided by 4, 34.00 in war notes being equivalent to P1.00 in Philippine currency). The assessed value of said property in Philippine currency at the time of acquisition was P46,910.00. It is quite incredible that real property with an assessed value of P46,910.00 should have been sold by the owner thereof in Japanese war notes with an equivalent value in Philippine currency of only P17,239.75. We are more inclined to believe the allegation that it was purchased for P68,959.00 in genuine Philippine currency. Since the property was sold for P94,000.00 on February 9, 1951, the gain derived from the sale is P15,361.75, after deducting from the selling price the cost of acquisition in the sum of P68,959.00 and the expense of sale in the sum of P9,679.25.

The above appraisal is correct, and We have no plausible reason to disturb the same.

Consequently, the total undeclared income of petitioners derived from the sales of the Manila and Quezon City properties in 1951 is P17,111.75 (P1,750.00 plus P15,361.75), 50% of which in the sum of P8,555.88 is taxable, the said properties being capital assets held for more than one year.

IN VIEW HEREOF, the petition in each of the above-entitled cases is dismissed, and the decision appealed from is affirmed, without special pronouncement as to costs.

G.R. No. 148187 April 16, 2008

PHILEX MINING CORPORATION, petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, respondent.

D E C I S I O N

YNARES-SANTIAGO, J.:

This is a petition for review on certiorari of the June 30, 2000 Decision1 of the Court of Appeals in CA-G.R. SP No. 49385, which affirmed the Decision2 of the Court of Tax Appeals in C.T.A. Case No. 5200. Also assailed is the April 3, 2001 Resolution3 denying the motion for reconsideration.

The facts of the case are as follows:

On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into an agreement4 with Baguio Gold Mining Company ("Baguio Gold") for the former to manage and operate the latter’s mining claim, known as the Sto. Nino mine, located in Atok and Tublay, Benguet Province. The parties’ agreement was denominated as "Power of Attorney" and provided for the following terms:





4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall make available to the MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS (P11,000,000.00), in such amounts as from time to time may be required by the MANAGERS within the said 3-year period, for use in the MANAGEMENT of the STO. NINO MINE. The said ELEVEN MILLION PESOS (P11,000,000.00) shall be deemed, for internal audit purposes, as the owner’s account in the Sto. Nino PROJECT. Any part of any income of the PRINCIPAL from the STO. NINO MINE, which is left with the Sto. Nino PROJECT, shall be added to such owner’s account.

5. Whenever the MANAGERS shall deem it necessary and convenient in connection with the MANAGEMENT of the STO. NINO MINE, they may transfer their own funds or property to the Sto. Nino PROJECT, in accordance with the following arrangements:

(a) The properties shall be appraised and, together with the cash, shall be carried by the Sto. Nino PROJECT as a special fund to be known as the MANAGERS’ account.

(b) The total of the MANAGERS’ account shall not exceed P11,000,000.00, except with prior approval of the PRINCIPAL; provided, however, that if the compensation of the MANAGERS as herein provided cannot be paid in cash from the Sto. Nino PROJECT, the amount not so paid in cash shall be added to the MANAGERS’ account.

(c) The cash and property shall not thereafter be withdrawn from the Sto. Nino PROJECT until termination of this Agency.

(d) The MANAGERS’ account shall not accrue interest. Since it is the desire of the PRINCIPAL to extend to the MANAGERS the benefit of subsequent appreciation of property, upon a projected termination of this Agency, the ratio which the MANAGERS’ account has to the owner’s account will be determined, and the corresponding proportion of the entire assets of the STO. NINO MINE, excluding the claims, shall be transferred to the MANAGERS, except that such transferred assets shall not include mine development, roads, buildings, and similar property which will be valueless, or of slight value, to the MANAGERS. The MANAGERS can, on the other hand, require at their option that property originally transferred by them to the Sto. Nino PROJECT be re-transferred to them. Until such assets are transferred to the MANAGERS, this Agency shall remain subsisting.

x x x x

12. The compensation of the MANAGER shall be fifty per cent (50%) of the net profit of the Sto. Nino PROJECT before income tax. It is understood that the MANAGERS shall pay income tax on their compensation, while the PRINCIPAL shall pay income tax on the net profit of the Sto. Nino PROJECT after deduction therefrom of the MANAGERS’ compensation.

x x x x

16. The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS and, in the future, may incur other obligations in favor of the MANAGERS. This Power of Attorney has been executed as security for the payment and satisfaction of all such obligations of the PRINCIPAL in favor of the MANAGERS and as a means

to fulfill the same. Therefore, this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS’ account. After all obligations of the PRINCIPAL in favor of the MANAGERS have been paid and satisfied in full, this Agency shall be revocable by the PRINCIPAL upon 36-month notice to the MANAGERS.

17. Notwithstanding any agreement or understanding between the PRINCIPAL and the MANAGERS to the contrary, the MANAGERS may withdraw from this Agency by giving 6-month notice to the PRINCIPAL. The MANAGERS shall not in any manner be held liable to the PRINCIPAL by reason alone of such withdrawal. Paragraph 5(d) hereof shall be operative in case of the MANAGERS’ withdrawal.

x x x x5

In the course of managing and operating the project, Philex Mining made advances of cash and property in accordance with paragraph 5 of the agreement. However, the mine suffered continuing losses over the years which resulted to petitioner’s withdrawal as manager of the mine on January 28, 1982 and in the eventual cessation of mine operations on February 20, 1982.6

Thereafter, on September 27, 1982, the parties executed a "Compromise with Dation in Payment"7 wherein Baguio Gold admitted an indebtedness to petitioner in the amount of P179,394,000.00 and agreed to pay the same in three segments by first assigning Baguio Gold’s tangible assets to petitioner, transferring to the latter Baguio Gold’s equitable title in its Philodrill assets and finally settling the remaining liability through properties that Baguio Gold may acquire in the future.




On December 31, 1982, the parties executed an "Amendment to Compromise with Dation in Payment"8 where the parties determined that Baguio Gold’s indebtedness to petitioner actually amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other creditors that petitioner had assumed as guarantor. These liabilities pertained to long-term loans amounting to US$11,000,000.00 contracted by Baguio Gold from the Bank of America NT & SA and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two segments by first assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a remaining outstanding indebtedness to petitioner in the amount of P114,996,768.00.

Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding indebtedness of Baguio Gold by charging P112,136,000.00 to allowances and reserves that were set up in 1981 and P2,860,768.00 to the 1982 operations.

In its 1982 annual income tax return, petitioner deducted from its gross income the amount of P112,136,000.00 as "loss on settlement of receivables from Baguio Gold against reserves and allowances."9 However, the Bureau of Internal Revenue (BIR) disallowed the amount as deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39.

Petitioner protested before the BIR arguing that the deduction must be allowed since all requisites for a bad debt deduction were satisfied, to wit: (a) there was a valid and existing debt; (b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable year when it was determined to be worthless.



Petitioner emphasized that the debt arose out of a valid management contract it entered into with Baguio Gold. The bad debt deduction represented advances made by petitioner which, pursuant to the management contract, formed part of Baguio Gold’s "pecuniary obligations" to petitioner. It also included payments made by petitioner as guarantor of Baguio Gold’s long-term loans which legally entitled petitioner to be subrogated to the rights of the original creditor.

Petitioner also asserted that due to Baguio Gold’s irreversible losses, it became evident that it would not be able to recover the advances and payments it had made in behalf of Baguio Gold. For a debt to be considered worthless, petitioner claimed that it was neither required to institute a judicial action for collection against the debtor nor to sell or dispose of collateral assets in satisfaction of the debt. It is enough that a taxpayer exerted diligent efforts to enforce collection and exhausted all reasonable means to collect.

On October 28, 1994, the BIR denied petitioner’s protest for lack of legal and factual basis. It held that the alleged debt was not ascertained to be worthless since Baguio Gold remained existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a valid and subsisting debt considering that, under the management contract, petitioner was to be paid fifty percent (50%) of the project’s net profit.10

Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment, as follows:

WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby DENIED for lack of merit. The assessment in question, viz: FAS-1-82-88-003067 for deficiency income tax in the amount of P62,811,161.39 is hereby AFFIRMED.


ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to PAY respondent Commissioner of Internal Revenue the amount of P62,811,161.39, plus, 20% delinquency interest due computed from February 10, 1995, which is the date after the 20-day grace period given by the respondent within which petitioner has to pay the deficiency amount x x x up to actual date of payment.

SO ORDERED.11

The CTA rejected petitioner’s assertion that the advances it made for the Sto. Nino mine were in the nature of a loan. It instead characterized the advances as petitioner’s investment in a partnership with Baguio Gold for the development and exploitation of the Sto. Nino mine. The CTA held that the "Power of Attorney" executed by petitioner and Baguio Gold was actually a partnership agreement. Since the advanced amount partook of the nature of an investment, it could not be deducted as a bad debt from petitioner’s gross income.

The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of Baguio Gold could not be allowed as a bad debt deduction. At the time the payments were made, Baguio Gold was not in default since its loans were not yet due and demandable. What petitioner did was to pre-pay the loans as evidenced by the notice sent by Bank of America showing that it was merely demanding payment of the installment and interests due. Moreover, Citibank imposed and collected a "pre-termination penalty" for the pre-payment.

The Court of Appeals affirmed the decision of the CTA.12 Hence, upon denial of its motion for reconsideration,13 petitioner took this recourse under Rule 45 of the Rules of Court, alleging that:




I.

The Court of Appeals erred in construing that the advances made by Philex in the management of the Sto. Nino Mine pursuant to the Power of Attorney partook of the nature of an investment rather than a loan.

II.

The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of the Sto. Nino Mine indicates that Philex is a partner of Baguio Gold in the development of the Sto. Nino Mine notwithstanding the clear absence of any intent on the part of Philex and Baguio Gold to form a partnership.

III.

The Court of Appeals erred in relying only on the Power of Attorney and in completely disregarding the Compromise Agreement and the Amended Compromise Agreement when it construed the nature of the advances made by Philex.

IV.

The Court of Appeals erred in refusing to delve upon the issue of the propriety of the bad debts write-off.14

Petitioner insists that in determining the nature of its business relationship with Baguio Gold, we should not only rely on the "Power of Attorney", but also on the subsequent "Compromise with Dation in Payment" and "Amended


Compromise with Dation in Payment" that the parties executed in 1982. These documents, allegedly evinced the parties’ intent to treat the advances and payments as a loan and establish a creditor-debtor relationship between them.

The petition lacks merit.

The lower courts correctly held that the "Power of Attorney" is the instrument that is material in determining the true nature of the business relationship between petitioner and Baguio Gold. Before resort may be had to the two compromise agreements, the parties’ contractual intent must first be discovered from the expressed language of the primary contract under which the parties’ business relations were founded. It should be noted that the compromise agreements were mere collateral documents executed by the parties pursuant to the termination of their business relationship created under the "Power of Attorney". On the other hand, it is the latter which established the juridical relation of the parties and defined the parameters of their dealings with one another.

The execution of the two compromise agreements can hardly be considered as a subsequent or contemporaneous act that is reflective of the parties’ true intent. The compromise agreements were executed eleven years after the "Power of Attorney" and merely laid out a plan or procedure by which petitioner could recover the advances and payments it made under the "Power of Attorney". The parties entered into the compromise agreements as a consequence of the dissolution of their business relationship. It did not define that relationship or indicate its real character.

An examination of the "Power of Attorney" reveals that a partnership or joint venture was indeed intended by the parties. Under a contract of partnership, two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves.15 While a corporation, like


petitioner, cannot generally enter into a contract of partnership unless authorized by law or its charter, it has been held that it may enter into a joint venture which is akin to a particular partnership:

The legal concept of a joint venture is of common law origin. It has no precise legal definition, but it has been generally understood to mean an organization formed for some temporary purpose. x x x It is in fact hardly distinguishable from the partnership, since their elements are similar – community of interest in the business, sharing of profits and losses, and a mutual right of control. x x x The main distinction cited by most opinions in common law jurisdictions is that the partnership contemplates a general business with some degree of continuity, while the joint venture is formed for the execution of a single transaction, and is thus of a temporary nature. x x x This observation is not entirely accurate in this jurisdiction, since under the Civil Code, a partnership may be particular or universal, and a particular partnership may have for its object a specific undertaking. x x x It would seem therefore that under Philippine law, a joint venture is a form of partnership and should be governed by the law of partnerships. The Supreme Court has however recognized a distinction between these two business forms, and has held that although a corporation cannot enter into a partnership contract, it may however engage in a joint venture with others. x x x (Citations omitted) 16

Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties had intended to create a partnership and establish a common fund for the purpose. They also had a joint interest in the profits of the business as shown by a 50-50 sharing in the income of the mine.


Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money, property and industry to the common fund known as the Sto. Niño mine.17 In this regard, we note that there is a substantive equivalence in the respective contributions of the parties to the development and operation of the mine. Pursuant to paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were to contribute equally to the joint venture assets under their respective accounts. Baguio Gold would contribute P11M under its owner’s account plus any of its income that is left in the project, in addition to its actual mining claim. Meanwhile, petitioner’s contribution would consist of its expertise in the management and operation of mines, as well as the manager’s account which is comprised of P11M in funds and property and petitioner’s "compensation" as manager that cannot be paid in cash.

However, petitioner asserts that it could not have entered into a partnership agreement with Baguio Gold because it did not "bind" itself to contribute money or property to the project; that under paragraph 5 of the agreement, it was only optional for petitioner to transfer funds or property to the Sto. Niño project "(w)henever the MANAGERS shall deem it necessary and convenient in connection with the MANAGEMENT of the STO. NIÑO MINE."18

The wording of the parties’ agreement as to petitioner’s contribution to the common fund does not detract from the fact that petitioner transferred its funds and property to the project as specified in paragraph 5, thus rendering effective the other stipulations of the contract, particularly paragraph 5(c) which prohibits petitioner from withdrawing the advances until termination of the parties’ business relations. As can be seen, petitioner became bound by its contributions once the transfers were made. The contributions acquired an obligatory nature as soon as petitioner had chosen to exercise its option under paragraph 5.



There is no merit to petitioner’s claim that the prohibition in paragraph 5(c) against withdrawal of advances should not be taken as an indication that it had entered into a partnership with Baguio Gold; that the stipulation only showed that what the parties entered into was actually a contract of agency coupled with an interest which is not revocable at will and not a partnership.

In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the principal due to an interest of a third party that depends upon it, or the mutual interest of both principal and agent.19 In this case, the non-revocation or non-withdrawal under paragraph 5(c) applies to the advances made by petitioner who is supposedly the agent and not the principal under the contract. Thus, it cannot be inferred from the stipulation that the parties’ relation under the agreement is one of agency coupled with an interest and not a partnership.

Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the parties was one of agency and not a partnership. Although the said provision states that "this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS’ account," it does not necessarily follow that the parties entered into an agency contract coupled with an interest that cannot be withdrawn by Baguio Gold.

It should be stressed that the main object of the "Power of Attorney" was not to confer a power in favor of petitioner to contract with third persons on behalf of Baguio Gold but to create a business relationship between petitioner and Baguio Gold, in which the former was to manage and operate the latter’s mine through the parties’ mutual contribution of material resources and industry. The essence of an agency, even one that is coupled with interest, is the agent’s


ability to represent his principal and bring about business relations between the latter and third persons.20 Where representation for and in behalf of the principal is merely incidental or necessary for the proper discharge of one’s paramount undertaking under a contract, the latter may not necessarily be a contract of agency, but some other agreement depending on the ultimate undertaking of the parties.21

In this case, the totality of the circumstances and the stipulations in the parties’ agreement indubitably lead to the conclusion that a partnership was formed between petitioner and Baguio Gold.

First, it does not appear that Baguio Gold was unconditionally obligated to return the advances made by petitioner under the agreement. Paragraph 5 (d) thereof provides that upon termination of the parties’ business relations, "the ratio which the MANAGER’S account has to the owner’s account will be determined, and the corresponding proportion of the entire assets of the STO. NINO MINE, excluding the claims" shall be transferred to petitioner.22 As pointed out by the Court of Tax Appeals, petitioner was merely entitled to a proportionate return of the mine’s assets upon dissolution of the parties’ business relations. There was nothing in the agreement that would require Baguio Gold to make payments of the advances to petitioner as would be recognized as an item of obligation or "accounts payable" for Baguio Gold.

Thus, the tax court correctly concluded that the agreement provided for a distribution of assets of the Sto. Niño mine upon termination, a provision that is more consistent with a partnership than a creditor-debtor relationship. It should be pointed out that in a contract of loan, a person who receives a loan or money or any fungible thing acquires ownership thereof and is bound to pay the creditor an equal amount of the same kind and quality.23 In this case, however, there





was no stipulation for Baguio Gold to actually repay petitioner the cash and property that it had advanced, but only the return of an amount pegged at a ratio which the manager’s account had to the owner’s account.

In this connection, we find no contractual basis for the execution of the two compromise agreements in which Baguio Gold recognized a debt in favor of petitioner, which supposedly arose from the termination of their business relations over the Sto. Nino mine. The "Power of Attorney" clearly provides that petitioner would only be entitled to the return of a proportionate share of the mine assets to be computed at a ratio that the manager’s account had to the owner’s account. Except to provide a basis for claiming the advances as a bad debt deduction, there is no reason for Baguio Gold to hold itself liable to petitioner under the compromise agreements, for any amount over and above the proportion agreed upon in the "Power of Attorney".

Next, the tax court correctly observed that it was unlikely for a business corporation to lend hundreds of millions of pesos to another corporation with neither security, or collateral, nor a specific deed evidencing the terms and conditions of such loans. The parties also did not provide a specific maturity date for the advances to become due and demandable, and the manner of payment was unclear. All these point to the inevitable conclusion that the advances were not loans but capital contributions to a partnership.

The strongest indication that petitioner was a partner in the Sto Niño mine is the fact that it would receive 50% of the net profits as "compensation" under paragraph 12 of the agreement. The entirety of the parties’ contractual stipulations simply leads to no other conclusion than that petitioner’s "compensation" is actually its share in the income of the joint venture.

Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in the profits of a business is prima facie evidence that he is a partner in the business." Petitioner asserts, however, that no such inference can be drawn against it since its share in the profits of the Sto Niño project was in the nature of compensation or "wages of an employee", under the exception provided in Article 1769 (4) (b).24

On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold who will be paid "wages" pursuant to an employer-employee relationship. To begin with, petitioner was the manager of the project and had put substantial sums into the venture in order to ensure its viability and profitability. By pegging its compensation to profits, petitioner also stood not to be remunerated in case the mine had no income. It is hard to believe that petitioner would take the risk of not being paid at all for its services, if it were truly just an ordinary employee.

Consequently, we find that petitioner’s "compensation" under paragraph 12 of the agreement actually constitutes its share in the net profits of the partnership. Indeed, petitioner would not be entitled to an equal share in the income of the mine if it were just an employee of Baguio Gold.25 It is not surprising that petitioner was to receive a 50% share in the net profits, considering that the "Power of Attorney" also provided for an almost equal contribution of the parties to the St. Nino mine. The "compensation" agreed upon only serves to reinforce the notion that the parties’ relations were indeed of partners and not employer-employee.

All told, the lower courts did not err in treating petitioner’s advances as investments in a partnership known as the Sto. Nino mine. The advances were not "debts" of Baguio Gold to petitioner inasmuch as the latter was under no unconditional obligation to return the same to the former under the "Power of Attorney". As for the amounts that



petitioner paid as guarantor to Baguio Gold’s creditors, we find no reason to depart from the tax court’s factual finding that Baguio Gold’s debts were not yet due and demandable at the time that petitioner paid the same. Verily, petitioner pre-paid Baguio Gold’s outstanding loans to its bank creditors and this conclusion is supported by the evidence on record.26

In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income. Deductions for income tax purposes partake of the nature of tax exemptions and are strictly construed against the taxpayer, who must prove by convincing evidence that he is entitled to the deduction claimed.27 In this case, petitioner failed to substantiate its assertion that the advances were subsisting debts of Baguio Gold that could be deducted from its gross income. Consequently, it could not claim the advances as a valid bad debt deduction.

WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in CA-G.R. SP No. 49385 dated June 30, 2000, which affirmed the decision of the Court of Tax Appeals in C.T.A. Case No. 5200 is AFFIRMED. Petitioner Philex Mining Corporation is ORDERED to PAY the deficiency tax on its 1982 income in the amount of P62,811,161.31, with 20% delinquency interest computed from February 10, 1995, which is the due date given for the payment of the deficiency income tax, up to the actual date of payment.



G.R. No. L-22265 December 22, 1967

COLLECTOR OF INTERNAL REVENUE, petitioner, vs.GOODRICH INTERNATIONAL RUBBER CO., respondent.

Manuel O. Chan for respondent.Manuel O. Chan for respondent.

CONCEPCION, C.J.:

Appeal by the Government from a decision of the Court of Tax Appeals, setting aside the assessments made by the Commissioner of Internal Revenue, in the sums of P14,128.00 and P8,439.00, as deficiency income taxes allegedly due from respondent Goodrich International Rubber Company — hereinafter referred to as Goodrich — for the years 1951 and 1952, respectively.

These assessments were based on disallowed deductions, claimed by Goodrich, consisting of several alleged bad debts, in the aggregate sum of P50,455.41, for the year 1951, and the sum of P30,138.88, as representation expenses allegedly incurred in the year 1952. Goodrich had appealed from said assessments to the Court of Tax Appeals, which, after appropriate proceedings, rendered, on June 8, 1963, a decision allowing the deduction for bad debts, but disallowing the alleged representation expenses. On motion for reconsideration and new trial, filed by Goodrich, on November 19,

1963, the Court of Tax Appeals amended its aforementioned decision and allowed said deductions for representation expenses. Hence, this appeal by the Government.

The alleged representation expenses are:

1. Expenses at Elks Club P10,959.21

2. Manila Polo Club 4,947.35

3. Army and Navy Club 2,812.95

4. Manila Golf Club 4,478.45

5. Wack Wack Golf Club, Casino Español, etc.

6,940.92

T O T A L P30,138.88

The claim for deduction thereof is based upon receipts issued, not by the entities in which the alleged expenses had been incurred, but by the officers of Goodrich who allegedly paid them.

The claim must be rejected. If the expenses had really been incurred, receipts or chits would have been issued by the entities to which the payments had been made, and it would have been easy for Goodrich or its officers to produce such

receipts.lawphil These issued by said officers merely attest to their claim that they had incurred and paid said expenses. They do not establish payment of said alleged expenses to the entities in which the same are said to have been incurred. The Court of Tax Appeals erred, therefore, in allowing the deduction thereof.

The alleged bad debts are:

1. Portillo's Auto Seat Cover P630.31

2. Visayan Rapid Transit 17,810.26

3. Bataan Auto Seat Cover 373.13

4. Tres Amigos Auto Supply 1,370.31

5. P. C. Teodorolawphil 650.00

6. Ordnance Service, P.A. 386.42

7. Ordnance Service, P.C. 796.26

8. National land Settlement Administration

3,020.76

9. National Coconut Corporation 644.74

10. Interior Caltex Service Station

1,505.87

11. San Juan Auto Supply 4,530.64

12. P A C S A 45.36

13. Philippine Naval Patrol 14.18

14. Surplus Property Commission

277.68

15. Alverez Auto Supply 285.62

16. Lion Shoe Store 1,686.93

17. Ruiz Highway Transit 2,350.00

18. Esquire Auto Seat Cover 3,536.94

T O T A L P50,455.41*

The issue, in connection with these debts is whether or not the same had been properly deducted as bad debts for the year 1951. In this connection, we find:

Portillo's Auto Seat Cover (P730.00):

This debt was incurred in 1950. In 1951, the debtor paid P70.00, leaving a balance of P630.31. That same year, the account was written off as bad debt (Exhibit 3-C-4). Counsel for Goodrich had merely sent two (2) letters of demand in 1951 (Exh. B-14). In 1952, the debtor paid the full balance (Exhibit A).

Visayan Rapid Transit (P17,810.26):

This debt was, also, incurred in 1950. In 1951, it was charged off as bad debt, after the debtor had paid P275.21. No other payment had been made.lawphil Taxpayer's Accountant testified that, according to its branch manager in Cebu, he had been unable to collect the balance. The debtor had merely promised and kept on promising to pay. Taxpayer's counsel stated that the debtor had gone out of business and became insolvent, but no proof to this effect. was introduced.

Bataan Auto Seat Cover (P373.13):

This is the balance of a debt of P474.13 contracted in 1949. In 1951, the debtor paid P100.00. That same year, the balance of P373.13 was charged off as bad debt. The next year, the debtor paid the additional sum of P50.00.

Tres Amigos Auto Supply (P1,370.31):

This account had been outstanding since 1949. Counsel for the taxpayer had merely sent demand letters (Exh. B-13) without success.

P. C. Teodoro (P650.00):

In 1949, the account was P751.91. In 1951, the debtor paid P101.91, thus leaving a balance of P650.00, which the taxpayer charged off as bad debt in the same year. In 1952, the debtor made another payment of P150.00.

Ordinance Service, P.A. (P386.42):

In 1949, the outstanding account of this government agency was P817.55. Goodrich's counsel sent demand letters (Exh. B-8). In 1951, it paid Goodrich P431.13. The balance of P386.42 was written off as bad debt that same year.

Ordinance Service, P.C. (P796.26):

In 1950, the account was P796.26.lawphil It was referred to counsel for collection. In 1951, the account was written off as a debt. In 1952, the debtor paid it in full.

National Land Settlement Administration (P3,020.76):

The outstanding account in 1949 was P7,041.51. Collection letters were sent (Exh. B-7). In 1951, the debtor paid P4,020.75, leaving a balance of P3,020.76, which was written off, that same year, as a bad debt. This office was under liquidation, and its Board of Liquidators promised to pay when funds shall become available.

National Coconut Corporation (P644.74):

This account had been outstanding since 1949. Collection letters were sent (Exh. B-12) without success. It was written off as bad debt in 1951, while the corporation was under a Board of Liquidators, which promised to pay upon availability of funds. In 1961, the debt was fully paid.

Interior Caltex Service Station (P1,505.87):

The original account was P2,705.87, when, in 1950, it was turned over for collection to counsel for Goodrich (p. 156, CTA Records). Counsel began sending letters of collection in April 1950. Interior Caltex made partial payments, so that as of December, 1951, the balance outstanding was P1,505.87.lawphil.net The debtor paid P200, in 1952; P113.20, in 1954; P750.00, in 1961; and P300.00.00 in 1962. The account had been written off as bad debt in 1951.

The claim for deduction of these ten (10) debts should be rejected. Goodrich has not established either that the debts are actually worthless or that it had reasonable grounds to believe them to be so in 1951. Our statute permits the deduction of debts "actually ascertained to be worthless within the taxable year," obviously to prevent arbitrary action by the taxpayer, to unduly avoid tax liability.

The requirement of ascertainment of worthlessness requires proof of two facts: (1) that the taxpayer did in fact ascertain the debt to be worthlessness, in the year for which the deduction is sought; and (2) that, in so doing, he acted in good faith.1

Good faith on the part of the taxpayer is not enough. He must show, also, that he had reasonably investigated the relevant facts and had drawn a reasonable inference from the information thus obtained by him.2 Respondent herein has not adequately made such showing.

The payments made, some in full, after some of the foregoing accounts had been characterized as bad debts, merely stresses the undue haste with which the same had been written off. At any rate, respondent has not proven that said debts were worthless. There is no evidence that the debtors can not pay them.lawphil.net It should be noted also that, in violation of Revenue Regulations No. 2, Section 102, respondent had not attached to its income tax returns a statement showing the propriety of the deductions therein made for alleged bad debts.

Upon the other hand, we find that the following accounts were properly written off:

San Juan Auto Supply (P4,530.64):

This account was contracted in 1950. Referred, for collection, to respondent's counsel, the latter secured no payment. In November, 1950, the corresponding suit for collection was filed (Exh. C). The debtor's counsel was allowed to withdraw, as such, the debtor having failed to meet him. In fact, the debtor did not appear at the hearing of the case.lawphil.net Judgment was rendered in 1951 for the creditor (Exh. C-2). The corresponding writ of execution (Exh. C-3) was returned unsatisfied, for no properties could be attached or levied upon.

PACSA (P45.36),

Philippine Naval Patrol (P14.18),

Surplus Property Commission

(P277.68),

Alvarez Auto Supply (P285.62):

These four (4) accounts were 2 or 3 years old in 1951. After the collectors of the creditor had failed to collect the same, its counsel wrote letters of demand (Exhs. B-10, B-11, B-6 and B-2) to no avail. Considering the small amounts involved in these accounts, the taxpayer was justified in feeling that the unsuccessful efforts therefore exerted to collect the same sufficed to warrant their being written off.3

Lion Shoe Store (P11,686.93),

Ruiz Highway Transit (P2,350.00), and

Esquire Auto Seat Cover (P3,536.94):

These three (3) accounts were among those referred to counsel for Goodrich for collection. Up to 1951, when they were written off, counsel had sent 17 Letters of demand to Lion Shoe Store (Exh. B); 16 demand letters to Ruiz Highway

Transit (Exh. B-1); and 6 letters of demand to Esquire Auto Seat Cover (Exit. B-5) In 1951, Lion Shoe Store, Ruiz Highway Transit, and Esquire Auto Seat Cover had made partial payments in the sums of P1,050.00, P400.00, and P300.00 respectively. Subsequent to the write-off, additional small payments were made and accounted for as income of Goodrich. Counsel interviewed the debtors, investigated their ability to pay and threatened law suits. He found that the debtors were in strained financial condition and had no attachable or leviable property. Moreover, Lion Shoe Store was burned twice, in 1948 and 1949. Thereafter, it continued to do business on limited scale. Later; it went out of business. Ruiz Highway Transit, had more debts than assets. Counsel, therefore, advised respondent to write off these accounts as bad debts without going to court, for it would be "foolish to spend good money after bad."

The deduction of these eight (8) accounts, aggregating P22,627.35, as bad debts should be allowed.

WHEREFORE, the decision appealed from should be, as it is hereby, modified, in the sense that respondent's alleged representation expenses are totally disallowed, and its claim for bad debts allowed up to the sum of P22,627.35 only. Without special pronouncement as to costs. It is so ordered.

G.R. No. L-22265 March 27, 1968

COLLECTOR OF INTERNAL REVENUE, petitioner, vs.GOODRICH INTERNATIONAL RUBBER CO., respondent.

Office of the Solicitor General for petitioner.Manuel O. Chan for respondent.

R E S O L U T I O N

REYES, J.B.L., :

In the decision of December 22, 1967, this Court modified that of the Court of Tax Appeals, and ruled that respondent's alleged representation expenses were fully taxable; it also reduced the claim for bad debts up to P22,627.35 only.

Petitioner-appellant Collector of Internal Revenue has now filed a motion for reconsideration praying that the Court order also the payment by respondent of 5% surcharge and 1% monthly interest as provided in section 51(e) of the National Internal Revenue Code (before it was amended by Republic Act No. 2343). The respondent Goodrich International Rubber Co. opposes this motion on the ground that this claim for surcharge and monthly interest was not specifically pointed out in petitioner's assignment of errors.

It appearing, however, that the imposition of the 5% surcharge and 1% monthly interest is required expressly by the statute, the Court believes that the failure to assign it as error should not be an obstacle to its imposition where proper, considering that "taxes are the lifeblood of the government and their prompt and certain availability an imperious need" (Bull v. U.S., 79 L. Ed. 1421, 1427).

Finding the motion for reconsideration meritorious, the dispositive part of our main decision is hereby modified by adding a paragraph reading as follows:

The respondent is therefore ordered:

(1) To pay the sum of P8,439.00, as deficiency income tax for 1952, plus the 5% surcharge and 1% monthly interest thereon from July 20, 1956 until full payment thereof; and

(2) To pay the sum of P7,612.66 as deficiency income tax for 1951, plus the 5% surcharge and 1% monthly interest, thereon from December 29, 1957 until full payment thereof.

G.R. No. L-21551 September 30, 1969

FERNANDEZ HERMANOS, INC., petitioner, vs.COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

-----------------------------


COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.FERNANDEZ HERMANOS, INC., and COURT OF TAX APPEALS, respondents.

-----------------------------


COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.FERNANDEZ HERMANOS INC., and the COURT OF TAX APPEALS, respondents.

-----------------------------


FERNANDEZ HERMANOS, INC., petitioner, vs.THE COMMISSIONER OF INTERNAL REVENUE, and HON. ROMAN A. UMALI, COURT OF TAX APPEALS, respondents.

L-21551:

Rafael Dinglasan for petitioner.Office of the Solicitor General Arturo A. Alafriz, Solicitor Alejandro B. Afurong and Special Attorney Virgilio G. Saldajeno for respondent.

L-21557:

Office of the Solicitor General for petitioner.Rafael Dinglasan for respondent Fernandez Hermanos, Inc.

L-24972:

Office of the 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.

L-24978:

Rafael Dinglasan for petitioner.Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Antonio G. Ibarra and Special Attorney Virgilio G. Saldajeno for respondent.

TEEHANKEE, J.:

These four appears 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 L-21551 and L-21557

The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation 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 Manganese Mines, Inc. (1951) 353,134.25

c. Losses in Balamban Coal Mines —

1950 8,989.761951 27,732.66

d. Losses in Hacienda Dalupiri —

1950 17,418.95

1951 29,125.821952 26,744.811953 21,932.621954 42,938.56

e. Losses in Hacienda Samal —

1951 8,380.251952 7,621.73

2. Excessive depreciation of Houses —

1950 P 8,180.401951 8,768.111952 18,002.161953 13,655.251954 29,314.98

3. Taxable increase in net worth —

1950 P 30,050.00

1951 1,382.85

4. Gain realized from sale of real property in 1950 P 11,147.2611

The Tax Court sustained the Commissioner's disallowances of Item 1, sub-items (b) and (e) and Item 2 of the above summary, but overruled the Commissioner's 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 P2,748.001951 108,724.001952 3,600.001953 2,501.001954 5,863.00

Total P123,436.00

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 deficiency 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 eased to operate, it had no assets, in other words, completely insolvent. This information as to the insolvency of the Company — reached (the

taxpayer) in 1950," when it properly claimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30 (e) (3) of the National Internal Revenue Code. 2

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 it 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.

"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. H-2)

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 pre-war assets. (t.s.n., pp. 136-139, 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 Mine 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.

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

The Tax Court's disallowance of the write-off 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 bad debts but insists that it is either a loss or a bad debt." 4 We sustain the government's position that the advances made by the taxpayer to its 100% subsidiary, Palawan Manganese Mines, Inc. amounting to P587,308,07 as of 1951 were investments and not loans. 5 The evidence on record shows that the board of 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's balance sheet as its investment in its subsidiary company. 6 This fact explains the liberality with which the taxpayer made such large advances to the subsidiary, despite the latter's admittedly poor financial condition.

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 alleged 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 for the purpose of paying the wages of the laborers who needed help." 7 The correctness of the Tax Court's ruling in sustaining the disallowance of the write-off in 1951 of the taxpayer's claimed losses is borne out by subsequent events shown in Cases L-24972 and L-24978 involving the taxpayer'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 1, 1956 that the subsidiary decided to cease operations. 8

(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 in 1950 and 1951, when they were still in operation." 9 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 from 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 appealed judgment.

(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). — The Tax Court overruled the Commissioner's disallowance of 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.1awphîl.nèt

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 non-business purposes. Therefore, it is

entitled to deduct expenses and losses in connection with the operation of said farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939-1, 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:

"If 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 21-22, 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. The same is true with respect to loss sustained in the operation of the Hacienda Samal for the years 1951 and 1952. 10

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 ... which merely consisted of an alleged physical count of the number of the livestock in Hacienda Dalupiri for the years involved." 11

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 (1950-1954). — 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 contention that it has many zero or one-peso assets, 12 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 (1950-1951). — The Tax Court set aside the Commissioner's treatment as taxable 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 319,750.00, 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. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 & L-11558, 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 P1,382.85) remained in petitioner's books as outstanding liabilities of trade creditors. These 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 was not the result of receipt by petitioner of taxable income." 13 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 all 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 for P11,852.74, and was sold in 1950 for P60,000.00, apparently, resulting in a gain of P48,147.26. 14 The taxpayer reported in its return a gain of P37,000.00, or a discrepancy of P11,147.26. 15 It was sufficiently proved from the taxpayer's books that after acquiring the property, the taxpayer had made improvements totalling P11,147.26, 16 accounting for the apparent discrepancy in the reported gain. In other words, this figure added to the original acquisition cost of P11,852.74 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 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 for review wherein payment of the tax is prayed for." 17 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. 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 five-year period to effect collection by judicial action counted from the date of assessment.

Cases L-24972 and L-24978

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 P29,178.70Add: Unallowable deductions:(1) Net loss claimed on Ha. Dalupiri 89,547.33(2) Amortization of Contractual right claimed as an expense under Mines Operations 48,481.62

Net income per investigation P167,297.65Tax due thereon 38,818.00

Less: Amount already assessed 5,836.00B a l a n c e P32,982.00Add: 1/2% monthly interest from 6-20-59 to 6-20-62 5,936.76TOTAL AMOUNT DUE AND COLLECTIBLE P38,918.76 18

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

Both parties again appealed from the respective adverse rulings against them in the Tax Court's decision.

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.

... 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 Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 12.08, p. 26.) 20

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., during 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 P442,895.23." (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 evaluation 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. E-1, 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 as worth P97,636.96; and (2) that the alleged amortization of "contractual rights" is not allowed by the Revenue Code.

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. — ... (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, ... 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 one-fifth (1/5) of 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 above-quoted.

x x x x x 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. 31-32, 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 it 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 disallowance of the alleged "contractual rights" amounting to P48,481.62 must therefore be sustained. 21

The taxpayer insists in this appeal that it could use as a method for depletion under the pertinent provision of the Tax Code its "capital investment," representing the alleged value of its contractual rights and titles to mining claims in the sum of P242,408.10 and thus deduct outright one-fifth (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 the estimated cost of the reserve used up is allowed." 22 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 ... 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. L-21551 and L-21557, 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. L-24972 and L-24978 is affirmed in toto. No costs. So ordered.

G.R. No. L-19537 May 20, 1965

The late LINO GUTIERREZ substituted by ANDREA C. VDA. DE GUTIERREZ, ANTONIO D. GUTIERREZ, GUILLERMO D. GUTIERREZ, SANTIAGO D. GUTIERREZ and TOMAS D. GUTIERREZ,petitioners, vs.COLLECTOR (now COMMISSIONER) OF INTERNAL REVENUE, respondent.

Rosendo J. Tansinsin, Sr., Rosendo Tansinsin, Jr. and Juan C. Nabong, Jr.for petitioners.Office of the Solicitor General for respondent.

BENGZON, J.P., J.:

Lino Gutierrez was primarily engaged in the business of leasing real property for which he paid estate broker's privilege tax. He filed his income tax returns for the years 1951, 1952, 1953 and 1954 on the following dates:

Year Date Filed

1951 March 1, 1952

1952 February 28, 1953

1953 February 22, 1954

1954 February 23, 1955

and paid the corresponding tax declared therein.

On July 10, 1956 the Commissioner (formerly Collector) of Internal Revenue assessed against Gutierrez the following defiency income tax:

1951 . . . . . . . . . . . . . . P 1,400.00

1952 . . . . . . . . . . . . . . 672.00

1953 . . . . . . . . . . . . . . 5,161.00

1954 . . . . . . . . . . . . . . 4,608.00

Total . . . . . . . . . . . . . . P 11,841.00==========

The above defiency tax came about by the disallowance of deductions from gross income representing depreciation, expenses Gutierrez allegely incurred in carrying on his business, and the addition to gross income of receipts which he

did not report in his income tax returns. The disallowed business expenses which were considered by the Commissioner either as personal or capital expenditures consisted of:

1951

Personal expenses:

Transportation expenses to attend funeral of various persons

P 96.50

Repair of car and salary of driver 59.80

Expenses in attending National Convention of Filipino Businessmen in Baguio 121.35

Alms to indigent family 15.00

Capital expenditures:

Electrical fixtures and supplies 100.00

Transportation and other expenses to watch laborers in construction work 516.00

Realty tax not paid by former owner of property acquired by Gutierrez

350.00

Litigation expenses to collect rental and eject lessee 702.65

Other disallowed deductions:

Fines and penalties for late payment of taxes 64.48

1952

Personal expenses:

Car expenses, salary of driver and car depreciation

P1,454.37

Contribution to Lydia Samson and G. Trinidad 52.00

Officers' jewels and aprons donated to Biak-na-Bato Lodge No. 7, Free Masons 280.00

Luncheon of Homeowners' Association 5.50

Ticket to opera "Aida" 15.00

1953

Personal expenses:

Car expenses, salary of driver, car depreciation P 1,409.24

Cruise to Corregidor with Homeowners' Association

43.00

Contribution to alms to various individuals 70.00

Tickets to operas 28.00


Cost of one set of Comments on the Rules of Court by Moran

P 145.00

1954

Personal expenses:

Car expenses, salary of driver and car depreciation

P 1,413.67

Furniture given as commission in connection with business transaction 115.00

Cost of iron door of Gutierrez' residence 55.00


Painting of rental apartments P 908.00

Carpentry and lumber for rental apartments 335.83

Tinsmith and plumbing for rental apartments 605.25

Cement, tiles, gravel, sand and masonry for rental apartments

199.48

Iron bars, venetian blind, water pumps for rental apartments

1,340.00

Relocation and registration of property used in taxpayer's business

1,758.12

He also claimed the depreciation of his residence as follows:

1952 . . . . . . P 992.22

1953 . . . . . . 942.61

1954 . . . . . . 895.45

The following are the items of income which Gutierrez did not declare in his income tax returns:

1951

Income of wife (admitted by Gutierrez) P 2,749.90.

1953

Overstatement of purchase price of real estate P 8,476.92

Understatement of profits from sale of real estate

5,803.74

1954

Understatement of profits from sale of real estate

P 5,444.24

The overstatement of purchase price of real estate refers to the sale of two pieces of property in 1953. In 1943 Gutierrez bought a parcel of land situated along Padre Faura St. in Manila for P35,000.00. Sometime in 1953, he sold the same for P30,400.00. Expenses of sale amounted to P631.80. In his return he claimed a loss of P5,231.80. 1 However, the Commissioner, including the said property was bought in Japanese military notes, converting the buying price to its equivalent in PhilippineCommonwealth peso by the use of the Ballantyne Scale of Values. At P1.30 Japanese military notes per Commonwealth peso, the acquisition cost of P35,000.00 Japanese military notes was valued at P26,923.00 PhilippineCommonwealth peso. Accordingly, the Commissioner determined a profit of P3,476.92 after restoring to Gutierrez' gross income the P5,231.80 deductionfor loss.

In another transaction, Gutierrez sold a piece of land for P1,200.00. Alleging the said property was purchased for P1,200.00, he reported no profit hereunder. However, after verifying the deed of acquisition, the Commissioner discovered the purchase price to be only P800.00. Consequently, he determined a profit of P400.00 which was added to the gross income for 1953.1äwphï1.ñët

The understatement of profit from the sale of real estate may be explained thus: In 1953 and 1954 Gutierrez sold four other properties upon which he made substantial profits.2Convinced that said properties were capital assets, he declared only 50% of the profits from their sale. However, treating said properties as ordinary assets (as property held and used byGutierrez in his business), the Commissioner taxed 100% of the profits from their disposition pursuant to Section 35 of the Tax Code.

Having unsuccessfully questioned the legality and correctness of the aforesaid assessment, Gutierrez instituted on February 17, 1958, the Commissioner issued a warrant of distraint and levy on one of Gutierrez' real properties but desisted from enforcing the same when Gutierrez filed a bond to assure payment of his tax liability.

In a decision dated January 28, 1962, the Court of Tax Appeals upheld in toto the assessment of the Commissioner of Internal Revenue. Hence, this appeal.

On October 18, 1962, Lino Guttierrez died and he was substituted by Andrea C. Vda. de Gutierrez, Antonio D. Gutierrez, Santiago D. Gutierrez, Guillermo D. Gutierrez and Tomas D. Gutierrez, his heirs,as party petitioners.

The issues are: (1) Are the taxpayer's aforementioned claims for deduction proper and allowable? (2) May the Ballantyne Scale of Values be applied indetermining the acquisition cost in 1943 of a real property sold in 1953, for income tax purposes? (3) Are real properties used in the trade or business of the taxpayer capital or ordinary assets? (4) Has the right of the Commissioner of Internal Revenue to collect the deficiency income tax for the years 1951 and 1952 prescribed? (5) Has the right of the Commissioner of Internal Revenue to collect by distraint and levy the deficiency income tax for 1953 prescribed? If not, may the taxpayer's rea lproperty be distrained and levied upon without first exhausting his personal property?

We come first to question whether or not the deductions claimed by Gutierrez are allowable. Section 30(a) of the Tax Code allows business expenses tobe deducted from gross income. We quote:

SEC. 30. Deductions from gross income. — In computing net income there shall be allowed as deductions —

(a) Expenses:

(1) In general. — All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; travelling expenses while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to be continued use of possession, for the purposes of the trade or business, or property to which the taxpayer has not taken or is not taking title or in which he has no equity.

To be deductible, therefore, an expense must be (1) ordinary and necessary;(2) paid or incurred within the taxable year; and, (3) paid or incurred in carrying on a trade or business. 3

The transportation expenses which petitioner incurred to attend the funeral of his friends and the cost of admission tickets to operas were expenses relative to his personal and social activities rather than to his business of leasing real estate. Likewise, the procurement and installation of an iron door to is residence is purely a personal expense. Personal, living, or family expenses are not deductible. 4

On the other hand, the cost of furniture given by the taxpayer as commission in furtherance of a business transaction, the expenses incurred in attending the National Convention of Filipino Businessmen, luncheon meeting and cruise to Corregidor of the Homeowners' Association were shown to have been made in the pursuit of his business. Commissions given in consideration for bringing about a profitable transaction are part of the cost of the business transaction and are deductible.

The record shows that Gutierrez was an officer of the Junior Chamber of Commerce which sponsored the National Convention of Filipino Businessmen. He was also the president of the Homeowners' Association, an organization established by those engaged in the real estate trade. Having proved that his membership thereof and activities in connection therewith were solely to enhance his business, the expenses incurred thereunder are deductible as ordinary and necessary business expenses.

With respect to the taxpayer's claim for deduction for car expenses, salary of his driver and car depreciation, one-third of the same was disallowed by the Commissioner on the ground that the taxpayer used his car and driver both for personal and business purposes. There is no clear showing, however, that the car was devoted more for the taxpayer's business than for his personal and business needs. 5 According to the evidence, the taxpayer's car was utilized both for personal and business needs. We therefore find it reasonable to allow as deduction one-half of the driver's salary, car expenses and depreciation.

The electrical supplies, paint, lumber, plumbing, cement, tiles, gravel, masonry and labor used to repair the taxpayer's rental apartments did not increase the value of such apartments, or prolong their life. They merely kept the apartments in an ordinary operating condition. Hence, the expenses incurred therefor are deductible as necessary expenditures for the maintenance of the taxpayer's business.

Similarly, the litigation expenses defrayed by Gutierrez to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expenses in pursuing his business. It is routinary and necessary for one in the leasing business to collect rentals and to eject tenants who refuse to pay their accounts.

The following are not deductible business expenses but should be integrated into the cost of the capital assets for which they were incurred and depreciated yearly: (1) Expenses in watching over laborers in construction work. Watching over laborers is an activity more akin to the construction work than to running the taxpayer's business. Hence, the expenses incurred therefor should form part of the construction cost. (2) Real estate tax which remained unpaid by the former owner of Gutierrez' rental property but which the latter paid, is an additional cost to acquire such property and ought therefore to be treated as part of the property's purchase price. (3) The iron bars, venetian blind and water pump augmented the value of the, apartments where they were installed. Their cost is not a maintenance charge, 6 hence, not deductible.. 7 (4) Expenses for the relocation, survey and registration of property tend to strengthen title over the property, hence, they should be considered as addition to the costs of such property. (5) The set of "Comments on the Rules of Court" having a life span of more than one year should be depreciated ratably during its whole life span instead of its total cost being deducted in one year.

Coming to the claim for depreciation of Gutierrez' residence, we find the same not deductible. A taxpayer may deduct from gross income a reasonable allowance for deterioration of property arising out of its use or employment in business or trade. 8 Gutierrez' residence was not used in his trade or business.

Gutierrez also claimed for deduction the fines and penalties which he paid for late payment of taxes. While Section 30 allows taxes to be deducted from gross income, it does not specifically allow fines and penalties to be so deducted. Deductions from gross income are matters of legislative grace; what is not expressly granted by Congress is withheld. Moreover, when acts are condemned, by law and their commission is made punishable by fines or forfeitures, to allow them to be deducted from the wrongdoer's gross income, reduces, and so in part defeats, the prescribed punishment..9

As regards the alms to an indigent family and various individuals, contributions to Lydia Yamson and G. Trinidad and a donation consisting of officers' jewels and aprons to Biak-na-Bato Lodge No. 7, the same are not deductible from gross income inasmuch as their recipients have not been shown to be among those specified by law. Contributions are deductible when given to the Government of the Philippines, or any of its political subdivisions for exclusively public purposes, to domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, athletic, cultural or educational purposes, or for the rehabilitation of veterans, or to societies for the prevention of cruelty to children or animals, no part of the net income of which inures to the benefit of any private stockholder or individual. 10

We come to the question of whether or not the Ballantyne Scale of Values can be applied to tax cases.

Sometime in 1943 Gutierrez bought a piece of real estate in Manila for a price of P35,000.00. In 1953 he sold said property for P30,400.00, thereby incurring a loss which he claimed as deduction in his income tax return for 1953. The Commissioner of Internal Revenue, convinced that the purchase price of the property in 1943 was in Japanese military notes, converted said purchase price into Philippine Commonwealth pesos by the use of the Ballantyne Scale of Values. As a result, the Commissioner found Gutierrez to have profited, instead of lost in the sale.

Firstly, Gutierrez maintains that the purchase price was paid for in Commonwealth pesos. On the other hand the Commissioner insists that inasmuch as the prevailing currency in the City of Manila in 1943 was the Japanese military issue, the transaction could have been in said military notes. The evidence offered by Gutierrez, consisting of the testimony of his son to the effect that it was he who carried the bundle of Commonwealth pesos and Japanese military

notes when his father purchased the property, did not convince the Tax Court. No cogent reason to alter the court a quo's finding of fact in this regard has been given. There is no definite showing that Gutierrez paid for the property in Commonwealth pesos. Considering that in 1943 the medium of exchange in Manila was the Japanese military notes, the use of which the Japanese Military Government enforced with stringent measures, we are inclined to concur with the finding that the purchase price was in Japanese military notes. We are specifically mindful of the fact that Gutierrez sold the property in 1953 for only P30,400.00 at a time when the price of real estate in the City of Manila was much greater than in 1943.

It is further contended by Gutierrez that the money he used to pay for the purchase of the property in question came from the proceeds of merchandise acquired prior to World War II but which he sold after Manila was occupied by the Japanese military forces, hence, the purchase price should be deemed to have been made in Commonwealth pesos inasmuch as the aforesaid merchandise was purchased in Commonwealth pesos. This contention, if true, strengthens our conclusion that the real estate in question was bought in Japanese military notes. For, at the time Gutierrez sold his merchandise, the prevailing currency in the City of Manila was the Japanese military money. Consequently, the proceeds therefrom, which were used to buy the real estate in question, were Japanese military notes.

Gutierrez assails the use of the Ballantyne Scale of Values in converting the purchase price of the real estate in question from Japanese military notes to Philippine Commonwealth pesos on the ground that (1) the Ballantyne Scale of Values was intended only for transactions entered into by parties voluntarily during the Japanese occupation, wherein a portion of the contract was left unperformed until liberation of the Philippines by the Americans; (2) that such Scale of Values cannot be the basis of a tax, for it is not a law.

In determining the gain or loss from the sale of property the purchase price and the selling price ought to be in the same currency. Since in this case the purchase price was in Japanese military notes and the selling price was in our present legal tender, the Japanese military notes should be converted to the present currency. Since the only standard scale recognized by courts for the purpose is the Ballantyne Scale of Values, we find it compelling to use such table of values rather than adopt an arbitrary scale. It may not be amiss to state in this connection that the Ballantyne Scale of Values is not being used herein as the authority to impose the tax, but only as a medium of computing the tax base upon which the tax is to be imposed.

It is furthermore proffered by the taxpayer that in determining gain or loss, the real value of the Commonwealth peso at the time the property was purchased and the value of the Republic peso at the time. the same property was sold should be considered. The Commonwealth peso and the Republic peso are the same currency, with the same intrinsic value, sanctioned by the same authorities. Both are legal tender and accepted at face value regardless of fluctuation in their buying power. The 1941 Commonwealth peso when used to buy in 1963 or in 1965 is accorded the same value: one peso.

In his income tax returns for 1953 and 1954, Gutierrez reported only 50% of profits he realized from the sale of real properties during the years 1953 and 1954 on the ground that said properties were capital assets. Profits from the sale of capital assets are taxable to the extent of 50% thereof pursuant to Section 34 of the Tax Code.

Section 34 provides:

SEC. 34. Capital gains and losses. — (a) Definitions. — As used in this title —

(1) Capital assets. — The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in subsection (f) of section thirty; or real property used in the trade or business of the taxpayer.

x x x x x x x x x

(b) Percentage taken into account. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of capital asset hall be taken into account in computing net capital gain, net capital loss, and net income:

(1) One hundred per centum if the capital asset has been held for not more than twelve months;

(2) Fifty per centum if the capital asset has been held for not more than twelve months.

Section 34, before it was amended by Republic Act 82 in 1947, considered as capital assets real property used in the trade or business of a taxpayer. However, with the passage of Republic Act 82, Congress classified "real property used in the trade or business of the taxpayer" is ordinary asset. The explanatory note to Republic Act 82 says — "... the words "or real property used in the trade or business of the taxpayer" have been included among the non-capital assets. This has the effect of withdrawing the gain or loss from the sale or exchange of real property used in the trade or

business of the taxpayer from the operation of the capital gains and losses provisions. As such real property is used in the trade or business of the taxpayer, it is logical that the gain or loss from the sale or exchange thereof should be treated as ordinary income or loss. 11 Accordingly, the real estate, admittedly used by Gutierrez in his business, which he sold in 1953 and 1954 should be treated as ordinary assets and the gain from the sale thereof, as ordinary gain, hence, fully taxable. 12

With regard to the issue of the prescription of the Commissioner's right to collect deficiency tax for 1951 and 1952, Gutierrez claims that the counting of the 5-year period to collect income tax should start from the time the income tax returns were filed. He, therefore, urges us to declare the Commissioner's right to collect the deficiency tax for 1951 and 1952 to have prescribed, the income tax returns for 1951 and 1952 having been filed in March 1952 and on February 28, 1953, respectively, and the action to collect the tax having been instituted on March 5, 1958 when the Commissioner filed his answer to the petition for review in C.T.A. Case No. 504. On the other hand, the Commissioner argues that the running of the prescriptive period to collect commences from the time of assessment. Inasmuch as the tax for 1951 and 1952 were assessed only on July 10, 1956, less than five years lapsed when he filed his answer on March 5, 1958.

The period of limitation to collect income tax is counted from the assessment of the tax as provided for in paragraph (c) of Section 332 quoted below:

SEC. 332(c). Where the assessment of any internal revenue tax has been made within the period of limitation above prescribed such tax may be collected by distraint or levy or by a proceeding in court, but only if begun (1)

within five years after the assessment of the tax, or (2) prior to the expiration of any period for collection agreed upon in writing by the Collector of Internal Revenue and the taxpayer before the expiration of such five-year period. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.

Inasmuch as the assessment for deficiency income tax was made on July 10, 1956 which is 7 months and 25 days prior to the action for collection, the right of the Commissioner to collect such tax has not prescribed.

The next issue relates to the prescription of the right of the Commissioner of Internal Revenue to collect the deficiency tax for 1954 by distraint and levy.

The pertinent provision of the Tax Code states:

SEC. 51(d). Refusal or neglect to make returns; fraudulent returns, etc. — In cases of refusal or neglect to make a return and in cases of erroneous, false, or fraudulent returns, the Collector of Internal Revenue shall, upon the discovery thereof, at any time within three years after said return is due or has been made, make a return upon information obtained as provided for in this code or by existing law, or require the necessary corrections to be made, and the assessment made by the Collector of Internal Revenue thereon shall be paid by such person or corporation immediately upon notification of the amount of such assessment.

On February 23, 1955 Gutierrez filed his income tax return for 1954 and on February 24, 1958 the Commissioner of Internal Revenue issued a warrant of distraint and levy to collect the tax due thereunder. Gutierrez contends that the

Commissioner's right to issue said warrant is barred, for the same was issued more than 3 years from the time he filed his income tax return. On the other hand, the Commissioner of Internal Revenue maintains that his right did not lapse inasmuch as from the last day prescribed by law for the filing of the 1954 return to the date when he issued the warrant of distraint and levy, less than 3 years passed. The question now is: should the counting of the prescriptive period commence from the actual filing of the return or from the last day prescribed by law for the filing thereof?

We observe that Section 51(d) speaks of erroneous, false or fraudulent returns, and refusal or neglect of the taxpayer to file a return. It also provides for two dates from which to count the three-year prescriptive period, namely, the date when the return is due and the date the return has been made. We are inclined to conclude that the date when the return is due refers to cases where the taxpayer refused or neglected to file a return, and the date when the return has been made refers to instances where the taxpayer filed erroneous, false or fraudulent returns. Since Gutierrez filed an income tax return, the three-year prescriptive period should be counted from the time he filed such return. From February 23, 1955 when the income tax return for 1954 was filed, to February 24, 1958, when the warrant of distraint and levy was issued, 3 years and 2 days elapsed. The right of the Commissioner to issue said warrant of distraint and levy having lapsed by two days, the warrant issued is null and void.

The above finding has made academic the question of whether or not the warrant of distraint and levy can be enforced against the taxpayer's real property without first exhausting his personal properties.

In resume the tax liability of Lino Gutierrez for 1951, 1952, 1953 and 1954 may be computed as follows:

1951Net income per investigation P29,471.81Add: Disallowed deductions for salary of driver and car expenses 29.90

P29,501.81Less: Allowable deductions: Expenses in attending National Convention of Filipino Businessmen P 121.35 Repair of rental apartments

802.65 924.00

Net income P30,425.71Less: Personal exemption 3,600.00

Amount subject to tax P26,825.71

Tax due thereon P 5,668.00

Less tax already paid 3,981.00

Deficiency income tax due P 1,687.00==========

1952Net income per investigation P21,632.22Add: Disallowed deductions: Salary of driver P 260.67 Car expenses 401.51 Car depreciation 65.00 727.18

P22,359.40Less Allowable deduction: Luncheon, Homeowners' Association

5.50



Tax due thereon P 3,324.00Less tax already paid 2,476.00

Deficiency income tax due 848.00==========


P69,785.40Less: Allowable deduction: Cruise to Corregidor with Homeowners' Association 42.00

Net Income P69,828 40Less: Personal exemption 3,600.00


Tax due thereon P15,179.00Less tax already paid 9,805.00



P44,508.75Less: Allowable deductions: Furniture given in connection with business transaction P 115.00 Repairs of rental 2,048.56 2,163.56

apartments



Tax due thereon P 9,984.00Less tax already paid 5,964.00


S U M M A R Y

1951 . . . . . . . . . . . . . . . . P 1,687.00

1952 . . . . . . . . . . . . . . . . 848.00

1953 . . . . . . . . . . . . . . . . 5,374.00

1954 . . . . . . . . . . . . . . . . 4,020.00

TOTAL . . . . . . . . . .P 11,929.00

=========

WHEREFORE, the decision appealed from is modified and Lino Gutierrez and/or his heirs, namely, Andrea C. Vda. de Gutierrez, Antonio D. Gutierrez, Santiago D. Gutierrez, Guillermo D. Gutierrez and Tomas D. Gutierrez, are ordered to pay the sums of P1,687.00, P848.00, P5,374.00, and P4,020.00, as deficiency income tax for the years 1951, 1952, 1953 and 1954, respectively, or a total of P11,929.00, plus the statutory penalties in case of delinquency. No costs. So ordered.

G.R. No. 148083 July 21, 2006

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.BICOLANDIA DRUG CORPORATION (Formerly known as ELMAS DRUG CO.), respondent.

D E C I S I O N

VELASCO, JR., J.:

In cases of conflict between the law and the rules and regulations implementing the law, the law shall always prevail. Should Revenue Regulations deviate from the law they seek to implement, they will be struck down.

The Facts

In 1992, Republic Act No. 7432, otherwise known as "An Act to Maximize the Contribution of Senior Citizens to Nation Building, Grant Benefits and Special Privileges and For Other Purposes," granted senior citizens several privileges, one of which was obtaining a 20 percent discount from all establishments relative to the use of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country.1 The law also provided that the private establishments giving the discount to senior citizens may claim the cost as tax credit.2 In compliance with the law, the Bureau of Internal Revenue issued Revenue Regulations No. 2-94, which defined "tax credit" as follows:

http://www.lawphil.net/judjuris/juri2006/jul2006/gr_148083_2006.html#fnt2


Tax Credit – refers to the amount representing the 20% discount granted to a qualified senior citizen by all establishments relative to their utilization of transportation services, hotels and similar lodging establishments, restaurants, halls, circuses, carnivals and other similar places of culture, leisure and amusement, which discount shall be deducted by the said establishments from their gross income for income tax purposes and from their gross sales for value-added tax or other percentage tax purposes.3

In 1995, respondent Bicolandia Drug Corporation, a corporation engaged in the business of retailing pharmaceutical products under the business style of "Mercury Drug," granted the 20 percent sales discount to qualified senior citizens purchasing their medicines in compliance with R.A. No. 7432.4 Respondent treated this discount as a deduction from its gross income in compliance with Revenue Regulations No. 2-94, which implemented R.A. No. 7432.5 On April 15, 1996, respondent filed its 1995 Corporate Annual Income Tax Return declaring a net loss position with nil income tax liability.6

On December 27, 1996, respondent filed a claim for tax refund or credit in the amount of PhP 259,659.00 with the Appellate Division of the Bureau of Internal Revenue—because its net losses for the year 1995 prevented it from benefiting from the treatment of sales discounts as a deduction from gross sales during the said taxable year.7 It alleged that the petitioner Commissioner of Internal Revenue erred in treating the 20 percent sales discount given to senior citizens as a deduction from its gross income for income tax purposes or other percentage tax purposes rather than as a tax credit.8







On April 6, 1998, respondent appealed to the Court of Tax Appeals in order to toll the running of two (2)-year prescriptive period to file a claim for refund pursuant to Section 230 of the Tax Code then.9 Respondent argued that since Section 4 of R.A. No. 7432 provided that discounts granted to senior citizens may be claimed as tax credit, Section 2(i) of Revenue Regulations No. 2-94, which referred to the tax credit as the amount representing the 20 percent discount that "shall be deducted by the said establishments from their gross income for income tax purposes and from their gross sales for value-added tax or other percentage tax purposes,"10 is illegal, void and without effect for being inconsistent with the statute it implements.

Petitioner maintained that Revenue Regulations No. 2-94 is valid since the law tasked the Department of Finance, among other government offices, with the issuance of the necessary rules and regulations to carry out the objectives of the law.11

Ruling of the Court of Tax Appeals

The Court of Tax Appeals declared that the provisions of R.A. No. 7432 would prevail over Section 2(i) of Revenue Regulations No. 2-94, whose definition of "tax credit" deviated from the intendment of the law; and as a result, partially granted the respondent's claim for a refund. After examining the evidence on record, the Court of Tax Appeals reduced the claimed 20 percent sales discount, thus reducing the refund to be given. It ruled that "Respondent is hereby ORDERED to REFUND in favor of Petitioner the amount of P236,321.52, representing overpaid income tax for the year 1995."12

Ruling of the Court of Appeals





On appeal, the Court of Appeals modified the decision of the Court of Tax Appeals as the law provided for a tax credit, not a tax refund. The fallo of the Decision states:

WHEREFORE, premises considered, the present appeal is hereby GRANTED and the Decision of the Court of Tax Appeals in C.T.A. Case No. 5599 is hereby MODIFIED in the sense that the award of tax refund is ANNULLED and SET ASIDE. Instead, the petitioner is hereby ORDERED to issue a tax credit certificate in favor of the respondent in the amount of P 236,321.52.

No pronouncement as to costs.13

The Issue

Petitioner now argues that the Court of Appeals erred in holding that the 20 percent sales discount granted to qualified senior citizens by the respondent pursuant to R.A. No. 7432 may be claimed as a tax credit, instead of a deduction from gross income or gross sales.14

The Court's Ruling

The petition is not meritorious.

Redefining "Tax Credit" as "Tax Deduction"



The problem stems from the issuance of Revenue Regulations No. 2-94, which was supposed to implement R.A. No. 7432, and the radical departure it made when it defined the "tax credit" that would be granted to establishments that give 20 percent discount to senior citizens. Under Revenue Regulations No. 2-94, the tax credit is "the amount representing the 20 percent discount granted to a qualified senior citizen by all establishments relative to their utilization of transportation services, hotels and similar lodging establishments, restaurants, drugstores, recreation centers, theaters, cinema houses, concert halls, circuses, carnivals and other similar places of culture, leisure and amusement, which discount shall be deducted by the said establishments from their gross income for income tax purposes and from their gross sales for value-added tax or other percentage tax purposes."15 It equated "tax credit" with "tax deduction," contrary to the definition in Black's Law Dictionary, which defined tax credit as:

An amount subtracted from an individual's or entity's tax liability to arrive at the total tax liability. A tax credit reduces the taxpayer's liability x x x, compared to a deduction which reduces taxable income upon which the tax liability is calculated. A credit differs from deduction to the extent that the former is subtracted from the tax while the latter is subtracted from income before the tax is computed.16

The interpretation of an administrative government agency, which is tasked to implement the statute, is accorded great respect and ordinarily controls the construction of the courts.17 Be that as it may, the definition laid down in the questioned Revenue Regulations can still be subjected to scrutiny. Courts will not hesitate to set aside an executive interpretation when it is clearly erroneous. There is no need for interpretation when there is no ambiguity in the rule, or when the language or words used are clear and plain or readily understandable to an ordinary reader.18 The definition of





the term "tax credit" is plain and clear, and the attempt of Revenue Regulations No. 2-94 to define it differently is the root of the conflict.

Tax Credit is not Tax Refund

Petitioner argues that the tax credit is in the nature of a tax refund and should be treated as a return for tax payments erroneously or excessively assessed against a taxpayer, in line with Section 204(c) of Republic Act No. 8424, or the National Internal Revenue Code of 1997. Petitioner claims that there should first be payment of the tax before the tax credit can be claimed. However, in the National Internal Revenue Code, we see at least one instance where this is not the case. Any VAT-registered person, whose sales are zero-rated or effectively zero-rated may, within two (2) years after the close of the taxable quarter when the sales were made, apply for the issuance of a tax credit certificate or refund of creditable input tax due or paid attributable to such sales, except transitional input tax, to the extent that such input tax has not been applied against output tax.19 It speaks of a tax credit for tax due, so payment of the tax has not yet been made in that particular example.

The Court of Appeals expressly recognized the differences between a "tax credit" and a "tax refund," and stated that the same are not synonymous with each other, which is why it modified the ruling of the Court of Tax Appeals.

Revenue Regulations No. 2-94 vs. R.A. No. 7432 andR.A. No. 7432 vs. the National Internal Revenue Code


Petitioner contends that since R.A. No. 7432 used the word "may," the availability of the tax credit to private establishments is only permissive and not absolute or mandatory. From that starting point, petitioner further argues that the definition of the term "tax credit" in Revenue Regulations No. 2-94 was validly issued under the authority granted by the law to the Department of Finance to formulate the needed guidelines. It further explained that Revenue Regulations No. 2-94 can be harmonized with R.A No. 7432, such that the definition of the term "tax credit" in Revenue Regulations No. 2-94 is controlling. It claims that to do otherwise would result in Section 4(a) of R.A. No. 7432 impliedly repealing Section 204 (c) of the National Internal Revenue Code.

These arguments must also fail.

Revenue Regulations No. 2-94 is still subordinate to R.A. No. 7432, and in cases of conflict, the implementing rule will not prevail over the law it seeks to implement. While seemingly conflicting laws must be harmonized as far as practicable, in this particular case, the conflict cannot be resolved in the manner the petitioner wishes. There is a great divide separating the idea of "tax credit" and "tax deduction," as seen in the definition in Black's Law Dictionary.

The claimed absurdity of Section 4(a) of R.A. No. 7432 impliedly repealing Section 204(c) of the National Internal Revenue Code could only come about if it is accepted that a tax credit is akin to a tax refund wherein payment of taxes must be made in order for it to be claimed. But as shown in Section 112(a) of the National Internal Revenue Code, it is not always necessary for payment to be made for a tax credit to be available.

Looking into R.A. No. 7432

Finally, petitioner argues that should private establishments, which count respondent in their number, be allowed to claim tax credits for discounts given to senior citizens, they would be earning and not just be reimbursed for the discounts given.

It cannot be denied that R.A. No. 7432 has a laudable goal. Moreover, it cannot be argued that it was the intent of lawmakers for private establishments to be the primary beneficiaries of the law. However, while the purpose of the law to benefit senior citizens is praiseworthy, the concerns of the affected private establishments were also considered by the lawmakers. As in other cases wherein private property is taken by the State for public use, there must be just compensation. In this particular case, it took the form of the tax credit granted to private establishments, purposely chosen by the lawmakers. In the similar case of Commissioner of Internal Revenue v. Central Luzon Drug Corporation,20 scrutinizing the deliberations of the Bicameral Conference Committee Meeting on Social Justice on February 5, 1992 which finalized R.A. No. 7432, the discussions of the lawmakers clearly showed the intent that the cost of the 20 percent discount may be claimed by the private establishments as a tax credit. An excerpt from the deliberations is as follows:

SEN. ANGARA. In the case of private hospitals they got the grant of 15% discount, provided that, the private hospitals can claim the expense as a tax credit.

REP. AQUINO. Yah could be allowed as deductions in the preparation of (inaudible) income.

SEN. ANGARA. I-tax credit na lang natin para walang cash-out?


REP. AQUINO. Oo, tax credit. Tama. Okay. Hospitals ba o lahat ng establishments na covered.

THE CHAIRMAN. Sa kuwan lang yon, as private hospitals lang.

REP. AQUINO. Ano ba yung establishments na covered?

SEN. ANGARA. Restaurant, lodging houses, recreation centers.

REP. AQUINO. All establishments covered siguro?

SEN. ANGARA. From all establishments. Alisin na natin `yung kuwan kung ganon. Can we go back to Section 4 ha?

REP. AQUINO. Oho.

SEN. ANGARA. Letter A. To capture that thought, we'll say the grant of 20% discount from all establishments et cetera, et cetera, provided that said establishments may claim the cost as a tax credit. Ganon ba `yon?

REP. AQUINO. Yah.

SEN. ANGARA. Dahil kung government, they don't need to claim it.

THE CHAIRMAN. Tax credit.

SEN. ANGARA. As a tax credit [rather] than a kuwan – deduction, Okay.21

It is clear that the lawmakers intended the grant of a tax credit to complying private establishments like the respondent.

If the private establishments appear to benefit more from the tax credit than originally intended, it is not for petitioner to say that they shouldn't. The tax credit may actually have provided greater incentive for the private establishments to comply with R.A. No. 7432, or quicker relief from the cut into profits of these businesses.

Revenue Regulations No. 2-94 Null and Void

From the above discussion, it must be concluded that Revenue Regulations No. 2-94 is null and void for failing to conform to the law it sought to implement. In case of discrepancy between the basic law and a rule or regulation issued to implement said law, the basic law prevails because said rule or regulation cannot go beyond the terms and provisions of the basic law.22

Revenue Regulations No. 2-94 being null and void, it must be ruled then that under R.A. No. 7432, which was effective at the time, respondent is entitled to its claim of a tax credit, and the ruling of the Court of Appeals must be affirmed.

But even as this particular case is decided in this manner, it must be noted that the concerns of the petitioner regarding tax credits granted to private establishments giving discounts to senior citizens have been addressed. R.A. No. 7432 has been amended by Republic Act No. 9257, the "Expanded Senior Citizens Act of 2003." In this, the term "tax credit" is no longer used. The 20 percent discount granted by hotels and similar lodging establishments, restaurants and



recreation centers, and in the purchase of medicines in all establishments for the exclusive use and enjoyment of senior citizens is treated in the following manner:

The establishment may claim the discounts granted under (a), (f), (g) and (h) as tax deduction based on the net cost of the goods sold or services rendered: Provided, That the cost of the discount shall be allowed as deduction from gross income for the same taxable year that the discount is granted. Provided, further, that the total amount of the claimed tax deduction net of value added tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as amended.23

This time around, there is no conflict between the law and the implementing Revenue Regulations. Under Revenue Regulations No. 4-2006, "(o)nly the actual amount of the discount granted or a sales discount not exceeding 20% of the gross selling price can be deducted from the gross income, net of value added tax, if applicable, for income tax purposes, and from gross sales or gross receipts of the business enterprise concerned, for VAT or other percentage tax purposes."24 Under the new law, there is no tax credit to speak of, only deductions.

Petitioner can find some vindication in the amendment made to R.A. No. 7432 by R.A. No. 9257, which may be more in consonance with the principles of taxation, but as it was R.A. No. 7432 in force at the time this case arose, this law controls the result in this particular case, for which reason the petition must fail.

This case should remind all heads of executive agencies which are given the power to promulgate rules and regulations, that they assume the roles of lawmakers. It is well-settled that a regulation should not conflict with the law it



implements. Thus, those drafting the regulations should study well the laws their rules will implement, even to the extent of reviewing the minutes of the deliberations of Congress about its intent when it drafted the law. They may also consult the Secretary of Justice or the Solicitor General for their opinions on the drafted rules. Administrative rules, regulations and orders have the efficacy and force of law so long as they do not contravene any statute or the Constitution.25 It is then the duty of the agencies to ensure that their rules do not deviate from or amend acts of Congress, for their regulations are always subordinate to law.

WHEREFORE, the Petition is hereby DENIED. The assailed Decision of the Court of Appeals is AFFIRMED. There is no pronouncement as to costs.


G.R. Nos. L-18169, L-18262 & L-21434 July 31, 1964

COMMISSIONER OF INTERNAL REVENUES, petitioner, vs.V.E. LEDNICKY and MARIA VALERO LEDNICKY, respondents.

Office of the Solicitor General for petitioner.Ozaeta, Gibbs and Ozaeta for respondents.

REYES, J.B.L., J.:

The above-captioned cases were elevated to this Court under separate petitions by the Commissioner for review of the corresponding decisions of the Court of Tax Appeals. Since these cases involve the same parties and issues akin to each case presented, they are herein decided jointly.

The respondents, V. E. Lednicky and Maria Valero Lednicky, are husband and wife, respectively, both American citizens residing in the Philippines, and have derived all their income from Philippine sources for the taxable years in question.

In compliance with local law, the aforesaid respondents, on 27 March 1957, filed their income tax return for 1956, reporting therein a gross income of P1,017,287. 65 and a net income of P733,809.44 on which the amount of

P317,395.4 was assessed after deducting P4,805.59 as withholding tax. Pursuant to the petitioner's assessment notice, the respondents paid the total amount of P326,247.41, inclusive of the withheld taxes, on 15 April 1957.

On 17 March 1959, the respondents Lednickys filed an amended income tax return for 1956. The amendment consists in a claimed deduction of P205,939.24 paid in 1956 to the United States government as federal income tax for 1956. Simultaneously with the filing of the amended return, the respondents requested the refund of P112,437.90.

When the petitioner Commissioner of Internal Revenue failed to answer the claim for refund, the respondents filed their petition with the Tax Court on 11 April 1959 as CTA Case No. 646, which is now G. R. No. L-18286 in the Supreme Court.

G. R. No. L-18169 (formerly CTA Case No. 570) is also a claim for refund in the amount of P150,269.00, as alleged overpaid income tax for 1955, the facts of which are as follows:

On 28 February 1956, the same respondents-spouses filed their domestic income tax return for 1955, reporting a gross income of P1,771,124.63 and a net income of P1,052,550.67. On 19 April 1956, they filed an amended income tax return, the amendment upon the original being a lesser net income of P1,012,554.51, and, on the basis of this amended return, they paid P570,252.00, inclusive of withholding taxes. After audit, the petitioner determined a deficiency of P16,116.00, which amount, the respondents paid on 5 December 1956.

Back in 1955, however, the Lednickys filed with the U.S. Internal Revenue Agent in Manila their federal income tax return for the years 1947, 1951, 1952, 1953, and 1954 on income from Philippine sources on a cash basis. Payment of

these federal income taxes, including penalties and delinquency interest in the amount of P264,588.82, were made in 1955 to the U.S. Director of Internal Revenue, Baltimore, Maryland, through the National City Bank of New York, Manila Branch. Exchange and bank charges in remitting payment totaled P4,143.91.

Wherefore, the parties respectfully pray that the foregoing stipulation of facts be admitted and approved by this Honorable Court, without prejudice to the parties adducing other evidence to prove their case not covered by this stipulation of facts. 1äwphï1.ñët

On 11 August 1958, the said respondents amended their Philippine income tax return for 1955 to include the following deductions:

U.S. Federal income taxes P471,867.32

Interest accrued up to May 15, 1955 40,333.92

Exchange and bank charges 4,143.91

T o t a l P516,345.15

and therewith filed a claim for refund of the sum of P166,384.00, which was later reduced to P150,269.00.

The respondents Lednicky brought suit in the Tax Court, which was docketed therein as CTA Case No. 570.

In G. R. No. 21434 (CTA Case No. 783), the facts are similar, but refer to respondents Lednickys' income tax return for 1957, filed on 28 February 1958, and for which respondents paid a total sum of P196,799.65. In 1959, they filed an amended return for 1957, claiming deduction of P190,755.80, representing taxes paid to the U.S. Government on income derived wholly from Philippine sources. On the strength thereof, respondents seek refund of P90 520.75 as overpayment. The Tax Court again decided for respondents.

The common issue in all three cases, and one that is of first impression in this jurisdiction, is whether a citizen of the United States residing in the Philippines, who derives income wholly from sources within the Republic of the Philippines, may deduct from his gross income the income taxes he has paid to the United States government for the taxable year on the strength of section 30 (C-1) of the Philippine Internal Revenue Code, reading as follows:

SEC. 30. Deduction from gross income. — In computing net income there shall be allowed as deductions —

(a) ...

(b) ...

(c) Taxes:

(1) In general. — Taxes paid or accrued within the taxable year, except —

(A) The income tax provided for under this Title;

(B) Income, war-profits, and excess profits taxes imposed by the authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for foreign countries);

(C) Estate, inheritance and gift taxes; and

(D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed. (Emphasis supplied)

The Tax Court held that they may be deducted because of the undenied fact that the respondent spouses did not "signify" in their income tax return a desire to avail themselves of the benefits of paragraph 3 (B) of the subsection, which reads:

Par. (c) (3) Credits against tax for taxes of foreign countries. — If the taxpayer signifies in his return his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited with —

(A) ...;

(B) Alien resident of the Philippines. — In the case of an alien resident of the Philippines, the amount of any such taxes paid or accrued during the taxable year to any foreign country, if the foreign country of

which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the Philippines residing in such country;

It is well to note that the tax credit so authorized is limited under paragraph 4 (A and B) of the same subsection, in the following terms:

Par. (c) (4) Limitation on credit. — The amount of the credit taken under this section shall be subject to each of the following limitations:

(A) The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources within such country taxable under this Title bears to his entire net income for the same taxable year; and

(B) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources without the Philippines taxable under this Title bears to his entire net income for the same taxable year.

We agree with appellant Commissioner that the Construction and wording of Section 30 (c) (1) (B) of the Internal Revenue Act shows the law's intent that the right to deduct income taxes paid to foreign government from the taxpayer's gross income is given only as an alternative or substitute to his right to claim a tax credit for such foreign income taxes under section 30 (c) (3) and (4); so that unless the alien resident has a right to

claim such tax credit if he so chooses, he is precluded from deducting the foreign income taxes from his gross income. For it is obvious that in prescribing that such deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) (relating to credits for taxes paid to foreign countries), the statute assumes that the taxpayer in question also may signify his desire to claim a tax credit and waive the deduction; otherwise, the foreign taxes would always be deductible, and their mention in the list of non-deductible items in Section 30(c) might as well have been omitted, or at least expressly limited to taxes on income from sources outside the Philippine Islands.

Had the law intended that foreign income taxes could be deducted from gross income in any event, regardless of the taxpayer's right to claim a tax credit, it is the latter right that should be conditioned upon the taxpayer's waiving the deduction; in which Case the right to reduction under subsection (c-1-B) would have been made absolute or unconditional (by omitting foreign taxes from the enumeration of non-deductions), while the right to a tax credit under subsection (c-3) would have been expressly conditioned upon the taxpayer's not claiming any deduction under subsection (c-1). In other words, if the law had been intended to operate as contended by the respondent taxpayers and by the Court of Tax Appeals section 30 (subsection (c-1) instead of providing as at present:

SEC. 30. Deduction from gross income. — In computing net income there shall be allowed as deductions —

(a) ...

(b) ...

(c) Taxes:

(1) In general. — Taxes paid or accrued within the taxable year, except —

(A) The income tax provided for under this Title;

(B) Income, war-profits, and excess profits taxes imposed by the authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign countries);

(C) Estate, inheritance and gift taxes; and

(D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

would have merely provided:

SEC. 30. Decision from grow income. — In computing net income there shall be allowed as deductions:

(a) ...

(b) ...

(c) Taxes paid or accrued within the taxable year, EXCEPT —

(A) The income tax provided for in this Title;

(B) Omitted or else worded as follows:

Income, war profits and excess profits taxes imposed by authority of any foreign country on income earned within the Philippines if the taxpayer does not claim the benefits under paragraph 3 of this subsection;

(C) Estate, inheritance or gift taxes;

(D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

while subsection (c-3) would have been made conditional in the following or equivalent terms:

(3) Credits against tax for taxes of foreign countries. — If the taxpayer has not deducted such taxes from his gross income but signifies in his return his desire to have the benefits of this paragraph, the tax imposed by Title shall be credited with ... (etc.).

Petitioners admit in their brief that the purpose of the law is to prevent the taxpayer from claiming twice the benefits of his payment of foreign taxes, by deduction from gross income (subs. c-1) and by tax credit (subs. c-3). This danger of double credit certainly can not exist if the taxpayer can not claim benefit under either of these headings at his option, so

that he must be entitled to a tax credit (respondent taxpayers admittedly are not so entitled because all their income is derived from Philippine sources), or the option to deduct from gross income disappears altogether.

Much stress is laid on the thesis that if the respondent taxpayers are not allowed to deduct the income taxes they are required to pay to the government of the United States in their return for Philippine income tax, they would be subjected to double taxation. What respondents fail to observe is that double taxation becomes obnoxious only where the taxpayer is taxed twice for the benefit of the same governmental entity (cf. Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579; Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the present case, while the taxpayers would have to pay two taxes on the same income, the Philippine government only receives the proceeds of one tax. As between the Philippines, where the income was earned and where the taxpayer is domiciled, and the United States, where that income was not earned and where the taxpayer did not reside, it is indisputable that justice and equity demand that the tax on the income should accrue to the benefit of the Philippines. Any relief from the alleged double taxation should come from the United States, and not from the Philippines, since the former's right to burden the taxpayer is solely predicated on his citizenship, without contributing to the production of the wealth that is being taxed.

Aside from not conforming to the fundamental doctrine of income taxation that the right of a government to tax income emanates from its partnership in the production of income, by providing the protection, resources, incentive, and proper climate for such production, the interpretation given by the respondents to the revenue law provision in question operates, in its application, to place a resident alien with only domestic sources of income in an equal, if not in a better, position than one who has both domestic and foreign sources of income, a situation which is manifestly unfair and short of logic.

Finally, to allow an alien resident to deduct from his gross income whatever taxes he pays to his own government amounts to conferring on the latter the power to reduce the tax income of the Philippine government simply by increasing the tax rates on the alien resident. Everytime the rate of taxation imposed upon an alien resident is increased by his own government, his deduction from Philippine taxes would correspondingly increase, and the proceeds for the Philippines diminished, thereby subordinating our own taxes to those levied by a foreign government. Such a result is incompatible with the status of the Philippines as an independent and sovereign state.

IN VIEW OF THE FOREGOING, the decisions of the Court of Tax Appeals are reversed, and, the disallowance of the refunds claimed by the respondents Lednicky is affirmed, with costs against said respondents-appellees.


THE COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.CONSUELO L. VDA. DE PRIETO, respondent.

Office of the Solicitor General Edilberto Barot, Solicitor F.R. Rosete and Special Atty. B. Gatdula, Jr. for petitioner.Formilleza and Latorre for respondent.

GUTIERREZ DAVID, J.:

This is an appeal from a decision of the Court of tax Appeals reversing the decision of the Commissioner of Internal Revenue which held herein respondent Consuelo L. Vda. de Prieto liable for the payment of the sum of P21,410.38 as deficiency income tax, plus penalties and monthly interest.

The case was submitted for decision in the court below upon a stipulation of facts, which for brevity is summarized as follows: On December 4, 1945, the respondent conveyed by way of gifts to her four children, namely, Antonio, Benito, Carmen and Mauro, all surnamed Prieto, real property with a total assessed value of P892,497.50. After the filing of the gift tax returns on or about February 1, 1954, the petitioner Commissioner of Internal Revenue appraised the real property donated for gift tax purposes at P1,231,268.00, and assessed the total sum of P117,706.50 as donor's gift tax, interest and compromises due thereon. Of the total sum of P117,706.50 paid by respondent on April

29, 1954, the sum of P55,978.65 represents the total interest on account of deliquency. This sum of P55,978.65 was claimed as deduction, among others, by respondent in her 1954 income tax return. Petitioner, however, disallowed the claim and as a consequence of such disallowance assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the aforesaid P55,978.65, including interest up to March 31, 1957, surcharge and compromise for the late payment.

Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should be interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within the year. It is here conceded that the interest paid by respondent was in consequence of the late payment of her donor's tax, and the same was paid within the year it is sought to be declared. The only question to be determined, as stated by the parties, is whether or not such interest was paid upon an indebtedness within the contemplation of section 30 (b) (1) of the Tax Code, the pertinent part of which reads:

SEC. 30 Deductions from gross income. — In computing net income there shall be allowed as deductions —

x x x x x x x x x

(b) Interest:

(1) In general. — The amount of interest paid within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt from taxation as income under this Title.

The term "indebtedness" as used in the Tax Code of the United States containing similar provisions as in the above-quoted section has been defined as an unconditional and legally enforceable obligation for the payment of money.1awphîl.nèt (Federal Taxes Vol. 2, p. 13,019, Prentice-Hall, Inc.; Merten's Law of Federal Income Taxation, Vol. 4, p. 542.) Within the meaning of that definition, it is apparent that a tax may be considered an indebtedness. As stated by this Court in the case of Santiago Sambrano vs. Court of Tax Appeals and Collector of Internal Revenue (101 Phil., 1; 53 Off. Gaz., 4839) —

Although taxes already due have not, strictly speaking, the same concept as debts, they are, however, obligations that may be considered as such.

The term "debt" is properly used in a comprehensive sense as embracing not merely money due by contract but whatever one is bound to render to another, either for contract, or the requirement of the law. (Camben vs. Fink Coule and Coke Co. 61 LRA 584)

Where statute imposes a personal liability for a tax, the tax becomes, at least in a board sense, a debt. (Idem).

A tax is a debt for which a creditor's bill may be brought in a proper case. (State vs. Georgia Co., 19 LRA 485).

It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her gross income under section 30(b) of the Tax Code above quoted.

The above conclusion finds support in the established jurisprudence in the United States after whose laws our Income Tax Law has been patterned. Thus, under sec. 23(b) of the Internal Revenue Code of 1939, as amended 1 , which contains similarly worded provisions as sec. 30(b) of our Tax Code, the uniform ruling is that interest on taxes is interest on indebtedness and is deductible. (U.S. vs. Jaffray, 306 U.S. 276. See also Lustig vs. U.S., 138 F. Supp. 870; Commissioner of Internal Revenue vs. Bryer, 151 F. 2d 267, 34 AFTR 151; Penrose vs. U.S. 18 F. Supp. 413, 18 AFTR 1289; Max Thomas Davis, et al. vs. Commissioner of Internal Revenue, 46 U.S. Boared of Tax Appeals Reports, p. 663, citing U.S. vs. Jaffray, 6 Tax Court of United States Reports, p. 255; Armour vs. Commissioner of Internal Revenue, 6 Tax Court of the United States Reports, p. 359; The Koppers Coal Co. vs. Commissioner of Internal Revenue, 7 Tax Court of United States Reports, p. 1209; Toy vs. Commissioner of Internal Revenue; Lucas vs. Comm., 34 U.S. Board of Tax Appeals Reports, 877; Evens and Howard Fire Brick Co. vs. Commissioner of Internal Revenue, 3 Tax Court of United States Reports, p. 62). The rule applies even though the tax is nondeductible. (Federal Taxes, Vol. 2, Prentice Hall, sec. 163, 13,022; see also Merten's Law of Federal Income Taxation, Vol. 5, pp. 23-24.)

To sustain the proposition that the interest payment in question is not deductible for the purpose of computing respondent's net income, petitioner relies heavily on section 80 of Revenue Regulation No. 2 (known as Income Tax

Regulation) promulgated by the Department of Finance, which provides that "the word `taxes' means taxes proper and no deductions should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency." The court below, however, held section 80 as inapplicable to the instant case because while it implements sections 30(c) of the Tax Code governing deduction of taxes, the respondent taxpayer seeks to come under section 30(b) of the same Code providing for deduction of interest on indebtedness. We find the lower court's ruling to be correct. Contrary to petitioner's belief, the portion of section 80 of Revenue Regulation No. 2 under consideration has been part and parcel of the development to the law on deduction of taxes in the United States. (See Capital Bldg. and Loan Assn. vs. Comm., 23 BTA 848. Thus, Mertens in his treatise says: "Penalties are to be distinguished from taxes and they are not deductible under the heading of taxs." . . . Interest on state taxes is not deductible as taxes." (Vol. 5, Law on Federal Income Taxation, pp. 22-23, sec. 27.06, citing cases.) This notwithstanding, courts in that jurisdiction, however, have invariably held that interest on deficiency taxes are deductible, not as taxes, but as interest. (U.S. vs. Jaffray, et al., supra; see also Mertens, sec. 26.09, Vol. 4, p. 552, and cases cited therein.) Section 80 of Revenue Regulation No. 2, therefore, merely incorporated the established application of the tax deduction statute in the United States, where deduction of "taxes" has always been limited to taxes proper and has never included interest on delinquent taxes, penalties and surcharges.

To give to the quoted portion of section 80 of our Income Tax Regulations the meaning that the petitioner gives it would run counter to the provision of section 30(b) of the Tax Code and the construction given to it by courts in the United States. Such effect would thus make the regulation invalid for a "regulation which operates to create a rule out of harmony with the statute, is a mere nullity." (Lynch vs. Tilden Produce Co., 265 U.S. 315; Miller vs. U.S., 294 U.S. 435.) As already stated, section 80 implements only section 30(c) of the Tax Code, or the provision allowing deduction

of taxes, while herein respondent seeks to be allowed deduction under section 30(b), which provides for deduction of interest on indebtedness.

In conclusion, we are of the opinion and so hold that although interest payment for delinquent taxes is not deductible as tax under Section 30(c) of the Tax Code and section 80 of the Income Tax Regulations, the taxpayer is not precluded thereby from claiming said interest payment as deduction under section 30(b) of the same Code.

In view of the foregoing, the decision sought to be reviewed is affirmed, without pronouncement as to costs.

G.R. No. L-15922 November 29, 1961

C. F. CALANOC, petitioner, vs.THE COLLECTOR OF INTERNAL REVENUE, respondent.

Francisco M. Gonzales for petitioner.Office of the Solicitor General and Special Attorney Librada del Rosario-Natividad for respondent.

LABRADOR, J.:

This is a petition to review the decision of the Court of Tax Appeals affirming an assessment of P7,378.57, by the Collector of Internal Revenue as amusement tax and surcharge due on a boxing and wrestling exhibition held by petitioner Calanoc on December 3, 1949 at the Rizal Memorial Stadium.

By authority of a solicitation permit issued by the Social Welfare Commission on November 24, 1949, whereby the petitioner was authorized to solicit and receive contributions for the orphans and destitute children of the Child Welfare Workers Club of the Commission, the petitioner on December 3, 1949 financed and promoted a boxing and wrestling exhibition at the Rizal Memorial Stadium for the said charitable purpose. Before the exhibition took place, the petitioner applied with the respondent Collector of Internal Revenue for exemption from payment of the amusement

tax, relying on the provisions of Section 260 of the National Internal Revenue Code, to which the respondent answered that the exemption depended upon petitioner's compliance with the requirements of law.

After the said exhibition, the respondent, through his agent, investigated the tax case of the petitioner, and from the statement of receipts which was furnished the agent, the latter found that the gross sales amounted to P26,553.00; the expenditures incurred was P25,157.62; and the net profit was only P1,375,30. Upon examination of the said receipts, the agent also found the following items of expenditures: (a) P461.65 for police protection; (b) P460.00 for gifts; (c) P1,880.05 for parties; and (d) several items for representation.

Out of the proceeds of the exhibition, only P1,375.38 was remitted to the Social Welfare Commission for the said charitable purpose for which the permit was issued.

On November 24, 1951, the Collector of Internal Revenue demanded from the petitioner payment of the amount of 533.00; the expenditures incurred was P25,157.62; and the net profit was only P1,375,38. Upon examination of the Secretary of Finance dated June 15, 1948, authorizing denial of application for exemption from payment of amusement tax in cases where the net proceeds are not substantial or where the expenses are exorbitant. Not satisfied with the assessment imposed upon him, the petitioner brought this case to the Court of Tax Appeals for review.

After hearing, the tax court rendered the decision sought herein to be reviewed. Hence, this petition.

Before this Court, the petitioner questions the validity of the assessment of P7,378.57 imposed upon him by the respondent, as affirmed by the tax court. He denies having received the stadium fee P1,000, which is not included in the

receipts, and claims that if he did, he can not be made to pay almost seven times the amount as amusement tax. But evidence was submitted that while he did not receive said stadium fee of P1,000, said amount was paid by the O-SO Beverages directly to the stadium for advertisement privileges in the evening of the entertainments. As the fee was paid by said concessionaire, petitioner had no right to include the P1,000 stadium fee among the items of his expenses. It results, therefore, that P1,000 went into petitioner's pocket which is not accounted for.

Furthermore petitioner admitted that he could not justify the other expenses, such as those for police protection and gifts. He claims further that the accountant who prepared the statement of receipts is already dead and could no longer be questioned on the items contained in said statement.

We have examined the records of the case and we agree with the lower court that most of the items of expenditures contained in the statement submitted to the agent are either exorbitant or not supported by receipts. We agree with the tax court that the payment of P461.65 for police protection is illegal as it is a consideration given by the petitioner to the police for the performance by the latter of the functions required of them to be rendered by law. The expenditures of P460.00 for gifts, P1,880.05 for parties and other items for representation are rather excessive, considering that the purpose of the exhibition was for a charitable cause.

WHEREFORE, the decision sought herein to be reviewed is hereby affirmed, with costs against the petitioner.

G.R. No. L-23226 November 28, 1967

ALHAMBRA CIGAR and CIGARETTE MANUFACTURING COMPANY, petitioner-appellant, vs.THE COMMISSIONER OF INTERNAL REVENUE, respondent-appellee.

Gamboa and Gamboa for petitioner-appellant. Office of the Solicitor General for respondent-appellee.

FERNANDO, J.:

This Court, in this petition for the review of a decision of the Court of Tax Appeals is not faced with a problem of undue complexity. The law governing the matter has been authoritatively expounded in an opinion by the then Justice, now Chief Justice, Concepcion in Alhambra Cigar v. Collector of Internal Revenue,1 a case involving the same parties over a similar question but covering an earlier period of time. The limits of a power of respondent Commissioner of Internal Revenue to allow deductions from the gross income "the ordinary and necessary expenses paid or increased during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries and other compensation for personal services actually rendered . . ."2 had thus been authoritatively expounded. What remains to be decided in this litigation is whether the decision of the Court of Tax Appeals sought to be reviewed reflected with fidelity the doctrine thus announced or deviated therefrom.

According to the petition for review, Alhambra Cigar & Cigarette Manufacturing Company, petitioner-appellant, "is a corporation duly organized and existing under the laws of the Philippines, with principal office at 31 Tayuman street, Tondo, Manila; and the respondent-appellee is the duly appointed and qualified Commissioner of Internal Revenue, vested with authority to act as such for the Government of the Republic of the Philippines, . . . .3

In the petition for review it was contended that the Court of Tax Appeals, in affirming the action taken by respondent-appellee Commissioner of Internal Revenue, erred "(a) In holding that A. P. Kuenzle and H.A. Streiff who were the President and Vice-President, respectively, of the petitioner-appellant, were entitled to a salary of only P6,000.00 each year, for 1954, 1955, 1956 and 1957, and a bonus equal to the reduced bonus of W. Eggmann for each of said years; and disallowing as deductions the portions of their salary and bonus in excess of said amounts; (b) In disallowing, as deductions, all the directors' fees and commissions paid by the petitioner-appellant to A.P. Kuenzle and H.A. Streiff; (c) In holding that the petitioner-appellant is liable for the alleged deficiency income taxes in question."4

It is indisputable as noted in the brief for petitioner-appellant that the deductions disallowed by respondent-appellee, Commissioner of Internal Revenue, for the year 1954 to 1957 designated as salaries, officers; bonus, officers; commissions to managers and directors' fees "relate exclusively to the compensations paid by the petitioner-appellant in 1954, 1955, 1956 and 1957, to A. P. Kuenzle and H.A. Streiff who were, during the said years, as they had been in prior years and still are, directors and the president and vice-president, respectively, of the petitioner-appellant. . . ."5

Under the category of salaries, officers of the fixed annual compensation of A. P. Kuenzle and H. A. Streiff in the amount of P15,000.00 each "the respondent-appellee allowed for each of them a salary of only P6,000.00 and disallow

the balance of P9,000.00, or a total disallowance of P18,00.0,0 for both of them, for each of the years in question."6 Under that of the bonus, officers of the amount under such category paid to the above gentlemen for the year 1954 of P14,750.00 each, "the respondent-appellee allowed each of them a bonus of only P5,850.00, and disallowed the balance of P8,900.00 or a total disallowance of P17,800.00 for both of them."7 For the year 1955, the bonus being paid, once again, amounting to P14,750.00 to each of them, "the respondent-appellee allowed for each of them, a bonus of only P7,000.00, and disallowed the balance of P7,750.00 each, or a total disallowance of P15,500.00 for both of them."8 For the year 1956, again the amount, not suffering any change for each, "the respondent-appellee allowed for each of them a bonus of only P5,500.00 and disallowed the balance of P9,250.00 each, or a total disallowance of P18,500.00 for both of them."9 Lastly, for the year 1957, of a similar amount payable to each in the concept of bonus, "the respondent-appellee allowed for each of them a bonus of only P6,500.00, and disallowed the balance of P8,250.00 each, or a total disallowance of P16,500.00 for both of them."10

As to the deduction in the concept of commissions to managers, the brief for the petitioner appellant states: "The commissions paid by the petitioner-appellant to A. P. Kuenzle and H. A. Streiff in the amount of P13,607.61 each in 1954, or a total of P27,215.22 for both of them; P14,097.62 each in 1955, or a total of P28,195.24 for both of them; P13,180.87 each in 1956, or a total of P26,361.74 for both of them; and P13,144.29 each in 1957, or a total of P26,288.48 for both of them, were entirely disallowed by the respondent-appellee."11

Concerning the directors' fees paid to both officials by petitioner-appellant, it is noted in the brief that "in the amount of P11,504.71 each in 1954, or a total of P23,009.42 for both of them; P10,693.02 each in 1955, or a total of P21,386.04

for both of them; P10,360.23 each in 1956, or a total of P20,720.46 for both of them; and P9,716.63 each in 1957, or a total of P19,433.26 for both of them were also entirely disallowed by the respondent-appellee."12

In the decision of the respondent Court of Tax Appeals sought to be reviewed, there was an appraisal of the evidence on which respondent-appellee Commissioner of Internal Revenue based the above deduction on salaries and bonuses: "The evidence shows that prior to 1954, Messrs. A. P. Kuenzle and H. A. Streiff President and Vice-President, respectively, of petitioner corporation, were each paid an annual salary P6,000.00 and a bonus of about four times as much as the annual salary. In Alhambra Cigar and Cigarette Manufacturing Company v. Coll. of Int. Rev. C.T.A. No. 142 January 31, 1957 (affd. in G.R. Nos. L-12026 & L-12131, May 29, 1959), this Court held that considering the nature of the services performed by Messrs. Kuenzle and Streiff the salary of P6,000.00 paid to each of them was reasonable and, therefore, deductions is ordinary and necessary business expense. The bonus paid to each of said officers was however reduced to the amount equivalent to that paid to Mr. W. Eggmann, the resident Treasurer and Manager of petitioner. Following the decision of the Supreme Court in G. R. Nos. L-12026 & L- 12131, . . ., respondent allowed as deduction P6,000.00 as salary to Messrs. Kuenzle and Streiff and a bonus equivalent to that paid annually to Mr. Eggmann from 1954 to 1957, as indicated above."13

Then the decision of respondent Court of Tax Appeals in affirming what respondent-appellee did explained why: "Upon the evidence of record, we find no justification to reverse or modify the decision of respondent with respect to the disallowance of a portion of the salaries and bonuses paid to Messrs. Kuenzle and Streiff. Petitioner seeks to justify the increase in the salaries of Messrs. Kuenzle and Streiff on the ground of increased costs of living. The said officers of petitioner are, however, non-residents of the Philippines."14

It may be stated in this connection that the brief for petitioner-appellant did not actually dispute the fact of non-residence of the aforesaid officials. Thus: "A. P. Kuenzle or H. A. Streiff usually came to the Philippines every two years, and generally stayed from five to eight weeks (t.s.n., pp. 203-204). During the years in question, H. A. Streiff was in the Philippines from January 27 to March 20, 1954. He was personally present at the special meeting of the board of directors of the petitioner-appellant on February 19, 1954 and at the regular meeting on February 27, 1954, the minutes of all of which he signed as Vice-President (Exhibits Q, Q-1 and Q-2). He was also personally present at the semi-annual meeting of stockholders of the petitioner-appellant on February 19, 1954, the minutes of which he also signed as vice-president (Exh. R). A. P. Kuenzle was in the Philippines from February 3 to March 8, 1956 (t.s.n., pp. 204-205). He was personally present at the special meeting of the board of directors on February 22, and on February 23, 1956, and at the semi-annual general meeting of stockholders on February 23, 1956, the minutes of all of which he signed as President (Exhs. Q-8, Q-9. and R-4). H. A. Streiff came again to the Philippines in 1958, and he personally attended the special meeting of the board of directors on March 7, 1968, the minutes of which he also, signed as Vice-President (Exh. Q-16)."15

There was in the brief of petitioner-appellant stress laid on those work performed by them, both in and outside the Philippines. "During their stay in the Philippines, A. P. Kuenzle or H. A. Streiff inspected the install petitions of the petitioner-appellant, and discussed with the local management, personnel and management matters, long-range planning and policies of the company (t.s.n., pp. 205-206). Aside from these visits of A. P. Kuenzle and H. A. Streiff to the Philippines, there were other personal consultations between them and the local management. There were about seven staff members in the local management, and each of them went on home leave every four years and for consultations in Switzerland with the general managers, AP Kuenzle and H. A. Streiff. These home leaves each lasted

for six months. In this way, at least one staff member went on home leave every year and for consultations with the general manager. . . ."16

As to commissions and directors' fees, it is the finding of the Court of Tax Appeals: "In connection with the commissions paid to Messrs. Kuenzle and Streiff there is no evidence of any particular service rendered by them to petitioner to warrant payment of commissions. Counsel for petitioner sought to prove the various types of services performed by said officers, but the services mentioned are those for which they have been more than adequately compensated in the form of salaries and bonuses. As regards the directors' fees, it is admitted that Messrs. Kuenzle and Streiff "usually came to the Philippines every two years, and generally stayed from five to eight weeks." (Page 17, Memorandum for Petitioner.) We cannot see any justification for the payment of director's fees of about P10,000.00 to each of said officers for coming to the Philippines to visit their corporation once in two years. Being non-resident President and Vice-President of Petitioner corporation of which they are the controlling stockholders, we are more inclined to believe that said commissions and directors' fees, payment of which was based on a certain percentage of the annual profits of petitioner, are in the nature of dividend distributions,"17

Considering how carefully the Court of Tax Appeals considered the matter of the disallowances in the light of Section 30 of the National Internal Revenue Code, the task for petitioner-appellant in proving that it erred in holding that A. P. Kuenzle and H. A. Streiff were entitled only to the salary of P6,000.00 each a year, for 1954, 1955, 1956 and 1957, and a bonus equal to the reduced bonus of one of its officials a certain W. Eggmann, for each of said years, and in disallowing as deductions the directors' fees and commissions paid by it to them, was far from easy. Nor could it be

said that petitioner-appellant did succeed in such effort As mentioned earlier, the previous case of Alhambra Cigar & Cigarette Manufacturing Company v. The Collector of Internal Revenue,18 has laid down the applicable principle of law.

In the language of then Justice, now Chief Justice, Concepcion: "In the light of the tenor of the foregoing provision, whenever a controversy arises on the deductibility, for purposes of income tax, of certain items for alleged compensation of officers of the taxpayer, two (2) questions become material, namely: (a) Have "personal services" been "actually rendered" by said officers? (b) In the affirmative case, what is the "reasonable allowance" therefore? When the Collector of Internal Revenue disallowed the fees, bonuses and commissions aforementioned, and the company appealed therefrom, it became necessary for the [Court of Tax Appeals] to determine whether said officer had correctly applied section 30 of the Tax Code, and this, in turn, required the consideration of the two (2) questions already adverted to. In the circumstances surrounding the case, we are of the opinion that the [Court of Tax Appeals] has correctly construed and applied said provision." So it is now. This appeal too cannot prosper.

Even if there were no such previous decision, it would still follow, in the light of the controlling doctrines, that the Court of Tax Appeals must be sustained. The well written brief for petitioner-appellant citing Botany Worsted Bills v. United States,19 states: "Whether the amounts disallowed by the respondent-appellee in the respective years were reasonable compensation for personal services, is a question of fact to be determined from all the evidence."20 That the question thus involved is inherently factual, appears to be undeniable. This Court is bound by the finding of facts of the Court of Tax Appeals, especially so, where as here, the evidence in support thereof is more than substantial, only questions of law thus being left open to it for determination.21 Without ignoring this various factors which petitioner-

appellant would have this Court consider in passing upon the determination made by the Court of Tax Appeals but with full recognition of the fact that the two officials were non-residents, it cannot be said that it committed the alleged errors, calling for the interposition of the corrective authority of this Court. Nor as a matter of principle is it advisable for this Court to set aside the conclusion reached by an agency such as the Court of Tax Appeals which is, by the very nature of its function, dedicated exclusively to the study and consideration of tax problems and has necessarily developed an expertise on the subject unless, as did not happen here, there has been an abuse or improvident exercise of its authority.

WHEREFORE, the decision of the Court of Tax Appeals is affirmed, with costs against petitioner-appellant.