G.R. No. L-13912             September 30, 1960

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 amended1 , 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-16626            October 29, 1966

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.CARLOS PALANCA, JR., respondent.

Office of the Solicitor General for petitioner.Manuel B. San Jose for respondent.

REGALA, J.:

This is an appeal by the Government from the decision of the Court of Tax Appeals in CTA Case No. 571 ordering the petitioner to refund to the respondent the amount of P20,624.01 representing alleged over-payment of income taxes for the calendar year 1955. The facts are:

Sometime in July, 1950, the late Don Carlos Palanca, Sr. donated in favor of his son, the petitioner, herein shares of stock in La Tondeña, Inc. amounting to 12,500 shares. For failure to file a return on the donation within the statutory period, the petitioner was assessed the sums of P97,691.23, P24,442.81 and P47,868.70 as gift tax, 25% surcharge and interest, respectively, which he paid on June 22, 1955.

On March 1, 1956, the petitioner filed with the Bureau of Internal Revenue his income tax return for the calendar year 1955, claiming, among others, a deduction for interest amounting to P9,706.45 and reporting a taxable income of P65,982.12. On the basis of this return, he was assessed the sum of P21,052.91, as income tax, which he paid, as follows:

Taxes withheld by La Tondeña Inc. from Mr. Palanca's wages P13,172.41

Payment under Income Tax Receipt No. 677395 dated May 11, 1956 3,939.80

Payment under Income Tax Receipt dated August 14, 1956 3,939.80

P21,052.01

Subsequently, on November 10, 1956, the petitioner filed an amended return for the calendar year 1955, claiming therein an additional deduction in the amount of P47,868.70 representing interest paid on the donee's gift tax, thereby reporting a taxable net income of P18,113.42 and a tax due thereon in the sum of P3,167.00. The claim for deduction was based on the provisions of Section 30(b) (1) of the Tax Code, which authorizes the deduction from gross income of interest paid within the taxable year on indebtedness. A claim for the refund of alleged overpaid income taxes for the year 1955 amounting to P17,885.01, which is the difference between the amount of P21,052.01 he paid as income taxes under his original return and of P3,167.00, was filed together with this amended return. In a communication dated June 20, 1957, the respondent (BIR) denied the claim for refund.

On August 27, 1957, the petitioner reiterated his claim for refund, and at the same time requested that the case be elevated to the Appellate Division of the Bureau of Internal Revenue for decision. The reiterated claim was denied on October 14, 1957.

On November 2, 1957, the petitioner requested that the case be referred to the Conference Staff of the Bureau of Internal Revenue for review. Later, on November 6, 1957, he requested the respondent to hold his action on the case in abeyance until after the Court

of Tax Appeals renders its division on a similar case. And on November 7, 1957, the respondent denied the claim for the refund of the sum of P17,885.01.

Meanwhile, the Bureau of Internal Revenue considered the transfer of 12,500 shares of stock of La Tondeña Inc. to be a transfer in contemplation of death pursuant to Section 88(b) of the National Internal Revenue Code. Consequently, the respondent assessed against the petitioner the sum of P191,591.62 as estate and inheritance taxes on the transfer of said 12,500 shares of stock. The amount of P17,002.74 paid on June 22, 1955 by the petitioner as gift tax, including interest and surcharge, under Official Receipt No. 2855 was applied to his estate and inheritance tax liability. On the tax liability of P191,591.62, the petitioner paid the amount of P60,581.80 as interest for delinquency as follows:

1% monthly interest on P76,724.38September 2, 1952 to February 16, 1955

P22,633.69

1% monthly interest on P71,264.77February 16, 1955 to March 31, 1955

1,068.97

1% monthly interest on P114,867.24September 2, 1952 to April 16, 1953

4,287.99

1% monthly interest on P50,832.77 March 31, 1955 to June 22, 1955

1,372.48

1% monthly interest on P119,155.23April 16, 1953 to June 22, 1955

31,218.67

T o t a l P60,581.80

On August 12, 1958, the petitioner once more filed an amended income tax return for the calendar year 1955, claiming, in addition to the interest deduction of P9,076.45 appearing in his original return, a deduction in the amount of P60,581.80, representing interest on the estate and inheritance taxes on the 12,500 shares of stock, thereby reporting a net taxable income for 1955 in the amount of P5,400.32 and an income tax due thereon in the sum of P428.00. Attached to this amended return was a letter of the petitioner, dated August 11, 1958, wherein he requested the refund of P20,624.01 which is the difference between the amounts of P21,052.01 he paid as income tax under his original return and of P428.00.

Without waiting for the respondent's decision on this claim for refund, the petitioner filed his petition for review before this Court on August 13, 1958. On July 24, 1959, the respondent denied the petitioner's request for the refund of the sum of P20,624.01.

The Commissioner of Internal Revenue now seeks the reversal of the Court of Tax Appeal's ruling on the aforementioned petition for review. Specifically, he takes issue with the said court's determination that the amount paid by respondent Palanca for interest on his delinquent estate

and inheritance tax is deductible from the gross income for that year under Section 30 (b) (1) of the Revenue Code, and, that said respondent's claim for refund therefor has not prescribed.

On the first point, the Commissioner urges that a tax is not an indebtedness. Citing American cases, he argues that there is a material and fundamental distinction between a "tax" and a "debt." (Meriwether v. Garrett, 102 U.S. 427; Liberty Mutual Ins. Co. v. Johnson Shipyards Corporation, 5 AFTR pp. 5504, 5507; City of Camden v. Allen, 26 N.J. Law, p. 398). He adopts the view that "debts are due to the government in its corporate capacity, while taxes are due to the government in its sovereign capacity. A debt is a sum of money due upon contract express or implied or one which is evidenced by a judgment. Taxes are imposts levied by government for its support or some special purpose which the government has recognized." In view of the distinction, then, the Commissioner submits that the deductibility of "interest on indebtedness" from a person's income tax under Section 30(b) (1) cannot extend to "interest on taxes."

We find for the respondent. While "taxes" and "debts" are distinguishable legal concepts, in certain cases as in the suit at bar, on account of their nature, the distinction becomes inconsequential. This qualification is recognized even in the United States. Thus,

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 requirements of the law. (Camden vs. Fink Coule and Coke Co., 61 ALR 584).

Where statutes impose a personal liability for a tax, the tax becomes at least in a broad sense, a debt. (Idem.)

Some American authorities hold that, especially for remedial purposes, Federal taxes are debts. (Tax Commission vs. National Malleable Castings Co., 35 ALR 1448)

In our jurisdiction, the rule is settled that although taxes already due have not, strictly speaking, the same concept as debts, they are, however obligations that may be considered as such. (Sambrano vs. Court of Tax Appeals, G.R. no. L-8652, March 30, 1957). In a more recent case Commissioner of Internal Revenue vs. Prieto, G.R. No. L-13912, September 30, 1960, we explicitly announced that while the distinction between "taxes" and "debts" was recognized in this jurisdiction, the variance in their legal conception does not extend to the interests paid on them, at least insofar as Section 30 (b) (1) of the National Internal Revenue Code is concerned. Thus,

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 deducted. 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 —

xxx           xxx           xxx

"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 the unconditional and legally enforceable obligation for the payment of money. (Federal Taxes Vol. 2, p. 13, 019, Prentice Hall, Inc.; Mertens' 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. . . . (Emphasis supplied)

"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."

We do not see any element in this case which can justify a departure from or abandonment of the doctrine in the Prieto case above. In both this and the said case, the taxpayer sought the allowance as deductible items from the gross income of the amounts paid by them as interests on delinquent tax liabilities. Of course, what was involved in the cited case was the donor's tax while the present suit pertains to interest paid on the estate and inheritance tax. This difference, however, submits no appreciable consequence to the rationale of this Court's previous determination that interests on taxes should be considered as interests on indebtedness within the meaning of Section 30(b) (1) of the Tax Code. The interpretation we have placed upon the said section was predicated on the congressional intent, not on the nature of the tax for which the interest was paid.

On the issue of prescription: There were actually two claims for refund filed by the herein respondent, Carlos Palanca, Jr., anent the case at bar. The first one was on November 10, 1956, when he filed a claim for refund on the interest paid by him on the donee's gift tax of P17,885.10, as originally demanded by the Bureau of Internal Revenue. The second one was the one filed by him on August 12, 1958, which was a claim for refund on the interest paid by him on the estate and inheritance tax assessed by the same Bureau in the amount of P20,624.01. Actually, this second assessment by the Bureau was for the same transaction as that for which they assessed respondent Palanca the above donee's gift tax. The Bureau, however, on further consideration, decided that the donation of the stocks in question was made in contemplation of death, and hence, should be assessed as an inheritance. Thus the second assessment. The first claim was denied by the petitioner for the first time on June 20, 1957. Thereafter, the said denial was twice reiterated, on October 14, 1957 and November 7, 1957, upon respondent Palanca's

plea for the reconsideration of the ruling of June 20, 1957. The second claim was filed with the Court of Tax Appeals on August 13, 1958, or even before the same had been denied by the petitioner. Respondent Palanca's second claim was denied by the latter on July 24, 1959.

The petitioner contends that under Section 11 of Republic Act 1124,1 the herein claimant's claim for refund has prescribed since the same was filed outside the thirty-day period provided for therein. According to the petitioner, the said prescriptive period commenced to run on October 14, 1947 when the denial by the Bureau of Internal Revenue of the respondent Palanca's claim for refund, under his letter of November 10, 1956, became final. Considering that the case was filed with the Court of Tax Appeals only on August 13, 1958, then it is urged that the same had prescribed.

The petitioner also invokes prescription, at least with respect to the sum of P17,112.21, under Section 306 of the Tax Code.2 He claims that for the calendar year 1955, respondent Palanca paid his income tax as follows:

Taxes withheld by La Tondeña Inc. from Mr. Palanca's wages P13,172.41

Payment under Income Tax Receipt No. 677395 dated May 11, 1956 3,939.89

Payment under Income Tax Receipt No. 742334 dated August 14, 1956 3,939.89

P21,952.01

Therefore, the petitioner contends, the amounts paid by claimant Palanca under his withheld tax and under Receipt No. 677395 dated May 11, 1956 may no longer be refunded since the claim therefor was filed in court only on August 13, 1958, or beyond two years of their payment.

We find the petitioner's contention on prescription untenable.

In the first place, the 30-day period under Section 11 of Republic Act 1125 did not even commence to run in this incident. It should be recalled that while the herein petitioner originally assessed the respondent-claimant for alleged gift tax liabilities, the said assessment was subsequently abandoned and in its lieu, a new one was prepared and served on the respondent-taxpayer. In this new assessment, the petitioner charged the said respondent with an entirely new liability and for a substantially different amount from the first. While initially the petitioner assessed the respondent for donee's gift tax in the amount of P170,002.74, in the subsequent assessment the latter was asked to pay P191,591.62 for delinquent estate and inheritance tax. Considering that it is the interest paid on this latter-assessed estate and inheritance tax that respondent Palanca is claiming refund for, then the thirty-day period under the abovementioned section of Republic Act 1125 should be computed from the receipt of the final denial by the Bureau of Internal Revenue of the said claim. As has earlier been recited, respondent Palanca's claim in this incident was filed with the Court of Tax Appeals even before it had been denied by

the herein petitioner or the Bureau of Internal Revenue. The case was filed with the said court on August 13, 1958 while the petitioner denied the claim subject of the said case only on July 24, 1959.

In the second place, the claim at bar refers to the alleged overpayment by respondent Palanca of his 1955 income tax. Inasmuch as the said account was paid by him by installment, then the computation of the two-year prescriptive period, under Section 306 of the National Internal Revenue Code, should be from the date of the last installment. (Antonio Prieto, et al. vs. Collector of Internal Revenue, G.R. No. L-11976, August 29, 1961) Respondent Palanca paid the last installment on his 1955 income tax account on August 14, 1956. His claim for refund of the alleged overpayment on it was filed with the court on August 13, 1958. It was, therefore, still timely instituted.

WHEREFORE, the decision appealed from is affirmed in full, without pronouncement on costs.

G.R. Nos. 106949-50 December 1, 1995

PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner, vs.COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS,respondents.

G.R. Nos. 106984-85 December 1, 1995

COMMISSIONER INTERNAL REVENUE, petitioner, vs.PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT OF APPEALS and THE COURT OF TAX APPEALS, respondents.

 

FELICIANO, J.:

The Paper Industries Corporation of the Philippines ("Picop"), which is petitioner in G.R. Nos. 106949-50 and private respondent in G.R. Nos. 106984-85, is a Philippine corporation registered with the Board of Investments ("BOI") as a preferred pioneer enterprise with respect to its integrated pulp and paper mill, and as a preferrednon-pioneer enterprise with respect to its integrated plywood and veneer mills.

On 21 April 1983, Picop received from the Commissioner of Internal Revenue ("CIR") two (2) letters of assessment and demand both dated 31 March 1983: (a) one for deficiency transaction tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate amount ofP88,763,255.00. These assessments were computed as follows:

Transaction Tax

Interest payments on

money market

borrowings P 45,771,849.00———————

35% Transaction tax due

thereon 16,020,147.00

Add: 25% surcharge 4,005,036.75

——————

T o t a l P 20,025,183.75

Add:

14% int. fr.

1-20-78 to

7-31-80 P 7,093,302.57

20% int, fr.

8-1-80 to

3-31-83 10,675,523.58

——————

17,768,826.15

——————

P 37,794,009.90

Documentary and Science Stamps Tax

Total face value of

debentures P100,000,000.00

Documentary Stamps

Tax Due

(P0.30 x P100,000.000 )

( P200 ) P 150,000.00

Science Stamps Tax Due

(P0.30 x P100,000,000 )

( P200 ) P 150,000.00

——————

T o t a l P 300,000.00

Add: Compromise for

non-affixture 300.00

——————

300,300.00

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 38,094,309.90

===========

Deficiency Income Tax for 1977

Net income per return P 258,166.00

Add: Unallowable deductions

1) Disallowed deductions

availed of under

R.A. No. 5186 P 44,332,980.00

2) Capitalized interest

expenses on funds

used for acquisition

of machinery & other

equipment 42,840,131.00

3) Unexplained financial

guarantee expense 1,237,421.00

4) Understatement

of sales 2,391,644.00

5) Overstatement of

cost of sales 604,018.00

——————

P91,406,194.00

Net income per investigation P91,664,360.00

Income tax due thereon 34,734,559.00

Less: Tax already assessed per return 80,358.00

——————

Deficiency P34,654,201.00

Add:

14% int. fr.

4-15-78 to

7-31-81 P 11,128,503.56

20% int. fr.

8-1-80 to

4-15-81 4,886,242.34

——————

P16,014,745.90

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 50,668,946.90 1

===========

On 26 April 1983, Picop protested the assessment of deficiency transaction tax and documentary and science stamp taxes. Picop also protested on 21 May 1983 the deficiency income tax assessment for 1977. These protests were not formally acted upon by respondent CIR. On 26 September 1984, the CIR issued a warrant of distraint on personal property and a warrant of levy on real property against Picop, to enforce collection of the contested assessments; in effect, the CIR denied Picop's protests.

Thereupon, Picop went before the Court of Tax Appeals ("CTA") appealing the assessments. After trial, the CTA rendered a decision dated 15 August 1989, modifying the findings of the CIR and holding Picop liable for the reduced aggregate amount of P20,133,762.33, which was itemized in the dispositive portion of the decision as follows:

35% Transaction Tax P 16,020,113.20

Documentary & Science

Stamp Tax 300,300.00

Deficiency Income Tax Due 3,813,349.33

——————

TOTAL AMOUNT DUE AND PAYABLE P 20,133,762.53 2

===========

Picop and the CIR both went to the Supreme Court on separate Petitions for Review of the above decision of the CTA. In two (2) Resolutions dated 7 February 1990 and 19 February 1990, respectively, the Court referred the two (2) Petitions to the Court of Appeals. The Court of Appeals consolidated the two (2) cases and rendered a decision, dated 31 August 1992, which further reduced the liability of Picop to P6,338,354.70. The dispositive portion of the Court of Appeals decision reads as follows:

WHEREFORE, the appeal of the Commissioner of Internal Revenue is denied for lack of merit. The judgment against PICOP is modified, as follows:

1. PICOP is declared liable for the 35% transaction tax in the amount of P3,578,543.51;

2. PICOP is absolved from the payment of documentary and science stamp tax of P300,000.00 and the compromise penalty of P300.00;

3. PICOP shall pay 20% interest per annum on the deficiency income tax of P1,481,579.15, for a period of three (3) years from 21 May 1983, or in the total amount of P888,947.49, and a surcharge of 10% on the latter amount, or P88,984.75.

No pronouncement as to costs.

SO ORDERED.

Picop and the CIR once more filed separate Petitions for Review before the Supreme Court. These cases were consolidated and, on 23 August 1993, the Court resolved to give due course to both Petitions in G.R. Nos. 106949-50 and 106984-85 and required the parties to file their Memoranda.

Picop now maintains that it is not liable at all to pay any of the assessments or any part thereof. It assails the propriety of the thirty-five percent (35%) deficiency transaction tax which the Court of Appeals held due from it in the amount of P3,578,543.51. Picop also questions the imposition by the Court of Appeals of the deficiency income tax of P1,481,579.15, resulting from disallowance of certain claimed financial guarantee expenses and claimed year-end adjustments of sales and cost of sales figures by Picop's external auditors. 3

The CIR, upon the other hand, insists that the Court of Appeals erred in finding Picop not liable for surcharge and interest on unpaid transaction tax and for documentary and science stamp taxes and in allowing Picop to claim as deductible expenses:

(a) the net operating losses of another corporation (i.e., Rustan Pulp and Paper Mills, Inc.); and

(b) interest payments on loans for the purchase of machinery and equipment.

The CIR also claims that Picop should be held liable for interest at fourteen percent (14%) per annum from 15 April 1978 for three (3) years, and interest at twenty percent (20%) per annum for a maximum of three (3) years; and for a surcharge of ten percent (10%), on Picop's deficiency income tax. Finally, the CIR contends that Picop is liable for the corporate development tax equivalent to five percent (5%) of its correct 1977 net income.

The issues which we must here address may be sorted out and grouped in the following manner:

I. Whether Picop is liable for:

(1) the thirty-five percent (35%) transaction tax;

(2) interest and surcharge on unpaid transaction tax; and

(3) documentary and science stamp taxes;

II. Whether Picop is entitled to deductions against income of:

(1) interest payments on loans for the purchase of machinery and equipment;

(2) net operating losses incurred by the Rustan Pulp and Paper Mills, Inc.; and

(3) certain claimed financial guarantee expenses; and

III. (1) Whether Picop had understated its sales and overstated its cost of sales for 1977; and

(2) Whether Picop is liable for the corporate development tax of five percent (5%) of its net income for 1977.

We will consider these issues in the foregoing sequence.

I.

(1) Whether Picop is liablefor the thirty-five percent(35%) transaction tax.

With the authorization of the Securities and Exchange Commission, Picop issued commercial paper consisting of serially numbered promissory notes with the total face value of P229,864,000.00 and a maturity period of one (1) year, i.e., from 24 December 1977 to 23 December 1978. These promissory notes were purchased by various commercial banks and financial institutions. On these promissory notes, Picop paid interest in the aggregate amount of P45,771,849.00. In respect of these interest payments, the CIR required Picop to pay the thirty-five percent (35%) transaction tax.

The CIR based this assessment on Presidential Decree No. 1154 dated 3 June 1977, which reads in part as follows:

Sec. 1. The National Internal Revenue Code, as amended, is hereby further amended by adding a new section thereto to read as follows:

Sec. 195-C. Tax on certain interest. — There shall be levied, assessed, collected and paid on every commercial paper issued in the primary market as principal instrument, a transaction tax equivalent to thirty-five percent (35%) based on the gross amount of interest thereto as defined hereunder, which shall be paid by the borrower/issuer: Provided, however, that in the case of a long-term commercial paper whose maturity exceeds more than one year, the borrower shall pay the tax based on the amount of interest corresponding to one year, and thereafter shall pay the tax upon accrual or actual payment (whichever is earlier) of the untaxed portion of the interest which corresponds to a period not exceeding one year.

The transaction tax imposed in this section shall be a final tax to be paid by the borrower and shall be allowed as a deductible item for purposes of computing the borrower's taxable income.

For purposes of this tax —

(a) "Commercial paper" shall be defined as an instrument evidencing indebtedness of any person or entity, including banks and non-banks performing quasi-banking functions, which is issued, endorsed, sold, transferred or in any manner conveyed to another person or entity, either with or without recourse and irrespective of maturity. Principally, commercial papers are promissory notesand/or similar instruments issued in the primary market and shall not include repurchase agreements, certificates of assignments, certificates of participations, and such other debt instruments issued in the secondary market.

(b) The term "interest" shall mean the difference between what the principal borrower received and the amount it paid upon maturity of the commercial paper which shall, in no case, be lower than the interest rate prevailing at the time of the issuance or renewal of the commercial paper. Interest shall be deemed synonymous with discount and shall include all fees, commissions, premiums and other payments which form integral parts of the charges imposed as a consequence of the use of money.

In all cases, where no interest rate is stated or if the rate stated is lower than the prevailing interest rate at the time of the issuance or renewal of commercial paper, the Commissioner of Internal Revenue, upon consultation with the Monetary Board of the Central Bank of the Philippines, shall adjust the interest rate in accordance herewith, and assess the tax on the basis thereof.

The tax herein imposed shall be remitted by the borrower to the Commissioner of Internal Revenue or his Collection Agent in the municipality where such borrower has its principal place of business within five (5) working days from the issuance of the commercial paper. In the case of long term commercial paper, the tax upon

the untaxed portion of the interest which corresponds to a period not exceeding one year shall be paid upon accrual payment, whichever is earlier. (Emphasis supplied)

Both the CTA and the Court of Appeals sustained the assessment of transaction tax.

In the instant Petition, Picop reiterates its claim that it is exempt from the payment of the transaction tax by virtue of its tax exemption under R.A. No. 5186, as amended, known as the Investment Incentives Act, which in the form it existed in 1977-1978, read in relevant part as follows:

Sec. 8. Incentives to a Pioneer Enterprise. In addition to the incentives provided in the preceding section, pioneer enterprises shall be granted the following incentive benefits:

(a) Tax Exemption. Exemption from all taxes under the National Internal Revenue Code, except income tax, from the date the area of investment is included in the Investment Priorities Plan to the following extent:

(1) One hundred per cent (100%) for the first five years;

(2) Seventy-five per cent (75%) for the sixth through the eighth years;

(3) Fifty per cent (50%) for the ninth and tenth years;

(4) Twenty per cent (20%) for the eleventh and twelfth years; and

(5) Ten per cent (10%) for the thirteenth through the fifteenth year.

xxx xxx xxx 4

We agree with the CTA and the Court of Appeals that Picop's tax exemption under R.A. No. 5186, as amended, does not include exemption from the thirty-five percent (35%) transaction tax. In the first place, the thirty-five percent (35%) transaction tax 5 is an income tax, that is, it is a tax on the interest income of the lenders or creditors. InWestern Minolco Corporation v. Commissioner of Internal Revenue, 6 the petitioner corporation borrowed funds from several financial institutions from June 1977 to October 1977 and paid the corresponding thirty-five (35%) transaction tax thereon in the amount of P1,317,801.03, pursuant to Section 210 (b) of the 1977 Tax Code. Western Minolco applied for refund of that amount alleging it was exempt from the thirty-five (35%) transaction tax by reason of Section 79-A of C.A. No. 137, as amended, which granted new mines and old mines resuming operation "five (5) years complete tax exemptions, except income tax, from the time of its actual bonafide orders for equipment for commercial production." In denying the claim for refund, this Court held:

The petitioner's contentions deserve scant consideration. The 35% transaction tax is imposed on interest income from commercial papers issued in the primary money market. Being a tax on interest, it is a tax on income.

As correctly ruled by the respondent Court of Tax Appeals:

Accordingly, we need not and do not think it necessary to discuss further the nature of the transaction tax more than to say that the incipient scheme in the issuance of Letter of Instructions No. 340 on November 24, 1975 (O.G. Dec. 15, 1975), i.e., to achieve operational simplicity and effective administration in capturing the interest-income "windfall" from money market operations as a new source of revenue, has lost none of its animating principle in parturition of amendatory Presidential Decree No. 1154, now Section 210 (b) of the Tax Code. The tax thus imposed is actually a tax on interest earnings of the lenders or placers who are actually the taxpayers in whose income is imposed. Thus "the borrower withholds the tax of 35% from the interest he would have to pay the lender so that he (borrower) can pay the 35% of the interest to the Government." (Citation omitted) . . . . Suffice it to state that the broad consensus of fiscal and monetary authorities is that "even if nominally, the borrower is made to pay the tax, actually, the tax is on the interest earning of the immediate and all prior lenders/placers of the money. . . ." (Rollo, pp. 36-37)

The 35% transaction tax is an income tax on interest earnings to the lenders or placers. The latter are actually the taxpayers. Therefore, the tax cannot be a tax imposed upon the petitioner. In other words, the petitioner who borrowed funds from several financial institutions by issuing commercial papers merely withheld the 35% transaction tax before paying to the financial institutions the interests earned by them and later remitted the same to the respondent Commissioner of Internal Revenue. The tax could have been collected by a different procedure but the statute chose this method. Whatever collecting procedure is adopted does not change the nature of the tax.

xxx xxx xxx 7

(Emphasis supplied)

Much the same issue was passed upon in Marinduque Mining Industrial Corporation v. Commissioner of Internal Revenue 8 and resolved in the same way:

It is very obvious that the transaction tax, which is a tax on interest derived from commercial paper issued in the money market, is not a tax contemplated in the above-quoted legal provisions. The petitioner admits that it is subject to income tax. Its tax exemption should be strictly construed.

We hold that petitioner's claim for refund was justifiably denied. The transaction tax, although nominally categorized as a business tax, is in reality a withholding tax as positively stated in LOI No. 340. The petitioner could have shifted the tax to the lenders or recipients of the interest. It did not choose to do so. It cannot be heard now to complain about the tax. LOI No. 340 is an extraneous or extrinsic aid to the construction of section 210 (b).

xxx xxx xxx 9

(Emphasis supplied)

It is thus clear that the transaction tax is an income tax and as such, in any event, falls outside the scope of the tax exemption granted to registered pioneer enterprises by Section 8 of R.A. No. 5186, as amended. Picop was the withholding agent, obliged to withhold thirty-five percent (35%) of the interest payable to its lenders and to remit the amounts so withheld to the Bureau of Internal Revenue ("BIR"). As a withholding agent, Picop is madepersonally liable for the thirty-five percent (35%) transaction tax 10 and if it did not actually withhold thirty-five percent (35%) of the interest monies it had paid to its lenders, Picop had only itself to blame.

Picop claims that it had relied on a ruling, dated 6 October 1977, issued by the CIR, which held that Picop was not liable for the thirty-five (35%) transaction tax in respect of debenture bonds issued by Picop. Prior to the issuance of the promissory notes involved in the instant case, Picop had also issued debenture bonds P100,000,000.00 in aggregate face value. The managing underwriter of this debenture bond issue, Bancom Development Corporation, requested a formal ruling from the Bureau of Internal Revenue on the liability of Picop for the thirty-five percent (35%) transaction tax in respect of such bonds. The ruling rendered by the then Acting Commissioner of Internal Revenue, Efren I. Plana, stated in relevant part:

It is represented that PICOP will be offering to the public primary bonds in the aggregate principal sum of one hundred million pesos (P100,000,000.00); that the bonds will be issued as debentures in denominations of one thousand pesos (P1,000.00) or multiples, to mature in ten (10) years at 14% interest per annum payable semi-annually; that the bonds are convertible into common stock of the issuer at the option of the bond holder at an agreed conversion price; that the issue will be covered by a "Trust Indenture" with a duly authorized trust corporation as required by the Securities and Exchange Commission, which trustee will act for and in behalf of the debenture bond holders as beneficiaries; that once issued, the bonds cannot be preterminated by the holder and cannot be redeemed by the issuer until after eight (8) years from date of issue; that the debenture bonds will besubordinated to present and future debts of PICOP; and that said bonds are intended to be listed in the stock exchanges, which will place them alongside listed equity issues.

In reply, I have the honor to inform you that although the bonds hereinabove described are commercial papers which will be issued in the primary market, however, it is clear from the abovestated facts that said bonds will not be issued

as money market instruments. Such being the case, and considering that the purposes of Presidential Decree No. 1154, as can be gleaned from Letter of Instruction No. 340, dated November 21, 1975, are (a) to regulate money market transactions and (b) to ensure the collection of the tax on interest derived from money market transactions by imposing a withholding tax thereon, said bonds do not come within the purview of the"commercial papers" intended to be subjected to the 35% transaction tax prescribed in Presidential Decree No. 1154, as implemented by Revenue Regulations No. 7-77. (See Section 2 of said Regulation) Accordingly, PICOP is not subject to 35% transaction tax on its issues of the aforesaid bonds. However, those investing in said bonds should be made aware of the fact that the transaction tax is not being imposed on the issuer of said bonds by printing or stamping thereon, in bold letters, the following statement: "ISSUER NOT SUBJECT TO TRANSACTION TAX UNDER P.D. 1154. BONDHOLDER SHOULD DECLARE INTEREST EARNING FOR INCOME TAX." 11 (Emphases supplied)

In the above quoted ruling, the CIR basically held that Picop's debenture bonds did not constitute "commercial papers" within the meaning of P.D. No. 1154, and that, as such, those bonds were not subject to the thirty-five percent (35%) transaction tax imposed by P.D. No. 1154.

The above ruling, however, is not applicable in respect of the promissory notes which are the subject matter of the instant case. It must be noted that the debenture bonds which were the subject matter of Commissioner Plana's ruling were long-term bonds maturing in ten (10) years and which could not be pre-terminated and could not be redeemed by Picop until after eight (8) years from date of issue; the bonds were moreover subordinated to present and future debts of Picop and convertible into common stock of Picop at the option of the bondholder. In contrast, the promissory notes involved in the instant case are short-term instruments bearing a one-year maturity period. These promissory notes constitute the very archtype of money market instruments. For money market instruments are precisely, by custom and usage of the financial markets, short-term instruments with a tenor of one (1) year or less. 12 Assuming, therefore, (without passing upon) the correctness of the 6 October 1977 BIR ruling, Picop's short-term promissory notes must be distinguished, and treated differently, from Picop's long-term debenture bonds.

We conclude that Picop was properly held liable for the thirty-five percent (35%) transaction tax due in respect of interest payments on its money market borrowings.

At the same time, we agree with the Court of Appeals that the transaction tax may be levied only in respect of the interest earnings of Picop's money market lenders accruing after P.D. No. 1154 went into effect, and not in respect of all the 1977 interest earnings of such lenders. The Court of Appeals pointed out that:

PICOP, however contends that even if the tax has to be paid, it should be imposed only for the interests earned after 20 September 1977 when PD 1154 creating the tax became effective. We find merit in this contention. It appears that the tax was levied on interest earnings from January to October, 1977. However, as found by

the lower court, PD 1154 was published in the Official Gazette only on 5 September 1977, and became effective only fifteen (15) days after the publication, or on 20 September 1977, no other effectivity date having been provided by the PD. Based on the Worksheet prepared by the Commissioner's office, the interests earned from 20 September to October 1977 was P10,224,410.03. Thirty-five (35%) per cent of this is P3,578,543.51 which is all PICOP should pay as transaction tax. 13 (Emphasis supplied)

P.D. No. 1154 is not, in other words, to be given retroactive effect by imposing the thirty-five percent (35%) transaction tax in respect of interest earnings which accrued before the effectivity date of P.D. No. 1154, there being nothing in the statute to suggest that the legislative authority intended to bring about such retroactive imposition of the tax.

(2) Whether Picop is liablefor interest and surchargeon unpaid transaction tax.

With respect to the transaction tax due, the CIR prays that Picop be held liable for a twenty-five percent (25%) surcharge and for interest at the rate of fourteen percent (14%) per annum from the date prescribed for its payment. In so praying, the CIR relies upon Section 10 of Revenue Regulation 7-77 dated 3 June 1977, 14 issued by the Secretary of Finance. This Section reads:

Sec. 10. Penalties. — Where the amount shown by the taxpayer to be due on its return or part of such payment is not paid on or before the date prescribed for its payment, the amount of the tax shall be increased by twenty-five (25%) per centum, the increment to be a part of the tax and theentire amount shall be subject to interest at the rate of fourteen (14%) per centum per annum from the date prescribed for its payment.

In the case of willful neglect to file the return within the period prescribed herein or in case a false or fraudulent return is willfully made, there shall be added 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, asurcharge of fifty (50%) per centum of its amount. The amount so added to any tax shall be collected at the same time and in the same manner and as part of the tax unless the tax has been paid before the discovery of the falsity or fraud, in which case the amount so added shall be collected in the same manner as the tax.

In addition to the above administrative penalties, the criminal and civil penalties as provided for under Section 337 of the Tax Code of 1977 shall be imposed for violation of any provision of Presidential Decree No. 1154. 15 (Emphases supplied)

The 1977 Tax Code itself, in Section 326 in relation to Section 4 of the same Code, invoked by the Secretary of Finance in issuing Revenue Regulation 7-77, set out, in comprehensive terms, the rule-making authority of the Secretary of Finance:

Sec. 326. Authority of Secretary of Finance to Promulgate Rules and Regulations. — The Secretary of Finance, upon recommendation of the Commissioner of Internal Revenue, shall promulgate all needful rules and regulations for the effective enforcement of the provisions of this Code. (Emphasis supplied)

Section 4 of the same Code contains a list of subjects or areas to be dealt with by the Secretary of Finance through the medium of an exercise of his quasi-legislative or rule-making authority. This list, however, while it purports to be open-ended, does not include the imposition of administrative or civil penalties such as the payment of amounts additional to the tax due. Thus, in order that it may be held to be legally effective in respect of Picop in the present case, Section 10 of Revenue Regulation 7-77 must embody or rest upon some provision in the Tax Code itself which imposes surcharge and penalty interest for failure to make a transaction tax payment when due.

P.D. No. 1154 did not itself impose, nor did it expressly authorize the imposition of, a surcharge and penalty interest in case of failure to pay the thirty-five percent (35%) transaction tax when due. Neither did Section 210 (b) of the 1977 Tax Code which re-enacted Section 195-C inserted into the Tax Code by P.D. No. 1154.

The CIR, both in its petition before the Court of Appeals and its Petition in the instant case, points to Section 51 (e) of the 1977 Tax Code as its source of authority for assessing a surcharge and penalty interest in respect of the thirty-five percent (35%) transaction tax due from Picop. This Section needs to be quoted in extenso:

Sec. 51. Payment and Assessment of Income Tax. —

(c) Definition of deficiency. — As used in this Chapter in respect of a tax imposed by this Title, the term "deficiency" means:

(1) The amount by which the tax imposed by this Title exceeds the amount shown as the tax by the taxpayer upon his return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected without assessment) as a deficiency, and decreased by the amount previously abated, credited, returned, or otherwise in respect of such tax; . . .

xxx xxx xxx

(e) Additions to the tax in case of non-payment. —

(1) Tax shown on the return. — Where the amount determined by the taxpayer as the tax imposed by this Title or any installment thereof, or any part of such amount or installment is not paid on or before the date prescribed for its payment, there shall be collected as a part of the tax, interest upon such unpaid amount at the rate of fourteen per centum per annum from the date prescribed for its payment until it is paid: Provided, That the maximum amount that may be collected as interest on deficiency shall in no case exceed the amount

corresponding to a period of three years, the present provisions regarding prescription to the contrary notwithstanding.

(2) Deficiency. — Where a deficiency, or any interest assessed in connection therewith under paragraph (d) of this section, or any addition to the taxes provided for in Section seventy-two of this Code is not paid in full within thirty days from the date of notice and demand from the Commissioner of Internal Revenue, there shall be collected upon the unpaid amount as part of the tax, interest at the rate of fourteen per centum per annum from the date of such notice and demand until it is paid:Provided, That the maximum amount that may be collected as interest on deficiency shall in no case exceed the amount corresponding to a period of three years, the present provisions regarding prescription to the contrary notwithstanding.

(3) Surcharge. — If any amount of tax included in the notice and demand from the Commissioner of Internal Revenue is not paid in full within thirty days after such notice and demand, there shall be collected in addition to the interest prescribed herein and in paragraph (d) above and as part of the tax a surcharge of five per centum of the amount of tax unpaid. (Emphases supplied)

Section 72 of the 1977 Tax Code referred to in Section 51 (e) (2) above, provides:

Sec. 72. Surcharges for failure to render returns and for rendering false and fraudulent returns. — In case of willful neglect to file the return or list required by this Title within the time prescribed by law, or in case a false or fraudulent return or list is wilfully made, the Commissioner 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, as 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 or list within the time prescribed by law or by the Commissioner or other Internal Revenue Officer, not due to willful neglect, the Commissioner of Internal Revenue shall add to the tax twenty-five per centum of its amount, except that, when a return is voluntarily and without notice from the Commissioner or other officer filed after such time, and it is shown that the failure to file it 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. (Emphases supplied)

It will be seen that Section 51 (c) (1) and (e) (1) and (3), of the 1977 Tax Code, authorize the imposition of surcharge and interest only in respect of a "tax imposed by this Title," that is to say, Title II on "Income Tax." It will also be seen that Section 72 of the 1977 Tax Code imposes a surcharge only in case of failure to file a return or list "required by this Title," that is, Title II on "Income Tax." The thirty-five percent (35%) transaction tax is, however, imposed in the 1977 Tax Code by Section 210 (b) thereof which Section is embraced in Title V on"Taxes on Business"

of that Code. Thus, while the thirty-five percent (35%) transaction tax is in truth a tax imposed on interest income earned by lenders or creditors purchasing commercial paper on the money market, the relevant provisions, i.e., Section 210 (b), were not inserted in Title II of the 1977 Tax Code. The end result is that the thirty-five percent (35%) transaction tax is not one of the taxes in respect of which Section 51 (e) authorized the imposition of surcharge and interest and Section 72 the imposition of a fraud surcharge.

It is not without reluctance that we reach the above conclusion on the basis of what may well have been an inadvertent error in legislative draftsmanship, a type of error common enough during the period of Martial Law in our country. Nevertheless, we are compelled to adopt this conclusion. We consider that the authority to impose what the present Tax Code calls (in Section 248) civil penalties consisting of additions to the tax due, must be expressly given in the enabling statute, in language too clear to be mistaken. The grant of that authority is not lightly to be assumed to have been made to administrative officials, even to one as highly placed as the Secretary of Finance.

The state of the present law tends to reinforce our conclusion that Section 51 (c) and (e) of the 1977 Tax Code did not authorize the imposition of a surcharge and penalty interest for failure to pay the thirty-five percent (35%) transaction tax imposed under Section 210 (b) of the same Code. The corresponding provision in the current Tax Code very clearly embraces failure to pay all taxes imposed in the Tax Code, without any regard to the Title of the Code where provisions imposing particular taxes are textually located. Section 247 (a) of the NIRC, as amended, reads:

Title X

Statutory Offenses and Penalties

Chapter I

Additions to the Tax

Sec. 247. General Provisions. — (a) The additions to the tax or deficiency tax prescribed in this Chapter shall apply to all taxes, fees and charges imposed in this Code. The amount so added to the tax shall be collected at the same time, in the same manner and as part of the tax. . . .

Sec. 248. Civil Penalties. — (a) There shall be imposed, in addition to the tax required to be paid, penalty equivalent to twenty-five percent (25%) of the amount due, in the following cases:

xxx xxx xxx

(3) failure to pay the tax within the time prescribed for its payment; or

xxx xxx xxx

(c) the penalties imposed hereunder shall form part of the tax and the entire amount shall be subject to the interest prescribed in Section 249.

Sec. 249. Interest. — (a) In General. — There shall be assessed and collected on any unpaid amount of tax, interest at the rate of twenty percent (20%) per annum or such higher rate as may be prescribed by regulations, from the date prescribed for payment until the amount is fully paid. . . . (Emphases supplied)

In other words, Section 247 (a) of the current NIRC supplies what did not exist back in 1977 when Picop's liability for the thirty-five percent (35%) transaction tax became fixed. We do not believe we can fill that legislative lacuna by judicial fiat. There is nothing to suggest that Section 247 (a) of the present Tax Code, which was inserted in 1985, was intended to be given retroactive application by the legislative authority. 16

(3) Whether Picop is Liablefor Documentary andScience Stamp Taxes.

As noted earlier, Picop issued sometime in 1977 long-term subordinated convertible debenture bonds with an aggregate face value of P100,000,000.00. Picop stated, and this was not disputed by the CIR, that the proceeds of the debenture bonds were in fact utilized to finance the BOI-registered operations of Picop. The CIR assessed documentary and science stamp taxes, amounting to P300,000.00, on the issuance of Picop's debenture bonds. It is claimed by Picop that its tax exemption — "exemption from all taxes under the National Internal Revenue Code, except income tax" on a declining basis over a certain period of time — includes exemption from the documentary and science stamp taxes imposed under the NIRC.

The CIR, upon the other hand, stresses that the tax exemption under the Investment Incentives Act may be granted or recognized only to the extent that the claimant Picop was engaged in registered operations, i.e., operations forming part of its integrated pulp and paper project. 17 The borrowing of funds from the public, in the submission of the CIR, was not an activity included in Picop's registered operations. The CTA adopted the view of the CIR and held that "the issuance of convertible debenture bonds [was] not synonymous [with] the manufactur[ing] operations of an integrated pulp and paper mill." 18

The Court of Appeals took a less rigid view of the ambit of the tax exemption granted to registered pioneer enterprises. Said the Court of Appeals:

. . . PICOP's explanation that the debenture bonds were issued to finance its registered operation is logical and is unrebutted. We are aware that tax exemptions must be applied strictly against the beneficiary in order to deter their abuse. It would indeed be altogether a different matter if there is a showing that the issuance of the debenture bonds had no bearing whatsoever on the registered operations PICOP and that they were issued in connection with a totally different business undertaking of PICOP other than its registered operation. There is, however, a dearth of evidence in this regard. It cannot be denied that PICOP

needed funds for its operations. One of the means it used to raise said funds was to issue debenture bonds. Since the money raised thereby was to be used in its registered operation, PICOP should enjoy the incentives granted to it by R.A. 5186, one of which is the exemption from payment of all taxes under the National Internal Revenue Code, except income taxes, otherwise the purpose of the incentives would be defeated. Documentary and science stamp taxes on debenture bonds are certainly not income taxes. 19 (Emphasis supplied)

Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be extended beyond the ordinary and reasonable intendment of the language actually used by the legislative authority in granting the exemption. The issuance of debenture bonds is certainly conceptually distinct from pulping and paper manufacturing operations. But no one contends that issuance of bonds was a principal or regular business activity of Picop; only banks or other financial institutions are in the regular business of raising money by issuing bonds or other instruments to the general public. We consider that the actual dedication of the proceeds of the bonds to the carrying out of Picop's registered operations constituted a sufficient nexus with such registered operations so as to exempt Picop from stamp taxes ordinarily imposed upon or in connection with issuance of such bonds. We agree, therefore, with the Court of Appeals on this matter that the CTA and the CIR had erred in rejecting Picop's claim for exemption from stamp taxes.

It remains only to note that after commencement of the present litigation before the CTA, the BIR took the position that the tax exemption granted by R.A. No. 5186, as amended, does include exemption from documentary stamp taxes on transactions entered into by BOI-registered enterprises. BIR Ruling No. 088, dated 28 April 1989, for instance, held that a registered preferred pioneer enterprise engaged in the manufacture of integrated circuits, magnetic heads, printed circuit boards, etc., is exempt from the payment of documentary stamp taxes. The Commissioner said:

You now request a ruling that as a preferred pioneer enterprise, you are exempt from the payment of Documentary Stamp Tax (DST).

In reply, please be informed that your request is hereby granted. Pursuant to Section 46 (a) of Presidential Decree No. 1789, pioneer enterprises registered with the BOI are exempt from all taxes under the National Internal Revenue Code, except from all taxes under the National Internal Revenue Code, except income tax, from the date the area of investment is included in the Investment Priorities Plan to the following extent:

xxx xxx xxx

Accordingly, your company is exempt from the payment of documentary stamp tax to the extent of the percentage aforestated on transactions connected with the registered business activity. (BIR Ruling No. 111-81) However, if said transactions conducted by you require the execution of a taxable document with other parties, said parties who are not exempt shall be the one directly liable for the tax. (Sec. 173, Tax Code, as amended; BIR Ruling No. 236-87) In other

words, said parties shall be liable to the same percentage corresponding to your tax exemption. (Emphasis supplied)

Similarly, in BIR Ruling No. 013, dated 6 February 1989, the Commissioner held that a registered pioneer enterprise producing polyester filament yarn was entitled to exemption "from the documentary stamp tax on [its] sale of real property in Makati up to December 31, 1989." It appears clear to the Court that the CIR, administratively at least, no longer insists on the position it originally took in the instant case before the CTA.

II

(1) Whether Picop is entitledto deduct against currentincome interest paymentson loans for the purchaseof machinery and equipment.

In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in order to finance the purchase of machinery and equipment needed for its operations. In its 1977 Income Tax Return, Picop claimed interest payments made in 1977, amounting to P42,840,131.00, on these loans as a deduction from its 1977 gross income.

The CIR disallowed this deduction upon the ground that, because the loans had been incurred for the purchase of machinery and equipment, the interest payments on those loans should have been capitalized instead and claimed as a depreciation deduction taking into account the adjusted basis of the machinery and equipment (original acquisition cost plus interest charges) over the useful life of such assets.

Both the CTA and the Court of Appeals sustained the position of Picop and held that the interest deduction claimed by Picop was proper and allowable. In the instant Petition, the CIR insists on its original position.

We begin by noting that interest payments on loans incurred by a taxpayer (whether BOI-registered or not) are allowed by the NIRC as deductions against the taxpayer's gross income. Section 30 of the 1977 Tax Code provided as follows:

Sec. 30. Deduction from Gross Income. — The following may be deducted from gross income:

(a) Expenses:

xxx xxx xxx

(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: . . . (Emphasis supplied)

Thus, the general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under loans incurred in connection with the carrying on of the business of the taxpayer. 20 In the instant case, the CIR does not dispute that the interest payments were made by Picop on loansincurred in connection with the carrying on of the registered operations of Picop, i.e., the financing of the purchase of machinery and equipment actually used in the registered operations of Picop. Neither does the CIR deny that such interest payments were legally due and demandable under the terms of such loans, and in fact paid by Picop during the tax year 1977.

The CIR has been unable to point to any provision of the 1977 Tax Code or any other Statute that requires the disallowance of the interest payments made by Picop. The CIR invokes Section 79 of Revenue Regulations No. 2 as amended which reads as follows:

Sec. 79. Interest on Capital. — Interest calculated for cost-keeping or other purposes on account of capital or surplus invested in the business, which does not represent a charge arising under an interest-bearing obligation, is not allowable deduction from gross income. (Emphases supplied)

We read the above provision of Revenue Regulations No. 2 as referring to so called "theoretical interest," that is to say, interest "calculated" or computed (and not incurred or paid) for the purpose of determining the "opportunity cost" of investing funds in a given business. Such "theoretical" or imputed interest does notarise from a legally demandable interest-bearing obligation incurred by the taxpayer who however wishes to find out, e.g., whether he would have been better off by lending out his funds and earning interest rather than investing such funds in his business. One thing that Section 79 quoted above makes clear is that interest which does constitute a charge arising under an interest-bearing obligation is an allowable deduction from gross income.

It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was "patterned after" paragraph 1.266-1 (b), entitled "Taxes and Carrying Charges Chargeable to Capital Account and Treated as Capital Items" of the U.S. Income Tax Regulations, which paragraph reads as follows:

(B) Taxes and Carrying Charges. — The items thus chargeable to capital accounts are —

(11) In the case of real property, whether improved or unimproved and whether productive or nonproductive.

(a) Interest on a loan (but not theoretical interest of a taxpayer using his own funds). 21

The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs to be related to the relevant provisions of the U.S. Internal Revenue Code, which provisions deal with the general topic of adjusted basis for determining allowable gain or loss on sales or exchanges of property and allowable depreciation and depletion of capital assets of the taxpayer:

Present Rule. The Internal Revenue Code, and the Regulations promulgated thereunder provide that "No deduction shall be allowed for amounts paid or accrued for such taxes and carrying charges as, under regulations prescribed by the Secretary or his delegate, are chargeable to capital account with respect to property, if the taxpayer elects, in accordance with such regulations, to treat such taxes orcharges as so chargeable."

At the same time, under the adjustment of basis provisions which have just been discussed, it is provided that adjustment shall be made for all "expenditures, receipts, losses, or other items" properly chargeable to a capital account, thus including taxes and carrying charges; however, an exception exists, in which event such adjustment to the capital account is not made, with respect to taxes and carrying charges which the taxpayer has not elected to capitalize but for which a deduction instead has been taken. 22 (Emphasis supplied)

The "carrying charges" which may be capitalized under the above quoted provisions of the U.S. Internal Revenue Code include, as the CIR has pointed out, interest on a loan "(but not theoretical interest of a taxpayer using his own funds)." What the CIR failed to point out is that such "carrying charges" may, at the election of the taxpayer, either be (a) capitalized in which case the cost basis of the capital assets, e.g., machinery and equipment, will be adjusted by adding the amount of such interest payments or alternatively, be (b) deducted from gross income of the taxpayer. Should the taxpayer elect to deduct the interest payments against its gross income, the taxpayer cannot at the same time capitalize the interest payments. In other words, the taxpayer is not entitled to both the deduction from gross income and the adjusted (increased) basis for determining gain or loss and the allowable depreciation charge. The U.S. Internal Revenue Code does not prohibit the deduction of interest on a loan obtained for purchasing machinery and equipment against gross income, unless the taxpayer has also or previously capitalized the same interest payments and thereby adjusted the cost basis of such assets.

We have already noted that our 1977 NIRC does not prohibit the deduction of interest on a loan incurred for acquiring machinery and equipment. Neither does our 1977 NIRC compel the capitalization of interest payments on such a loan. The 1977 Tax Code is simply silent on a taxpayer's right to elect one or the other tax treatment of such interest payments. Accordingly, the general rule that interest payments on a legally demandable loan are deductible from gross income must be applied.

The CIR argues finally that to allow Picop to deduct its interest payments against its gross income would be to encourage fraudulent claims to double deductions from gross income:

[t]o allow a deduction of incidental expense/cost incurred in the purchase of fixed asset in the year it was incurred would invite tax evasion through fraudulent application of double deductions from gross income. 23 (Emphases supplied)

The Court is not persuaded. So far as the records of the instant cases show, Picop has not claimed to be entitled to double deduction of its 1977 interest payments. The CIR has neither alleged nor proved that Picop had previously adjusted its cost basis for the machinery and equipment purchased with the loan proceeds by capitalizing the interest payments here involved. The Court will not assume that the CIR would be unable or unwilling to disallow "a double deduction" should Picop, having deducted its interest cost from its gross income, also attempt subsequently to adjust upward the cost basis of the machinery and equipment purchased and claim, e.g., increased deductions for depreciation.

We conclude that the CTA and the Court of Appeals did not err in allowing the deductions of Picop's 1977 interest payments on its loans for capital equipment against its gross income for 1977.

(2) Whether Picop is entitledto deduct against currentincome net operating lossesincurred by Rustan Pulpand Paper Mills, Inc.

On 18 January 1977, Picop entered into a merger agreement with the Rustan Pulp and Paper Mills, Inc. ("RPPM") and Rustan Manufacturing Corporation ("RMC"). Under this agreement, the rights, properties, privileges, powers and franchises of RPPM and RMC were to be transferred, assigned and conveyed to Picop as the surviving corporation. The entire subscribed and outstanding capital stock of RPPM and RMC would be exchanged for 2,891,476 fully paid up Class "A" common stock of Picop (with a par value of P10.00) and 149,848 shares of preferred stock of Picop (with a par value of P10.00), to be issued by Picop, the result being that Picop would wholly own both RPPM and RMC while the stockholders of RPPM and RMC would join the ranks of Picop's shareholders. In addition, Picop paid off the obligations of RPPM to the Development Bank of the Philippines ("DBP") in the amount of P68,240,340.00, by issuing 6,824,034 shares of preferred stock (with a par value of P10.00) to the DBP. The merger agreement was approved in 1977 by the creditors and stockholders of Picop, RPPM and RMC and by the Securities and Exchange Commission. Thereupon, on 30 November 1977, apparently the effective date of merger, RPPM and RMC were dissolved. The Board of Investments approved the merger agreement on 12 January 1978.

It appears that RPPM and RMC were, like Picop, BOI-registered companies. Immediately before merger effective date, RPPM had over preceding years accumulated losses in the total amount of P81,159,904.00. In its 1977 Income Tax Return, Picop claimed P44,196,106.00 of RPPM's accumulated losses as a deduction against Picop's 1977 gross income. 24

Upon the other hand, even before the effective date of merger, on 30 August 1977, Picop sold all the outstanding shares of RMC stock to San Miguel Corporation for the sum of P38,900,000.00, and reported a gain of P9,294,849.00 from this transaction. 25

In claiming such deduction, Picop relies on section 7 (c) of R.A. No. 5186 which provides as follows:

Sec. 7. Incentives to Registered Enterprise. — A registered enterprise, to the extent engaged in a preferred area of investment, shall be granted the following incentive benefits:

xxx xxx xxx

(c) Net Operating Loss Carry-over. — A net operating loss incurred in any of the first ten years of operations may be carried over as a deduction from taxable income for the six years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the six taxable years following the loss, and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining five years. The net operating loss shall be computed in accordance with the provisions of the National Internal Revenue Code, any provision of this Act to the contrary notwithstanding, except that income not taxable either in whole or in part under this or other laws shall be included in gross income. (Emphasis supplied)

Picop had secured a letter-opinion from the BOI dated 21 February 1977 — that is, after the date of the agreement of merger but before the merger became effective — relating to the deductibility of the previous losses of RPPM under Section 7 (c) of R.A. No. 5186 as amended. The pertinent portions of this BOI opinion, signed by BOI Governor Cesar Lanuza, read as follows:

2) PICOP will not be allowed to carry over the losses of Rustan prior to the legal dissolution of the latter because at that time the two (2) companies still had separate legal personalities;

3) After BOI approval of the merger, PICOP can no longer apply for the registration of the registered capacity of Rustan because with the approved merger, such registered capacity of Rustan transferred to PICOP will have the same registration date as that of Rustan. In this case, the previous losses of Rustan may be carried over by PICOP, because with the merger, PICOP assumes all the rights and obligations of Rustan subject, however, to the period prescribed for carrying over of such losses. 26 (Emphasis supplied)

Curiously enough, Picop did not also seek a ruling on this matter, clearly a matter of tax law, from the Bureau of Internal Revenue. Picop chose to rely solely on the BOI letter-opinion.

The CIR disallowed all the deductions claimed on the basis of RPPM's losses, apparently on two (2) grounds. Firstly, the previous losses were incurred by "another taxpayer," RPPM, and not by Picop in connection with Picop's own registered operations. The CIR took the view that Picop, RPPM and RMC were merged into one (1) corporate personality only on 12 January 1978, upon approval of the merger agreement by the BOI. Thus, during the taxable year 1977, Picop on the one hand and RPPM and RMC on the other, still had their separate juridical personalities. Secondly, the CIR alleged that these losses had been incurred by RPPM "from the borrowing of funds" and not from carrying out of RPPM's registered operations. We focus on the first ground. 27

The CTA upheld the deduction claimed by Picop; its reasoning, however, is less than crystal clear, especially in respect of its view of what the U.S. tax law was on this matter. In any event, the CTA apparently fell back on the BOI opinion of 21 February 1977 referred to above. The CTA said:

Respondent further averred that the incentives granted under Section 7 of R.A. No. 5186 shall be available only to the extent in which they are engaged in registered operations, citing Section 1 of Rule IX of the Basic Rules and Regulations to Implement the Intent and Provisions of the Investment Incentives Act, R.A. No. 5186.

We disagree with respondent. The purpose of the merger was to rationalize the container board industry and not to take advantage of the net losses incurred by RPPMI prior to the stock swap. Thus, when stock of a corporation is purchased in order to take advantage of the corporation's net operating loss incurred in years prior to the purchase, the corporation thereafter entering into a trade or business different from that in which it was previously engaged, the net operating loss carry-over may be entirely lost. [IRC (1954), Sec. 382(a), Vol. 5, Mertens, Law of Federal Income Taxation, Chap. 29.11a, p. 103]. 28 Furthermore, once the BOI approved the merger agreement, the registered capacity of Rustan shall be transferred to PICOP, and the previous losses of Rustan may be carried over by PICOP by operation of law. [BOI ruling dated February 21, 1977 (Exh. J-1)] It is clear therefrom, that the deduction availed of under Section 7(c) of R.A. No. 5186 was only proper." (pp. 38-43,Rollo of SP No. 20070) 29 (Emphasis supplied)

In respect of the above underscored portion of the CTA decision, we must note that the CTA in fact overlooked the statement made by petitioner's counsel before the CTA that:

Among the attractions of the merger to Picop was the accumulated net operating loss carry-over of RMC that it might possibly use to relieve it (Picop) from its income taxes, under Section 7 (c) of R.A.5186. Said section provides:

xxx xxx xxx

With this benefit in mind, Picop addressed three (3) questions to the BOI in a letter dated November 25, 1976. The BOI replied on February 21, 1977 directly answering the three (3) queries. 30 (Emphasis supplied)

The size of RPPM's accumulated losses as of the date of the merger — more than P81,000,000.00 — must have constituted a powerful attraction indeed for Picop.

The Court of Appeals followed the result reached by the CTA. The Court of Appeals, much like the CTA, concluded that since RPPM was dissolved on 30 November 1977, its accumulated losses were appropriately carried over by Picop in the latter's 1977 Income Tax Return "because by that time RPPMI and Picop were no longer separate and different taxpayers." 31

After prolonged consideration and analysis of this matter, the Court is unable to agree with the CTA and Court of Appeals on the deductibility of RPPM's accumulated losses against Picop's 1977 gross income.

It is important to note at the outset that in our jurisdiction, the ordinary rule — that is, the rule applicable in respect of corporations not registered with the BOI as a preferred pioneer enterprise — is that net operating losses cannot be carried over. Under our Tax Code, both in 1977 and at present, losses may be deducted from gross income only if such losses were actually sustained in the same year that they are deducted or charged off. Section 30 of the 1977 Tax Code provides:

Sec. 30. Deductions from Gross Income. — In computing net income, there shall be allowed as deduction —

xxx xxx xxx

(d) Losses:

(1) By Individuals. — In the case of an individual, losses actually sustained during the taxable yearand not compensated for by an insurance or otherwise —

(A) If incurred in trade or business;

xxx xxx xxx

(2) By Corporations. — In a case of a corporation, all losses actually sustained and charged off within the taxable year and not compensated for by insurance or otherwise.

(3) By Non-resident Aliens or Foreign Corporations. — In the case of a non-resident alien individual or a foreign corporation, the losses deductible are those actually sustained during the year incurred in business or trade conducted within the Philippines, . . . 32 (Emphasis supplied)

Section 76 of the Philippine Income Tax Regulations (Revenue Regulation No. 2, as amended) is even more explicit and detailed:

Sec. 76. When charges are deductible. — Each year's return, so far as practicable, both as to gross income and deductions therefrom should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses, interests, taxes, or other charges,he can not deduct them from the income of the next or any succeeding year. . . .

xxx xxx xxx

. . . . If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year including such amount of loss in the deduction from gross income and may in proper cases file a claim for refund of the excess paid by reason of the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in one year and discovered in another is ordinarily deductible for the year in which sustained. (Emphases supplied)

It is thus clear that under our law, and outside the special realm of BOI-registered enterprises, there is no such thing as a carry-over of net operating loss. To the contrary, losses must be deducted against current income in the taxable year when such losses were incurred. Moreover, such losses may be charged offonly against income earned in the same taxable year when the losses were incurred.

Thus it is that R.A. No. 5186 introduced the carry-over of net operating losses as a very special incentive to be granted only to registered pioneer enterprises and only with respect to their registered operations. The statutory purpose here may be seen to be the encouragement of the establishment and continued operation of pioneer industries by allowing the registered enterprise to accumulate its operating losses which may be expected during the early years of the enterprise and to permit the enterprise to offset such losses against income earned by it in later years after successful establishment and regular operations. To promote its economic development goals, the Republic foregoes or defers taxing the income of the pioneer enterprise until after that enterprise has recovered or offset its earlier losses. We consider that the statutory purpose can be served only if the accumulated operating losses are carried over and charged off against income subsequently earned and accumulated by the same enterprise engaged in the same registered operations.

In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. RPPM far from benefiting from the tax incentive granted by the BOI statute, in fact gave up the struggle and went out of existence and its former stockholders joined the

much larger group of Picop's stockholders. To grant Picop's claimed deduction would be to permit Picop to shelter its otherwise taxable income (an objective which Picop had from the very beginning) which had not been earned by the registered enterprise which had suffered the accumulated losses. In effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated operating losses. Under the CTA and Court of Appeals decisions, Picop would benefit by immunizing P44,196,106.00 of its income from taxation thereof although Picop had not run the risks and incurred the losses which had been encountered and suffered by RPPM. Conversely, the income that would be shielded from taxation is not income that was, after much effort, eventually generated by the same registered operations which earlier had sustained losses. We consider and so hold that there is nothing in Section 7 (c) of R.A. No. 5186 which either requires or permits such a result. Indeed, that result makes non-sense of the legislative purpose which may be seen clearly to be projected by Section 7 (c), R.A. No. 5186.

The CTA and the Court of Appeals allowed the offsetting of RPPM's accumulated operating losses against Picop's 1977 gross income, basically because towards the end of the taxable year 1977, upon the arrival of the effective date of merger, only one (1) corporation, Picop, remained. The losses suffered by RPPM's registered operations and the gross income generated by Picop's own registered operations now came under one and the same corporate roof. We consider that this circumstance relates much more to form than to substance. We do not believe that that single purely technical factor is enough to authorize and justify the deduction claimed by Picop. Picop's claim for deduction is not only bereft of statutory basis; it does violence to the legislative intent which animates the tax incentive granted by Section 7 (c) of R.A. No. 5186. In granting the extraordinary privilege and incentive of a net operating loss carry-over to BOI-registered pioneer enterprises, the legislature could not have intended to require the Republic to forego tax revenues in order to benefit a corporation which had run no risks and suffered no losses, but had merely purchased another's losses.

Both the CTA and the Court of Appeals appeared much impressed not only with corporate technicalities but also with the U.S. tax law on this matter. It should suffice, however, simply to note that in U.S. tax law, the availability to companies generally of operating loss carry-overs and of operating loss carry-backs is expressly provided and regulated in great detail by statute. 33 In our jurisdiction, save for Section 7 (c) of R.A. No. 5186, no statute recognizes or permits loss carry-overs and loss carry-backs. Indeed, as already noted, our tax law expressly rejects the very notion of loss carry-overs and carry-backs.

We conclude that the deduction claimed by Picop in the amount of P44,196,106.00 in its 1977 Income Tax Return must be disallowed.

(3) Whether Picop is entitledto deduct against currentincome certain claimedfinancial guarantee expenses.

In its Income Tax Return for 1977, Picop also claimed a deduction in the amount of P1,237,421.00 as financial guarantee expenses.

This deduction is said to relate to chattel and real estate mortgages required from Picop by the Philippine National Bank ("PNB") and DBP as guarantors of loans incurred by Picop from foreign creditors. According to Picop, the claimed deduction represents registration fees and other expenses incidental to registration of mortgages in favor of DBP and PNB.

In support of this claimed deduction, Picop allegedly showed its own vouchers to BIR Examiners to prove disbursements to the Register of Deeds of Tandag, Surigao del Sur, of particular amounts. In the proceedings before the CTA, however, Picop did not submit in evidence such vouchers and instead presented one of its employees to testify that the amount claimed had been disbursed for the registration of chattel and real estate mortgages.

The CIR disallowed this claimed deduction upon the ground of insufficiency of evidence. This disallowance was sustained by the CTA and the Court of Appeals. The CTA said:

No records are available to support the abovementioned expenses. The vouchers merely showed that the amounts were paid to the Register of Deeds and simply cash account. Without the supporting papers such as the invoices or official receipts of the Register of Deeds, these vouchers standing alone cannot prove that the payments made were for the accrued expenses in question.The best evidence of payment is the official receipts issued by the Register of Deeds. The testimony of petitioner's witness that the official receipts and cash vouchers were shown to the Bureau of Internal Revenue will not suffice if no records could be presented in court for proper marking and identification. 34 Emphasis supplied)

The Court of Appeals added:

The mere testimony of a witness for PICOP and the cash vouchers do not suffice to establish its claim that registration fees were paid to the Register of Deeds for the registration of real estate and chattel mortgages in favor of Development Bank of the Philippines and the Philippine National Bank as guarantors of PICOP's loans. The witness could very well have been merely repeating what he was instructed to say regardless of the truth, while the cash vouchers, which we do not find on file, are not said to provide the necessary details regarding the nature and purpose of the expenses reflected therein. PICOP should have presented, through the guarantors, its owner's copy of the registered titles with the lien inscribed thereon as well as an official receipt from the Register of Deeds evidencing payment of the registration fee. 35 (Emphasis supplied)

We must support the CTA and the Court of Appeals in their foregoing rulings. A taxpayer has the burden of proving entitlement to a claimed deduction. 36 In the instant case, even Picop's own vouchers were not submitted in evidence and the BIR Examiners denied that such vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only confirm the fact of disbursement but not necessarily the purpose thereof. 37 The best evidence that Picop should have presented to support its claimed deduction were the invoices and official receipts issued by the Register of Deeds. Picop not only failed to present such documents; it also failed to explain the loss thereof, assuming they had existed before. 38 Under the best evidence rule, 39 therefore,

the testimony of Picop's employee was inadmissible and was in any case entitled to very little, if any, credence.

We consider that entitlement to Picop's claimed deduction of P1,237,421.00 was not adequately shown and that such deduction must be disallowed.

III

(1) Whether Picop had understatedits sales and overstated itscost of sales for 1977.

In its assessment for deficiency income tax for 1977, the CIR claimed that Picop had understated its sales by P2,391,644.00 and, upon the other hand, overstated its cost of sales by P604,018.00. Thereupon, the CIR added back both sums to Picop's net income figure per its own return.

The 1977 Income Tax Return of Picop set forth the following figures:

Sales (per Picop's Income Tax Return):

Paper P 537,656,719.00

Timber P 263,158,132.00

———————

Total Sales P 800,814,851.00

============

Upon the other hand, Picop's Books of Accounts reflected higher sales figures:

Sales (per Picop's Books of Accounts):

Paper P 537,656,719.00

Timber P 265,549,776.00

———————

Total Sales P 803,206,495.00

============

The above figures thus show a discrepancy between the sales figures reflected in Picop's Books of Accounts and the sales figures reported in its 1977 Income Tax Return, amounting to: P2,391,644.00.

The CIR also contended that Picop's cost of sales set out in its 1977 Income Tax Return, when compared with the cost figures in its Books of Accounts, was overstated:

Cost of Sales(per Income Tax Return) P607,246,084.00Cost of Sales(per Books of Accounts) P606,642,066.00

———————

Discrepancy P 604,018.00============

Picop did not deny the existence of the above noted discrepancies. In the proceedings before the CTA, Picop presented one of its officials to explain the foregoing discrepancies. That explanation is perhaps best presented in Picop's own words as set forth in its Memorandum before this Court:

. . . that the adjustment discussed in the testimony of the witness, represent the best and most objective method of determining in pesos the amount of the correct and actual export sales during the year. It was this correct and actual export sales and costs of sales that were reflected in the income tax return and in the audited financial statements. These corrections did not result in realization of income and should not give rise to any deficiency tax.

xxx xxx xxx

What are the facts of this case on this matter? Why were adjustments necessary at the year-end?

Because of PICOP's procedure of recording its export sales (reckoned in U.S. dollars) on the basis of a fixed rate, day to day and month to month, regardless of the actual exchange rate and without waiting when the actual proceeds are received. In other words, PICOP recorded its export sales at a pre-determined fixed exchange rate. That pre-determined rate was decided upon at the beginning of the year and continued to be used throughout the year.

At the end of the year, the external auditors made an examination. In that examination, the auditors determined with accuracy the actual dollar proceeds of the export sales received. What exchange rate was used by the auditors to convert these actual dollar proceeds into Philippine pesos? They used the average of the differences between (a) the recorded fixed exchange rate and (b) the exchange

rate at the time the proceeds were actually received. It was this rate at time of receipt of the proceeds that determined the amount of pesos credited by the Central Bank (through the agent banks) in favor of PICOP. These accumulated differences were averaged by the external auditors and this was what was used at the year-end for income tax and other government-report purposes. (T.s.n., Oct. 17/85, pp. 20-25) 40

The above explanation, unfortunately, at least to the mind of the Court, raises more questions than it resolves. Firstly, the explanation assumes that all of Picop's sales were export sales for which U.S. dollars (or other foreign exchange) were received. It also assumes that the expenses summed up as "cost of sales" were all dollar expenses and that no peso expenses had been incurred. Picop's explanation further assumes that a substantial part of Picop's dollar proceeds for its export sales were not actually surrendered to the domestic banking system and seasonably converted into pesos; had all such dollar proceeds been converted into pesos, then the peso figures could have been simply added up to reflect the actual peso value of Picop's export sales. Picop offered no evidence in respect of these assumptions, no explanation why and how a "pre-determined fixed exchange rate" was chosen at the beginning of the year and maintained throughout. Perhaps more importantly, Picop was unable to explain why its Books of Accounts did not pick up the same adjustments that Picop's External Auditors were alleged to have made for purposes of Picop's Income Tax Return. Picop attempted to explain away the failure of its Books of Accounts to reflect the same adjustments (no correcting entries, apparently) simply by quoting a passage from a case where this Court refused to ascribe much probative value to the Books of Accounts of a corporate taxpayer in a tax case. 41 What appears to have eluded Picop, however, is that its Books of Accounts, which are kept by its own employees and are prepared under its control and supervision, reflect what may be deemed to be admissions against interest in the instant case. For Picop's Books of Accounts precisely show higher sales figures andlower cost of sales figures than Picop's Income Tax Return.

It is insisted by Picop that its Auditors' adjustments simply present the "best and most objective" method of reflecting in pesos the "correct and ACTUAL export sales" 42 and that the adjustments or "corrections" "did not result in realization of [additional] income and should not give rise to any deficiency tax." The correctness of this contention is not self-evident. So far as the record of this case shows, Picop did not submit in evidence the aggregate amount of its U.S. dollar proceeds of its export sales; neither did it show the Philippine pesos it had actually received or been credited for such U.S. dollar proceeds. It is clear to this Court that the testimonial evidence submitted by Picop fell far short of demonstrating the correctness of its explanation.

Upon the other hand, the CIR has made out at least a prima facie case that Picop had understated its sales and overstated its cost of sales as set out in its Income Tax Return. For the CIR has a right to assume that Picop's Books of Accounts speak the truth in this case since, as already noted, they embody what must appear to be admissions against Picop's own interest.

Accordingly, we must affirm the findings of the Court of Appeals and the CTA.

(2) Whether Picop is liable forthe corporate development

tax of five percent (5%)of its income for 1977.

The five percent (5%) corporate development tax is an additional corporate income tax imposed in Section 24 (e) of the 1977 Tax Code which reads in relevant part as follows:

(e) Corporate development tax. — In addition to the tax imposed in subsection (a) of this section, an additional tax in an amount equivalent to 5 per cent of the same taxable net income shall be paid by a domestic or a resident foreign corporation; Provided, That this additional tax shall be imposed only if the net income exceeds 10 per cent of the net worth, in case of a domestic corporation, or net assets in the Philippines in case of a resident foreign corporation: . . . .

The additional corporate income tax imposed in this subsection shall be collected and paid at the same time and in the same manner as the tax imposed in subsection (a) of this section.

Since this five percent (5%) corporate development tax is an income tax, Picop is not exempted from it under the provisions of Section 8 (a) of R.A. No. 5186.

For purposes of determining whether the net income of a corporation exceeds ten percent (10%) of its net worth, the term "net worth" means the stockholders' equity represented by the excess of the total assets over liabilities as reflected in the corporation's balance sheet provided such balance sheet has been prepared in accordance with generally accepted accounting principles employed in keeping the books of the corporation. 43

The adjusted net income of Picop for 1977, as will be seen below, is P48,687,355.00. Its net worth figure or total stockholders' equity as reflected in its Audited Financial Statements for 1977 is P464,749,528.00. Since its adjusted net income for 1977 thus exceeded ten percent (10%) of its net worth, Picop must be held liable for the five percent (5%) corporate development tax in the amount of P2,434,367.75.

Recapitulating, we hold:

(1) Picop is liable for the thirty-five percent (35%) transaction tax in the amount of P3,578,543.51.

(2) Picop is not liable for interest and surcharge on unpaid transaction tax.

(3) Picop is exempt from payment of documentary and science stamp taxes in the amount of P300,000.00 and the compromise penalty of P300.00.

(4) Picop is entitled to its claimed deduction of P42,840,131.00 for interest payments on loans for, among other things, the purchase of machinery and equipment.

(5) Picop's claimed deduction in the amount of P44,196,106.00 for the operating losses previously incurred by RPPM, is disallowed for lack of merit.

(6) Picop's claimed deduction for certain financial guarantee expenses in the amount P1,237,421.00 is disallowed for failure adequately to prove such expenses.

(7) Picop has understated its sales by P2,391,644.00 and overstated its cost of sales by P604,018.00, for 1977.

(8) Picop is liable for the corporate development tax of five percent (5%) of its adjusted net income for 1977 in the amount of P2,434,367.75.

Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled to hold Picop liable for deficiency income tax for the year 1977 computed as follows:

Deficiency Income Tax

Net Income Per Return P 258,166.00

Add:

Unallowable Deductions

(1) Deduction of netoperating lossesincurred by RPPM P 44,196,106.00

(2) Unexplained financialguarantee expenses P 1,237,421.00

(3) Understatement ofSales P 2,391,644.00

(4) Overstatement ofCost of Sales P 604,018.00

——————

Total P 48,429,189.00

——————

Net Income as Adjusted P 48,687,355.00

===========

Income Tax Due Thereon 44 P 17,030,574.00

Less:

Tax Already Assessed perReturn 80,358.00

——————

Deficiency Income Tax P 16,560,216.00

Add:

Five percent (5%) CorporateDevelopment Tax P 2,434,367.00

Total Deficiency Income Tax P 18,994,583.00

===========

Add:

Five percent (5%) surcharge 45 P 949,729.15

——————

Total Deficiency Income Tax

with surcharge P 19,944,312.15

Add:

Fourteen percent (14%)

interest from 15 April

1978 to 14 April 1981 46 P 8,376,610.80

Fourteen percent (14%)

interest from 21 April

1983 to 20 April 1986 47 P 11,894,787.00

——————

Total Deficiency Income Tax

Due and Payable P 40,215,709.00

===========

WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is hereby MODIFIED and Picop is hereby ORDERED to pay the CIR the aggregate amount of P43,794,252.51 itemized as follows:

(1) Thirty-five percent (35%)

transaction tax P 3,578,543.51

(2) Total Deficiency Income

Tax Due 40,215,709.00

———————

Aggregate Amount Due and Payable P 43,794,252.51

============

No pronouncement as to costs.

SO ORDERED.

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.

EN BANC 

COMMISSIONER OF INTERNAL REVENUE,Petitioner,    

-versus-  

  FILINVEST DEVELOPMENT CORPORATION,Respondent.  x-------------------------------------x COMMISSIONER OF INTERNAL REVENUE,Petitioner,    -versus-   FILINVEST DEVELOPMENT CORPORATION,Respondent.

G. R. No. 163653                G. R. No. 167689 Present: CORONA, C.J.,CARPIO,VELASCO, JR.,LEONARDO-DE CASTRO,BRION,PERALTA,BERSAMIN,DEL CASTILLO,ABAD,VILLARAMA, JR.,PEREZ,MENDOZA, andSERENO,* JJ.

     Promulgated: July 19, 2011

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

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, FLIs ownership structure was changed to the extent reflected in the following tabular prcis, 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 1,226,177,000 32.58% 0 1,226,177,000 29.01%

   ----------------- -----------

 -------------- ---------------

  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 BIRs 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 1996[9] 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 FDCs 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 RHPLs 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 arms-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 ofP1,477,494,638.23 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 Issues[22] 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 FAI[23] 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 ofP5,691,972.03 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 2005[33] 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 certiorariassailing 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 Courts 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 FDCS SHAREHOLDINGS IN FAC IS NOT TAXABLE.[36]

 The Courts Ruling

 While the petition in G.R. No. 163653 is bereft of merit, we find the CIRs 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 CTAs 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 NIRC[38] 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 provision[39] 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 arms 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 arms 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 partners 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 comingto 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 inBonifacio 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 corporations 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. 

 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 NIRC[65] 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. 250[69] 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 FDCs 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 FDCs 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 CAs 16 December 2003 Decision in G.R. No. 72992 is AFFIRMED in toto. The CIRs petition in G.R. No. 167689 isPARTIALLY GRANTED and the CAs 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 FDCs Deed of Exchange with FAI and FLI; and (c) income from the dilution resulting from FDCs Shareholders Agreement with RHPL is, however, upheld.SO ORDERED.

 

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.