Professional Documents
Culture Documents
(c) Taxes:
We agree with appellant Commissioner that the
Construction and wording of Section 30 (c) (1) (B) of the
(1) In general. — Taxes paid or accrued within the Internal Revenue Act shows the law's intent that the right
taxable year, except — to deduct income taxes paid to foreign government from
the taxpayer's gross income is given only as an alternative
(A) The income tax provided for under this Title; or substitute to his right to claim a tax credit for such
foreign income taxes under section 30 (c) (3) and (4); so
(B) Income, war-profits, and excess profits taxes imposed that unless the alien resident has a right to claim such tax
by the authority of any foreign country; but this deduction credit if he so chooses, he is precluded from deducting
shall be allowed in the case of a taxpayer who does not the foreign income taxes from his gross income. For it is
signify in his return his desire to have to any extent the obvious that in prescribing that such deduction shall be
benefits of paragraph (3) of this subsection (relating to allowed in the case of a taxpayer who does not signify in
credit for foreign countries); 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
(C) Estate, inheritance and gift taxes; and question also may signify his desire to claim a tax credit
and waive the deduction; otherwise, the foreign taxes
(D) Taxes assessed against local benefits of a kind would always be deductible, and their mention in the list
tending to increase the value of the property assessed. of non-deductible items in Section 30(c) might as well
(Emphasis supplied) have been omitted, or at least expressly limited to taxes
on income from sources outside the Philippine Islands.
The Tax Court held that they may be deducted because
of the undenied fact that the respondent spouses did not Had the law intended that foreign income taxes could be
"signify" in their income tax return a desire to avail deducted from gross income in any event,regardless of
themselves of the benefits of paragraph 3 (B) of the the taxpayer's right to claim a tax credit, it is the latter
subsection, which reads: right that should be conditioned upon the taxpayer's
waiving the deduction; in which Case the right to
Par. (c) (3) Credits against tax for taxes of foreign reduction under subsection (c-1-B) would have been
countries. — If the taxpayer signifies in his return his desire made absolute or unconditional (by omitting foreign
to have the benefits of this paragraph, the tax imposed taxes from the enumeration of non-deductions), while the
by this Title shall be credited with — 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
(A) ...;
words, if the law had been intended to operate as
contended by the respondent taxpayers and by the
(B) Alien resident of the Philippines. — In the case of an Court of Tax Appeals section 30 (subsection (c-1) instead
alien resident of the Philippines, the amount of any such of providing as at present:
taxes paid or accrued during the taxable year to any
foreign country, if the foreign country of which such alien
SEC. 30. Deduction from gross income. — In computing
resident is a citizen or subject, in imposing such taxes,
net income there shall be allowed as deductions —
allows a similar credit to citizens of the Philippines residing
in such country;
(a) ...
It is well to note that the tax credit so authorized is limited
under paragraph 4 (A and B) of the same subsection, in (b) ...
the following terms:
(c) Taxes:
Par. (c) (4) Limitation on credit. — The amount of the
credit taken under this section shall be subject to each of (1) In general. — Taxes paid or accrued within the
the following limitations: taxable year, except —
(A) The income tax provided for under this Title; Much stress is laid on the thesis that if the respondent
taxpayers are not allowed to deduct the income taxes
(B) Income, war-profits, and excess profits taxes imposed they are required to pay to the government of the United
by the authority of any foreign country; but this deduction States in their return for Philippine income tax, they would
shall be allowed in the case of a taxpayer who does not be subjected to double taxation. What respondents fail
signify in his return his desire to have to any extent the to observe is that double taxation becomes obnoxious
benefits of paragraph (3) of this subsection (relating to only where the taxpayer is taxed twice for the benefit of
credit for taxes of foreign countries); 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
(C) Estate, inheritance and gift taxes; and
taxpayers would have to pay two taxes on the same
income, the Philippine government only receives the
(D) Taxes assessed against local benefits of a kind tending proceeds of one tax. As between the Philippines, where
to increase the value of the property assessed. the income was earned and where the taxpayer is
domiciled, and the United States, where that income
would have merely provided: was not earned and where the taxpayer did not reside, it
is indisputable that justice and equity demand that the
SEC. 30. Decision from grow income. — In computing net tax on the income should accrue to the benefit of the
income there shall be allowed as deductions: 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
(a) ... is solely predicated on his citizenship, without contributing
to the production of the wealth that is being taxed.
(b) ...
Aside from not conforming to the fundamental doctrine
(c) Taxes paid or accrued within the taxable year, EXCEPT 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,
(A) The income tax provided for in this Title; 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
(B) Omitted or else worded as follows:
place a resident alien with only domestic sources of
income in an equal, if not in a better, position than one
Income, war profits and excess profits taxes imposed by who has both domestic and foreign sources of income, a
authority of any foreign country on income earned within situation which is manifestly unfair and short of logic.
the Philippines if the taxpayer does not claim the benefits
under paragraph 3 of this subsection;
Finally, to allow an alien resident to deduct from his gross
income whatever taxes he pays to his own government
(C) Estate, inheritance or gift taxes; amounts to conferring on the latter the power to reduce
the tax income of the Philippine government simply by
(D) Taxes assessed against local benefits of a kind tending increasing the tax rates on the alien resident. Everytime
to increase the value of the property assessed. the rate of taxation imposed upon an alien resident is
increased by his own government, his deduction from
while subsection (c-3) would have been made Philippine taxes would correspondingly increase, and the
conditional in the following or equivalent terms: 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
(3) Credits against tax for taxes of foreign countries. — If
of the Philippines as an independent and sovereign state.
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 IN VIEW OF THE FOREGOING, the decisions of the Court of
be credited with ... (etc.). Tax Appeals are reversed, and, the disallowance of the
refunds claimed by the respondents Lednicky is affirmed,
with costs against said respondents-appellees
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.
Republic of the Philippines G.R. No. 65774 (CTA Case No. 2561, the Second Case)
SUPREME COURT
Manila On 17 November 1971, BOAC was assessed deficiency
income taxes, interests, and penalty for the fiscal years
1968-1969 to 1970-1971 in the aggregate amount of
EN BANC
P549,327.43, and the additional amounts of P1,000.00 and
P1,800.00 as compromise penalties for violation of Section
G.R. No. L-65773-74 April 30, 1987 46 (requiring the filing of corporation returns) penalized
under Section 74 of the National Internal Revenue Code
COMMISSIONER OF INTERNAL REVENUE, petitioner, (NIRC).
vs.
BRITISH OVERSEAS AIRWAYS CORPORATION and COURT On 25 November 1971, BOAC requested that the
OF TAX APPEALS, respondents. assessment be countermanded and set aside. In a letter,
dated 16 February 1972, however, the CIR not only
Petitioner Commissioner of Internal Revenue (CIR) seeks a denied the BOAC request for refund in the First Case but
review on certiorari of the joint Decision of the Court of also re-issued in the Second Case the deficiency income
Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561, tax assessment for P534,132.08 for the years 1969 to 1970-
dated 26 January 1983, which set aside petitioner's 71 plus P1,000.00 as compromise penalty under Section
assessment of deficiency income taxes against 74 of the Tax Code. BOAC's request for reconsideration
respondent British Overseas Airways Corporation (BOAC) was denied by the CIR on 24 August 1973. This prompted
for the fiscal years 1959 to 1967, 1968-69 to 1970-71, BOAC to file the Second Case before the Tax Court
respectively, as well as its Resolution of 18 November, praying that it be absolved of liability for deficiency
1983 denying reconsideration. income tax for the years 1969 to 1971.
BOAC is a 100% British Government-owned corporation This case was subsequently tried jointly with the First Case.
organized and existing under the laws of the United
Kingdom It is engaged in the international airline business On 26 January 1983, the Tax Court rendered the assailed
and is a member-signatory of the Interline Air Transport joint Decision reversing the CIR. The Tax Court held that
Association (IATA). As such it operates air transportation the proceeds of sales of BOAC passage tickets in the
service and sells transportation tickets over the routes of Philippines by Warner Barnes and Company, Ltd., and
the other airline members. During the periods covered by later by Qantas Airways, during the period in question, do
the disputed assessments, it is admitted that BOAC had not constitute BOAC income from Philippine sources
no landing rights for traffic purposes in the Philippines, and "since no service of carriage of passengers or freight was
was not granted a Certificate of public convenience and performed by BOAC within the Philippines" and,
necessity to operate in the Philippines by the Civil therefore, said income is not subject to Philippine income
Aeronautics Board (CAB), except for a nine-month tax. The CTA position was that income from transportation
period, partly in 1961 and partly in 1962, when it was is income from services so that the place where services
granted a temporary landing permit by the CAB. are rendered determines the source. Thus, in the
Consequently, it did not carry passengers and/or cargo dispositive portion of its Decision, the Tax Court ordered
to or from the Philippines, although during the period petitioner to credit BOAC with the sum of P858,307.79,
covered by the assessments, it maintained a general and to cancel the deficiency income tax assessments
sales agent in the Philippines — Wamer Barnes and against BOAC in the amount of P534,132.08 for the fiscal
Company, Ltd., and later Qantas Airways — which was years 1968-69 to 1970-71.
responsible for selling BOAC tickets covering passengers
and cargoes. 1
Hence, this Petition for Review on certiorari of the
Decision of the Tax Court.
G.R. No. 65773 (CTA Case No. 2373, the First Case)
The Solicitor General, in representation of the CIR, has
On 7 May 1968, petitioner Commissioner of Internal aptly defined the issues, thus:
Revenue (CIR, for brevity) assessed BOAC the aggregate
amount of P2,498,358.56 for deficiency income taxes
1. Whether or not the revenue derived by private
covering the years 1959 to 1963. This was protested by
respondent British Overseas Airways Corporation (BOAC)
BOAC. Subsequent investigation resulted in the issuance
from sales of tickets in the Philippines for air transportation,
of a new assessment, dated 16 January 1970 for the years
while having no landing rights here, constitute income of
1959 to 1967 in the amount of P858,307.79. BOAC paid
BOAC from Philippine sources, and, accordingly, taxable.
this new assessment under protest.
(h) the term resident foreign corporation engaged in Next, we address ourselves to the issue of whether or not
trade or business within the Philippines or having an office the revenue from sales of tickets by BOAC in the
or place of business therein. Philippines constitutes income from Philippine sources
and, accordingly, taxable under our income tax laws.
(i) The term "non-resident foreign corporation" applies to a
foreign corporation not engaged in trade or business The Tax Code defines "gross income" thus:
within the Philippines and not having any office or place
of business therein "Gross income" includes gains, profits, and income
derived from salaries, wages or compensation for
It is our considered opinion that BOAC is a resident foreign personal service of whatever kind and in whatever form
corporation. There is no specific criterion as to what paid, or from profession, vocations, trades,business,
constitutes "doing" or "engaging in" or "transacting" commerce, sales, or dealings in property, whether real or
business. Each case must be judged in the light of its personal, growing out of the ownership or use of or
peculiar environmental circumstances. The term implies a interest in such property; also from interests, rents,
continuity of commercial dealings and arrangements, dividends, securities, or the transactions of any business
and contemplates, to that extent, the performance of carried on for gain or profile, or gains, profits, and income
acts or works or the exercise of some of the functions derived from any source whatever (Sec. 29[3]; Emphasis
normally incident to, and in progressive prosecution of supplied)
commercial gain or for the purpose and object of the
business organization. 2 "In order that a foreign The definition is broad and comprehensive to include
corporation may be regarded as doing business within a proceeds from sales of transport documents. "The words
State, there must be continuity of conduct and intention 'income from any source whatever' disclose a legislative
to establish a continuous business, such as the policy to include all income not expressly exempted
appointment of a local agent, and not one of a within the class of taxable income under our laws."
temporary character. 3 Income means "cash received or its equivalent"; it is the
amount of money coming to a person within a specific
BOAC, during the periods covered by the subject - time ...; it means something distinct from principal or
assessments, maintained a general sales agent in the capital. For, while capital is a fund, income is a flow. As
Philippines, That general sales agent, from 1959 to 1971, used in our income tax law, "income" refers to the flow of
"was engaged in (1) selling and issuing tickets; (2) wealth. 6
breaking down the whole trip into series of trips — each
trip in the series corresponding to a different airline The records show that the Philippine gross income of
company; (3) receiving the fare from the whole trip; and BOAC for the fiscal years 1968-69 to 1970-71 amounted to
(4) consequently allocating to the various airline P10,428,368 .00. 7
companies on the basis of their participation in the
services rendered through the mode of interline Did such "flow of wealth" come from "sources within the
settlement as prescribed by Article VI of the Resolution Philippines",
No. 850 of the IATA Agreement." 4 Those activities were in
exercise of the functions which are normally incident to,
The source of an income is the property, activity or
and are in progressive pursuit of, the purpose and object
service that produced the income. 8 For the source of
of its organization as an international air carrier. In fact,
income to be considered as coming from the Philippines,
the regular sale of tickets, its main activity, is the very
it is sufficient that the income is derived from activity
lifeblood of the airline business, the generation of sales
within the Philippines. In BOAC's case, the sale of tickets in
being the paramount objective. There should be no
the Philippines is the activity that produces the income.
doubt then that BOAC was "engaged in" business in the
The tickets exchanged hands here and payments for
Philippines through a local agent during the period
fares were also made here in Philippine currency. The site
covered by the assessments. Accordingly, it is a resident
of the source of payments is the Philippines. The flow of
foreign corporation subject to tax upon its total net
wealth proceeded from, and occurred within, Philippine
income received in the preceding taxable year from all
territory, enjoying the protection accorded by the
sources within the Philippines. 5
Philippine government. In consideration of such
protection, the flow of wealth should share the burden of
Sec. 24. Rates of tax on corporations. — ... supporting the government.
We shall now tackle the issues raised. If the assailed provisions are indeed unconstitutional,
there is no better time than the present to settle such
question once and for all.
EXISTENCE OF A JUSTICIABLE CONTROVERSY Respondents next argue that petitioner has no legal
standing to sue:
Courts will not assume jurisdiction over a
constitutional question unless the following requisites are Petitioner is an association of some of the
satisfied: (1) there must be an actual case calling for the real estate developers and builders in the
exercise of judicial review; (2) the question before the Philippines. Petitioners did not allege that [it] itself
court must be ripe for is in the real estate business. It did not allege any
material interest or any wrong that it may suffer convenience. This will go a long way in ensuring
from the enforcement of [the assailed that corporations will pay their just share in
provisions].[15] supporting our public life and our economic
advancement.[22]
Legal standing or locus standi is a party’s
personal and substantial interest in a case such that it has Domestic corporations owe their corporate
sustained or will sustain direct injury as a result of the existence and their privilege to do business to the
governmental act being challenged.[16] In Holy Spirit government. They also benefit from the efforts of the
Homeowners Association, Inc. v. Defensor,[17] we held government to improve the financial market and to
that the association had legal standing because its ensure a favorable business climate. It is therefore fair for
members stood to be injured by the enforcement of the the government to require them to make a reasonable
assailed provisions: contribution to the public expenses.
Petitioner association has the legal Congress intended to put a stop to the practice
standing to institute the instant petition xxx. There of corporations which, while having large turn-overs,
is no dispute that the individual members of report minimal or negative net income resulting in
petitioner association are residents of the NGC. minimal or zero income taxes year in and year out,
As such they are covered and stand to be either through under-declaration of income or over-deduction
benefited or injured by the enforcement of the of expenses otherwise called tax shelters.[23]
IRR, particularly as regards the selection process
of beneficiaries and lot allocation to qualified Mr. Javier (E.) [This] is what the Finance
beneficiaries. Thus, petitioner association may Dept. is trying to remedy, that is why they have
assail those provisions in the IRR which it believes proposed the [MCIT]. Because from experience
to be unfavorable to the rights of its members. xxx too, you have corporations which have been
Certainly, petitioner and its members have losing year in and year out and paid no tax. So, if
sustained direct injury arising from the the corporation has been losing for the past five
enforcement of the IRR in that they have been years to ten years, then that corporation has no
disqualified and eliminated from the selection business to be in business. It is dead. Why
process.[18] continue if you are losing year in and year out?
So, we have this provision to avoid this type of tax
shelters, Your Honor.[24]
In any event, this Court has the discretion to take
cognizance of a suit which does not satisfy the The primary purpose of any legitimate business is
requirements of an actual case, ripeness or legal standing to earn a profit. Continued and repeated losses after
when paramount public interest is involved.[19] The operations of a corporation or consistent reports of
questioned MCIT and CWT affect not only petitioners but minimal net income render its financial statements and its
practically all domestic corporate taxpayers in our tax payments suspect. For sure, certain tax avoidance
country. The transcendental importance of the issues schemes resorted to by corporations are allowed in our
raised and their overreaching significance to society jurisdiction. The MCIT serves to put a cap on such tax
make it proper for us to take cognizance of this shelters. As a tax on gross income, it prevents tax evasion
petition.[20] and minimizes tax avoidance schemes achieved through
sophisticated and artful manipulations of deductions and
CONCEPT AND RATIONALE OF THE MCIT other stratagems. Since the tax base was broader, the
tax rate was lowered.
The MCIT on domestic corporations is a new
concept introduced by RA 8424 to the Philippine taxation To further emphasize the corrective nature of the MCIT,
system. It came about as a result of the perceived the following safeguards were incorporated into the law:
inadequacy of the self-assessment system in capturing
the true income of corporations.[21] It was devised as a First, recognizing the birth pangs of businesses
relatively simple and effective revenue-raising instrument and the reality of the need to recoup initial major capital
compared to the normal income tax which is more expenditures, the imposition of the MCIT commences only
difficult to control and enforce. It is a means to on the fourth taxable year immediately following the year
ensure that everyone will make some minimum in which the corporation commenced its
contribution to the support of the public sector. The operations.[25] This grace period allows a new business to
congressional deliberations on this are illuminating: stabilize first and make its ventures viable before it is
subjected to the MCIT.[26]
Senator Enrile. Mr. President, we are not
unmindful of the practice of certain corporations Second, the law allows the carrying forward of
of reporting constantly a loss in their operations to any excess of the MCIT paid over the normal income tax
avoid the payment of taxes, and thus avoid which shall be credited against the normal income tax for
sharing in the cost of government. In this regard, the three immediately succeeding years.[27]
the Tax Reform Act introduces for the first time a
new concept called the [MCIT] so as to minimize Third, since certain businesses may be incurring
tax evasion, tax avoidance, tax manipulation in genuine repeated losses, the law authorizes the Secretary
the country and for administrative of Finance to suspend the imposition of MCIT if a
corporation suffers losses due to prolonged labor situs (place) of taxation.[36] It has the authority to
dispute, force majeure and legitimate business prescribe a certain tax at a specific rate for a particular
reverses.[28] public purpose on persons or things within its
jurisdiction. In other words, the legislature wields the
Even before the legislature introduced the MCIT power to define what tax shall be imposed, why it should
to the Philippine taxation system, several other countries be imposed, how much tax shall be imposed, against
already had their own system of minimum corporate whom (or what) it shall be imposed and where it shall be
income taxation. Our lawmakers noted that most imposed.
developing countries, particularly Latin American and
Asian countries, have the same form of safeguards as we As a general rule, the power to tax is plenary and
do. As pointed out during the committee hearings: unlimited in its range, acknowledging in its very nature no
limits, so that the principal check against its abuse is to be
[Mr. Medalla:] Note that most developing found only in the responsibility of the legislature (which
countries where you have of course quite a bit imposes the tax) to its constituency who are to pay
of room for underdeclaration of gross receipts it.[37] Nevertheless, it is circumscribed by constitutional
have this same form of safeguards. limitations. At the same time, like any other statute, tax
legislation carries a presumption of constitutionality.
In the case of Thailand, half a percent (0.5%),
theres a minimum of income tax of half a The constitutional safeguard of due process is
percent (0.5%) of gross assessable income. In embodied in the fiat [no] person shall be deprived of life,
Korea a 25% of taxable income before liberty or property without due process of law. In Sison, Jr.
deductions and exemptions. Of course the v. Ancheta, et al.,[38] we held that the due process clause
different countries have different basis for that may properly be invoked to invalidate, in appropriate
minimum income tax. cases, a revenue measure[39] when it amounts to a
confiscation of property.[40] But in the same case, we also
The other thing youll notice is the explained that we will not strike down a revenue measure
preponderance of Latin American countries that as unconstitutional (for being violative of the due process
employed this method. Okay, those are clause) on the mere allegation of arbitrariness by the
additional Latin American countries.[29] taxpayer.[41] There must be a factual foundation to such
an unconstitutional taint.[42] This merely adheres to the
authoritative doctrine that, where the due process clause
At present, the United States of America, Mexico, is invoked, considering that it is not a fixed rule but rather
Argentina, Tunisia, Panama and Hungary have their own a broad standard, there is a need for proof of such
versions of the MCIT.[30] persuasive character.[43]
MCIT IS NOT VIOLATIVE OF DUE PROCESS Petitioner is correct in saying that income is
distinct from capital.[44] Income means all the wealth
Petitioner claims that the MCIT under Section 27(E) of RA which flows into the taxpayer other than a mere return on
8424 is unconstitutional because it is highly oppressive, capital. Capital is a fund or property existing at one
arbitrary and confiscatory which amounts to deprivation distinct point in time while income denotes a flow of
of property without due process of law. It explains that wealth during a definite period of time.[45] Income is gain
gross income as defined under said provision only derived and severed from capital.[46] For income to be
considers the cost of goods sold and other direct taxable, the following requisites must exist:
expenses; other major expenditures, such as
administrative and interest expenses which are equally (1) there must be gain;
necessary to produce gross income, were not taken into (2) the gain must be realized or received and
account.[31] Thus, pegging the tax base of the MCIT to a (3) the gain must not be excluded by law or
corporations gross income is tantamount to a treaty from taxation.[47]
confiscation of capital because gross income, unlike net
income, is not realized gain.[32] Certainly, an income tax is arbitrary and confiscatory if it
taxes capital because capital is not income. In other
We disagree. words, it is income, not capital, which is subject to income
tax. However, the MCIT is not a tax on capital.
Taxes are the lifeblood of the
government. Without taxes, the government can neither The MCIT is imposed on gross income which is
exist nor endure. The exercise of taxing power derives its arrived at by deducting the capital spent by a
source from the very existence of the State whose social corporation in the sale of its goods, i.e., the cost of
contract with its citizens obliges it to promote public goods[48] and other direct expenses from gross
interest and the common good.[33] sales. Clearly, the capital is not being taxed.
Taxation is an inherent attribute of Furthermore, the MCIT is not an additional tax imposition.
sovereignty.[34] It is a power that is purely It is imposed in lieu of the normal net income tax, and
legislative.[35] Essentially, this means that in the legislature only if the normal income tax is suspiciously low. The MCIT
primarily lies the discretion to determine the nature (kind), merely approximates the amount of net income tax due
object (purpose), extent (rate), coverage (subjects) and from a corporation, pegging the rate at a very much
reduced 2% and uses as the base the corporations gross In sum, petitioner failed to support, by any
income. factual or legal basis, its allegation that the MCIT is
arbitrary and confiscatory. The Court cannot strike down
Besides, there is no legal objection to a broader tax base a law as unconstitutional simply because of its
or taxable income by eliminating all deductible items and yokes.[58] Taxation is necessarily burdensome because, by
at the same time reducing the applicable tax rate.[49] its nature, it adversely affects property rights.[59] The party
alleging the laws unconstitutionality has the burden to
Statutes taxing the gross "receipts," demonstrate the supposed violations in understandable
"earnings," or "income" of particular terms.[60]
corporations are found in many jurisdictions. Tax
thereon is generally held to be within the power
of a state to impose; or constitutional, unless it RR 9-98 MERELY CLARIFIES
interferes with interstate commerce or violates SECTION 27(E) OF RA 8424
the requirement as to uniformity of taxation.[50]
Petitioner alleges that RR 9-98 is a deprivation of
property without due process of law because the MCIT is
The United States has a similar alternative being imposed and collected even when there is
minimum tax (AMT) system which is generally actually a loss, or a zero or negative taxable income:
characterized by a lower tax rate but a broader tax
base.[51] Since our income tax laws are of American Sec. 2.27(E) [MCIT] on Domestic
origin, interpretations by American courts of our parallel Corporations.
tax laws have persuasive effect on the interpretation of
these laws.[52] Although our MCIT is not exactly the same (1) Imposition of the Tax. xxx The MCIT
as the AMT, the policy behind them and the procedure of shall be imposed whenever such
their implementation are comparable. On the question of corporation has zero or negative taxable
the AMTs constitutionality, the United States Court of income or whenever the amount of
Appeals for the Ninth Circuit stated in Okin v. [MCIT] is greater than the normal income
Commissioner:[53] tax due from such
corporation. (Emphasis supplied)
In enacting the minimum tax, Congress
attempted to remedy general taxpayer distrust RR 9-98, in declaring that MCIT should be
of the system growing from large numbers of imposed whenever such corporation has zero or negative
taxpayers with large incomes who were yet taxable income, merely defines the coverage of Section
paying no taxes. 27(E). This means that even if a corporation incurs a net
loss in its business operations or reports zero income after
xxx xxx xxx deducting its expenses, it is still subject to an MCIT of 2% of
its gross income. This is consistent with the law which
We thus join a number of other courts in imposes the MCIT on gross income notwithstanding the
upholding the constitutionality of the [AMT]. xxx amount of the net income. But the law also states that
[It] is a rational means of obtaining a broad- the MCIT is to be paid only if it is greater than the normal
based tax, and therefore is constitutional.[54] net income. Obviously, it may well be the case that the
MCIT would be less than the net income of the
corporation which posts a zero or negative taxable
The U.S. Court declared that the congressional intent to income.
ensure that corporate taxpayers would contribute a
minimum amount of taxes was a legitimate governmental We now proceed to the issues involving the CWT.
end to which the AMT bore a reasonable relation.[55]
American courts have also emphasized that Congress The withholding tax system is a procedure
has the power to condition, limit or deny deductions from through which taxes (including income taxes) are
gross income in order to arrive at the net that it chooses collected.[61] Under Section 57 of RA 8424, the types of
to tax.[56] This is because deductions are a matter of income subject to withholding tax are divided into three
legislative grace.[57] categories: (a) withholding of final tax on certain
incomes; (b) withholding of creditable tax at source and
Absent any other valid objection, the assignment (c) tax-free covenant bonds.Petitioner is concerned with
of gross income, instead of net income, as the tax base the second category (CWT) and maintains that the
of the MCIT, taken with the reduction of the tax rate from revenue regulations on the collection of CWT on sale of
32% to 2%, is not constitutionally objectionable. real estate categorized as ordinary assets are
unconstitutional.
Moreover, petitioner does not cite any actual,
specific and concrete negative experiences of its Petitioner, after enumerating the distinctions
members nor does it present empirical data to show that between capital and ordinary assets under RA 8424,
the implementation of the MCIT resulted in the contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and
confiscation of their property. Sections 4(a)(ii) and (c)(ii) of RR 7-2003 were promulgated
with grave abuse of discretion amounting to lack of
jurisdiction and patently in contravention of
law[62] because they ignore such distinctions. Petitioners provided for by law, at the rate of not less than
conclusion is based on the following premises: (a) the one percent (1%) but not more than thirty-two
revenue regulations use gross selling price (GSP) or fair percent (32%) thereof, which shall be credited
market value (FMV) of the real estate as basis for against the income tax liability of the taxpayer
determining the income tax for the sale of real estate for the taxable year.
classified as ordinary assets and (b) they mandate the
collection of income tax on a per transaction basis, i.e.,
upon consummation of the sale via the CWT, contrary to The questioned provisions of RR 2-98, as
RA 8424 which calls for the payment of the net income at amended, are well within the authority given by Section
the end of the taxable period.[63] 57(B) to the Secretary, i.e., the graduated rate of 1.5%-5%
Petitioner theorizes that since RA 8424 treats is between the 1%-32% range; the withholding tax is
capital assets and ordinary assets differently, respondents imposed on the income payable and the tax is
cannot disregard the distinctions set by the legislators as creditable against the income tax liability of the taxpayer
regards the tax base, modes of collection and payment for the taxable year.
of taxes on income from the sale of capital and ordinary
assets. EFFECT OF RRS ON THE TAX BASE FOR THE INCOME TAX OF
Petitioners arguments have no merit. INDIVIDUALS OR CORPORATIONS ENGAGED IN THE REAL
ESTATE BUSINESS
Petitioner submits that only passive income can Indeed, Section 57(A) and (B) are distinct. Section 57(A)
be subjected to withholding tax, whether final or refers to FWT while Section 57(B) pertains to CWT. The
creditable. According to petitioner, the whole of Section former covers the kinds of passive income enumerated
57 governs the withholding of income tax on passive therein and the latter encompasses any income other
income. The enumeration in Section 57(A) refers to than those listed in 57(A). Since the law itself makes
passive income being subjected to FWT. It follows that distinctions, it is wrong to regard 57(A) and 57(B) in the
Section 57(B) on CWT should also be limited to passive same way.
income:
To repeat, the assailed provisions of RR 2-98, as
SEC. 57. Withholding of Tax at Source. amended, do not modify or deviate from the text of
Section 57(B). RR 2-98 merely implements the law by
(A) Withholding of Final Tax on Certain Incomes. specifying what income is subject to CWT. It has been
Subject to rules and regulations, the [Secretary] held that, where a statute does not require any particular
may promulgate, upon the recommendation of procedure to be followed by an administrative agency,
the [CIR], requiring the filing of income tax return the agency may adopt any reasonable method to carry
by certain income payees, the tax imposed or out its functions.[77] Similarly, considering that the law uses
prescribed by Sections 24(B)(1), 24(B)(2), 24(C), the general term income, the Secretary and CIR may
24(D)(1); 25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), specify the kinds of income the rules will apply to based
25(E); 27(D)(1), 27(D)(2), 27(D)(3), 27(D)(5); on what is feasible. In addition, administrative rules and
28(A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b), regulations ordinarily deserve to be given weight and
28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3), 28(B)(4), respect by the courts[78] in view of the rule-making
28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 of authority given to those who formulate them and their
this Code on specified items of income shall be specific expertise in their respective fields.
withheld by payor-corporation and/or person
and paid in the same manner and subject to the
same conditions as provided in Section 58 of this NO DEPRIVATION OF PROPERTY
Code. WITHOUT DUE PROCESS
(B) Withholding of Creditable Tax at Source. The Petitioner avers that the imposition of CWT on
[Secretary] may, upon the recommendation of GSP/FMV of real estate classified as ordinary assets
the [CIR], require the withholding of a tax on the deprives its members of their property without due
items of income payable to natural or juridical process of law because, in their line of business, gain is
persons, residing in the Philippines, by payor- never assured by mere receipt of the selling price. As a
corporation/persons as provided for by law, at result, the government is collecting tax from net income
the rate of not less than one percent (1%) but not not yet gained or earned.
more than thirty-two percent (32%) thereof, which
shall be credited against the income tax liability Again, it is stressed that the CWT is creditable against the
of the taxpayer for the taxable year. (Emphasis tax due from the seller of the property at the end of the
supplied) taxable year. The seller will be able to claim a tax refund
if its net income is less than the taxes withheld. Nothing is
This line of reasoning is non sequitur. taken that is not due so there is no confiscation of
property repugnant to the constitutional guarantee of
Section 57(A) expressly states that final tax can due process. More importantly, the due process
be imposed on certain kinds of income and enumerates requirement applies to the power to tax.[79] The CWT does
these as passive income. The BIR defines passive income not impose new taxes nor does it increase taxes.[80] It
by stating what it is not: relates entirely to the method and time of payment.
if the income is generated in the Petitioner protests that the refund remedy does
active pursuit and performance of the not make the CWT less burdensome because taxpayers
corporations primary purposes, the same have to wait years and may even resort to litigation
is not passive income[76] before they are granted a refund.[81] This argument is
misleading. The practical problems encountered in
It is income generated by the taxpayers assets. These claiming a tax refund do not affect the constitutionality
assets can be in the form of real properties that return and validity of the CWT as a method of collecting the tax.
rental income, shares of stock in a corporation that earn
dividends or interest income received from savings. Petitioner complains that the amount withheld
would have otherwise been used by the enterprise to pay
On the other hand, Section 57(B) provides that labor wages, materials, cost of money and other
the Secretary can require a CWT on income payable to expenses which can then save the entity from having to
natural or juridical persons, residing in the obtain loans entailing considerable interest expense.
Philippines. There is no requirement that this income be Petitioner also lists the expenses and pitfalls of the trade
which add to the burden of the realty industry: huge
investments and borrowings; long gestation bigger and its frequency of transaction limited, making it
period; sudden and unpredictable interest rate surges; less cumbersome for the parties to comply with the
continually spiraling development/construction costs; withholding tax scheme.
heavy taxes and prohibitive up-front regulatory fees from
at least 20 government agencies.[82] On the other hand, each manufacturing enterprise may
have tens of thousands of transactions with several
Petitioners lamentations will not support its attack thousand customers every month involving both minimal
on the constitutionality of the CWT. Petitioners complaints and substantial amounts. To require the customers of
are essentially matters of policy best addressed to the manufacturing enterprises, at present, to withhold the
executive and legislative branches of the taxes on each of their transactions with their tens or
government. Besides, the CWT is applied only on the hundreds of suppliers may result in an inefficient and
amounts actually received or receivable by the real unmanageable system of taxation and may well defeat
estate entity. Sales on installment are taxed on a per- the purpose of the withholding tax system.
installment basis.[83] Petitioners desire to utilize for its
operational and capital expenses money earmarked for Petitioner counters that there are other businesses
the payment of taxes may be a practical business option wherein expensive items are also sold
but it is not a fundamental right which can be demanded infrequently, e.g. heavy equipment, jewelry, furniture,
from the court or from the government. appliance and other capital goods yet these are not
similarly subjected to the CWT.[89] As already discussed,
NO VIOLATION OF EQUAL PROTECTION the Secretary may adopt any reasonable method to
carry out its functions.[90] Under Section 57(B), it may
Petitioner claims that the revenue regulations choose what to subject to CWT.
are violative of the equal protection clause because the
CWT is being levied only on real estate A reading of Section 2.57.2 (M) of RR 2-98 will also show
enterprises. Specifically, petitioner points out that that petitioners argument is not accurate. The sales of
manufacturing enterprises are not similarly imposed a manufacturers who have clients within the top 5,000
CWT on their sales, even if their manner of doing business corporations, as specified by the BIR, are also subject to
is not much different from that of a real estate CWT for their transactions with said 5,000 corporations.[91]
enterprise. Like a manufacturing concern, a real estate
business is involved in a continuous process of Lastly, petitioner assails Section 2.58.2 of RR 2-98,
production and it incurs costs and expenditures on a which provides that the Registry of Deeds should not
regular basis. The only difference is that goods produced effect the regisration of any document transferring real
by the real estate business are house and lot units.[84] property unless a certification is issued by the CIR that the
withholding tax has been paid. Petitioner proffers hardly
Again, we disagree. any reason to strike down this rule except to rely on its
contention that the CWT is unconstitutional. We have
The equal protection clause under the ruled that it is not. Furthermore, this provision uses almost
Constitution means that no person or class of persons shall exactly the same wording as Section 58(E) of RA 8424
be deprived of the same protection of laws which is and is unquestionably in accordance with it:
enjoyed by other persons or other classes in the same
place and in like circumstances.[85] Stated differently, all Sec. 58. Returns and Payment of Taxes Withheld at
persons belonging to the same class shall be taxed Source.
alike. It follows that the guaranty of the equal protection
of the laws is not violated by legislation based on a (E) Registration with Register of Deeds. - No registration of
reasonable classification. Classification, to be valid, must any document transferring real property shall be
(1) rest on substantial distinctions; (2) be germane to the effected by the Register of Deeds unless the [CIR] or his
purpose of the law; (3) not be limited to existing duly authorized representative has certified that such
conditions only and (4) apply equally to all members of transfer has been reported, and the capital gains or
the same class.[86] [CWT], if any, has been paid: xxxx any violation of this
provision by the Register of Deeds shall be subject to the
The taxing power has the authority to make reasonable penalties imposed under Section 269 of this Code.
classifications for purposes of taxation.[87] Inequalities (Emphasis supplied)
which result from a singling out of one particular class for
taxation, or exemption, infringe no constitutional
limitation.[88] The real estate industry is, by itself, a class CONCLUSION
and can be validly treated differently from other business
enterprises. The renowned genius Albert Einstein was once quoted as
saying [the] hardest thing in the world to understand is
Petitioner, in insisting that its industry should be treated the income tax.[92] When a party questions the
similarly as manufacturing enterprises, fails to realize that constitutionality of an income tax measure, it has to
what distinguishes the real estate business from other contend not only with Einstein’s observation but also with
manufacturing enterprises, for purposes of the imposition the vast and well-established jurisprudence in support of
of the CWT, is not their production processes but the the plenary powers of Congress to impose
prices of their goods sold and the number of transactions taxes. Petitioner has miserably failed to discharge its
involved. The income from the sale of a real property is
burden of convincing the Court that the imposition of In each of said cases an effort was made to collect an
MCIT and CWT is unconstitutional. "income tax" upon "stock dividends" and in each case it
was held that "stock dividends" were capital and not an
WHEREFORE, the petition is hereby DISMISSED. "income" and therefore not subject to the "income tax"
law.
Costs against petitioner.
The appellee admits the doctrine established in the case
of Eisner vs. Macomber (252 U.S., 189) that a "stock
SO ORDERED. dividend" is not "income" but argues that said Act No.
2833, in imposing the tax on the stock dividend, does not
violate the provisions of the Jones Law. The appellee
further argues that the statute of the United States
providing for tax upon stock dividends is different from the
statute of the Philippine Islands, and therefore the
decision of the Supreme Court of the United States should
G.R. No. L-17518 October 30, 1922 not be followed in interpreting the statute in force here.
FREDERICK C. FISHER, plaintiff-appellant, For the purpose of ascertaining the difference in the said
vs. statutes ( (United States and Philippine Islands), providing
WENCESLAO TRINIDAD, Collector of Internal for an income tax in the United States as well as that in
Revenue, defendant-appellee. the Philippine Islands, the two statutes are here quoted
for the purpose of determining the difference, if any, in
The only question presented by this appeal is: Are the the language of the two statutes.
"stock dividends" in the present case "income" and
taxable as such under the provisions of section 25 of Act Chapter 463 of an Act of Congress of September 8, 1916,
No. 2833? While the appellant presents other important in its title 1 provides for the collection of an "income tax."
questions, under the view which we have taken of the Section 2 of said Act attempts to define what is an
facts and the law applicable to the present case, we income. The definition follows:
deem it unnecessary to discuss them now.
That the term "dividends" as used in this title shall be held
The defendant demurred to the petition in the lower to mean any distribution made or ordered to made by a
court. The facts are therefore admitted. They are simple corporation, . . . which stock dividend shall be considered
and may be stated as follows: income, to the amount of its cash value.
That during the year 1919 the Philippine American Drug Act No. 2833 of the Philippine Legislature is an Act
Company was a corporation duly organized and existing establishing "an income tax." Section 25 of said Act
under the laws of the Philippine Islands, doing business in attempts to define the application of the income tax. The
the City of Manila; that he appellant was a stockholder in definition follows:
said corporation; that said corporation, as result of the
business for that year, declared a "stock dividend"; that The term "dividends" as used in this Law shall be held to
the proportionate share of said stock divided of the mean any distribution made or ordered to be made by a
appellant was P24,800; that the stock dividend for that corporation, . . . out of its earnings or profits accrued since
amount was issued to the appellant; that thereafter, in March first, nineteen hundred and thirteen, and payable
the month of March, 1920, the appellant, upon demand to its shareholders, whether in cash or in stock of the
of the appellee, paid under protest, and voluntarily, unto corporation, . . . . Stock dividend shall be considered
the appellee the sum of P889.91 as income tax on said income, to the amount of the earnings or profits
stock dividend. For the recovery of that sum (P889.91) the distributed.
present action was instituted. The defendant demurred to
the petition upon the ground that it did not state facts
sufficient to constitute cause of action. The demurrer was It will be noted from a reading of the provisions of the two
sustained and the plaintiff appealed. laws above quoted that the writer of the law of the
Philippine Islands must have had before him the statute of
the United States. No important argument can be based
To sustain his appeal the appellant cites and relies on upon the slight different in the wording of the two
some decisions of the Supreme Court of the United States sections.
as will as the decisions of the supreme court of some of
the states of the Union, in which the questions before us,
based upon similar statutes, was discussed. Among the It is further argued by the appellee that there are no
most important decisions may be mentioned the constitutional limitations upon the power of the Philippine
following: Towne vs. Eisner, 245 U.S., 418; Doyle vs. Mitchell Legislature such as exist in the United States, and in
Bors. Co., 247 U.S., 179; Eisner vs. Macomber, 252 U.S., 189; support of that contention, he cites a number of
Dekoven vs Alsop, 205 Ill., 309; 63 L.R.A., 587; Kaufman vs. decisions. There is no question that the Philippine
Charlottesville Woolen Mills, 93 Va., 673. Legislature may provide for the payment of an income
tax, but it cannot, under the guise of an income tax,
collect a tax on property which is not an "income." The
Philippine Legislature can not impose a tax upon new supplies. At the close of the year there is not a
"property" under a law which provides for a tax upon centavo in the treasury, with which either A or B could
"income" only. The Philippine Legislature has no power to buy a cup of coffee or a pair of shoes for his family. At the
provide a tax upon "automobiles" only, and under that beginning of the year they were P2,000, and at the end
law collect a tax upon acarreton or bull cart. of the year they were P4,000, and neither of the
Constitutional limitations, that is to say, a statute expressly stockholders have received a centavo from the business
adopted for one purpose cannot, without amendment, during the year. At the close of the year, when it is
be applied to another purpose which is entirely distinct discovered that the assets are P4,000 and not P2,000,
and different. A statute providing for an income tax instead of selling the extra merchandise on hand and
cannot be construed to cover property which is not, in thereby reducing the business to its original capital, they
fact income. The Legislature cannot, by a statutory agree among themselves to increase the capital they
declaration, change the real nature of a tax which it agree among themselves to increase the capital issued
imposes. A law which imposes an important tax on rice and for that purpose issue additional stock in the form of
only cannot be construed to an impose an importation "stock dividends" or additional stock of P1,000 each,
tax on corn. which represents the actual increase of the shares of
interest in the business. At the beginning of the year each
It is true that the statute in question provides for an stockholder held one-half interest in the capital. At the
income tax and contains a further provision that "stock close of the year, and after the issue of the said stock
dividends" shall be considered income and are therefore dividends, they each still have one-half interest in the
subject to income tax provided for in said law. If "stock business. The capital of the corporation increased during
dividends" are not "income" then the law permits a tax the year, but has either of them received an income? It is
upon something not within the purpose and intent of the not denied, for the purpose of ordinary taxation, that the
law. taxable property of the corporation at the beginning of
the year was P2,000, that at the close of the year it
was P4,000, and that the tax rolls should be changed in
It becomes necessary in this connection to ascertain
accordance with the changed conditions in the business.
what is an "income in order that we may be able to
In other words, the ordinary tax should be increased by
determine whether "stock dividends" are "income" in the
P2,000.
sense that the word is used in the statute. Perhaps it
would be more logical to determine first what are "stock
dividends" in order that we may more clearly understand Another illustration: C and D organized a corporation for
their relation to "income." Generally speaking, stock agricultural purposes with an authorized capital stock of
dividends represent undistributed increase in the capital P20,000 each contributing P5,000. With that capital they
of corporations or firms, joint stock companies, etc., etc., purchased a farm and, with it, one hundred head of
for a particular period. They are used to show the cattle. Every peso contributed is invested. There is no
increased interest or proportional shares in the capital of money in the treasury. Much time and labor was
each stockholder. In other words, the inventory of the expanded during the year by the stockholders on the
property of the corporation, etc., for particular period farm in the way of improvements. Neither received a
shows an increase in its capital, so that the stock centavo during the year from the farm or the cattle. At
theretofore issued does not show the real value of the the beginning of the year the assets of the corporation,
stockholder's interest, and additional stock is issued including the farm and the cattle, were P10,000, and at
showing the increase in the actual capital, or property, or the close of the year and inventory of the property of the
assets of the corporation, etc. corporation is made and it is then found that they have
the same farm with its improvements and two hundred
head of cattle by natural increase. At the end of the year
To illustrate: A and B form a corporation with an
it is also discovered that, by reason of business changes,
authorized capital of P10,000 for the purpose of opening
the farm and the cattle both have increased in value,
and conducting a drug store, with assets of the value of
and that the value of the corporate property is now
P2,000, and each contributes P1,000. Their entire assets
P20,000 instead of P10,000 as it was at the beginning of
are invested in drugs and put upon the shelves in their
the year. The incorporators instead of reducing the
place of business. They commence business without a
property to its original capital, by selling off a part of its,
cent in the treasury. Every dollar contributed is invested.
issue to themselves "stock dividends" to represent the
Shares of stock to the amount of P1,000 are issued to
proportional value or interest of each of the stockholders
each of the incorporators, which represent the actual
in the increased capital at the close of the year. There is
investment and entire assets of the corporation. Business
still not a centavo in the treasury and neither has
for the first year is good. Merchandise is sold, and
withdrawn a peso from the business during the year. No
purchased, to meet the demands of the growing trade.
part of the farm or cattle has been sold and not a single
At the end of the first year an inventory of the assets of
peso was received out of the rents or profits of the capital
the corporation is made, and it is then ascertained that
of the corporation by the stockholders.
the assets or capital of the corporation on hand amount
to P4,000, with no debts, and still not a cent in the
treasury. All of the receipts during the year have been Another illustration: A, an individual farmer, buys a farm
reinvested in the business. Neither of the stockholders with one hundred head of cattle for the sum of P10,000.
have withdrawn a penny from the business during the At the end of the first year, by reason of business
year. Every peso received for the sale of merchandise conditions and the increase of the value of both real
was immediately used in the purchase of new stock — estate and personal property, it is discovered that the
value of the farm and the cattle is P20,000. A, during the thoughtful discussion that the case received below, we
year, has received nothing from the farm or the cattle. His cannot doubt that the dividend was capital as well for
books at the beginning of the year show that he had the purposes of the Income Tax Law. . . . 'A stock dividend
property of the value of P10,000. His books at the close of really takes nothing from the property of the corporation,
the year show that he has property of the value of and adds nothing to the interests of the shareholders. Its
P20,000. A is not a corporation. The assets of his business property is not diminished and their interest are not
are not shown therefore by certificates of stock. His increased. . . . The proportional interest of each
books, however, show that the value of his property has shareholder remains the same. . . .' In short, the
increased during the year by P10,000, under any theory of corporation is no poorer and the stockholder is no richer
business or law, be regarded as an "income" upon which then they were before." (Gibbons vs. Mahon, 136 U.S.,
the farmer can be required to pay an income tax? Is 549, 559, 560; Logan County vs. U.S., 169 U.S., 255, 261).
there any difference in law in the condition of A in this
illustration and the condition of A and B in the In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179,
immediately preceding illustration? Can the increase of Mr. Justice Pitney, speaking for the court, said that the
the value of the property in either case be regarded as act employs the term "income" in its natural and obvious
an "income" and be subjected to the payment of the sense, as importing something distinct from principal or
income tax under the law? capital and conveying the idea of gain or increase
arising from corporate activity.
Each of the foregoing illustrations, it is asserted, is
analogous to the case before us and, in view of that fact, Mr. Justice Pitney, in the case of Eisner vs. Macomber (252
let us ascertain how lexicographers and the courts have U.S., 189), again speaking for the court said: "An income
defined an "income." The New Standard Dictionary, may be defined as the gain derived from capital, from
edition of 1915, defines an income as "the amount of labor, or from both combined, provided it be understood
money coming to a person or corporation within a to include profit gained through a sale or conversion of
specified time whether as payment or corporation within capital assets."
a specified time whether as payment for services, interest,
or profit from investment." Webster's International
For bookkeeping purposes, when stock dividends are
Dictionary defines an income as "the receipt, salary;
declared, the corporation or company acknowledges a
especially, the annual receipts of a private person or a
liability, in form, to the stockholders, equivalent to the
corporation from property." Bouvier, in his law dictionary,
aggregate par value of their stock, evidenced by a
says that an "income" in the federal constitution and
"capital stock account." If profits have been made by the
income tax act, is used in its common or ordinary
corporation during a particular period and not divided,
meaning and not in its technical, or economic sense. (146
they create additional bookkeeping liabilities under the
Northwestern Reporter, 812) Mr. Black, in his law
head of "profit and loss," "undivided profits," "surplus
dictionary, says "An income is the returnin money from
account," etc., or the like. None of these, however, gives
one's business, labor, or capital invested; gains, profit or
to the stockholders as a body, much less to any one of
private revenue." "An income tax is a tax on the yearly
them, either a claim against the going concern or
profits arising from property , professions, trades, and
corporation, for any particular sum of money, or a right to
offices."
any particular portion of the asset, or any shares sells or
until the directors conclude that dividends shall be made
The Supreme Court of the United States, in the case o a part of the company's assets segregated from the
Gray vs. Darlington (82 U.S., 653), said in speaking of common fund for that purpose. The dividend normally is
income that mere advance in value in no sense payable in money and when so paid, then only does the
constitutes the "income" specified in the revenue law as stockholder realize a profit or gain, which becomes his
"income" of the owner for the year in which the sale of separate property, and thus derive an income from the
the property was made. Such advance constitutes and capital that he has invested. Until that, is done
can be treated merely as an increase of capital. (In theincreased assets belong to the corporation and not to
re Graham's Estate, 198 Pa., 216; Appeal of Braun, 105 the individual stockholders.
Pa., 414.)
When a corporation or company issues "stock dividends"
Mr. Justice Hughes, later Associate Justice of the Supreme it shows that the company's accumulated profits have
Court of the United States and now Secretary of State of been capitalized, instead of distributed to the
the United States, in his argument before the Supreme stockholders or retained as surplus available for
Court of the United States in the case of Towne vs. distribution, in money or in kind, should opportunity offer.
Eisner, supra, defined an "income" in an income tax law, Far from being a realization of profits of the stockholder, it
unless it is otherwise specified, to mean cash or its tends rather to postpone said realization, in that the fund
equivalent. It does not mean choses in action represented by the new stock has been transferred from
or unrealized increments in the value of the property, and surplus to assets, and no longer is available for actual
cites in support of the definition, the definition given by distribution. The essential and controlling fact is that the
the Supreme Court in the case of Gray vs. stockholder has received nothing out of the company's
Darlington, supra. assets for his separate use and benefit; on the contrary,
every dollar of his original investment, together with
In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, whatever accretions and accumulations resulting from
speaking for the court, said: "Notwithstanding the employment of his money and that of the other
stockholders in the business of the company, still remains disbursement to the stockholder of accumulated
the property of the company, and subject to business risks earnings, and the corporation at once parts irrevocably
which may result in wiping out of the entire investment. with all interest thereon. The other involves no
Having regard to the very truth of the matter, to disbursement by the corporation. It parts with nothing to
substance and not to form, the stockholder by virtue of the stockholder. The latter receives, not an actual
the stock dividend has in fact received nothing that dividend, but certificate of stock which simply evidences
answers the definition of an "income." (Eisner vs. his interest in the entire capital, including such as by
Macomber, 252 U.S., 189, 209, 211.) investment of accumulated profits has been added to
the original capital. They are not income to him, but
The stockholder who receives a stock dividend has represent additions to the source of his income, namely,
received nothing but a representation of his increased his invested capital. (DeKoven vs. Alsop, 205, Ill., 309; 63
interest in the capital of the corporation. There has been L.R.A. 587). Such a person is in the same position, so far as
no separation or segregation of his interest. All the his income is concerned, as the owner of young domestic
property or capital of the corporation still belongs to the animal, one year old at the beginning of the year, which
corporation. There has been no separation of the interest is worth P50 and, which, at the end of the year, and by
of the stockholder from the general capital of the reason of its growth, is worth P100. The value of his
corporation. The stockholder, by virtue of the stock property has increased, but has had an income during
dividend, has no separate or individual control over the the year? It is true that he had taxable property at the
interest represented thereby, further than he had before beginning of the year of the value of P50, and the same
the stock dividend was issued. He cannot use it for the taxable property at another period, of the value of P100,
reason that it is still the property of the corporation and but he has had no income in the common acceptation
not the property of the individual holder of stock of that word. The increase in the value of the property
dividend. A certificate of stock represented by the stock should be taken account of on the tax duplicate for the
dividend is simply a statement of his proportional interest purposes of ordinary taxation, but not as income for he
or participation in the capital of the corporation. For has had none.
bookkeeping purposes, a corporation, by issuing stock
dividend, acknowledges a liability in form to the The question whether stock dividends are income, or
stockholders, evidenced by a capital stock account. The capital, or assets has frequently come before the courts
receipt of a stock dividend in no way increases the in another form — in cases of inheritance. A is a
money received of a stockholder nor his cash account at stockholder in a large corporation. He dies leaving a will
the close of the year. It simply shows that there has been by the terms of which he give to B during his lifetime the
an increase in the amount of the capital of the "income" from said stock, with a further provision that C
corporation during the particular period, which may be shall, at B's death, become the owner of his share in the
due to an increased business or to a natural increase of corporation. During B's life the corporation issues a stock
the value of the capital due to business, economic, or dividend. Does the stock dividend belong to B as an
other reasons. We believe that the Legislature, when it income, or does it finally belong to C as a part of his share
provided for an "income tax," intended to tax only the in the capital or assets of the corporation, which had
"income" of corporations, firms or individuals, as that term been left to him as a remainder by A? While there has
is generally used in its common acceptation; that is that been some difference of opinion on that question, we
the income means money received, coming to a person believe that a great weight of authorities hold that the
or corporation for services, interest, or profit from stock dividend is capital or assets belonging to C and not
investments. We do not believe that the Legislature an income belonging to B. In the case of D'Ooge vs.
intended that a mere increase in the value of the capital Leeds (176 Mass., 558, 560) it was held that stock
or assets of a corporation, firm, or individual, should be dividends in such cases were regarded as capital and
taxed as "income." Such property can be reached under not as income(Gibbons vs. Mahon, 136 U.S., 549.)
the ordinary from of taxation.
In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray
Mr. Justice Pitney, in the case of the Einer vs. said: "The distinction between the title of a corporation,
Macomber, supra, said in discussing the difference and the interest of its members or stockholders in the
between "capital" and "income": "That the fundamental property of the corporation, is familiar and well settled.
relation of 'capital' to 'income' has been much discussed The ownership of that property is in the corporation, and
by economists, the former being likened to the tree or the not in the holders of shares of its stock. The interest of
land, the latter to the fruit or the crop; the former each stockholder consists in the right to a proportionate
depicted as a reservoir supplied from springs; the latter as part of the profits whenever dividends are declared by
the outlet stream, to be measured by its flow during a the corporation, during its existence, under its charter,
period of time." It may be argued that a stockholder and to a like proportion of the property remaining, upon
might sell the stock dividend which he had acquired. If the termination or dissolution of the corporation, after
he does, then he has received, in fact, an income and payment of its debts." (Minot vs. Paine, 99 Mass., 101;
such income, like any other profit which he realizes from Greeff vs. Equitable Life Assurance Society, 160 N. Y., 19.)
the business, is an income and he may be taxed thereon. In the case of Dekoven vs. Alsop (205 Ill ,309, 63 L. R. A.
587) Mr. Justice Wilkin said: "A dividend is defined as a
There is a clear distinction between an extraordinary cash corporate profit set aside, declared, and ordered by the
dividend, no matter when earned, and stock dividends directors to be paid to the stockholders on demand or at
declared, as in the present case. The one is a a fixed time. Until the dividend is declared, these
corporate profits belong to the corporation, not to the authorized the Philippine Legislatures to provide for an
stockholders, and are liable for corporate indebtedness. income tax. That fact may also be admitted. But a
careful reading of that Act will show that, while it
There is a clear distinction between an extraordinary cash permitted a tax upon income, the same provided that
dividend, no matter when earned, and stock dividends income shall include gains, profits, and income derived
declared. The one is a disbursement to the stockholders from salaries, wages, or compensation for personal
of accumulated earning, and the corporation at once services, as well as from interest, rent, dividends, securities,
parts irrevocably with all interest thereon. The other etc. The appellee emphasizes the "income from
involves no disbursement by the corporation. It parts with dividends." Of course, income received as dividends is
nothing to the stockholders. The latter receives, not an taxable as an income but an income from "dividends" is a
actual dividend, but certificates of stock which evidence very different thing from receipt of a "stock dividend."
in a new proportion his interest in the entire capital. When One is an actual receipt of profits; the other is a receipt of
a cash becomes the absolute property of the a representation of the increased value of the assets of
stockholders and cannot be reached by the creditors of corporation.
the corporation in the absence of fraud. A stock dividend
however, still being the property of the corporation and In all of the foregoing argument we have not overlooked
not the stockholder, it may be reached by an execution the decisions of a few of the courts in different parts of
against the corporation, and sold as a part of the the world, which have reached a different conclusion
property of the corporation. In such a case, if all the from the one which we have arrived at in the present
property of the corporation is sold, then the stockholder case. Inasmuch, however, as appeals may be taken from
certainly could not be charged with having received an this court to the Supreme Court of the United States, we
income by virtue of the issuance of the stock dividend. feel bound to follow the same doctrine announced by
Until the dividend is declared and paid, the corporate that court.
profits still belong to the corporation, not to the
stockholders, and are liable for corporate indebtedness. Having reached the conclusion, supported by the great
The rule is well established that cash dividend, whether weight of the authority, that "stock dividends" are not
large or small, are regarded as "income" and all stock "income," the same cannot be taxes under that provision
dividends, as capital or assets (Cook on Corporation, of Act No. 2833 which provides for a tax upon income.
Chapter 32, secs. 534, 536; Davis vs. Jackson, 152 Mass., Under the guise of an income tax, property which is not
58; Mills vs. Britton, 64 Conn., 4; 5 Am., and Eng. Encycl. of an income cannot be taxed. When the assets of a
Law, 2d ed., p. 738.) corporation have increased so as to justify the issuance of
a stock dividend, the increase of the assets should be
If the ownership of the property represented by a stock taken account of the Government in the ordinary tax
dividend is still in the corporation and to in the holder of duplicates for the purposes of assessment and collection
such stock, then it is difficult to understand how it can be of an additional tax. For all of the foregoing reasons, we
regarded as income to the stockholder and not as a part are of the opinion, and so decide, that the judgment of
of the capital or assets of the corporation. (Gibbsons vs. the lower court should be revoked, and without any
Mahon, supra.) the stockholder has received nothing but finding as to costs, it is so ordered.
a representation of an interest in the property of the
corporation and, as a matter of fact, he may never
receive anything, depending upon the final outcome of
the business of the corporation. The entire assets of the
corporation may be consumed by mismanagement, or
eaten up by debts and obligations, in which case the
holder of the stock dividend will never have received an
income from his investment in the corporation. A
corporation may be solvent and prosperous today and
issue stock dividends in representation of its increased
assets, and tomorrow be absolutely insolvent by reason of
changes in business conditions, and in such a case the
stockholder would have received nothing from his
investment. In such a case, if the holder of the stock
dividend is required to pay an income tax on the same,
the result would be that he has paid a tax upon an
income which he never received. Such a conclusion is
absolutely contradictory to the idea of an income. An
income subject to taxation under the law must be an
actual income and not a promised or prospective
income.
Section 21 of the National Internal Revenue Code, before The issue now is, what exchange rate should be used to
its amendment by Presidential Decrees Nos. 69 and 323 determine the peso equivalent of the foreign earnings of
which took effect on January 1, 1973 and January 1, petitioners for income tax purposes. Petitioners claim that
1974, respectively, imposed a tax upon the taxable net since the dollar earnings do not fall within the
income received during each taxable year from all classification of foreign exchange transactions, there
sources by a citizen of the Philippines, whether residing occurred no actual inward remittances, and, therefore,
here or abroad. they are not included in the coverage of Central Bank
Circular No. 289 which provides for the specific instances
Petitioners are citizens of the Philippines temporarily when the par value of the peso shall not be the
residing abroad by virtue of their employment. Thus, in conversion rate used. They conclude that their earnings
their tax returns for the period involved herein, they gave should be converted for income tax purposes using the
their legal residence/address as c/o Procter & Gamble par value of the Philippine peso.
PMC, Ayala Ave., Makati, Rizal (Annexes "A" to "A-8" and
Annexes "C" to "C-8", Petition for Review, CTA Nos. 2511 Respondent Commissioner argues that CB Circular No.
and 2594). 289 speaks of receipts for export products, receipts of sale
of foreign exchange or foreign borrowings and
Petitioners being subject to Philippine income tax, their investments but not income tax. He also claims that he
dollar earnings should be converted into Philippine pesos had to use the prevailing free market rate of exchange in
in computing the income tax due therefrom, in these cases because of the need to ascertain the true
accordance with the provisions of Revenue and correct amount of income in Philippine peso of dollar
Memorandum Circular No. 7-71 dated February 11, 1971 earners for Philippine income tax purposes.
for 1970 income and Revenue Memorandum Circular No.
41-71 dated December 21, 1971 for 1971 income, which A careful reading of said CB Circular No. 289 8 shows that
reiterated BIR Ruling No. 70-027 dated May 4, 1970, to wit: the subject matters involved therein are export products,
invisibles, receipts of foreign exchange, foreign exchange
For internal revenue tax purposes, the free marker rate of payments, new foreign borrowing and
conversion (Revenue Circulars Nos. 7-71 and 41-71) investments — nothing by way of income tax payments.
should be applied in order to determine the true and Thus, petitioners are in error by concluding that since C.B.
correct value in Philippine pesos of the income of Circular No. 289 does not apply to them, the par value of
petitioners. 3 the peso should be the guiding rate used for income tax
purposes.
After a careful examination of the records, the laws
involved and the jurisprudence on the matter, We are The dollar earnings of petitioners are the fruits of their
inclined to agree with respondents Court of Tax Appeals labors in the foreign subsidiaries of Procter & Gamble. It
and Commissioner of Internal Revenue and thus vote to was a definite amount of money which came to them
deny the petition. within a specified period of time of two yeas as payment
for their services.
This basically an income tax case. For the proper
resolution of these cases income may be defined as an Section 21 of the National Internal Revenue Code,
amount of money coming to a person or corporation amended up to August 4, 1969, states as follows:
within a specified time, whether as payment for services,
interest or profit from investment. Unless otherwise Sec. 21. Rates of tax on citizens or
specified, it means cash or its equivalent. 4 Income can residents. — A tax is hereby imposed
also be though of as flow of the fruits of one's labor. 5 upon the taxable net income received
during each taxable year from all
Petitioners are correct as to their claim that their dollar sources by every individual, whether a
earnings are not receipts derived from foreign exchange citizen of the Philippines residing therein
transactions. For a foreign exchange transaction is simply or abroad or an alien residing in the
that — a transaction in foreign exchange, foreign Philippines, determined in accordance
exchange being "the conversion of an amount of money with the following schedule:
or currency of one country into an equivalent amount of
money or currency of another." 6 When petitioners were xxx xxx xxx
assigned to the foreign subsidiaries of Procter & Gamble,
they were earning in their assigned nation's currency and And in the implementation for the proper enforcement of
were ALSO spending in said currency. There was no the National Internal Revenue Code, Section 338 thereof
conversion, therefore, from one currency to another. empowers the Secretary of Finance to "promulgate all
needful rules and regulations" to effectively enforce its
provisions. 9
Pursuant to this authority, Revenue Memorandum Circular The Revenue Act of September 8, 1916, c. 463, 39 Stat.
Nos. 7-71 10 and 41-71 11 were issued to prescribed a 756, plainly evinces the purpose of Congress to impose
uniform rate of exchange from US dollars to Philippine such taxes, and is to that extent in conflict with Art. I, § 2,
pesos for INTERNAL REVENUE TAX PURPOSES for the years cl. 3, and Art. I, § 9, cl. 4, of the Constitution. Pp. 252 U. S.
1970 and 1971, respectively. Said revenue circulars were 199, 252 U. S. 217.
a valid exercise of the authority given to the Secretary of
Finance by the Legislature which enacted the Internal These provisions of the Constitution necessarily limit the
Revenue Code. And these are presumed to be a valid extension, by construction, of the Sixteenth Amendment.
interpretation of said code until revoked by the Secretary P. 252 U. S. 205.
of Finance himself. 12
What is or is not "income" within the meaning of the
Petitioners argue that since there were no remittances Amendment must be determined in each case
and acceptances of their salaries and wages in US dollars according to truth and substance, without regard to
into the Philippines, they are exempt from the coverage form. P. 252 U. S. 206.
of such circulars. Petitioners forget that they are citizens of
the Philippines, and their income, within or without, and in
Income may be defined as the gain derived from capital,
these cases wholly without, are subject to income tax.
from labor, or from both combined, including profit
Sec. 21, NIRC, as amended, does not brook any
gained through sale or conversion of capital.
exemption.
Congress was not empowered by the Sixteenth On January 1, 1916, the Standard Oil Company of
Amendment to tax, as income of the stockholder, without California, a corporation of that state, out of an
apportionment, a stock dividend made lawfully and in authorized capital stock of $100,000,000, had shares of
good faith against profits accumulated by the stock outstanding, par value $100 each, amounting in
corporation since March 1, 1913. P.252 U. S. 201. Towne v. round figures to $50,000,000. In addition, it had surplus
Eisner, 245 U. S. 418. and undivided profits invested in plant, property, and
business and required for the purposes of the corporation,
amounting to about $45,000,000, of which about "It is manifest that the stock dividend in question cannot
$20,000,000 had been earned prior to March 1, 1913, the be reached by the Income Tax Act and could not, even
balance thereafter. In January, 1916, in order to readjust though Congress expressly declared it to be taxable as
the capitalization, the board of directors decided to issue income, unless it is in fact income."
additional shares sufficient to constitute a stock dividend
of 50 percent of the outstanding stock, and to transfer It declined, however, to accede to the contention that,
from surplus account to capital stock account an in Gibbons v. Mahon, 136 U. S. 549, "stock dividends" had
amount equivalent to such issue. Appropriate resolutions received a definition sufficiently clear to be controlling,
were adopted, an amount equivalent to the par value of treated the language of this Court in that case as obiter
the proposed new stock was transferred accordingly, dictum in respect of the matter then before it (p. 706),
and the new stock duly issued against it and divided and examined the question as res nova, with the result
among the stockholders. stated. When the case came here, after overruling a
motion to dismiss made by the government upon the
Defendant in error, being the owner of 2,200 shares of the ground that the only question involved was the
old stock, received certificates for 1, 100 additional construction of the statute, and not its constitutionality,
shares, of which 18.07 percent, or 198.77 shares, par value we dealt upon the merits with the question of
$19,877, were treated as representing surplus earned construction only, but disposed of it upon consideration
between March 1, 1913, and January 1, 1916. She was of the essential nature of a stock dividend disregarding
called upon to pay, and did pay under protest, a tax the fact that the one in question was based upon surplus
imposed under the Revenue Act of 1916, based upon a earnings that accrued before the Sixteenth Amendment
supposed income of $19,877 because of the new shares, took effect. Not only so, but we rejected the reasoning of
and, an appeal to the Commissioner of Internal Revenue the district court, saying (245 U.S. 245 U. S. 426):
having been disallowed, she brought action against the
Collector to recover the tax. In her complaint, she "Notwithstanding the thoughtful discussion that the case
alleged the above facts and contended that, in received below we cannot doubt that the dividend was
imposing such a tax the Revenue Act of 1916 violated capital as well for the purposes of the Income Tax Law as
article 1, § 2, cl. 3, and Article I, § 9, cl. 4, of the for distribution between tenant for life and
Constitution of the United States, requiring direct taxes to remainderman. What was said by this Court upon the
be apportioned according to population, and that the latter question is equally true for the former."
stock dividend was not income within the meaning of the
Sixteenth Amendment. A general demurrer to the
"A stock dividend really takes nothing from the property
complaint was overruled upon the authority of Towne v.
of the corporation, and adds nothing to the interests of
Eisner, 245 U. S. 418, and, defendant having failed to
the shareholders. Its property is not diminished, and their
plead further, final judgment went against him. To review
interests are not increased. . . . The proportional interest of
it, the present writ of error is prosecuted.
each shareholder remains the same. The only change is
in the evidence which represents that interest, the new
The case was argued at the last term, and reargued at shares and the original shares together representing the
the present term, both orally and by additional briefs. same proportional interest that the original shares
represented before the issue of the new ones."
We are constrained to hold that the judgment of the
district court must be affirmed, first, because the question "Gibbons v. Mahon, 136 U. S. 549, 136 U. S. 559-560. In
at issue is controlled by Towne v. Eisner, supra; secondly, short, the corporation is no poorer and the stockholder is
because a reexamination of the question with the no richer than they were before. Logan County v. United
additional light thrown upon it by elaborate arguments States, 169 U. S. 255, 169 U. S. 261. If the plaintiff gained
has confirmed the view that the underlying ground of any small advantage by the change, it certainly was not
that decision is sound, that it disposes of the question an advantage of $417,450, the sum upon which he was
here presented, and that other fundamental taxed. . . . What has happened is that the plaintiff's old
considerations lead to the same result. certificates have been split up in effect and have
diminished in value to the extent of the value of the new."
In Towne v. Eisner, the question was whether a stock
dividend made in 1914 against surplus earned prior to This language aptly answered not only the reasoning of
January 1, 1913, was taxable against the stockholder the district court, but the argument of the Solicitor
under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, General in this Court, which discussed the essential nature
which provided (§ B, p. 167) that net income should of a stock dividend. And if, for the reasons thus expressed,
include "dividends," and also "gains or profits and income such a dividend is not to be regarded as "income" or
derived from any source whatever." Suit having been "dividends" within the meaning of the Act of 1913, we are
brought by a stockholder to recover the tax assessed unable to see how it can be brought within the meaning
against him by reason of the dividend, the district court of "incomes" in the Sixteenth Amendment, it being very
sustained a demurrer to the complaint. 242 F. 702. The clear that Congress intended in that act to exert its
court treated the construction of the act as inseparable power to the extent permitted by the amendment.
from the interpretation of the Sixteenth Amendment; and, In Towne v. Eisner, it was not contended that any
having referred to Pollock v. Farmers' Loan & Trust construction of the statute could make it narrower than
Co., 158 U. S. 601, and quoted the Amendment, the constitutional grant; rather the contrary.
proceeded very properly to say (p. 704):
The fact that the dividend was charged against profits Nevertheless, in view of the importance of the matter,
earned before the Act of 1913 took effect, even before and the fact that Congress in the Revenue Act of 1916
the amendment was adopted, was neither relied upon declared (39 Stat. 757) that a "stock dividend shall be
nor alluded to in our consideration of the merits in that considered income, to the amount of its cash value," we
case. Not only so, but had we considered that a stock will deal at length with the constitutional question,
dividend constituted income in any true sense, it would incidentally testing the soundness of our previous
have been held taxable under the Act of 1913 conclusion.
notwithstanding it was based upon profits earned before
the amendment. We ruled at the same term, in Lynch v. The Sixteenth Amendment must be construed in
Hornby, 247 U. S. 339, that a cash dividend extraordinary connection with the taxing clauses of the original
in amount, and in Peabody v. Eisner, 247 U. S. 347, that a Constitution and the effect attributed to them before the
dividend paid in stock of another company, were amendment was adopted. In Pollock v. Farmers' Loan &
taxable as income although based upon earnings that Trust Co., 158 U. S. 601, under the Act of August 27, 1894,
accrued before adoption of the amendment. In the c. 349, § 27, 28 Stat. 509, 553, it was held that taxes upon
former case, concerning "corporate profits that rents and profits of real estate and upon returns from
accumulated before the act took effect," we declared investments of personal property were in effect direct
(pp. 247 U. S. 343-344): taxes upon the property from which such income arose,
imposed by reason of ownership, and that Congress
"Just as we deem the legislative intent manifest to tax the could not impose such taxes without apportioning them
stockholder with respect to such accumulations only if among the states according to population, as required
and when, and to the extent that, his interest in them by Article I, § 2, cl. 3, and § 9, cl. 4, of the original
comes to fruition as income, that is, in dividends Constitution.
declared, so we can perceive no constitutional obstacle
that stands in the way of carrying out this intent when Afterwards, and evidently in recognition of the limitation
dividends are declared out of a preexisting surplus. . . . upon the taxing power of Congress thus determined, the
Congress was at liberty under the amendment to tax as Sixteenth Amendment was adopted, in words lucidly
income, without apportionment, everything that became expressing the object to be accomplished:
income, in the ordinary sense of the word, after the
adoption of the amendment, including dividends
"The Congress shall have power to lay and collect taxes
received in the ordinary course by a stockholder from a
on incomes, from whatever source derived, without
corporation, even though they were extraordinary in
apportionment among the several states and without
amount and might appear upon analysis to be a mere
regard to any census or enumeration."
realization in possession of an inchoate and contingent
interest that the stockholder had in a surplus of corporate
assets previously existing." As repeatedly held, this did not extend the taxing power
to new subjects, but merely removed the necessity which
otherwise might exist for an apportionment among the
In Peabody v. Eisner, 247 U. S. 349, 247 U. S. 350, we
states of taxes laid on income. Brushaber v. Union Pacific
observed that the decision of the district court in Towne v.
R. Co., 240 U. S. 1, 240 U. S. 17-19; Stanton v. Baltic Mining
Eisner had been reversed
Co., 240 U. S. 103, 240 U. S. 112 et seq.; Peck & Co. v.
Lowe, 247 U. S. 165, 247 U. S. 172-173.
"only upon the ground that it related to a stock dividend
which in fact took nothing from the property of the
A proper regard for its genesis, as well as its very clear
corporation and added nothing to the interest of the
language, requires also that this amendment shall not be
shareholder, but merely changed the evidence which
extended by loose construction, so as to repeal or
represented that interest," and we distinguished
modify, except as applied to income, those provisions of
the Peabody case from the Towne case upon the ground
the Constitution that require an apportionment
that "the dividend of Baltimore & Ohio shares was not a
according to population for direct taxes upon property,
stock dividend but a distribution in specie of a portion of
real and personal. This limitation still has an appropriate
the assets of the Union Pacific."
and important function, and is not to be overridden by
Congress or disregarded by the courts.
Therefore, Towne v. Eisner cannot be regarded as turning
upon the point that the surplus accrued to the company
In order, therefore, that the clauses cited from Article I of
before the act took effect and before adoption of the
the Constitution may have proper force and effect, save
amendment. And what we have quoted from the
only as modified by the amendment, and that the latter
opinion in that case cannot be regarded as obiter
also may have proper effect, it becomes essential to
dictum, it having furnished the entire basis for the
distinguish between what is and what is not "income," as
conclusion reached. We adhere to the view then
the term is there used, and to apply the distinction, as
expressed, and might rest the present case there not
cases arise, according to truth and substance, without
because that case in terms decided the constitutional
regard to form. Congress cannot by any definition it may
question, for it did not, but because the conclusion there
adopt conclude the matter, since it cannot by legislation
reached as to the essential nature of a stock dividend
alter the Constitution, from which alone it derives its
necessarily prevents its being regarded as income in any
power to legislate, and within whose limitations alone that
true sense.
power can be lawfully exercised.
The fundamental relation of "capital" to "income" has immediate or remote, have contributed capital to the
been much discussed by economists, the former being enterprise, that he is entitled to a corresponding interest
likened to the tree or the land, the latter to the fruit or the proportionate to the whole, entitled to have the property
crop; the former depicted as a reservoir supplied from and business of the company devoted during the
springs, the latter as the outlet stream, to be measured by corporate existence to attainment of the common
its flow during a period of time. For the present purpose, objects, entitled to vote at stockholders' meetings, to
we require only a clear definition of the term "income," as receive dividends out of the corporation's profits if and
used in common speech, in order to determine its when declared, and, in the event of liquidation, to
meaning in the amendment, and, having formed also a receive a proportionate share of the net assets, if any,
correct judgment as to the nature of a stock dividend, remaining after paying creditors. Short of liquidation, or
we shall find it easy to decide the matter at issue. until dividend declared, he has no right to withdraw any
part of either capital or profits from the common
After examining dictionaries in common use (Bouv. L.D.; enterprise; on the contrary, his interest pertains not to any
Standard Dict.; Webster's Internat. Dict.; Century Dict.), part, divisible or indivisible, but to the entire assets,
we find little to add to the succinct definition adopted in business, and affairs of the company. Nor is it the interest
two cases arising under the Corporation Tax Act of 1909 of an owner in the assets themselves, since the
(Stratton's Independence v. Howbert, 231 U. S. 399, 231 U. corporation has full title, legal and equitable, to the
S. 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 247 U. S. whole. The stockholder has the right to have the assets
185), "Income may be defined as the gain derived from employed in the enterprise, with the incidental rights
capital, from labor, or from both combined," provided it mentioned; but, as stockholder, he has no right to
be understood to include profit gained through a sale or withdraw, only the right to persist, subject to the risks of
conversion of capital assets, to which it was applied in the enterprise, and looking only to dividends for his return.
the Doyle case, pp. 247 U. S. 183-185. If he desires to dissociate himself from the company, he
can do so only by disposing of his stock.
Brief as it is, it indicates the characteristic and
distinguishing attribute of income essential for a correct For bookkeeping purposes, the company acknowledges
solution of the present controversy. The government, a liability in form to the stockholders equivalent to the
although basing its argument upon the definition as aggregate par value of their stock, evidenced by a
quoted, placed chief emphasis upon the word "gain," "capital stock account." If profits have been made and
which was extended to include a variety of meanings; not divided, they create additional bookkeeping liabilities
while the significance of the next three words was either under the head of "profit and loss," "undivided profits,"
overlooked or misconceived. "Derived from capital;" "surplus account," or the like. None of these, however,
"the gain derived from capital," etc. Here, we have the gives to the stockholders as a body, much less to any one
essential matter: not a gain accruing to capital; not of them, either a claim against the going concern for any
a growth or increment of value in the investment; but a particular sum of money or a right to any particular
gain, a profit, something of exchangeable portion of the assets or any share in them unless or until
value, proceeding from the property, severed from the the directors conclude that dividends shall be made and
capital, however invested or employed, and coming a part of the company's assets segregated from the
in, being "derived" -- that is, received or drawn by the common fund for the purpose. The dividend normally is
recipient (the taxpayer) for his separate use, benefit and payable in money, under exceptional circumstances in
disposal -- that is income derived from property. Nothing some other divisible property, and when so paid, then
else answers the description. only (excluding, of course, a possible advantageous sale
of his stock or winding-up of the company) does the
stockholder realize a profit or gain which becomes his
The same fundamental conception is clearly set forth in
separate property, and thus derive income from the
the Sixteenth Amendment --
capital that he or his predecessor has invested.
"incomes, from whatever source derived" -- the essential
thought being expressed with a conciseness and lucidity
entirely in harmony with the form and style of the In the present case, the corporation had surplus and
Constitution. undivided profits invested in plant, property, and business,
and required for the purposes of the corporation,
amounting to about $45,000,000, in addition to
Can a stock dividend, considering its essential character,
outstanding capital stock of $50,000,000. In this, the case
be brought within the definition? To answer this, regard
is not extraordinary. The profits of a corporation, as they
must be had to the nature of a corporation and the
appear upon the balance sheet at the end of the year,
stockholder's relation to it. We refer, of course, to a
need not be in the form of money on hand in excess of
corporation such as the one in the case at bar, organized
what is required to meet current liabilities and finance
for profit, and having a capital stock divided into shares
current operations of the company. Often, especially in a
to which a nominal or par value is attributed.
growing business, only a part, sometimes a small part, of
the year's profits is in property capable of division, the
Certainly the interest of the stockholder is a capital remainder having been absorbed in the acquisition of
interest, and his certificates of stock are but the evidence increased plant, equipment, stock in trade, or accounts
of it. They state the number of shares to which he is receivable, or in decrease of outstanding liabilities. When
entitled and indicate their par value and how the stock only a part is available for dividends, the balance of the
may be transferred. They show that he or his assignors, year's profits is carried to the credit of undivided profits, or
surplus, or some other account having like significance. If Being concerned only with the true character and effect
thereafter the company finds itself in funds beyond of such a dividend when lawfully made, we lay aside the
current needs, it may declare dividends out of such question whether, in a particular case, a stock dividend
surplus or undivided profits; otherwise it may go on for may be authorized by the local law governing the
years conducting a successful business, but requiring corporation, or whether the capitalization of profits may
more and more working capital because of the extension be the result of correct judgment and proper business
of its operations, and therefore unable to declare policy on the part of its management, and a due regard
dividends approximating the amount of its profits. Thus, for the interests of the stockholders. And we are
the surplus may increase until it equals or even exceeds considering the taxability of bona fidestock dividends
the par value of the outstanding capital stock. This may only.
be adjusted upon the books in the mode adopted in the
case at bar -- by declaring a "stock dividend." This, We are clear that not only does a stock dividend really
however, is no more than a book adjustment, in essence - take nothing from the property of the corporation and
- not a dividend, but rather the opposite; no part of the add nothing to that of the shareholder, but that the
assets of the company is separated from the common antecedent accumulation of profits evidenced thereby,
fund, nothing distributed except paper certificates that while indicating that the shareholder is the richer
evidence an antecedent increase in the value of the because of an increase of his capital, at the same time
stockholder's capital interest resulting from an shows he has not realized or received any income in the
accumulation of profits by the company, but profits so far transaction.
absorbed in the business as to render it impracticable to
separate them for withdrawal and distribution. In order to
It is said that a stockholder may sell the new shares
make the adjustment, a charge is made against surplus
acquired in the stock dividend, and so he may, if he can
account with corresponding credit to capital stock
find a buyer. It is equally true that, if he does sell, and in
account, equal to the proposed "dividend;" the new
doing so realizes a profit, such profit, like any other, is
stock is issued against this and the certificates delivered
income, and, so far as it may have arisen since the
to the existing stockholders in proportion to their previous
Sixteenth Amendment, is taxable by Congress without
holdings. This, however, is merely bookkeeping that does
apportionment. The same would be true were he to sell
not affect the aggregate assets of the corporation or its
some of his original shares at a profit. But if a shareholder
outstanding liabilities; it affects only the form, not the
sells dividend stock, he necessarily disposes of a part of
essence, of the "liability" acknowledged by the
his capital interest, just as if he should sell a part of his old
corporation to its own shareholders, and this through a
stock, either before or after the dividend. What he retains
readjustment of accounts on one side of the balance
no longer entitles him to the same proportion of future
sheet only, increasing "capital stock" at the expense of
dividends as before the sale. His part in the control of the
"surplus"; it does not alter the preexisting proportionate
company likewise is diminished. Thus, if one holding
interest of any stockholder or increase the intrinsic value
$60,000 out of a total $100,000 of the capital stock of a
of his holding or of the aggregate holdings of the other
corporation should receive in common with other
stockholders as they stood before. The new certificates
stockholders a 50 percent stock dividend, and should sell
simply increase the number of the shares, with
his part, he thereby would be reduced from a majority to
consequent dilution of the value of each share.
a minority stockholder, having six-fifteenths instead of six-
tenths of the total stock outstanding. A corresponding
A "stock dividend" shows that the company's and proportionate decrease in capital interest and in
accumulated profits have been capitalized, instead of voting power would befall a minority holder should he sell
distributed to the stockholders or retained as surplus dividend stock, it being in the nature of things impossible
available for distribution in money or in kind should for one to dispose of any part of such an issue without a
opportunity offer. Far from being a realization of profits of proportionate disturbance of the distribution of the entire
the stockholder, it tends rather to postpone such capital stock and a like diminution of the seller's
realization, in that the fund represented by the new stock comparative voting power -- that "right preservative of
has been transferred from surplus to capital, and no rights" in the control of a corporation.
longer is available for actual distribution.
Yet, without selling, the shareholder, unless possessed of
The essential and controlling fact is that the stockholder other resources, has not the wherewithal to pay an
has received nothing out of the company's assets for his income tax upon the dividend stock. Nothing could more
separate use and benefit; on the contrary, every dollar of clearly show that to tax a stock dividend is to tax a
his original investment, together with whatever accretions capital increase, and not income, than this
and accumulations have resulted from employment of his demonstration that, in the nature of things, it requires
money and that of the other stockholders in the business conversion of capital in order to pay the tax.
of the company, still remains the property of the
company, and subject to business risks which may result
Throughout the argument of the government, in a variety
in wiping out the entire investment. Having regard to the
of forms, runs the fundamental error already mentioned --
very truth of the matter, to substance and not to form, he
a failure to appraise correctly the force of the term
has received nothing that answers the definition of
"income" as used in the Sixteenth Amendment, or at least
income within the meaning of the Sixteenth Amendment.
to give practical effect to it. Thus, the government
contends that the tax "is levied on income derived from
corporate earnings," when in truth the stockholder has
"derived" nothing except paper certificates, which, so far The complaint contains averments respecting the market
as they have any effect, deny him present participation prices of stock such as plaintiff held, based upon sales
in such earnings. It contends that the tax may be laid before and after the stock dividend, tending to show that
when earnings "are received by the stockholder," the receipt of the additional shares did not substantially
whereas he has received none; that the profits are change the market value of her entire holdings. This tends
"distributed by means of a stock dividend," although a to show that, in this instance, market quotations reflected
stock dividend distributes no profits; that, under the Act of intrinsic values -- a thing they do not always do. But we
1916, "the tax is on the stockholder's share in corporate regard the market prices of the securities as an unsafe
earnings," when in truth a stockholder has no such share, criterion in an inquiry such as the present, when the
and receives none in a stock dividend; that "the profits question must be not what will the thing sell for, but what
are segregated from his former capital, and he has a is it in truth and in essence.
separate certificate representing his invested profits or
gains," whereas there has been no segregation of profits, It is said there is no difference in principle between a
nor has he any separate certificate representing a simple stock dividend and a case where stockholders use
personal gain, since the certificates, new and old, are money received as cash dividends to purchase
alike in what they represent -- a capital interest in the additional stock contemporaneously issued by the
entire concerns of the corporation. corporation. But an actual cash dividend, with a real
option to the stockholder either to keep the money for his
We have no doubt of the power or duty of a court to look own or to reinvest it in new shares, would be as far
through the form of the corporation and determine the removed as possible from a true stock dividend, such as
question of the stockholder's right in order to ascertain the one we have under consideration, where nothing of
whether he has received income taxable by Congress value is taken from the company's assets and transferred
without apportionment. But, looking through the form, we to the individual ownership of the several stockholders
cannot disregard the essential truth disclosed, ignore the and thereby subjected to their disposal.
substantial difference between corporation and
stockholder, treat the entire organization as unreal, look The government's reliance upon the supposed analogy
upon stockholders as partners when they are not such, between a dividend of the corporation's own shares and
treat them as having in equity a right to a partition of the one made by distributing shares owned by it in the stock
corporate assets when they have none, and indulge the of another company calls for no comment beyond the
fiction that they have received and realized a share of statement that the latter distributes assets of the
the profits of the company which in truth they have company among the shareholders, while the former does
neither received nor realized. We must treat the not, and for no citation of authority except Peabody v.
corporation as a substantial entity separate from the Eisner, 247 U. S. 347, 247 U. S. 349-350.
stockholder not only because such is the practical fact,
but because it is only by recognizing such separateness
Two recent decisions, proceeding from courts of high
that any dividend -- even one paid in money or property
jurisdiction, are cited in support of the position of the
-- can be regarded as income of the stockholder. Did we
government.
regard corporation and stockholders as altogether
identical, there would be no income except as the
corporation acquired it, and while this would be taxable Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose
against the corporation as income under appropriate under the Dividend Duties Act of Western Australia, which
provisions of law, the individual stockholders could not be provided that "dividend" should include "every dividend,
separately and additionally taxed with respect to their profit, advantage, or gain intended to be paid or
several shares even when divided, since, if there were credited to or distributed among any members or
entire identity between them and the company, they directors of any company," except, etc. There was a
could not be regarded as receiving anything from it, any stock dividend, the new shares being allotted among the
more than if one's money were to be removed from one shareholders pro rata, and the question was whether this
pocket to another. was a distribution of a dividend within the meaning of the
act. The Judicial Committee of the Privy Council
sustained the dividend duty upon the ground that,
Conceding that the mere issue of a stock dividend makes
although "in ordinary language the new shares would not
the recipient no richer than before, the government
be called a dividend, nor would the allotment of them be
nevertheless contends that the new certificates measure
a distribution of a dividend," yet, within the meaning of
the extent to which the gains accumulated by the
the act, such new shares were an "advantage" to the
corporation have made him the richer. There are two
recipients. There being no constitutional restriction upon
insuperable difficulties with this. In the first place, it would
the action of the lawmaking body, the case presented
depend upon how long he had held the stock whether
merely a question of statutory construction, and
the stock dividend indicated the extent to which he had
manifestly the decision is not a precedent for the
been enriched by the operations of the company; unless
guidance of this Court when acting under a duty to test
he had held it throughout such operations, the measure
an act of Congress by the limitations of a written
would not hold true. Secondly, and more important for
Constitution having superior force.
present purposes, enrichment through increase in value
of capital investment is not income in any proper
meaning of the term. In Tax Commissioner v. Putnam, (1917) 227 Mass. 522, it
was held that the Forty-Fourth amendment to the
Constitution of Massachusetts, which conferred upon the The court held an individual taxable upon his proportion
legislature full power to tax incomes, "must be interpreted of the earnings of a corporation although not declared
as including every item which by any reasonable as dividends and although invested in assets not in their
understanding can fairly be regarded as income" (pp. nature divisible. Conceding that the stockholder for
526, 531), and that under it, a stock dividend was taxable certain purposes had no title prior to dividend declared,
as income, the court saying (p. 535): the court nevertheless said (p. 79 U. S. 18):
"In essence, the thing which has been done is to distribute "Grant all that, still it is true that the owner of a share of
a symbol representing an accumulation of profits, which, stock in a corporation holds the share with all its incidents,
instead of being paid out in cash, is invested in the and that among those incidents is the right to receive all
business, thus augmenting its durable assets. In this aspect future dividends -- that is, his proportional share of all
of the case, the substance of the transaction is no profits not then divided. Profits are incident to the share to
different from what it would be if a cash dividend had which the owner at once becomes entitled provided he
been declared with the privilege of subscription to an remains a member of the corporation until a dividend is
equivalent amount of new shares. " made. Regarded as an incident to the shares, undivided
profits are property of the shareholder, and as such are
We cannot accept this reasoning. Evidently, in order to the proper subject of sale, gift, or devise. Undivided profits
give a sufficiently broad sweep to the new taxing invested in real estate, machinery, or raw material for the
provision, it was deemed necessary to take the symbol for purpose of being manufactured are investments in which
the substance, accumulation for distribution, capital the stockholders are interested, and when such profits are
accretion for its opposite, while a case where money is actually appropriated to the payment of the debts of the
paid into the hand of the stockholder with an option to corporation, they serve to increase the market value of
buy new shares with it, followed by acceptance of the the shares, whether held by the original subscribers or by
option, was regarded as identical in substance with a assignees."
case where the stockholder receives no money and has
no option. The Massachusetts court was not under an Insofar as this seems to uphold the right of Congress to tax
obligation, like the one which binds us, of applying a without apportionment a stockholder's interest in
constitutional amendment in the light of other accumulated earnings prior to dividend declared, it must
constitutional provisions that stand in the way of be regarded as overruled by Pollock v. Farmers' Loan &
extending it by construction. Trust Co.,158 U. S. 601, 158 U. S. 627-628, 158 U. S. 637.
Conceding Collector v. Hubbard was inconsistent with
Upon the second argument, the government, the doctrine of that case, because it sustained a direct
recognizing the force of the decision in Towne v. Eisner, tax upon property not apportioned among the states, the
supra, and virtually abandoning the contention that a government nevertheless insists that the sixteenth
stock dividend increases the interest of the stockholder or Amendment removed this obstacle, so that now
otherwise enriches him, insisted as an alternative that, by the Hubbard case is authority for the power of Congress
the true construction of the Act of 1916, the tax is to levy a tax on the stockholder's share in the
imposed not upon the stock dividend, but rather upon accumulated profits of the corporation even before
the stockholder's share of the undivided profits previously division by the declaration of a dividend of any kind.
accumulated by the corporation, the tax being levied as Manifestly this argument must be rejected, since the
a matter of convenience at the time such profits become amendment applies to income only, and what is called
manifest through the stock dividend. If so construed, the stockholder's share in the accumulated profits of the
would the act be constitutional? company is capital, not income. As we have pointed out,
a stockholder has no individual share in accumulated
profits, nor in any particular part of the assets of the
That Congress has power to tax shareholders upon their
corporation, prior to dividend declared.
property interests in the stock of corporations is beyond
question, and that such interests might be valued in view
of the condition of the company, including its Thus, from every point of view, we are brought irresistibly
accumulated and undivided profits, is equally clear. But to the conclusion that neither under the Sixteenth
that this would be taxation of property because of Amendment nor otherwise has Congress power to tax
ownership, and hence would require apportionment without apportionment a true stock dividend made
under the provisions of the Constitution, is settled beyond lawfully and in good faith, or the accumulated profits
peradventure by previous decisions of this Court. behind it, as income of the stockholder. The Revenue Act
of 1916, insofar as it imposes a tax upon the stockholder
because of such dividend, contravenes the provisions of
The government relies upon Collector v. Hubbard, (1870)
Article I, § 2, cl. 3, and Article I, § 9, cl. 4, of the
12 Wall. 1, which arose under § 117 of the Act of June 30,
Constitution, and to this extent is invalid notwithstanding
1864, c. 173, 13 Stat. 223, 282, providing that
the Sixteenth Amendment.
"Had the company distributed the �101,450 among the Gregorio Araneta for appellants.
shareholders, and had the shareholders repaid such sums Assistant Attorney Round for appellees.
to the company as the price of the 81, 160 new shares,
the duty on the �101,450 would clearly have been
MALCOLM, J.:
payable. Is not this virtually the effect of what was
actually done? I think it is."
This appeal calls for consideration of the Income Tax Law,
a law of American origin, with reference to the Civil
Sixth. If stock dividends representing profits are held
Code, a law of Spanish origin.
exempt from taxation under the Sixteenth Amendment,
the owners of the most successful businesses in America
will, as the facts in this case illustrate, be able to escape STATEMENT OF THE CASE.
taxation on a large part of what is actually their income.
So far as their profits are represented by stock received as Vicente Madrigal and Susana Paterno were legally
dividends, they will pay these taxes not upon their married prior to January 1, 1914. The marriage was
income, but only upon the income of their income. That contracted under the provisions of law concerning
such a result was intended by the people of the United conjugal partnerships (sociedad de gananciales). On
States when adopting the Sixteenth Amendment is February 25, 1915, Vicente Madrigal filed sworn
inconceivable. Our sole duty is to ascertain their intent as declaration on the prescribed form with the Collector of
therein expressed. [Footnote 7] In terse, comprehensive Internal Revenue, showing, as his total net income for the
language befitting the Constitution, they empowered year 1914, the sum of P296,302.73. Subsequently Madrigal
Congress "to lay and collect taxes on incomes from submitted the claim that the said P296,302.73 did not
whatever source derived." They intended to include represent his income for the year 1914, but was in fact the
thereby everything which by reasonable understanding income of the conjugal partnership existing between
can fairly be regarded as income. That stock dividends himself and his wife Susana Paterno, and that in
representing profits are so regarded not only by the plain computing and assessing the additional income tax
people, but by investors and financiers and by most of provided by the Act of Congress of October 3, 1913, the
the courts of the country, is shown beyond peradventure income declared by Vicente Madrigal should be divided
by their acts and by their utterances. It seems to me into two equal parts, one-half to be considered the
clear, therefore, that Congress possesses the power income of Vicente Madrigal and the other half of Susana
which it exercised to make dividends representing profits Paterno. The general question had in the meantime been
taxable as income whether the medium in which the submitted to the Attorney-General of the Philippine
dividend is paid be cash or stock, and that it may define, Islands who in an opinion dated March 17, 1915, held with
as it has done, what dividends representing profits shall the petitioner Madrigal. The revenue officers being still
be deemed income. It surely is not clear that the unsatisfied, the correspondence together with this
enactment exceeds the power granted by the Sixteenth opinion was forwarded to Washington for a decision by
Amendment. And, as this Court has so often said, the the United States Treasury Department. The United States
high prerogative of declaring an act of Congress invalid Commissioner of Internal Revenue reversed the opinion of
should never be exercised except in a clear case. the Attorney-General, and thus decided against the
[Footnote 8] claim of Madrigal.
"It is but a decent respect due to the wisdom, the After payment under protest, and after the protest of
integrity, and the patriotism of the legislative body by Madrigal had been decided adversely by the Collector
which any law is passed to presume in favor of its validity of Internal Revenue, action was begun by Vicente
until its violation of the Constitution is proved beyond all Madrigal and his wife Susana Paterno in the Court of First
reasonable doubt." Instance of the city of Manila against Collector of Internal
Revenue and the Deputy Collector of Internal Revenue
for the recovery of the sum of P3,786.08, alleged to have
been wrongfully and illegally collected by the
defendants from the plaintiff, Vicente Madrigal, under
the provisions of the Act of Congress known as the
Income Tax Law. The burden of the complaint was that if
the income tax for the year 1914 had been correctly and
lawfully computed there would have been due payable
by each of the plaintiffs the sum of P2,921.09, which taken
together amounts of a total of P5,842.18 instead of
P9,668.21, erroneously and unlawfully collected from the wealth by a progressive scheme of taxation, which
plaintiff Vicente Madrigal, with the result that plaintiff places the burden on those best able to pay. To carry out
Madrigal has paid as income tax for the year 1914, this idea, public considerations have demanded an
P3,786.08, in excess of the sum lawfully due and payable. exemption roughly equivalent to the minimum of
subsistence. With these exceptions, the income tax is
The answer of the defendants, together with an analysis supposed to reach the earnings of the entire non-
of the tax declaration, the pleadings, and the stipulation, governmental property of the country. Such is the
sets forth the basis of defendants' stand in the following background of the Income Tax Law.
way: The income of Vicente Madrigal and his wife Susana
Paterno of the year 1914 was made up of three items: (1) Income as contrasted with capital or property is to be the
P362,407.67, the profits made by Vicente Madrigal in his test. The essential difference between capital and
coal and shipping business; (2) P4,086.50, the profits income is that capital is a fund; income is a flow. A fund
made by Susana Paterno in her embroidery business; (3) of property existing at an instant of time is called capital.
P16,687.80, the profits made by Vicente Madrigal in a A flow of services rendered by that capital by the
pawnshop company. The sum of these three items is payment of money from it or any other benefit rendered
P383,181.97, the gross income of Vicente Madrigal and by a fund of capital in relation to such fund through a
Susana Paterno for the year 1914. General deductions period of time is called an income. Capital is wealth,
were claimed and allowed in the sum of P86,879.24. The while income is the service of wealth. (See Fisher, "The
resulting net income was P296,302.73. For the purpose of Nature of Capital and Income.") The Supreme Court of
assessing the normal tax of one per cent on the net Georgia expresses the thought in the following figurative
income there were allowed as specific deductions the language: "The fact is that property is a tree, income is
following: (1) P16,687.80, the tax upon which was to be the fruit; labor is a tree, income the fruit; capital is a tree,
paid at source, and (2) P8,000, the specific exemption income the fruit." (Waring vs. City of Savannah [1878], 60
granted to Vicente Madrigal and Susana Paterno, Ga., 93.) A tax on income is not a tax on property.
husband and wife. The remainder, P271,614.93 was the "Income," as here used, can be defined as "profits or
sum upon which the normal tax of one per cent was gains." (London County Council vs. Attorney-General
assessed. The normal tax thus arrived at was P2,716.15. [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49
Week. Rep., 686; 4 Tax Cas., 265. See further Foster's
The dispute between the plaintiffs and the defendants Income Tax, second edition [1915], Chapter IV; Black on
concerned the additional tax provided for in the Income Income Taxes, second edition [1915], Chapter VIII;
Tax Law. The trial court in an exhausted decision found in Gibbons vs. Mahon [1890], 136 U.S., 549; and
favor of defendants, without costs. Towne vs.Eisner, decided by the United States Supreme
Court, January 7, 1918.)
ISSUES.
A regulation of the United States Treasury Department
relative to returns by the husband and wife not living
The contentions of plaintiffs and appellants having to do
apart, contains the following:
solely with the additional income tax, is that is should be
divided into two equal parts, because of the conjugal
partnership existing between them. The learned The husband, as the head and legal representative of the
argument of counsel is mostly based upon the provisions household and general custodian of its income, should
of the Civil Code establishing the sociedad de make and render the return of the aggregate income of
gananciales. The counter contentions of appellees are himself and wife, and for the purpose of levying the
that the taxes imposed by the Income Tax Law are as the income tax it is assumed that he can ascertain the total
name implies taxes upon income tax and not upon amount of said income. If a wife has a separate estate
capital and property; that the fact that Madrigal was a managed by herself as her own separate property, and
married man, and his marriage contracted under the receives an income of more than $3,000, she may make
provisions governing the conjugal partnership, has no return of her own income, and if the husband has other
bearing on income considered as income, and that the net income, making the aggregate of both incomes
distinction must be drawn between the ordinary form of more than $4,000, the wife's return should be attached to
commercial partnership and the conjugal partnership of the return of her husband, or his income should be
spouses resulting from the relation of marriage. included in her return, in order that a deduction of $4,000
may be made from the aggregate of both incomes. The
tax in such case, however, will be imposed only upon so
DECISION.
much of the aggregate income of both shall exceed
$4,000. If either husband or wife separately has an
From the point of view of test of faculty in taxation, no less income equal to or in excess of $3,000, a return of annual
than five answers have been given the course of history. net income is required under the law, and such return
The final stage has been the selection of income as the must include the income of both, and in such case the
norm of taxation. (See Seligman, "The Income Tax," return must be made even though the combined income
Introduction.) The Income Tax Law of the United States, of both be less than $4,000. If the aggregate net income
extended to the Philippine Islands, is the result of an of both exceeds $4,000, an annual return of their
effect on the part of the legislators to put into statutory combined incomes must be made in the manner stated,
form this canon of taxation and of social reform. The aim although neither one separately has an income of $3,000
has been to mitigate the evils arising from inequalities of per annum. They are jointly and separately liable for such
return and for the payment of the tax. The single or SIR: This office is in receipt of your letter of June 22, 1915,
married status of the person claiming the specific transmitting copy of correspondence "from the Philippine
exemption shall be determined as one of the time of authorities relative to the method of submission of income
claiming such exemption which return is made, otherwise tax returns by marred person."
the status at the close of the year."
You advise that "The Governor-General, in forwarding the
With these general observations relative to the Income papers to the Bureau, advises that the Insular Auditor has
Tax Law in force in the Philippine Islands, we turn for a been authorized to suspend action on the warrants in
moment to consider the provisions of the Civil Code question until an authoritative decision on the points
dealing with the conjugal partnership. Recently in two raised can be secured from the Treasury Department."
elaborate decisions in which a long line of Spanish
authorities were cited, this court in speaking of the From the correspondence it appears that Gregorio
conjugal partnership, decided that "prior to the Araneta, married and living with his wife, had an income
liquidation the interest of the wife and in case of her of an amount sufficient to require the imposition of the
death, of her heirs, is an interest inchoate, a mere net income was properly computed and then both
expectancy, which constitutes neither a legal nor an income and deductions and the specific exemption were
equitable estate, and does not ripen into title until there divided in half and two returns made, one return for each
appears that there are assets in the community as a result half in the names respectively of the husband and wife,
of the liquidation and settlement." (Nable Jose vs. Nable so that under the returns as filed there would be an
Jose [1916], 15 Off. Gaz., 871; Manuel and escape from the additional tax; that Araneta claims the
Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.) returns are correct on the ground under the Philippine
law his wife is entitled to half of his earnings; that Araneta
Susana Paterno, wife of Vicente Madrigal, has an has dominion over the income and under the Philippine
inchoate right in the property of her husband Vicente law, the right to determine its use and disposition; that in
Madrigal during the life of the conjugal partnership. She this case the wife has no "separate estate" within the
has an interest in the ultimate property rights and in the contemplation of the Act of October 3, 1913, levying an
ultimate ownership of property acquired as income after income tax.
such income has become capital. Susana Paterno has no
absolute right to one-half the income of the conjugal It appears further from the correspondence that upon the
partnership. Not being seized of a separate estate, foregoing explanation, tax was assessed against the
Susana Paterno cannot make a separate return in order entire net income against Gregorio Araneta; that the tax
to receive the benefit of the exemption which would was paid and an application for refund made, and that
arise by reason of the additional tax. As she has no estate the application for refund was rejected, whereupon the
and income, actually and legally vested in her and matter was submitted to the Attorney-General of the
entirely distinct from her husband's property, the income Islands who holds that the returns were correctly
cannot properly be considered the separate income of rendered, and that the refund should be allowed; and
the wife for the purposes of the additional tax. Moreover, thereupon the question at issue is submitted through the
the Income Tax Law does not look on the spouses as Governor-General of the Islands and Bureau of Insular
individual partners in an ordinary partnership. The Affairs for the advisory opinion of this office.
husband and wife are only entitled to the exemption of
P8,000 specifically granted by the law. The higher
By paragraph M of the statute, its provisions are extended
schedules of the additional tax directed at the incomes
to the Philippine Islands, to be administered as in the
of the wealthy may not be partially defeated by reliance
United States but by the appropriate internal-revenue
on provisions in our Civil Code dealing with the conjugal
officers of the Philippine Government. You are therefore
partnership and having no application to the Income Tax
advised that upon the facts as stated, this office holds
Law. The aims and purposes of the Income Tax Law must
that for the Federal Income Tax (Act of October 3, 1913),
be given effect.
the entire net income in this case was taxable to
Gregorio Araneta, both for the normal and additional
The point we are discussing has heretofore been tax, and that the application for refund was properly
considered by the Attorney-General of the Philippine rejected.
Islands and the United States Treasury Department. The
decision of the latter overruling the opinion of the
The separate estate of a married woman within the
Attorney-General is as follows:
contemplation of the Income Tax Law is that which
belongs to her solely and separate and apart from her
TREASURY DEPARTMENT, Washington. husband, and over which her husband has no right in
equity. It may consist of lands or chattels.
Income Tax.
The statute and the regulations promulgated in
FRANK MCINTYRE, accordance therewith provide that each person of
Chief, Bureau of Insular Affairs, War Department, lawful age (not excused from so doing) having a net
Washington, D. C. income of $3,000 or over for the taxable year shall make
a return showing the facts; that from the net income so
shown there shall be deducted $3,000 where the person
making the return is a single person, or married and not G.R. No. L-12174 April 26, 1962
living with consort, and $1,000 additional where the
person making the return is married and living with
MARIA B. CASTRO, petitioner,
consort; but that where the husband and wife both make
vs.
returns (they living together), the amount of deduction
THE COLLECTOR OF INTERNAL REVENUE, respondent.
from the aggregate of their several incomes shall not
exceed $4,000.
Rosendo J. Tansinsin and Manuel O. Chan for petitioner.
Office of the Solicitor General and Special Attorney
The only occasion for a wife making a return is where she
Librada del Rosario-Natividad for respondent.
has income from a sole and separate estate in excess of
$3,000, but together they have an income in excess of
$4,000, in which the latter event either the husband or REYES, J.B.L., J.:
wife may make the return but not both. In all instances
the income of husband and wife whether from separate Appeal from a decision of the Court of Tax Appeals (in its
estates or not, is taken as a whole for the purpose of the C.T.A. Case 141) holding petitioner Maria B. Castro liable
normal tax. Where the wife has income from a separate under the War Profits Tax Law, Republic Act No. 55, and
estate makes return made by her husband, while the ordering her to pay a deficiency war profits tax (including
incomes are added together for the purpose of the surcharges and interest) in the amount of P1,360,514.66,
normal tax they are taken separately for the purpose of and costs.
the additional tax. In this case, however, the wife has no
separate income within the contemplation of the Income The background of this case is set forth in great detail in
Tax Law. the decision appealed from. We quote:
On February 9, 1948, the motion of petitioner to quash the 15% surcharge 343,371.09
information was denied by the Court of First Instance of
1% monthly interest thereon from April 1947
Manila. At the sheduled hearing of the case on the merits to September 30, 1950 (42%)
961,439.06
on March 7, 1949, the City Fiscal of Manila manifested in
open court that after a re-investigation of the case "the Total amount collectible on
amount of the tax due and for which the accused stands September 30, 1950 P3,593,950.78
charged for evading payment is only about P700,000.00,
instead of P1,048,687.76 as stated in the information."
However, at the continuation of the hearing of the case The findings and recommendations of the Pedrosa
on February 22, 1950, Supervising Examiner Felipe Aquino Committee were forwarded to the President of the
of the Bureau of Internal Revenue, who testified for the Philippines for approval and on September 22, 1950, the
prosecution, declared in answer to questions President approved the same in toto.
propounded by the City Fiscal "that as a result of a
detailed reinvestigation conducted by his office, it was Accordingly, on September 23, 1950 the respondent
found out that no war profits tax was due from the demanded from the petitioner Maria B. Castro the
accused in connection with the present case." payment of the total amount of P3,593,950.78 as war
Whereupon, City Fiscal Angeles moved for the dismissal of profits tax computed in detail as follows: .
the case. Finding the petition for dismissal to be well
taken, the Court of First Instance of Manila, in an Order
dated February 22, 1950, dismissed Criminal Case No.
4976 against petitioner.
Such method is in effect but an application (in reverse) of (c) The third main ground of appeal is predicated on the
the inventory or networth system that, contrary to acquittal of petitioner in case No. 4976 of the Court of
appellants contention (Error XIII), has been approved by First Instance of Manila, wherein she was criminally
this Court in Perez vs. Collector of Internal Revenue, G.R. prosecuted for failure to render a true and accurate
No. L-10507, May 30, 1958; Collector vs. A. P. Reyes, L- return of the war profits tax due from her, with intent to
11534, November 25, 1958; and Commissioner of Internal evade payment of the tax. She contends (Assignments of
Revenue vs. Avelino, L-14847, September 19, 1961. Error II to IV) that the acquittal should operate as a bar to
the imposition of the tax and specially the 50% surcharge
The analysis of petitioner's transactions for 1945 and 1946 provided by section 6 of the War Profits law (R.A. No. 55),
merely laid the basis for determining the undisclosed cash invoking the ruling in Coffey v. U.S., 29 L. Ed. 436.
funds in her possession as of February 26, 1945
(amounting to P1,807,444.61), and it is this cash thatwas With regard to the tax proper, the state correctly points
found subject to the war profits tax. out in its brief that the acquittal in the criminal case could
not operate to discharge petitioner from the duty to pay
It is urged, however, that even if this finding were correct, the tax, since that duty is imposed by statute prior to and
still, under Republic Act No. 55, only "cash in banks" is independently of any attempts on the part of the
expressly mentioned as taxable, and appellant infers that taxpayer to evade payment. The obligation to pay the
cash on hand not so deposited was not intended to be tax is not a mere consequence of the felonious acts
subject to war profits tax. This thesis appears charged in the information, nor is it a mere civil liability
unmeritorious: cash heldby the taxpayer on February 26, derived from crime that would be wiped out by the
1945 clearly falls under the description of "assets, judicial declaration that the criminal acts charged did
including real and personal property" that section 2 of the not exist.
Act expressly order included in determining the taxable
net worth. If "cash in banks" is expressly mentioned by the As to the 50% surcharge, the very United States Supreme
Act, it is not because cash on hand was intended to be Court that rendered the Coffey decision has
excluded, but because "cash in banks" is not, strictly, subsequently pointed out that additions of this kind to the
speaking, part of the assets of the taxpayer, but assets of main tax are not penalties but civil administrative
the banks where the cash is deposited. It is well sanctions, provided primarily as a safeguard for the
established that a so-called "bank deposit" is in reality a protection of the state revenue and to reimburse the
loan to the bank, the latter acquiring title to the amount government for the heavy expense of investigation and
"deposited", subject to its withdrawal (or recall of the the loss resulting from the taxpayer's fraud (Helvering vs.
loan) on the dates specified. Taxpayer's "assets", Mitchell, 303 U.S. 390, 82 L. Ed. 917; Spies vs. U.S. 317 U.S.
therefore, would not per se include cash deposited in 492). This is made plain by the fact that such surcharges
banks by the taxpayer; and its inclusion had to be are enforceable, like the primary tax itself, by distraint or
expressly prescribed by the statute in order to remove all civil suit, and that they are provided in a section of R.A.
doubt as to its taxability. No. 55 (section 5) that is separate and distinct from that
providing for criminal prosecution (section 7). We
Petitioner endeavored to show (Errors VII to XI) that part conclude that the defense of jeopardy and estoppel by
of the amount of cash thus arrived at actually originated reason of the petitioner's acquittal is untenable and
in receipts from transactions made by her after February without merit. Whether or not there was fraud committed
26, 1945 but which were not disclosed in the books and by the taxpayer justifying the imposition of the surcharge
accounts. Aside from the fact that this claim in her behalf is an issue of fact to be inferred from the evidence and
contradicted her admission to the Pedrosa Committee surrounding circumstances; and the finding of its
that all her 1946 receipts were recorded in her books (v. existence by the Tax Court is conclusive upon us.
Respondent's Exhibit 6-A), it lay within the exclusive (Gutierrez v. Collector, G.R. No. L-9771, May 31, 1951 ;
discretion of the Tax Court to believe or not to believe her Perez vs. Collector, supra).
evidence and statements, and those of her witnesses
regarding the source of the cash in question; and the rule (d) The fourth main ground adduced on behalf of the
is well settled that in cases of this kind, only errors of law, petitioner (Errors II and XlV) is that the sale and forfeiture
and not rulings on the weight of evidence, are to the government (due to lack of bidders) of the
reviewable by this Court. The same principle precludes us properties of petitioner in Manila, Balintawak, Pasay,
from interfering with the Tax Court's refusal to credit the Makati, Tarlac, Tagaytay and Caloocan which had been
other deductions claimed by petitioner as amounts levied upon by the respondent Collector of Internal
obtained from loans from various individuals. The Court of Revenue and advertised for sale in 1950 and 1954,
Tax Appeals found those items unproved, except the constitutes a full discharge of petitioner's tax liabilities. In
P76,000.00 payable to Lao Kang Suy, which is accepted,
so arguing, she relies on the provisions of paragraph 1 of (e) As pointed out by the counsel for the Government,
Section 328 of the Internal Revenue Code, reading as appellant's stand that the undeclared cash should be
follows: . averaged or spread out for the years 1945, 1946 and 1947
(Error XVI) assumes that what was being subjected to tax
SEC. 328. Forfeiture to Government for Want of was her undeclared income during said years, which is
Bidder. - In case there is no bidder for real not correct, as previously declared in this opinion. If her
property exposed for sale as herein above expenditures during 1945 and 1946 were scrutinized and
provided or if the highest bid is for an amount analyzed, it was merely to determine the actual value of
insufficient to pay the taxes, penalties, and costs, her taxable net worth as of February 26, 1945, that was
the provincial or city treasurer shall declare the subject to the war profits tax, as representing
property forfeited to the Government in accumulated profits earned during the occupation
satisfaction of the claim in question and within years.
two days thereafter shall make a return of his
proceedings and the forfeiture, which shall be Finally, no argument is needed to show that unless taxes
spread upon the records of his office, are to be left at the discretion of the taxpayer, she can
not be allowed to seek refuge or relief by pleading (Error
and appellant contends that in the provision to the effect XVII) the alleged inefficient and erratic manner in which
that in the absence of bidders, the property is to be her books of account and supporting papers had been
"forfeited to the Government in satisfaction of the claim in prepared, contrary to the requirements of the revenue
question", the term "satisfaction" signifies nothing but full laws; and that it is incredible that a trader like the
discharge of the taxes, penalties, and costs claimed by appellant should be able to do business running into
the state. Carried to its logical conclusion, this theory millions of pesos without knowing exactly her financial
would permit a clever taxpayer, who is able to conceal condition.
most or the more valuable part of his property from the
revenue officers, to escape payment of his tax liability by Appellant's alleged Error XIX, being merely pro forma,
sacrificing an insignificant portion of his holdings; and we requires no discussion.
can not agree that in providing that the forfeiture of the
taxpayer's distrained or levied property, for lack of Finding no reversible error in the decision appealed from,
adequate bids, should operate in satisfaction of the total we hereby affirm the same, with costs against appellant.
tax claims even beyond the value of the property
forfeited. That the satisfaction prescribed in section 328 of
the Revenue Code was intended to mean only a
discharge pro tanto is confirmed by the provisions of
section 330 of the Revenue Code to the effect that
"remedy by distraint of personal property and levy on
realty may be repeated if necessary until the full
amount due including all expenses, is collected". This
section makes no distinction between forfeitures to the
Government and sales to third persons, and we are
satisfied that no distinction was intended and that none is
warranted.
"WHEREAS, to compensate the FIRST Is the said amount deductible as a bad debt? As already
PARTY for the advances that it has stated, petitioner gave advances to Palawan
agreed to extend to the SECOND PARTY, Manganese Mines, Inc., without expectation of
the latter has agreed to pay to the repayment. Petitioner could not sue for recovery under
former fifteen per centum (15%) of its net the memorandum agreement because the obligation of
profits. Palawan Manganese Mines, Inc. was to pay petitioner
15% of its net profits, not the advances. No bad debt
"NOW THEREFORE, for and in could arise where there is no valid and subsisting debt.
consideration of the above premises, the
parties hereto have agreed and Again, assuming that in this case there was a valid and
covenanted that in consideration of the subsisting debt and that the debtor was incapable of
financial help to be extended by the paying the debt in 1951, when petitioner wrote off the
FIRST PARTY to the SECOND PARTY to advances and deducted the amount in its return for said
enable the latter to resume its mining year, yet the debt is not deductible in 1951 as a worthless
operations in Coron, Palawan, the debt. It appears that the debtor was still in operation in
SECOND PARTY has agreed and 1951 and 1952, as petitioner continued to give advances
undertaken as it hereby agrees and in those years. It has been held that if the debtor
undertakes to pay to the FIRST PARTY corporation, although losing money or insolvent, was still
fifteen per centum (15%) of its net profits." operating at the end of the taxable year, the debt is not
(Exh. H-2) considered worthless and therefore not deductible. 3
Pursuant to the agreement mentioned above, petitioner The Tax Court's disallowance of the write-off was proper.
gave to Palawan Manganese Mines, Inc. yearly The Solicitor General has rightly pointed out that the
advances starting from 1945, which advances amounted taxpayer has taken an "ambiguous position " and "has not
to P587,308.07 by the end of 1951. Despite these definitely taken a stand on whether the amount involved
advances and the resumption of operations by Palawan is claimed as losses or as bad debts but insists that it is
Manganese Mines, Inc., it continued to suffer losses. By either a loss or a bad debt." 4 We sustain the government's
1951, petitioner became convinced that those advances position that the advances made by the taxpayer to its
could no longer be recovered. While it continued to give 100% subsidiary, Palawan Manganese Mines, Inc.
advances, it decided to write off as worthless the sum of amounting to P587,308,07 as of 1951 were investments
P353,134.25. This amount "was arrived at on the basis of and not loans. 5 The evidence on record shows that the
the total of advances made from 1945 to 1949 in the sum board of directors of the two companies since August,
of P438,981.39, from which amount the sum of P85,647.14 1945, were identical and that the only capital of Palawan
had to be deducted, the latter sum representing its pre- Manganese Mines, Inc. is the amount of P100,000.00
war assets. (t.s.n., pp. 136-139, Id)." (Page 4, entered in the taxpayer's balance sheet as its investment
Memorandum for Petitioner.) Petitioner decided to in its subsidiary company. 6 This fact explains the liberality
maintain the advances given in 1950 and 1951 in the with which the taxpayer made such large advances to
hope that it might be able to recover the same, as in fact the subsidiary, despite the latter's admittedly poor
it continued to give advances up to 1952. From these financial condition.
facts, and as admitted by petitioner itself, Palawan
Manganese Mines, Inc., was still in operation when the The taxpayer's contention that its advances were loans to
advances corresponding to the years 1945 to 1949 were its subsidiary as against the Tax Court's finding that under
written off the books of petitioner. Under the their memorandum agreement, the taxpayer did not
circumstances, was the sum of P353,134.25 properly expect to be repaid, since if the subsidiary had no
claimed by petitioner as deduction in its income tax earnings, there was no obligation to repay those
return for 1951, either as losses or bad debts? advances, becomes immaterial, in the light of our
resolution of the question. The Tax Court correctly held
It will be noted that in giving advances to Palawan that the subsidiary company was still in operation in 1951
Manganese Mine Inc., petitioner did not expect to be and 1952 and the taxpayer continued to give it
repaid. It is true that some testimonial evidence was advances in those years, and, therefore, the alleged
presented to show that there was some agreement that debt or investment could not properly be considered
the advances would be repaid, but no documentary worthless and deductible in 1951, as claimed by the
evidence was presented to this effect. The memorandum taxpayer. Furthermore, neither under Section 30 (d) (2) of
agreement signed by the parties appears to be very our Tax Code providing for deduction by corporations of
losses actually sustained and charged off during the Petitioner deducted losses in the operation of its
taxable year nor under Section 30 (e) (1) thereof Hacienda Dalupiri the sums of P17,418.95 in 1950,
providing for deduction of bad debts actually P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62
ascertained to be worthless and charged off within the in 1953, and P42,938.56 in 1954. These deductions
taxable year, can there be a partial writing off of a loss or were disallowed by respondent on the ground
bad debt, as was sought to be done here by the that the farm was operated solely for pleasure or
taxpayer. For such losses or bad debts must be as a hobby and not for profit. This conclusion is
ascertained to be so and written off during the taxable based on the fact that the farm was operated
year, are therefore deductible in full or not at all, in the continuously at a loss.1awphîl.nèt
absence of any express provision in the Tax Code
authorizing partial deductions. From the evidence, we are convinced that the
Hacienda Dalupiri was operated by petitioner for
The Tax Court held that the taxpayer's loss of its business and not pleasure. It was mainly a cattle
investment in its subsidiary could not be deducted for the farm, although a few race horses were also
year 1951, as the subsidiary was still in operation in 1951 raised. It does not appear that the farm was used
and 1952. The taxpayer, on the other hand, claims that its by petitioner for entertainment, social activities,
advances were irretrievably lost because of the or other non-business purposes. Therefore, it is
staggering losses suffered by its subsidiary in 1951 and entitled to deduct expenses and losses in
that its advances after 1949 were "only limited to the connection with the operation of said farm. (See
purpose of salvaging whatever ore was already 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M.
available, and for the purpose of paying the wages of 21103, CB 1939-1, p.164)
the laborers who needed help." 7 The correctness of the
Tax Court's ruling in sustaining the disallowance of the Section 100 of Revenue Regulations No. 2,
write-off in 1951 of the taxpayer's claimed losses is borne otherwise known as the Income Tax Regulations,
out by subsequent events shown in Cases L-24972 and L- authorizes farmers to determine their gross
24978 involving the taxpayer's 1957 income tax liability. income on the basis of inventories. Said
(Infra, paragraph 6.) It will there be seen that by 1956, the regulations provide:
obligation of the taxpayer's subsidiary to it had been
reduced from P587,398.97 in 1951 to P442,885.23 in 1956,
"If gross income is ascertained by
and that it was only on January 1, 1956 that the subsidiary
inventories, no deduction can be made
decided to cease operations. 8
for livestock or products lost during the
year, whether purchased for resale,
(c) Disallowance of losses in Balamban Coal Mines (1950 produced on the farm, as such losses will
and 1951). — The Court sustains the Tax Court's be reflected in the inventory by reducing
disallowance of the sums of P8,989.76 and P27,732.66 the amount of livestock or products on
spent by the taxpayer for the operation of its Balamban hand at the close of the year."
coal mines in Cebu in 1950 and 1951, respectively, and
claimed as losses in the taxpayer's returns for said years.
Evidently, petitioner determined its income or
The Tax Court correctly held that the losses "are
losses in the operation of said farm on the basis of
deductible in 1952, when the mines were abandoned,
inventories. We quote from the memorandum of
and not in 1950 and 1951, when they were still in
counsel for petitioner:
operation." 9 The taxpayer's claim that these expeditions
should be allowed as losses for the corresponding years
that they were incurred, because it made no sales of "The Taxpayer deducted from its income
coal during said years, since the promised road or outlet tax returns for the years from 1950 to 1954
through which the coal could be transported from the inclusive, the corresponding yearly losses
mines to the provincial road was not constructed, cannot sustained in the operation of Hacienda
be sustained. Some definite event must fix the time when Dalupiri, which losses represent the
the loss is sustained, and here it was the event of actual excess of its yearly expenditures over the
abandonment of the mines in 1952. The Tax Court held receipts; that is, the losses represent the
that the losses, totalling P36,722.42 were properly difference between the sales of livestock
deductible in 1952, but the appealed judgment does not and the actual cash disbursements or
show that the taxpayer was credited therefor in the expenses." (Pages 21-22, Memorandum
determination of its tax liability for said year. This for Petitioner.)
additional deduction of P36,722.42 from the taxpayer's
taxable income in 1952 would result in the elimination of As the Hacienda Dalupiri was operated by
the deficiency tax liability for said year in the sum of petitioner for business and since it sustained losses
P3,600.00 as determined by the Tax Court in the in its operation, which losses were determined by
appealed judgment. means of inventories authorized under Section
100 of Revenue Regulations No. 2, it was error for
(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 respondent to have disallowed the deduction of
to 1954) and Hacienda Samal (1951-1952). — The Tax said losses. The same is true with respect to loss
Court overruled the Commissioner's disallowance of these sustained in the operation of the Hacienda
items of losses thus: Samal for the years 1951 and 1952. 10
The Commissioner questions that the losses sustained by May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 &
the taxpayer were properly based on the inventory L-11558, Nov. 25, 1958.) In this case, the increase
method of accounting. He concedes, however, "that the in the net worth of petitioner for 1950 to the
regulations referred to does not specify how the extent of P30,050.00 was not the result of the
inventories are to be made. The Tax Court, however, felt receipt by it of taxable income. It was merely the
satisfied with the evidence presented by the taxpayer ... outcome of the correction of an error in the entry
which merely consisted of an alleged physical count of in its books relating to its indebtedness to the
the number of the livestock in Hacienda Dalupiri for the Manila Insurance Company. The Income Tax Law
years involved." 11 The Tax Court was satisfied with the imposes a tax on income; it does not tax any or
method adopted by the taxpayer as a farmer breeding every increase in net worth whether or not
livestock, reporting on the basis of receipts and derived from income. Surely, the said sum of
disbursements. We find no Compelling reason to disturb P30,050.00 was not income to petitioner, and it
its findings. was error for respondent to assess a deficiency
income tax on said amount.
2. Disallowance of excessive depreciation of buildings
(1950-1954). — During the years 1950 to 1954, the The same holds true in the case of the alleged increase in
taxpayer claimed a depreciation allowance for its net worth of petitioner for the year 1951 in the sum of
buildings at the annual rate of 10%. The Commissioner P1,382.85. It appears that certain items (all amounting to
claimed that the reasonable depreciation rate is only 3% P1,382.85) remained in petitioner's books as outstanding
per annum, and, hence, disallowed as excessive the liabilities of trade creditors. These accounts were
amount claimed as depreciation allowance in excess of discovered in 1951 as having been paid in prior years, so
3% annually. We sustain the Tax Court's finding that the that the necessary adjustments were made to correct the
taxpayer did not submit adequate proof of the errors. If there was an increase in net worth of the
correctness of the taxpayer's claim that the depreciable petitioner, the increase in net worth was not the result of
assets or buildings in question had a useful life only of 10 receipt by petitioner of taxable income." 13 The
years so as to justify its 10% depreciation per annum Commissioner advances no valid grounds in his brief for
claim, such finding being supported by the record. The contesting the Tax Court's findings. Certainly, these
taxpayer's contention that it has many zero or one-peso increases in the taxpayer's net worth were not taxable
assets, 12representing very old and fully depreciated increases in net worth, as they were not the result of the
assets serves but to support the Commissioner's position receipt by it of unreported or unexplained taxable
that a 10% annual depreciation rate was excessive. income, but were shown to be merely the result of the
correction of errors in its entries in its books relating to its
3. Taxable increase in net worth (1950-1951). — The Tax indebtednesses to certain creditors, which had been
Court set aside the Commissioner's treatment as taxable erroneously overstated or listed as outstanding when they
income of certain increases in the taxpayer's net worth. It had in fact been duly paid. The Tax Court's action must
found that: be affirmed.
For the year 1950, respondent determined that 4. Gain realized from sale of real property (1950). — We
petitioner had an increase in net worth in the sum likewise sustain as being in accordance with the
of P30,050.00, and for the year 1951, the sum of evidence the Tax Court's reversal of the Commissioner's
P1,382.85. These amounts were treated by assessment on all alleged unreported gain in the sum of
respondent as taxable income of petitioner for P11,147.26 in the sale of a certain real property of the
said years. taxpayer in 1950. As found by the Tax Court, the
evidence shows that this property was acquired in 1926
for P11,852.74, and was sold in 1950 for P60,000.00,
It appears that petitioner had an account with
apparently, resulting in a gain of P48,147.26. 14 The
the Manila Insurance Company, the records
taxpayer reported in its return a gain of P37,000.00, or a
bearing on which were lost. When its records
discrepancy of P11,147.26. 15 It was sufficiently proved
were reconstituted the amount of P349,800.00
from the taxpayer's books that after acquiring the
was set up as its liability to the Manila Insurance
property, the taxpayer had made improvements totalling
Company. It was discovered later that the
P11,147.26, 16 accounting for the apparent discrepancy in
correct liability was only 319,750.00, or a
the reported gain. In other words, this figure added to the
difference of P30,050.00, so that the records were
original acquisition cost of P11,852.74 results in a total cost
adjusted so as to show the correct liability. The
of P23,000.00, and the gain derived from the sale of the
correction or adjustment was made in 1950.
property for P60,000.00 was correctly reported by the
Respondent contends that the reduction of
taxpayer at P37,000.00.
petitioner's liability to Manila Insurance Company
resulted in the increase of petitioner's net worth
to the extent of P30,050.00 which is taxable. This is On the second issue of prescription, the taxpayer's
erroneous. The principle underlying the taxability contention that the Commissioner's action to recover its
of an increase in the net worth of a taxpayer rests tax liability should be deemed to have prescribed for
on the theory that such an increase in net worth, failure on the part of the Commissioner to file a complaint
if unreported and not explained by the taxpayer, for collection against it in an appropriate civil action, as
comes from income derived from a taxable contradistinguished from the answer filed by the
source. (See Perez v. Araneta, G.R. No. L-9193, Commissioner to its petition for review of the questioned
assessments in the case a quo has long been rejected by deficiency income tax for the year 1957, plus the
this Court. This Court has consistently held that "a judicial corresponding interest provided in Section 51 of
action for the collection of a tax is begun by the filing of the Revenue Code. If the deficiency tax is not
a complaint with the proper court of first instance, paid in full within thirty (30) days from the date
or where the assessment is appealed to the Court of Tax this decision becomes final and executory,
Appeals, by filing an answer to the taxpayer's petition for petitioner shall pay a surcharge of five per cent
review wherein payment of the tax is prayed for." 17 This is (5%) of the unpaid amount, plus interest at the
but logical for where the taxpayer avails of the right to rate of one per cent (1%) a month, computed
appeal the tax assessment to the Court of Tax Appeals, from the date this decision becomes final until
the said Court is vested with the authority to pronounce paid, provided that the maximum amount that
judgment as to the taxpayer's liability to the exclusion of may be collected as interest shall not exceed the
any other court. In the present case, regardless of amount corresponding to a period of three (3)
whether the assessments were made on February 24 and years. Without pronouncement as to costs. 19
27, 1956, as claimed by the Commissioner, or on
December 27, 1955 as claimed by the taxpayer, the Both parties again appealed from the respective adverse
government's right to collect the taxes due has clearly rulings against them in the Tax Court's decision.
not prescribed, as the taxpayer's appeal or petition for
review was filed with the Tax Court on May 4, 1960, with
5. Allowance of losses in Hacienda Dalupiri (1957). — The
the Commissioner filing on May 20, 1960 his Answer with a
Tax Court cited its previous decision overruling the
prayer for payment of the taxes due, long before the
Commissioner's disallowance of losses suffered by the
expiration of the five-year period to effect collection by
taxpayer in the operation of its Hacienda Dalupiri, since it
judicial action counted from the date of assessment.
was convinced that the hacienda was operated for
business and not for pleasure. And in this appeal, the
Cases L-24972 and L-24978 Commissioner cites his arguments in his appellant's brief in
Case No. L-21557. The Tax Court, in setting aside the
These cases refer to the taxpayer's income tax liability for Commissioner's principal objections, which were directed
the year 1957. Upon examination of its corresponding to the accounting method used by the taxpayer found
income tax return, the Commissioner assessed it for that:
deficiency income tax in the amount of P38,918.76,
computed as follows: It is true that petitioner followed the cash basis
method of reporting income and expenses in the
Net income per return operation of the Hacienda Dalupiri and used the
P29,178.70
accrual method with respect to its mine
Add: Unallowable deductions: operations. This method of accounting, otherwise
(1) Net loss claimed on Ha. Dalupiri 89,547.33known as the hybrid method, followed by
petitioner is not without justification.
(2) Amortization of Contractual right claimed as an
expense under Mines Operations 48,481.62
... A taxpayer may not, ordinarily,
combine the cash and accrual bases.
Net income per investigation P167,297.65
The 1954 Code provisions permit,
Tax due thereon 38,818.00 however, the use of a hybrid method of
accounting, combining a cash and
Less: Amount already assessed 5,836.00 accrual method, under circumstances
Balance P32,982.00 and requirements to be set out in
Regulations to be issued. Also, if a
Add: 1/2% monthly interest from 6-20-59 to 6-20-62 5,936.76
taxpayer is engaged in more than one
1 trade or business he may use a different
TOTAL AMOUNT DUE AND COLLECTIBLE 8 P38,918.76 method of accounting for each trade or
business. And a taxpayer may report
income from a business on accrual basis
The Tax Court overruled the Commissioner's disallowance
and his personal income on the cash
of the taxpayer's losses in the operation of its Hacienda
basis.' (See Mertens, Law of Federal
Dalupiri in the sum of P89,547.33 but sustained the
Income Taxation, Zimet & Stanley
disallowance of the sum of P48,481.62, which allegedly
Revision, Vol. 2, Sec. 12.08, p. 26.) 20
represented 1/5 of the cost of the "contractual right" over
the mines of its subsidiary, Palawan Manganese Mines,
Inc. which the taxpayer had acquired. It found the The Tax Court, having satisfied itself with the
taxpayer liable for deficiency income tax for the year adequacy of the taxpayer's accounting method
1957 in the amount of P9,696.00, instead of P32,982.00 as and procedure as properly reflecting the
originally assessed, and rendered the following judgment: taxpayer's income or losses, and the
Commissioner having failed to show the contrary,
we reiterate our ruling [supra, paragraph 1 (d)
WHEREFORE, the assessment appealed from is
and (e)] that we find no compelling reason to
hereby modified. Petitioner is hereby ordered to
disturb its findings.
pay to respondent the amount of P9,696.00 as
6. Disallowance of amortization of alleged "contractual disallowed the deduction on the following
rights." — The reasons for sustaining this disallowance are grounds: (1) that the Palawan Manganese Mines,
thus given by the Tax Court: Inc. could not transfer P242,408.10 worth of assets
to petitioner because the balance sheet of the
It appears that the Palawan Manganese Mines, said corporation for 1955 shows that it had only
Inc., during a special meeting of its Board of current as worth P97,636.96; and (2) that the
Directors on January 19, 1956, approved a alleged amortization of "contractual rights" is not
resolution, the pertinent portions of which read as allowed by the Revenue Code.
follows:
The law in point is Section 30(g) (1) (B) of the
"RESOLVED, as it is hereby resolved, that Revenue Code, before its amendment by
the corporation's current assets Republic Act No. 2698, which provided in part:
composed of ores, fuel, and oil, materials
and supplies, spare parts and canteen "(g) Depletion of oil and gas wells and
supplies appearing in the inventory and mines.:
balance sheet of the Corporation as of
December 31, 1955, with an aggregate "(1) In general. — ... (B) in the case of
value of P97,636.98, contractual rights for mines, a reasonable allowance for
the operation of various mining claims in depletion thereof not to exceed the
Palawan with a value of P100,000.00, its market value in the mine of the product
title on various mining claims in Palawan thereof, which has been mined and sold
with a value of P142,408.10 or a total during the year for which the return and
value of P340,045.02 be, as they are computation are made. The allowances
hereby ceded and transferred to shall be made under rules and
Fernandez Hermanos, Inc., as partial regulations to be prescribed by the
settlement of the indebtedness of the Secretary of Finance: Provided, That
corporation to said Fernandez Hermanos when the allowances shall equal the
Inc. in the amount of P442,895.23." (Exh. capital invested, ... no further allowance
E, p. 17, CTA rec.) shall be made."
On March 29, 1956, petitioner's corporation Assuming, arguendo, that the Palawan
accepted the above offer of transfer, thus: Manganese Mines, Inc. had assets worth
P242,408.10 which it actually transferred to the
"WHEREAS, the Palawan Manganese petitioner in 1956, the latter cannot just deduct
Mines, Inc., due to its yearly substantial one-fifth (1/5) of said amount from its gross
losses has decided to cease operation income for the year 1957 because such
on January 1, 1956 and in order to satisfy deduction in the form of depletion charge was
at least a part of its indebtedness to the not sanctioned by Section 30(g) (1) (B) of the
Corporation, it has proposed to transfer Revenue Code, as above-quoted.
its current assets in the amount of NINETY
SEVEN THOUSAND SIX HUNDRED THIRTY xxx xxx xxx
SIX PESOS & 98/100 (P97,636.98) as per its
balance sheet as of December 31, 1955,
The sole basis of petitioner in claiming the
its contractual rights valued at ONE
amount of P48,481.62 as a deduction was the
HUNDRED THOUSAND PESOS
memorandum of its mining engineer (Exh. 1, pp.
(P100,000.00) and its title over various
31-32, CTA rec.), who stated that the ore reserves
mining claims valued at ONE HUNDRED
of the Busuange Mines (Mines transferred by the
FORTY TWO THOUSAND FOUR HUNDRED
Palawan Manganese Mines, Inc. to the
EIGHT PESOS & 10/100 (P142,408.10) or a
petitioner) would be exhausted in five (5) years,
total evaluation of THREE HUNDRED
hence, the claim for P48,481.62 or one-fifth (1/5)
FORTY THOUSAND FORTY FIVE PESOS &
of the alleged cost of the mines corresponding to
08/100 (P340,045.08) which shall be
the year 1957 and every year thereafter for a
applied in partial settlement of its
period of 5 years. The said memorandum merely
obligation to the Corporation in the
showed the estimated ore reserves of the mines
amount of FOUR HUNDRED FORTY TWO
and it probable selling price. No evidence
THOUSAND EIGHT HUNDRED EIGHTY FIVE
whatsoever was presented to show the
PESOS & 23/100 (P442,885.23)," (Exh. E-1,
produced mine and for how much they were
p. 18, CTA rec.)
sold during the year for which the return and
computation were made. This is necessary in
Petitioner determined the cost of the mines at order to determine the amount of depletion that
P242,408.10 by adding the value of the can be legally deducted from petitioner's gross
contractual rights (P100,000.00) and the value of income. The method employed by petitioner in
its mining claims (P142,408.10). Respondent making an outright deduction of 1/5 of the cost
of the mines is not authorized under Section 30(g) G.R. No. L-45544 April 25, 1939
(1) (B) of the Revenue Code. Respondent's
disallowance of the alleged "contractual rights"
THE COLLECTOR OF INTERNAL REVENUE, petitioner-
amounting to P48,481.62 must therefore be
appellant,
sustained. 21
vs.
THE ADMINISTRATRIX OF THE ESTATE OF LORENZO
The taxpayer insists in this appeal that it could use as a ECHARRI, oppositor-appellee.
method for depletion under the pertinent provision of the
Tax Code its "capital investment," representing the
Undersecretary of Justice Melencio for appellant.
alleged value of its contractual rights and titles to mining
Hilado and Hilado for appellee.
claims in the sum of P242,408.10 and thus deduct outright
one-fifth (1/5) of this "capital investment" every year.
regardless of whether it had actually mined the product LAUREL, J.:
and sold the products. The very authorities cited in its brief
give the correct concept of depletion charges that they This is an appeal by the Collector of Internal revenue from
"allow for the exhaustion of the capital value of the the order of the Court of First Instance of Occidental
deposits by production"; thus, "as the cost of the raw Negros, under date of may 26, 1936, the dispositive part
materials must be deducted from the gross income of which reads as follows:
before the net income can be determined, so the
estimated cost of the reserve used up is allowed." 22 The Y bajo esta computacion se declara que el
alleged "capital investment" method invoked by the Administrador de Rentas Internas solamente
taxpayer is not a method of depletion, but the Tax Code debe cobrar de este intestado la cantidad de
provision, prior to its amendment by Section 1, of P1,467.57, en lugar de la cantidad de P14,475.13,
Republic Act No. 2698, which took effect on June 18, ordenandose en su consecuencia al
1960, expressly provided that "when the allowances shall administrador de este intestado que pague
equal the capital invested ... no further allowances shall dicha suma de P1,467.59 al Gobierno de las Islas
be made;" in other words, the "capital investment" was Filipinas, por conducto del Tesorero Provincial de
but the limitation of the amount of depletion that could Negros Occidental, dentro del plazo de cinco
be claimed. The outright deduction by the taxpayer of dias.
1/5 of the cost of the mines, as if it were a "straight line"
rate of depreciation, was correctly held by the Tax Court
In probate proceedings in the matter of the intestate
not to be authorized by the Tax Code.
estate of Lorenzo Echarri, deceased, pending in the
Court of First Instance of Occidental Negros, the
ACCORDINGLY, the judgment of the Court of Tax provincial fiscal of said province, in behalf of the Insular
Appeals, subject of the appeals in Cases Nos. L-21551 Government, filed on February 18, 1931, a motion under
and L-21557, as modified by the crediting of the losses of date of February 10, of the same year, submitting
P36,722.42 disallowed in 1951 and 1952 to the taxpayer therewith annex A, which is proof of debt subscribed to
for the year 1953 as directed in paragraph 1 (c) of this by the Collector of Internal Revenue on January 12, 1931,
decision, is hereby affirmed. The judgment of the Court of in which it is claimed, that Lorenzo Echarri, deceased, is
Tax Appeals appealed from in Cases Nos. L-24972 and L- indebted to the Government of the Philippine Islands in
24978 is affirmed in toto. No costs. So ordered. the sum of P14,475.13 as income tax found to be due
from him for year 1927. On May 19, 1932, the Collector of
Internal Revenue, represented by the provincial fiscal of
said province, filed another motion in which he prayed
that the administratrix of the intestate estate be ordered
to pay to the Government of the Philippines the amount
of the income tax above referred to. On May 28, 1932,
the administratrix filed an answer to said motion in which
she challenged the validity of the assessment made by
the Collector of Internal Revenue and prayed that the
assessment be amended and, if necessary, the claim be
set for hearing for introduction of evidence. On the same
date, the administratrix filed additional memorandum in
which it is contended that annex B of her answer to the
motion of the Collector of Internal Revenue was not a
contract of sale. On January 30, 1934, the Collector of
Internal Revenue, in a motion submitted to the court,
raised the question of propriety of contesting the
assessment or the legality of the tax without the
administratrix paying first the tax under protest and
brining the corresponding action under section 1579 of
the Revised Administrative Code. On June 15, 1934, the
lower court upheld the contention of the Collector of
Internal Revenue and ordered the administratrix to pay to
the Government the sum of P14,475.13, under protest P1,467.57, instead of the sum of P14,475.13 which is the
authorizing her at the same time to institute the amount of the income tax assessed by the Collector of
corresponding judicial action to recover the amount paid Internal Revenue.
in accordance with the aforecited section 1579 of the
Revised Administrative Code. On July 7, 1934, the The questions raised in the first and second assignments
administratrix filed a motion for reconsideration, and on can be fairly disposed of by taking into account the time
July 18, 1934, the court reconsidered its order of June 15, of the discovery of the deficiency of the income-tax
1934, and set the claim of the Government for trial on the return, dated March 30, 1928, of Lorenzo Echarri,
merit. Both parties presented evidence. On May 26, 1936, deceased. According to the records of this case the
the lower court rendered its decision ordering the return was received in the office of the Collector of
administratrix to pay to the Collector of Internal Revenue Internal Revenue on March 31, 1928 (Exhibit C), and that
the sum of P1,467.57, instead of the P14,475.13, as the alleged errors in said return were the subject of
additional income tax. From this order the Collector of correspondence between the Collector of Internal
Internal Revenue, has appealed to this court. Revenue and the attorney for the administratrix of said
intestate even before January 5, 1931 (Annex A). It is
The appellant makes the following assignment of errors: therefore obvious that the error or deficiency of the
income-tax return was discovered within three years from
I. The lower court erred in holding that it has jurisdiction to the time that such erroneous declaration was made. In
receive evidence and decide on its merit the claim of the Collector of Customs vs. Haygood (G.R. No. 44038,
Government filed in these proceedings. promulgated on May 18, 1938), we said:
II. The lower court erred in not ordering the administratrix 1.º, que cuando el descubrimiento de
to pay the claim of the Government under protest and declaraciones erroneas de impuestos se hace
bring later an action for its recovery as provided for in dentro de los tres años siguientes a la fecha en
section 1579 of the Revised Administrative Code. que deben hacerse dichas declaraciones y el
declarante ha fallecido, la reclamacion para el
cobro del pago del impuesto tasado por el
III. The lower court erred in holding that the transaction
Administrador de Rentas Internas debe hacerse
involved in the document, Exhibit A, which refers to the
en la testamentaria o abintestato mediante
transfer of the properties known as "Hacienda Urbasa,"
mocion acompañada de una relacion jurada
with all the improvements existing thereon, by Lorenzo
por dicho Administrador de los impuestos
Echarri to the Central Azucarera del Danao, to pay the
adeudados y el Tribunal competente puede
value of 1,437 shares of stock of said central which Echarri
sumariamente ordenar al Administrador judicial
had subscribed, does not have the nature of a sale but of
sin previa vista el pago de la reclamacion si este
an exchange or barter.
tuviere fondos disponibles, teniendo en cuenta
las prelaciones establecidas en el articulo 753 del
IV. The lower court erred in holding that, considering the Codigo de Procedimiento Civil, pudiendo dicho
nature of the transaction involved in Exhibit A as administrador hacer el pago bajo protesta para
exchange, the net value that should be given to the recobrar en juicio aparte lo que hubiera pagado
"Hacienda Urbasa" is 143,700, and that the value of 1,437 indebidamente; y 2.º, que cuando el
shares, at the par value of P100 each, being P143,700, the descubrimiento de declaraciones erroneas tiene
result is that Lorenzo Echarri did not realize any gain lugar despues de los tres años contados desde la
subject to taxation. fecha en que se han hecho dichas
declaraciones, la reclamacion que presentare el
V. The lower court erred in not holding that the Administrador de Rentas Internas debe hacerse
transaction involved in Exhibit A partakes of the nature of tambien mediante mocion acompañada de
a sale whereby Lorenzo Echarri sold his "Hacienda una relacion jurada de impuestos no pagados,
Urbasa" together with all the improvements thereon, with teniendo dicha mocion caracter de una
an aggregate value of P238,838.31, to the Central demanda civil que debe tramitarse mediante
Azucarera del Danao, in payment of the 1,437 shares of presentacion de contestacion escrita y practica
stock subscribed by Echarri on condition that the central de prueba.
should assume the obligations of Echarri in the amount of
P256,878.31. The case of Pineda vs. Court of First Instance of Tayabas
and Collector of Internal Revenue (52 Phil., 803), relied
VI. The lower court erred in not holding that the profit upon by the petitioner-appellant is good authority on the
realized by Lorenzo Echarri from the sale of his "Hacienda proposition that the court having control over the
Urbasa" to the Central Azucarera del Danao in payment administration proceedings has jurisdiction to entertain
of his 1,437 shares of stock amounts to P161,740, being the claim presented by the government for taxes due
the difference between the selling price of P400,578.31 and to order the administrator to pay the tax should it find
and the cost price of "Hacienda Urbasa" in the amount of that the assessment was proper, and that the tax was
P238,838.31. legal, due and collectible. And the rule laid down in that
case must be understood in relation to the case
VII. The lower court erred in ordering the administratrix to of Collector of Customs vs. Haygood, supra, as to the
pay to the Collector of Internal Revenue the sum of procedure to be followed in a given case by the
government to effectuate the collection of the tax. G.R. No. L-66416 March 21, 1990
Categorically stated, where during the pendency of
judicial over the estate of a deceased person a claim for
COMMISSIONER OF INTERNAL REVENUE, petitioner,
taxes is presented by the government, the court has the
vs.
authority to order the payment by the administrator; but,
TOURS SPECIALISTS, INC., and THE COURT OF TAX
in the same way that it has authority to order payment or
APPEALS, respondents.
satisfaction, it also has the negative authority to deny the
same. While there are cases where courts are required to
perform certain duties mandatory and ministerial in This is a petition to review on certiorari the decision of the
character, the function of the court in a case of the Court of Tax Appeals which ruled that the money
present character is not one of them; and here, the court entrusted to private respondent Tours Specialists, Inc.,
cannot be an organism endowed with latitude of earmarked and paid for hotel room charges of tourists,
judgment in one direction, and converted into a mere travelers and/or foreign travel agencies does not form
mechanical contrivance in another direction. This part of its gross receipts subject to the 3% independent
principle is sound notwithstanding the unqualified contractor's tax under the National Internal Revenue
application suggested by the petitioner-appellant of Code of 1977.
section 1579 of the Revised Administrative Code in the
light of our pronouncements in Sarasola vs. Trinidad (40 We adopt the findings of facts of the Court of Tax
Phil., 252) and Churchill and Tait vs. Rafferty (32 Phil., 580). Appeals as follows:
The first and second assignments of error are therefore For the years 1974 to 1976, petitioner (Tours Specialists,
overruled. Inc.) had derived income from its activities as a travel
agency by servicing the needs of foreign tourists and
The other questions raised have reference to the nature travelers and Filipino "Balikbayans" during their stay in this
of the transaction marked as Exhibit A of the government. country. Some of the services extended to the tourists
The lower court concluded that the parties intended an consist of booking said tourists and travelers in local hotels
exchange of properties. In reality, for the purposes of the for their lodging and board needs; transporting these
application of the Income Tax Law whether the foreign tourists from the airport to their respective hotels,
transaction was a sale or an exchange is immaterial. The and from the latter to the airport upon their departure
determining factor was whether any gain or profit was from the Philippines, transporting them from their hotels to
derived therefrom (Act No. 2833, sec. 2, subpars. [c] and various embarkation points for local tours, visits and
[3]; Atkins' Estate vs. Lucas, 36 Fed. [2d], 611). excursions; securing permits for them to visit places of
interest; and arranging their cultural entertainment,
shopping and recreational activities.
Whether gain was derived from the transaction is a
question of fact. The determination of that question
presupposes review of the computation of the In order to ably supply these services to the foreign
assessment made by the Collector of Internal Revenue tourists, petitioner and its correspondent counterpart
no less than of the evidence presented by the parties. tourist agencies abroad have agreed to offer a package
The lower court reached the conclusion that in the fee for the tourists. Although the fee to be paid by said
transaction the deceased had neither realized any gain tourists is quoted by the petitioner, the payments of the
nor suffered any loss. We cannot alter this finding made hotel room accommodations, food and other personal
presumably after consideration of the evidence expenses of said tourists, as a rule, are paid directly either
presented before the lower court especially where we do by tourists themselves, or by their foreign travel agencies
not find any abuse or misapplication of the law. to the local hotels (pp. 77, t.s.n., February 2, 1981; Exhs. O
& O-1, p. 29, CTA rec.; pp. 2425, t.s.n., ibid) and
restaurants or shops, as the case may be.
The appeal is dismissed without pronouncement
regarding costs. So ordered.
It is also the case that some tour agencies abroad
request the local tour agencies, such as the petitioner in
the case, that the hotel room charges, in some specific
cases, be paid through them. (Exh. Q, Q-1, p. 29 CTA rec.,
p. 25, T.s.n., ibid, pp. 5-6, 17-18, t.s.n., Aug. 20, 1981.; See
also Exh. "U", pp. 22-23, t.s.n., Oct. 9, 1981, pp. 3-4, 11.,
t.s.n., Aug. 10, 1982). By this arrangement, the foreign tour
agency entrusts to the petitioner Tours Specialists, Inc., the
fund for hotel room accommodation, which in turn is paid
by petitioner tour agency to the local hotel when billed.
The procedure observed is that the billing hotel sends the
bill to the petitioner. The local hotel identifies the
individual tourist, or the particular groups of tourists by
code name or group designation and also the duration
of their stay for purposes of payment. Upon receipt of the
bill, the petitioner then pays the local hotel with the funds
entrusted to it by the foreign tour correspondent agency.
Despite this arrangement, respondent Commissioner of through petitioner without any increase in the room
Internal Revenue assessed petitioner for deficiency 3% charged (t.s.n., Oct. 9, 1981, pp. 21-25) and that the
contractor's tax as independent contractor by including reason why tourists pay their room charge, or through
the entrusted hotel room charges in its gross receipts from their foreign tourists agencies, is the fact that the room
services for the years 1974 to 1976. Consequently, on charge is exempt from hotel room tax under P.D. 31.
December 6, 1979, petitioner received from respondent (t.s.n., Ibid., pp. 25-29.) Witness Isada stated, on cross-
the 3% deficiency independent contractor's tax examination, that if their payment is made, thru
assessment in the amount of P122,946.93 for the years petitioner's tour agency, the hotel cost or charges "is only
1974 to 1976, inclusive, computed as follows: an act of accomodation on our (its) part" or that the
"agent abroad instead of sending several telexes and
1974 deficiency percentage tax saving on bank charges they take the option to send
per investigation P 3,995.63 money to us to be held in trust to be endorsed to the
15% surcharge for late payment 998.91 hotel." (pp. 3-4, t.s.n.Aug. 10, 1982.)
—————
P 4,994.54 Nevertheless, on June 2, 1980, respondent, without
14% interest computed by quarters deciding the petitioner's written protest, caused the
up to 12-28-79 3,953.18 issuance of a warrant of distraint and levy. (p. 51, BIR
P 8,847.72 Rec.) And later, respondent had petitioner's bank
1975 deficiency percentage tax deposits garnished. (pp. 49-50, BIR Rec.)
per investigation P 8,427.39
25% surcharge for late payment 2,106.85 Taking this action of respondent as the adverse and final
————— decision on the disputed assessment, petitioner
P 10,534.24 appealed to this Court. (Rollo, pp. 40-45)
14% interest computed by quarters
up to 12-28-79 6,808.47
The petitioner raises the lone issue in this petition as
P 17,342.71
follows:
1976 deficiency percentage
per investigation P 54,276.42 WHETHER AMOUNTS RECEIVED BY A
25% surcharge for late payment 13,569.11 LOCAL TOURIST AND TRAVEL AGENCY
————— INCLUDED IN A PACKAGE FEE FROM
P 67,845.53 TOURISTS OR FOREIGN TOUR AGENCIES,
14% interest computed by quarters INTENDED OR EARMARKED FOR HOTEL
up to 12-28-79 28,910.97 ACCOMMODATIONS FORM PART OF
P 96,756.50 GROSS RECEIPTS SUBJECT TO 3%
————— ————— CONTRACTOR'S TAX. (Rollo, p. 23)
Total P122,946.93
The petitioner premises the issue raised on the following
assumptions:
In addition to the deficiency contractor's tax of
P122,946.93, petitioner was assessed to pay a Firstly, the ruling overlooks the fact that the amounts
compromise penalty of P500.00. received, intended for hotel room accommodations,
were received as part of the package fee and,
Subsequently on December 11, 1979, petitioner formally therefore, form part of "gross receipts" as defined by law.
protested the assessment made by respondent on the
ground that the money received and entrusted to it by Secondly, there is no showing and is not established by
the tourists, earmarked to pay hotel room charges, were the evidence. that the amounts received and
not considered and have never been considered by it as "earmarked" are actually what had been paid out as
part of its taxable gross receipts for purposes of hotel room charges. The mere possibility that the amounts
computing and paying its contractor's tax. actually paid could be less than the amounts received is
sufficient to destroy the validity of the ruling. (Rollo, pp.
During one of the hearings in this case, a witness, Serafina 26-27)
Sazon, Certified Public Accountant and in charge of the
Accounting Department of petitioner, had testified, her In effect, the petitioner's lone issue is based on alleged
credibility not having been destroyed on cross error in the findings of facts of the respondent court.
examination, categorically stated that the amounts
entrusted to it by the foreign tourist agencies intended for The well-settled doctrine is that the findings of facts of the
payment of hotel room charges, were paid entirely to the Court of Tax Appeals are binding on this Court and
hotel concerned, without any portion thereof being absent strong reasons for this Court to delve into facts,
diverted to its own funds. (t.s.n., Feb. 2, 1981, pp. 7, 25; only questions of law are open for determination. (Nilsen
t.s.n., Aug. 20, 1981, pp. 5-9, 17-18). The testimony of v. Commissioner of Customs, 89 SCRA 43 [1979]; Balbas v.
Serafina Sazon was corroborated by Gerardo Isada, Domingo, 21 SCRA 444 [1967]; Raymundo v. De Joya, 101
General Manager of petitioner, declaring to the effect SCRA 495 [1980]). In the recent case of Sy Po v. Court of
that payments of hotel accommodation are made
Appeals, (164 SCRA 524 [1988]), we ruled that the factual =========
findings of the Court of Tax Appeals are binding upon this
court and can only be disturbed on appeal if not Oct. 1976 P 71,134.80
supported by substantial evidence. Nov. 1976 409,019.17
Dec. 1976 142,761.55
In the instant case, we find no reason to disregard and —————
deviate from the findings of facts of the Court of Tax 622,915.51
Appeals. —————
Grand Total P 904,995.29
=========
As quoted earlier, the Court of Tax Appeals sufficiently
explained the services of a local travel agency, like the
herein private respondent, rendered to foreign It is not true therefore, as stated by respondent, that there
customers. The respondent differentiated between the is no evidence proving the amounts earmarked for hotel
package fee — offered by both the local travel agency room charges. Since the BIR examiners could not have
and its correspondent counterpart tourist agencies manufactured the above figures representing "advances
abroad and the requests made by some tour agencies for hotel room accommodations," these payments must
abroad to local tour agencies wherein the hotel room have certainly been taken from the records of petitioner,
charges in some specific cases, would be paid to the such as the invoices, hotel bills, official receipts and other
local hotels through them. In the latter case, the pertinent documents. (Rollo, pp. 48-49)
correspondent court found as a fact ". . . that the foreign
tour agency entrusts to the petitioner Tours Specialists, The factual findings of the respondent court are
Inc. the fund for hotel room accommodation, which in supported by substantial evidence, hence binding upon
turn is paid by petitioner tour agency to the local hotel this Court.
when billed." (Rollo, p. 42) The following procedure is
followed: The billing hotel sends the bill to the respondent; With these clarifications, the issue to be threshed out is as
the local hotel then identifies the individual tourist, or the stated by the respondent court, to wit:
particular group of tourist by code name or group
designation plus the duration of their stay for purposes of
. . . [W]hether or not the hotel room charges held in trust
payment; upon receipt of the bill the private respondent
for foreign tourists and travelers and/or correspondent
pays the local hotel with the funds entrusted to it by the
foreign travel agencies and paid to local host hotels form
foreign tour correspondent agency.
part of the taxable gross receipts for purposes of the 3%
contractor's tax. (Rollo, p. 45)
Moreover, evidence presented by the private respondent
shows that the amounts entrusted to it by the foreign
The petitioner opines that the gross receipts which are
tourist agencies to pay the room charges of foreign
subject to the 3% contractor's tax pursuant to Section 191
tourists in local hotels were not diverted to its funds; this
(Section 205 of the National Internal Revenue Code of
arrangement was only an act of accommodation on the
1977) of the Tax Code include the entire gross receipts of
part of the private respondent. This evidence was not
a taxpayer undiminished by any amount. According to
refuted.
the petitioner, this interpretation is in consonance with
B.I.R. Ruling No. 68-027, dated 23 October, 1968
In essence, the petitioner's assertion that the hotel room (implementing Section 191 of the Tax Code) which states
charges entrusted to the private respondent were part of that the 3% contractor's tax prescribed by Section 191 of
the package fee paid by foreign tourists to the the Tax Code is imposed of the gross receipts of the
respondent is not correct. The evidence is clear to the contractor, "no deduction whatever being allowed by
effect that the amounts entrusted to the private said law." The petitioner contends that the only exception
respondent were exclusively for payment of hotel room to this rule is when there is a law or regulation which
charges of foreign tourists entrusted to it by foreign travel would exempt such gross receipts from being subjected
agencies. to the 3% contractor's tax citing the case of Commissioner
of Internal Revenue v. Manila Jockey Club, Inc. (108 Phil.
As regards the petitioner's second assumption, the 821 [1960]). Thus, the petitioner argues that since there is
respondent court stated: no law or regulation that money entrusted, earmarked
and paid for hotel room charges should not form part of
. . . [C]ontrary to the contention of respondent, the the gross receipts, then the said hotel room charges are
records show, firstly, in the Examiners' Worksheet (Exh. T, p. included in the private respondent's gross receipts for
22, BIR Rec.), that from July to December 1976 alone, the purposes of the 3% contractor's tax.
following sums made up the hotel room
accommodations: In the case of Commissioner of Internal Revenue
v. Manila Jockey Club, Inc. (supra), the Commissioner
July 1976 P 102,702.97 appealed two decisions of the Court of Tax Appeals
Aug. 1976 121,167.19 disapproving his levy of amusement taxes upon the
Sept. 1976 53,209.61 Manila Jockey Club, a duly constituted corporation
————— authorized to hold horse races in Manila. The facts of the
P 282,079.77 case show that the monies sought to be taxed never
really belonged to the club. The decision shows that admittedly 5% out of that 12-1/2% commission. As it did
during the period November 1946 to 1950, the Manila not at that time contemplate the application of "gross
Jockey Club paid amusement tax on its commission but receipts" revenue principle, the law in making a
without including the 5-1/2% which pursuant to Executive distribution of the total wager funds, took no trouble of
Order 320 and Republic Act 309 went to the Board of separating one item from the other; and for
Races, the owner of horses and jockeys. Section 260 of convenience, grouped three items under one common
the Internal Revenue Code provides that the amusement denomination.
tax was payable by the operator on its "gross receipts".
The Manila Jockey Club, however, did not consider as Needless to say, gross receipts of the proprietor of the
part of its "gross receipts" subject to amusement tax the amusement place should not include any money which
amounts which it had to deliver to the Board on Races, although delivered to the amusement place has been
the horse owners and the jockeys. This view was fully especially earmarked by law or regulation for some
sustained by three opinions of the Secretary of Justice, to person other than the proprietor. (The situation thus differs
wit: from one in which the owner of the amusement place, by
a private contract, with its employees or partners, agrees
There is no question that the Manila Jockey, Inc., owns to reserve for them a portion of the proceeds of the
only 7-1/2% of the total bets registered by the Totalizer. establishment. (See Wong & Lee v. Coll. 104 Phil. 469; 55
This portion represents its share or commission in the total Off. Gaz. [51] 10539; Sy Chuico v. Coll., 107 Phil., 428; 59
amount of money it handles and goes to the funds Off. Gaz., [6] 896).
thereof as its own property which it may legally disburse
for its own purposes. The 5% does not belong to the club. In the second case, the facts of the case are:
It is merely held in trust for distribution as prizes to the
owners of winning horses. It is destined for no other object
The Manila Jockey Club holds once a year a so called
than the payment of prizes and the club cannot
"special Novato race", wherein only "novato" horses, (i.e.
otherwise appropriate this portion without incurring
horses which are running for the first time in an official [of
liability to the owners of winning horses. It cannot be
the club] race), may take part. Owners of these horses
considered as an item of expense because the sum used
must pay to the Club an inscription fee of P1.00, and a
for the payment of prizes is not taken from the funds of
declaration fee of P1.00 per horse. In addition, each of
the club but from a certain portion of the total bets
them must contribute to a common fund (P10.00 per
especially earmarked for that purpose.
horse). The Club contributes an equal amount P10.00 per
horse) to such common fund, the total amount of which is
In view of all the foregoing, I am of the opinion that in the added to the 5% participation of horse owners already
submission of the returns for the amusement tax of 10% described herein-above in the first case.
(now it is 20% of the "gross receipts", provided for in
Section 260 of the National Internal Revenue Code), the
Since the institution of this yearly special novato race in
5% of the total bets that is set aside for prizes to owners of
1950, the Manila Jockey Club never paid amusement tax
winning horses should not be included by the Manila
on the moneys thus contributed by horse owners (P10.00
Jockey Club, Inc.
each) because it entertained the belief that in
accordance with the three opinions of the Secretary of
The Collector of the Internal Revenue, however had a Justice herein-above described, such contributions never
different opinion on the matter and demanded payment formed part of its gross receipts. On the inscription fee of
of amusement taxes. The Court of Tax Appeals reversed the P1.00 per horse, it paid the tax. It did not on the
the Collector. declaration fee of P1.00 because it was imposed by the
Municipal Ordinance of Manila and was turned over to
We affirmed the decision of the Court of Tax Appeals and the City officers.
stated:
The Collector of Internal Revenue required the Manila
The Secretary's opinion was correct. The Government Jockey Club to pay amusement tax on such contributed
could not have meant to tax as gross receipt of the fund P10.00 per horse in the special novato race, holding
Manila Jockey Club the 1/2% which it directs same Club they were part of its gross receipts. The Manila Jockey
to turn over to the Board on Races. The latter being a Club protested and resorted to the Court of Tax Appeals,
Government institution, there would be double taxation, where it obtained favorable judgment on the same
which should be avoided unless the statute admits of no grounds sustained by said Court in connection with the
other interpretation. In the same manner, the 5% of the total wager funds in the herein-mentioned first
Government could not have intended to consider as case; they were not receipts of the Club.
gross receipt the portion of the funds which it directed
the Club to give, or knew the Club would give, to winning We resolved the issue in the following manner:
horses and jockeys — admittedly 5%. It is true that the law
says that out of the total wager funds 12-1/2% shall be set
We think the reasons for upholding the Tax Court's
aside as the "commission" of the race track owner, but
decision in the first case apply to this one. The ten-peso
the law itself takes official notice, and actually approves
contribution never belonged to the Club. It was held by it
or directs payment of the portion that goes to owners of
as a trust fund. And then, after all, when it received the
horses as prizes and bonuses of jockeys, which portion is
ten-peso contribution, it at the same time contributed ten
pesos out of its own pocket, and thereafter distributed someone else. (Pollock v. Farmers, L & T Co., 1957 US 429,
both amounts as prizes to horse owners. It would seem 15 S. Ct. 673, 39 Law. ed. 759). The contractor's tax is of
unreasonable to regard the ten-peso contribution of the course payable by the contractor but in the last analysis it
horse owners as taxable receipt of the Club, since the is the owner of the building that shoulders the burden of
latter, at the same moment it received the contribution the tax because the same is shifted by the contractor to
necessarily lost ten pesos too. the owner as a matter of self-preservation. Thus, it is an
indirect tax. And it is an indirect tax on the WHO because,
As demonstrated in the above-mentioned case, gross although it is payable by the petitioner, the latter can shift
receipts subject to tax under the Tax Code do not include its burden on the WHO. In the last analysis it is the WHO
monies or receipts entrusted to the taxpayer which do that will pay the tax indirectly through the contractor and
not belong to them and do not redound to the taxpayer's it certainly cannot be said that 'this tax has no bearing
benefit; and it is not necessary that there must be a law upon the World Health Organization.'"
or regulation which would exempt such monies and
receipts within the meaning of gross receipts under the Petitioner claims that under the authority of the Philippine
Tax Code. Acetylene Company versus Commissioner of Internal
Revenue, et al., (127 Phil. 461) the 3% contractor's tax falls
Parenthetically, the room charges entrusted by the directly on Gotamco and cannot be shifted to the WHO.
foreign travel agencies to the private respondent do not The Court of Tax Appeals, however, held that the said
form part of its gross receipts within the definition of the case is not controlling in this case, since the Host
Tax Code. The said receipts never belonged to the Agreement specifically exempts the WHO from "indirect
private respondent. The private respondent never taxes." We agree. The Philippine Acetylene case involved
benefited from their payment to the local hotels. As a tax on sales of goods which under the law had to be
stated earlier, this arrangement was only to paid by the manufacturer or producer; the fact that the
accommodate the foreign travel agencies. manufacturer or producer might have added the
amount of the tax to the price of the goods did not make
the sales tax "a tax on the purchaser." The Court held that
Another objection raised by the petitioner is to the
the sales tax must be paid by the manufacturer or
respondent court's application of Presidential Decree 31
producer even if the sale is made to tax-exempt entities
which exempts foreign tourists from payment of hotel
like the National Power Corporation, an agency of the
room tax. Section 1 thereof provides:
Philippine Government, and to the Voice of America, an
agency of the United States Government.
Sec. 1. — Foreign tourists and travelers shall be exempt
from payment of any and all hotel room tax for the entire
The Host Agreement, in specifically exempting the WHO
period of their stay in the country.
from "indirect taxes," contemplates taxes which, although
not imposed upon or paid by the Organization directly,
The petitioner now alleges that P.D. 31 has no relevance form part of the price paid or to be paid by it.
to the case. He contends that the tax under Section 191
of the Tax Code is in the nature of an excise tax; that it is
Accordingly, the significance of P.D. 31 is clearly
a tax on the exercise of the privilege to engage in
established in determining whether or not hotel room
business as a contractor and that it is imposed on, and
charges of foreign tourists in local hotels are subject to
collectible from the person exercising the privilege. He
the 3% contractor's tax. As the respondent court aptly
sums his arguments by stating that "while the burden may
stated:
be shifted to the person for whom the services are
rendered by the contractor, the latter is not relieved from
payment of the tax." (Rollo, p. 28) . . . If the hotel room charges entrusted to petitioner will
be subjected to 3% contractor's tax as what respondent
would want to do in this case, that would in effect do
The same arguments were submitted by the
indirectly what P.D. 31 would not like hotel room charges
Commissioner of Internal Revenue in the case
of foreign tourists to be subjected to hotel room tax.
of Commissioner of Internal Revenue v. John Gotamco &
Although, respondent may claim that the 3% contractor's
Son., Inc. (148 SCRA 36 [1987]), to justify his imposition of
tax is imposed upon a different incidence i.e. the gross
the 3% contractor's tax under Section 191 of the National
receipts of petitioner tourist agency which he asserts
Internal Revenue Code on the gross receipts John
includes the hotel room charges entrusted to it, the effect
Gotamco & Sons, Inc., realized from the construction of
would be to impose a tax, and though different, it
the World Health Organization (WHO) office building in
nonetheless imposes a tax actually on room charges.
Manila. We rejected the petitioner's arguments and ruled:
One way or the other, it would not have the effect of
promoting tourism in the Philippines as that would
We agree with the Court of Tax Appeals in rejecting this increase the costs or expenses by the addition of a hotel
contention of the petitioner. Said the respondent court: room tax in the overall expenses of said tourists. (Rollo, pp.
51-52)
"In context, direct taxes are those that are demanded
from the very person who, it is intended or desired, should WHEREFORE, the instant petition is DENIED. The decision of
pay them; while indirect taxes are those that are the Court of Tax Appeals is AFFIRMED. No
demanded in the first instance from one person in the pronouncement as to costs.
expectation and intention that he can shift the burden to
SO ORDERED. 7. The objection that this construction would lead to an
absurdity not contemplated by Congress if the employer
were called upon to pay the tax on the additional
income and a further tax on that payment, and so on, will
Old Colony Trust Co. v. Commissioner of Internal Revenue not he considered, no attempt having been made by the
Treasury to collect further taxes upon the theory that
payment of additional taxes creates further income.
279 U.S. 716
P. 279 U. S. 730.
CERTIFICATE FROM CIRCUIT COURT OF APPEALS Response to a question of law certified by the circuit
court of appeals, arising upon review of a decision of the
FOR THE FIRST CIRCUIT Board of Tax Appeals approving a finding by the
Commissioner of Internal Revenue of deficiencies in
Syllabus income tax returns. See 7 B.T.A. 648. This case was
reargued and decided with the one next following. *
1. A proceeding before the circuit court of appeals,
under Revenue Act of 1926, §§ 283(b), 1001 et seq., in MR. CHIEF JUSTICE TAFT delivered the opinion of the
which a taxpayer sought review of a decision of the Court.
Board of Tax Appeals finding a deficiency in his income
tax return, held to present a " case or controversy " We have before us for consideration two questions
cognizable by that court under the judicial article of the certified from the same circuit court of appeals, No. 130
Constitution. Pp. 279 U. S. 722 et seq. and No. 129. They are presented upon different
statements of facts, and the cases reach the certifying
2. A proceeding begun by an administrative or executive court in different ways, but the questions are so nearly
determination may be a "case or controversy" when it alike that the certifying judges deemed it convenient to
comes on review before a court if it calls for the exercise present them in consolidated form. We prefer to separate
of judicial power only; nor is it essential that there should the questions, discuss and decide No. 130 first, and then
be power to award execution where the final judgment consider No. 129.
establishes a duty of an executive department and is
enforceable through action of the department. P. 279 U. No. 130 comes here by certificate from the Circuit Court
S. 722. of Appeals for the First Circuit. The action in that court
was begun by a petition to review a decision of the
3. Under §§ 1001-1005 of the Revenue Act of 1926, the United States Board of Tax Appeals. The petitioners are
courts authorized to review decisions of the Board of Tax the executors of the will of William M. Wood, deceased.
Appeals have power to award execution of their final On June 27, 1925, before Mr. Wood's death, the
judgments. P. 279 U. S. 726. Commissioner of Internal Revenue notified him by
registered mail of the determination of a deficiency in
4. Assuming that, under § 283(b) of the Revenue Act of income tax against him for the years 1919 and 1920,
1926, a taxpayer whose appeal to the Board of Tax under the Revenue Act of 1918 (40 Stat. 1057). The
Appeals was taken before the date of that Act and deficiency was revised by the Commissioner August 18,
decided adversely to him after it may resort both to the 1925. An appeal was taken to the Board of Tax Appeals,
circuit court of appeals by way of review and to the which was filed October 27, 1925. A hearing before the
district court by way of an action to recover the tax Board, April 11, 1927, resulted in a decision November 12,
(having first paid it), this does not prevent the circuit court 1927. The Board approved the action of the
of appeals, being a constitutional court, from having Commissioner, and found a deficiency in the federal
jurisdiction under the Act, since, on the principle of res income tax return of Mr. Wood for the year 1919 of
judicata, if both remedies were pursued, the judgment $708,781.93, and for the year 1920 of $350,837.14. The
first in time would be a final adjudication conclusive on petition for review was perfected December 23, 1927,
both courts. P. 279 U. S. 727. pursuant to the Revenue Act of 1926, § 283(j), and §§
1001 to 1005, c. 27, 44 Stat. 9, 65, 109, and Rule 38 of the
First Circuit Court of Appeals.
5. A certificate by the circuit court of appeals of a
question of law involved in a review of a decision of the
Board of Tax Appeals held within the appellate The facts certified to us are substantially as follows:
jurisdiction of this Court under the Constitution. P. 279 U. S.
728. William M. Wood was president of the American Woolen
Company during the years 1918, 1919, and 1920. In 1918
6. Payment by an employer of the income taxes he received as salary and commissions from the
assessable against the compensation of an employee, company $978,725, which he included in his federal
made in consideration of his services, constitutes income tax return for 1918. In 1919, he received as salary
additional taxable income of the employee under the and commissions from the company $548,132.87, which
Revenue Act of 1918. P. 279 U. S. 729. he included in his return for 1919.
August 3, 1916, the American Woolen Company had created by Congress to provide taxpayers an opportunity
adopted the following resolution, which was in effect in to secure an independent review of the Commissioner of
1919 and 1920: Internal Revenue's determination of additional income
and estate taxes by the Board in advance of their paying
"Voted: That this company pay any and all income taxes, the tax found by the Commissioner to be due. Before the
state and Federal, that may hereafter become due and Act of 1924, the taxpayer could only contest the
payable upon the salaries of all the officers of the Commissioner's determination of the amount of the tax
company, including the president, William M. Wood; the after its payment. The Board's duty under the Act of 1924
comptroller, Parry C. Wiggin; the auditor, George was to hear, consider, and decide whether deficiencies
R.Lawton, and the following members of the staff, to-wit: reported by the Commissioner were right.
Frank H. Carpenter, Edwin L. Heath, Samuel R. Haines,
and William M. Lasbury, to the end that said persons and Section 273 of that Act defined a "deficiency" to be the
officers shall receive their salaries or other compensation amount by which the tax imposed exceeded the amount
in full without deduction on account of income taxes, shown by the return of the taxpayer after the return was
state or federal, which taxes are to be paid out of the increased by the amounts previously assessed or
treasury of this corporation." disallowed. There was under the Act of 1924 no direct
judicial review of the proceedings before the Board of
This resolution was amended on March 25, 1918, as Tax Appeals. But each party had the unhindered right to
follows: seek separate action by a court of competent jurisdiction
to test the correctness of the Board's action. Such court
proceedings were to be begun within one year after the
"Voted: That, referring to the vote passed by this board on
final decision of the Board.
August 3, 1916, in reference to income taxes, state and
federal, payable upon the salaries or compensation of
the officers and certain employees of this company, the Section 274(b) provided that, if the Board determined
method of computing said taxes shall be as follows, viz.:" there was a deficiency, the amount so determined
should be assessed and paid upon notice and demand
from the collector. No part of the amount determined as
"The difference between what the total amount of his tax
a deficiency by the Commissioner, but disallowed as a
would be, including his income from all sources, and the
deficiency by the Board, could be assessed, but the
amount of his tax when computed upon his income
Commissioner was at liberty, notwithstanding the decision
excluding such compensation or salaries paid by this
of the Board against him, to bring a suit in a proper court
company."
against the taxpayer to collect the alleged deficiency.
"Did the payment by the employer of the income taxes The chief change made by the Act of 1926 was the
assessable against the employee constitute additional provision for direct judicial review of the Board's decisions
taxable income to such employee?" by the filing by the Commissioner or the taxpayer of a
petition for review in a circuit court of appeals or the
The first point presented to us is that of the jurisdiction of Court of Appeals of the District of Columbia under rules
this Court to answer the question of law certified. It adopted by such courts.
requires us to examine the original statute providing for
the Board of Tax Appeals under the Revenue Act of 1924, It is suggested that the proceedings before the circuit
and the amending act of 1926. courts of appeals or the district court of appeals on a
petition to review are, and cannot be, judicial, for they
The Board of Tax Appeals, established by § 900 of the involve "no case or controversy," and, without this, a
Revenue Act of 1924, Tit. 9, c. 243, 43 Stat. 253, 336, was circuit court of appeals, which is a constitutional court (Ex
parte Bakelite Corporation, ante, p. 279 U. S. 438) is respecting them shall assume such a form that the
incapable of exercising its judicial function. This view of judicial power is capable of acting on it. That power is
the nature of the proceedings we cannot sustain. capable of acting only when the subject is submitted to it
by a party who asserts his rights in the form prescribed by
The case is analogous to the suits which are lodged in the law. It then becomes a case, and the Constitution
circuit courts of appeals upon petition or finding of an declares that the judicial power shall extend to all cases
executive or administrative tribunal. It is not important arising under the Constitution, laws, and treaties of the
whether such a proceeding was originally begun by an United States."
administrative or executive determination if, when it
comes to the court, whether legislative or constitutional, it The circuit court of appeals is a constitutional court under
calls for the exercise of only the judicial power of the the definition of such courts as given in
court upon which jurisdiction has been conferred by law. the Bakelite case, supra,and a case or controversy may
come before it provided it involves neither advisory nor
The jurisdiction in this cause is quite like that of circuit executive action by it.
courts of appeals in review of orders of the Federal Trade
Commission. Federal Trade Commission v. Eastman Kodak In the case we have here, there are adverse parties. The
Co., 274 U. S. 619, 274 U. S. 623; Silver Co. v. Federal Trade United States or its authorized official asserts its right to the
Commission, 292 F. 752. There are other instances of a like the payment by a taxpayer of a tax due from him to the
kind which can be cited. United States v. Ritchie, 17 How. government, and the taxpayer is resisting that payment
525, 58 U. S. 534; Interstate Commerce Commission v. or is seeking to recover what he has already paid as taxes
Brimson, 154 U. S. 447, 154 U. S. 469; Stephens v. Cherokee when by law they were not properly due. That makes a
Nation, 174 U. S. 445, 174 U. S. 477. See also Fong Yue Ting case or controversy, and the proper disposition of it is the
v. United States, 149 U. S. 698, 149 U. S. 714. exercise of judicial power. The courts are either the circuit
court of appeals or the District of Columbia Court of
It is not necessary that the proceeding, to be judicial, Appeals. The subject matter of the controversy is the
should be one entirely de novo. It is enough that, before amount of the tax claimed to be due or refundable and
the judgment, which must be final, has been invoked as its validity, and the judgment to be rendered is a judicial
an exercise of judicial power, it shall have certain judgment.
necessary features. What these are has been often
declared by this Court. Perhaps the most comprehensive The Board of Tax Appeals is not a court. It is an executive
definitions of them are set forth in Muskrat v. United or administrative board, upon the decision of which the
States, 219 U. S. 346, 219 U. S. 356, where this Court parties are given an opportunity to base a petition for
entered into the inquiry what was the exercise of judicial review to the courts after the administrative inquiry of the
power as conferred by the Constitution. There was cited Board has been had and decided.
there a definition by Mr. Justice Field in Re Pacific Railway
Commission, 32 F. 241, 255, which has been generally It is next suggested that there is no adequate finality
accepted as accurate. He said: provided in respect to the action of these courts. In the
first place, it is not necessary, in order to constitute a
"The judicial article of the Constitution mentions cases judicial judgment, that there should be both a
and controversies. The term 'controversies,' if determination of the rights of the litigants and also power
distinguishable at all from 'cases,' is so in that it is less to issue formal execution to carry the judgment into
comprehensive than the latter, and includes only suits of effect in the way that judgments for money or for the
a civil nature. Chisholm v. Georgia, 2 Dall. 431, 2 U. S. 432; possession of land usually are enforced. A judgment is
1 Tuck.Bl. Comm.App. 420, 421. By cases and sometimes regarded as properly enforceable through the
controversies are intended the claims of litigants brought executive departments, instead of through an award of
before the courts for determination by such regular execution by this Court, where the effect of the judgment
proceedings as are established by law or custom for the is to establish the duty of the department to enforce it. La
protection or enforcement of rights or the prevention, Abra Silver Mining Co. v. United States, 175 U. S. 423, 175
redress, or punishment of wrongs. Whenever the claim of U. S. 457, 175 U. S. 461. The case of Fidelity National Bank
a party under the Constitution, laws, or treaties of the & Trust Co. v. Swope, 274 U. S. 123, 274 U. S. 132, shows
United States takes such a form that the judicial power is clearly that there are instances where the award of
capable of acting upon it, then it has become a case. execution is not an indispensable element of a
The term implies the existence of present or possible constitutional case or controversy. In that decision there
adverse parties whose contentions are submitted to the are collected familiar examples of judicial proceedings
court for adjudication." resulting in a final adjudication of the rights of litigants
without it.
In Osborn v. United States Bank, 9 Wheat. 738, Chief
Justice Marshall construed Article III of the Constitution as But, even if a formal execution be required, we think
follows: power to resort to it is clearly shown with respect to the
enforcement of the action of the courts here involved by
"This clause enables the judicial department to receive §§ 1001 to 1005.
jurisdiction to the full extent of the constitution, laws and
treaties of the United States when any question
By the first, the decision of the Board of Tax Appeals enactment of this Act, the Board shall have jurisdiction of
rendered after the passage of the Act of 1926 may be the appeal. In all such cases, the powers, duties, rights,
reviewed by the circuit court of appeals or the district and privileges of the Commissioner and of the person
court of appeals if a petition for such review is filed either who has brought the appeal, and the jurisdiction of the
by the Commissioner or the taxpayer within six months Board and of the courts, shall be determined, and the
after the decision is rendered. The courts are to adopt computation of the tax shall be made, in the same
rules for the filing of the petition, the preparation of the manner as provided in subdivision (a) of this section,
record, and the conduct of the proceedings upon such except as provided in subdivision (j) of this section and
review. The review is not to operate as a stay of except that the person liable for the tax shall not be
assessment or collection of any portion of the amount of subject to the provisions of subdivision (d) of Section 284."
the deficiency determined by the Board unless a petition
for review is filed by the taxpayer, or unless the taxpayer The provisions of § 284(d) are those which deny to the
has filed a bond which when enforced will operate finally taxpayer the power to bring any suit for the recovery of
to settle the rights of the parties as found by the courts. the tax after he has adopted the procedure of appealing
to the Board of Tax Appeals or to the circuit court of
By § 1002, it is provided in what venue the decision may appeals.
be reviewed. In § 1003, the circuit courts of appeals and
the court of appeals of the district are given exclusive By this last exception in 283(b), there seems still open to
jurisdiction to review the decisions of the Board, and it is the taxpayers who have filed a petition under the law of
declared that their judgments shall be final, except that 1924 and have not had a decision by the Board before
they shall be subject to review by the Supreme Court of the enactment of the law of 1926, the right to pay the tax
the United States, on certificate or by certiorari in the and sue for a refund in the proper district court
manner provided in § 240 of the Judicial Code as (paragraph 20 of § 24 of the Judicial Code, as amended
amended, and, in such review, the courts shall have the by § 1310(c), c. 136, 42 Stat. 311, U.S.Code, Title 28, §
power to affirm, or, if the decision of the Board is not in 41). Emery v. United States, 27 F.2d 992, and Old Colony
accordance with law, to modify or reverse, the decision R. Co. v. United States, 27 F.2d 994, hold that the
of the Board, with or without remanding the case for a petitioner still retains this earlier remedy.
rehearing, as justice may require.
The truth seems to be that, in making provision to render
By § 1004, the same courts are given power to impose conclusive judgments on petitions for review in the circuit
damages in any case where the decision of the Board is courts of appeals, Congress was not willing, in cases
affirmed and it appears that the petition was filed merely where the Board of Tax Appeals had not decided the
for delay. issue before the passage of the Act of 1926, to cut off the
taxpayer from paying the tax and suing for a refund in
By § 1005, the decision of the Board is to become final in the proper district court. But the apparent conflict in such
respect to all the numerous instances which in the course cases can be easily resolved by the use of the principles
of the review may naturally end further litigation. In the of res judicata. If both remedies are pursued, the one in a
provisions of these sections, the legislation prescribes district court for refund and the other on a petition for
minute details for the enforcement of the judgments that review in the circuit court of appeals, the judgment which
are the result of these petitions for review in the several is first rendered will then put an end to the questions
courts vested with jurisdiction over them. involved, and in effect make all proceedings in the other
court of no avail. Whichever judgment is first in time is
The complete purpose of Congress to provide a final necessarily final to the extent to which it becomes a
adjudication in such proceedings, binding all the parties, judgment. There is no reason, therefore, in the case
is manifest, and demonstrates the unsoundness of the before us to decline to take jurisdiction. See Bryar v.
objection. Campbell, 177 U. S. 649; Kline v. Burke Construction
Co., 260 U. S. 226, 260 U. S. 230; Stanton v. Embry, 93 U. S.
548, 93 U. S. 554.
We have before us, however, for actual inquiry a case
different from one just considered in the regular course of
a petition for review of a decision of the Board begun Second. The jurisdiction here is based upon the certificate
and decided all after the enactment of the Act of 1926. It of a question of law. That is whether the payment by the
is one in which the appeal to the Board of Tax Appeals employer of the income taxes assessed against the
had been taken, but the appeal had not been decided employee constitutes additional returnable taxable
by the Board before the passage of the Act of 1926. That income to such employee. The certification of such a
presents what involves a troublesome exception or question by the circuit court of appeals is an invocation
duplication in the procedure. This occurs because of the of the appellate jurisdiction of this Court, and therefore
last excepting clause of § 283(b) of the amending act of within the Constitution.
1926, which is as follows:
Third. Coming now to the merits of this case, we think the
"If, before the enactment of this Act, any person has question presented is whether a taxpayer, having
appealed to the Board of Tax Appeals under subdivision induced a third person to pay his income tax or having
(a) of Section 274 of the Revenue Act of 1924 . . . and the acquiesced in such payment as made in discharge of an
appeal is pending before the Board at the time of the obligation to him, may avoid the making of a return
thereof and the payment of a corresponding tax. We logical conclusion, and results in an absurdity which
think he may not do so. The payment of the tax by the Congress could not have contemplated.
employers was in consideration of the services rendered
by the employee, and was again derived by the In the first place, no attempt has been made by the
employee from his labor. The form of the payment is Treasury to collect further taxes upon the theory that the
expressly declared to make no difference. Section 213, payment of the additional taxes creates further income,
Revenue Act of 1918, c. 18, 40 Stat. 1065. It is therefore and the question of a tax upon a tax was not before the
immaterial that the taxes were directly paid over to the circuit court of appeals, and has not been certified to this
government. The discharge by a third person of an Court. We can settle questions of that sort when an
obligation to him is equivalent to receipt by the person attempt to impose a tax upon a tax is undertaken, but
taxed. The certificate shows that the taxes were imposed not now. United States v. Sullivan, 274 U. S. 259, 274 U. S.
upon the employee, that the taxes were actually paid by 264; Yazoo & Mississippi Valley R. Co. v. Jackson Vinegar
the employer, and that the employee entered upon his Co., 226 U. S. 217, 226 U. S. 219. It is not, therefore,
duties in the years in question under the express necessary to answer the argument based upon an
agreement that his income taxes would be paid by his algebraic formula to reach the amount of taxes due. The
employer. This is evidenced by the terms of the resolution question in this case is, "Did the payment by the employer
passed August 3, 1916, more than one year prior to the of the income taxes assessable against the employee
year in which the taxes were imposed. The taxes were constitute additional taxable income to such employee?"
paid upon a valuable consideration -- namely, the The answer must be "Yes."
services rendered by the employee and as part of the
compensation therefor. We think, therefore, that the
* After the first argument, the Court, on February 18, 1929,
payment constituted income to the employee.
made the following order:
Affirmed.
The principal issue before us is whether money obtained In 1941, in response to petitioner's request, Reinfeld gave
by extortion is income taxable to the extortioner under § him about $10,000 to help buy a tavern. When petitioner
22(a) of the Internal Revenue Code. [Footnote 1] For the used the money for other purposes, Reinfeld refused to
reasons hereafter stated, we hold that it is. finance him further, and his "trouble" with petitioner
began. In 1942, petitioner again claimed that he had
The petitioner, Rutkin, was indicted under 26 U.S.C. § had an interest in Browne Vintners Company and that
145(b) [Footnote 2] for willfully attempting to evade and Reinfeld must give him $100,000 to help him pay his debts.
defeat a large part of his income and victory taxes for Upon Reinfeld's refusal, petitioner threatened to kill him.
1943. He was charged with filing a false and fraudulent From that time on, the record presents a lurid story of
return stating his net income to be $18,966.64, whereas he petitioner's unsatisfied demands upon Reinfeld for various
knew that it was $268,622.04. That difference, which sums up to $500,000, petitioner's threatening use of a gun,
would increase his tax liability from $6,843.93 to and his repeated statements that he would kill Reinfeld
and Reinfeld's family unless his demands were met. Such gains are taxable in the yearly period during which
Finally, on May 11, 1943, in New Jersey, Reinfeld paid they are realized. This statutory policy is invoked in the
petitioner $250,000 in cash. [Footnote 5] interest of orderly administration.
Throughout this melodrama, petitioner asserted that he "[C]ollection of the revenue cannot be delayed, nor
was entitled to the payments he demanded from should the Treasury be compelled to decide when a
Reinfeld because of petitioner's alleged former interest in possessor's claims are without legal warrant."
Browne Vinters Company. That interest never was
identified by petitioner. Reinfeld and others testified National City Bank v. Helvering, 98 F.2d 93, 96. There is no
positively that petitioner never had any such interest. adequate reason why assailable unlawful gains should be
Nevertheless, on May 11, Reinfeld handed to petitioner treated differently in this respect from assailable lawful
$250,000 in cash at the same time that Reinfeld paid gains. Certainly there is no reason for treating them more
$358,000 to Zwillman and Stacher representing their leniently. United States v. Sullivan, 274 U. S. 259, 274 U. S.
conceded interest in the proceeds of Browne Vintners 263.
stock. Petitioner, with Zwillman and Stacher, thereupon
signed a "general release." It did not state the amounts
There has been a widespread and settled administrative
paid, but it did purport to release Reinfeld, Browne
and judicial recognition of the taxability of unlawful gains
Vintners Company and others from all claims the signers
of many kinds under § 22(a). [Footnote 8] The application
had against them.
of this section to unlawful gains is obvious from its
legislative history. Section II, subd. B of the Income Tax Act
Under the jury's verdict, we accept the fact to be that of 1913 provided that
petitioner had no basis for his claim to this $250,000, and
that he obtained it by extortion. Accordingly, if proceeds
"the net income of a taxable person shall include gains,
of extortion constitute income taxable to the extortioner,
profits, and income . . . from . . . the transaction of
his omission of it from his tax return was unlawful. The
any lawfulbusiness carried on for gain or profit, or gains or
further factual issue whether, under all the surrounding
profits and income derived from any source whatever. . .
circumstances, petitioner's omission of the $250,000 from
."
his tax return amounted to a willful attempt to evade and
defeat the tax is not open to review here. That issue is
settled by the verdict of the jury supported by substantial (Emphasis supplied.) 38 Stat. 167. In 1916, this was
evidence. [Footnote 6] It remains for us to determine the amended by omitting the one word "lawful" with the
legal issue of whether money obtained by extortion is obvious intent thereafter to tax unlawful as well as lawful
taxable to the extortioner under § 22(a). gains, profits or income derived from any source
whatever. [Footnote 9]
Under the instructions to the jury, extortion here meant
that the $250,000 was paid to petitioner in response to his There is little doubt now that, where unlawful gains are
false claim thereto, his harassing demands therefor, and secured by the fraud of the taxpayer, they are taxable.
his repeated threats to kill Reinfeld and Reinfeld's family [Footnote 10] In the instant case, it is not questioned that
unless the payment were made. [Footnote 7] Petitioner the $250,000 would have been taxable to petitioner if he
was unable to induce Reinfeld to believe petitioner's false had obtained it by fraudulently inducing Reinfeld to
and fraudulent claims to the money to be true. He believe petitioner's false claims to be true. That being so,
induced Reinfeld to consent to pay the money by it would be an extraordinary result to hold here that
creating a fear in Reinfeld that harm otherwise would petitioner is to be tax free because his fraud was so
come to him and to his family. Reinfeld thereupon transparent that it did not mislead his victim and his victim
delivered his own money to petitioner. Petitioner's control paid him the money because of fear, instead of fraud.
over the cash so received was such that, in the absence
of Reinfeld's unlikely repudiation of the transaction and We do not reach in this case the factual situation
demand for the money's return, petitioner could enjoy its involved in Commissioner v. Wilcox, 327 U. S. 404. We limit
use as fully as though his title to it were unassailable. that case to its facts. There, embezzled funds were held
not to constitute taxable income to the embezzler under
An unlawful gain, as well as a lawful one, constitutes § 22(a). The issue here is whether money extorted from a
taxable income when its recipient has such control over it victim with his consent induced solely by harassing
that, as a practical matter, he derives readily realizable demands and threats of violence is included in the
economic value from it. Burnet v. Wells, 289 U. S. 670, 289 definition of gross income under § 22(a). We think the
U. S. 678; Corliss v. Bowers, 281 U. S. 376, 281 U. S. 378. That power of Congress to tax these receipts as income under
occurs when cash, as here, is delivered by its owner to the Sixteenth Amendment is unquestionable. The broad
the taxpayer in a manner which allows the recipient language of § 22(a) supports the declarations of this
freedom to dispose of it at will, even though it may have Court that Congress, in enacting that section, exercised
been obtained by fraud and his freedom to use it may be its full power to tax income. [Footnote 11] We therefore
assailable by someone with a better title to it. conclude that § 22(a) reaches these receipts.
1. Where, in 1934 and 1935, an owner of negotiable The court below thought that, as the consideration for the
bonds, who reported income on the cash receipts basis, coupons had passed to the obligor, the donor had, by
detached from the bonds negotiable interest coupons the gift, parted with all control over them and their
before their due date and delivered them as a gift to his payment, and for that reason the case was
son, who, in the same year, collected them at distinguishable from Lucas v. Earl, supra, and Burnet v.
maturity, held that, under § 22 of the Revenue Act of Leininger, 285 U. S. 136, where the assignment of
1934, and in the year that the interest payments were compensation for services had preceded the rendition of
made, there was a realization of income, in the amount the services, and where the income was held taxable to
of such payments, taxable to the donor. P. 311 U. S. 117. the donor.
2. The dominant purpose of the income tax laws is the The holder of a coupon bond is the owner of two
taxation of income to those who earn or otherwise create independent and separable kinds of right. One is the right
the right to receive it and who enjoy the benefit of it to demand and receive at maturity the principal amount
when paid. P. 311 U. S. 119. of the bond representing capital investment. The other is
the right to demand and receive interim payments of
3. The tax laid by the 1934 Revenue Act upon income interest on the investment in the amounts and on the
"derived from . . . wages or compensation for personal dates specified by the coupons. Together, they are an
service, of whatever kind and in whatever form paid . . . ; obligation to pay principal and interest given in
also from interest . . . " cannot fairly be interpreted as not exchange for money or property which was presumably
applying to income derived from interest or the consideration for the obligation of the bond. Here
compensation when he who is entitled to receive it respondent, as owner of the bonds, had acquired the
makes use of his power to dispose of it in procuring legal right to demand payment at maturity of the interest
satisfactions which he would otherwise procure only by specified by the coupons and the power to command its
the use of the money when received. P. 311 U. S. 119. payment to others which constituted an economic gain
to him.
4. This case distinguished from Blair v. Commissioner, 300
U. S. 5, and compared with Lucas v. Earl, 281 U. S. 111, Admittedly not all economic gain of the taxpayer is
and Burnet v. Leininger, 285 U. S. 136. Pp. 311 U. S. 118-120. taxable income. From the beginning, the revenue laws
have been interpreted as defining "realization" of income
107 F.2d 906, reversed. as the taxable event, rather than the acquisition of the
right to receive it. And "realization" is not deemed to
occur until the income is paid. But the decisions and
Certiorari, 309 U.S. 650, to review the reversal of an order regulations have consistently recognized that receipt in
of the Board of Tax Appeals, 39 B.T.A. 757, sustaining a cash or property is not the only characteristic of
determination of a deficiency in income tax. realization of income to a taxpayer on the cash receipts
basis. Where the taxpayer does not receive payment of
MR. JUSTICE STONE delivered the opinion of the Court. income in money or property, realization may occur
when the last step is taken by which he obtains the
The sole question for decision is whether the gift, during fruition of the economic gain which has already accrued
the donor's taxable year, of interest coupons detached to him. Old Colony Trust Co. v. Commissioner, 279 U. S.
from the bonds, delivered to the donee and later in the 716; Corliss v. Bowers, 281 U. S. 376, 281 U. S. 378. Cf.
year paid at maturity, is the realization of income taxable Burnet v. Wells, 289 U. S. 670.
to the donor.
In the ordinary case the taxpayer who acquires the right
In 1934 and 1935, respondent, the owner of negotiable to receive income is taxed when he receives it, regardless
bonds, detached from them negotiable interest coupons of the time when his right to receive payment accrued.
shortly before their due date and delivered them as a gift But the rule that income is not taxable until realized has
to his son, who, in the same year, collected them at never been taken to mean that the taxpayer, even on
maturity. The Commissioner ruled that, under the the cash receipts basis, who has fully enjoyed the benefit
applicable § 22 of the Revenue Act of 1934, 48 Stat. 680, of the economic gain represented by his right to receive
686, the interest payments were taxable, in the years income can escape taxation because he has not himself
when paid, to the respondent donor, who reported his received payment of it from his obligor. The rule, founded
income on the cash receipts basis. The circuit court of on administrative convenience, is only one of
appeals reversed the order of the Board of Tax Appeals postponement of the tax to the final event of enjoyment
sustaining the tax. 107 F.2d 906; 39 B.T.A. 757. We granted of the income, usually the receipt of it by the taxpayer,
and not one of exemption from taxation where the the fruits of his investment or labor because he has
enjoyment is consummated by some event other than assigned them instead of collecting them himself and
the taxpayer's personal receipt of money or property. Cf. then paying them over to the donee is to affront
Aluminum Castings Co. v. Routzahn, 282 U. S. 92,282 U. S. common understanding and to deny the facts of
98. This may occur when he has made such use or common experience. Common understanding and
disposition of his power to receive or control the income experience are the touchstones for the interpretation of
as to procure in its place other satisfactions which are of the revenue laws.
economic worth. The question here is whether, because
one who in fact receives payment for services or interest The power to dispose of income is the equivalent of
payments is taxable only on his receipt of the payments, ownership of it. The exercise of that power to procure the
he can escape all tax by giving away his right to income payment of income to another is the enjoyment, and
in advance of payment. If the taxpayer procures hence the realization, of the income by him who
payment directly to his creditors of the items of interest or exercises it. We have had no difficulty in applying that
earnings due him, see Old Colony Trust Co. v. proposition where the assignment preceded the rendition
Commissioner, supra; Bowers v. Kerbaugh-Empire Co.,271 of the services, Lucas v. Earl, supra; Burnet v. Leininger,
U. S. 170; United States v. Kirby Lumber Co., 284 U. S. 1, or if supra, for it was recognized in the Leininger case that, in
he sets up a revocable trust with income payable to the such a case, the rendition of the service by the assignor
objects of his bounty, §§ 166, 167, Corliss v. Bowers, supra; was the means by which the income was controlled by
cf. Dickey v. Burnet, 56 F.2d 917, 921, he does not escape the donor, and of making his assignment effective. But it is
taxation because he did not actually receive the the assignment by which the disposition of income is
money. Cf. Douglas v. Willcuts, 296 U. S. 1; Helvering v. controlled when the service precedes the assignment,
Clifford, 309 U. S. 331. and, in both cases, it is the exercise of the power of
disposition of the interest or compensation, with the
Underlying the reasoning in these cases is the thought resulting payment to the donee, which is the enjoyment
that income is "realized" by the assignor because he, who by the donor of income derived from them.
owns or controls the source of the income, also controls
the disposition of that which he could have received This was emphasized in Blair v. Commissioner, 300 U. S. 5,
himself and diverts the payment from himself to others as on which respondent relies, where the distinction was
the means of procuring the satisfaction of his wants. The taken between a gift of income derived from an
taxpayer has equally enjoyed the fruits of his labor or obligation to pay compensation and a gift of income-
investment and obtained the satisfaction of his desires producing property. In the circumstances of that case,
whether he collects and uses the income to procure the right to income from the trust property was thought to
those satisfactions or whether he disposes of his right to be so identified with the equitable ownership of the
collect it as the means of procuring them. Cf. Burnet v. property from which alone the beneficiary derived his
Wells, supra. right to receive the income and his power to command
disposition of it that a gift of the income by the
Although the donor here, by the transfer of the coupons, beneficiary became effective only as a gift of his
has precluded any possibility of his collecting them ownership of the property producing it. Since the gift was
himself, he has nevertheless, by his act, procured deemed to be a gift of the property, the income from it
payment of the interest, as a valuable gift to a member was held to be the income of the owner of the property,
of his family. Such a use of his economic gain, the right to who was the donee, not the donor, a refinement which
receive income, to procure a satisfaction which can be was unnecessary if respondent's contention here is right,
obtained only by the expenditure of money or property but one clearly inapplicable to gifts of interest or wages.
would seem to be the enjoyment of the income whether Unlike income thus derived from an obligation to pay
the satisfaction is the purchase of goods at the corner interest or compensation, the income of the trust was
grocery, the payment of his debt there, or such regarded as no more the income of the donor than
nonmaterial satisfactions as may result from the payment would be the rent from a lease or a crop raised on a farm
of a campaign or community chest contribution, or a gift after the leasehold or the farm had been given
to his favorite son. Even though he never receives the away. Blair v. Commissioner, supra, 300 U. S. 12-13, and
money, he derives money's worth from the disposition of cases cited. See also Reinecke v. Smith, 289 U. S. 172, 289
the coupons which he has used as money or money's U. S. 177. We have held without deviation that, where the
worth in the procuring of a satisfaction which is donor retains control of the trust property, the income is
procurable only by the expenditure of money or money's taxable to him although paid to the donee. Corliss v.
worth. The enjoyment of the economic benefit accruing Bowers, supra. Cf. Helvering v. Clifford, supra.
to him by virtue of his acquisition of the coupons is
realized as completely as it would have been if he had The dominant purpose of the revenue laws is the taxation
collected the interest in dollars and expended them for of income to those who earn or otherwise create the right
any of the purposes named. Burnet v. Wells, supra. to receive it and enjoy the benefit of it when paid. See
Corliss v. Bowers, supra, 281 U. S. 378; Burnet v.
In a real sense, he has enjoyed compensation for money Guggenheim, 288 U. S. 280, 288 U. S. 283. The tax laid by
loaned or services rendered, and not any the less so the 1934 Revenue Act upon income "derived from . . .
because it is his only reward for them. To say that one wages, or compensation for personal service, of
who has made a gift thus derived from interest or whatever kind and in whatever form paid . . . ; also from
earnings paid to his donee has never enjoyed or realized interest . . ." therefore cannot fairly be interpreted as not
applying to income derived from interest or Commissioner, holding that the amounts collected on the
compensation when he who is entitled to receive it coupons were taxable as income to the petitioner."
makes use of his power to dispose of it in procuring
satisfactions which he would otherwise procure only by The decision of the Board of Tax Appeals was reversed,
the use of the money when received. and properly so, I think.
It is the statute which taxes the income to the donor The unmatured coupons given to the son were
although paid to his donee. Lucas v. Earl, supra; Burnet v. independent negotiable instruments, complete in
Leininger, supra. True, in those cases, the service which themselves. Through the gift, they became at once the
created the right to income followed the assignment, absolute property of the donee, free from the donor's
and it was arguable that, in point of legal theory, the right control and in no way dependent upon ownership of the
to the compensation vested instantaneously in the bonds. No question of actual fraud or purpose to defraud
assignor when paid, although he never received it, while the revenue is presented.
here, the right of the assignor to receive the income
antedated the assignment which transferred the right,
Neither Lucas v. Earl, 281 U. S. 111, nor Burnet v.
and thus precluded such an instantaneous vesting. But
Leininger, 285 U. S. 136, supports petitioner's view. Blair v.
the statute affords no basis for such "attenuated
Commissioner,300 U. S. 5, 300 U. S. 11-12, shows that
subtleties." The distinction was explicitly rejected as the
neither involved an unrestricted completed transfer of
basis of decision in Lucas v. Earl. It should be rejected
property.
here, for no more than in the Earl case can the purpose
of the statute to tax the income to him who earns or
creates and enjoys it be escaped by "anticipatory Helvering v. Clifford, 309 U. S. 331, 309 U. S. 335-336,
arrangements . . . however skilfully devised" to prevent decided after the opinion below, is much relied upon by
the income from vesting even for a second in the donor. petitioner, but involved facts very different from those
now before us. There, no separate thing was absolutely
transferred and put beyond possible control by the
Nor is it perceived that there is any adequate basis for
transferor. The court affirmed that Clifford, both conveyor
distinguishing between the gift of interest coupons here
and trustee,
and a gift of salary or commissions. The owner of a
negotiable bond and of the investment which it
represents, if not the lender, stands in the place of the "retained the substance of full enjoyment of all the rights
lender. When, by the gift of the coupons, he has which previously he had in the property. . . . In substance,
separated his right to interest payments from his his control over the corpus was in all essential respects the
investment and procured the payment of the interest to same after the trust was created, as before. . . . With that
his donee, he has enjoyed the economic benefits of the control in his hands, he would keep direct command over
income in the same manner and to the same extent as all that he needed to remain in substantially the same
though the transfer were of earnings, and, in both cases, financial situation as before."
the import of the statute is that the fruit is not to be
attributed to a different tree from that on which it The general principles approved in Blair v.
grew. See Lucas v. Earl, supra, 281 U. S. 115. Commissioner, 300 U. S. 5, are applicable and controlling.
The challenged judgment should be affirmed.
Reversed.
In view of the failure of petitioner Commissioner of Internal WHEREFORE, in view of all the
Revenue (CIR) to resolve their request for foregoing, the court finds the instant
reconsideration/protest within the aforesaid period, FDC petition partly meritorious. Accordingly,
and FAI filed on 17 October 2000 a petition for review Assessment Notice No. SP-INC-96-00018-
with the Court of Tax Appeals (CTA) pursuant to Section 2000 imposing deficiency income tax on
228 of the 1997 NIRC. Docketed before said court as CTA FDC for taxable year 1996, Assessment
Case No. 6182, the petition alleged, among other Notice No. SP-DST-96-00020-2000 and SP-
matters, that as previously opined in BIR Ruling No. S-34- DST-97-00021-2000 imposing deficiency
046-97, no taxable gain should have been assessed from documentary stamp tax on FDC for
the subject Deed of Exchange since FDC and FAI taxable years 1996 and 1997,
collectively gained further control of FLI as a respectively and Assessment Notice No.
consequence of the exchange; that correlative to the SP-INC-97-0027-2000 imposing deficiency
CIR's lack of authority to impute theoretical interests on income tax on FAI for the taxable year
the cash advances FDC extended in favor of its affiliates, 1997 are hereby CANCELLED and SET
the rule is settled that interests cannot be demanded in ASIDE.However, [FDC] is hereby ORDERED
the absence of a stipulation to the effect; that not being to PAY the amount of P5,691,972.03 as
promissory notes or certificates of obligations, the deficiency income tax for taxable year
instructional letters as well as the cash and journal 1997. In addition, petitioner is
vouchers evidencing said cash advances were not also ORDERED to PAY 20% delinquency
subject to documentary stamp taxes; and, that no interest computed from February 16,
income tax may be imposed on the prospective gain 2000 until full payment thereof pursuant
from the supposed appreciation of FDC's shareholdings in to Section 249 (c) (3) of the Tax Code.[26]
income taxes on the exchange of property between
FDC, FAI and FLI; (b) for deficiency documentary stamp
Finding that the collective increase of the equity taxes on the documents evidencing FDC's cash
participation of FDC and FAI in FLI rendered the gain advances to its affiliates; and (c) for deficiency income
derived from the exchange tax-free, the CTA also ruled tax on the gain FDC purportedly realized from the
that the increase in the value of FDC's shares in FAC did increase of the value of its shareholdings in FAC. [32] The
not result in economic advantage in the absence of foregoing petition was, however, denied due course and
actual sale or conversion thereof. While likewise finding dismissed for lack of merit in the herein assailed decision
that the documents evidencing the cash advances FDC dated 26 January 2005[33] rendered by the CA's then
extended to its affiliates cannot be considered as loan Fourteenth Division, upon the following findings and
agreements that are subject to documentary stamp tax, conclusions, to wit:
the CTA enunciated, however, that the CIR was justified
in assessing undeclared interests on the same cash 1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-
advances pursuant to his authority under Section 43 of 046-97, the 29 November 1996 Deed of Exchange
the NIRC in order to forestall tax evasion. For persuasive resulted in the combined control by FDC and FAI of
effect, the CTA referred to the equivalent provision in the more than 51% of the outstanding shares of FLI, hence,
Internal Revenue Code of the United States (IRC-US), i.e., no taxable gain can be recognized from the transaction
Sec. 482, as implemented by Section 1.482-2 of 1965-1969 under Section 34 (c) (2) of the old NIRC;
Regulations of the Law of Federal Income Taxation.[27]
2. The instructional letters as well as the cash and journal
Dissatisfied with the foregoing decision, FDC filed on 5 vouchers evidencing the advances FDC extended to its
November 2002 the petition for review docketed before affiliates are not subject to documentary stamp taxes
the CA as CA-G.R. No. 72992, pursuant to Rule 43 of pursuant to BIR Ruling No. 116-98, dated 30 July 1998,
the 1997 Rules of Civil Procedure. Calling attention to the since they do not partake the nature of loan
fact that the cash advances it extended to its affiliates agreements;
were interest-free in the absence of the express
stipulation on interest required under Article 1956 of 3. Although BIR Ruling No. 116-98 had been subsequently
the Civil Code, FDC questioned the imposition of an modified by BIR Ruling No. 108-99, dated 15 July 1999, to
arm's-length interest rate thereon on the ground, among the effect that documentary stamp taxes are imposable
others, that the CIR's authority under Section 43 of the on inter-office memos evidencing cash advances similar
NIRC: (a) does not include the power to impute to those extended by FDC, said latter ruling cannot be
imaginary interest on said transactions; (b) is directed only given retroactive application if to do so would be
against controlled taxpayers and not against mother or prejudicial to the taxpayer;
holding corporations; and, (c) can only be invoked in
cases of understatement of taxable net income or 4. FDC's alleged gain from the increase of its
evident tax evasion.[28] Upholding FDC's position, the CA's shareholdings in FAC as a consequence of the
then Special Fifth Division rendered the herein assailed Shareholders' Agreement it executed with RHPL cannot
decision dated 16 December 2003,[29] the decretal be considered taxable income since, until actually
portion of which states: converted thru sale or disposition of said shares, they
merely represent unrealized increase in capital.[34]
WHEREFORE, premises considered, the
instant petition is hereby GRANTED. The Respectively docketed before this Court as G.R. Nos.
assailed Decision dated September 10, 163653 and 167689, the CIR's petitions for review
2002 rendered by the Court of Tax on certiorari assailing the 16 December 2003 decision in
Appeals in CTA Case No. 6182 directing CA-G.R. No. 72992 and the 26 January 2005 decision in
petitioner Filinvest Development CA-G.R. SP No. 74510 were consolidated pursuant to the
Corporation to pay the amount 1 March 2006 resolution issued by this Courts Third Division.
of P5,691,972.03 representing deficiency
income tax on allegedly undeclared The Issues
interest income for the taxable year
1997, plus 20% delinquency interest
computed from February 16, 2000 until In G.R. No. 163653, the CIR urges the grant of its petition
full payment thereof is REVERSED and SET on the following ground:
ASIDE and, a new one entered annulling
Assessment Notice No. SP-INC-97-00019- THE COURT OF APPEALS ERRED IN
2000 imposing deficiency income tax on REVERSING THE DECISION OF THE COURT
petitioner for taxable year 1997. No OF TAX APPEALS AND IN HOLDING THAT
pronouncement as to costs.[30] THE ADVANCES EXTENDED BY
RESPONDENT TO ITS AFFILIATES ARE NOT
With the denial of its partial motion for SUBJECT TO INCOME TAX.[35]
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
In G.R. No. 167689, on the other hand, petitioner proffers organizations, trades or businesses (whether or not
the following issues for resolution: incorporated and whether or not organized in the
Philippines) owned or controlled directly or indirectly by
I the same interests, the Commissioner of Internal Revenue
is authorized to distribute, apportion or allocate gross
THE HONORABLE COURT OF APPEALS COMMITTED income or deductions between or among such
GRAVE ABUSE OF DISCRETION IN HOLDING THAT organization, trade or business, if he determines that such
THE EXCHANGE OF SHARES OF STOCK FOR distribution, apportionment or allocation is necessary in
PROPERTY AMONG FILINVEST DEVELOPMENT order to prevent evasion of taxes or clearly to reflect the
CORPORATION (FDC), FILINVEST ALABANG, income of any such organization, trade or business. In
INCORPORATED (FAI) AND FILINVEST LAND amplification of the equivalent provision[39] under
INCORPORATED (FLI) MET ALL THE REQUIREMENTS Commonwealth Act No. 466,[40] Sec. 179(b) of Revenue
FOR THE NON-RECOGNITION OF TAXABLE GAIN Regulation No. 2 states as follows:
UNDER SECTION 34 (c) (2) OF THE OLD NATIONAL
INTERNAL REVENUE CODE (NIRC) (NOW SECTION Determination of the taxable net income of
40 (C) (2) (c) OF THE NIRC. controlled taxpayer.
THE HONORABLE COURT OF APPEALS COMMITTED (1) The term organization includes any kind,
REVERSIBLE ERROR IN HOLDING THAT THE LETTERS whether it be a sole proprietorship, a partnership, a trust,
OF INSTRUCTION OR CASH VOUCHERS EXTENDED an estate, or a corporation or association, irrespective of
BY FDC TO ITS AFFILIATES ARE NOT DEEMED LOAN the place where organized, where operated, or where
AGREEMENTS SUBJECT TO DOCUMENTARY STAMP its trade or business is conducted, and regardless of
TAXES UNDER SECTION 180 OF THE NIRC. whether domestic or foreign, whether exempt or
taxable, or whether affiliated or not.
III
(2) The terms trade or business include any trade
THE HONORABLE COURT OF APPEALS GRAVELY or business activity of any kind, regardless of whether or
ERRED IN HOLDING THAT GAIN ON DILUTION AS A where organized, whether owned individually or
RESULT OF THE INCREASE IN THE VALUE OF FDCS otherwise, and regardless of the place where carried on.
SHAREHOLDINGS IN FAC IS NOT TAXABLE.[36]
(3) The term controlled includes any kind of
The Courts Ruling control, direct or indirect, whether legally enforceable,
and however exercisable or exercised. It is the reality of
While the petition in G.R. No. 163653 is bereft of merit, we the control which is decisive, not its form or mode of
find the CIRs petition in G.R. No. 167689 impressed with exercise. A presumption of control arises if income or
partial merit. deductions have been arbitrarily shifted.
In G.R. No. 163653, the CIR argues that the CA erred in (4) The term controlled taxpayer means any one
reversing the CTAs finding that theoretical interests can of two or more organizations, trades, or businesses
be imputed on the advances FDC extended to its owned or controlled directly or indirectly by the same
affiliates in 1996 and 1997 considering that, for said interests.
purpose, FDC resorted to interest-bearing fund borrowings
from commercial banks. Since considerable interest (5) The term group and group of controlled
expenses were deducted by FDC when said funds were taxpayers means the organizations, trades or businesses
borrowed, the CIR theorizes that interest income should owned or controlled by the same interests.
likewise be declared when the same funds were sourced
for the advances FDC extended to its affiliates. Invoking (6) The term true net income means, in the case
Section 43 of the 1993 NIRC in relation to Section 179(b) of of a controlled taxpayer, the net income (or as the case
Revenue Regulation No. 2, the CIR maintains that it is may be, any item or element affecting net income)
vested with the power to allocate, distribute or apportion which would have resulted to the controlled taxpayer,
income or deductions between or among controlled had it in the conduct of its affairs (or, as the case may
organizations, trades or businesses even in the absence of be, any item or element affecting net income) which
fraud, since said power is intended to prevent evasion of would have resulted to the controlled taxpayer, had it in
taxes or clearly to reflect the income of any such the conduct of its affairs (or, as the case may be, in the
organizations, trades or businesses. In addition, the CIR particular contract, transaction, arrangement or other
asseverates that the CA should have accorded weight act) dealt with the other members or members of the
and respect to the findings of the CTA which, as the group at arms length. It does not mean the income, the
specialized court dedicated to the study and deductions, or the item or element of either, resulting to
consideration of tax matters, can take judicial notice of the controlled taxpayer by reason of the particular
US income tax laws and regulations.[37] contract, transaction, or arrangement, the controlled
taxpayer, or the interest controlling it, chose to make
Admittedly, Section 43 of the 1993 (even though such contract, transaction, or
NIRC[38] provides that, (i)n any case of two or more
arrangement be legally binding upon the parties taxpayer's taxable income is not reflective of that which it
thereto). would have realized had it been dealing at arm's length
with an uncontrolled taxpayer, the CIR can make the
(B) SCOPE AND PURPOSE. - The purpose of Section 44 of necessary rectifications in order to prevent evasion of
the Tax Code is to place a controlled taxpayer on a tax taxes.
parity with an uncontrolled taxpayer, by determining,
according to the standard of an uncontrolled taxpayer, Despite the broad parameters provided,
the true net income from the property and business of a however, we find that the CIR's powers of distribution,
controlled taxpayer. The interests controlling a group of apportionment or allocation of gross income and
controlled taxpayer are assumed to have complete deductions under Section 43 of the 1993 NIRC and
power to cause each controlled taxpayer so to conduct Section 179 of Revenue Regulation No. 2 does not
its affairs that its transactions and accounting records include the power to impute "theoretical interests" to the
truly reflect the net income from the property and controlled taxpayer's transactions. Pursuant to Section 28
business of each of the controlled taxpayers. If, however, of the 1993 NIRC,[42] after all, the term gross income is
this has not been done and the taxable net income are understood to mean all income from whatever
thereby understated, the statute contemplates that the source derived, including, but not limited to the following
Commissioner of Internal Revenue shall intervene, and, items: compensation for services, including fees,
by making such distributions, apportionments, or commissions, and similar items; gross income derived from
allocations as he may deem necessary of gross income business; gains derived from dealings in property; interest;
or deductions, or of any item or element affecting net rents; royalties; dividends; annuities; prizes and winnings;
income, between or among the controlled taxpayers pensions; and partners distributive share of the gross
constituting the group, shall determine the true net income of general professional partnership.[43] While it has
income of each controlled taxpayer. The standard to be been held that the phrase "from whatever source
applied in every case is that of an uncontrolled derived" indicates a legislative policy to include all
taxpayer. Section 44 grants no right to a controlled income not expressly exempted within the class of
taxpayer to apply its provisions at will, nor does it grant taxable income under our laws, the term "income" has
any right to compel the Commissioner of Internal been variously interpreted to mean "cash received or its
Revenue to apply its provisions. equivalent", "the amount of money coming to a person
within a specific time" or "something distinct from principal
(C) APPLICATION Transactions between controlled or capital."[44] Otherwise stated, there must be proof of
taxpayer and another will be subjected to special the actual or, at the very least, probable receipt or
scrutiny to ascertain whether the common control is realization by the controlled taxpayer of the item of gross
being used to reduce, avoid or escape taxes. In income sought to be distributed, apportioned or
determining the true net income of a controlled allocated by the CIR.
taxpayer, the Commissioner of Internal Revenue is not
restricted to the case of improper accounting, to the Our circumspect perusal of the record yielded no
case of a fraudulent, colorable, or sham transaction, or evidence of actual or possible showing that the
to the case of a device designed to reduce or avoid tax advances FDC extended to its affiliates had resulted to
by shifting or distorting income the interests subsequently assessed by the CIR. For all its
or deductions. The authority to determine true net harping upon the supposed fact that FDC had resorted
income extends to any case in which either by to borrowings from commercial banks, the CIR had
inadvertence or design the taxable net income in whole adduced no concrete proof that said funds were,
or in part, of a controlled taxpayer, is other than it would indeed, the source of the advances the former provided
have been had the taxpayer in the conduct of his affairs its affiliates. While admitting that FDC obtained interest-
been an uncontrolled taxpayer dealing at arms length bearing loans from commercial banks,[45] Susan
with another uncontrolled taxpayer.[41] Macabelda - FDC's Funds Management Department
Manager who was the sole witness presented before the
As may be gleaned from the definitions of the CTA - clarified that the subject advances were sourced
terms controlled and "controlled taxpayer" under from the corporation's rights offering in 1995 as well as the
paragraphs (a) (3) and (4) of the foregoing provision, it sale of its investment in Bonifacio Land in 1997.[46] More
would appear that FDC and its affiliates come within the significantly, said witness testified that said advances: (a)
purview of Section 43 of the 1993 NIRC. Aside from were extended to give FLI, FAI, DSCC and FCI financial
owning significant portions of the shares of stock of FLI, assistance for their operational and capital expenditures;
FAI, DSCC and FCI, the fact that FDC extended and, (b) were all temporarily in nature since they were
substantial sums of money as cash advances to its said repaid within the duration of one week to three months
affiliates for the purpose of providing them financial and were evidenced by mere journal entries, cash
assistance for their operational and capital expenditures vouchers and instructional letters.[47]
seemingly indicate that the situation sought to be
addressed by the subject provision exists. From the tenor Even if we were, therefore, to accord precipitate
of paragraph (c) of Section 179 of Revenue Regulation credulity to the CIR's bare assertion that FDC had
No. 2, it may also be seen that the CIR's power to deducted substantial interest expense from its gross
distribute, apportion or allocate gross income or income, there would still be no factual basis for the
deductions between or among controlled taxpayers may imputation of theoretical interests on the subject
be likewise exercised whether or not fraud inheres in the advances and assess deficiency income taxes
transaction/s under scrutiny. For as long as the controlled thereon. More so, when it is borne in mind that, pursuant
to Article 1956 of the Civil Code of the Philippines, no Then as now, the CIR argues that taxable gain should be
interest shall be due unless it has been expressly stipulated recognized for the exchange considering that FDC's
in writing. Considering that taxes, being burdens, are not controlling interest in FLI was actually decreased as a
to be presumed beyond what the applicable statute result thereof.For said purpose, the CIR calls attention to
expressly and clearly declares,[48] the rule is likewise the fact that, prior to the exchange, FDC owned
settled that tax statutes must be construed strictly against 2,537,358,000 or 67.42% of FLI's 3,763,535,000 outstanding
the government and liberally in favor of the capital stock. Upon the issuance of 443,094,000 additional
taxpayer.[49] Accordingly, the general rule of requiring FLI shares as a consequence of the exchange and with
adherence to the letter in construing statutes applies with only 42,217,000 thereof accruing in favor of FDC for a
peculiar strictness to tax laws and the provisions of a total of 2,579,575,000 shares, said corporations controlling
taxing act are not to be extended by interest was supposedly reduced to 61%.03 when
implication.[50] While it is true that taxes are the lifeblood reckoned from the transferee's aggregate 4,226,629,000
of the government, it has been held that their assessment outstanding shares. Without owning a share from FLI's
and collection should be in accordance with law as any initial 3,763,535,000 outstanding shares, on the other
arbitrariness will negate the very reason for government hand, FAI's acquisition of 420,877,000 FLI shares as a result
itself.[51] of the exchange purportedly resulted in its control of only
9.96% of said transferee corporation's 4,226,629,000
In G.R. No. 167689, we also find a dearth of merit outstanding shares. On the principle that the transaction
in the CIR's insistence on the imposition of deficiency did not qualify as a tax-free exchange under Section 34
income taxes on the transfer FDC and FAI effected in (c) (2) of the 1993 NIRC, the CIR asseverates that taxable
exchange for the shares of stock of FLI. With respect to gain in the sum of P263,386,921.00 should be recognized
the Deed of Exchange executed between FDC, FAI and on the part of FDC and in the sum of P3,088,711,367.00 on
FLI, Section 34 (c) (2) of the 1993 NIRC pertinently provides the part of FAI.[57]
as follows:
The paucity of merit in the CIR's position is, however,
Sec. 34. Determination of amount of and evident from the categorical language of Section 34 (c)
recognition of gain or loss.- (2) of the 1993 NIRC which provides that gain or loss will
xxxx not be recognized in case the exchange of property for
stocks results in the control of the transferee by the
(c) Exception x x x x transferor, alone or with other transferors not exceeding
four persons. Rather than isolating the same as proposed
No gain or loss shall also be recognized if by the CIR, FDC's 2,579,575,000 shares or 61.03% control of
property is transferred to a corporation by a FLI's 4,226,629,000 outstanding shares should, therefore,
person in exchange for shares of stock in such be appreciated in combination with the 420,877,000 new
corporation of which as a result of such shares issued to FAI which represents 9.96% control of said
exchange said person, alone or together with transferee corporation. Together FDC's 2,579,575,000
others, not exceeding four persons, gains control shares (61.03%) and FAI's 420,877,000 shares (9.96%)
of said corporation; Provided, That stocks issued clearly add up to 3,000,452,000 shares or 70.99% of FLI's
for services shall not be considered as issued in 4,226,629,000 shares. Since the term "control" is clearly
return of property. 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
As even admitted in the 14 February 2001 Section 34 (c) (6) [c] of the 1993 NIRC, the exchange of
Stipulation of Facts submitted by the parties,[52] the property for stocks between FDC FAI and FLI clearly
requisites for the non-recognition of gain or loss under the qualify as a tax-free transaction under paragraph 34 (c)
foregoing provision are as follows: (a) the transferee is a (2) of the same provision.
corporation; (b) the transferee exchanges its shares of
stock for property/ies of the transferor; (c) the transfer is Against the clear tenor of Section 34(c) (2) of the 1993
made by a person, acting alone or together with others, NIRC, the CIR cites then Supreme Court Justice Jose Vitug
not exceeding four persons; and, (d) as a result of the and CTA Justice Ernesto D. Acosta who, in their book Tax
exchange the transferor, alone or together with others, Law and Jurisprudence, opined that said provision could
not exceeding four, gains control of the be inapplicable if control is already vested in the
transferee.[53] Acting on the 13 January 1997 request filed exchangor prior to exchange.[58] Aside from the fact that
by FLI, the BIR had, in fact, acknowledged the that the 10 September 2002 Decision in CTA Case No.
concurrence of the foregoing requisites in the Deed of 6182 upholding the tax-exempt status of the exchange
Exchange the former executed with FDC and FAI by between FDC, FAI and FLI was penned by no less than
issuing BIR Ruling No. S-34-046-97.[54] With the BIR's Justice Acosta himself,[59] FDC and FAI significantly point
reiteration of said ruling upon the request for clarification out that said authors have acknowledged that the
filed by FLI,[55] there is also no dispute that said transferee position taken by the BIR is to the effect that "the law
and transferors subsequently complied with the would apply even when the exchangor already has
requirements provided for the non-recognition of gain or control of the corporation at the time of the
loss from the exchange of property for tax, as provided exchange."[60] This was confirmed when, apprised in FLI's
under Section 34 (c) (2) of the 1993 NIRC.[56] request for clarification about the change of percentage
of ownership of its outstanding capital stock, the BIR
opined as follows:
thousand pesos (P250,000.00) executed by an individual
Please be informed that regardless of the foregoing, the for his purchase on installment for his personal use or that
transferors, Filinvest Development Corp. and Filinvest of his family and not for business, resale, barter or hire of
Alabang, Inc. still gained control of Filinvest Land, a house, lot, motor vehicle, appliance or furniture shall
Inc. The term 'control' shall mean ownership of stocks in a be exempt from the payment of documentary stamp
corporation by possessing at least 51% of the total voting tax provided under this Section.
power of all classes of stocks entitled to vote. Control is
determined by the amount of stocks received, i.e., total When read in conjunction with Section 173 of the 1993
subscribed, whether for property or for services by the NIRC,[63] the foregoing provision concededly applies to
transferor or transferors. In determining the 51% stock "(a)ll loan agreements, whether made or signed in the
ownership, only those persons who transferred property Philippines, or abroad when the obligation or right arises
for stocks in the same transaction may be counted up to from Philippine sources or the property or object of the
the maximum of five (BIR Ruling No. 547-93 dated contract is located or used in the
December 29, 1993.[61] Philippines." Correlatively, Section 3 (b) and Section 6 of
Revenue Regulations No. 9-94 provide as follows:
At any rate, it also appears that the supposed reduction
of FDC's shares in FLI posited by the CIR is more apparent Section 3. Definition of Terms. For purposes of these
than real. As the uncontested owner of 80% of the Regulations, the following term shall mean:
outstanding shares of FAI, it cannot be gainsaid that FDC
ideally controls the same percentage of the 420,877,000 (b) 'Loan agreement' refers to a contract in writing
shares issued to its said co-transferor which, by itself, where one of the parties delivers to another money or
represents 7.968% of the outstanding shares of other consumable thing, upon the condition that the
FLI. Considered alongside FDC's 61.03% control of FLI as a same amount of the same kind and quality shall be
consequence of the 29 November 1996 Deed of Transfer, paid. The term shall include credit facilities, which may
said 7.968% add up to an aggregate of 68.998% of said be evidenced by credit memo, advice or drawings.
transferee corporation's outstanding shares of stock
which is evidently still greater than the 67.42% FDC initially The terms 'Loan Agreement" under Section 180 and
held prior to the exchange. This much was admitted by "Mortgage' under Section 195, both of the Tax Code, as
the parties in the 14 February 2001 Stipulation of Facts, amended, generally refer to distinct and separate
Documents and Issues they submitted to the instruments. A loan agreement shall be taxed under
CTA.[62] Inasmuch as the combined ownership of FDC Section 180, while a deed of mortgage shall be taxed
and FAI of FLI's outstanding capital stock adds up to a under Section 195."
total of 70.99%, it stands to reason that neither of said
transferors can be held liable for deficiency income taxes "Section 6. Stamp on all Loan Agreements. All loan
the CIR assessed on the supposed gain which resulted agreements whether made or signed in the Philippines,
from the subject transfer. or abroad when the obligation or right arises from
Philippine sources or the property or object of the
On the other hand, insofar as documentary stamp taxes contract is located in the Philippines shall be subject to
on loan agreements and promissory notes are the documentary stamp tax of thirty centavos (P0.30) on
concerned, Section 180 of the NIRC provides follows: each two hundred pesos, or fractional part thereof, of
the face value of any such agreements, pursuant to
Sec. 180. Stamp tax on all loan agreements, promissory Section 180 in relation to Section 173 of the Tax Code.
notes, bills of exchange, drafts, instruments and
securities issued by the government or any of its In cases where no formal agreements or promissory
instrumentalities, certificates of deposit bearing interest notes have been executed to cover credit facilities, the
and others not payable on sight or demand. On all loan documentary stamp tax shall be based on the amount
agreements signed abroad wherein the object of the of drawings or availment of the facilities, which may be
contract is located or used in the Philippines; bill of evidenced by credit/debit memo, advice or drawings
exchange (between points within the Philippines), drafts, by any form of check or withdrawal slip, under Section
instruments and securities issued by the Government or 180 of the Tax Code.
any of its instrumentalities or certificates of deposits
drawing interest, or orders for the payment of any sum of Applying the aforesaid provisions to the case at
money otherwise than at sight or on demand, or on all bench, we find that the instructional letters as well as the
promissory notes, whether negotiable or non-negotiable, journal and cash vouchers evidencing the advances FDC
except bank notes issued for circulation, and on each extended to its affiliates in 1996 and 1997 qualified as
renewal of any such note, there shall be collected a loan agreements upon which documentary stamp taxes
documentary stamp tax of Thirty centavos (P0.30) on may be imposed. In keeping with the caveat attendant
each two hundred pesos, or fractional part thereof, of to every BIR Ruling to the effect that it is valid only if the
the face value of any such agreement, bill of exchange, facts claimed by the taxpayer are correct, we find that
draft, certificate of deposit or note: Provided, That only the CA reversibly erred in utilizing BIR Ruling No. 116-
one documentary stamp tax shall be imposed on either 98, dated 30 July 1998 which, strictly speaking, could be
loan agreement, or promissory notes issued to secure invoked only by ASB Development Corporation, the
such loan, whichever will yield a higher tax: Provided taxpayer who sought the same. In said ruling, the CIR
however, That loan agreements or promissory notes the opined that documents like those evidencing the
aggregate of which does not exceed Two hundred fifty
advances FDC extended to its affiliates are not subject to penalty is, in turn, warranted under Sec. 250 [69] of the
documentary stamp tax, to wit: NIRC which prescribes the imposition thereof in case of
each failure to file an information or return, statement or
On the matter of whether or not the inter-office memo list, or keep any record or supply any information required
covering the advances granted by an affiliate company on the date prescribed therefor.
is subject to documentary stamp tax, it is informed that
nothing in Regulations No. 26 (Documentary Stamp Tax To our mind, no reversible error can, finally, be imputed
Regulations) and Revenue Regulations No. 9-94 states against both the CTA and the CA for invalidating the
that the same is subject to documentary stamp tax. Assessment Notice issued by the CIR for the deficiency
Such being the case, said inter-office memo evidencing income taxes FDC is supposed to have incurred as a
the lendings or borrowings which is neither a form of consequence of the dilution of its shares in FAC. Anent
promissory note nor a certificate of indebtedness issued FDCs Shareholders Agreement with RHPL, the record
by the corporation-affiliate or a certificate of obligation, shows that the parties were in agreement about the
which are, more or less, categorized as 'securities', is not following factual antecedents narrated in the 14 February
subject to documentary stamp tax imposed under 2001 Stipulation of Facts, Documents and Issues they
Section 180, 174 and 175 of the Tax Code of 1997, submitted before the CTA,[70] viz.:
respectively. Rather, the inter-office memo is being
prepared for accounting purposes only in order to avoid 1.11. On November 15, 1996, FDC entered into a
the co-mingling of funds of the corporate affiliates. 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 its appeal before the CA, the CIR argued that the in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and 7,
foregoing ruling was later modified in BIR Ruling No. 108- Answer).
99 dated 15 July 1999, which opined that inter-office
memos evidencing lendings or borrowings extended by a 1.12. FAC, the joint venture company formed by FDC
corporation to its affiliates are akin to promissory notes, and RHPL, is tasked to develop and manage the 50%
hence, subject to documentary stamp taxes. [64] In ownership interest of FDC in its PBCom Office Tower
brushing aside the foregoing argument, however, the CA Project (Project) with the Philippine Bank of
applied Section 246 of the 1993 NIRC[65] from which Communications (par. 6.12, Petition; par. 7, Answer).
proceeds the settled principle that rulings, circulars, rules
and regulations promulgated by the BIR have no 1.13. Pursuant to the SA between FDC and RHPL, the
retroactive application if to so apply them would be equity participation of FDC and RHPL in FAC was 60%
prejudicial to the taxpayers.[66] Admittedly, this rule does and 40% respectively.
not apply: (a) where the taxpayer deliberately misstates
or omits material facts from his return or in any document 1.14. In accordance with the terms of the SA, FDC
required of him by the Bureau of Internal Revenue; (b) subscribed to P500.7 million worth of shares of stock
where the facts subsequently gathered by the Bureau of representing a 60% equity participation in FAC. In turn,
Internal Revenue are materially different from the facts on RHPL subscribed to P433.8 million worth of shares of stock
which the ruling is based; or (c) where the taxpayer of FAC representing a 40% equity participation in FAC.
acted in bad faith.[67] Not being the taxpayer who, in the
first instance, sought a ruling from the CIR, however, FDC 1.15. In payment of its subscription in FAC, FDC executed
cannot invoke the foregoing principle on non- a Deed of Assignment transferring to FAC a portion of
retroactivity of BIR rulings. FDCs right and interests in the Project to the extent
of P500.7 million.
Viewed in the light of the foregoing considerations, we
find that both the CTA and the CA erred in invalidating 1.16. FDC reported a net loss of P190,695,061.00 in its
the assessments issued by the CIR for the deficiency Annual Income Tax Return for the taxable year 1996. [71]
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 Alongside the principle that tax revenues are not
1997. In Assessment Notice No. SP-DST-96-00020-2000, the intended to be liberally construed,[72] the rule is settled
CIR correctly assessed the sum of P6,400,693.62 for that the findings and conclusions of the CTA are
documentary stamp tax, P3,999,793.44 in interests accorded great respect and are generally upheld by this
and P25,000.00 as compromise penalty, for a total Court, unless there is a clear showing of a reversible error
of P10,425,487.06. Alongside the sum of P4,050,599.62 for or an improvident exercise of authority.[73] Absent
documentary stamp tax, the CIR similarly showing of such error here, we find no strong and cogent
assessed P1,721,099.78 in interests and P25,000.00 as reasons to depart from said rule with respect to the CTA's
compromise penalty in Assessment Notice No. SP-DST-97- finding that no deficiency income tax can be assessed
00021-2000 or a total of P5,796,699.40. The imposition of on the gain on the supposed dilution and/or increase in
deficiency interest is justified under Sec. 249 (a) and (b) of the value of FDC's shareholdings in FAC which the CIR, at
the NIRC which authorizes the assessment of the same at any rate, failed to establish. Bearing in mind the meaning
the rate of twenty percent (20%), or such higher rate as of "gross income" as above discussed, it cannot be
may be prescribed by regulations, from the date gainsaid, even then, that a mere increase or
prescribed for the payment of the unpaid amount of tax appreciation in the value of said shares cannot be
until full payment.[68] The imposition of the compromise considered income for taxation purposes. Since a mere
advance in the value of the property of a person or (1) The BIR’s disallowance of ICC’s claimed expense
corporation in no sense constitute the income specified in deductions for professional and security services billed to
the revenue law, it has been held in the early case and paid by ICC in 1986, to wit:
of Fisher vs. Trinidad,[74] that it constitutes and can be
treated merely as an increase of capital. Hence, the CIR (a) Expenses for the auditing services of SGV & Co., 3 for
has no factual and legal basis in assessing income tax on the year ending December 31, 1985;4
the increase in the value of FDC's shareholdings in FAC
until the same is actually sold at a profit.
(b) Expenses for the legal services [inclusive of retainer
fees] of the law firm Bengzon Zarraga Narciso Cudala
WHEREFORE, premises considered, the CIR's petition for
Pecson Azcuna & Bengson for the years 1984 and 1985.5
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. (c) Expense for security services of El Tigre Security &
167689 is PARTIALLY GRANTED and the CAs 26 January Investigation Agency for the months of April and May
2005 Decision in CA-G.R. SP No. 74510 isMODIFIED. 1986.6
Accordingly, Assessment Notices Nos. SP-DST-96- (2) The alleged understatement of ICC’s interest income
00020-2000 and SP-DST-97-00021-2000 issued for on the three promissory notes due from Realty
deficiency documentary stamp taxes due on the Investment, Inc.
instructional letters as well as journal and cash vouchers
evidencing the advances FDC extended to its affiliates The deficiency expanded withholding tax
are declared valid. of P4,897.79 (inclusive of interest and surcharge) was
allegedly due to the failure of ICC to withhold 1%
The cancellation of Assessment Notices Nos. SP- expanded withholding tax on its claimed P244,890.00
INC-96-00018-2000, SP-INC-97-00019-2000 and SP-INC-97- deduction for security services.7
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) On March 23, 1990, ICC sought a reconsideration of the
income from the dilution resulting from FDCs Shareholders subject assessments. On February 9, 1995, however, it
Agreement with RHPL is, however, upheld. received a final notice before seizure demanding
SO ORDERED. payment of the amounts stated in the said notices.
Hence, it brought the case to the CTA which held that
the petition is premature because the final notice of
G.R. No. 172231 February 12, 2007 assessment cannot be considered as a final decision
appealable to the tax court. This was reversed by the
Court of Appeals holding that a demand letter of the BIR
COMMISSIONER OF INTERNAL REVENUE, Petitioner, reiterating the payment of deficiency tax, amounts to a
vs. final decision on the protested assessment and may
ISABELA CULTURAL CORPORATION, Respondent. therefore be questioned before the CTA. This conclusion
was sustained by this Court on July 1, 2001, in G.R. No.
DECISION 135210.8 The case was thus remanded to the CTA for
further proceedings.
YNARES-SANTIAGO, J.:
On February 26, 2003, the CTA rendered a decision
Petitioner Commissioner of Internal Revenue (CIR) assails canceling and setting aside the assessment notices
the September 30, 2005 Decision1 of the Court of Appeals issued against ICC. It held that the claimed deductions
in CA-G.R. SP No. 78426 affirming the February 26, 2003 for professional and security services were properly
Decision2 of the Court of Tax Appeals (CTA) in CTA Case claimed by ICC in 1986 because it was only in the said
No. 5211, which cancelled and set aside the Assessment year when the bills demanding payment were sent to
Notices for deficiency income tax and expanded ICC. Hence, even if some of these professional services
withholding tax issued by the Bureau of Internal Revenue were rendered to ICC in 1984 or 1985, it could not
(BIR) against respondent Isabela Cultural Corporation declare the same as deduction for the said years as the
(ICC). amount thereof could not be determined at that time.
The facts show that on February 23, 1990, ICC, a domestic The CTA also held that ICC did not understate its interest
corporation, received from the BIR Assessment Notice No. income on the subject promissory notes. It found that it
FAS-1-86-90-000680 for deficiency income tax in the was the BIR which made an overstatement of said
amount of P333,196.86, and Assessment Notice No. FAS-1- income when it compounded the interest income
86-90-000681 for deficiency expanded withholding tax in receivable by ICC from the promissory notes of Realty
the amount of P4,897.79, inclusive of surcharges and Investment, Inc., despite the absence of a stipulation in
interest, both for the taxable year 1986. the contract providing for a compounded interest; nor of
a circumstance, like delay in payment or breach of
contract, that would justify the application of
The deficiency income tax of P333,196.86, arose from:
compounded interest.
Likewise, the CTA found that ICC in fact withheld 1% be taken for the taxable year in which ‘paid or accrued’
expanded withholding tax on its claimed deduction for or ‘paid or incurred’, dependent upon the method of
security services as shown by the various payment orders accounting upon the basis of which the net income is
and confirmation receipts it presented as evidence. The computed x x x".
dispositive portion of the CTA’s Decision, reads:
Accounting methods for tax purposes comprise a set of
WHEREFORE, in view of all the foregoing, Assessment rules for determining when and how to report income
Notice No. FAS-1-86-90-000680 for deficiency income tax and deductions.12 In the instant case, the accounting
in the amount of P333,196.86, and Assessment Notice No. method used by ICC is the accrual method.
FAS-1-86-90-000681 for deficiency expanded withholding
tax in the amount of P4,897.79, inclusive of surcharges Revenue Audit Memorandum Order No. 1-2000, provides
and interest, both for the taxable year 1986, are hereby that under the accrual method of accounting, expenses
CANCELLED and SET ASIDE. not being claimed as deductions by a taxpayer in the
current year when they are incurred cannot be claimed
SO ORDERED.9 as deduction from income for the succeeding year. Thus,
a taxpayer who is authorized to deduct certain expenses
Petitioner filed a petition for review with the Court of and other allowable deductions for the current year but
Appeals, which affirmed the CTA decision,10 holding that failed to do so cannot deduct the same for the next
although the professional services (legal and auditing year.13
services) were rendered to ICC in 1984 and 1985, the cost
of the services was not yet determinable at that time, The accrual method relies upon the taxpayer’s right to
hence, it could be considered as deductible expenses receive amounts or its obligation to pay them, in
only in 1986 when ICC received the billing statements for opposition to actual receipt or payment, which
said services. It further ruled that ICC did not understate characterizes the cash method of accounting. Amounts
its interest income from the promissory notes of Realty of income accrue where the right to receive them
Investment, Inc., and that ICC properly withheld and become fixed, where there is created an enforceable
remitted taxes on the payments for security services for liability. Similarly, liabilities are accrued when fixed and
the taxable year 1986. determinable in amount, without regard to
indeterminacy merely of time of payment.14
Hence, petitioner, through the Office of the Solicitor
General, filed the instant petition contending that since For a taxpayer using the accrual method, the
ICC is using the accrual method of accounting, the determinative question is, when do the facts present
expenses for the professional services that accrued in themselves in such a manner that the taxpayer must
1984 and 1985, should have been declared as recognize income or expense? The accrual of income
deductions from income during the said years and the and expense is permitted when the all-events test has
failure of ICC to do so bars it from claiming said expenses been met. This test requires: (1) fixing of a right to income
as deduction for the taxable year 1986. As to the alleged or liability to pay; and (2) the availability of the
deficiency interest income and failure to withhold reasonable accurate determination of such income or
expanded withholding tax assessment, petitioner invoked liability.
the presumption that the assessment notices issued by
the BIR are valid. The all-events test requires the right to income or liability
be fixed, and the amount of such income or liability be
The issue for resolution is whether the Court of Appeals determined with reasonable accuracy. However, the test
correctly: (1) sustained the deduction of the expenses for does not demand that the amount of income or liability
professional and security services from ICC’s gross be known absolutely, only that a taxpayer has at his
income; and (2) held that ICC did not understate its disposal the information necessary to compute the
interest income from the promissory notes of Realty amount with reasonable accuracy. The all-events test is
Investment, Inc; and that ICC withheld the required 1% satisfied where computation remains uncertain, if its basis
withholding tax from the deductions for security services. is unchangeable; the test is satisfied where a
computation may be unknown, but is not as much as
The requisites for the deductibility of ordinary and unknowable, within the taxable year. The amount of
necessary trade, business, or professional expenses, like liability does not have to be determined exactly; it must
expenses paid for legal and auditing services, are: (a) the be determined with "reasonable accuracy." Accordingly,
expense must be ordinary and necessary; (b) it must have the term "reasonable accuracy" implies something less
been paid or incurred during the taxable year; (c) it must than an exact or completely accurate amount.[15]
have been paid or incurred in carrying on the trade or
business of the taxpayer; and (d) it must be supported by The propriety of an accrual must be judged by the facts
receipts, records or other pertinent papers.11 that a taxpayer knew, or could reasonably be expected
to have known, at the closing of its books for the taxable
The requisite that it must have been paid or incurred year.[16] Accrual method of accounting presents largely
during the taxable year is further qualified by Section 45 a question of fact; such that the taxpayer bears the
of the National Internal Revenue Code (NIRC) which burden of proof of establishing the accrual of an item of
states that: "[t]he deduction provided for in this Title shall income or deduction.17
Corollarily, it is a governing principle in taxation that tax 1986. Hence, per Revenue Audit Memorandum Order No.
exemptions must be construed in strictissimi juris against 1-2000, they cannot be validly deducted from its gross
the taxpayer and liberally in favor of the taxing authority; income for the said year and were therefore properly
and one who claims an exemption must be able to justify disallowed by the BIR.
the same by the clearest grant of organic or statute law.
An exemption from the common burden cannot be As to the expenses for security services, the records show
permitted to exist upon vague implications. And since a that these expenses were incurred by ICC in 1986 20and
deduction for income tax purposes partakes of the could therefore be properly claimed as deductions for
nature of a tax exemption, then it must also be strictly the said year.
construed.18
Anent the purported understatement of interest income
In the instant case, the expenses for professional fees from the promissory notes of Realty Investment, Inc., we
consist of expenses for legal and auditing services. The sustain the findings of the CTA and the Court of Appeals
expenses for legal services pertain to the 1984 and 1985 that no such understatement exists and that only simple
legal and retainer fees of the law firm Bengzon Zarraga interest computation and not a compounded one should
Narciso Cudala Pecson Azcuna & Bengson, and for have been applied by the BIR. There is indeed no
reimbursement of the expenses of said firm in connection stipulation between the latter and ICC on the application
with ICC’s tax problems for the year 1984. As testified by of compounded interest.21 Under Article 1959 of the Civil
the Treasurer of ICC, the firm has been its counsel since Code, unless there is a stipulation to the contrary, interest
the 1960’s.19 From the nature of the claimed deductions due should not further earn interest.
and the span of time during which the firm was retained,
ICC can be expected to have reasonably known the
Likewise, the findings of the CTA and the Court of
retainer fees charged by the firm as well as the
Appeals that ICC truly withheld the required withholding
compensation for its legal services. The failure to
tax from its claimed deductions for security services and
determine the exact amount of the expense during the
remitted the same to the BIR is supported by payment
taxable year when they could have been claimed as
order and confirmation receipts.22 Hence, the Assessment
deductions cannot thus be attributed solely to the
Notice for deficiency expanded withholding tax was
delayed billing of these liabilities by the firm. For one, ICC,
properly cancelled and set aside.
in the exercise of due diligence could have inquired into
the amount of their obligation to the firm, especially so
that it is using the accrual method of accounting. For In sum, Assessment Notice No. FAS-1-86-90-000680 in the
another, it could have reasonably determined the amount of P333,196.86 for deficiency income tax should
amount of legal and retainer fees owing to its familiarity be cancelled and set aside but only insofar as the
with the rates charged by their long time legal consultant. claimed deductions of ICC for security services. Said
Assessment is valid as to the BIR’s disallowance of ICC’s
expenses for professional services. The Court of Appeal’s
As previously stated, the accrual method presents largely
cancellation of Assessment Notice No. FAS-1-86-90-000681
a question of fact and that the taxpayer bears the
in the amount of P4,897.79 for deficiency expanded
burden of establishing the accrual of an expense or
withholding tax, is sustained.
income. However, ICC failed to discharge this burden. As
to when the firm’s performance of its services in
connection with the 1984 tax problems were completed, WHEREFORE, the petition is PARTIALLY GRANTED. The
or whether ICC exercised reasonable diligence to inquire September 30, 2005 Decision of the Court of Appeals in
about the amount of its liability, or whether it does or CA-G.R. SP No. 78426, is AFFIRMED with the
does not possess the information necessary to compute MODIFICATION that Assessment Notice No. FAS-1-86-90-
the amount of said liability with reasonable accuracy, are 000680, which disallowed the expense deduction of
questions of fact which ICC never established. It simply Isabela Cultural Corporation for professional and security
relied on the defense of delayed billing by the firm and services, is declared valid only insofar as the expenses for
the company, which under the circumstances, is not the professional fees of SGV & Co. and of the law firm,
sufficient to exempt it from being charged with Bengzon Zarraga Narciso Cudala Pecson Azcuna &
knowledge of the reasonable amount of the expenses for Bengson, are concerned. The decision is affirmed in all
legal and auditing services. other respects.
In the same vein, the professional fees of SGV & Co. for The case is remanded to the BIR for the computation of
auditing the financial statements of ICC for the year 1985 Isabela Cultural Corporation’s liability under Assessment
cannot be validly claimed as expense deductions in Notice No. FAS-1-86-90-000680.
1986. This is so because ICC failed to present evidence
showing that even with only "reasonable accuracy," as SO ORDERED.
the standard to ascertain its liability to SGV & Co. in the
year 1985, it cannot determine the professional fees
which said company would charge for its services.
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.
ICC thus failed to discharge the burden of proving that BANK OF COMMERCE, respondent.
the claimed expense deductions for the professional
services were allowable deductions for the taxable year
DECISION receipts must be an allowable exclusion under the Tax
Code and its pertinent implementing Rules and
CALLEJO, SR., J.: Regulations. Moreover, it must be supported by
evidence;
This is a petition for review on certiorari of the
Decision[1] of the Court of Appeals (CA) in CA-G.R. SP No. 7. Petitioner must likewise prove that the alleged
52706, affirming the ruling of the Court of Tax Appeals refundable/creditable gross receipt taxes were neither
(CTA)[2] in CTA Case No. 5415. automatically applied as tax credit against its tax liability
The facts of the case are undisputed. for the succeeding quarter/s of the succeeding year nor
included as creditable taxes declared and applied to the
In 1994 and 1995, the respondent Bank of succeeding taxable year/s;
Commerce derived passive income in the form of
interests or discounts from its investments in government 8. Claims for tax refund/credit are construed in strictissimi
securities and private commercial papers. On several juris against the taxpayer as it partakes the nature of an
occasions during the said period, it paid 5% gross receipts exemption from tax and it is incumbent upon the
tax on its income, as reflected in its quarterly percentage petitioner to prove that it is entitled thereto under the law.
tax returns. Included therein were the respondent banks Failure on the part of the petitioner to prove the same is
passive income from the said investments amounting fatal to its claim for tax refund/credit;
to P85,384,254.51, which had already been subjected to
a final tax of 20%.
9. Furthermore, petitioner must prove that it has complied
Meanwhile, on January 30, 1996, the CTA rendered with the provision of Section 230 (now Section 229) of the
judgment in Asia Bank Corporation v. Commissioner of Tax Code, as amended.[3]
Internal Revenue, CTA Case No. 4720, holding that the
20% final withholding tax on interest income from banks The CTA summarized the issues to be resolved as
does not form part of taxable gross receipts for Gross follows: whether or not the final income tax withheld
Receipts Tax (GRT) purposes. The CTA relied on Section should form part of the gross receipts[4] of the taxpayer for
4(e) of Revenue Regulations (Rev. Reg.) No. 12-80. GRT purposes; and whether or not the respondent bank
was entitled to a refund of P853,842.54.[5]
Relying on the said decision, the respondent bank
filed an administrative claim for refund with the The respondent bank averred that for purposes of
Commissioner of Internal Revenue on July 19, 1996. It computing the 5% gross receipts tax, the final withholding
claimed that it had overpaid its gross receipts tax for 1994 tax does not form part of gross receipts.[6] On the other
to 1995 by P853,842.54, computed as follows: hand, while the Commissioner conceded that the Court
defined gross receipts as all receipts of taxpayers
Gross receipts subjected to excluding those which have been especially earmarked
Final Tax Derived from Passive by law or regulation for the government or some person
Investment P85,384,254.51 other than the taxpayer in CIR v. Manila Jockey Club,
x 20% Inc.,[7] he claimed that such definition was applicable
20% Final Tax Withheld 17,076,850.90 only to a proprietor of an amusement place, not a
at Source x 5% banking institution which is an entirely different entity
P 853,842.54 altogether. As such, according to the Commissioner, the
ruling of the Court in Manila Jockey Club was
Before the Commissioner could resolve the claim, inapplicable.
the respondent bank filed a petition for review with the In its Decision dated April 27, 1999, the CTA by a
CTA, lest it be barred by the mandatory two-year majority decision[8] partially granted the petition and
prescriptive period under Section 230 of the Tax Code ordered that the amount of P355,258.99 be refunded to
(now Section 229 of the Tax Reform Act of 1997). the respondent bank. Thefallo of the decision reads:
In his answer to the petition, the Commissioner
interposed the following special and affirmative defenses: WHEREFORE, in view of all the foregoing, respondent is
hereby ORDERED to REFUND in favor of petitioner Bank of
5. The alleged refundable/creditable gross receipts taxes Commerce the amount of P355,258.99 representing
were collected and paid pursuant to law and pertinent validly proven erroneously withheld taxes from interest
BIR implementing rules and regulations; hence, the same income derived from its investments in government
are not refundable. Petitioner must prove that the income securities for the years 1994 and 1995.[9]
from which the refundable/creditable taxes were paid
from, were declared and included in its gross income In ruling for respondent bank, the CTA relied on the
during the taxable year under review; ruling of the Court in Manila Jockey Club, and held that
the term gross receipts excluded those which had been
6. Petitioners allegation that it erroneously and excessively especially earmarked by law or regulation for the
paid its gross receipt tax during the year under review government or persons other than the taxpayer. The CTA
does not ipso facto warrant the refund/credit. Petitioner also cited its rulings in China Banking Corporation
must prove that the exclusions claimed by it from its gross v. CIR[10] and Equitable Banking Corporation v. CIR.[11]
The CTA ratiocinated that the aforesaid amount The Commissioner now assails the said decision
of P355,258.99 represented the claim of the respondent before this Court, contending that:
bank, which was filed within the two-year mandatory
prescriptive period and was substantiated by material THE COURT OF APPEALS ERRED IN HOLDING THAT THE 20%
and relevant evidence. The CTA applied Section 204(3) FINAL WITHHOLDING TAX ON BANKS INTEREST INCOME
of the National Internal Revenue Code (NIRC).[12] DOES NOT FORM PART OF THE TAXABLE GROSS RECEIPTS
The Commissioner then filed a petition for review IN COMPUTING THE 5% GROSS RECEIPTS TAX (GRT, for
under Rule 43 of the Rules of Court before the CA, brevity).[17]
alleging that:
The petitioner avers that the reliance by the CTA
(1) There is no provision of law which excludes the and the CA on Section 4(e) of Rev. Reg. No. 12-80 is
20% final income tax withheld under Section misplaced; the said provision merely authorizes the
50(a) of the Tax Code in the computation of determination of the amount of gross receipts based on
the 5% gross receipts tax. the taxpayers method of accounting under then Section
37 (now Section 43) of the Tax Code. The petitioner
asserts that the said provision ceased to exist as of
(2) The Tax Court erred in applying the ruling in October 15, 1984, when Rev. Reg. No. 17-84 took effect.
Collector of Internal Revenue vs. Manila Jockey The petitioner further points out that under paragraphs
Club (108 Phil. 821) in the resolution of the legal 7(a) and (c) of Rev. Reg. No. 17-84, interest income of
issues involved in the instant case.[13] financial institutions (including banks) subject to
withholding tax are included as part of the gross receipts
The Commissioner reiterated his stand that the ruling upon which the gross receipts tax is to be imposed. Citing
of this Court in Manila Jockey Club, which was affirmed the ruling of the CA in Commissioner of Internal Revenue
in Visayan Cebu Terminal Co., Inc. v. Commissioner of v. Asianbank Corporation[18] (which likewise cited Bank of
Internal Revenue,[14] is not decisive. He averred that the America NT & SA v. Court of Appeals, [19]) the petitioner
factual milieu in the said case is different, involving as it posits that in computing the 5% gross receipts tax, the
did the wager fund. The Commissioner further pointed out income need not be actually received. For income to
that in Manila Jockey Club, the Court ruled that the race form part of the taxable gross receipts, constructive
tracks commission did not form part of the gross receipts, receipt is enough. The petitioner is, likewise, adamant in
and as such were not subjected to the 20% amusement his claim that the final withholding tax from the
tax. On the other hand, the issue in Visayan Cebu respondent banks income forms part of the taxable gross
Terminal was whether or not the gross receipts receipts for purposes of computing the 5% of gross
corresponding to 28% of the total gross income of the receipts tax. The petitioner posits that the ruling of this
service contractor delivered to the Bureau of Customs Court in Manila Jockey Club is not decisive of the issue in
formed part of the gross receipts was subject to 3% of this case.
contractors tax under Section 191 of the Tax Code. It was
further pointed out that the respondent bank, on the The petition is meritorious.
other hand, was a banking institution and not a The issues in this case had been raised and resolved
contractor. The petitioner insisted that the term gross by this Court in China Banking Corporation v. Court of
receipts is self-evident; it includes all items of income of Appeals,[20] and CIR v. Solidbank Corporation.[21]
the respondent bank regardless of whether or not the
same were allocated or earmarked for a specific Section 27(D)(1) of the Tax Code reads:
purpose, to distinguish it from net receipts.
On August 14, 2001, the CA rendered judgment (D) Rates of Tax on Certain Passive Incomes.
dismissing the petition. Citing Sections 51 and 58(A) of the
NIRC, Section 4(e) of Rev. Reg. No. 12-80[15] and the ruling (1) Interest from Deposits and Yield or any other Monetary
of this Court inManila Jockey Club, the CA held that Benefit from Deposit Substitutes and from Trust Funds and
the P17,076,850.90 representing the final withholding tax Similar Arrangements, and Royalties. A final tax at the
derived from passive investments subjected to final tax rate of twenty percent (20%) is hereby imposed upon the
should not be construed as forming part of the gross amount of interest on currency bank deposit and yield or
receipts of the respondent bank upon which the 5% gross any other monetary benefit from deposit substitutes and
receipts tax should be imposed. The CA declared that from trust funds and similar arrangements received by
the final withholding tax in the amount of P17,768,509.00 domestic corporations, and royalties, derived from
was a trust fund for the government; hence, does not sources within the Philippines: Provided, however, That
form part of the respondents gross receipts. The legal interest income derived by a domestic corporation from
ownership of the amount had already been vested in the a depository bank under the expanded foreign currency
government. Moreover, the CA declared, the respondent deposit system shall be subject to a final income tax at
did not reap any benefit from the said amount. As such, the rate of seven and one-half percent (7%) of such
subjecting the said amount to the 5% gross receipts tax interest income.
would result in double taxation. The appellate court
further cited CIR v. Tours Specialists, Inc.,[16] and declared On the other hand, Section 57(A)(B) of the Tax Code
that the ruling of the Court in Manila Jockey Club was authorizes the withholding of final tax on certain income
decisive of the issue. creditable at source:
SEC. 57. Withholding of Tax at Source. Provided, however, That in case the maturity period
referred to in paragraph (a) is shortened thru pre-
(A) Withholding of Final Tax on Certain Incomes. Subject termination, then the maturity period shall be reckoned
to rules and regulations, the Secretary of Finance may to end as of the date of pre-termination for purposes of
promulgate, upon the recommendation of the classifying the transaction as short, medium or long-term
Commissioner, requiring the filing of income tax return by and the correct rate of tax shall be applied accordingly.
certain income payees, the tax imposed or prescribed by
Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1); 25(A)(2), Nothing in this Code shall preclude the Commissioner
25(A)(3), 25(B), 25(C), 25(D), 25(E); 27(D)(1), 27(D)(2), from imposing the same tax herein provided on persons
27(D)(3), 27(D)(5); 28(A)(4), 28(A)(5), 28(A)(7)(a), performing similar banking activities.
28(A)(7)(b), 28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3),
28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 The Tax Code does not define gross receipts. Absent
of this Code on specified items of income shall be any statutory definition, the Bureau of Internal Revenue
withheld by payor-corporation and/or person and paid in has applied the term in its plain and ordinary meaning.[23]
the same manner and subject to the same conditions as
provided in Section 58 of this Code. In National City Bank v. CIR,[24] the CTA held that
gross receipts should be interpreted as the whole amount
(B) Withholding of Creditable Tax at Source. The Secretary received as interest, without deductions; otherwise, if
of Finance may, upon the recommendation of the deductions were to be made from gross receipts, it would
Commissioner, require the withholding of a tax on the be considered as net receipts. The CTA changed course,
items of income payable to natural or juridical persons, however, when it promulgated its decision in Asia Bank; it
residing in the Philippines, by payor-corporation/persons applied Section 4(e) of Rev. Reg. No. 12-80 and the ruling
as provided for by law, at the rate of not less than one of this Court in Manila Jockey Club, holding that the 20%
percent (1%) but not more than thirty-two percent (32%) final withholding tax on the petitioner banks interest
thereof, which shall be credited against the income tax income should not form part of its taxable gross receipts,
liability of the taxpayer for the taxable year. since the final tax was not actually received by the
petitioner bank but went to the coffers of the
government.
The tax deducted and withheld by withholding
agents under the said provision shall be held as a special The Court agrees with the contention of the
fund in trust for the government until paid to the petitioner that the appellate courts reliance on Rev. Reg.
collecting officer.[22] No. 12-80, the rulings of the CTA in Asia Bank, and of this
Court in Manila Jockey Club has no legal and factual
Section 121 (formerly Section 119) of the Tax Code bases. Indeed, the Court ruled in China Banking
provides that a tax on gross receipts derived from sources Corporation v. Court of Appeals[25] that:
within the Philippines by all banks and non-bank financial
intermediaries shall be computed in accordance with the
schedules therein: In Far East Bank & Trust Co. v. Commissioner and Standard
Chartered Bank v. Commissioner, both promulgated on
16 November 2001, the tax court ruled that the final
(a) On interest, commissions and discounts from lending withholding tax forms part of the banks gross receipts in
activities as well as income from financial leasing, on the computing the gross receipts tax. The tax court held that
basis of remaining maturities of instruments from which Section 4(e) of Revenue Regulations No. 12-80 did not
such receipts are derived: prescribe the computation of the amount of gross
receipts but merely authorized the determination of the
Short-term maturity (not in excess of two (2) years) 5% amount of gross receipts on the basis of the method of
accounting being used by the taxpayer.
Medium-term maturity (over two (2) years but
not exceeding four (4) years) 3% The word gross must be used in its plain and ordinary
meaning. It is defined as whole, entire, total, without
Long-term maturity deduction. A common definition is without
deduction.[26] Gross is also defined as taking in the whole;
having no deduction or abatement; whole, total as
(1) Over four (4) years but not exceeding
opposed to a sum consisting of separate or specified
seven (7) years 1%
parts.[27] Gross is the antithesis of net.[28] Indeed, in China
Banking Corporation v. Court of Appeals, [29] the Court
(2) Over seven (7) years 0% defined the term in this wise:
Absent a statutory definition, the term gross receipts is In the same vein, the respondent banks reliance on
understood in its plain and ordinary meaning. Words in a Section 4(e) of Rev. Reg. No. 12-80 and the ruling of the
statute are taken in their usual and familiar signification, CTA in Asia Bank is misplaced. The Courts discussion
with due regard to their general and popular use. The in China Banking Corporation[33] is instructive on this
Supreme Court of Hawaii held in Bishop Trust Company v. score:
Burns that -
CBC also relies on the Tax Courts ruling in Asia Bank that
xxx It is fundamental that in construing or interpreting a Section 4(e) of Revenue Regulations No. 12-80 authorizes
statute, in order to ascertain the intent of the legislature, the exclusion of the final tax from the banks taxable gross
the language used therein is to be taken in the generally receipts. Section 4(e) provides that:
accepted and usual sense. Courts will presume that the
words in a statute were used to express their meaning in Sec. 4. x x x
common usage. This principle is equally applicable to a
tax statute. [Citations omitted] (Emphasis supplied)
(e) Gross receipts tax on banks, non-bank financial
intermediaries, financing companies, and other non-bank
The Court, likewise, declared that Section 121 of the financial intermediaries not performing quasi-banking
Tax Code expressly subjects interest income of banks to functions. - The rates of taxes to be imposed on the gross
the gross receipts tax. Such express inclusion of interest receipts of such financial institutions shall be based on all
income in taxable gross receipts creates items of income actually received. Mere accrual shall not
a presumption that the entire amount of the interest be considered, but once payment is received on such
income, without any deduction, is subject to the gross accrual or in cases of prepayment, then the amount
receipts tax. Indeed, there is a presumption that receipts actually received shall be included in the tax base of
of a person engaging in business are subject to the gross such financial institutions, as provided hereunder: x x x.
receipts tax. Such presumption may only be overcome by (Emphasis supplied by Tax Court)
pointing to a specific provision of law allowing such
deduction of the final withholding tax from the taxable
Section 4(e) states that the gross receipts shall be based Act No. 309 and Executive Order No. 320 apportioned
on all items of income actually received. The tax court the total amount of the bets in horse races as follows:
in Asia Bank concluded that it is but logical to infer that
the final tax, not having been received by petitioner but 87 % as dividends to holders of winning tickets, 12 % as
instead went to the coffers of the government, should no commission of the Manila Jockey Club, of which % was
longer form part of its gross receipts for the purpose of assigned to the Board of Races and 5% was distributed as
computing the GRT. prizes for owners of winning horses and authorized
bonuses for jockeys.
The Tax Court erred glaringly in interpreting Section 4(e) of
Revenue Regulations No. 12-80. Income may be taxable A subsequent law, Republic Act No. 1933 (RA No. 1933),
either at the time of its actual receipt or its accrual, amended the sharing by ordering the distribution of the
depending on the accounting method of the taxpayer. bets as follows:
Section 4(e) merely provides for an exception to the rule,
making interest income taxable for gross receipts tax
Sec. 19. Distribution of receipts. The total wager funds or
purposes only upon actual receipt. Interest is accrued,
gross receipts from the sale of pari-mutuel tickets shall
and not actually received, when the interest is due and
be apportioned as follows: eighty-seven and one-half per
demandable but the borrower has not actually paid and
centum shall be distributed in the form of dividends
remitted the interest, whether physically or constructively.
among the holders of win, place and show horses, as the
Section 4(e) does not exclude accrued interest income
case may be, in the regular races; six and one-half per
from gross receipts but merely postpones its inclusion until
centum shall be set aside as the commission of the
actual payment of the interest to the lending bank. This is
person, racetrack, racing club, or any other entity
clear when Section 4(e) states that [m]ere accrual shall
conducting the races; five and one-half per centum shall
not be considered, but once payment is received on
be set aside for the payment of stakes or prizes for win,
such accrual or in case of prepayment, then the amount
place and show horses and authorized bonuses for
actually received shall be included in the tax base of
jockeys; and one-half per centum shall be paid to a
such financial institutions x x x.
special fund to be used by the Games and Amusements
Board to cover its expenses and such other purposes
Actual receipt of interest income is not limited to physical authorized under this Act. xxx. (Emphasis supplied)
receipt. Actual receipt may either be physical receipt or
constructive receipt. When the depository bank withholds
Under the distribution of receipts expressly mandated in
the final tax to pay the tax liability of the lending bank,
Section 19 of RA No. 1933, the gross receipts apportioned
there is prior to the withholding a constructive receipt by
to Manila Jockey Club referred only to its own 6 %
the lending bank of the amount withheld. From the
commission. There is no dispute that the 5 % share of the
amount constructively received by the lending bank, the
horse-owners and jockeys, and the % share of the Games
depository bank deducts the final withholding tax and
and Amusements Board, do not form part of Manila
remits it to the government for the account of the lending
Jockey Clubs gross receipts. RA No. 1933 took effect on
bank. Thus, the interest income actually received by the
22 June 1957, three years before the Court
lending bank, both physically and constructively, is the
decided Manila Jockey Club on 30 June 1960.
net interest plus the amount withheld as final tax.
Even under the earlier law, Manila Jockey Club did not
The concept of a withholding tax on income obviously
own the entire 12 % commission. Manila Jockey Club
and necessarily implies that the amount of the tax
owned, and could keep and use, only 7% of the total
withheld comes from the income earned by the
bets. Manila Jockey Club merely held in trust the balance
taxpayer. Since the amount of the tax withheld
of 5 % for the benefit of the Board of Races and the
constitutes income earned by the taxpayer, then that
winning horse-owners and jockeys, the real owners of the
amount manifestly forms part of the taxpayers gross
5 1/2 % share.
receipts. Because the amount withheld belongs to the
taxpayer, he can transfer its ownership to the
government in payment of his tax liability. The amount The Court in Manila Jockey Club quoted with approval
withheld indubitably comes from income of the taxpayer, the following Opinion of the Secretary of Justice
and thus forms part of his gross receipts. made prior to RA No. 1933:
The Court went on to explain in that case that far There is no question that the Manila Jockey Club, Inc.
from supporting the petitioners contention, its ruling owns only 7-1/2% [sic] of the bets registered by the
in Manila Jockey Club, in fact even buttressed the Totalizer. This portion represents its share or commission in
contention of the Commissioner. Thus: the total amount of money it handles and goes to the
funds thereof as its own property which it may legally
disburse for its own purposes. The 5% [sic] does not belong
CBC cites Collector of Internal Revenue v. Manila Jockey
to the club. It is merely held in trust for distribution as prizes
Club as authority that the final withholding tax on interest
to the owners of winning horses. It is destined for no other
income does not form part of a banks gross receipts
object than the payment of prizes and the club cannot
because the final tax is earmarked by regulation for the
otherwise appropriate this portion without incurring
government. CBCs reliance on the Manila Jockey Club is
liability to the owners of winning horses. It can not be
misplaced. In this case, the Court stated that Republic
considered as an item of expense because the sum used
for the payment of prizes is not taken from the funds of the national government under the Tax Code and
the club but from a certain portion of the total bets operate within the same Philippine jurisdiction for the
especially earmarked for that purpose. (Emphasis same purpose of raising revenues, the taxing periods they
supplied) affect are different. The FWT is deducted and withheld as
soon as the income is earned, and is paid after
Consequently, the Court ruled that the 5 % balance of every calendar quarter in which it is earned. On the other
the commission, not being owned by Manila Jockey hand, the GRT is neither deducted nor withheld, but is
Club, did not form part of its gross receipts for purposes of paid only after every taxable quarter in which it is earned.
the amusement tax. Manila Jockey Club correctly paid
the amusement tax based only on its own 7% commission Third, these two taxes are of different kinds or characters.
under RA No. 309 and Executive Order No. 320. The FWT is an income tax subject to withholding, while the
GRT is a percentage tax not subject to withholding.
Manila Jockey Club does not support CBCs contention
but rather the Commissioners position. The Court ruled In short, there is no double taxation, because there is no
in Manila Jockey Club that receipts not owned by the taxing twice, by the same taxing authority, within the
Manila Jockey Club but merely held by it in trust did not same jurisdiction, for the same purpose, in different taxing
form part of Manila Jockey Clubs gross receipts. periods, some of the property in the territory. Subjecting
Conversely, receipts owned by the Manila Jockey Club interest income to a 20% FWT and including it in the
would form part of its gross receipts.[34] computation of the 5% GRT is clearly not double taxation.
We reverse the ruling of the CA that subjecting the IN LIGHT OF THE FOREGOING, the petition is
Final Withholding Tax (FWT) to the 5% of gross receipts tax GRANTED. The decision of the Court of Appeals in CA-
would result in double taxation. In CIR v. Solidbank G.R. SP No. 52706 and that of the Court of Tax Appeals in
Corporation,[35] we ruled, thus: CTA Case No. 5415 are SET ASIDE and REVERSED. The CTA
is hereby ORDERED to DISMISS the petition of respondent
We have repeatedly said that the two taxes, subject of Bank of Commerce. No costs.
this litigation, are different from each other. The basis of SO ORDERED.
their imposition may be the same, but their natures are
different, thus leading us to a final point. Is there double
taxation?
Appeal interposed by petitioner Limpan Investment Less: Amount already assessed 657.00
Corporation against a decision of the Court of Tax
Appeals, in its CTA Case No. 699, holding and ordering it Balance P4,892.00
(petitioner) to pay respondent Commissioner of Internal
Revenue the sums of P7,338.00 and P30,502.50, Add: 50% Surcharge 2,446.00
representing deficiency income taxes, plus 50% surcharge
DEFICIENCY TAX DUE P7,338.00
and 1% monthly interest from June 30, 1959 to the date of
payment, with cost. 90-AR-C-1196-58/57
The facts of this case are: Net income per audited return P11,098.00