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MADRIGAL VS.

RAFFERTY- Difference Between


Capital and Income
The essential difference between capital and income is that capital is a fund; income is a flow. A
fund of property existing at an instant of time is called capital. A flow of services rendered by that
capital by the payment of money from it or any other benefit rendered by a fund of capital in
relation to such fund through a period of time is called income. Capital is wealth, while income is
the service of wealth.

FACTS:
• Vicente Madrigal and Susana Paterno were legally married prior to Januray 1, 1914. The
marriage was contracted under the provisions of law concerning conjugal partnership
• On 1915, Madrigal filed a declaration of his net income for year 1914, the sum of P296,302.73
• Vicente Madrigal was contending that the said declared income does not represent his income
for the year 1914 as it was the income of his conjugal partnership with Paterno. He said that in
computing for his additional income tax, the amount declared should be divided by 2.
• The revenue officer was not satisfied with Madrigal’s explanation and ultimately, the United
States Commissioner of Internal Revenue decided against the claim of Madrigal.
• Madrigal paid under protest, and the couple decided to recover the sum of P3,786.08 alleged to
have been wrongfully and illegally assessed and collected by the CIR.

ISSUE: Whether or not the income reported by Madrigal on 1915 should be


divided into 2 in computing for the additional income tax.

HELD:
• No! The point of view of the CIR is that the Income Tax Law, as the name implies, taxes upon
income and not upon capital and property.
• The essential difference between capital and income is that capital is a fund; income is a flow. A
fund of property existing at an instant of time is called capital. A flow of services rendered by that
capital by the payment of money from it or any other benefit rendered by a fund of capital in
relation to such fund through a period of time is called income. Capital is wealth, while income is
the service of wealth.
• As Paterno has no estate and income, actually and legally vested in her and entirely distinct
from her husband’s property, the income cannot properly be considered the separate income of
the wife for the purposes of the additional tax.
• To recapitulate, Vicente wants to half his declared income in computing for his tax since he is
arguing that he has a conjugal partnership with his wife. However, the court ruled that the one
that should be taxed is the income which is the flow of the capital, thus it should not be divided
into 2.
Republic of the Philippines
SUPREME COURT
Manila

EN BANC

G.R. No. L-12287 August 7, 1918

VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants,


vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION,
Deputy Collector of Internal Revenue, defendants-appellees.

Gregorio Araneta for appellants.


Assistant Attorney Round for appellees.

MALCOLM, J.:

This appeal calls for consideration of the Income Tax Law, a law of American origin, with
reference to the Civil Code, a law of Spanish origin.

STATEMENT OF THE CASE.

Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The
marriage was contracted under the provisions of law concerning conjugal partnerships
(sociedad de gananciales). On February 25, 1915, Vicente Madrigal filed sworn declaration
on the prescribed form with the Collector of Internal Revenue, showing, as his total net
income for the year 1914, the sum of P296,302.73. Subsequently Madrigal submitted the
claim that the said P296,302.73 did not represent his income for the year 1914, but was in
fact the income of the conjugal partnership existing between himself and his wife Susana
Paterno, and that in computing and assessing the additional income tax provided by the Act
of Congress of October 3, 1913, the income declared by Vicente Madrigal should be divided
into two equal parts, one-half to be considered the income of Vicente Madrigal and the other
half of Susana Paterno. The general question had in the meantime been submitted to the
Attorney-General of the Philippine Islands who in an opinion dated March 17, 1915, held with
the petitioner Madrigal. The revenue officers being still unsatisfied, the correspondence
together with this opinion was forwarded to Washington for a decision by the United States
Treasury Department. The United States Commissioner of Internal Revenue reversed the
opinion of the Attorney-General, and thus decided against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided adversely
by the Collector of Internal Revenue, action was begun by Vicente Madrigal and his wife
Susana Paterno in the Court of First Instance of the city of Manila against Collector of
Internal Revenue and the Deputy Collector of Internal Revenue for the recovery of the sum
of P3,786.08, alleged to have been wrongfully and illegally collected by the defendants from
the plaintiff, Vicente Madrigal, under the provisions of the Act of Congress known as the
Income Tax Law. The burden of the complaint was that if the income tax for the year 1914
had been correctly and lawfully computed there would have been due payable by each of the
plaintiffs the sum of P2,921.09, which taken together amounts of a total of P5,842.18 instead
of P9,668.21, erroneously and unlawfully collected from the plaintiff Vicente Madrigal, with
the result that plaintiff Madrigal has paid as income tax for the year 1914, P3,786.08, in
excess of the sum lawfully due and payable.

The answer of the defendants, together with an analysis of the tax declaration, the pleadings,
and the stipulation, sets forth the basis of defendants' stand in the following way: The income
of Vicente Madrigal and his wife Susana Paterno of the year 1914 was made up of three
items: (1) P362,407.67, the profits made by Vicente Madrigal in his coal and shipping
business; (2) P4,086.50, the profits made by Susana Paterno in her embroidery business; (3)
P16,687.80, the profits made by Vicente Madrigal in a pawnshop company. The sum of
these three items is P383,181.97, the gross income of Vicente Madrigal and Susana Paterno
for the year 1914. General deductions were claimed and allowed in the sum of P86,879.24.
The resulting net income was P296,302.73. For the purpose of assessing the normal tax of
one per cent on the net income there were allowed as specific deductions the following: (1)
P16,687.80, the tax upon which was to be paid at source, and (2) P8,000, the specific
exemption granted to Vicente Madrigal and Susana Paterno, husband and wife. The
remainder, P271,614.93 was the sum upon which the normal tax of one per cent was
assessed. The normal tax thus arrived at was P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax provided
for in the Income Tax Law. The trial court in an exhausted decision found in favor of
defendants, without costs.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional income
tax, is that is should be divided into two equal parts, because of the conjugal partnership
existing between them. The learned argument of counsel is mostly based upon the
provisions of the Civil Code establishing the sociedad de gananciales. The counter
contentions of appellees are that the taxes imposed by the Income Tax Law are as the name
implies taxes upon income tax and not upon capital and property; that the fact that Madrigal
was a married man, and his marriage contracted under the provisions governing the conjugal
partnership, has no bearing on income considered as income, and that the distinction must
be drawn between the ordinary form of commercial partnership and the conjugal partnership
of spouses resulting from the relation of marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have been
given the course of history. The final stage has been the selection of income as the norm of
taxation. (See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the United
States, extended to the Philippine Islands, is the result of an effect on the part of the
legislators to put into statutory form this canon of taxation and of social reform. The aim has
been to mitigate the evils arising from inequalities of wealth by a progressive scheme of
taxation, which places the burden on those best able to pay. To carry out this idea, public
considerations have demanded an exemption roughly equivalent to the minimum of
subsistence. With these exceptions, the income tax is supposed to reach the earnings of the
entire non-governmental property of the country. Such is the background of the Income Tax
Law.

Income as contrasted with capital or property is to be the test. The essential difference
between capital and income is that capital is a fund; income is a flow. A fund of property
existing at an instant of time is called capital. A flow of services rendered by that capital by
the payment of money from it or any other benefit rendered by a fund of capital in relation to
such fund through a period of time is called an income. Capital is wealth, while income is the
service of wealth. (See Fisher, "The Nature of Capital and Income.") The Supreme Court of
Georgia expresses the thought in the following figurative language: "The fact is that property
is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree, income the
fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on income is not a tax on
property. "Income," as here used, can be defined as "profits or gains." (London County
Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49
Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition [1915],
Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon
[1890], 136 U.S., 549; and Towne vs.Eisner, decided by the United States Supreme Court,
January 7, 1918.)

A regulation of the United States Treasury Department relative to returns by the husband
and wife not living apart, contains the following:

The husband, as the head and legal representative of the household and general custodian
of its income, should make and render the return of the aggregate income of himself and
wife, and for the purpose of levying the income tax it is assumed that he can ascertain the
total amount of said income. If a wife has a separate estate managed by herself as her own
separate property, and receives an income of more than $3,000, she may make return of her
own income, and if the husband has other net income, making the aggregate of both
incomes more than $4,000, the wife's return should be attached to the return of her husband,
or his income should be included in her return, in order that a deduction of $4,000 may be
made from the aggregate of both incomes. The tax in such case, however, will be imposed
only upon so much of the aggregate income of both shall exceed $4,000. If either husband or
wife separately has an income equal to or in excess of $3,000, a return of annual net income
is required under the law, and such return must include the income of both, and in such case
the return must be made even though the combined income of both be less than $4,000. If
the aggregate net income of both exceeds $4,000, an annual return of their combined
incomes must be made in the manner stated, although neither one separately has an income
of $3,000 per annum. They are jointly and separately liable for such return and for the
payment of the tax. The single or married status of the person claiming the specific
exemption shall be determined as one of the time of claiming such exemption which return is
made, otherwise the status at the close of the year."

With these general observations relative to the Income Tax Law in force in the Philippine
Islands, we turn for a moment to consider the provisions of the Civil Code dealing with the
conjugal partnership. Recently in two elaborate decisions in which a long line of Spanish
authorities were cited, this court in speaking of the conjugal partnership, decided that "prior
to the liquidation the interest of the wife and in case of her death, of her heirs, is an interest
inchoate, a mere expectancy, which constitutes neither a legal nor an equitable estate, and
does not ripen into title until there appears that there are assets in the community as a result
of the liquidation and settlement." (Nable Jose vs. Nable Jose [1916], 15 Off. Gaz., 871;
Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)

Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her
husband Vicente Madrigal during the life of the conjugal partnership. She has an interest in
the ultimate property rights and in the ultimate ownership of property acquired as income
after such income has become capital. Susana Paterno has no absolute right to one-half the
income of the conjugal partnership. Not being seized of a separate estate, Susana Paterno
cannot make a separate return in order to receive the benefit of the exemption which would
arise by reason of the additional tax. As she has no estate and income, actually and legally
vested in her and entirely distinct from her husband's property, the income cannot properly
be considered the separate income of the wife for the purposes of the additional tax.
Moreover, the Income Tax Law does not look on the spouses as individual partners in an
ordinary partnership. The husband and wife are only entitled to the exemption of P8,000
specifically granted by the law. The higher schedules of the additional tax directed at the
incomes of the wealthy may not be partially defeated by reliance on provisions in our Civil
Code dealing with the conjugal partnership and having no application to the Income Tax
Law. The aims and purposes of the Income Tax Law must be given effect.

The point we are discussing has heretofore been considered by the Attorney-General of the
Philippine Islands and the United States Treasury Department. The decision of the latter
overruling the opinion of the Attorney-General is as follows:

TREASURY DEPARTMENT, Washington.

Income Tax.

FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of
correspondence "from the Philippine authorities relative to the method of submission
of income tax returns by marred person."

You advise that "The Governor-General, in forwarding the papers to the Bureau,
advises that the Insular Auditor has been authorized to suspend action on the
warrants in question until an authoritative decision on the points raised can be
secured from the Treasury Department."

From the correspondence it appears that Gregorio Araneta, married and living with
his wife, had an income of an amount sufficient to require the imposition of the net
income was properly computed and then both income and deductions and the
specific exemption were divided in half and two returns made, one return for each
half in the names respectively of the husband and wife, so that under the returns as
filed there would be an escape from the additional tax; that Araneta claims the
returns are correct on the ground under the Philippine law his wife is entitled to half
of his earnings; that Araneta has dominion over the income and under the Philippine
law, the right to determine its use and disposition; that in this case the wife has no
"separate estate" within the contemplation of the Act of October 3, 1913, levying an
income tax.

It appears further from the correspondence that upon the foregoing explanation, tax
was assessed against the entire net income against Gregorio Araneta; that the tax
was paid and an application for refund made, and that the application for refund was
rejected, whereupon the matter was submitted to the Attorney-General of the Islands
who holds that the returns were correctly rendered, and that the refund should be
allowed; and thereupon the question at issue is submitted through the Governor-
General of the Islands and Bureau of Insular Affairs for the advisory opinion of this
office.

By paragraph M of the statute, its provisions are extended to the Philippine Islands,
to be administered as in the United States but by the appropriate internal-revenue
officers of the Philippine Government. You are therefore advised that upon the facts
as stated, this office holds that for the Federal Income Tax (Act of October 3, 1913),
the entire net income in this case was taxable to Gregorio Araneta, both for the
normal and additional tax, and that the application for refund was properly rejected.

The separate estate of a married woman within the contemplation of the Income Tax
Law is that which belongs to her solely and separate and apart from her husband,
and over which her husband has no right in equity. It may consist of lands or chattels.

The statute and the regulations promulgated in accordance therewith provide that
each person of lawful age (not excused from so doing) having a net income of
$3,000 or over for the taxable year shall make a return showing the facts; that from
the net income so shown there shall be deducted $3,000 where the person making
the return is a single person, or married and not living with consort, and $1,000
additional where the person making the return is married and living with consort; but
that where the husband and wife both make returns (they living together), the amount
of deduction from the aggregate of their several incomes shall not exceed $4,000.

The only occasion for a wife making a return is where she has income from a sole
and separate estate in excess of $3,000, but together they have an income in excess
of $4,000, in which the latter event either the husband or wife may make the return
but not both. In all instances the income of husband and wife whether from separate
estates or not, is taken as a whole for the purpose of the normal tax. Where the wife
has income from a separate estate makes return made by her husband, while the
incomes are added together for the purpose of the normal tax they are taken
separately for the purpose of the additional tax. In this case, however, the wife has
no separate income within the contemplation of the Income Tax Law.

Respectfully,

DAVID A. GATES.
Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas. The
Income Tax Law was drafted by the Congress of the United States and has been by the
Congress extended to the Philippine Islands. Being thus a law of American origin and being
peculiarly intricate in its provisions, the authoritative decision of the official who is charged
with enforcing it has peculiar force for the Philippines. It has come to be a well-settled rule
that great weight should be given to the construction placed upon a revenue law, whose
meaning is doubtful, by the department charged with its execution. (U.S. vs. Cerecedo
Hermanos y Cia. [1907], 209 U.S., 338; In re Allen [1903], 2 Phil., 630; Government of the
Philippine Islands vs. Municipality of Binalonan, and Roman Catholic Bishop of Nueva
Segovia [1915], 32 Phil., 634.) We conclude that the judgment should be as it is hereby
affirmed with costs against appellants. So ordered.

Torres, Johnson, Carson, Street and Fisher, JJ., concur.

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