Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No.

163583 April 15, 2009 BRITISH AMERICAN TOBACCO, Petitioner, vs. JOSE ISIDRO N. CAMACHO, in his capacity as Secretary of the Department of Finance and GUILLERMO L. PARAYNO, JR., in his capacity as Commissioner of the Bureau of Internal Revenue, Respondents. Philip Morris Philippines Manufacturing, Inc., fortune tobacco, corp., MIGHTY CORPOR.A.TION, and JT InTERNATIONAL, S.A., Respondents-in-Intervention. RESOLUTION YNARES-SANTIAGO, J.: On August 20, 2008, the Court rendered a Decision partially granting the petition in this case, viz: WHEREFORE, the petition is PARTIALLY GRANTED and the decision of the Regional Trial Court of Makati, Branch 61, in Civil Case No. 03-1032, is AFFIRMED with MODIFICATION. As modified, this Court declares that: (1) Section 145 of the NIRC, as amended by Republic Act No. 9334, is CONSTITUTIONAL; and that (2) Section 4(B)(e)(c), 2nd paragraph of Revenue Regulations No. 1-97, as amended by Section 2 of Revenue Regulations 9-2003, and Sections II(1)(b), II(4)(b), II(6), II(7), III (Large Tax Payers Assistance Division II) II(b) of Revenue Memorandum Order No. 6-2003, insofar as pertinent to cigarettes packed by machine, are INVALID insofar as they grant the BIR the power to reclassify or update the classification of new brands every two years or earlier. SO ORDERED. In its Motion for Reconsideration, petitioner insists that the assailed provisions (1) violate the equal protection and uniformity of taxation clauses of the Constitution, (2) contravene Section 19,1 Article XII of the Constitution on unfair competition, and (3) infringe the constitutional provisions on regressive and inequitable taxation. Petitioner further argues that assuming the assailed provisions are constitutional, petitioner is entitled to a downward reclassification of Lucky Strike from the premium-priced to the high-priced tax bracket. The Court is not persuaded.

The assailed law does not violate the equal protection and uniformity of taxation clauses. Petitioner argues that the classification freeze provision violates the equal protection and uniformity of taxation clauses because Annex "D" brands are taxed based on their 1996 net retail prices while new brands are taxed based on their present day net retail prices. Citing Ormoc Sugar Co. v. Treasurer of Ormoc City,2 petitioner asserts that the assailed provisions accord a special or privileged status to Annex "D" brands while at the same time discriminate against other brands. These contentions are without merit and a rehash of petitioner s previous arguments before this Court. As held in the assailed Decision, the instant case neither involves a suspect classification nor impinges on a fundamental right. Consequently, the rational basis test was properly applied to gauge the constitutionality of the assailed law in the face of an equal protection challenge. It has been held that "in the areas of social and economic policy, a statutory classification that neither proceeds along suspect lines nor infringes constitutional rights must be upheld against equal protection challenge if there is any reasonably conceivable state of facts that could provide a rational basis for the classification."3 Under the rational basis test, it is sufficient that the legislative classification is rationally related to achieving some legitimate State interest. As the Court ruled in the assailed Decision, viz: A legislative classification that is reasonable does not offend the constitutional guaranty of the equal protection of the laws. The classification is considered valid and reasonable provided that: (1) it rests on substantial distinctions; (2) it is germane to the purpose of the law; (3) it applies, all things being equal, to both present and future conditions; and (4) it applies equally to all those belonging to the same class. The first, third and fourth requisites are satisfied. The classification freeze provision was inserted in the law for reasons of practicality and expediency. That is, since a new brand was not yet in existence at the time of the passage of RA 8240, then Congress needed a uniform mechanism to fix the tax bracket of a new brand. The current net retail price, similar to what was used to classify the brands under Annex "D" as of October 1, 1996, was thus the logical and practical choice. Further, with the amendments introduced by RA 9334, the freezing of the tax classifications now expressly applies not just to Annex "D" brands but to newer brands introduced after the effectivity of RA 8240 on January 1, 1997 and any new brand that will be

introduced in the future. (However, as will be discussed later, the intent to apply the freezing mechanism to newer brands was already in place even prior to the amendments introduced by RA 9334 to RA 8240.) This does not explain, however, why the classification is "frozen" after its determination based on current net retail price and how this is germane to the purpose of the assailed law. An examination of the legislative history of RA 8240 provides interesting answers to this question. xxxx From the foregoing, it is quite evident that the classification freeze provision could hardly be considered arbitrary, or motivated by a hostile or oppressive attitude to unduly favor older brands over newer brands. Congress was unequivocal in its unwillingness to delegate the power to periodically adjust the excise tax rate and tax brackets as well as to periodically resurvey and reclassify the cigarette brands based on the increase in the consumer price index to the DOF and the BIR. Congress doubted the constitutionality of such delegation of power, and likewise, considered the ethical implications thereof. Curiously, the classification freeze provision was put in place of the periodic adjustment and reclassification provision because of the belief that the latter would foster an anti-competitive atmosphere in the market. Yet, as it is, this same criticism is being foisted by petitioner upon the classification freeze provision. To our mind, the classification freeze provision was in the main the result of Congress s earnest efforts to improve the efficiency and effectivity of the tax administration over sin products while trying to balance the same with other State interests. In particular, the questioned provision addressed Congress s administrative concerns regarding delegating too much authority to the DOF and BIR as this will open the tax system to potential areas for abuse and corruption. Congress may have reasonably conceived that a tax system which would give the least amount of discretion to the tax implementers would address the problems of tax avoidance and tax evasion. To elaborate a little, Congress could have reasonably foreseen that, under the DOF proposal and the Senate Version, the periodic reclassification of brands would tempt the cigarette manufacturers to manipulate their price levels or bribe the tax implementers in order to allow their brands to be classified at a lower tax bracket even if their net retail prices have already migrated to a higher tax bracket after the adjustment of the tax brackets to the increase in the consumer price index. Presumably, this could be done when a resurvey and reclassification is forthcoming. As briefly touched upon in the Congressional deliberations, the difference of the

excise tax rate between the medium-priced and the high-priced tax brackets under RA 8240, prior to its amendment, was P3.36. For a moderately popular brand which sells around 100 million packs per year, this easily translates to P336,000,000. The incentive for tax avoidance, if not outright tax evasion, would clearly be present. Then again, the tax implementers may use the power to periodically adjust the tax rate and reclassify the brands as a tool to unduly oppress the taxpayer in order for the government to achieve its revenue targets for a given year. Thus, Congress sought to, among others, simplify the whole tax system for sin products to remove these potential areas of abuse and corruption from both the side of the taxpayer and the government. Without doubt, the classification freeze provision was an integral part of this overall plan. This is in line with one of the avowed objectives of the assailed law "to simplify the tax administration and compliance with the tax laws that are about to unfold in order to minimize losses arising from inefficiencies and tax avoidance scheme, if not outright tax evasion." RA 9334 did not alter this classification freeze provision of RA 8240. On the contrary, Congress affirmed this freezing mechanism by clarifying the wording of the law. We can thus reasonably conclude, as the deliberations on RA 9334 readily show, that the administrative concerns in tax administration, which moved Congress to enact the classification freeze provision in RA 8240, were merely continued by RA 9334. Indeed, administrative concerns may provide a legitimate, rational basis for legislative classification. In the case at bar, these administrative concerns in the measurement and collection of excise taxes on sin products are readily apparent as afore-discussed. Aside from the major concern regarding the elimination of potential areas for abuse and corruption from the tax administration of sin products, the legislative deliberations also show that the classification freeze provision was intended to generate buoyant and stable revenues for government. With the frozen tax classifications, the revenue inflow would remain stable and the government would be able to predict with a greater degree of certainty the amount of taxes that a cigarette manufacturer would pay given the trend in its sales volume over time. The reason for this is that the previously classified cigarette brands would be prevented from moving either upward or downward their tax brackets despite the changes in their net retail prices in the future and, as a result, the amount of taxes due from them would remain predictable. The classification freeze provision would, thus, aid in the revenue planning of the government.

All in all, the classification freeze provision addressed Congress s administrative concerns in the simplification of tax administration of sin products, elimination of potential areas for abuse and corruption in tax collection, buoyant and stable revenue generation, and ease of projection of revenues. Consequently, there can be no denial of the equal protection of the laws since the rational-basis test is amply satisfied. Moreover, petitioner s contention that the assailed provisions violate the uniformity of taxation clause is similarly unavailing. In Churchill v. Concepcion,4 we explained that a tax "is uniform when it operates with the same force and effect in every place where the subject of it is found."5 It does not signify an intrinsic but simply a geographical uniformity.6 A levy of tax is not unconstitutional because it is not intrinsically equal and uniform in its operation.7The uniformity rule does not prohibit classification for purposes of taxation.8 As ruled in Tan v. Del Rosario, Jr.:9 Uniformity of taxation, like the kindred concept of equal protection, merely requires that all subjects or objects of taxation, similarly situated, are to be treated alike both in privileges and liabilities (citations omitted). Uniformity does not forfend classification as long as: (1) the standards that are used therefore are substantial and not arbitrary, (2) the categorization is germane to achieve the legislative purpose, (3) the law applies, all things being equal, to both present and future conditions, and (4) the classification applies equally well to all those belonging to the same class (citations omitted).10 In the instant case, there is no question that the classification freeze provision meets the geographical uniformity requirement because the assailed law applies to all cigarette brands in the Philippines. And, for reasons already adverted to in our August 20, 2008 Decision, the above four-fold test has been met in the present case. Petitioner s reliance on Ormoc Sugar Co. is misplaced. In said case, the controverted municipal ordinance specifically named and taxed only the Ormoc Sugar Company, and excluded any subsequently established sugar central from its coverage. Thus, the ordinance was found unconstitutional on equal protection grounds because its terms do not apply to future conditions as well. This is not the case here. The classification freeze provision uniformly applies to all cigarette brands whether existing or to be introduced in the market at some future time. It does not purport to exempt any brand from its operation nor single out a brand for the purpose of imposition of excise taxes. At any rate, petitioner s real disagreement lies with the legitimate State interests. Although it concedes that the Court utilized the rationality test and that the

classification freeze provision was necessitated by several legitimate State interests, however, it refuses to accept the justifications given by Congress for the classification freeze provision. As we elucidated in our August 20, 2008 Decision, this line of argumentation revolves around the wisdom and expediency of the assailed law which we cannot inquire into, much less overrule. Equal protection is not a license for courts to judge the wisdom, fairness, or logic of legislative choices.11 We reiterate, therefore, that petitioner s remedy is with Congress and not this Court. The assailed provisions do not violate the constitutional prohibition on unfair competition. Petitioner asserts that the Court erroneously applied the rational basis test allegedly because this test does not apply in a constitutional challenge based on a violation of Section 19, Article XII of the Constitution on unfair competition. Citing Tatad v. Secretary of the Department of Energy,12 it argues that the classification freeze provision gives the brands under Annex "D" a decisive edge because it constitutes a substantial barrier to the entry of prospective players; that the Annex "D" provision is no different from the 4% tariff differential which we invalidated in Tatad; that some of the new brands, like Astro, Memphis, Capri, L&M, Bowling Green, Forbes, and Canon, which were introduced into the market after the effectivity of the assailed law on January 1, 1997, were "killed" by Annex "D" brands because the former brands were reclassified by the BIR to higher tax brackets; that the finding that price is not the only factor in the market as there are other factors like consumer preference, active ingredients, etc. is contrary to the evidence presented and the deliberations in Congress; that the classification freeze provision will encourage predatory pricing in contravention of the constitutional prohibition on unfair competition; and that the cumulative effect of the operation of the classification freeze provision is to perpetuate the oligopoly of intervenors Philip Morris and Fortune Tobacco in contravention of the constitutional edict for the State to regulate or prohibit monopolies, and to disallow combinations in restraint of trade and unfair competition. The argument lacks merit. While previously arguing that the rational basis test was not satisfied, petitioner now asserts that this test does not apply in this case and that the proper matrix to evaluate the constitutionality of the assailed law is the prohibition on unfair competition under Section 19, Article XII of the Constitution. It should be noted that during the trial below, petitioner did not invoke said constitutional provision as it relied solely on the alleged violation of the equal protection and uniformity of taxation clauses. Well-settled is the rule that points of

law, theories, issues and arguments not adequately brought to the attention of the lower court will not be ordinarily considered by a reviewing court as they cannot be raised for the first time on appeal.13 At any rate, even if we were to relax this rule, as previously stated, the evidence presented before the trial court is insufficient to establish the alleged violation of the constitutional proscription against unfair competition. Indeed, in Tatad we ruled that a law which imposes substantial barriers to the entry and exit of new players in our downstream oil industry may be struck down for being violative of Section 19, Article XII of the Constitution.14However, we went on to say in that case that "if they are insignificant impediments, they need not be stricken down."15 As we stated in our August 20, 2008 Decision, petitioner failed to convincingly prove that there is a substantial barrier to the entry of new brands in the cigarette market due to the classification freeze provision. We further observed that several new brands were introduced in the market after the assailed law went into effect thus negating petitioner s sweeping claim that the classification freeze provision is an insurmountable barrier to the entry of new brands. We also noted that price is not the only factor affecting competition in the market for there are other factors such as taste, brand loyalty, etc. We see no reason to depart from these findings for the following reasons: First, petitioner did not lay down the factual foundations, as supported by verifiable documentary proof, which would establish, among others, the cigarette brands in competition with each other; the current net retail prices of Annex "D" brands, as determined through a market survey, to provide a sufficient point of comparison with those covered by the BIR s market survey of new brands; and the causal connection with as well as the extent of the impact on the competition in the cigarette market of the classification freeze provision. Other than petitioner s selfserving allegations and testimonial evidence, no adequate documentary evidence was presented to substantiate its claims. Absent ample documentary proof, we cannot accept petitioner s claim that the classification freeze provision is an insurmountable barrier to the entry of new players. Second, we cannot lend credence to petitioner s claim that it cannot produce cigarettes that can compete with Marlboro and Philip Morris in the high-priced tax bracket. Except for its self-serving testimonial evidence, no sufficient documentary evidence was presented to substantiate this claim. The current net retail price, which is the basis for determining the tax bracket of a cigarette brand, more or less consists of the costs of raw materials, labor, advertising and profit margin. To a large

extent, these factors are controllable by the manufacturer, as such, the decision to enter which tax bracket will depend on the pricing strategy adopted by the individual manufacturer. The same holds true for its claims that other new brands, like Astro, Memphis, Capri, L&M, Bowling Green, Forbes, and Canon, were "killed" by Annex "D" brands due to the effects of the operation of the classification freeze provision over time. The evidence that petitioner presented before the trial court failed to substantiate the basis for these claims. Essentially, petitioner would want us to accept its conclusions of law without first laying down the factual foundations of its arguments. This Court, which is not a trier of facts, cannot take judicial notice of the factual premises of these arguments as petitioner now seems to suggest. The evidence should have been presented before the trial court to allow it to examine and determine for itself whether such factual premises, as supported by sufficient documentary evidence, provide reasonable basis for petitioner s conclusion that there arose an unconstitutional unfair competition due to the operation of the classification freeze provision. Petitioner should be reminded that it appealed this case from the adverse ruling of the trial court directly to this Court on pure questions of law instead of resorting to the Court of Appeals. Third, Tatad is not applicable to the instant case. In Tatad, we found that the 4% tariff differential between imported crude oil and imported refined petroleum products erects a high barrier to the entry of new players because (1) it imposes an undue burden on new players to spend billions of pesos to build refineries in order to compete with the old players, and (2) new players, who opt not to build refineries, suffer from the huge disadvantage of increasing their product cost by 4%.16 The tariff was imposed on the raw materials uniformly used by the players in the oil industry. Thus, the adverse effect on competition arising from this discriminatory treatment was readily apparent. In contrast, the excise tax under the assailed law is imposed based on the current net retail price of a cigarette brand. As previously explained, the current net retail price is determined by the pricing strategy of the manufacturer. This Court cannot simply speculate that the reason why a new brand cannot enter a specific tax bracket and compete with the brands therein was because of the classification freeze provision, rather than the manufacturer s own pricing decision or some other factor solely attributable to the manufacturer. Again, the burden of proof in this regard is on petitioner which it failed to muster.

Fourth, the finding in our August 20, 2008 Decision that price is not the only factor which affects consumer behavior in the cigarette market is based on petitioner s own evidence. On cross-examination, petitioner s witness admitted that notwithstanding the change in price, a cigarette smoker may prefer the old brand because of its addictive formulation.17 As a result, even if we were to assume that the classification freeze provision distorts the pricing scheme of the market players, it is not clear whether a substantial barrier to the entry of new players would thereby be created because of these other factors affecting consumer behavior. Last, the claim that the assailed provisions encourage predatory pricing was never raised nor substantiated before the trial court. It is merely an afterthought and cannot be given weight. In sum, the totality of the evidence presented by petitioner before the trial court failed to convincingly establish the alleged violation of the constitutional prohibition on unfair competition. It is a basic postulate that the one who challenges the constitutionality of a law carries the heavy burden of proof for laws enjoy a strong presumption of constitutionality as it is an act of a co-equal branch of government. Petitioner failed to carry this burden. The assailed law does not transgress the constitutional provisions on regressive and inequitable taxation. Petitioner argues that the classification freeze provision is a form of regressive and inequitable tax system which is proscribed under Article VI, Section 28(1)18 of the Constitution. It claims that people in equal positions should be treated alike. The use of different tax bases for brands under Annex "D" vis--vis new brands is discriminatory, and thus, iniquitous. Petitioner further posits that the classification freeze provision is regressive in character. It asserts that the harmonization of revenue flow projections and ease of tax administration cannot override this constitutional command. We note that the points raised by petitioner with respect to alleged inequitable taxation perpetuated by the classification freeze provision are a mere reformulation of its equal protection challenge. As stated earlier, the assailed provisions do not infringe the equal protection clause because the four-fold test is satisfied. In particular, the classification freeze provision has been found to rationally further legitimate State interests consistent with rationality review. Petitioner s repackaged argument has, therefore, no merit. Anent the issue of regressivity, it may be conceded that the assailed law imposes an excise tax on cigarettes which is a form of indirect tax, and thus, regressive in

character. While there was an attempt to make the imposition of the excise tax more equitable by creating a four-tiered taxation system where higher priced cigarettes are taxed at a higher rate, still, every consumer, whether rich or poor, of a cigarette brand within a specific tax bracket pays the same tax rate. To this extent, the tax does not take into account the person s ability to pay. Nevertheless, this does not mean that the assailed law may be declared unconstitutional for being regressive in character because the Constitution does not prohibit the imposition of indirect taxes but merely provides that Congress shall evolve a progressive system of taxation. As we explained in Tolentino v. Secretary of Finance:191avvphi1.zw+ [R]egressivity is not a negative standard for courts to enforce. What Congress is required by the Constitution to do is to "evolve a progressive system of taxation." This is a directive to Congress, just like the directive to it to give priority to the enactment of laws for the enhancement of human dignity and the reduction of social, economic and political inequalities [Art. XIII, Section 1] or for the promotion of the right to "quality education" [Art. XIV, Section 1]. These provisions are put in the Constitution as moral incentives to legislation, not as judicially enforceable rights.20 Petitioner is not entitled to a downward reclassification of Lucky Strike. Petitioner alleges that assuming the assailed law is constitutional, its Lucky Strike brand should be reclassified from the premium-priced to the high-priced tax bracket. Relying on BIR Ruling No. 018-2001 dated May 10, 2001, it claims that it timely sought redress from the BIR to have the market survey conducted within three months from product launch, as provided for under Section 4(B)21 of Revenue Regulations No. 1-97, in order to determine the actual current net retail price of Lucky Strike, and thus, fix its tax classification. Further, the upward reclassification of Lucky Strike amounts to deprivation of property right without due process of law. The conduct of the market survey after two years from product launch constitutes gross neglect on the part of the BIR. Consequently, for failure of the BIR to conduct a timely market survey, Lucky Strike s classification based on its suggested gross retail price should be deemed its official tax classification. Finally, petitioner asserts that had the market survey been timely conducted sometime in 2001, the current net retail price of Lucky Strike would have been found to be under the high-priced tax bracket. These contentions are untenable and misleading. First, BIR Ruling No. 018-2001 was requested by petitioner for the purpose of fixing Lucky Strike s initial tax classification based on its suggested gross retail price

relative to its planned introduction of Lucky Strike in the market sometime in 2001 and not for the conduct of the market survey within three months from product launch. In fact, the said Ruling contained an express reservation that the tax classification of Lucky Strike set therein "is without prejudice, however, to the subsequent conduct of a survey x x x in order to determine if the actual gross retail price thereof is consistent with [petitioner s] suggested gross retail price."22 In short, petitioner acknowledged that the initial tax classification of Lucky Strike may be modified depending on the outcome of the survey which will determine the actual current net retail price of Lucky Strike in the market. Second, there was no upward reclassification of Lucky Strike because it was taxed based on its suggested gross retail price from the time of its introduction in the market in 2001 until the BIR market survey in 2003. We reiterate that Lucky Strikes actual current net retail price was surveyed for the first time in 2003 and was found to be fromP10.34 to P11.53 per pack, which is within the premium-priced tax bracket. There was, thus, no prohibited upward reclassification of Lucky Strike by the BIR based on its current net retail price. Third, the failure of the BIR to conduct the market survey within the three-month period under the revenue regulations then in force can in no way make the initial tax classification of Lucky Strike based on its suggested gross retail price permanent. Otherwise, this would contravene the clear mandate of the law which provides that the basis for the tax classification of a new brand shall be the current net retail price and not the suggested gross retail price. It is a basic principle of law that the State cannot be estopped by the mistakes of its agents. Last, the issue of timeliness of the market survey was never raised before the trial court because petitioner s theory of the case was wholly anchored on the alleged unconstitutionality of the classification freeze provision. As a consequence, no documentary evidence as to the actual net retail price of Lucky Strike in 2001, based on a market survey at least comparable to the one mandated by law, was presented before the trial court. Evidently, it cannot be assumed that had the BIR conducted the market survey within three months from its product launch sometime in 2001, Lucky Strike would have been found to fall under the high-priced tax bracket and not the premium-priced tax bracket. To so hold would run roughshod over the State s right to due process. Verily, petitioner prosecuted its case before the trial court solely on the theory that the assailed law is unconstitutional instead of merely challenging the timeliness of the market survey. The rule is that a party is bound by the theory he adopts and by the cause of action he stands on. He cannot be

permitted after having lost thereon to repudiate his theory and cause of action, and thereafter, adopt another and seek to re-litigate the matter anew either in the same forum or on appeal.23 Having pursued one theory and lost thereon, petitioner may no longer pursue another inconsistent theory without thereby trifling with court processes and burdening the courts with endless litigation. WHEREFORE, the motion for reconsideration is DENIED. SO ORDERED. CONSUELO YNARES-SANTIAGO Associate Justice WE CONCUR: REYNATO S. PUNO Chief Justice LEONARDO A. QUISUMBING Associate Justice MA. ALICIA AUSTRIA-MARTINEZ Associate Justice CONCHITA CARPIO MORALES Associate Justice MINITA V. CHICO-NAZARIO Associate Justice ANTONIO EDUARDO B. NACHURA Associate Justice ARTURO D. BRION Associate Justice ANTONIO T. CARPIO Associate Justice RENATO C. CORONA Associate Justice DANTE O. TINGA Associate Justice PRESBITERO J. VELASCO, JR. Associate Justice TERESITA J. LEONARDO-DE CASTRO Associate Justice DIOSDADO M. PERALTA Associate Justice

LUCAS P. BERSAMIN Associate Justice CERTIFICATION Pursuant to Section 13, Article VIII of the Constitution, it is hereby certified that the conclusions in the above Resolution were reached in consultation before the case was assigned to the writer of the opinion of the Court.

REYNATO S. PUNO Chief Justice Footnotes 1 The State shall regulate or prohibit monopolies when the public interest so requires. No combinations in restraint of trade or unfair competition shall be allowed. 2 G.R. No. L-23794, February 17, 1968, 22 SCRA 603. 3 Federal Communications Commission v. Beach Communications, Inc., 508 U.S. 307, 313 (1993). 4 34 Phil. 969, 976-977 (1916). 5 Id. at 976. 6 Id. 7 Bernas, The 1987 Constitution of the Republic of the Philippines: A Commentary (2003), p. 777. 8 Id. 9 G.R. No. 109289, October 3, 1994, 237 SCRA 324. 10 Id. at 331. 11 Supra note 3. 12 346 Phil. 321 (1997). 13 Natalia v. Court of Appeals, G.R. No. 116216, June 20, 1997, 274 SCRA 527, 538-539. 14 Supra note 12 at 368. 15 Id. 16 Id. at 369. 17 Q- In other words, Mr. Witness, you are also suggesting in your expert opinion that there is also a possibility that notwithstanding the change in the price of the particular cigarette product considering that cigarette smoking is habit forming, and considering also that that cigarette product won or satisfied the taste of the market, there is a tendency that notwithstanding the price, a particular consumer would still stick on the particular product? A- Yes, by your own word, you say that it is habit forming. So, it is loyalty to the brand. (Testimony of Dennis Belgira, TSN February 20, 2004, records, vol. II, pp. 679-680.) 18 Section 28(1). The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation.

G.R. No. 115455, August 25, 1994, 235 SCRA 630. Id. at 684-685. 21 Section 4. Classification and Manner of Taxation of Existing Brands, New Brands and Variant of Existing Brands. xxxx B. New Brand New brands shall be classified according to their current net retail price. In the meantime that the current net retail price has not yet been established, the suggested net retail price shall be used to determine the specific tax classification. Thereafter, a survey shall be conducted in 20 major supermarkets or retail outlets in Metro Manila (for brands of cigarette marketed nationally) or in five (5) major supermarkets or retail outlets in the region (for brands which are marketed only outside Metro Manila) at which the cigarette is sold on retail in reams/carton, three (3) months after the initial removal of the new brand to determine the actual net retail price excluding the excise tax and value added tax which shall then be the basis in determining the specific tax classification. In case the current net retail price is higher than the suggested net retail price, the former shall prevail. Otherwise, the suggested net retail price shall prevail. Any difference in the specific tax due shall be assessed and collected inclusive of increments as provided for by the National Internal Revenue Code, as amended. The survey contemplated herein to establish the current net retail price on locally manufactured and imported cigarettes shall be conducted by the duly authorized representatives of the Commissioner of Internal Revenue together with a representative of the Regional Director from each Regional Office having jurisdiction over the retail outlet within the Region being surveyed, and who shall submit, without delay, their consolidated written report to the Commissioner of Internal Revenue. 22 Records, vol. 1, p. 66. 23 Bashier v. Commission on Elections, G.R. No. L-33692, February 24, 1972, 43 SCRA 238, 266.
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Less: Personal and additional exemptions Republic of the Philippines SUPREME COURT Manila SECOND DIVISION G.R. No. 108067 January 20, 2000 CYANAMID PHILIPPINES, INC., petitioner, vs. THE COURT OF APPEALS, THE COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE,respondent. QUISUMBING, J.: Petitioner disputes the decision1 of the Court of Appeals which affirmed the decision2 of the Court of Tax Appeals, ordering petitioner to pay respondent Commissioner of Internal Revenue the amount of three million, seven hundred seventy-four thousand, eight hundred sixty seven pesos and fifty centavos (P3,774,867.50) as 25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987, under Sec. 25 of the National Internal Revenue Code.1wphi1.nt The Court of Tax Appeals made the following factual findings: Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished goods, and an importer/indentor. On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the payment of deficiency income tax of one hundred nineteen thousand eight hundred seventeen (P119,817.00) pesos for taxable year 1981, as follows: Net income disclosed by the return as audited Add: Discrepancies: Professional fees/yr. per investigation Total Adjustment Net income per Investigation 17018 261,877.00 110,399.37 152,477.00 14,727,687.00 14,575,210.00 Amount subject to tax 14,727,687.00

Income tax due thereon . . . 25% Surtax 2,385,231.50 3,237,495.00 Less: Amount already assessed BALANCE monthly interest from Compromise penalties TOTAL AMOUNT DUE 3,774,867.50 119,817.003 5,161,788.00 75,709.00 1,389,639.00 44,108.00

On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and 1981 Deficiency Percentage Assessment of P8,846.72.4 Petitioner, through its external accountant, Sycip, Gorres, Velayo & Co., claimed, among others, that the surtax for the undue accumulation of earnings was not proper because the said profits were retained to increase petitioner's working capital and it would be used for reasonable business needs of the company. Petitioner contended that it availed of the tax amnesty under Executive Order No. 41, hence enjoyed amnesty from civil and criminal prosecution granted by the law. On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the cancellation of the assessment notices and rendered its resolution, as follows: It appears that your client availed of Executive Order No. 41 under File No. 32A-F-000455-41B as certified and confirmed by our Tax Amnesty Implementation Office on October 6, 1987. In reply thereto, I have the honor to inform you that the availment of the tax amnesty under Executive Order No. 41, as amended is sufficient basis, in appropriate cases, for the cancellation of the assessment issued after August 21, 1986. (Revenue Memorandum Order No. 4-87) Said availment does not, therefore, result in cancellation of assessments issued before August 21, 1986. as in the instant case. In other words, the assessments in this case

issued on January 30, 1985 despite your client's availment of the tax amnesty under Executive Order No. 41, as amended still subsist. Such being the case, you are therefore, requested to urge your client to pay this Office the aforementioned deficiency income tax and surtax on undue accumulation of surplus in the respective amounts of P119,817.00 and P3,774,867.50 inclusive of interest thereon for the year 1981, within thirty (30) days from receipt hereof, otherwise this office will be constrained to enforce collection thereof thru summary remedies prescribed by law. This constitutes the final decision of this Office on this matter.5 Petitioner appealed to the Court of Tax Appeals. During the pendency of the case, however, both parties agreed to compromise the 1981 deficiency income tax assessment of P119,817.00. Petitioner paid a reduced amount twenty-six thousand, five hundred seventy-seven pesos (P26,577.00) as compromise settlement. However, the surtax on improperly accumulated profits remained unresolved. Petitioner claimed that CIR's assessment representing the 25% surtax on its accumulated earnings for the year 1981 had no legal basis for the following reasons: (a) petitioner accumulated its earnings and profits for reasonable business requirements to meet working capital needs and retirement of indebtedness; (b) petitioner is a wholly owned subsidiary of American Cyanamid Company, a corporation organized under the laws of the State of Maine, in the United States of America, whose shares of stock are listed and traded in New York Stock Exchange. This being the case, no individual shareholder income taxes by petitioner's accumulation of earnings and profits, instead of distribution of the same. In denying the petition, the Court of Tax Appeals made the following pronouncements: Petitioner contends that it did not declare dividends for the year 1981 in order to use the accumulated earnings as working capital reserve to meet its "reasonable business needs". The law permits a stock corporation to set aside a portion of its retained earnings for specified purposes (citing Section 43, paragraph 2 of the Corporation Code of the Philippines). In the case at bar, however, petitioner's purpose for accumulating its earnings does not fall within the ambit of any of these specified purposes. More compelling is the finding that there was no need for petitioner to set aside a portion of its retained earnings as working capital reserve as it claims since it had considerable liquid funds. A thorough review of petitioner's

financial statement (particularly the Balance Sheet, p. 127, BIR Records) reveals that the corporation had considerable liquid funds consisting of cash accounts receivable, inventory and even its sales for the period is adequate to meet the normal needs of the business. This can be determined by computing the current asset to liability ratio of the company: current ratio = current assets/ current liabilities = P 47,052,535.00 / P21,275,544.00 = 2.21: 1 ======== The significance of this ratio is to serve as a primary test of a company's solvency to meet current obligations from current assets as a going concern or a measure of adequacy of working capital. xxx xxx xxx We further reject petitioner's argument that "the accumulated earnings tax does not apply to a publicly-held corporation" citing American jurisprudence to support its position. The reference finds no application in the case at bar because under Section 25 of the NIRC as amended by Section 5 of P.D. No. 1379 [1739] (dated September 17, 1980), the exceptions to the accumulated earnings tax are expressly enumerated, to wit: Bank, non-bank financial intermediaries, corporations organized primarily, and authorized by the Central Bank of the Philippines to hold shares of stock of banks, insurance companies, or personal holding companies, whether domestic or foreign. The law on the matter is clear and specific. Hence, there is no need to resort to applicable cases decided by the American Federal Courts for guidance and enlightenment as to whether the provision of Section 25 of the NIRC should apply to petitioner. Equally clear and specific are the provisions of E.O. 41 particularly with respect to its effectivity and coverage . . . . . . Said availment does not result in cancellation of assessments issued before August 21, 1986 as petitioner seeks to do in the case at bar. Therefore, the assessments in this case, issued on January 30, 1985 despite petitioner's availment of the tax amnesty under E.O. 41 as amended, still subsist. xxx xxx xxx WHEREFORE, petitioner Cyanamid Philippines, Inc., is ordered to pay respondent Commissioner of Internal Revenue the sum of P3,774,867.50

representing 25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987.6 Petitioner appealed the Court of Tax Appeal's decision to the Court of Appeals. Affirming the CTA decision, the appellate court said: In reviewing the instant petition and the arguments raised herein, We find no compelling reason to reverse the findings of the respondent Court. The respondent Court's decision is supported by evidence, such as petitioner corporation's financial statement and balance sheets (p. 127, BIR Records). On the other hand the petitioner corporation could only come up with an alternative formula lifted from a decision rendered by a foreign court (Bardahl Mfg. Corp. vs. Commissioner, 24 T.C.M. [CCH] 1030). Applying said formula to its particular financial position, the petitioner corporation attempts to justify its accumulated surplus earnings. To Our mind, the petitioner corporation's alternative formula cannot overturn the persuasive findings and conclusion of the respondent Court based, as it is, on the applicable laws and jurisprudence, as well as standards in the computation of taxes and penalties practiced in this jurisdiction. WHEREFORE, in view of the foregoing, the instant petition is hereby DISMISSED and the decision of the Court of Tax Appeals dated August 6, 1992 in C.T.A. Case No. 4250 is AFFIRMED in toto.7 Hence, petitioner now comes before us and assigns as sole issue: WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE PETITIONER IS LIABLE FOR THE ACCUMULATED EARNINGS TAX FOR THE YEAR 1981.8 Sec. 259 of the old National Internal Revenue Code of 1977 states: Sec. 25. Additional tax on corporation improperly accumulating profits or surplus (a) Imposition of tax. If any corporation is formed or availed of for the purpose of preventing the imposition of the tax upon its shareholders or members or the shareholders or members of another corporation, through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there is levied and assessed against such corporation, for each taxable year, a tax equal to twenty-five per-centum of the undistributed portion of its accumulated profits or surplus which shall be in addition to the tax imposed by section twenty-four, and shall be computed,

collected and paid in the same manner and subject to the same provisions of law, including penalties, as that tax. (b) Prima facie evidence. The fact that any corporation is mere holding company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members. Similar presumption will lie in the case of an investment company where at any time during the taxable year more than fifty per centum in value of its outstanding stock is owned, directly or indirectly, by one person. (c) Evidence determinative of purpose. The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by clear preponderance of evidence, shall prove the contrary. (d) Exception. The provisions of this sections shall not apply to banks, nonbank financial intermediaries, corporation organized primarily, and authorized by the Central Bank of the Philippines to hold shares of stock of banks, insurance companies, whether domestic or foreign. The provision discouraged tax avoidance through corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings by shareholders could, in turn, be taxed. Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned company.10 Specifically, petitioner cites Golconda Mining Corp. vs. Commissioner, 507 F.2d 594, whereby the U.S. Ninth Circuit Court of Appeals had taken the position that the accumulated earnings tax could only apply to a closely held corporation. A review of American taxation history on accumulated earnings tax will show that the application of the accumulated earnings tax to publicly held corporations has been problematic. Initially, the Tax Court and the Court of Claims held that the accumulated earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of Appeals ruled in Golconda that the accumulated earnings tax could only apply to closely held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax could be imposed on widely held corporations including

those not controlled by a few shareholders or groups of shareholders. The Service indicated it would not follow the Ninth Circuit regarding publicly held corporations.11 In 1984, American legislation nullified the Ninth Circuit's Golconda ruling and made it clear that the accumulated earnings tax is not limited to closely held corporations.12 Clearly, Golconda is no longer a reliable precedent. The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739, enumerated the corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily and authorized by the Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall among those exempt classes. Besides, the rule on enumeration is that the express mention of one person, thing, act, or consequence is construed to exclude all others.13 Laws granting exemption from tax are construed strictissimi juris against the taxpayer and liberally in favor of the taxing power.14 Taxation is the rule and exemption is the exception.15 The burden of proof rests upon the party claiming exemption to prove that it is, in fact, covered by the exemption so claimed,16 a burden which petitioner here has failed to discharge. Another point raised by the petitioner in objecting to the assessment, is that increase of working capital by a corporation justifies accumulating income. Petitioner asserts that respondent court erred in concluding that Cyanamid need not infuse additional working capital reserve because it had considerable liquid funds based on the 2.21:1 ratio of current assets to current liabilities. Petitioner relies on the so-called "Bardahl" formula, which allowed retention, as working capital reserve, sufficient amounts of liquid assets to carry the company through one operating cycle. The "Bardahl"17 formula was developed to measure corporate liquidity. The formula requires an examination of whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and any extraordinary expenses reasonably anticipated, plus enough to operate the business during one operating cycle. Operating cycle is the period of time it takes to convert cash into raw materials, raw materials into inventory, and inventory into sales, including the time it takes to collect payment for the sales.18 Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts that Cyanamid had a working capital deficit of P7,986,633.00.19 Therefore, the P9,540,926.00 accumulated income as of 1981 may

be validly accumulated to increase the petitioner's working capital for the succeeding year. We note, however, that the companies where the "Bardahl" formula was applied, had operating cycles much shorter than that of petitioner. In Atlas Tool Co., Inc, vs. CIR,20 the company's operating cycle was only 3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi vs. United States,21 the corporation's operating cycle was only 56.87 days, or 15.58% of the year. In the case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the operating costs of the business. There are variations in the application of the "Bardahl" formula, such as average operating cycle or peak operating cycle. In times when there is no recurrence of a business cycle, the working capital needs cannot be predicted with accuracy. As stressed by American authorities, although the "Bardahl" formula is well-established and routinely applied by the courts, it is not a precise rule. It is used only for administrative convenience.22 Petitioner's application of the "Bardahl" formula merely creates a false illusion of exactitude. Other formulas are also used, e.g. the ratio of current assets to current liabilities and the adoption of the industry standard.23 The ratio of current assets to current liabilities is used to determine the sufficiency of working capital. Ideally, the working capital should equal the current liabilities and there must be 2 units of current assets for every unit of current liability, hence the so-called "2 to 1" rule.24 As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said working capital was expected to increase further when more funds were generated from the succeeding year's sales. Available income covered expenses or indebtedness for that year, and there appeared no reason to expect an impending "working capital deficit" which could have necessitated an increase in working capital, as rationalized by petitioner. In Basilan Estates, Inc. vs. Commissioner of Internal Revenue,25 we held that: . . . [T]here is no need to have such a large amount at the beginning of the following year because during the year, current assets are converted into cash and with the income realized from the business as the year goes, these expenses may well be taken care of. [citation omitted]. Thus, it is erroneous to say that the taxpayer is entitled to retain enough liquid net assets in amounts approximately equal to current operating needs for the year to cover "cost of goods sold and operating expenses:" for "it excludes proper

consideration of funds generated by the collection of notes receivable as trade accounts during the course of the year."26 If the CIR determined that the corporation avoided the tax on shareholders by permitting earnings or profits to accumulate, and the taxpayer contested such a determination, the burden of proving the determination wrong, together with the corresponding burden of first going forward with evidence, is on the taxpayer. This applies even if the corporation is not a mere holding or investment company and does not have an unreasonable accumulation of earnings or profits.27 In order to determine whether profits are accumulated for the reasonable needs to avoid the surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifest at the time of accumulation, not intentions declared subsequently, which are mere afterthoughts.28 Furthermore, the accumulated profits must be used within a reasonable time after the close of the taxable year. In the instant case, petitioner did not establish, by clear and convincing evidence, that such accumulation of profit was for the immediate needs of the business. In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue,29 we ruled: To determine the "reasonable needs" of the business in order to justify an accumulation of earnings, the Courts of the United States have invented the so-called "Immediacy Test" which construed the words "reasonable needs of the business" to mean the immediate needs of the business, and it was generally held that if the corporation did not prove an immediate need for the accumulation of the earnings and profits, the accumulation was not for the reasonable needs of the business, and the penalty tax would apply. (Mertens. Law of Federal Income Taxation, Vol. 7, Chapter 39, p, 103).30 In the present case, the Tax Court opted to determine the working capital sufficiency by using the ratio between current assets to current liabilities. The working capital needs of a business depend upon nature of the business, its credit policies, the amount of inventories, the rate of the turnover, the amount of accounts receivable, the collection rate, the availability of credit to the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to impress the tax court with the required definiteness envisioned by the statute. We agree with the tax court that the burden of proof to establish that the profits accumulated were not beyond the reasonable needs of the company, remained on the taxpayer. This Court will not set aside lightly the conclusion reached by the Court of Tax Appeals which, by the very nature of its function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an expertise on the subject, unless there

has been an abuse or improvident exercise of authority.31 Unless rebutted, all presumptions generally are indulged in favor of the correctness of the CIR's assessment against the taxpayer. With petitioner's failure to prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold the correctness of tax court's ruling as affirmed by the Court of Appeals. WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals, sustaining that of the Court of Tax Appeals, is hereby AFFIRMED. Costs against petitioner.1wphi1.nt SO ORDERED. Bellosillo, Mendoza, Buena and De Leon, Jr., JJ., concur. Footnotes 1 Rollo, pp. 25-34. 2 CA Rollo, pp. 19-28. 3 Records, CA Rollo, p. 24. 4 Id. at 25. 5 Id., at 27. 6 Id. at 24-28. 7 Rollo, p. 33. 8 Id. at 9. 9 The tax on improperly accumulated income tax underwent changes since the time of assessment of herein petitioner, in 1985, until the enactment of the present tax code, the 1997 NIRC. This provision was subsequently repealed by Executive Order No. 37 which took effect on January 1, 1986. The reason for the repeal was explained by the Commissioner of Internal Revenue through Revenue Memorandum Circular No. 26-86 as follows: "The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute corporate earnings so that the said earnings will be taxed to the shareholders. The exemption of dividends from income tax renders the improperly accumulated surplus tax meaningless. Accordingly, the provisions of the tax on improper accumulation or surplus are repealed and replaced with provisions to govern the taxation of foreign corporation which are lifted from Section 24 (b)." (Annotation, Improper Accumulation of Corporate Surplus or Profit by Severiano S. Tabios, 173 SCRA, pp. 403-408.) However, Section 29 of the New 1997 NIRC provides for the revival of the imposition of improperly accumulated earnings tax. The

exemption from this rule now includes publicly held corporation (par. B, 2, Section 29, 1997 NIRC). 10 A publicly owned corporation was one where the outstanding stock was owned by more than 1,500 persons and not more than 10% of either the total combined voting power, or, the total value of all classes of its outstanding stock was owned at the close of the taxable year, by any one individual, either directly or indirectly, under the provision for attribution of ownership. 11 10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.05. 12 Ibid. 13 Commissioner of Customs vs. Court of Tax Appeals, 224 SCRA 665, 669-670 (1993); Centeno vs. Villalon-Pornillos, 236 SCRA 197 (1994). 14 Commissioner of Internal Revenue vs. Mitsubishi Metal Corporation, 181 SCRA 214, 223-224 (1990). 15 Ibid. 16 Ibid. 17 Bardahl Manufacturing Corp. vs. Commissioner, 24 TCM 1030. 18 10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.133. 19 Rollo, p. 118. 20 614 F2d 860. 21 535 F 2d 1225. 22 10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.132. 23 Id. at Sec. 39.128. 24 19 Fletcher Cyclopedia Corporations, Chapter 68, Corporation Practice, Section 9248 (1975). 25 21 SCRA 17 (1967). 26 Id. at 27. 27 Nolledo and Nolledo, The National Internal Revenue Code of the Philippines, Annotated (1982) 28 Basilan Estates, Inc. vs. Commissioner of Internal Revenue, 21 SCRA 17, 26 (1967), citing Jacob Mertens, Jr., The Law of Federal Income Taxation, Vol. 7, Cumulative Supplement, p. 213. 29 127 SCRA 483 (1984).

Id. at 494. Commissioner of Internal Revenue vs. Court of Appeals, 271 SCRA 605, 608 (1997).
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